Edited version of your written advice

Authorisation Number: 1013077240631

Date of advice: 5 September 2016

Ruling

Subject: Proposed sale of pre-CGT shares

Question 1

Will any capital gain or capital loss made by either Shareholder X or the trustee of the Head Family Trust from the proposed sale of their shares in Head Company be disregarded pursuant to subsection 104-10(5) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

At any time prior to entry into the agreement governing the proposed sale (the Proposed Share Sale Agreement), will subdivision 149-B of the ITAA 1997 cause any pre-CGT asset of Head Company or of any subsidiary member of the Head Company tax consolidated group to stop being a pre-CGT asset for the purposes of the ITAA 1997 or Income Tax Assessment Act 1936 (the ITAA 1936)?

Answer

No

Question 3

Has subdivision 149-B of the ITAA 1997 operated at any time prior to entry into the Proposed Share Sale Agreement, to cause any Head Company shares held by the trustee of the Head Family Trust or Shareholder X to stop being pre-CGT assets for the purposes of the ITAA 1997 or ITAA 1936?

Answer

No

Question 4

Will CGT event K6 happen in relation to the shares in Head Company at the time of entry into the Proposed Share Sale Agreement?

Answer

No

Question 5

Will any of the proceeds of the proposed share sale (the Sale Proceeds) be included in the assessable income of Shareholder X?

Answer

No

Question 6

Will any Sale Proceeds be included in the net income of the trust estate of the Head Family Trust calculated in accordance with subsection 95(1) of the ITAA 1936?

Answer

No

Question 7

Will any Sale Proceeds or any amount in relation to or in respect of the Sale Proceeds be assessable income to the trustee of the Head Family Trust by the operation of sections 99, 99A of the ITAA 1936 or section 6-5 of the ITAA 1997?

Answer

No

Question 8

Will any part of the Proposed Capital Distribution to be made following the Proposed Share Sale be included in the assessable income of each of the Immediate Family pursuant to:

(a) section 97 of the ITAA 1936;

(b) section 99B of the ITAA 1936;

(c) section 104-70 of the ITAA 1997; or

(d) section 6-5 of the ITAA 1997

Answer

No

This ruling applies for the following periods:

The income year ended 30 June 20XX

The income year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstance

The Business

1. In the 19X0s, the Trading Company was incorporated by its Founder to conduct a wholesale trading business (the Business). The Business continued in this form until the 19Z0s.

2. During the 19Y0s, as part of a restructure, Head Company was incorporated and became (and remains) a non-operating holding company for the group. These entities and the Trading Company's subsequent subsidiaries collectively form the Family Group.

3. During the 19Z0s, the ownership of the shares in the Head Company was transferred as follows:

• The trustee of the Head Family Trust as to all ordinary and preference shares;

• Shareholder X as to all redeemable preference shares - these shares had no rights attaching other than to receive dividends behind the preference shares and the return of the nominal paid capital.

4. During that time, the Business also employed Immediate Family of the Founder as staff and directors of the Family Group entities.

5. During the 19Z0s, the Trading Company commenced a vertically integrated operation which involved the obtaining of raw materials, the processing of those raw materials and the production of finished products for sale to wholesale markets.

6. Since the late 19Z0s and into the mid-19XYs, the Family Group's business has expanded with significant growth in its processing capability, supply chain and product lines.

7. Just prior to 20 September 1985, the Family Group was primarily in the business of processing and marketing of products. These products were sold by the Trading Company in both domestic and export markets to wholesale customers.

8. Since 20 September 1985, the Business has further expanded through the Trading Company's acquisition of additional land, business operations and plant and equipment. The number of entities comprising the Family Group has also increased as the group has typically used 'new' entities to undertake any business acquisition.

9. Any businesses acquired as part of the Business' expansion since 20 September 1985 were ultimately discontinued and any associated goodwill was allowed to lapse.

10. Currently, the Trading Company and its group of companies still conduct a processing business with sales being made to wholesale customers predominantly in overseas markets with some sales to Australian wholesale customers.

11. The category of products produced by the Trading Company is largely the same as that prior to 20 September 1985, notwithstanding some expansion in the range of raw materials used, the processing methods undertaken by members of the Family Group and the types of products sold. A small portion of the current Business involves the sale of by-products arising from the main processing business.

12. None of the assets used in the Business are held by entities outside the Family Group with the exception of a small proportion of real property assets used in the Business that are held by entities associated with the Immediate Family.

13. The bulk of sales revenue from the Business is generated by the Trading Company. The goodwill of the Business is also considered to be held by the Trading Company.

14. In 200X, the Family Group formed a tax consolidated group for the purposes of section 703-50 of the ITAA 1997 with the Head Company as its head company.

The Head Family Trust

15. The Head Family Trust was established in the early 19Z0s. The trustee of the Head Family Trust is Trustee X. The beneficiaries of the Head Family Trust were the Founder, their Immediate Family and their Descendants.

16. The Deed of the Head Family Trust was amended after 20 September 1985 to assure borrowing and to clarify the name of the Trust.

17. Between 200Y and 201X, a number of Deeds (the Restructure) were also entered into by the Immediate Family, which in effect, assigned certain beneficiary entitlements held by them in the Head Family Trust to other entities controlled by the Immediate Family whilst still ensuring that the operation of the Family Group and the Head Family Trust continued to align with the entitlements and patterns established in the past.

18. Since 200Y, and up to 200Z, the Head Family Trust has continued to distribute all income in accordance with the Restructure documents and the Immediate Family and their Descendants continue to be the ultimate beneficiaries of the Head Family Trust income.

