Edited version of your written advice

Authorisation Number: 1012908942727

Date of advice: 11 November 2015

Ruling

Subject: Whether capital gain or capital loss of foreign resident is disregarded

Question

Is any capital gain or capital loss that ForCo makes from the sale of its shares in AusCo disregarded under Subdivision 855-A of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. Any capital gain or capital loss that ForCo makes from the sale of its shares in AusCo is disregarded under Subdivision 855-A of the ITAA 1997.

This ruling applies for the following periods:

1 January 2015 - 31 December 2015

The scheme commences on:

1 July 2015

Relevant facts and circumstances

1. ForCo is a company incorporated in a foreign country and resident for tax purposes in that country.

2. ForCo does not carry on a business in Australia, does not have its central management and control in Australia and its voting power is not controlled by shareholders who are residents of Australia.

3. ForCo entered into a contract for the sale of shares it held in an Australian resident company, AusCo, and shortly thereafter disposed of the shares, in accordance with the contract.

4. The shares disposed of represented more than 10% of the total paid-up share capital of AusCo.

5. The shares were not pre-CGT assets as defined in subsection 149-10(1) of the ITAA 1997.

6. A valuation of the assets of AusCo established that at the time ForCo entered into the contract for the sale of the shares, the sum of the market values of AusCo's assets that were taxable Australian real property (as defined in section 855-20 of the ITAA 1997) did not exceed the sum of the market values of AusCo's assets that were not taxable Australian real property.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 317

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1936 section 350

Income Tax Assessment Act 1997 section 4-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 section 855-10

Income Tax Assessment Act 1997 section 855-15

Income Tax Assessment Act 1997 section 855-20

Income Tax Assessment Act 1997 section 855-25

Income Tax Assessment Act 1997 section 855-30

Income Tax Assessment Act 1997 section 855-32

Income Tax Assessment Act 1997 section 960-130

Income Tax Assessment Act 1997 section 960-135

Income Tax Assessment Act 1997 section 960-180

Income Tax Assessment Act 1997 section 960-185

Income Tax Assessment Act 1997 section 960-190

Income Tax Assessment Act 1997 section 960-195

Income Tax Assessment Act 1997 section 960-405

Income Tax Assessment Act 1997 subsection 995-1(1)

A New Tax System (Goods and Services Tax) Act 1999 section 195-1

Anti-avoidance rules

Not considered.

Reasons for decision

All legislative references below are to the ITAA 1997 unless specified otherwise.

Summary

As the shares held by ForCo in AusCo were not pre-CGT assets at the time of entering into the contract for their sale, section 104-10(5) does not apply to disregard any capital gain or capital loss from the occurrence of CGT event A1 at that time.

However, as ForCo is a foreign resident, any capital gain or capital loss from the sale is disregarded under Subdivision 855-A unless the shares are taxable Australian property.

The shares are not an indirect Australian real property interest as defined in section 855-25 because the principal asset test in section 855-30 is not passed; nor are the shares any other type of taxable Australian property as defined under section 855-15. Consequently, any capital gain or loss from the disposal of the shares is disregarded under subsection 855-10(1).

Detailed reasoning

Applicable law

Section 108-5 - CGT assets

Subsection 108-5(1) states that a CGT asset is any kind of property, or a legal or equitable right that is not property. Note 1 to section 108-5 lists a number of examples of CGT assets, including shares in a company.

Section 104-10 - Disposal of a CGT asset: CGT event A1

CGT event A1 happens to an entity if it disposes of a CGT asset: subsection 104-10(1). The entity disposes of the asset if there is a change of ownership of the asset from the entity to another entity. Merely ceasing to be the legal owner is insufficient - there must be a change in beneficial ownership: subsection 104-10(2). The time of the event is when the entity enters into the contract for the disposal, or if there is no contract, when the change of ownership occurs: subsection 104-10(3).

