Edited version of your written advice

Authorisation Number: 1012796270416

Ruling

Subject: CGT rollover & unpaid present entitlements

Issue 1

Question 1

Will the exchange of units in the Green Unit Trust held by White Nominees Pty Ltd for shares in Black Holdings Pty Ltd be eligible for the CGT rollover relief provided for in Division 615 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. As the scheme meets all the relevant conditions, the exchange of units for shares in Black Holdings Pty Ltd will be eligible for the CGT rollover relief under Division 615 of the ITAA 1997.

Issue 2

Question 1

Will the Commissioner apply section 100A of the Income Tax Assessment Act 1936 (ITAA 1936) to assess Green Corporation P/L under section 99A of the ITAA 1936 on that part of the net income of the Green Unit Trust for an income year to which Black Holdings P/L has become entitled but has not received payment?

Answer

No

Question 2

Will Division 7A of Part III (Division 7A) of the ITAA 1936 apply in respect of any unpaid present entitlements of Black Holdings P/L from the Green Unit Trust?

Answer

No

This ruling applies for the following period:

1 July 2014 to 30 June 2016

Relevant facts and circumstances

White Nominees P/L holds X of the X (i.e. 76%) ordinary units on issue in the Green Unit Trust ('GUT') and White Pty Ltd as trustee of the White Family Trust No 2 holds X units (i.e. 10%). They are collectively referred to as the White Interests. X units (14%) are held by non-resident individuals, referred to here as the Foreign Interests, who are not related to any of the beneficiaries of the White Interests. Foreign Individual A holds 4 units, Foreign Individual B holds 1 unit, Foreign Individual C holds 1 unit and Foreign Individual D holds X unit.

The present directors of Green Corporation P/L are Mr White, their X children and Foreign Individual A. While this means that although collectively the White Interests hold XX% of the units in GUT, they could be said to represent only 80% of the board of directors of Green Corporation P//L with Foreign Individual representing 20% of the board.

A copy of the Trust Deed governing the GUT shows that the GUT was established on dd/mm/yyyy (i.e. pre CGT) with White Nominees P/L then owning X units (i.e. 52%) with X units (i.e. 24%) held by the trustee of a trust known as the Red Family Trust and a further X units (i.e. 24%) being initially held by Foreign Individual E. Variations to the trust deed were made on dd/mm/yyyy and dd/mm/yyyy.

The variation amends the unit holders approvals or directions made at unit holders meetings by reducing the 'approval percentage' from 80% to 75% (clause 25(2)). The variation also amends clauses 21(1) and 21(3) which deal with the retirement of the Trustee at the special direction of the unitholders.

In December 19XX White Nominees P/L purchased a further XX units (i.e. 24%) from the Red Family Trust.

In 200X White P/L purchased X units (i.e. 8%) from the Foreign Interests and a further 1 unit (i.e. 2%) from the Foreign Interests in 200X.

The terms of the Trust Deed governing the GUT empowers Green Corporation P/L to distribute the whole or part of the income of the GUT for an accounting period to one or more "relatives" of the unit holders (see clause 10(1) of the Trust Deed). Although this power, which requires the unanimous consent of all the unit holders, has never been exercised, it was thought that this feature might lead the Commissioner to form the view that the GUT was not a unit trust and consequently the CGT rollover relief provided for in Subdivision 124-H of the ITAA 1997 would not be available to White Nominees P/L, White P/L and the Foreign Interests on transferring their respective units in the GUT to Black Holdings P/L.

The trustee proposes to execute an amendment to the trust deed, pursuant to a power of amendment contained in the deed, to remove the following words in the existing clause 10 - 'for such of the Unitholders and their relatives (as defined in s 6 of the Income Tax Assessment Act 1936) as the Trustees shall, prior to the last day of that Accounting Period, determine in writing with the unanimous consent in writing of the Unitholders; and in the absence of any such determination they shall hold the said income in trust'.

