Edited version of your written advice

Authorisation Number: 1012746626375

Ruling

Subject: Majority underlying interest

Question

Is the Commissioner satisfied, or thinks it reasonable to assume, that the majority underlying interests in the assets held by X and Y did not change on, and by virtue of the vesting of the A, B, C and D Trusts, in the 1998 income year?

Answer: Yes

This ruling applies for the following period(s)

Year ended 30 June 1998

The scheme commences on

1 July 1997

Relevant facts and circumstances

X is a company.

Prior to 20 September 1985 the shareholders in X were as follows;

In the 1990's, E died and their shares passed to their A, B and C in equal shares;

As of the 1998 income year the shareholders in X were as follows;

The rights attaching to the shares in X are as follows;

a) Cumulative preference shares - the right:

i. To a fixed cumulative preferential dividend of 6% per annum on the capital paid up on such shares, in priority to any other shares;

ii. To repayment of capital on winding up or reduction of capital in priority to other shareholders but no further right to participate in profits or assets or otherwise;

iii. To vote at general meetings while the holder held the shares or was alive; and otherwise to vote on a winding up or reduction of capital or on a sale of the undertaking of the company or where the rights of the shareholders would be affected or dividends on the shares were in arrears for six months

b) Ordinary shares - all rights (dividends, voting and equity/surplus) subject to the rights of the cumulative preference shares. The rights to dividends and repayment of capital rank after the rights of the preference shareholders.

The A,B,C and D Trusts (the Four Trusts) were each established by E (as Settlor) for the primary benefit of A,B,C and D.

The Trust Deeds are in substantively identical terms. Consistent with the foregoing, the Default Beneficiary (as to both capital and income) of the Trusts (see Clause 1(i) of the respective Deeds) are as follows;

a) A Trust - A

b) B Trust - B

c) C Trust - C

d) D Trust - D

By virtue of their terms (notably the definition of 'vesting date' and the provisions of Clause 1(i)), each of the Four Trusts vested on in the 1998 income year, and the capital of each Trust vested in favour of the Default Beneficiary for each respective trust.

Available accounts for the Four Trusts acknowledge that the Trusts were established for the benefit of the four Default Beneficiaries respectively.

To the knowledge of the four Default Beneficiaries and consistent with the accounting records which are available, all distributions of income of the Four Trusts have been made to the named Default Beneficiary for that Trust. There have been no distributions of capital under each Trust.

No new beneficiaries have been added to the trust who are not members of the family of the existing beneficiaries.

X has at all times held pre-CGT shares in Y, a company.

The shares in Y are all ordinary shares, which have rights to dividends, voting and equity.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 149-30

Income Tax Assessment Act 1997 Section 149-35

Income Tax Assessment Act 1997 Section 149-15

Income Tax Assessment Act 1936 Section 160ZZS

Reasons for decision

Majority underlying interests

Subsections 149-30(1) and 149-30(1A) of the Income Tax Assessment Act 1997 (ITAA 1997) provide that an asset stops being a pre-capital gains tax (CGT) asset at the earliest time when majority underlying interests in the asset were not held by the ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. This applies to the asset as if the entity had acquired the asset at the earliest date when majority underlying interest changed.

In these cases, the asset is deemed to have a new date of acquisition (the date the majority underlying interest changed). Section 149-35 of the ITAA 1997 provides that the deemed first element acquisition costs for the purposes of determining the cost base (and reduced cost base), will be the market value of the asset at the time of change.

Majority underlying interests is defined in subsection 149-15(1) of the ITAA 1997 as more than 50% of:

(a) the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset and

(b) the beneficial interests that ultimate owners have (whether directly or indirectly) in any income that may be derived from the asset.

Accordingly, ultimate owners who held majority underlying interests in an asset just before 20 September 1985 must retain such interests after that date, otherwise Division 149 of the ITAA 1997 will be triggered to convert the asset into a post-CGT asset.

Subsection 149-30(2) of the ITAA 1997 provides that if the Commissioner is satisfied or thinks it reasonable to assume that at all times on and after 20 September 1985 and before a particular time majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day, subsections 149-30(1) and 149-30(1A) of the ITAA 1997 apply as if that were in fact the case. That is, subsection 149-30(2) of the ITAA 1997 provides scope for the Commissioner to simply be satisfied that there was continuity of majority underlying beneficial interests.

