Edited version of your written advice

Authorisation Number: 1051186046858

Date of advice: 6 February 2017

Ruling

Subject: Capital Gains Tax - Roll-overs

Question 1

Will a CGT event happen for the shareholders when the company constitution is modified?

Answer

No

Question 2

Can the shareholders obtain CGT roll-over relief under section 124-240 of the ITAA 1997 when their existing shares are cancelled and they are issued with new shares in consideration?

Answer

Yes

Question 3

Does section 124-190 of the ITAA 1997 apply to the shareholder when title to an individual lot is transferred to them?

Answer

Yes

This ruling applies for the following period

Year ending 30 June 2017

The scheme commenced on

1 July 2016

Relevant facts

The Company was incorporated after 20 September 1985. In the year following incorporation the Company acquired a piece of land.

The original share structure for the company was:

After receiving the approval for the multiple occupancy arrangement, occupancy rights were issued to each of the initial shareholders.

The occupancy rights were subsequently reflected by the issue of D class shares, which resulted in the share structure of the company being as follows:

The company constitution does not provide 'occupancy rights' under any of the share classes (including the D class shares).

New shareholders

Person F was admitted as a shareholder. They were issued 2 D class shares to notionally reflect his occupancy right over his particular 'lot' on the land. They paid $ to the company in subscribing for their 2 D class shares. They commenced building a dwelling on their 'lot' within a year of purchasing the shares. However, the dwelling was not completed.

The share structure of the company at that time was as follows:

About 5 years later, Person F transferred their 2 D class shares to Person G. Person G subsequently completed the dwelling and commenced living on the 'lot'.

Person H and Person I were admitted as shareholders in the same year. They were each issued with 1 D class share to notionally reflect their occupancy right over a 'lot' on the land.

The 'original' shareholder group was issued additional D class shares at around the same time. This was to satisfy the Council) requirements for the granting of community title in respect of the land, which required occupancy rights to be present for all 'lots'.

Person H and Person I each paid $ to the company in subscribing for their D class shares (i.e. $ in total as a couple).

The share structure at that time was as follows:

The land continued to be held as a single title (and it still does at the present point in time). However, the land had been 'notionally' dissected into the following 'lots':

In 201X, Person C and Person D transferred their notional occupancy rights in respect of Lot 7 to Person J. They paid $ for 2 D class shares which provided occupancy rights in relation to the notional lot 7.

The share structure of the company after the transfer was as follows (and remains as follows):

All current shareholders are residents of Australia for tax purposes.

This resulted in the notional lots being held as follows:

The following shareholders are married/de-facto partners:

● Person I and Person H

● Person C and Person D; and

● Person B and Person A.

There is no relationship between any of the other shareholders.

The current directors of the Company are:

● Person G;

● Person I;

● Person A;

● Person B

● Person D;

● Person C; and

● Person E.

The Land

The Company is the owner of approximately 100 acres of land situated in a relevant State or Territory (the Land). When it was acquired, the Land consisted of a single title and had 1 building entitlement on it. The Land was purchased by the company using funds contributed from the personal savings of the original shareholders. The company did not borrow any money to purchase the land.

The land was acquired with the intention of allowing numerous individuals to occupy a parcel of rural land under a multiple occupancy arrangement. The multiple occupancy arrangement was to enable participants to enjoy a rural lifestyle, noting that they would not have the financial capacity to acquire such a parcel of land on their own.

Since it was acquired, the Land has been held under a single title. With the support of the Council, the company applied to the relevant State or Territory Court to have the Land approved for multiple occupancy. The land was approved by the relevant State or Territory Court for a Multi-Occupancy development consisting less than 10 dwellings and a community facility (the MO Approval). Since this time the land has been 'notionally' dissected to reflect the MO Approval into distinct 'lots', each of which is capable of separate and independent occupation.

The multiple occupancy arrangement did not result in a subdivision of the Land. The Land continues to consist of a single title at the present point in time. The proposed community title arrangement will result in the subdivision of the land into separate lots (each on a separate title), which are subject to the terms of the community title rules.

The land is the only asset that has ever been owned by the company. The company has never completed any 'similar' transactions to what has been proposed. The Company has never undertaken any activities other than holding the land.

Given the length of time that the Land has been owned by the company, it is difficult to precisely identify the timing and amount of expenditure that has been incurred on the land. However, examples of capital expenditure include:

● The construction of dwellings which are occupied by the owners (and partial construction of dwellings on other lots, that are not yet occupied), including tree removal and earthworks;

● Expenditure on council development applications, plans, consultant reports, consultants, surveys, legal advice, etc. associated with the process in gaining approval for the community title arrangement; and

● Road maintenance and improvements, electricity, etc.