The Scheme

19. The scheme is the proposed sale of all the shares in the Head Company to an arms-length third party (the Proposed Share Sale).

20. The Head Company shareholders have set a minimum reserve price (Reserve Price) below which the scheme will not be executed.

21. At the time that the scheme will be executed, all the tangible assets of the Head Company and its subsidiaries were acquired after 20 September 1985.

22. The key intangible asset of the Head Company and its subsidiaries is the goodwill associated with the Business operated by the Trading Company. That goodwill was acquired prior to 20 September 1985 when the Trading Company commenced its business operations.

23. The market value of the tangible assets of the Head Company, and its subsidiaries, will be less than half of the Reserve Price at the time that the scheme is executed.

Proposed Distributions from the Head Family Trust

24. In the income year in which the Proposed Share Sale occurs, it is expected that the trustee of the Head Family Trust will receive the Sale Proceeds, fully franked dividends, rental income and bank interest.

25. The trustee of the Head Family Trust proposes to treat the fully franked dividends, rental income and bank interest as 'income of the trust estate'.

26. The trustee of the Head Family Trust intends to treat the Sale Proceeds as part of 'the corpus of the Trust Fund'.

27. The trustee of the Head Family Trust then will resolve, prior to the end of 30 June of the sale income year,

(a) That the Immediate Family be made presently entitled to the proposed income distribution; and

(b) to pay or apply the Sale Proceeds to the Immediate Family (referred to as the Proposed Capital Distribution).

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 25A

Income Tax Assessment Act 1936 Subsection 95(1)

Income Tax Assessment Act 1936 Section 97

Income Tax Assessment Act 1936 Section 99

Income Tax Assessment Act 1936 Section 99A

Income Tax Assessment Act 1936 Section 99B

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 104-10(5)

Income Tax Assessment Act 1997 Section 104-70

Income Tax Assessment Act 1997 Section 104-230

Income Tax Assessment Act 1997 Section 109-10

Income Tax Assessment Act 1997 Section 149-10

Income Tax Assessment Act 1997 Section 149-15

Income Tax Assessment Act 1997 Section 149-30

Reasons for decision

Question 1

Summary

28. Any capital gain or capital loss made by either Shareholder X or the trustee of the Head Family Trust from the proposed sale of their shares in Head Company will be disregarded pursuant to subsection 104-10(5) of the ITAA 1997.

Detailed reasoning

29. Capital Gains Tax (CGT) events occurring under provisions contained in Division 104 of the ITAA 1997 (including section 104-10 of the ITAA 1997) give rise to assessable income under Division 102 of the ITAA 1997.

30. Section 104-10 of the ITAA 1997 contains CGT event A1 and provides in part:

• CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997); and

• 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 (subsection 104-10(2) of the ITAA 1997).

31. Paragraph 104-10(5)(a) of the ITAA 1997 however provides an exception to the application of section 104-10 of the ITAA 1997 to asset disposals where the asset was acquired before 20 September 1985. Assets acquired before this date are referred to as pre-CGT assets.

32. As a consequence of the Proposed Share Sale Agreement, each of the shareholders in Head Company, the trustee of the Head Family Trust and Shareholder X, will dispose of a CGT asset being the Head Company Shares and therefore CGT event A1 will occur.

33. Both the trustee of the Head Family Trust and Shareholder X acquired their shares in Head Company in the 19Z0s, before 20 September 1985. Consequently any capital gain or capital loss from CGT event A1 happening as a result of the proposed sale of these shares will be disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997.

Question 2

Summary

34. Subdivision 149-B of the ITAA 1997 will not cause any pre-CGT asset of Head Company or of any subsidiary member of the Head Company tax consolidated group to stop being a pre-CGT asset for the purposes of the ITAA 1997 at any time prior to entry into the Proposed Share Sale Agreement.

Detailed reasoning

35. Division 149 of the ITAA 1997 contains the rules which govern when an asset acquired before 20 September 1985 (a 'pre-CGT asset') is treated as having been acquired after that date. Section 149-10 of the ITAA 1997 defines what is meant by a pre-CGT asset.

36. 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 ITAA 1936; or

(ii) Subdivision C of Division 20 of former Part IIIA of the ITAA 1936;

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.

37. A CGT asset acquired before 20 September 1985 remains a pre-CGT asset if the majority underlying interests in the asset have not changed since before 20 September 1985. Where a change in majority underlying interests occurs after 19 September 1985, the CGT asset is deemed to be acquired on the date the change occurred, either under Division 20 of the ITAA 1936 (pre 1998-99 income years) or Division 149 of the ITAA 1997.

38. Pursuant to section 149-30 of the ITAA 1997, an asset stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by the ultimate owners who held the majority underlying interests in the asset immediately before 20 September 1985.

39. This means the Commissioner has to be satisfied that the majority underlying interests in an asset have not changed. Otherwise the asset is deemed to have been acquired at the time that the change in majority underlying interests in the asset happened.

40. 'Majority underlying interests' is defined in subsection 149-15(1) of the ITAA 1997 as more than 50% of:

(a) the beneficial interests that the ultimate holders hold (whether directly or indirectly) in the asset; and

(b) the beneficial interests that ultimate owners hold (whether directly or indirectly) in any ordinary income that may be derived from that asset.

41. An 'ultimate owner' is defined to include an individual - refer subsection 149-15(3) of the ITAA 1997. Accordingly, it is necessary to trace the underlying beneficial interests in the relevant assets back to natural persons.

