Edited version of your written advice

Authorisation Number: 1013131014286

Date of advice: 25 November 2016

Ruling

Subject: The distribution of liquidation proceeds

Question 1

Will the capital gain made by the Proprietary Limited on the Land under the Contract of Sale be disregarded pursuant to subsection 104-10(5) of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

(a) Will the capital gain made by the Proprietary Limited on the goodwill of the Business under the Sale of Business Agreement be disregarded pursuant to subsection 104-10(5) of the Income Tax Assessment Act 1997?

(b) Will for the purposes of Part 3-1 of the Income Tax Assessment Act 1997 the capital proceeds for the Goodwill in the consideration for sale under the Sale of Business Agreement be the value attributed to the asset in the professional valuation report?

Answer

(a) Yes

(b) Yes

Question 3

Will distributions to the trustees as shareholders under a voluntary liquidation funded out of the following components of the capital profits reserve:

1) (1) the capital gain on the sale Land; and

2) (2) the capital gain on the sale the goodwill

not be treated as payments of amounts representing income derived by the company and consequently subsection 47(1) of the Income Tax Assessment Act 1936 will not apply to those payments?

Answer

Yes

Question 4

Will the liquidator distributions:

(a) in the hands of the trustees as shareholders, be treated as the proceeds of:

(i) CGT event C2 to the extent the distribution is a final distribution; or

(ii) CGT event C2 to the extent the distribution is an interim distribution and the Proprietary Limited is dissolved within 18 months of that distribution being made; or

(iii) CGT event G1 to the extent the distribution is an interim distribution and the Proprietary Limited is not dissolved within 18 months of that distribution being made?

(b) to the extent these payments exceed the cost of the shares in the hands of the trustees, be taken to be capital gains which would be disregarded by operation of subsections 104-25(5) or 104-135(5) of the Income Tax Assessment Act 1997 on the basis that their shares in the Proprietary Limited are pre-CGT assets in their hands?

(c) on payment to beneficiaries by the trustees, not be assessable income of the beneficiary?

Answer

(a) Yes

(b) Yes

(c) Yes

This ruling applies for the following periods:

01/07/2014 to 30/06/2015

01/07/2015 to 30/06/2016

01/07/2016 to 30/06/2017

The scheme commences on:

1 July 2014

Relevant facts and circumstances

Since before September 1985 and until liquidation the family trusts equally held the ordinary shares on issue in the Proprietary Limited and the family members each held a share in the trustee company.

There have been no amendments to the terms of the family trusts. Nor have there been any amendments to the named beneficiary or class of beneficiaries specified in the trusts.

The Proprietary Limited was the registered proprietor of the Land and owner of a Business operating on the Land. The nature of the business has never changed.

The buildings were built on the land before September 1985 and have not been enlarged by any repairs or refurbishments as necessary from time to time, but with one exception that cost $100,000 in 2007. At no point in time up to the disposal of the land were any further capital works undertaken.

In the 2015 income year the Proprietary Limited executed without a condition precedent to becoming operative a Contract of Sale for the land and a Sale of Business Agreement. The Sale of Business Agreement was silent on the break-up of the purchase price.

A professional valuation was prepared for the business and its components.

Following the receipt of the proceeds of sale, there will be a winding-up of the Proprietary Limited and a distribution of the capital proceeds to the trustees as shareholders and thereon to the family beneficiaries.

Relevant legislative provisions

Income Tax Assessment Act 1997 Paragraph 108-5(2)(b)

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

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

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

Income Tax Assessment Act 1997 Subsection 108-70(2)

Income Tax Assessment Act 1997 Subsection 109-5(1)

Income Tax Assessment Act 1997 Subsection 104-25(3)

Income Tax Assessment Act 1997 Subsection 104-25(5)

Income Tax Assessment Act 1997 Subection 104-135(3)

Income Tax Assessment Act 1997 Subection 104-135(5)

Income Tax Assessment Act 1997 Subection 104-135(6)

Income Tax Assessment Act 1997 Subsection 124-10(4)

Income Tax Assessment Act 1997 Subsection 124-140(1)