The above expenses have generally been paid by the shareholders:

● Directly in respect of expenses relating to their particular 'lot' on the land; and

● Based on an agreed percentage based on improvements to the common property (e.g. roads).

Subsequent to the acquisition of the land, a number of practical issues have arisen with the arrangement, and it has become evident that the present situation is not practical (or desirable) moving forward. These issues are:

● Legal advice has identified that the company constitution does not align with the manner in which the company is being operated. The existing constitution does not provide shareholders with any particular rights in relation to the land;

● Banks are unwilling to lend money to individuals for the purpose of acquiring an interest in the land (via the shares). This limits the number of people who are able to acquire an interest in the land. In effect, it is only those individuals who have accumulated savings (without needing to borrow) who can practically acquire an interest in the land;

● Further, banks are unwilling to lend money to existing shareholders in order to construct dwellings on the land. Even if a bank was willing to lend, under the present arrangement the company would be the borrower and all of the land would be provided as security for the borrowing. This is not desirable, practical or feasible given the different owners and the different parts of the land being used for different purposes.

● The inability to borrow means that some shareholders are unable to construct a dwelling on their part of the land, and thus they are unable to achieve their desired objective of living a rural lifestyle;

● Whilst shareholders are able to pass their shares in the company to their beneficiaries when they die, those shares do not provide the beneficiaries with an interest in the land. The shares merely provide the shareholders with a specified interest in the company (as set out in the company constitution); and

● Disputes between shareholders are less easily resolved, given the company ownership of all of the land, and the imprecise means of determining responsibility between the different shareholders.

Proposed Arrangement

The proposed arrangement is to amend the company constitution such that different classes of shares provide rights to occupy different parcels of land (then converted into separate titles under the community title arrangement).

After the constitution is changed, the owners of each 'lot' and the size of each lot will remain unchanged, from the current situation.

To date, the Company has been administered in a manner that is consistent with a 'company title' arrangement, whereby:

● Shareholders acquire a share in the Company;

● As the holder of the share, the shareholder has the right to occupy (and enjoy exclusive possession of) a particular 'lot' on the land;

● The shareholder is permitted to undertake improvements on their particular lot (for example, to construct a dwelling);

● Subject to any agreement to the contrary, the shareholder is required to fund all of the costs associated with the improvement and maintenance of their 'lot'; and

● All shareholders are required to contribute to fund maintenance costs associated with 'common property' on the Land (i.e. parts of the land that is not occupied by any particular shareholder).

The Council issued a consolidated development consent under DA reference SF10311 incorporating modifications to the original consent pursuant to a section 96 modification application (the Consent).

The Consent allows for the transfer of land into Community Title upon the construction of a dwelling on each lot in the subdivision. This will allow the individual 'lots' to be registered as separate legal property, each of which can be dealt with independently from the other parts of the Land albeit, subject to the terms of the Community Title arrangement. The conversion to Community Title will also result in the creation of an area of common property.

The Consent is given for development in two or more stages:

● Stage 1 - Lots 1 (Common Property) and Lots 3 and 4; and

● Stage 2 - Lots 2, 5, 6, 7, 8, 9 and 10.

Lots 3 and 4 already have dwellings constructed on the lots. The subdivision certificate for State 1 to convert into Community Title can be granted for Lots 1, 3 and 4 when the Council issues a final occupation certificate for each constructed dwelling. This could happen in the near future as the dwellings are already completed.

The subdivision certificate will not be released for State 2 until a final occupation certificate has been issued for each dwelling constructed in Stage 2. The conversion into Community Title for Stage 2 may not happen in the near future as according to the current Development Consent, each dwelling has to be approved and constructed. Notwithstanding the Development Consent, the Council has advised the Company that if Stage 2 needs to be extended to allow the Lots to be individually approved for community title as dwellings are constructed, then the Company will need to submit a section 96 amendment application to the Council for each Lot thus varying the Development Consent. This means, there could be as many as 9 stages in the development.

The conversion into Community Title will be for Land upon which there are buildings (not vacant land).

Company Constitution

The Company's constitution is not consistent with a 'company title' arrangement because it does not specifically provide the rights for the owners of particular shares to occupy particular 'lots' on the land.

Prior to proceeding with the conversion to Community Title, it will be necessary to amend the company constitution. This will align the Company's constituent documents with the manner in which the Company has been administered to the present point in time.