Subsections 149-30(3) and 149-30(4) of the ITAA 1997 provide that, if an ultimate owner (new owner) has acquired an interest in an asset because it was transferred to the new owner by way of a marriage breakdown rollover or because of the death of a person (former owner), the 'new owner' is treated as having held the underlying interest of the 'former owner' for the period the 'former owner' held them.

Discretionary trusts and majority underlying interests

Taxation Ruling IT 2340 discusses the terms underlying interest and majority underlying interest, and former section 160ZZS of the Income Tax Assessment Act 1936 (since replaced by section 149-30 of the ITAA 1997). Paragraph 2 of IT 2340, advocates a look through approach in relation to chains of companies, partnerships and trusts in order to determine whether there has been a change in the effective interests of natural persons in the assets.

Where shares in a company are held by the trustee of a discretionary trust, the shares are not beneficially owned by any persons. This creates difficulties when assessing whether the majority underlying beneficial interest in an asset is maintained. In this regard, paragraph 6 of IT 2340 requires the taxpayer to show that the trustee has administered the trust for the benefit of members of a particular family at all times during the relevant years of income. Furthermore, in accordance with paragraph 8 of IT 2340, the trustee must not have exercised discretionary powers to appoint beneficiaries or amend the trust deed that would result in a practical change of 50% or more underlying interests in the trust assets.

The issue of what constitutes 'one family' for the purposes of IT 2340 must be considered based on the facts of the particular cases. What is often described as an 'extended' family (that is, including grandparents, children, grandchildren and their spouses) would ordinarily qualify as a 'family' for these purposes. Further, if distributions are made to post-19 September 1985 additions to a family (for example, the birth of new family members and new persons joining a family through marriage), the 'family' distribution criteria would ordinarily be satisfied.

Application to your circumstances

X - majority underlying interest

Prior to 20 September 1985, approximately 99% of the cumulative preference shares in X were held by E and 1% held by D. Of the ordinary shares, 20% were held by F and the Four Trusts held 20% each. These holdings remained that same until 9 May 1996, on the death of E.

The Deeds of the Four Trusts provide that the income of the trust is to be paid to a range of family beneficiaries at the discretion of the trustee, however, if no discretion is made by the trustee for an income year, then the income is to be distributed to the default beneficiary. Information provided by you, explains that income was only ever distributed to the default beneficiary in each of the Four Trusts.

The Deeds of the Four Trusts provide that the capital of the trust is, on vesting, to be paid to a range of family beneficiaries at the discretion of the trustee, however, if no discretion is made by the trustee, then the capital is to be distributed to the default beneficiary. Capital may also be distributed, at the discretion of the trustee, during the lifetime of the trust for the maintenance, educating and advancement or benefit of any one or more of the beneficiaries of trust. Information provided by you, explains that no capital was distributed by any of the Four Trusts until vesting day.

On the death of E the shares they held in X passed to their children. Pursuant to subsections 149-30(3) and (4) of the ITAA 1997, the shares maintain their pre-CGT status in the hands of the children.

Accordingly, from prior to 20 September 1985 and up until the day before vesting date (in accordance with the Commissioner's practice noted in IT 2340), it is reasonable to assume that there has been no change in majority underlying interest of the shares held in X.

On vesting day, the Four Trusts vested, and all remaining income, and capital of the Four Trusts, was distributed to the default beneficiary of each respective Trust.

Accordingly, the shares once held by each of the Four Trusts were distributed to the default beneficiaries. Therefore rather than holding an indirect beneficial interest in the shares held by each respective trust, the default beneficiaries now each hold a 20% direct interest in X.

Importantly, each default beneficiary is part of a family group to which each of the Four Trusts were set up to provide for and, all income and capital of the Four Trusts has only been paid to the default beneficiary. In addition, there have been no additions of new beneficiaries to each of the respective trusts who are not members of the family of the existing beneficiaries.

Accordingly, the Commissioner finds it reasonable to assume that at all times on and after 20 September 1985 and before a particular time majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day.

Y - majority underlying interest

As there is considered to be no change in majority underlying interest for the shares held in X, it follows that as X holds 96% of the shares in Y and continues to hold 96% of those shares, the Commissioner considers it reasonable to assume that there has been no change in the majority underlying interests in Y.