Income Tax Assessment Act 1997 Subsection 149-30(2)

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-135

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 108-85

Income Tax Assessment Act 1997 Section 116-40

Income Tax Assessment Act 1997 Section 149-30

Income Tax Assessment Act 1997 Division 104 of Part 3-1

Income Tax Assessment Act 1997 Division 149 of Part 3-3

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1936 Subsection 47(1)

Income Tax Assessment Act 1936 Subsection 47(1A)

Income Tax Assessment Act 1936 Subsection 95(1)

Income Tax Assessment Act 1936 Subsection 97(1)

Income Tax Assessment Act 1936 Section 47

Income Tax Assessment Act 1936 Section 101

Reasons for decision

Issue 1

The pre-CGT status of the land for the capital gain on disposal

Question 1

Summary

The land is a pre-CGT asset and the capital gain is disregarded

Detailed reasoning

The CGT events for which a capital gain or loss can be made are set out in Division 104 of Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997). Section 104-10 provides in so far as relevant:

A CGT asset is by virtue of section 108-5 of the ITAA 1997 any kind of property or a legal or equitable right that is not property. A list of examples of CGT assets in Note 1 to that provision includes 'land and buildings'.

In accordance with subsection 109-5(1) of the ITAA 1997 in general you acquire a CGT asset when you become its owner.

A capital improvement to a CGT asset acquired before 20 September 1985, that is not related to any other capital improvement to the asset, may be seperate CGT asset by virtue of subsection 108-70(2) of the ITAA 1997:

The Contract of Sale, without a condition precedent to the agreement becoming operative as a contract, was executed for property consisting of land including all improvements and fixtures.

Proprietary Limited disposed of the land under the Contract of Sale in accordance with subsection 104-10(2) of the ITAA 1997 (Allina Pty Ltd v FC of T 91 ATC 4195). The land including all improvements and fixtures is a CGT asset under section 108-5.

However, Proprietary Limited acquired the land in 1969 and added the building improvements in 1979. The only capital improvement on or after 19 September 1985 has been enclosing of an outdoor terracced dining area. That improvement is not a separate CGT asset under subsection 108-70(2) of the ITAA 1997 because when disposal occurred its cost base was less than the improvement threshold for the disposal income year 2015 of $140,443. In addition, the cost base of the capital improvement was not more than 5% of the capital proceeds from the disposal of the land.

Nevertheless, a CGT asset can stop being a pre-CGT asset (an asset acquired prior 20 September 1985) by virtue of a change in its majority underlying interests in accordance with Division 149 of Part 3-3 of the ITAA 1997. The relevant provisions provide:

149-15(2)  An underlying interest in a *CGT asset is a beneficial interest that an *ultimate owner has (whether directly or *indirectly) in the asset or in any *ordinary income that may be *derived from the asset.

149-15(4)  An *ultimate owner indirectly has a beneficial interest in a *CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of the capital of the other entity if:

(a) the other entity were to distribute any of its capital; and

(b) the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

Issue 2

The capital gains on disposal of the goodwill of the Business and the apportionment of the capital proceeds for the Goodwill under the Sale of Business Agreement.

Question 2

Summary

(a) The goodwill of the Business is a pre-CGT asset and the capital gain is disregarded on disposal;

(b) The capital proceeds for the Goodwill under the Sale of Business Agreement is the value attributed to that asset in the professional valuation report.

Detailed reasoning

Taxation Ruling TR 1999/16 provides in so far as relevant:

15. Goodwill is a species of intangible property. It can only exist in connection with the conduct of a business, even though it may not necessarily appear in the books of account and financial statements of the business.

16 ..... Goodwill of a business is a single CGT asset for the purposes of Part 3-1.

17. The whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset (subject to Division 149 - about when an asset stops being a pre-CGT asset - see paragraph 90) provided the same business continues to be carried on. This is so 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.

18. A business or the sources of its goodwill may change so much it can no longer be said to be the same business as that previously conducted. In other words the old business ceases and a new business commences. If this happens the goodwill of the original business ceases to exist and a new CGT asset - being the goodwill of the new business - is acquired.