Green Corporation P/L, White Nominees P/L, White P/L and the Foreign Interests will be executing a Supplemental Deed further varying the terms of the Trust Deed governing the GUT to delete that part of Clause 10(1) which had empowered Green Corporation P/L to make a distribution to relatives of unit holders (provided it obtained the unanimous consent of those unit holders).

There is an agreement between the White Interests and the Foreign Interests to restructure the ownership of Green Unit Trust. This will involve all of the units in the Green Unit Trust being transferred to Black Holdings P/L (a newly formed private company) in exchange for shares in that company. Once the agreed transactions are effected, Black Holdings P/L will be the sole unit holder in the Green Unit Trust and the shareholders of Black Holdings P/L will be White Nominees P/L, White P/L, Foreign Individual A, Foreign Individual B, Foreign Individual C and Foreign Individual D. These shareholdings will be in the same proportions to their current unit holdings in the Green Unit Trust.

Black Holdings P/L has been incorporated with a $1 redeemable subscriber share being issued to White Nominees P/L. This share will be redeemed for $1 when:

1) White Nominees P/L transfers its 26 pre-CGT units in the GUT to Black Holdings P/L in exchange for the issue by Black Holdings P/L of X of what are to be called OW Class Ordinary Shares which are to be credited as having been issued at $0.01 each or $X in total. The "OW" in the description of the ordinary shares is simply to identify them as having been issued to White Nominees P/L in exchange for the "Original White" units in GUT.

2) White Nominees P/L transfers its post-CGT shares in the GUT to Black Holdings P/L in exchange for the issue by Black Holdings P/L of X of what are to be called NW Class Ordinary Shares (as in "New White") which are to be credited as having been issued at $X each or $X in total (i.e. being the amount which White Nominees P/L paid the Red Family Trust for the X units in the GUT it purchased from the Red Family Trust in December 19XX).

3) Foreign Individual A transfers their pre-CGT units in the GUT to Black Holdings P/L in exchange for the issue by Black Holdings P/L of X of what are to be called FIA Class Ordinary Shares which are to be credited as having been issued to him at $0.01 each (i.e. $X in total). The "FIA" simply identifies these shares as being issued in exchange for Foreign Individual A's units in the GUT.

4) Foreign Individual B, who holds 1 unit in the GUT, will exchange that unit for X of what are to be called FIB Class Ordinary Shares in Black Holdings P/L for an issue price of $0.01 each (or $1 in total).

5) The same will happen in the case of Foreign Individual C, who also holds 1 unit in the GUT, which they will exchange for X FIC Class Ordinary Shares in Black Holdings P/L which will be issued to their at $0.01 each ($1 in total).

6) Foreign Individual D will exchange her 1 unit in the GUT for Xof what are to be called FID Class Ordinary Shares which will be issued to her for $0.01 each ($1 in total).

7) As White P/L acquired X units in the GUT in March 200X and another 1 unit on 1 July 200X from the Foreign Interests, it will be exchanging those 5 units for X of what are to be called OW Class Ordinary Shares (the "OW" being shorthand for Original White) for $X each (i.e. $X in total), being what White P/L paid the Foreign Interests for those X units.

While clause 6(1) of the Trust Deed provides that Green Corporation P/L, as trustee of the GUT, can decide to effect a transfer of units verbally, it is proposed to effect these transfers in writing in accordance with clause 6(3) of the Trust Deed.

Despite their different class initials, all of the shares to be issued by Black Holdings P/L will be ordinary class shares with there being no other shares on issue. The result will be that Black Holdings P/L will own all of the units in the GUT and the former unit holders in GUT will own all of the ordinary shares in Black Holdings P/L in the same proportions which they had previously held their units in the GUT. All the shares in Black Holdings P/L will carry exactly the same rights as to voting powers and rights to the income /capital of the company.

