Edited version of your written advice

Authorisation Number: 1012845920410

Date of advice: 30 July 2015

Ruling

Subject: CGT consequences of proposed amendments to the Constitution of a company in which you hold all the interests

Question 1

Will the proposed amendments to the terms of the Constitution of Company X to convert the company into a 'for profit' company, including the ability to make distributions to guarantee members, result in either CGT event A1, CGT event D1 or CGT event K8 happening to Company A under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

If question 1 is answered in the negative, will the proposed amendments to the terms of the Constitution of Company X to convert the company into a 'for profit' company, including the ability to make distributions to guarantee members, result in a capital gain arising for Company A pursuant to CGT event H2 as specified in subsection 104-155(3) of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

Company A is an Australian resident public company.

Company X is a public company limited by guarantee. Company X is currently treated as an exempt entity for income tax purposes.

Company A is the sole guarantee member of Company X. This guarantee membership interest is held on capital account and was not acquired by Company A prior to 20 September 1985.

Company A has not made an election to consolidate for income tax purposes.

Company A and Company X are separate taxpayers for income tax purposes.

Company X's Existing Constitution

Under Company X's current Constitution:

• Company A has no entitlements to dividends.

• Company A has no entitlement to the capital of Company X in the event Company X is wound up.

• Company A has full voting rights in Company X.

Company A is currently unable to access profits or retained earnings from Company X.

Proposal to Convert Company X to a 'For Profit' Company

Company X proposes to enter into a transaction to convert itself from a 'non-profit' entity into a 'for profit' entity. The conversion will be implemented by Company X amending its Constitution to allow for distributions to be made to its members.

When the conversion is implemented, Company X will cease to be treated as an exempt entity for income tax purposes.

Proposed Amendments to the Company X Constitution include:

• Amendments to introduce greater flexibility in the objects of the company.

• Removal of an Article of the Constitution restricting the use of the funds of Company X.

• Amendments to allow a sole member of Company X to appoint, remove or replace any director of Company X by notice.

• Insertion of various Articles which allow for the distribution of dividends and specific assets to members of Company X and associated provisions.

• Amendments to entitle members to a return of capital or distribution of surplus assets and profits upon winding up of the company.

No money or other consideration will be paid by Company A to Company X for the amendments to the Constitution of Company X, which will vary the rights of the guarantee membership interest held by Company A.

Company X will continue to be a company limited by guarantee.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 160M(1) (repealed)

Income Tax Assessment Act 1936 subsection 160M(6) (repealed)

Income Tax Assessment Act 1936 subsection 160M(6D) (repealed)

Income Tax Assessment Act 1936 subsection 160R (repealed)

Income Tax Assessment Act 1997 section 50-1

Income Tax Assessment Act 1997 section 50-30

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection 104-35(1)

Income Tax Assessment Act 1997 subsection 104-155(1)

Income Tax Assessment Act 1997 subsection 104-155(3)

Income Tax Assessment Act 1997 section 104-250

Income Tax Assessment Act 1997 subsection 104-250(1)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 paragraph 108-5(2)(a)

Income Tax Assessment Act 1997 subsection 116-20(2)

Income Tax Assessment Act 1997 subsection 725-145(1)

Income Tax Assessment Act 1997 subsection 725-145(2)

Income Tax Assessment Act 1997 subsection 725-145(3)

Income Tax Assessment Act 1997 subsection 725-155(1)

Income Tax Assessment Act 1997 section 725-245

Private Health Insurance (Prudential Supervision) Act 2015

Reasons for decision

Summary

The proposed amendments to the Constitution of Company X will not result in CGT event A1, CGT event D1, or CGT event K8 happening to Company A under Part 3-1 of the ITAA 1997.

CGT event A1 will not happen as the amendments to the Company X Constitution do not result in a change of ownership in Company A's sole guarantee membership interest in Company X and therefore, there will be no disposal of a CGT asset as required by subsection 104-10(1) of the ITAA 1997.

CGT event D1 will not happen as the amendments to the Company X Constitution will not create a contractual right or legal or equitable right in another entity as required under subsection 104-35(1) of the ITAA 1997.

CGT event K8 will not happen as the amendments to the Company X Constitution will not result in a taxing event generating a gain for a down interest under section 725-245 of the ITAA 1997 as required under subsection 104-250(1) of the ITAA 1997.

Detailed reasoning

Part 3-1 of the ITAA 1997 contains the general CGT provisions of the income tax law.