The entity makes a capital gain if the capital proceeds from the disposal exceed the asset's cost base, or a capital loss if the capital proceeds are less than the asset's reduced cost base: subsection 104-10(4). However, any capital gain or capital loss is disregarded if the entity acquired the asset before 20 September 1985: subsection 104-10(5).

Subsection 149-10(1) - Pre-CGT assets

The term 'pre-CGT asset' is defined in subsection 149-10 as follows:

A *CGT asset that an entity owns is a pre-CGT asset if, and only if:

(a) the entity last acquired the asset before 20 September 1985; and

(b) the entity was not, immediately before the start of the 1998-99 income year, taken under:

(i). former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or

(ii). Subdivision C of Division 20 of former Part IIIA of that Act;

to have acquired the asset on or after 20 September 1985; and

(c) the asset has not stopped being a pre-CGT asset of the entity because of this Division.

Subdivision 855-A - Disregarding a capital gain or loss by foreign residents

Subsection 855-10(1) states:

Disregard a *capital gain or *capital loss from a *CGT event if:

(a) you are a foreign resident, or the trustee of a *foreign trust for CGT purposes, just before the event happens; and

(b) the CGT event happens in relation to a *CGT asset that is not *taxable Australian property.

Note: A capital gain or capital loss from a CGT asset you have used at any time in carrying on a business through a permanent establishment in Australia may be reduced under section 855-35.

Note that:

• 'you' applies to entities generally, including companies: section 4-5; and

• 'foreign resident' is defined in subsection 995-1(1) to mean a person who is not a resident of Australia for the purposes of the Income Tax Assessment Act 1936 (ITAA 1936), ie (in the case of a company) is not incorporated in Australia and either does not carry on business in Australia or neither its central management control is in Australia nor is its voting power controlled by shareholders who are residents of Australia.

There are five categories of CGT assets that are 'taxable Australian property', set out in the table in section 855-15 as follows:

Section 855-20 explains that a CGT asset is 'taxable Australian real property' if it is:

• real property situated in Australia (including a lease of land, if the land is situated in Australia); or

• a *mining, quarrying or prospecting right (to the extent that the right is not real property), if the *minerals, *petroleum or quarry materials are situated in Australia.

Subsection 855-25(1) states that:

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.

A 'membership interest' is an interest or set of interests, or a right or set of rights, that an entity has in, or in relation to, another entity by virtue of which the entity is a 'member' of the other entity: section 960-135.

A 'member' of a company is a member of the company or a stockholder in the company: item 1 of the table in subsection 960-130(1). However, an entity is not a member of a company just because the entity holds interests or rights relating to the company that are debt interests (as defined in Subdivision 974-B): subsection 960-130(3). Thus, an entity holding shares in a company that are not debt interests is a member of the company, and the shares are membership interests in the company.

Section 960-195 states that:

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.

(Note: The definition of 'associate' is in section 318 of the ITAA 1936: subsection 995-1(1).)

A 'direct participation interest' that one entity has in another is defined in the table in subsection 960-190(1) and depends on what type of entity the other entity is.

Relevantly, item 1 of the table states that a direct participation interest in a company (within the meaning of Part X of the ITAA 1936, ie a company other than in the capacity of trustee: section 317 of the ITAA 1936) is the 'direct control interest' (within the meaning of section 350 of the ITAA 1936) that the first entity holds in the other entity.

Note that:

• for the purposes of subsection 960-190(1):

• the scope of section 350 of the ITAA 1936 is extended to Division 960: paragraph 960-190(2)(a); and

• subsections 350(6) and (7) of the ITAA 1936 are not to be applied: paragraph 960-190(2)(b); and

• for the purposes of subsection 855-25(1), in working out whether the interest passes the non-portfolio interest test in section 960-195 (above) and the principal asset test in section 855-30 (below), section 350 of the ITAA 1936 applies as if the words ", or is entitled to acquire," (wherever occurring) were omitted: paragraph 855-25(2)(a).

