Edited version of your written advice

Authorisation Number: 1012972503165

Date of advice: 19 February 2016

Ruling

Subject: Debt forgiveness, value shifting, part IVA and roll-over relief

Issue 1

Debt forgiveness

Question 1

Is the loan a 'commercial debt' for the purposes of section 245 of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Answer

Yes

Question 2

Is the value of the debt pursuant to section 245-55 of the ITAA 1997 $x million?

Answer

Yes

Question 3

Is an amount offset against the value of the debt such that the gross forgiven amount of the debt is nil?

Answer

Yes

Question 4

Will the debt forgiveness give rise to a capital loss for CompanyA when the loan is forgiven?

Answer

No

Question 5

Will the debt forgiveness constitute assessable income to CompanyB as creditor?

Answer

No

Question 6

Will the Commissioner seek to apply Part IVA to the Loan Reorganisation?

Answer

No

Issue 2

Value shifting

Question 7

Does the debt forgiveness give rise to an indirect value shift between the debtor and creditor?

Answer

Yes

Question 8

If the answer to question 7 is 'Yes', is there a nil reduction to the adjustable value in the losing entity when using the 'loss-focussed basis' method in section 727-780 of the ITAA 1997?

Answer

Yes

Question 9

If the answer to question 8 is 'Yes', is there a nil uplift adjustment in the gaining entity per section 727-800 of the ITAA 1997?

Answer

Yes

Issue 3

Roll-over relief

Question 10

Will the shareholders of CompanyA be eligible to elect for Capital Gains Tax ('CGT') rollover relief under Subdivision 124-M of the ITAA 1997 in relation to the sale of their shares in CompanyA?

Answer

Yes, to the extent the CompanyA shareholders received CompanyC shares in exchange for their shares in CompanyA.

Question 11

What will be the first element of the cost base of a replacement share if a CompanyA shareholder chooses to obtain CGT rollover relief?

Answer

The first element of the cost base of the replacement share will be the cost base of the CompanyA share, or the cost base of the CompanyA share minus the cost base of the CompanyA share reasonably attributable to any cash consideration, if applicable.

This ruling applies for the following periods:

For income year ending 30 June 20XX

The scheme commences on:

During income year ending 30 June 20XX

Relevant facts and circumstances

CompanyA is a privately owned company. CompanyA and CompanyB are companies incorporated in Australia and are Australian residents. Prior to the merger, CompanyA's shares were held by IndividualA, IndividualB and TrustA.

All CompanyA shares were issued after 19 September 1985.

CompanyB is a corporate entity also under the control of IndividualA, IndividualB and TrustA. CompanyB does not carry on any activities in a businesslike manner.

Merger transaction

During the income year ending 30 June 20XX, CompanyA merged with CompanyC. CompanyC is not a member of a wholly owned group.

Some of the relevant terms of the merger were as follows:

• CompanyC will acquire all of the shares in CompanyA from the CompanyA shareholders in an arm's length transaction.

• Existing CompanyA shareholders are entitled to participate in the merger on exactly the same terms and will be able to choose either of the following as consideration of their shares in CompanyA:

• Shares in CompanyC (subject to a share issue maximum); or

• Cash (subject to a cash maximum); or

• A combination of both cash and shares in CompanyC.

• The following consideration was received by the CompanyA shareholders in exchange for their shares in CompanyA:

• IndividualA and Individual B received a combination of cash and scrip; and

• The joint shareholding of IndividualA and IndividualB received all cash; and

• TrustA received all scrip.

• Any shares in CompanyC provided to CompanyA shareholders as consideration will carry the same kind of rights and obligations as those attached to the CompanyA shares.

• CompanyC cannot own shares in an entity which in turn owns shares in itself. As CompanyA owned shares in CompanyC, these shares were moved to another entity prior to the merger. In consideration of the transfer of CompanyC shares, CompanyA received an inter-entity loan which CompanyA assigned to CompanyB as part of the loan reorganisation discussed below.