Section 102-20 of the ITAA 1997 provides that you can make a capital gain or capital loss if and only if a CGT event happens. The capital gain or loss is made at the time of the CGT event. CGT events are detailed in Division 104 of the ITAA 1997.

Most CGT events involve a CGT asset. Subsection 108-5(1) of the ITAA 1997 provides that a CGT asset is any kind of property; or a legal or equitable right that is not property. Paragraph 108-5(2)(a) of the ITAA 1997 provides that a part of, or an interest in, an asset referred to in subsection 108-5(1) will also be a CGT asset. The guarantee membership interest of Company A in Company X is a kind of property and is a CGT asset.

CGT Event A1

Subsection 104-10(1) of the ITAA 1997 provides that:

CGT event A1 happens if you dispose of a CGT asset.

Subsection 104-10(2) of the ITAA 1997 provides that:

You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

As noted above, the guarantee membership interest of Company A in Company X is a CGT asset. The amendments to the Constitution will not result in a change of ownership of that interest, as Company A will continue to own the guarantee membership interest and will remain as the sole guarantee member of Company X.

However, the amendments to the Constitution of Company X will vary the rights attaching to Company A's guarantee membership interest in Company X. Therefore, the relevant question is whether this variation of rights will constitute a disposal for the purposes of subsection 104-10(1) of the ITAA 1997.

The Commissioner has provided his opinion on whether a variation of rights attaching to shares will result in a disposal of shares in Taxation Ruling TR 94/30 Income tax: capital gains tax implications of varying rights attaching to shares. This ruling concerns Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936). Part IIIA which dealt with capital gains and losses has since been repealed and rewritten into the ITAA 1997.

In particular, disposals of an asset formerly covered under subsection 160M(1) of the Income Tax Assessment Act 1936 (ITAA 1936) are now captured by CGT event A1 under the ITAA 1997. Similarly, paragraph 108-5(2)(a) of the ITAA 1997, which replaces former section 160R of the ITAA 1936 ensures that part disposals of a CGT asset are also captured under CGT event A1.

In respect of former subsection 160M(1) and former section 160R of the ITAA 1936, paragraphs 8 to 9 of TR 94/30 state that:

8. A variation in rights attaching to a share... does not result in a full disposal of an asset for the purposes of Part IIIA unless there is a cancellation or redemption of the share. In determining whether a disposal has occurred under Part IIIA, it is not relevant to consider whether the variation is slight (such as a small change to the nominal value of shares) or more significant (such as disposing of the preference to receive dividends).

9. A variation in rights attaching to shares does not result in a part disposal of an asset under section 160R.

A guarantee membership interest is sufficiently analogous to a share such that the principles in relation to variation of rights to shares should be applicable to variations to rights attaching to a guarantee membership interest. In this respect, paragraph 2 of Taxation Determination TD 2007/20 Income tax: can the attribution regime relating to controlled foreign companies apply to an Australian entity that is a member of a foreign company limited by guarantee? states that:

2. An Australian entity that is a member of a foreign company limited by guarantee (a 'guarantee company') is a shareholder of that company for income tax purposes.

The amendments to the Company X Constitution will result in a variation of rights attaching to the guarantee membership interest. However, these variations will not result in a disposal of all or part of the guarantee membership interest held by Company A in Company X. Therefore, the amendments to the Company X Constitution will not cause CGT event A1 to happen.

CGT Event D1

Subsection 104-35(1) of the ITAA 1997 states that:

CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity.

The amendments to the Company X Constitution will not result in the creation of a contractual right or legal or equitable right in another entity. The amendments will vary the rights attaching to the sole guarantee membership interest in Company X held by Company A. However, this variation will not result in the creation of a relevant right in another entity for the purposes of CGT event D1.

As noted above a guarantee membership interest in a company is sufficiently analogous to a share in a company and principles in relation to shares contained in TR 94/30 may be relevant. In this respect, paragraph 10 of TR 94/30 provides that a variation in rights attaching to shares does not constitute a deemed disposal of shares under former subsection 160M(6) of the ITAA 1936. Former subsection 160M(6) of the ITAA 1936 has been rewritten into CGT event D1.

In relation to former subsection 160M(6) of the ITAA 1936, TR 94/30 further states at paragraph 45 that:

…The broad criteria which trigger the new subsections 160M(6) to 160M(6D) are that a person must create an asset, not being corporeal property, which on its creation is vested in another person. As all these requirements are not present when a company resolves to vary the rights attaching to its shares, the subsection will not apply.