42. The expression 'beneficial interests' as used in the definition of 'majority underlying interests' is not defined. At general law, a shareholder does not have any legal or equitable interest in the asset of a company. Similarly, beneficiaries in a discretionary trust do not have an interest, either individually or collectively, in the assets or the income of a trust.

43. Under ordinary legal concepts, where there is a discretionary trust deed, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. Because the beneficiary of a discretionary trust does not hold an interest in any asset of the trust or in the ordinary income derived from the asset until the trustee's discretion is exercised, it would not be possible for a discretionary trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1) of the ITAA 1997.

44. Taxation Ruling IT 2340 (IT 2340) however provides that the Commissioner will apply an approach of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of section 160ZZS of the ITAA 1936, which preceded Division 149 of the ITAA 1997. This is highlighted in paragraph 2 of IT2340 which states:

'The terms "underlying interest" and "majority underlying interests", on the basis of which the provision operates, have the same meanings as they have in Subdivision G of Division 3 of Part III of the Act - which deals with the income tax treatment of interest in relation to "negatively geared" investments in rental property. In both cases (and like other provisions of the Act concerned with the measurement of ownership interests) underlying interests in relation to the assets concerned mean beneficial interests held by natural persons. The clear policy of the law thus permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be "looked through" in order to determine whether there has been a change in the effective interests of natural persons in the assets.'

The assets

45. In the current circumstances, Head Company owns (either directly or indirectly) the following pre-CGT assets that may be impacted by the operation of Division 149 of the ITAA 1997:

(a) the shares in the Trading Company acquired in the 19Z0s;

(b) shares in two other inactive entities; and

(c) the goodwill of the business conducted by the Trading Company.

The underlying interests

46. In order to determine the underlying interests and majority underlying interests in the ownership of Head Company's assets, the ownership of Head Company needs to be examined.

47. The shareholders of Head Company are:

(a) Trustee X in its capacity as trustee of the Head Family Trust as to all the ordinary shares which it acquired in the 19Z0s pursuant to a share issue by Head Company and all the preference shares which it acquired in the 19Z0s pursuant to a share transfer from the Founder;

(b) Shareholder X as to 100 redeemable preference shares which were acquired sometime in the 19Z0s pursuant to a share issue by Head Company.

Underlying interests held by the Head Family Trust

48. Prior to 20 September 1985, the trustee of the Head Family Trust held a majority underlying interest in Head Company through its shareholdings (ordinary and preference shares) in Head Company. Head Family Trust is a discretionary trust and therefore, as specified in paragraph 2 of IT 2340, it is necessary to 'look-through' this trust to identify its 'ultimate owners'.

49. In this regard, paragraphs 5 and 6 of IT 2340 are relevant as they state:

5. In relation to what are generally referred to as discretionary trusts, i.e., family trusts, the trustees of which have discretionary powers as to the distribution of trust income or property to beneficiaries, in considering the question of whether majority underlying interests have been maintained in the assets of the trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised.

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

50. Based on the terms of the Head Family Trust deed, it is evident that the Founder, the spouse of the Founder, the Immediate Family and their Descendants are provided with the following interests/rights in the Head Family Trust:

(a) An interests as takers in default in any income or capital of the Head Family Trust.

(b) Rights as mere objects of the Head Family Trust to have a beneficial entitlement to income and capital appointed to each of them by the Head Family Trust Trustee exercising its discretion in their favour.

51. Since 20 September 1985, the following changes have occurred which must be considered to determine whether there has been a change in the 'ultimate owners':

• The Amendments;

• The Restructure.

52. The Amendments resulted in relatively minor changes being made to the trust deed of the Head Family Trust. It is considered these Amendments did not change the ultimate owners of the Head Family Trust as these changes did not alter the identity or entitlements of the beneficiaries of the Head Family Trust or the identity and/or role of the trustee.

The Restructure

53. After 20 September 1985, a number of deeds were entered into by the Immediate Family, which in effect, assigned certain beneficiary entitlements held by them in the Head Family Trust to other entities controlled by the Immediate Family whilst still ensuring that the operation of the Family Group and the Head Family Trust continued to align with the entitlements and patterns established in the past.

54. Based on the information provided, it is accepted that the changes occurring from the Restructure did not change the majority underlying ownership of the Head Family Trust because the trust ultimately continued to be administered for the benefit of the relevant family members (as paragraph 6 of IT 2340 permits). It is therefore considered that majority underlying ownership of the shares in Head Company held by the Head Family Trust has been maintained.

55. As a result, Division 149 of the ITAA 1997 will not cause any pre-CGT asset of Head Company or of any subsidiary member (the Trading Company) of the Head Company tax consolidated group to stop being a pre-CGT asset for the purposes of the ITAA 1997.

Question 3

Summary

56. Subdivision 149-B of the ITAA 1997 will not cause any Head Company shares held by the trustee of the Head Family Trust or Shareholder X to stop being pre-CGT assets for the purposes of the ITAA 1997.

Detailed reasoning

57. Both the trustee of the Head Family Trust and Shareholder X acquired their shares in Head Company, before the commencement of the CGT regime on 20 September 1985. Consequently these shares are 'pre-CGT assets'.

58. It is therefore necessary to consider whether Division 149 of the ITAA 1997 may apply to treat these assets as having been acquired after that date and in this regard whether there has been a change in the majority underlying interests in these assets since before 20 September 1985.

59. In respect of the redeemable preference shares, these shares have been continuously held, since before 20 September 1985, by Shareholder X who is the ultimate owner.