The issue of X ordinary shares in Black Holdings P/L in exchange for each 1 unit in the GUT will accommodate the sale of a smaller share of interests - as little as 0.0X% of shares on issue. Presently each unit represents X% of the units on issue and consequently it is not possible for any of the unit holders to sell anything less than X% of the units on issue. However, by having X shares in Black Holdings P/L issued in exchange for every unit in the GUT it will be possible for each of the shareholders to dispose of what could be as small as only a 0.02% parcel of the total shares on issue.

There are unpaid present entitlements (UPE) owing to the existing unit holders.

After the restructure, the income of GUT will be allowed to be set aside for Black Holdings P/L as sole unitholder under clause 10.1 each year. It is not intended that the trustee will utilise the power in clause 10.2 to retain any income in each year. However, it is expected that the working capital requirements of GUT to be such that Black Holdings P/L will have to wait sometime before GUT will be able to pay some or all of Black Holdings P/L's entitlement. Further, it is planned that as and when surplus funds do become available, these will be used to pay the UPEs currently owing to the existing unitholders ahead of payments to Black Holdings P/L.

No formal loan agreements will be entered into between Black Holdings P/L and Green Unit Trust in respect of the UPEs. No interest will be payable on amounts not paid.

The UPEs will remain intermingled with other funds of the trust.

While clause 10 of the Trust Deed provides that the unit holders in the unit trust are entitled to the income or profit from the unit trust based on their respective unit holdings, distributions have been retained to meet working capital requirements of the business and to be made when surplus funds are available.

The proposed restructure will not affect the existing entitlements which may be owing to the present unit holders at the date they exchange their units for shares in Black Holdings P/L as those entitlements at that date, if any, would have already been vested in those unit holders and what they will be exchanging will only be their units in the GUT for shares in Black Holdings P/L and so would not have any impact on any of their pre-existing rights to income entitlements predating the change in unit holdings.

The proposed restructure will not have any impact on the operation of the business by Green Corporation P/L as trustee of the GUT and at year end what will be Black Holdings P/L as the only unit holder in the GUT will be entitled to all of the income of the GUT for that year (the first year ending on 30 June 2015). Green Corporation P/L, as trustee of the GUT, may, with the consent of Black Holdings P/L, resolve to accumulate some or all of the income of the GUT for future distributions.

The working capital obligations associated with the business are likely to continue to be such that Black Holdings P/L may have to wait some time until the financial position of the GUT is such as to be able to pay some or all of its entitlements to Black Holdings P/L.

Green Corporation P/L proposes to pay out any existing entitlements owing to existing unit holders as at the date they exchange their units for shares in Black Holdings P/L in proportion to their unit holdings as soon as excess funds become available, ahead of any payments to Black Holdings P/L in respect of what will be its first income entitlement which will arise on 30 June 2015. It will not use excess funds for anything other than making distributions to satisfy UPEs or for working capital requirements of its business. For example, it will not make loans, even on commercial terms, to anyone who would be regarded as an "associate" (as that word is very broadly defined in section 318 of the ITAA 1936).

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 104-10

Subdivision 124-A

Division 615

Section 615-5

Section 615-15

Section 615-20

Section 615-25

Section 615-30

Section 615-65

Subsection 960-130(1)

Section 995-1

Income Tax Assessment Act 1936

Division 6

Section 99A

Section 100A

Subsection 100A(1)

Subsection 100A(7)

Subsection 100A(8)

Subsection 100A(13)

Division 7A

Reasons for decision

Issue 1 Question 1

Detailed reasoning

The availability of roll-over relief under Division 615 of the ITAA 1997 enables a unitholder of a unit trust to disregard a capital gain or capital loss from a unit that is disposed of as part of a reorganisation of the affairs of the unit trust where the unitholder becomes the owner of new shares in a company.