• CompanyA was restricted from doing the following before the merger was completed:

• Being able to reduce its capital;

• Being able to declare, pay or distribute any dividends; and

• Being able to conduct a share buy-back.

• CompanyA needed to be acquired by CompanyC on a 'cash free/debt free' basis, with no loans currently outstanding to related parties.

The previous shareholders of CompanyA, being IndividualA, IndividualB and TrustA ('CompanyA shareholders'), now hold A% of the shares in CompanyC as a result of the merger.

CompanyA shareholders informed CompanyC in writing of the cost base of their original interests in CompanyA just before the merger occurred.

The loan reorganisation

In the income year ending 30 June 20XX, CompanyA issued loans to CompanyB, IndividualA, IndividualB and TrustA. All the loans were compliant with Division 7A (where relevant) and minimum repayments were being made as necessary. CompanyB used the loan from CompanyA for income producing purposes (currently, CompanyB does not carry on any activities in a businesslike manner).

In order to facilitate the merger with CompanyC, CompanyA undertook a loan reorganisation which would move the existing intercompany loan asset balances in CompanyA to CompanyB. The following occurred to facilitate the loan reorganisation:

• CompanyA loaned additional funds to CompanyB. The additional funds reflected the CompanyC shares and other loans to shareholders/associates of CompanyA.

• CompanyB on-loaned those funds to IndividualA, IndividualB and TrustA. The terms and repayment schedule of this loan from CompanyB is the same as the previous loan to these parties by CompanyA. The new loan is also compliant with Division 7A.

• IndividualA, IndividualB and TrustA repaid their loans in full to CompanyA

• The intercompany loan ('the loan') between CompanyA and CompanyB was forgiven in full. The amount of the loan from CompanyA to CompanyB at the time of forgiveness was $x million.

The loan from CompanyA to CompanyB was an interest free loan. The applicant has advised that although interest on the loan was not payable, had interest been payable, an interest deduction would have been available to CompanyB.

Prior to the merger, the market value of CompanyA shares was approximately $y million on a debt free/cash free basis and their total cost base was approximately $z million. The market value of CompanyB shares at 30 June 20XX was approximately $a million and their total cost base was approximately $b million.

The applicant has advised that no allowable deductions or capital losses are generated as a result of the loan reorganisation.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 subsection 177C(1)

Income Tax Assessment Act 1936 section 177CB

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 108-5(2)

Income Tax Assessment Act 1997 subsection 110-25(2)

Income Tax Assessment Act 1997 subsection 110-55(2)

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 Subdivision 124-M

Income Tax Assessment Act 1997 section 124-780

Income Tax Assessment Act 1997 section 124-782

Income Tax Assessment Act 1997 subsection 124-783(1)

Income Tax Assessment Act 1997 subsection 124-783(6)

Income Tax Assessment Act 1997 subsection 124-785(2)

Income Tax Assessment Act 1997 subsection 124-785(3)

Income Tax Assessment Act 1997 section 124-790

Income Tax Assessment Act 1997 section 124-795

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 paragraph 245-10(b)

Income Tax Assessment Act 1997 section 245-35

Income Tax Assessment Act 1997 Subdivision 245-C

Income Tax Assessment Act 1997 section 245-55

Income Tax Assessment Act 1997 section 245-65

Income Tax Assessment Act 1997 subsection 245-75(2)

Income Tax Assessment Act 1997 Subdivision 245-G

Income Tax Assessment Act 1997 Division 727

Income Tax Assessment Act 1997 section 727-15

Income Tax Assessment Act 1997 section 727-150

Income Tax Assessment Act 1997 paragraph 727-155(1)(e)

Income Tax Assessment Act 1997 section 727-550

Income Tax Assessment Act 1997 Subdivision 727-H

Income Tax Assessment Act 1997 section 727-770

Income Tax Assessment Act 1997 section 727-775

Income Tax Assessment Act 1997 section 727-780

Income Tax Assessment Act 1997 section 727-800

Income Tax Assessment Act 1997 section 727-805

Income Tax Assessment Act 1997 section 727-810

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

Reasons for decision

Issue 1

Question 1

Summary

The loan from CompanyA to CompanyB constitutes a commercial debt and Subdivisions 245-C to 245-G of the ITAA 1997 apply to the debt.