20. 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. The test to use for whether the same business is being carried on is not the same test as that described in paragraphs 9 and 10 of Taxation Ruling TR 95/31 for continuity of business in applying the tax loss provisions in subsection 165-210(1).

21. 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 .

22. Nor would it be a different business if all that happens is that portions of the operations of a business are discarded in an ordinary commercial way but the business retains its essential nature or character.

23. If the types of customers a business attracts change as the business evolves over the years, this does not necessarily mean the business is no longer the same business as was originally carried on.

24. It is not sufficient, however, if just a similar kind of business is carried on. It must be a business of the same essential nature or character that is carried on. 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.

25. The whole of the goodwill of a business is either pre-CGT goodwill (subject to Division 149 - about when an asset stops being a pre-CGT asset - see paragraph 90) or post-CGT goodwill. The goodwill of a particular business cannot be characterised as partly pre-CGT goodwill and partly post-CGT goodwill. Goodwill is a composite asset.

50. If goodwill is acquired on the acquisition of a business under a contract, the purchaser acquires it on the date the contract is entered into (subsection 109-5(2), event A1, case 1).

60. If a new business operation or activity introduced by a taxpayer is an expansion of an existing business (whether it commenced before or after 20 September 1985), any goodwill built up in conducting the expanded business is merely an expansion of the existing goodwill of the business. If a business which commenced before 20 September 1985 (a 'pre-CGT business') is expanded, goodwill generated in conducting the expanded business is merely an accretion to the pre-CGT goodwill.

61. If an introduced business activity is a new business, the goodwill attaching to that business is a new asset separate from the goodwill of the existing business.

62. Whether an increase in business operations or in the scale of activity constitutes an expansion of an existing business, or a new and separate business in its own right, is a question of fact dependent on the circumstances of each particular case. Factors that need to be considered in determining whether the business operation or activity is part of the existing business or is a new business include the nature of the new business operation or activity, the types of customers that the business operation or activity attracts and the extent to which the business operation or activity:

(a) is subject to the same integrated management and control as the existing business;

(b) is treated for banking and accounting purposes as an extension of the existing business or as a separate business;

(c) uses one or more different trading names; and

(d) is related to or dependent on the existing business in a practical, economic or commercial sense.

Proprietary Limited acquired the Business prior to Septrember 1985 and it is concluded any goodwill disposed under the Sale of Business Agreement is the same single pre-CGT asset because the same business continued to be carried on by Proprietary Limited, notwithstanding the sources of the goodwill varied in that time.

The goodwill did not stop being a pre-CGT asset under Division 149 of Part 3-3 of the ITAA 1997 because, in accordance with subsection 149-30(2), the Commissioner is satisfied, or thinks it reasonable to assume, that at all times on and after 20 September 1985 and before the disposal, the majority underlying interests in the assets were had by the ultimate owners who had majority underlying interests in the assets immediately before disposal.

Pursuant to subsection 104-10(5) of the ITAA 1997 any capital gain made on the disposal of the goodwill under the Sale of Business Agreement is disregarded.

The Sale of Business Agreement was silent on the break-up of the purchase price. The applicable rules in Part 3-1 of the ITAA 1997 for apportioning capital proceeds is provided in section 116-40:

116-40(1) If you receive a payment in connection with a transaction that relates to more than one *CGT event, the capital proceeds from each event are so much of the payment as is reasonably attributable to that event.

116-40(2) If you receive a payment in connection with a transaction that relates to one *CGT event and something else, the capital proceeds from the event are so much of the payment as is reasonably attributable to the event.

The capital proceeds for the Goodwill in the consideration for sale under the Sale of Business Agreement is reasonably attributed in accordance with the market value attributed to that asset in the professional valuation report.

Issue 3

Subsection 47(1) of the Income Tax Assessment Act 1936 and distributions by a liquidator under a voluntary liquidation funded out of the disregarded capital gains on the disposal of the land and the goodwill.

Question 3

Summary

Distributions under a voluntary liquidation funded out of the capital gains on the sale of the land and goodwill will not be treated as payments of amounts representing income derived by the company and consequently subsection 47(1) of the Income Tax Assessment Act 1936 will not apply to those payments.