60. Consequently Division 149 of the ITAA 1997 will not apply to cause the shares in Head Company held by Shareholder X to cease being pre-CGT assets for the purposes of the ITAA 1997.

61. The operation, context and application of subdivision 149-B of the ITAA 1997 and its relevant related provisions are described in the Detailed Reasoning for Question 2 above.

62. As previously noted, it is considered that the changes occurring since before 20 September 1985, and in particular the Restructure, fall within the concessions provided for in IT 2340 and therefore it is considered that a majority underlying ownership of the shares in Head Company held by the Head Family Trust has been maintained.

63. As a result, Division 149 of the ITAA 1997 will also not cause the shares in Head Company held by the trustee of the Head Family Trust to cease being pre-CGT assets for the purposes of the ITAA 1997.

Question 4

Summary

64. CGT event K6 will not happen in relation to the shares in Head Company at the time of entry into the Proposed Share Sale Agreement.

Detailed reasoning

65. CGT event K6 deems a taxpayer to have made a capital gain on pre CGT shares to which a relevant CGT event happens when the market value of the underlying post CGT property of the entity is 75% or more of the net value (as defined) of the company. Pursuant to subsection 104-230(1) of the ITAA 1997, CGT event K6 happens if:

(a) you own shares in a company that you acquired before 20 September 1985; and

(b) CGT event A1, C2, E1, E2, E3, E5, E6, E7, E8, J1 or K3 happens in relation to the shares or interest; and

(c) there is no roll-over for the other CGT event; and

(d) the applicable requirement in subsection (2) is satisfied

66. Subsection 104-230(2) of the ITAA 1997 provides that CGT event K6 will be triggered if either of the following tests is satisfied:

(a) the market value of the property of the company or trust that was acquired on or after 20 September 1985 (excluding trading stock) is at least 75% of the net value of the company or trust: paragraph104-230(2)(a) of the ITAA 1997 (the Paragraph A calculation); or

(b) where the company or trust owns interests in interposed entities or trusts (i.e. 'lower tier entities'), the market value of the interests in the property acquired on or after 20 September 1985 (excluding trading stock) of those lower tier entities is at least 75% of the net value of the company or trust: paragraphs 104-230(2)(b) of the ITAA 1997 (the Paragraph B calculation).

67. The time of CGT event K6 is when the CGT event mentioned in paragraph 104-230(1)(b) of the ITAA 1997 happens.

68. In the current circumstances, the Head Company Shares were acquired by the trustee of the Head Family Trust and Shareholder X prior to 20 September 1985. CGT event A1 will happen when each Head Company Share is disposed of pursuant to Proposed Share Sale Agreement and there will be no roll-over relevant to CGT event A1. The requirements in paragraphs 104- 230(1)(a) to 104-230(1)(c) of the ITAA 1997 are consequently met.

69. It is therefore necessary to consider the requirements in subsection 104-230(2) of the ITAA 1997 and specifically whether, just before CGT event A1 happens:

(a) the market value of property of the company (that is not its trading stock) that was acquired on or after 20 September 1985; or

(b) the market value of interests the company owns through interposed companies or trusts in property (except trading stock) that was acquired on or after 20 September 1985;

is at least 75% of the net value of the company.

70. Taxation Ruling TR 2004/18 Income tax: capital gains: application of CGT event K6 (about pre-CGT shares and pre-CGT trust interest) in section 104-230 of the Income Tax Assessment Act 1997 (TR 2004/18) provides the Commissioner's view of the operation of section 104-230 of the ITAA 1997 and, therefore, how he determines whether CGT event K6 will apply.

71. If CGT event K6 occurs, it will result in a part of the capital proceeds received by the trustee of the Head Family Trust and Shareholder X being a capital gain which is included in the calculation of net capital gain for the purposes of section 102-5 of the ITAA 1997.

Net value of the Trading Company

72. To determine whether the 75% requirement in subsection 104-230(2) of the ITAA 1997 is met, it is necessary to calculate the 'net value' of the company.

73. In this regard, 'net value' is defined in subsection 995-1(1) of the ITAA 1997 to mean 'the amount by which the sum of the market values of the assets of the entity exceed the sum of its liabilities'.

74. In the current circumstances, the Proposed Share Sale will involve the sale of all the shares in Head Company to an independent third party. It is therefore expected that the purchase price agreed to by the parties should constitute a fair market value for these shares and, as such, should reflect the amount by which the sum of the market value of the assets of Head Company exceeds it liabilities (and thus represents the 'net value' of Head Company for the purposes of the calculations in subsection 104-230(2) of the ITAA 1997).

75. It is further noted that the Head Company shareholders have set a reserve minimum price for the sale of all the shares in Head Company under the Proposed Share Sale.

76. In the current circumstances, based on the nature of the property and interests held by the Head Company, it is considered reasonable to utilise the minimum price as the net value of Head Company when assessing whether the thresholds in in subsection 104-230(2) of the ITAA 1997 have been met.

The Paragraph A calculation

77. Paragraphs 51 to 53 of TR 2004/18 set-out the Commissioner's view on what is meant by the term 'property' for the purposes of CGT event K6. In this regard, these paragraphs specifically state:

51. The term 'property' is not defined for the purposes of CGT event K6 although trading stock is specifically excluded. Property in section 104-230 has its ordinary legal meaning (see ICI Australia Ltd v. Commissioner of Taxation; Hepples v. Commissioner of Taxation; R v. Toohey; Ex parte Meneling Station Pty Ltd; Naval, Military and Airforce Club of South Australia Inc v. Commissioner of Taxation).