Detailed reasoning

Division 245 of the ITAA 1997 applies to any commercial debt that is forgiven.

Paragraph 245-10(b) of the ITAA 1997 provides that a debt will be considered to be commercial in cases where interest in respect of the debt is not payable, but had it been, that interest would have been deductible by the debtor.

There is no interest payable in relation to the loan provided by CompanyA to CompanyB. However, the applicant has advised that although interest is not payable, had interest been payable, an interest deduction would have been available to CompanyB, as the loan was used by CompanyB for income producing purposes.

Accordingly, the loan from CompanyA to CompanyB constitutes a commercial debt and Subdivisions 245-C to 245-G of the ITAA 1997 apply to the debt.

Question 2

Summary

The value of the debt at the forgiveness time is the market value of the debt, being $x million.

Detailed reasoning

Section 245-35 of the ITAA 1997 provides that a debt is forgiven if and when the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full.

In this case, CompanyB's obligation to pay the debt is waived by CompanyA. Therefore, the debt is taken to be forgiven for the purposes of Division 245 of the ITAA 1997.

Section 245-55 of the ITAA 1997 outlines the general rule for working out the value of a debt. Subsection 245-55(1) of the ITAA 1997 states the value of the debt at the time it is forgiven is the amount that would have been its market value at the forgiveness time, assuming that:

(a) When the debt was incurred, the debtor was able to pay all their debts as and when they fell due; and

(b) The debtor's capacity to pay the debt is the same at the forgiveness time as when the debtor incurred it.

Paragraph 245-55(1)(a) of the ITAA 1997 does not apply when calculating the value of the debt as CompanyA was an Australian resident at the forgiveness time, the debt was not a moneylending debt and CompanyA and CompanyB were not dealing with each other at arm's length (subsection 245-55(3) of the ITAA 1997).

The applicant has advised that CompanyB's capacity to pay the debt at the time of forgiveness was the same as when the debt was incurred.

Further subsection 245-55(2) of the ITAA 1997 is not applicable as there was no change in the rate of interest or rate of exchange that affects the market value of the debt.

Therefore, the value of the debt for the purposes of section 245-55 of the ITAA 1997 is the market value of the debt which is $x million (the face value of the loan).

Question 3

Summary

The value of the debt when it is forgiven is equal to the amount offset against the value of the debt under section 245-65 of the ITAA 1997. Therefore, the gross forgiveness amount of the debt is nil.

Detailed reasoning

The rules to determine the amount that can be offset against the value of a debt are set out in section 245-65 of the ITAA 1997.

In accordance with item 3 of the table in subsection 245-65(1) of the ITAA 1997, the value of the debt that is not a moneylending debt is offset by the market value of the debt at the time of forgiveness. Item 3 only applies if none of items 4, 5 and 6 apply and the conditions in subsection 245-65(2) of the ITAA 1997 are met.

Items 4, 5 and 6 do not apply as the debt from CompanyA to CompanyB was not assigned and there are no debt-for-equity swaps.

Subsection 245-65(2) of the ITAA 1997 provides that item 3 only applies to a debt where:

(a) either:

(i) the creditor is a resident when the debt is forgiven; or

(ii) the forgiveness is a CGT event involving an asset that is taxable Australian property.

(b) and either:

(i) there is no amount or property paid or given; or

(ii) the amount that would otherwise be taken to be paid or given is greater or less than the market value of the debt when it is forgiven, and the debtor and creditor were not dealing with each other at arm's length in relation to the forgiveness.

As CompanyA is an Australian resident when the debt is forgiven, and there is no consideration paid by CompanyB for the forgiveness of the debt, item 3 will apply. Therefore, the amount offset against the value of the debt when it is forgiven is $x million, being the market value of the debt at the time of forgiveness.