Specifically, the company constitution will be amended to:

● Align the Company's stated purposes with its actual activities in respect of the Land;

● Change the rights attaching to A class shares. The A class shares will provide the shareholder with an interest in the common property. A class shares will not provide shareholders with exclusive occupancy rights over the common property; and

● Change the rights attaching to other share classes (e.g. B class, C class). Each class of share will provide the relevant shareholder with rights to exclusive occupation of a specific 'lot' on the Land. For example, owners of B Class shares will have the right to occupy Lot 2, the owners of C class shares will have the right to occupy Lot 3. The rights of the existing D class shares will not be changed as part of the amendment to the constitution.

To align with the adoption of the new constitution, changes will be made to the shares that the company has on issue.

A class shares

At the present point in time A class shares are not owned by all shareholders.

To ensure that all shareholders have an interest in the common property, the company will issue new A class shares to those shareholders who do not currently hold A class shares. The A class shares will provide the shareholder with an interest in the common property. A class shares will not provide shareholders with exclusive occupancy rights over the common property.

One A class share will be issued in respect of each 'lot' on the land.

D class shares

At the present point in time, all shareholders own D class shares.

The company will cancel all of the D class shares that are currently on issue. This will be completed in a manner in accordance with the requirements of the Corporations Act 2001.

New Shares

In consideration for the cancellation of the D class shares, the Company will issue a new 'class' of shares to the existing shareholders.

Each shareholder will be issued with a class of share that carries with it the right to occupy their particular lot on the Land. That is, each shareholder group will receive a share in a different class.

At the present point in time, no shareholder has (notionally) been given exclusive occupancy rights over lot 5.

If a new participant is found prior to proceeding with the restructure, and they become a shareholder of the company, the shares relating to lot 5 will be issued to that person.

If no new participant is found prior to the restructure, the shares relating to lot 5 will be issued to the original shareholders:

● Person E;

● Person C and Person D; and

● Person B and Person A.

If the rights to lot 5 are eventually sold (i.e. the shares or the interest in the land itself is sold), the sale proceeds would be split between the above shareholders in the agreed proportions.

After the Community Title proposal is approved by Council, and the constitution and share structure has been modified (in the manner set out above) the Company proposes to transfer title to the specific lots to the shareholders.

This will involve the following transactions:

● The Company will cancel the shareholder's 'class' share, being the share that gives the holder the right to occupy a specific lot on the Land.

● In consideration for the cancellation of the class of share, the Company will transfer to the shareholder the title to the specific lot that they had the right to occupy. The lot that is transferred will continue to be subject to the terms of the Community Title arrangement; and

● The Company will continue to own the common property. Each shareholder will continue to own an A class share, which gives them rights in respect of the common property.

Other information

● There was no specific reason or purpose behind the purchase of the land in a company. At the time it was simply seen as the easiest way of allowing for multiple owners of the land under the multiple occupancy arrangement;

● The practical issues associated with the ownership of land via a company whilst attempting to facilitate a multiple occupancy arrangement have been problematic. These issues have been identified and growing over the more than 20 years that the company has owned the land;

● The underlying owners simply wish to continue owning their parcel of rural land, but in a way where they are able to actually deal with the land itself (for example, by including the land as an asset in their last will and testament);

● The land was not acquired, and is not held, for the purpose of resale for profit; and

● There is no profit making intention (or prospect) from the proposed arrangement.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Section 104-250

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 124-190

Income Tax Assessment Act 1997 Section 124-240

Income Tax Assessment Act 1997 Section 727-355

Income Tax Assessment Act 1997 Section 725-50

Income Tax Assessment Act 1997 Section 725-55

Income Tax Assessment Act 1997 Section 725-145

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1936 Section 160M

Income Tax Assessment Act 1936 former Section 160R

Reasons for decision

Will a CGT event happen for the shareholders when the company constitution is modified?

Part 3-1 of the ITAA 1997 contains the general CGT provisions of the income tax law.

Section 102-20 of the ITAA 1997 provides that you can make a capital gain or capital loss if and only if a CGT event happens. The capital gain or loss is made at the time of the CGT event. CGT events are detailed in Division 104 of the ITAA 1997.

Most CGT events involve a CGT asset. Subsection 108-5(1) of the ITAA 1997 provides that a CGT asset is any kind of property; or a legal or equitable right that is not property. The Land and the shares in the company are CGT assets.

CGT Event A1

Subsection 104-10(1) of the ITAA 1997 provides that:

CGT event A1 happens if you dispose of a CGT asset.

Subsection 104-10(2) of the ITAA 1997 provides that:

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.