52. The Macquarie Dictionary (3rd revised edition) defines 'property' to mean 'that which one owns; the possession or possessions of a particular owner'. The term 'property' in its context in section 104-230 is property owned by either the company referred to in paragraph 104-230(2)(a) or by lower tier companies.

53. It extends to any kind of property. It covers most CGT assets, including pre-CGT assets, but does not include a CGT asset that is not property. It can include such things as land and buildings, shares in a company, units in a unit trust, options, debts owed to the company, interests in assets and goodwill. Motor vehicles, in relation to which capital gains or capital losses are disregarded for CGT purposes, also constitute 'property'.

78. Based on the information provided, it is accepted that just before CGT event A1 happens, the only property Head Company acquired on or after 20 September 1985 will be cash, an intercompany receivable and its shares in one subsidiary. In addition, the market value of this property will not be at least 75% of the net value of Head Company. Consequently the test contained in paragraph 104-230(2)(a) of the ITAA 1997 will not be satisfied.

The Paragraph B calculation

79. The property taken into account under paragraph 104-230(2)(b) of the ITAA 1997 is post-CGT property that is owned by lower tier companies in which the company referred to in paragraph 104-230(2)(a) has a direct or indirect interest. If the company referred to in paragraph 104-230(2)(a) has a less than 100% interest in a lower tier company, only that percentage interest in the underlying post-CGT property is counted. It does not matter, for that purpose, whether the shares in the lower tier company giving rise to the interest were acquired pre-CGT or post-CGT. However, the property taken into account does not include post-CGT shares owned by one lower tier company in another.

80. In the current circumstances, Head Company owns shares in a number of companies i.e. the Trading Company and two other subsidiaries. Trading Company also holds shares in other entities. Just before the relevant CGT event, the property held by these entities will include cash, receivables, land and buildings, plant and equipment and goodwill.

81. The cash, receivables, land and buildings and plant and equipment were all acquired on or after 20 September 1985.

82. In addition to these identifiable assets, Head Company also indirectly owns goodwill stemming from the Trading Company's business. In accordance with the methodology articulated in paragraph 47 of Taxation Ruling TR 1999/16, the value of goodwill for the purpose of the Paragraph B calculation will be a minimum of the Reserve Price less the market value of the tangible assets.

Is the Trading Company's goodwill property that was acquired before 20 September 1985?

83. It is necessary to consider the acquisition date of the goodwill for the purposes of the application of paragraph 104-230(2)(b) of the ITAA 1997.

84. In this regard, section 109-10 of the ITAA 1997 sets out specific rules for the circumstances in which, and the time at which, you acquire a CGT asset otherwise than as a result of a CGT event happening.

85. Item 1 of section 109-10 of the ITAA 1997 provides that if you create a CGT asset and you own it when the CGT asset is created, you acquire the CGT asset at the time the work that resulted in its creation started. If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts the work that results in the creation of the goodwill.

86. In the current circumstances, the Trading Company commenced business before 20 September 1985 and therefore on face value its goodwill should be considered to have been acquired at this time.

87. Taxation Ruling TR 1999/16 Income Tax: capital gains: goodwill of a business (TR 1999/16) deals with CGT issues relating to the goodwill of a business. TR 1999/16 reflects the decision of the High Court of Australia in FC of T v Murry 98 ATC 4585; (1998) 39 ATR 129.

88. Paragraph 89 of TR 1999/16 states that the goodwill of a business that commenced before 20 September 1985 remains a pre-CGT asset provided the same business continues to be carried on. As stated at paragraph 17 of TR 1999/16, this principle holds even though:

(a) the sources of the goodwill of a business may vary during the life of the business; or

(b) there are fluctuations in goodwill during the life of the business.

89. As such, any accretion to its goodwill since 20 September 1985 will not be a post-CGT asset, provided the same business is being carried on.

90. Whether the same business is being carried on is a question of fact and degree that ultimately depends on the circumstances of each particular case.

91. Factors to consider include the nature or character of the business, its location and size; its customer base; the extent of changes in the assets and resources of the business; the activities of the business and whether the activities constitute, or are treated by the business owner as constituting separate or distinct activities, enterprises, divisions or undertakings and the way in which the business is structured, carried on, managed and controlled (refer to paragraphs 62 and 91 to 95 of TR 1999/16).

92. Paragraph 21 of TR 1999/16 provides that the business does not need to be identical from its acquisition to its disposal. If the essential nature or character of the business is not changed, the business remains the same business for the CGT goodwill provisions. A business owner may expand or contract activities, or change the way in which a business is carried on, without ceasing to carry on the same business provided the business retains its essential nature or character. Organic growth, expansion or diversification of a business by, for example:

(a) adopting new compatible operations;

(b) servicing different clients; or

(c) offering improved products or services

does not of itself cause it to be a new business provided the business retains its essential nature or character.

93. Paragraph 24 of TR 1999/16, however, provides the same business is not carried on if:

(a) through a planned or systematic process of change within a reasonable period of time, a business changes its essential nature or character, or

(b) there is a sudden and dramatic change in the business brought about by either the acquisition or the shedding of activities on a considerable scale.

94. Based on the information provided, it is evident that the Trading Company's business has developed and expanded since 1985 as it has:

• increased its customer base both domestically and internationally;

• increased the number of staff employed in its business;

• increased its business asset base;

• adopted various new processes and activities;

• produced and sold some new products; and

• acquired and disposed of a number of operating sites throughout Australia.