As the value of the debt when it is forgiven is equal to the amount offset under section 245-65 of the ITAA 1997, the gross forgiveness amount of the debt is nil. Therefore, Subdivisions 245-D to 245-F of the ITAA 1997 do not apply in respect of the debt (subsection 245-75(2) of the ITAA 1997).

Question 4

Summary

CGT event C2 occurs when the loan to CompanyB is forgiven by CompanyA. However, as the capital proceeds and reduced cost base from the event are equal, being the value of the loan forgiven, there will be no capital loss for CompanyA.

Detailed reasoning

A capital gain or capital loss is only made if a CGT event happens (section 102-20 of the ITAA 1997). According to section 104-25 of the ITAA 1997, CGT event C2 can happen when a taxpayer's ownership of an intangible CGT asset ends by the asset being released, discharged, satisfied, abandoned or surrendered.

The debt owed to a lender is an asset of the lender in accordance with subsection 108-5(2) of the ITAA 1997 and CGT Determination Number 2 ('TD 2'). As such, CGT event C2 will happen when CompanyA forgives the debt owed by CompanyB, as it will result in CompanyA's ownership of its asset ending.

Pursuant to subsection 104-25(3) of the ITAA 1997, a capital loss is made if the capital proceeds from the asset ending are less than the asset's reduced cost base.

Section 116-20 of ITAA 1997 provides that capital proceeds are the total of the money received or market value of the property received in respect of the event occurring.

However, under the market value substitution rule in section 116-30 of the ITAA 1997, where no capital proceeds are received from the CGT event, the taxpayer is taken to have received the market value of the CGT asset. Paragraph 2 of TD 2 provides that 'the market value of the debt at the time of its disposal is worked out as though the debt was not waived and was never intended to be waived'. As CompanyA did not receive any consideration for forgiving the loan, the capital proceeds will be deemed to be the market value of the loan at the time of forgiveness.

Under the general cost base and reduced cost base rules, the first element of the cost base and reduced cost base of a CGT asset is the sum of the amount paid and the market value of the property given in respect of acquiring the asset (subsections 110-25(2) and 110-55(2) of the ITAA 1997). However, the general rule may be modified by the market substitution rule under section 112-20 of the ITAA 1997 so that the first element of the cost base or reduced cost base of a CGT asset is its market value at the time of acquisition. Paragraph 3 of TD 2 provides that the '...cost base of the debt to the lender is the amount of the loan'.

The applicant has advised that the market value of the loan at the time it is forgiven is equal to the amount CompanyA loaned to CompanyB. As the reduced cost base of the loan owed to CompanyA and the capital proceeds received upon forgiveness of the loan are taken to be the same amount, no capital loss will be made by CompanyA.

Question 5

Summary

The debt forgiveness by CompanyA will not constitute assessable income to CompanyB as the debt forgiveness is not considered to be ordinary income and it will not give rise to any CGT consequences for CompanyB.

Detailed reasoning

Assessable income includes income according to ordinary concepts, i.e. ordinary income under section 6-5 of the ITAA 1997, and statutory income under section 6-10 of the ITAA 1997.

Ordinary Income

Income according to ordinary concepts is not defined in the ITAA 1997. However, there is a substantial body of case law which discusses factors which indicate whether an amount has the character of income according to ordinary concepts.

In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 the High Court of Australia held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. They further stated at page 138 that:

Sometimes, the character of receipts will be revealed…by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

In the case of Federal Commissioner of Taxation v The Myer Emporium Ltd 87 ATC 4363, the Full High Court held that a receipt from an isolated business operation may constitute income if the taxpayer had entered into the transaction with the intention or purpose of making a profit or gain.

In the case of Warner Music Australia Pty Ltd v FC of T 96 ATC 5046, a gain made by a taxpayer, as a result of being released from its liability, was treated as being ordinary income due to the gain being so intimately connected with the business carried on by the taxpayer.

Although CompanyB had previously conducted a business with CompanyA, since it's demerger from CompanyA, it has not carried on any activities in a businesslike manner. The applicant has stated that the forgiveness of the loan was not due to any previous balances between CompanyA and CompanyB when CompanyB was carrying on a business.