Detailed reasoning

Section 47 of the Income Tax Assessment Act 1936 (ITAA 1936) provides in so far as relevant:

47(1A)  A reference in subsection (1) to income derived by a company includes a reference to:

(a) an amount (except a net capital gain) included in the company's assessable income for a year of income; or

(b) a net capital gain that would be included in the company's assessable income for a year of income if the Income Tax Assessment Act 1997 required a net capital gain to be worked out as follows:

Method statement

The phrase 'capital gain that is disregarded' is not defined for the purposes of section 47 of the ITAA 1936. The High Court unanimously said in CIC Insurance Ltd v Bankstown Football Club Ltd [1997] HCA 2; 187 CLR 384 at 408:

[T]he modern approach to statutory interpretation (a) insists that the context be considered in the first instance, not merely at some later stage when ambiguity might be thought to arise, and (b) uses “context” in its widest sense to include such things as the existing state of the law and the mischief which, by legitimate means such as those just mentioned, one may discern the statute was intended to remedy.

More recently the High Court in FCT v Consolidated Media Holdings Ltd [2012] HCA 55 (at [39]) stated in a unanimous judgement:

This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the [statutory] text. So must the task of statutory construction end. The statutory text must be considered in its context. That context includes legislative history and extrinsic materials. Understanding context has utility if, and in so far as, it assists in fixing the meaning of the statutory text. Legislative history and extrinsic materials cannot displace the meaning of the statutory text. Nor is their examination an end in itself.

The context of the phrase 'capital gain that is disregarded' includes the other provisions of the ITAA 1936 and the ITAA 1997, more relevantly the capital gains scheme or measures in the ITAA 1997. The words in the phrase 'capital gain that is disregarded' are used in subsection 104-10(5) of the ITAA 1997 in reference to a capital gain from an asset acquired before 20 September 1985.

It is concluded that the ordinary meaning of the phrase 'capital gain that is disregarded' in subsection 47(1A) in the ITAA 1936 in the context includes a capital gain that is disregarded by virtue of subsection 104-10(5) of the ITAA 1997, that is a capital gain from an asset acquired before September 1985.

This outcome is consistent with that in Taxation Determination TD 2001/14 for the 'exempt' 50% component of a capital gain attributable to goodwill when distributed by a liquidator in the course of winding up.

In Taxation Determination TD 95/10 the Commissioner provides:

The [Archer Brothers] principle is that if a liquidator appropriates (or 'sources') a particular fund of profit or income in making a distribution (or part of a distribution), that appropriation ordinarily determines the character of the distributed amount for the purposes of section 47 and other provisions of the Income Tax Assessment Act 1936 (the Act). Generally, we accept that a liquidator may rely on the Archer Brothers principle, except where a specific provision in the Act produces a different result (e.g., the rules in section 160ZLA that specify the order in which different types of funds are distributed).

It follows, where the capital gains on the sale of land and the goodwill are disregarded by virtue of subsection 104-10(5) of the ITAA 1997, that distributions by the liquidator appointed by Proprietary Limited under a voluntary liquidation to the shareholders in Proprietary Limited that are funded out of the capital gains on the sale of the land and the goodwill in its capital profits reserve will not be treated as payments of amounts representing income derived by the company and consequently subsection 47(1) of the ITAA 1936 will not apply to those payments.

Issue 4

The operation of subsections 104-25(5) or 104-135(5) of the ITAA 1997 disregarding the capital gains of the trustees of the family trusts as shareholders on the liquidator distributions and the assessable income on payment to the beneficiaries of the family trusts.

Question 4

Summary

Those liquidator distributions:

(a) in the hands of the trustees of the family trusts as shareholders will be treated as the proceeds of:

(i) CGT event C2 to the extent the distribution is a final distribution; or

(ii) CGT event C2 to the extent the distribution is an interim distribution and the Proprietary Limited is dissolved within 18 months of that distribution being made; or

(iii) CGT event G1 to the extent the distribution is an interim distribution and the Proprietary Limited is not dissolved within 18 months of that distribution being made; and

(b) to the extent these payments exceed the cost of the shares in the hands of the trustees of the family trusts, will be taken to be capital gains which would be disregarded by operation of subsections 104-25(5) or 104-135(5) of the ITAA 1997 on the basis that their shares in the Proprietary Limited are pre-CGT assets in their hands; and

(c) on payment to the beneficiaries by the trustees of the family trusts, will not be assessable income of the beneficiary.