95. Nonetheless, it is considered that these changes represent organic growth and expansion of the Business that has not changed the character of the goodwill or its ownership because none of the expansions, growth, acquisitions or disposals changed the essential nature or character of the business, being 'processing and wholesale marketing'. Trading Company continues to carry on the same business as demonstrated by the following features:

• the Business has maintained its primary focus on processing and wholesale marketing of its products;

• the trading name of the business has not changed;

• the business structure, management and control has remained largely unchanged;

• the business has been headquartered continuously in the same city; and

• the business has not been supplemented through the acquisition of other businesses nor have divestments of entities or significant assets used in the Business occurred.

96. Accordingly, despite the developments and expansion of the Business over the years from 1985 to the present, the goodwill of the business is taken to have been acquired before 20 September 1985, and is therefore considered to be a pre-CGT asset.

Paragraph B calculation - percentage of the net value represented by post-CGT assets

97. All the tangible assets and property in the Family Group, of which Head Company is the head company, are post-CGT assets.

98. The net value of Head Company has been determined on the basis of the minimum reserve price set by Head Company's shareholders for the sale of 100% of their shares. The difference between the net value and the tangible assets is considered to be Head Company's goodwill. That goodwill is considered to be a pre-CGT asset.

99. The percentage of Head Company's net value that is represented by post-CGT assets for the purposes of the calculation required by paragraph 104-230(2)(b) of the ITAA 1997 is less than 50%. As this percentage will not be at least 75% of the net value of Head Company, the test contained in paragraph 104-230(2)(b) of the ITAA 1997 will not be satisfied.

Conclusion

100. Based on the above analysis, CGT event K6 will not happen in relation to the shares in Head Company at the time of entry into the Proposed Share Sale Agreement as the percentage of post CGT assets that are represented in Head Company's net value, calculated pursuant to paragraphs 104-230(2)(a) and 104-230(b) and subsection 104-230(2) of the ITAA 1997, does not exceed 75%.

Question 5

Summary

101. The proceeds from the Proposed Share Sale will not be included in the assessable income of Shareholder X.

Detailed reasoning

102. The Proposed Share Sale involves the sale of all the shares in Head Company. Shareholder X owns 100 redeemable preference shares which were acquired in the 19Z0s pursuant to a share issue by Head Company.

103. The Head Company Shares have been held by Shareholder X at all times since their acquisition on capital account and not on revenue account or as part of a profit making scheme.

104. The shares held by Shareholder X have been continuously held as a long term investment for the purposes of capital growth.

105. Shareholder X does not hold an extensive asset portfolio which is traded continuously and all the shares they hold and have held have been for long term capital growth and income returns.

Assessable income

106. Assessable income consists of income according to ordinary concepts ('ordinary income') and other amounts which are included in assessable income under the provisions of the ITAA 1936 or ITAA 1997 ('statutory income'). Statutory income includes net capital gains under section 102-5 of the ITAA 1997.

Ordinary income

107. Ordinary income is defined in subsection 6(1) of the ITAA 1936 as having the same meaning as defined in the ITAA 1997. Section 6-5 of the ITAA 1997 provides that ordinary income is 'income according to ordinary concepts' and that assessable income of Australian residents includes 'the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year'.

108. As the shares were acquired as a long term investment for the purposes of capital growth and have, at all times, been held on capital account and not on revenue account or as part of a profit making scheme, it is therefore reasonable to describe the proceeds of the Proposed Share Sale as being capital in nature.

109. The High Court in the Federal Commissioner of Taxation v Myer Emporium Ltd 163 (1987) CLR 199 (the Myer case) stated:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization.

110. Despite the legislation not providing a specific definition of whether a receipt is income or capital, there is a considerable amount of case law that explains the distinction between the two types of receipts. In particular, in Federal Commissioner of Taxation v. Smith (1981) 11 ATR 538, 81 ATC 4114, Gibbs, Stephen, Mason and Wilson JJ use the analogy of a tree and its fruit. The Justices explain that capital can be likened to the tree, with an ability to earn in the future. Fruit on the other hand demonstrates characteristics more similar to income; it is the fruit that is derived periodically and bears a direct relationship to some investment (the tree).

111. In the current circumstances, shares in Head Company constitute the 'tree' while dividends arising from an entitlement arising from holding those shares would constitute the 'fruit'.

112. The proceeds from the Proposed Share Sale will therefore not be ordinary income for the purpose of section 6-5 of the ITAA 1997.

Statutory income

113. Statutory income is defined in subsection 6(1) of the ITAA 1936 as having the same meaning as defined in the ITAA 1997. Subsection 6-10(2) of the ITAA 1997 provides:

Amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income.

114. Note 2 to subsection 6-10(2) of the ITAA 1997 provides a reference to section 10-5 of the ITAA 1997 which provides a summary list of statutory income provisions provided in the ITAA 1997 and the ITAA 1936. This list includes three provisions relevant to treatment of receipts of the Proposed Share Sale. These provisions are:

• section 15-15 of the ITAA 1997 relating to profit-making undertakings or plans;

• section 25A of the ITAA 1936 relating to sale of property acquired before 20 September 1985 for profit-making by sale; and

• section 102-5 of the ITAA 1997 relating to capital gains.

Operation of section 15-15 of the ITAA 1997

115. Subsection 15-15(1) of the ITAA 1997 provides that 'your assessable income includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan'.

116. Subsection 15-15(2) of the ITAA 1997 however limits the operation of this provision as it states that:

This section does not apply to a profit that:

(a) is assessable as ordinary income under section 6-5; or

(b) arises in respect of the sale of property acquired on or after 20 September 1985.