As noted above, the shares are CGT assets. The individual shareholders only have ownership interests in their shares. The amendments to the Constitution will vary the rights attaching to the shares in the Company. Therefore, the relevant question is whether this variation of rights will constitute a disposal for the purposes of subsection 104-10(1) of the ITAA 1997.

The Commissioner has provided his opinion on whether a variation of rights attaching to shares will result in a disposal of shares in Taxation Ruling TR 94/30 Income tax: capital gains tax implications of varying rights attaching to shares. This ruling concerns Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936). Part IIIA which dealt with capital gains and losses has since been repealed and rewritten into the ITAA 1997.

In particular, disposals of an asset formerly covered under subsection 160M(1) of the ITAA 1936 are now captured by CGT event A1 under the ITAA 1997. Similarly, paragraph 108-5(2)(a) of the ITAA 1997, which replaces former section 160R of the ITAA 1936, ensures that part disposals of a CGT asset are also captured under CGT event A1.

In respect of former subsection 160M(1) and former section 160R of the ITAA 1936, paragraphs 8 to 9 of TR 94/30 state that:

8. A variation in rights attaching to a share... does not result in a full disposal of an asset for the purposes of Part IIIA unless there is a cancellation or redemption of the share. In determining whether a disposal has occurred under Part IIIA, it is not relevant to consider whether the variation is slight (such as a small change to the nominal value of shares) or more significant (such as disposing of the preference to receive dividends).

9. A variation in rights attaching to shares does not result in a part disposal of an asset under section 160R.

The amendments to Constitution will result in a variation of rights attaching to the shares. However, these variations will not result in a disposal of all or part of the shares in the Company. Therefore, the amendments to the Constitution will not cause CGT event A1 to happen.

CGT Event D1

Subsection 104-35(1) of the ITAA 1997 states that:

CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity.

The amendments to the Constitution will not result in the creation of a contractual right or legal or equitable right in another entity. The amendments will vary the rights attaching to the shares. However, this variation will not result in the creation of a relevant right in another entity for the purposes of CGT event D1.

In this respect, paragraph 10 of TR 94/30 provides that a variation in rights attaching to shares does not constitute a deemed disposal of shares under former subsection 160M(6) of the ITAA 1936. Former subsection 160M(6) of the ITAA 1936 has been rewritten into CGT event D1.

In relation to former subsection 160M(6) of the ITAA 1936, TR 94/30 further states at paragraph 45 that:

…The broad criteria which trigger the new subsections 160M(6) to 160M(6D) are that a person must create an asset, not being corporeal property, which on its creation is vested in another person. As all these requirements are not present when a company resolves to vary the rights attaching to its shares, the subsection will not apply.

Accordingly, the variation in rights attached to the shares will not result in the creation of a contractual right, or other legal or equitable right in another entity for the purposes of subsection 104-35(1) of the ITAA 1997 and CGT event D1 will not happen.

CGT Event K8

CGT event K8 occurs under certain direct value shift scenarios where value is shifted from equity or loan interests in a company or trust to other equity or loan interests in the same company or a trust. The equity or loan interest from which value is shifted away from is referred to as the 'down interest' and the equity or loan interest to which value is shifted to is referred to as the 'up interest'

Subsection 104-250(1) of the ITAA 1997 provides that:

CGT event K8 happens if there is a taxing event generating a gain for a down interest under section 725-245.

A direct value shift: section 725-145 of the ITAA 1997

Direct value shift is defined in section 725-145 of the ITAA 1997.

Subsection 725-145(1) states:

There is a direct value shift under a scheme involving equity or loan interests in an entity (the target entity) if:

(a) there is a decrease in the market value of one or more equity or loan interests in the target entity; and

(b) the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things, is done; and

(c) either or both of subsections (2) or (3) are satisfied.

Subsections 725-145(2) and 725-145(3) of the ITAA 1997 continue that:

One or more ^*equity or loan interests in the target entity must be issued at a ^*discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

Or, there must be an increase in the *market value of one or more ^*equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

'Scheme' is defined broadly in section 995-1 of the ITAA 1997 to mean any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. In the present case, there is a scheme.

Under the scheme, the value of the Class A shares will remain unchanged. Each Class A share gives the right to use common property, as every Class A share will have the same right that currently exists there will be no change in the value of these shares.