The roll-over provisions in Division 615 of the ITAA 1997 relating to an exchange of units in a unit trust for shares in a company contain a number of conditions for eligibility to choose roll-over relief. The main conditions in relation to a disposal case that are relevant to the scheme are:

• there must be more than one entity that owns all the units in the unit trust;

• there must be a scheme for reorganising the trust's affairs and consideration on disposal of the units consists of shares in the company and nothing else;

• all unitholders must dispose of their units in exchange for shares in the company;

• the company must own all the units in the unit trust just after all the exchanging members have disposed of their units in the unit trust (the completion time);

• just after the completion time, each unitholder must own a whole number of shares in the company;

• just after the completion time, each unitholder must own a percentage of the shares in the company that were issued to all unitholders that is equal to the percentage of the units in the unit trust that the unitholder owned;

• just after the completion time, the unitholders must own all the shares in the company;

• the ratio test in subsection 615-20(2) of the ITAA 1997 is met

• the unit trust must be an Australian resident at the time the units are exchanged for shares

• the unitholders must be Australian residents, or if they are foreign residents the units and shares must be taxable Australian property

• the shares issued in the company must not be redeemable shares; and

• the company must make the choice that the rules in section 615-65 of the ITAA 1997 will apply;

As the scheme is a 'disposal case', the requirements in sections 615-5, 615-15 and 615-20 of the ITAA 1997 must be met. The first requirement is that the entity seeking the rollover relief must be a 'member' of a unit trust. It is accepted that White Nominees P/L is a 'member' of the GUT as defined in subsection 960-130(1) of the ITAA 1997.

Paragraph 615-5(1)b) of the ITAA 1997 requires that here be more than one entity that holds units in the unit trust (the 'exchanging members'). In this instance, White Nominees P/L, White P/L and the Foreign Interests, who, between them, hold all of the units in GUT, will be the 'exchanging members'.

Paragraph 615-5(1)(c) of the ITAA 1997 stipulates that the rollover must be under a scheme for reorganising the affairs of the trust and that under the scheme the exchanging members only receive shares in a company as consideration for the disposal of their units. Paragraph 26 of Taxation Ruling TR 97/18 refers to a "scheme for the reorganisation of the affairs of a unit trust" and interprets this phrase as meaning the "interposition of a company between the unit trust and its unit holders". In this case a new company, Black Holdings P/L, will be interposed between the GUT and its unit holders. The unit holders will only receive shares in the company (and nothing else) as consideration for the disposal of their units in the GUT.

Section 615-15 of the ITAA 1997 states that the company must own all the units in the unit trust just after all the exchanging members have disposed of their units in the unit trust (the completion time). In this case, Black Holdings P/L (the company), will own all of the units in the GUT at the completion time.

The next condition to be satisfied is that just after the completion time each unit holder must own a whole number of shares in the company and each unit holder must own a percentage of the shares in the company that were issued to all unit holders that is equal to the percentage of the units in the unit trust that the unit holder owned (subsection 615-20(1) of the ITAA 1997). Currently the units in the GUT are held by White Nominees P/L (X units), White P/L (X units) and the Foreign Interests (X units). After the rollover White Nominees P/L will own X shares, White P/L will own X shares and the Foreign Interests will own X shares. The shareholding percentage of each entity will equal the percentage of units previously held by each entity in the GUT.

In addition the market value of the each exchanging member's shares in the company compared to the value of all shares will equal the ratio of the market value units held in the unit trust compared to the market value of all the units that were disposed of (subsection 615-20(2) of the ITAA 1997. This condition is met because Black Holdings P/L only asset will be the units in GUT.

At the time of the disposal of the units White Nominees P/L will continue to be an Australian resident entity. Therefore the condition in subsection 615-20(3) of the ITAA 1997 will be satisfied.

A further condition for rollover relief is that the shares issued in the company must not be "redeemable shares" (as defined in section 995-1 of the ITAA 1997) and that the exchanging members must own all of the shares in the company (subsections 615-25(1), 615-25(2) and 615-25(3) of the ITAA 1997). In this instance all of the shares to be issued by Black Holdings P/L will be ordinary shares and will all be owned by the exchanging members (i.e. White Nominees P/L, White P/L and the Foreign Interests).