That is, for the purposes of subsection 855-25(1), section 350 of the ITAA 1936 applies as if it read as follows:

An entity holds a direct control interest in a company at a particular time equal to the percentage that the entity holds at that time of:

(a) the total paid-up share capital of the company; or

(b) the total rights of shareholders to vote, or participate in any decision-making, concerning any of the following:

(i)  the making of distributions of capital or profits of the company to its shareholders;

(ii)  the constituent document of the company;

(iii) any variation of the share capital of the company; or

(c) the total rights to distributions of capital or profits of the company to its shareholders on winding-up; or

(d) the total rights to distributions of capital or profits of the company to its shareholders, otherwise than on winding-up;

or, if different percentages are applicable under the preceding paragraphs, the greater or greatest of those percentages.

If the percentage of total rights to vote or participate in decision-making differs as between differing types of decision-making, the highest of those percentages applies for the purposes of paragraph (1)(b).

[Note: subsections (3), (4) and (5) have not been reproduced.]

Section 855-30 sets out the 'principal asset test' in the following terms:

(1) The purpose of this section is to define when an entity's underlying value is principally derived from Australian real property (see paragraph 855-5(2)(b)).

(2) A *membership interest held by an entity (the holding entity) in another entity (the test entity) passes the principal asset test if the sum of the *market values of the test entity's assets that are *taxable Australian real property exceeds the sum of the *market values of its assets that are not taxable Australian real property.

Note:

The market value of any of the latter kind of assets that are duplicated within the test entity's corporate group could be disregarded (see section 855-32).

(3) 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 2 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)

(4) For the purposes of subsection (2), treat the *market value of the TARP asset and the non-TARP asset according to the following table.

Market value of the TARP asset and the non-TARP asset
Item	If:	the market value of the TARP asset is:	the market value of the non-TARP asset is:
1	(a) the first entity's *direct participation interest in the other entity is less than 10%; or (b) the holding entity's *total participation interest in the other entity is less than 10%	zero	the *market value of the *membership interest mentioned in subsection (3)
2	item 1 does not apply	the product of: (a) the sum of the *market values of all the assets of the other entity that are *taxable Australian real property; and (b) the first entity's *direct participation interest in the other entity	the product of: (a) the sum of the market values of all the assets of the other entity that are not taxable Australian real property; and (b) the first entity's direct participation interest in the other entity

Note 1:

For the purposes of item 2 of the table, it is necessary to work out the market value of any TARP assets and non-TARP assets in relation to any membership interests held by the other entity before working out the value of the TARP asset and non-TARP asset held by the first entity.

Note 2:

The market value of an asset of the other entity that is not taxable Australian real property, and is duplicated within the other entity's corporate group, could be disregarded (see section 855-32).

(5) For the purposes of this section, disregard the *market value of any asset acquired by the test entity, or by any other entity, if the *acquisition was done for a purpose (other than an incidental purpose) that included ensuring that a *membership interest in any entity would not pass the principal asset test in this section.

The term 'total participation interest' is defined in section 960-180 as follows:

An entity's total participation interest at a particular time is the sum of:

(a) the entity's *direct participation interest in the other entity at that time; and

(b) the entity's *indirect participation interest in the other entity at that time.

The term 'indirect participation interest' is defined in section 960-185 as follows:

Work out the indirect participation interest that an entity (the holding entity) holds at a particular time in another entity (the test entity) by multiplying:

(a) the holding entity's *direct participation interest (if any) in another entity (the intermediate entity) at that time;

by:

(b) the sum of:

(i) the intermediate entity's direct participation interest (if any) in the test entity at that time; and

(ii) the intermediate entity's indirect participation interest (if any) in the test entity at that time (as worked out under one or more other applications of this section).

