Edited version of your written advice

Authorisation Number: 1012909654204

Date of advice: 14 November 2015

Ruling

Subject: Rights attached to shares

Question and answer

Will a resolution that confirms the Z Class shares of the Company do not have any rights to participate in the distribution of surplus capital of the Company in the event of winding up amount to a value shift for the purposes of Division 725 of the Income Tax Assessment Act 1997?

No.

This ruling applies for the following periods:

Year ending 30 June 2016

The scheme commences on:

1 July 2000

Relevant facts and circumstances

On its incorporation, the share capital of the Company was divided as follows:

• X Class shares - holding a right to a preferential dividend and return of capital.

• Y Class shares - holding a right to dividends after payment of the preferential dividend and rights to all of the capital after return of capital to the Y Class Shareholders.

Some years later, the Company passed a resolution authorising the creation of a number of Z Class shares. This resolution was silent as to the relevant share rights.

A number of the Z Class shares were issued to a number of shareholders at $X each. At that time, the value of the assets held by the company was in excess of $X.

It is the understanding of the directors and shareholders that the Z Class shares were created on the basis that these shares were entitled to receive dividends as may be declared in respect of those shares by the directors from time to time and, on a winding up of the Company, only the return of capital would be paid in respect of the shares. The Z Class shares would not be entitled to the payment of any surplus funds in the event of a winding up of the Company, or for any other reason.

The directors cannot locate any note or memorandum to substantiate the initial basis of the issue of the shares, only the resolution regarding the creation of the shares that was lodged with the Australian Securities and Investments Commission (ASIC) at the time which makes no mention as to the rights of the shares.

A letter issued around the time the Z Class shares were issued stated that the shares should have a right to all capital on a winding up after the return of capital to the X Class shareholders.

Another letter issued at the same time provides a summary of the shareholding of the Company in which it is stated that the Y Class shares were entitled to all capital on a winding up after the return of capital to the X Class shareholders. However, while the letter also states that dividends can be paid in respect of the Z Class shares, the letter is silent as to the rights to capital of the shares.

To remove any legal doubt, the Company intends to pass a resolution that confirms that the Z class shares do not have any rights to participate in the distribution of surplus capital of the Company in the event of its winding up.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 Section 725-145

Reasons for decision

Broadly, the entity interest direct value shifting rules apply where a scheme or arrangement effectively results in a value shift between equity or loan interests in a company or trust that is controlled (for value shifting purposes) by another entity. Such value shifts include the issue of interests in a company or trust at a discount to market value (shifting value out of existing interests) or the variation of rights attaching to a class of existing interests in a company or trust (for example, shifting value out of that class and increasing the value of another class).

Specifically, section 725-145 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that there is a direct value shift under a scheme 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 in the equity or loan interests in the target entity 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 the following are satisfied:

• one or more equity or loan interests in the target entity are issued at a discount. This issue must be, or must be reasonably attributable to the thing, or one or more of the things referred to in (b) above. The issue must occur at or after the time referred to in (b); or

• there is 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 one or more of the things referred to in (b) above. The issue must occur at or after the time referred to in (b).

In this case, the Company issued Z Class shares and it is the understanding of the Company directors and shareholders that the shares were created on the basis that they were entitled to receive dividends and on a winding up of the Company, only the return of capital would be paid; there was no right to receive any surplus capital of the Company

However, the directors cannot locate any note or memorandum to confirm the initial basis of the issue of the shares, only the resolution regarding the creation of the shares that was lodged with ASIC at the time which makes no mention as to the rights of the shares.

Therefore, to remove any legal doubt, the Company intends to pass a resolution that confirms that the Z Class shares do not have any rights to participate in the distribution of surplus capital of the Company in the event of winding up.

In regard to the documentary evidence available, the only evidence that could conflict with the view of the directors and shareholders is a letter that states that the Z Class shares should have a right to all capital on a winding up after the return of capital to the X Class shareholders. However, another letter that summarises the shareholdings of the Company specifically states that the Y Class shares have a right to all capital on winding up (after return of capital to the X Class shareholders), but makes no mention of the capital rights attached to the Z Class shares.

You have stated that as the value of the Company was approximately $X at the time of issue of the Z Class shares (at $X each), the shares would have been issued at a value which was not at all reflective of their true value if they had rights to all capital. Further, it would not make sense to also issue Z Class shares with the same rights as the Y Class shares as they would then rank the same.

Based on the information provided, there is no conclusive evidence to conflict with the understanding of the directors and shareholders of the Company in regard to the rights attached to the Z Class shares.

Therefore, a resolution that confirms the Z Class shares of the Company do not have any rights to participate in the distribution of surplus capital of the Company in the event of winding up will not amount to a value shift for the purposes of Division 725 of the Income Tax Assessment Act 1997.