Further, the applicant has stated that their reason for forgiving the loan to CompanyB was to facilitate a loan reorganisation in order to enable CompanyA to merge with CompanyC. Thus, as the forgiveness of the loan was not connected with any business carried on by CompanyB, the forgiveness of the debt will not constitute ordinary income in the hands of CompanyB.

Statutory Income (Capital Gains Tax)

Section 102-5 of the ITAA 1997 states that assessable income includes any net capital gain made during an income year. As mentioned in question 4 above, a capital gain (or capital loss) is only made if a CGT event happens (section 102-20 of the ITAA 1997).

CGT event C2 occurs if an intangible asset ends because it is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered, forfeited or expired (Section 104-25 of the ITAA 1997).

In CGT Determination Number 3 (TD 3) it states;

1. For CGT purposes, the borrower is not considered to have an asset. Accordingly, when the lender waives the debt, the borrower does not dispose of an asset and therefore makes no capital gain or loss.

2. No other CGT provisions apply to cause a capital gain or loss to the borrower when the lender waives the debt.

Therefore, as there is no asset to which a CGT event occurs, there are no CGT consequences for CompanyB when CompanyA forgives the debt.

Question 6

Summary

Part IVA will not apply as the Commissioner does not consider that a tax benefit is obtained in connection with the scheme.

Detailed reasoning

In order for Part IVA to apply, the following requirements must be satisfied:

• there is a scheme to which Part IVA applies;

• a tax benefit was or would (but for subsection 177F(1)) have been obtained by a taxpayer;

• the identified tax benefit was or would have been obtained in connection with the identified scheme; and

• the person, or one of the persons, who entered into or carried out the identified scheme (or any part of the scheme) did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit.

In light of the commercial objectives of the scheme, the Commissioner does not consider that a tax benefit is obtained in connection with the scheme.

Issue 2

Question 7

Summary

The debt forgiveness will give rise to an indirect value shift between CompanyA and CompanyB as an economic benefit will be provided by CompanyA to CompanyB to the value of $x million and nothing is provided by CompanyB to CompanyA in return.

Detailed reasoning

The indirect value shift ('IVS') provisions under Division 727 of the ITAA 1997 operate to prevent an inappropriate loss or gain from arising on realisation of an interest. The Division may result in the reduction of realised losses or gains, or adjustment to the interest's value for income tax purposes taking into account the indirect value shift.

An IVS may have consequences under Division 727 of the ITAA 1997 when:

• the losing entity is a company or trust (subsection 727-15(2) of the ITAA 1997); and

• the losing and gaining entities were not dealing at arm's length, or providing economic benefits in return for full market value (subsection 727-15(3) of the ITAA 1997); and

• the losing entity and the gaining entity have the same ultimate controller, or they have a high level of common ownership (subsection 727-15(4) of the ITAA 1997); and

• the only interests affected are the entities involved in the IVS or their associates (subsection 727-15(5) of the ITAA 1997); and

• none of the exclusions in subsection 727-15(6) of the ITAA 1997 apply.

In this case, CompanyA is the losing entity as it is forgiving a receivable loan, and CompanyB is the gaining entity. Both entities are companies and were not dealing at arm's length. Both entities are owned by IndividualA, IndividualB and TrustA and therefore have a high level of common ownership. The only interests affected are those owned by CompanyA or CompanyB or by their associates. None of the exclusions in subsection 727-15(6) of the ITAA 1997 apply.

Pursuant to section 727-150 of the ITAA 1997, there will be an IVS when the market value of economic benefits provided by the losing entity to the gaining entity exceeds:

• the market value of benefits provided by the gaining entity in connection with a scheme; or

• if no economic benefits are provided by the gaining entity, then nil.

Paragraph 727-155(1)(e) of the ITAA 1997 states that an example of an economic benefit provided to an entity includes an entity terminating all or part of the liability owed by the other entity.