Operation of section 25A of the ITAA 1936

117. Subsection 25A(1) of the ITAA 1936 provides:

The assessable income of a taxpayer shall include profit arising from the sale by the taxpayer of any property acquired by the taxpayer for the purpose of profit-making by sale, or from the carrying on or carrying out of any profit-making undertaking or scheme.

118. As previously highlighted, the High Court in the Myer case stated:

It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization.

119. The Myer case establishes that a 'profit-making undertaking or plan' (for the purpose of section 15-15 of the ITAA 1997) and 'the purpose of profit-making by sale' for the purpose of section 25A of the ITAA 1936 does not encompass circumstances where an asset that is to be realised was acquired with no intention of 'the purpose of profit-making by sale'.

Conclusion re the application of section 15-15 of the ITAA 1997 and section 25A of the ITAA 1936

120. Neither section 15-15 of the ITAA 1997 or section 25A of the ITAA 1936 will apply to the sale of Shareholder X's shares in Head Company because:

• Shareholder X is not carrying on, nor will they carry out, a profit-making undertaking or plan;

• any gain made on the Proposed Share Sale of the Head Company shares will arise from the realisation of a capital asset and will not be a gain in the nature of a profit arising from a profit-making undertaking or plan.

• Shareholder X did not acquire the Head Company shares for the purposes of profit-making by sale; and

• the Head Company shares were acquired prior to 20 September 1985.

121. Shareholder X did not acquire the shares with the intention or purpose of making a profit from their sale. The shares are not revenue assets of the shareholder on other grounds as they are not held as part of a business or an isolated business venture. Shareholder X is not in the business of selling shares. Rather the profit made on the sale of the shares is a 'mere realization' and a capital and not an income receipt.

Section 102-5 of the ITAA 1997

122. As detailed in question 1 in this ruling, any capital gain or capital loss from the sale of Shareholder X's shares in Head Company will be disregarded (pursuant to paragraph 104-10(5)(a) of the ITAA 1997) for the purpose of determining whether there is a taxable capital gain arising from CGT event A1. This is due to these shares having been acquired prior to 20 September 1985.

123. It is also noted that, as detailed in questions 2 and 3 in this ruling, the pre-CGT status of the shares held by Shareholder X will not be altered though the application of subdivision 149-B of the ITAA 1997.

124. Further, as detailed in the response to question 4 in this ruling, it is considered that the requirements in section 104-230 of the ITAA 1997 will not be met such that no capital gain will arise from CGT event K6 happening as a result of the proposed sale of Shareholder X's shares in Head Company.

125. On this basis, it is therefore considered that no capital gain or capital loss will arise as a result of the Proposed Share Sale that, in turn, may be taken into account when determining whether a net capital gain will be included in assessable income for the purposes of the calculation in section 102-5 of the ITAA 1997.

Conclusion

126. The Sale Proceeds will not be included in the assessable income of Shareholder X as they will not be ordinary income pursuant to section 6-5 of the ITAA 1997 or statutory income pursuant to section 6-10 of the ITAA 1997

Question 6

Summary

127. The Sale Proceeds will not be included in the net income of the trust estate of the Head Family Trust, calculated in accordance with subsection 95(1) of the ITAA 1936.

Detailed reasoning

128. The Proposed Share Sale involves the sale of all the shares in Head Company.

129. The Head Company shares have been held on capital account and not on revenue account or as part of a profit making scheme by the trustee of the Head Family Trust at all times since their acquisition.

130. The shares held by the trustee of the Head Family Trust have been continuously held, since their acquisition in the 19Z0s, as a long term investment for the purposes of capital growth.

131. The trustee of the Head Family Trust does not hold an extensive asset portfolio which is traded continuously and all the shares it holds, and has held, have been for long term capital growth and income returns.

Net income under subsection 95(1) of the ITAA 1936

132. The 'net income' in relation to a trust estate is determined in accordance with subsection 95(1) of the ITAA 1936 and means:

… the total assessable income of the trust estate calculated under the Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except deductions under Division 393 of the Income Tax Assessment Act 1997 (Farm Management Deposits) and except also, in respect of any beneficiary who has no beneficial interest in the corpus of the trust estate, or in respect of any life tenant, the deductions allowable under Division 36 of the Income Tax Assessment Act 1997 in respect of such of the tax losses of previous years as required to be met out of corpus.

133. Assessable income consists of income according to ordinary concepts ('ordinary income') and other amounts which are included in assessable income under provisions of the ITAA 1936 or ITAA 1997 ('statutory income'). Statutory income includes net capital gains under section 102-5 of the ITAA 1997.

134. The proceeds of the Proposed Share Sale received by the trustee of the Head Family Trust are the same in character and origin as those to be paid to Shareholder X. They will therefore not be assessable for the same reasons the proceeds of the Proposed Share Sale received by Shareholder X will not be assessable income, as articulated in the response to and detailed reasoning for question 5 of this ruling.

Question 7

Summary

135. The proceeds of the Proposed Sale (or any amount received in relation to or in respect of the Sale Proceeds) will not be included in the net income of the Head Family Trust (including under section 6-5 of the ITAA 1997). Consequently no portion of the net income that relates to the Sale Proceeds will be assessed to the trustee of the Head Family Trust pursuant to sections 99 and 99A of the ITAA 1936.