Detailed reasoning

Taxation Determination TD 2001/27 provides that section 104-25 of the ITAA 1997 applies to the full amount of distribution made by a liquidator on the winding-up of a company as it constitutes capital proceeds from the happening of a CGT event C2 when the company ceases to exist in accordance with the Corporations Act 2001 after the winding-up. However, under section 104-135 an interim distribution not taken to be a dividend under section 47 of the ITAA 1936 may be at the time of payment a CGT G1 event and the non-assessable part may result in a capital gain if more than the share's cost base. But section 104-135 does not apply to a payment by a liquidator by virtue of subsection 104-135(6) if the company ceases to exist within 18 months of the payment.

Section 104-25 of the ITAA 1997 provides (in so far as relevant):

104-25(3) You make a capital gain if the *capital proceeds from the ending are more than the asset's *cost base. You make a capital loss if those capital proceeds are less than the asset's *reduced cost base.

Exceptions

In accordance with plain terms of subsections 104-25(3) and 104-25(5) of the ITAA 1997, a liquidator's distribution that is the capital proceeds of a CGT event C2 and are more than the assets's cost base, result in a capital gain that is disregarded if the CGT asset is acquired before 20 September 1985.

Similarily, in accordance with plain terms of subsections 104-135(3) and 104-135(5) of the ITAA 1997, a liquidator's distribution that is the non-assessable part of a CGT event G1 and are more than the assets's cost base, result in a capital gain that is disregarded if the CGT asset is acquired before 20 September 1985.

Where a trustee of a family discretionary trust makes distributions a beneficiary is assessable under subsection 97(1) of the Income Tax Assessment Act (ITAA 1936) on that share or percentage (if any) of the trust's net income (commonly known as the taxable income) that accords with the share of the income of the trust estate (also known as distributable income) to which the beneficiary is present entitled in the income year. A beneficiary may be presently entitled to trust income under section 101 of the ITAA 1936 where the trustee pays or applies the income to the beneficiary.

The trust's taxable income is defined in subsection 95(1) of the ITAA 1936 which states (as far ar relevant):

net income, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except ….

It follows that the net income of the family trusts will not include either liquidator distributions of capital proceeds that are capital gains not included in assessable income by virtue of subsection 104-25(5) or subsection 104-135(5) of the ITAA 1997 and to which subsection 47(1) of the ITAA 1936 will not apply, nor capital gains disregarded by operation of subsections 104-25(5) or 104-135(5) of the ITAA 1997 on the basis that shares in hands of the trustee are pre-CGT assets.

In addition, the beneficiaries will not be present entitled to income by virtue of the trustees of the family trusts paying the liquidation proceeds to the beneficiaries as capital.

However, if trustees of the family trusts have other amounts that are assessable income, beneficiaries presently entitled to trust income may have assessable income in accordance with subsection 97(1) of the ITAA 1936.

It is concluded, for the liquidator distributions that it has been determined subsection 47(1) of the ITAA 1936 will not apply, that are:

(i) final distributions, will be treated as the proceeds of CGT event C2;

(ii) interim distributions, will be treated as the proceeds of CGT event C2 if

Proprietary Limited ceases to exist within 18 months of the distribution;

(iii) interim distributions that include a non-assessable part, will be treated as the

proceeds of CGT event G1 if Proprietary Limited does not cease to exist within

18 months of the distribution;

(b) to the extent these payments exceed the cost of the shares in the hands of the trustees of the family trusts, will be taken to be capital gains which would be disregarded by operation of subsections 104-25(5) or 104-135(5) of the ITAA 1997 on the basis that their shares in the Proprietary Limited are pre-CGT assets in their hands; and

(c) on payment to the beneficiaries by the trustees of the family trusts, will not be assessable income of the beneficiary.