Under the proposed loan reorganisation, CompanyA will forgive its loan to CompanyB in full. The amount of the loan being forgiven by CompanyA is $x million and there is nothing provided by CompanyB to CompanyA for the loan forgiveness. Therefore, as the value of the economic benefit provided by CompanyA to CompanyB is greater than nil, there will be an IVS between CompanyA and CompanyB as a result of the debt forgiveness.

Question 8

Summary

When applying the loss focussed basis, as both the old market value and the notional resulting market value are greater than the old adjustable value of the CompanyA interest, the adjustable value of the CompanyA interest will not be reduced because of the IVS.

Detailed reasoning

Where an IVS arises, the cost bases of the affected interests are adjusted using either the realisation time method or the adjustable value method. The applicant has stated in the ruling application that the ultimate owners of CompanyA choose to use the adjustable value method pursuant to section 727-550 of the ITAA 1997.

Under the adjustable value method in Subdivision 727-H of the ITAA 1997, the cost bases of affected interests in the losing entity are reduced at the time of the IVS.

Section 727-770 of the ITAA 1997 details the steps to work out the amount by which the adjustable value of an affected interest in the losing entity is reduced. Subsection 727-770(2) of the ITAA 1997 states that it must be worked out under section 727-775 of the ITAA 1997 whether the IVS produced for the owner of the interest a disaggregated attributable decrease in the market value of the interest.

Section 727-775 of the ITAA 1997 provides that there is a disaggregated attributable decrease where the old market value of the interest (i.e. the market value of the interest at the start of the IVS period) is greater than the notional resulting market value of the interest (i.e. the market value of the interest at the IVS time, disregarding the effect of all non-value shifting transactions on the value of that interest).

In this case, the debt forgiveness by CompanyA to CompanyB will result in the notional resulting market value of the interest in CompanyA being $x million lower than the old market value. Therefore, there has been a disaggregated attributable decrease in the market value of the interest in CompanyA.

According to subsection 727-770(3) of the ITAA 1997, the amount by which the interest's adjustable value is reduced is worked out on a loss-focussed basis under section 727-780 of the ITAA 1997.

The 'loss focussed basis' makes adjustments to the cost base of interests in the losing entity, but only to the extent the IVS would have resulted in a loss from those interests being realised. The 'loss focussed basis' involves comparing the old market value and the notional resulting market value of the interest with the interest's adjustable value immediately before the IVS time (old adjustable value).

As both the old market value and the notional resulting market value are greater than the old adjustable value of the CompanyA interest, item 2 of the table in section 727-780 of the ITAA 1997 would apply. Therefore, there will be no reduction to the adjustable value in CompanyA because of the IVS.

Question 9

Summary

There will be a nil uplift in the adjustable value of the interests in the gaining entity, CompanyB, as there were no reductions to the adjustable value of the interests in the losing entity, CompanyA.

Detailed reasoning

Section 727-800 of the ITAA 1997 details how the adjustable value of an affected interest in a gaining entity is uplifted under the adjustable value method. Subsection 727-800(2) of the ITAA 1997 states that it must first be worked out under section 727-805 of the ITAA 1997 whether the IVS has produced for the owner of the interest a disaggregated attributable increase in the market value of the interest.

The debt forgiveness by CompanyA to CompanyB will result in the notional resulting market value of the interest in CompanyB being $x million greater than the old market value. Therefore, there has been a disaggregated attributable increase in the market value of the interest in CompanyB.

Subsection 727-800(4) of the ITAA 1997 provides that the adjustable value is uplifted by the amount worked out using the following scaling-down formula in section 727-810 of the ITAA 1997:

The disaggregated attributable increase	x	Total reductions for affected interests
		Total disaggregated attributable decreases

The total reduction for the affected interest is nil as there was no reduction to the adjustable value in the losing entity, CompanyA (as discussed in question 8 above). Therefore there will be no uplift adjustment made to the adjustable value of the interests in CompanyB.