Detailed reasoning

136. Sections 99 and 99A of the ITAA 1936 provide for certain amounts of the net income of the trust estate to be assessed to a trustee (who is liable to pay tax on such income) as if it were the income of an individual who was a resident and were not subject to any deduction.

137. The proceeds of the Proposed Sale (or any amount received in relation to or in respect of the Sale Proceeds) will not be included in the net income of the Head Family Trust (including under section 6-5 of the ITAA 1997). Consequently no portion of the net income that relates to the Sale Proceeds will be assessed to the trustee of the Head Family Trust pursuant to sections 99 and 99A of the ITAA 1936.

Question 8

Summary

138. The Proposed Capital Distribution will not be included in the assessable income of the Immediate Family pursuant to the following provisions:

(a) section 97 of the ITAA 1936;

(b) section 99B of the ITAA 1936; or

(c) section 104-70 of the ITAA 1997; or

(d) section 6-5 of the ITAA 1997.

Detailed reasoning

139. The trustee of the Head Family Trust intends to treat the Sale Proceeds as part of 'the corpus of the Trust Fund' as permitted by the Head Family Trust deed.

140. The trustee of the Head Family Trust then will resolve, prior to the end of 30 June of the income year in which the Proposed Sale occurs that it will pay or apply the Sale Proceeds to the Immediate Family equally in accordance with the trust deed (referred to as the Proposed Capital Distribution).

Section 97 of the ITAA 1997

141. Where a beneficiary is presently entitled to a share of the income of a trust estate, paragraph 97(1)(a) of the ITAA 1936 requires that the beneficiary includes that share of the trust's net income in their assessable income.

142. As previously detailed in question 6 of this ruling, it is considered that the Sales Proceeds will not form part of the 'net income of the trust estate' (including under section 6-5 of the ITAA 1997). It therefore follows that the distribution of the Sale Proceeds by the trustee of the Head Family Trust, in the form of the Proposed Capital Distribution, will not be assessable to the beneficiaries of the Head Family Trust because it is not referrable to the trust's net income.

Section 99B of the ITAA 1997

143. Subsection 99B(1) of the ITAA 1936 provides for the inclusion, in the assessable income of a beneficiary of a trust, amounts paid to that beneficiary at any time during a year of income.

144. However, subsection 99B(1) of the ITAA 1936 is qualified by subsection 99B(2) of the ITAA 1936 which broadly reduces the amount included in the assessable income of the beneficiary to the extent that it represents:

• corpus of the trust estate - but not an amount that is attributable to income derived by the trust estate which would have been included in the assessable income of a resident taxpayer had it been derived by that taxpayer;

• an amount that would not have been included in the assessable income of a resident taxpayer had it been derived by that taxpayer

• an amount that is or has been included in the assessable income of the beneficiary under section 97 of the ITAA 1936

• an amount that has been assessed to either the trustee of the trust or the trustee of another trust under Division 6 of Part III of the ITAA 1936, or

• an amount that has been included in the assessable income of a taxpayer under Division 6AAA of Part III of the ITAA 1936.

145. The Proposed Capital Distribution will consist of 'property of the trust estate' and the distribution to the Immediate Family will constitute a payment or application for the benefit of these beneficiaries for the purposes of subsection 99B(1) of the ITAA 1936. The total amount of the Proposed Capital Distribution will however be reduced to nil, pursuant to subsection 99B(2) of the ITAA 1936, because:

• the Proposed Capital Distribution is attributable to corpus of the Head Family Trust; and

• is an amount that, if it had been derived by a resident taxpayer would not have been assessable income because:

(a) it is considered to be capital in nature and therefore not ordinary income (see the detailed reasoning for question 5 in this ruling for discussion regarding the characterisation of the distributions arising from the Proposed Share Sale); and

(b) any capital gain arising from the distribution will be disregarded because the relevant CGT asset was acquired prior to 20 September 1985 (see the detailed reasoning for questions 1 to 4 in this ruling for discussion regarding the CGT implications arising from the Proposed Share Sale).

Section 104-70 of the ITAA 1997

146. Section 104-70 of the ITAA 1997 provides that CGT Event E4 occurs if:

(a) the trustee of a trust makes a payment in respect of a taxpayer's unit or interest in the trust; and

(b) some or all of the payment (referred to as the "non-assessable part" is not included in the assessable income of the taxpayer.

147. The Commissioner's view of how this provision applies to payments made to a beneficiary of a discretionary trust is set out in Taxation Determination TD 2003/28 Income tax: capital gains: does CGT event E4 in section 104-70 of the Income Tax Assessment Act 1997 happen if the trustee of a discretionary trust makes a non-assessable payment to: (a) a mere object; or (b) a default beneficiary? (TD 2003/28). In this regard, TD 2003/28 explains that CGT event E4 does not occur in these circumstances because the interests of a mere object or a default beneficiary of a discretionary trust are not of a 'nature' or 'character' as required by paragraph 104-70(1)(a) of the ITAA 1997 (paragraph 3 of TD 2003/28).

148. In the current circumstances, the Immediate Family, as mere objects of a discretionary trust, will become entitled to the Proposed Capital Distribution as a consequence of the trustee of the Head Family Trust exercising the absolute discretion provided the Head Family Trust deed in their favour. On this basis, it follows that CGT event E4 will not occur in relation to the receipt of the Proposed Capital Distribution by the Immediate Family and Descendants.

Section 6-5 of the ITAA 1997

149. It is also considered that the Proposed Capital Distribution received by the Immediate Family and Descendants will not be assessable under section 6-5 of the ITAA 1997 because it is not income according to ordinary concepts.