The term 'market value' is stated by subsection 995-1(1) to have a meaning that is affected by Subdivision 960-S. Section 960-405 (within that Subdivision) reduces the market value of an asset at a time by the input tax credit (if any) to which an entity would be entitled if the entity had acquired the asset at that time solely for a creditable purpose (other than for assets, such as shares, the supply of which is not a taxable supply).

(Note: The terms 'input tax credit', 'creditable purpose', 'supply' and 'taxable supply' have the meanings indicated in section 195-1 of A New Tax System (Goods and Services Tax) Act 1999.)

With regard to note 2 following the table in subsection 855-30(4), section 855-32 operates to prevent the market values of non-TARP assets of a corporate group from being double counted where such assets are created under arrangements under which corresponding liabilities are created in other members of the group (see Example 3.1 in Chapter 3 of the Explanatory Memorandum to the Tax and Superannuation Laws Amendment (2014 Measures No. 4) Bill 2014).

Application to the facts

Is capital gain / loss from share sale disregarded under subsection 104-10(5)?

As a consequence of ForCo's disposal of its shares in AusCo, CGT event A1 happened at the time of entering into the contract of sale. As the shares were not pre-CGT assets of ForCo, any capital gain or capital loss from the disposal of the shares would not be disregarded under subsection 104-10(5).

However, it remains to determine whether the capital gain or capital loss would be disregarded under subsection 855-10(1).

Is capital gain / loss from share sale disregarded under subsection 855-10(1)?

ForCo was, just before the CGT event, a foreign resident as it did not meet the criteria for being a resident of Australia, and so ForCo satisfies the condition in paragraph 855-10(1)(a).

As to whether the condition in paragraph 855-10(1)(b) is satisfied, of the five categories of taxable Australian property mentioned in the table in section 855-15, the shares do not satisfy the description in items 1, 3, 4 or 5. It remains to determine whether or not the shares constitute an indirect real property interest under subsection 855-25(1). For the purposes of that subsection, ForCo is the holding entity and AusCo the test entity, and the shares held by ForCo in AusCo constitute a membership interest.

The greater than 10% shareholding that ForCo held in AusCo amounted to a direct control interest, and therefore a direct participation interest, in AusCo of a similar percentage just before the disposal. Therefore, the non-portfolio interest test in section 960-195 is passed, satisfying the condition in paragraph 855-25(1)(a) at that time.

In applying the principal asset test in section 855-30, again ForCo is the holding entity and AusCo the test entity. Therefore, the enquiry under subsection 855-30(2) is to establish whether the sum of the market values of AusCo's assets that are taxable Australian real property exceeds the sum of the market values of its assets that are not taxable Australian real property.

Under subsection 855-30(3), ForCo's membership interest in AusCo is treated as if it were two assets, one being taxable Australian real property (the TARP asset) and the other not (the non-TARP asset).

The market value of the TARP asset is, according to subsection 855-30(4), the sum of the market values of AusCo's assets that are taxable Australian real property multiplied by ForCo's direct participation interest in AusCo (over 10%), while the market value of the non-TARP asset is the same multiple of the sum of the market values of AusCo's assets that are not taxable Australian real property.

(Note that subsections 855-30(3) and (4) apply recursively to assets consisting of membership interests owned directly or indirectly by AusCo: refer to Note 1 to subsection (4).)

According to the valuation of AusCo's assets, the market value of the TARP asset does not exceed that of the non-TARP asset. Therefore, ForCo's membership interest consisting of its shares in AusCo fails the principal asset test, and therefore the condition in paragraph 855-25(1)(b) is not satisfied. That interest is therefore not an indirect Australian real property interest. Hence the shares are not taxable Australian property, and so the condition in paragraph 855-10(1)(b) is satisfied.

Therefore, any capital gain or capital loss from ForCo's disposal of its shares in AusCo is disregarded under subsection 855-10(1).

Conclusion

Any capital gain or capital loss that ForCo makes from the Sale is disregarded under Subdivision 855-A.