Issue 3

Question 10

Summary

The shareholders of CompanyA will be eligible to elect for scrip for scrip roll-over relief in relation to the sale of their CompanyA shares in exchange for shares in CompanyC. Scrip for scrip roll-over relief will not be available in relation to any cash received by CompanyA shareholders in exchange for CompanyA shares. Where CompanyA shareholders received a combination of cash and shares in CompanyC, a partial roll-over will be available in relation to the share component of the consideration.

Detailed reasoning

Subdivision 124-M of the ITAA 1997 allows a taxpayer to choose a scrip for scrip roll-over where the taxpayer's post-CGT shares are replaced with other shares. A taxpayer can choose to obtain roll-over when interests held in one entity (the original interests in the original entity) are exchanged by the taxpayer for replacement interests in another entity (the acquiring entity). This roll-over defers recognition of any capital gain until a CGT event happens to the replacement interest.

Section 124-780 of the ITAA 1997 provides that there is a roll-over if:

• shares in a company are exchanged for shares in another company;

• the exchange is a consequence of a single arrangement that satisfies subsection 124-780(2) of the ITAA 1997;

• conditions for roll-over in subsection 124-780(3) of the ITAA 1997 are satisfied;

• further conditions in subsection 124-780(5) of the ITAA 1997 are satisfied or are not applicable; and

• Exceptions to obtaining scrip for scrip rollover under section 124-795 of the ITAA 1997 are not applicable.

Shares exchanged for shares

Under the merger agreement with CompanyC, CompanyA shareholders can choose to receive: cash, shares in CompanyC or a combination of both cash and shares in CompanyC.

In order to obtain a roll-over, subparagraph 124-780(1)(a)(i) of the ITAA 1997 requires an entity to exchange a share in a company for a share in another company. Subsection 124-790(1) of the ITAA 1997 provides that there is no roll-over for the part of the consideration constituting ineligible proceeds. Paragraph 77 of Taxation Ruling TR 2005/19 provides that 'ineligible proceeds include, but are not limited to, cash'.

Therefore, subject to the satisfaction of other conditions in Subdivision 124-M, CompanyA shareholders would only be eligible to elect for roll-over relief in relation to the CompanyC shares they received in exchange for CompanyA shares.

Single arrangement

Paragraph 124-780(1)(b) of the ITAA 1997 requires that shares in an entity be exchanged in consequence of a single arrangement. In the context of the scrip for scrip roll-over provisions, the proposed merger in accordance with the merger agreement constitutes a single arrangement. The single arrangement also satisfies the conditions set out below:

• the single arrangement will result in CompanyC becoming the owner of X% or more of the voting shares in CompanyA as under the merger, CompanyC will acquire all of the shares in CompanyA.

• under the arrangement, all CompanyA shareholders are entitled to participate in the merger on exactly the same terms

Conditions for roll-over

The requirement in paragraph 124-780(3)(a) of the ITAA 1997 is satisfied as each original interest holder acquired their CompanyA shares on or after 20 September 1985.

Paragraph 124-780(3)(b) of the ITAA 1997 requires that, apart from the roll-over, the original interest holder would make a capital gain from a CGT event happening in relation to its original interest. This condition is satisfied as the market value of the shares is greater than their cost base, thus disposal of CompanyA shares by the CompanyA shareholders will give rise to a capital gain from CGT event A1.

Subparagraph 124-780(3)(c)(i) of the ITAA 1997 requires that the replacement interest is in the acquiring entity. This condition is also satisfied as CompanyA shareholders received their replacement interest in the acquiring entity, CompanyC.

Paragraph 124-780(3)(d) of the ITAA 1997 requires that the original interest holder chooses the roll-over or, if section 124-782 of the ITAA 1997 applies, the original interest holder and the replacement entity jointly choose to obtain the roll-over. Section 124-782 of the ITAA 1997 applies if an original interest holder is a significant stakeholder or a common stakeholder for an arrangement.

An original interest holder is a significant stakeholder for an arrangement if it had a significant stake in both (subsection 124-783(1) of the ITAA 1997):

• the original entity just before the arrangement started; and

• the replacement entity just after the arrangement was completed.