Black Holdings P/L will be making a choice under Section 615-30 of the ITAA 1997 that the rules contained in section 615-65 of the ITAA 1997 will apply to it and it will make the choice within 2 months of the completion time.

Conclusion

As all the relevant conditions will be satisfied, the exchange of units held in the GUT by White Nominees P/L for shares in Black Holdings P/L will qualify for the CGT rollover relief provided for in Division 615 of the ITAA 1997.

Issue 2 Question 1

Detailed reasoning

Present entitlement

Prior to considering the application of section 100A of the ITAA 1936, it is necessary to determine whether Black Holdings P/L would be presently entitled to a share of the trust income under the proposed arrangement.

In Harmer and Others v Commissioner of Taxation [1991] 173 CLR 264, the court concluded in its joint judgement that:

The parties are agreed that the cases (17) establish that a beneficiary is "presently entitled" to a share of the income of a trust estate if, but only if: (a) the beneficiary has an interest in the income which is both vested in interest and vested in possession; and (b) the beneficiary has a present legal right to demand and receive payment of income, whether or not the precise entitlement can be ascertained before the end of relevant year of income and whether or not the trustee has the funds available for immediate payment.

Clause10.1 would result in Black Holdings P/L, as sole unit holder, being presently entitled to 100% of the income of the Green Unit Trust in each year provided that the trustee refrains from exercising the power in clause 10.2 to accumulate any income.

The Commissioner considers that where Black Holdings P/L does not consent to the accumulation of trust income pursuant to clause 10.2, Black Holdings P/L will have the equitable entitlement to seek and receive payment of the trust income at any time pursuant to clause 10.1 and the agreement not to do so until the pre-existing UPEs have been paid to former unit holders is a mere promise which does not alter the nature of its interest as the current unitholder.

Is there is a reimbursement agreement for the purposes of section 100A of the ITAA 1936?

In broad terms, section 100A of the ITAA 1936 applies, in a nutshell, where a beneficiary of a trust estate who is not under a legal disability, has become presently entitled to income because it has been agreed that the income in question will be returned (or never demanded) and the agreement is made with the purpose that some other entity will pay less or no income tax.

Where a beneficiary's entitlement arises out of a reimbursement agreement, section 100A of the ITAA 1936 disregards that entitlement, in full or in part, and the taxable income that would otherwise have been assessed to the beneficiary (or trustee on their behalf) is instead assessed to the trustee under section 99A of the ITAA 1936.

Relevantly, 'reimbursement agreement' is broadly defined for the purposes of section 100A of the ITAA 1936

A reimbursement agreement, as defined in subsection 100A(7) of the ITAA 1936, refers to 'an agreement that provides for the payment of money or the transfer of property to, or the provision of services or other benefits for, a person or persons other than the beneficiary or the beneficiary and another person or other persons'- which would encompass the provision of funds to trustees.

In your ruling application you have submitted that the reference in subsection 100A(7) of the ITAA 1936 to "person or persons other than the beneficiary" cannot include the trustee of the distributing trust. The Commissioner does not agree with this contention. However, it is nonetheless concluded that the arrangement as set out in your ruling application does not give rise to a reimbursement agreement.

However, subsection 100A(8) of the ITAA 1936 provides that it does not include 'an agreement that is entered into without the purpose, or purposes including the purpose, of securing that a person who, if the agreement had not been entered into, would have been liable to pay income tax in respect of a year of income would not be liable to pay income tax or would be liable to pay less income tax than that person would have been liable to pay if the agreement had not been entered into'.

An agreement is defined to mean 'any agreement, arrangement or understanding, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings, but does not include an agreement, arrangement or understanding entered into in the course of ordinary family or commercial dealing. (See subsection 100A(13) of the ITAA 1936.)