Accordingly, the variation in rights to the guarantee membership interest of Company A will not result in the creation of a contractual right, or other legal or equitable right in another entity for the purposes of subsection 104-35(1) of the ITAA 1997 and CGT event D1 will not happen.

CGT Event K8

Subsection 104-250(1) of the ITAA 1997 provides that:

CGT event K8 happens if there is a taxing event generating a gain for a down interest under section 725-245.

Section 725-245 of the ITAA 1997 provides a table detailing situations where value shifted from a 'down interest' to a corresponding 'up interest' will give rise to a taxing event generating a gain. A 'down interest' is defined in subsection 725-155(1) of the ITAA 1997 which states that:

An equity or loan interest in the target entity is a down interest if a decrease in its market value is reasonably attributable to the one or more things referred to in paragraph 725-145(1)(b)…

Subsection 725-145(1) of the ITAA 1997 states:

There is a direct value shift under a scheme involving equity or loan interests in an entity (the target entity) if:

(a) there is a decrease in the market value of one or more equity or loan interests in the target entity; and

(b) the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things is done; and

(c) either or both of subsections (2) and (3) are satisfied.

Subsection 725-145(2) of the ITAA 1997 states:

One or more equity or loan interests in the target entity must be issued at a discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

Subsection 724-145(3) of the ITAA 1997 states:

Or, there must be an increase in the market value of one or more equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

In the present circumstances, Company X is the target entity. Applying the definition of down interest in subsection 725-155(1) of the ITAA 1997, there will only be a down interest if there is a decrease in the market value of an equity or loan interest in Company X.

The amendments to the Company X Constitution will not result in any equity or loan interests in Company X being issued. Company A holds on capital account all the interests in Company X.

The relevant question is therefore whether the amendments to the Company X Constitution will result in a decrease in the market value of the sole guarantee membership interest held by Company A. As previously noted, the amendments will vary the rights attaching to the guarantee membership interest such that Company X may distribute dividends and capital to Company A. The Commissioner does not consider that these and the other amendments to the Company X Constitution will result in a decrease in the market value of the guarantee membership interest. Consequently, there will not be a down interest for the purposes of section 725-245 of the ITAA 1997. This means that subsection 104-250(1) of the ITAA 1997 cannot apply and CGT event K8 will not happen as a result of the amendments to the Company X Constitution.

Question 2

Summary

Amendments to the Constitution of Company X to convert the company into a 'for profit' company, including the ability to make distributions to its members, will result in CGT event H2 happening under subsection 104-155(1) of the ITAA 1997. However, there will be no capital proceeds because of CGT event H2 and therefore Company A will not make a capital gain under subsection 104-155(3) of the ITAA 1997.

Detailed reasoning

Will CGT event H2 occur?

Subsection 104-155(1) of the ITAA 1997 states:

CGT event H2 happens if:

(a) an act, transaction or event occurs in relation to a CGT asset that you own; and

(b) the act, transaction or event does not result in an adjustment being made to the assets cost base or reduced cost base.

The amendments to the Company X Constitution which vary the rights attaching to the guarantee membership interest will constitute an act, transaction or event in relation to a CGT asset owned by Company A. The amendments will not result in an adjustment being made to the cost base or reduced cost base of the guarantee membership interest because none of the cost base or reduced cost base rules contained in Division 110 and Division 112 of the ITAA 1997 will apply to adjust the cost base or reduced cost base of the interest as a result of the amendments.

Therefore, the amendments to the Constitution of Company X will result in CGT event H2 happening.

Is there a capital gain?

In relation to CGT event H2, subsection 104-155(3) of the ITAA 1997 states:

You make a capital gain if the capital proceeds because of the CGT event are more than the incidental costs you incurred in relation to the event…

For the purposes of CGT event H2, 'capital proceeds' is defined in the table in subsection 116-20(2) of the ITAA 1997 as:

The money or other consideration you received, or are entitled to receive because of the act, transaction or event…

Company A will not receive any money or other consideration as a result of the amendments to the Constitution of Company X which vary the rights to the guarantee membership interest. Consequently the amendments will not give rise to capital proceeds as defined in subsection 116-20(2) of the ITAA 1997. Accordingly, Company A will not make a capital gain under subsection 104-155(3) of the ITAA 1997.