Subsection 124-783(6) of the ITAA 1997 states that an entity has a significant stake in a company if the entity, or the entity and its associates between them have at that time shares carrying 30% or more of the voting rights in the company.

IndividualA, IndividualB and TrustA previously owned 100% of the shares in CompanyA, and now own A% (greater than 30%) of the shares in CompanyC as a result of the merger. Therefore, they are significant stakeholders for the arrangement and must choose to obtain the roll-over jointly with CompanyC. In accordance with paragraph 124-780(3)(e) of the ITAA 1997, the CompanyA shareholders informed CompanyC in writing of the cost base of their original interests in CompanyA just prior to the merger.

Further conditions and exceptions

Subsection 124-780(4) of the ITAA 1997 states that further conditions stated in subsection 124-780(5) of the ITAA 1997 must be satisfied if the original interest holders and acquiring entity did not deal with each other at arm's length. In determining whether parties deal at arm's length, any connection between them and any other relevant circumstances' should be considered (subsection 995-1(1) of the ITAA 1997). As CompanyA shareholders and CompanyC dealt with each other at arm's length in relation to the arrangement, the further conditions in subsection 124-780(5) of the ITAA 1997 are not applicable.

Section 124-795 of the ITAA 1997 contains a number of exceptions where scrip for scrip roll-over cannot be chosen. However, none of these exceptions apply in relation to the arrangement between CompanyA shareholders and CompanyC.

Conclusion

As the conditions in Subdivision 124-M of the ITAA 1997 are satisfied, shareholders of CompanyA will be eligible to elect for scrip for scrip roll-over relief in relation to the sale of their CompanyA shares in exchange for shares in CompanyC. However, as stated above, scrip for scrip roll-over relief will not be available in relation to any cash received in exchange for CompanyA shares as they are regarded as ineligible proceeds (subsection 124-790(1) of the ITAA 1997). Where CompanyA shareholders received a combination of cash and shares in CompanyC, a partial roll-over will be available in relation to the share component of the consideration.

Question 11

Summary

Where the CompanyA shareholders received only CompanyC shares in exchange for their shares in CompanyA, the first element of the cost base of their CompanyC share will be equal to the cost base of the CompanyA share exchanged.

However, where the CompanyA shareholders received a combination of cash and CompanyC shares in exchange for their CompanyA shares, the first element of the cost base of the CompanyC share will be the cost base of the CompanyA share exchanged minus the cost base of the CompanyA share reasonably attributable to the cash consideration.

Detailed reasoning

In accordance with subsection 124-785(2) of the ITAA 1997, the first element of the cost base of the replacement CompanyC share is worked out by reasonably attributing to it the cost base of the CompanyA share exchanged for the CompanyC share.

However, the cost base of the CompanyA share must be reduced by so much of the cost base as is attributable to an ineligible part (subsection 124-785(3) of the ITAA 1997). Subsection 124-790(2) of the ITAA 1997 explains that the cost base of the ineligible part is that part of the cost base of the original interest as is reasonably attributable to it.

To work out the amount of the cost base of the original interest that is reasonably attributable to the ineligible part, for example cash consideration, the Commissioner accepts the following method:

Cost base of the original interest	x	Value of cash consideration
		Value of total consideration (cash and shares received)

Under the merger agreement, CompanyA shareholders can choose to receive either cash, shares in CompanyC or a combination of both cash and shares in CompanyC. As stated above in question 10, any cash received in exchange for the shares are regarded as ineligible proceeds (TR 2005/19).

Where the CompanyA shareholders elect for scrip for scrip roll-over relief and receive only CompanyC shares in exchange for their shares in CompanyA, the first element of the cost base of their CompanyC share will be equal to the cost base of their original CompanyA share exchanged.

However, where a partial roll-over is available, due to CompanyA shareholders receiving a combination of cash and CompanyC shares in exchange for their CompanyA shares, the first element of the cost base of the CompanyC share will be the cost base of the CompanyA share minus the cost base of the CompanyA share reasonably attributable to the cash consideration.