The phrases 'ordinary family' and 'commercial dealing' are not defined for the purposes of section 100A of the ITAA 1936. Whether a particular agreement comes within that exclusion will depend on all of the relevant facts. Amongst other things, the Commissioner accepts that, in the absence of any other factors, the retention of funds as working capital for the business (including paying previous unit holders their UPEs) would fall within the ambit of ordinary commercial dealing and would not be considered a reimbursement agreement for the purposes of section 100A of the ITAA 1936 (see Trust taxation - reimbursement agreement factsheet https://www.ato.gov.au/General/Trusts/In-detail/Technical-issues/Trust-taxation---reimbursement-agreement/).

In this case, distributions to Black Holdings P/L will be held on trust for Black Holdings P/L and the retained funds will be used as working capital for the business (i.e. the funds will be invested for income producing purposes only), including to pay what would be the previous unit holders their UPEs.

Accordingly, it would be reasonable to conclude that the retention of funds as working capital for the business is an ordinary commercial dealing, and as such it is not a reimbursement agreement for the purposes of section 100A of the ITAA 1936.

Issue 2 Question 2

Detailed reasoning

Division 7A of the ITAA 1936 deals broadly with private companies and the distributions of profits to shareholders (or their associates) in the form of non-arm's length loans.

TR 2010/3 sets out the Commissioner's view on when Division 7A applies in respect of loans from beneficiaries to the trust where the trust and private company beneficiary are members of the same family group. However, this does not mean that Division 7A is limited to those circumstances, as Division 7A is not premised on family groups.

Whilst TR 2010/3 and PSLA 2010/4 provide the Commissioner's views on the application of Division 7A in respect of arrangements where the trust and private company are members of the same family group, it is considered that the principles are equally applicable to situations other than trusts and private companies controlled by a family group, where that arrangement bears similar essential features - i.e. the trustee of the trust is an associate of the one or more shareholders of the beneficiary company, the private company has or had an a present entitlement to an amount from the trust and funds representing the present entitlement remain intermingled with other funds of the trust estate or loaned back to the trust by the relevant sub-trust (see paragraph 4 of TR 2010/3).

Irrespective of whether there is a family group in these circumstances, the issue here is whether the arrangement means that Black Holdings P/L will provide a financial accommodation or an in substance loan to Green Corporation P/L, such that Division 7A of the ITAA 1936 will apply to the arrangement.

ATOID 2012/74 considered the situation where the unit holders in a unit trust agreed that UPEs would not be called for and the capital instead used to retire trust debt. The view expressed in this ATOID is that the unit holders are not providing any financial accommodation or in substance loan to the trustee because the unit holders are deferring receipt of their entitlement for the purpose of receiving increased earnings from the trust. The key considerations in this decision are that the trust was not a discretionary trust and the UPEs deferred were in the same proportion as the unit holding and consequently expected future income distributions.

In this case, the arrangement bears some similarity to that in ATOID 2012/74. Green Unit Trust is not a discretionary trust in the sense that the trustee does not have a discretion to confer entitlements to unitholders i.e. appointments of income are to be on a proportional basis to unitholders based on units held. It is reasonable to accept that allowing the UPEs to remain unpaid for use as working capital will result in a commensurate return to Black Holdings P/L, as the sole unit holder. A key difference is that, on one view, the UPEs of Black Holdings P/L will be used to pay out the UPEs of the previous unit holders. However, the Commissioner accepts that this distinction has no bearing in this context as the trustee is merely paying out the benefits that already accrued to the previous unit holders rather than creating new benefits. In addition, the Commissioner considers that this arrangement is analogous to the replacement of borrowings in ATOID 2012/74. That is, the trust already has an obligation to pay these amounts to the previous unit holders and the UPEs arising in respect of Black Holdings P/L is being used to replace the working capital used to pay off the previous unit holders.

Therefore, consistent with the view expressed in ATOID 2012/74, Black Holdings P/L will not provide any financial accommodation or in substance loan to the trustee of the Green Unit Trust under the proposed arrangement. Consequently, Division 7A of the ITAA 1936 will not apply to the arrangement.