Edited version of your written advice

Authorisation Number: 1012791164731

Ruling

Subject: Market valuation

Question 1

Is Company A an entity that is 'connected with' you for the purposes of subsection 328-125(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No

Question 2

Is $XX considered an acceptable market value for Company A, for the purposes of section 152-15 and 152-20 of the ITAA 1997?

Answer:

Yes

This ruling applies for the following period(s)

Year ended 30 June 2013

The scheme commences on

1 July 20XX

Relevant facts and circumstances

Company A was a start-up company established by A and their then spouse several years ago. B joined A later to assist in the development. It was agreed that B would be given an interest in Company A at some time in the future. This was not documented at the time, however when A separated from their spouse, B bought A's spouse's shares in Company A.

A continued as business manager, salesperson etc. and also had the casting vote on all decisions of the company.

Company A continued to grow due to the marketing and sales efforts of A. B's role did not involve any commercial aspects of the company. B did not have any signing authority on bank accounts, any power to appoint or dismiss staff or any contract or commercial interactions with customers.

Later, B moved towns and continued to work for Company A. They had no involvement with the day to day running of the company and was absent from management and directors meetings.

Both A and B sold an equal portion of their shareholding to other staff who held managerial roles in the company. This reduced both A and B's holdings to approximately X% each. A, retained control as chairperson (with the casting vote), public officer and managing director. A had exclusive rights to appoint other directors. Over the years A appointed several other directors including B.

All staff reported via line-management through to A.

A commenced negotiations with X for the sale of Company A in its entirety, after X made an unsolicited offer for the company. The negotiations were a long process where A appointed external advisors, sought customer approvals and had lengthy discussions with shareholders and staff. A final price was agreed and the sale proceeded in 20XX, with the condition that A and other management team members (excluding B) stay with the company. A remains as the CEO and is currently still a director. B is no longer associated with Company A.

As part of the sale agreement, a condition precedent to the settlement of the contract was for the minor shareholders to transfer their shares to A and B, prior to A and B transferring 100% to X. This condition was included within the contract to ensure ease of settlement.

A and B had effective ownership of approximately X% of the shares each, immediately prior to the contract.

X acquired 100% of the Company A shares for $XX.

A valuation of Company A states the market value of the company was $XX.

A critique of the valuation report of Company A states the market value of the company was $XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-20

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

An entity that is 'connected with' you

Subsection 328-125(1) of the ITAA 1997 explains that an entity is connected with another entity if:

a) either entity controls the other entity in a way described in this section; or

b) both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(2) of the ITAA 1997 provides that an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates, if the other entity is a company - beneficially owns, or has the right to acquire beneficial ownership of, equity interests in the company that give at least 40% of the voting power in the company.

Subsection 328-125(6) of the ITAA 1997 provides that if the control percentage referred to in subsection (2) is at least 40%, but less than 50%, the Commissioner may determine that the first entity does not control the other entity if the Commissioner thinks that the other entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates.

This could occur in a small business context where there are 2 shareholders and the shareholder with a marginal controlling interest is the only active participant. The Commissioner's determination can be based on fact or on a reasonable assumption or inference. Whether or not the third party has a controlling interest (ie 40% or more) is a relevant - but not decisive - consideration.

Application to your circumstances

Based on the information provided, the Commissioner finds it reasonable to assume that A was the controlling entity of Company A.

Accordingly, Company A would not be an entity that is 'connected with' B for the purposes of subsection 328-125(2) of the ITAA 1997.

Maximum net asset value (MNAV) test

Section 152-15 of the ITAA 1997 explains that you satisfy the MNAV test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities connected with you;

(c) the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

Subsection 152-20(1) of the ITAA 1997 provides that the 'net value of the CGT assets' of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

(a) the liabilities of the entity that are related to the assets; and

(b) the following provisions made by the entity:

i. provisions for annual leave;

ii. provisions for long service leave;

iii. provisions for unearned income;

iv. provisions for tax liabilities.

Market Value

The current tax law does not define market value in any general provision. It is defined in the 'Definitions' part (section 995-1 of the ITAA 1997), but not in a way that fixes its meaning in all contexts. As a result, 'market value' usually takes the ordinary meanings given below, unless specially defined or qualified in a particular provision.

Valuers of real property adopt the definition used by the International Valuation Standards Council (IVSC):

... the estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in an arm's length transaction, after proper marketing, wherein the parties had each acted knowledgeably, prudently and without compulsion.

Business valuers in Australia typically define market value as:

…the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length.

The High Court cast light on the ordinary meaning of 'market value' in Spencer v The Commonwealth of Australia (1907) 5 CLR 418. In this case, the Commonwealth had compulsorily acquired land for a fort at North Fremantle in Western Australia.

In discussing the concept of market value, Griffith CJ commented (page 432) that:

… the test of value of land is to be determined, not by inquiring what price a man desiring to sell could have obtained for it on a given day, i.e. whether there was, in fact, on that day a willing buyer, but by inquiring: What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?

Isaacs J subsequently expanded on the concept (page 441):

… to arrive at the value of the land at that date, we have … to suppose it sold then, not by means of a forced sale, but by voluntary bargaining between the plaintiff and a purchaser willing to trade, but neither of them so anxious to do so that he would overlook any ordinary business consideration. We must further suppose both to be perfectly acquainted with the land and cognisant of all circumstances which might affect its value, either advantageously or prejudicially, including its situation, character, quality, proximity to conveniences or inconveniences, its surrounding features, the then present demand for land, and the likelihood as then appearing to persons best capable of forming an opinion, of a rise or fall for what reasons so ever in the amount which one would otherwise be willing to fix as to the value of the property.

In this case, the High Court recognised the principles of:

• the willing but not anxious vendor and purchaser

• a hypothetical market

• the parties being fully informed of the advantages and disadvantages associated with the asset being valued (in the specific case, land), and

• both parties being aware of current market conditions.

Application to you circumstances

We generally use valuers to confirm whether the market value is acceptable. They usually review the valuation process to see if it complies with accepted valuation industry practice. Broadly, the review involves looking at:

• how adequately you documented your process

• which market value definition you used

• how appropriate your method was, and

• what assumptions and information you relied on.

At the conclusion of the review, the valuers provide us with a report on the valuation which may include an estimate of the market value (or likely range) of the asset or assets, based on data available to them at that time.

You have provided a valuation of Company A valuing the company at $XX.

A critique of the valuation report values Company A at $XX.

Based on the information provided by you, and the critique of the valuation report in relation to the valuation of Company A, we consider that the market valuation of $XX is reasonable.

Accordingly, it is considered that $XX is an acceptable market value of Company A for the purposes of section 152-15 and 152-20 of the ITAA 1997.