Edited version of your written advice

Authorisation Number: 1012685144329

Ruling

Subject: Possible application of subsection 6-5(3) and Division 855 of the Income Tax Assessment Act 1997 and Part IVA of the Income Tax Assessment Act 1936.

Question 1

Is the gain made by Foreign Co on the disposal of its shares in an Australian resident entity an amount in the nature of income that is included in Foreign Co's assessable income in accordance with section 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is Foreign Co entitled to disregard the capital gain that it made on the disposal of its shares in the Australian resident entity as the shares in the Australian resident entity are not taxable Australian property within the meaning of section 855-15 of the ITAA 1997?

Answer

Yes.

Question 3

Will the Commissioner make a determination pursuant to Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) to cancel the whole or part of any tax benefit obtained under section 177C of the ITAA 1936, or that would but for section 177F be obtained, in connection with the transaction in which Foreign Co made a disregarded capital gain upon the disposal of its shares in the Australian resident entity?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2013

Relevant facts and circumstances

1) Foreign Co held shares in an Australian resident company, which it has disposed of.

2) Foreign Co is a non-resident of Australia for income tax purposes.

3) Foreign Co does not buy or sell shares as part of its ordinary business activities.

4) Calculation of principal asset test was provided.

5) Foreign Co did not pass the principal asset test as non-taxable Australian real property (TARP) assets were greater than TARP assets.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177CB

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1997 subsection 6-5(3)

Income Tax Assessment Act 1997 section 855-15

Income Tax Assessment Act 1997 section 855-30

Income Tax Assessment Act 1997 subsection 855-30(5)

Reasons for decision

Question 1

Subsection 6-5(3) of the ITAA 1997 states:

6-5(3) If you are a foreign resident, your assessable income includes:

(a) The *ordinary income you *derived directly or indirectly from all *Australian sources during the income year; and

(b) Other *ordinary income that a provision includes in your assessable income for the income year on some basis other than having an *Australian source.

In this case Taxation Determination TD 2010/21 and Taxation Determination TD 2011/24 were considered. It was determined as Foreign Co is not in the business of buying and selling shares the gain received from the sale of the shares in the Australian resident entity could not be considered as ordinary income of Foreign Co. Hence subsection 6-5(3) of the ITAA 1997 will not apply.

Question 2

Section 855-15 of the ITAA 1997 provides 5 categories of CGT assets that are taxable Australian property. The only relevant category in this instance is category 2.

Category 2 states:

A *CGT asset that:

(a) Is an *indirect Australian real property interest (see section 855-25); and

(b) Is not covered by item 5 of this table

Note: in this case (b) is not relevant as it relates to choosing to disregard a gain or loss on ceasing to be an Australian resident.

To determine if an indirect Australian real property exists in this case the possible application of section 855-25 shall now be reviewed.

Subsection 855-25(1) of the ITAA 1997 defines indirect Australian real property interests as follows:

855-25(1) A *membership interest held by an entity (the holding entity) in another entity (the test entity) at a time is an indirect Australian real property interest at that time if:

(a) the interest passes the *non-portfolio interest test (see section 960-195):

(i) at that time; or

(ii) throughout a 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

(b) the interest passes the principal asset test in section 855-30 at that time.

Thus, subsection 855-25(1) of the ITAA 1997 requires that to be an indirect Australian real property interest the relevant membership interest must pass both the non-portfolio interest test (in section 960-165 of the ITAA 1997) and the principal asset test (in section 855-30 of the ITAA 1997) at the relevant time.

The non-portfolio interest test (referred to in paragraph 855-25(1)(a) of the ITAA 1997) is defined in section 960-195 of the ITAA 1997 as follows:

An interest held by an entity (the holding entity) in another entity (the test entity) passes the non-portfolio interest test at a time if the sum of the direct participation interests held by the holding entity and its associates in the test entity at that time is 10% or more.

Foreign Co passes the non-portfolio interest test as it held in excess of 10% of the ordinary shares in the Australian resident entity at the time of the CGT event, which in this case was the sale of the shares held in the Australian resident entity.

As Foreign Co has passed the non-portfolio interest test, the principal asset test shall now be applied.

The purpose of the principal asset test in section 855-30 of the ITAA 1997 is to define when an entity's underlying value is principally derived from Australian real property (subsection 855-30(1)).

Subsection 855-30(2) of the ITAA 1997 provides that a membership interest held by the holding entity in the test entity passes the principal asset test if the sum of the market values of the assets of the test entity that are taxable Australian real property (TARP) exceeds the sum of the market values of its assets that are non-TARP.

Subsection 855-30(3) of the ITAA 1997 provides that for the purposes of subsection (2), treat an asset of an entity (the first entity) that is a membership interest in another entity (the other entity) as if it were instead the following two assets:

(a) an asset that is taxable Australian real property (the TARP asset);

(b) an asset that is not taxable Australian real property (the non-TARP asset).

The market value of the TARP asset and the non-TARP asset are worked out according to the table in subsection 855-30(4). Relevantly, columns 3 and 4 of item 2 of that table refer to the market values of assets of the 'other entity'.

The applicant has provided a table where TARP v Non-TARP assets were calculated.

The table showed that non-TARP assets were greater than TARP assets.

Foreign Co does not pass the principal asset test as the non-TARP assets exceed the TARP assets. Hence, the capital gain made by Foreign Co on the disposal of its shares in the Australian resident entity may be disregarded as the shares in the Australian resident entity are not taxable Australian property within the meaning of section 855-15 of the ITAA 1997.

Question 3

On the facts of this case it is considered that Part IVA of the Income Tax Assessment Act 1936 does not apply.