Under the scheme, the Class D shares will be cancelled and new shares will issue with a specific right to a particular lot. The right attached to the existing Class D shares include the underlying right to a specified portion of the assets of the Company. As there are currently 16 D class shares each share has the underlying right to 1/16^th of the assets of the Company, i.e. 1/16^th right to the value of Land. If the topographic properties of each notional lot was the same, given the different size of the lots, the underlying value of a share issued for any particular lot is likely to be different to 1/16^th value of the Land. This proposition that the value of the individual lots is unlikely to be 1/16^th of the Land value also holds given the different topographical nature of land. Therefore, the value shareholders are entitled to under the scheme is likely to change when new shares are issued.

Thus, there is a direct value shift under the scheme in accordance with section 725-145 of the ITAA 1997.

Consequences for a direct value shift: section 725-50 of the ITAA 1997

There can be consequences for a direct value shift where the conditions in section 725-50 of the ITAA 1997 are met. The section states:

A direct value shift under a scheme involving equity or loan interests in an entity (the target entity) has consequences for you under this Division if, and only if:

a. the target entity is a company or trust at some time during the ^*scheme period; and

b. section 725-55 (Controlling entity test) is satisfied; and

c. section 725-65 (Cause of the value shift) is satisfied; and

d. you are an *affected owner of a *down interest, or an *affected owner of an *up interest, or both; and

e. neither of sections 725-90 and 725-95 (about direct value shifts that are reversed) applies.

Note: For a down interest of which you are an affected owner, the direct value shift has consequences under this Division only if section 725-70 (about material decrease in market value) is satisfied.

Paragraph 725-50(a) of the ITAA 1997

The Company is the target entity during the scheme.

Paragraph 725-50(b) of the ITAA 1997

Section 725-55 of the ITAA 1997 contains the Controlling entity test and provides:

An entity (the controller) must *control (for value shifting purposes) the target entity at some time during the period starting when the *scheme is entered into and ending when it has been carried out. (The period is the scheme period)

Section 727-355 of the ITAA 1997 defines Control (for value shifting purposes) of a company. It provides three tests to determine Control:

1. 50% stake test

2. 40% stake test

3. Actual control test

The 50% stake test is described in subsection 727-355(1) of the ITAA 1997 and provides that an entity controls a company if the entity, or the entity and its associates between them:

a. can exercise, or can control the exercise of, at least 50% of the voting power in the company (either directly, or indirectly through one or more interposed entities); or

b. have the right to receive (either directly, or indirectly through one or more interposed entities) at least 50% of any dividends that the company may pay; or

c. have the right to receive (either directly, or indirectly through one or more interposed entities) at least 50% of any distribution of capital of the company.

The 40% stake test is described in subsection 727-355(2) of the ITAA 1997 and provides that an entity controls a company if the entity, or the entity and its associates between them:

a. can exercise, or can control the exercise of, at least 40% of the voting power in the company (either directly, or indirectly through one or more interposed entities); or

b. have the right to receive (either directly, or indirectly through one or more interposed entities) at least 40% of any dividends that the company may pay; or

c. have the right to receive (either directly, or indirectly through one or more interposed entities) at least 40% of any distribution of capital of the company;

unless an entity (other than the first entity and its associates) either alone or together with its associates in fact controls the company.

The actual control test is found in subsection 727-355(3) of the ITAA 1997 and provides that an entity controls (for value shifting purposes) a company if the entity, either alone or together with its associates, in fact controls the company.

As none of the shareholders and their associates meets the 40% stake test, nor do they actually control the Company, the controlling entity test is not satisfied, therefore any direct value shift under the scheme has no consequences.

Conclusion

Since the direct value shift has no consequences in this case as shown above, there is no CGT event K8.

Can the shareholders obtain CGT roll-over relief under section 124-240 of the ITAA 1997 when their existing shares are cancelled and they are issued with new shares in consideration?

Section 124-240 allows shareholders to choose a roll-over where there is an exchange of shares in the same company.

There are six conditions that must be met before the shareholder can choose the roll-over:

(a) the shareholder owns shares (the original shares) of a certain class in the company; and

(b) the company redeems or cancels all shares of that class; and

(c) the company issues new shares (and you receive nothing else) in substitution for the original shares; and

(d) the market value of the new shares just after they were issued is at least equal to the market value of the original shares just before they were redeemed or cancelled; and

(e) the paid-up share capital of the company just after the new shares were issued is the same as just before the original shares were redeemed or cancelled; and

(f) one of these requirements is satisfied:

iii. the shareholder is an Australian resident at the time of the redemption or cancellation; or

iv. if the shareholder is a foreign resident at that time - the original shares were taxable Australian property just before that time and the new shares are taxable Australian property when they are issued.

Conditions (a), (b), (c), (e), and (f) are met. The Commissioner accepts that the modifications to the company constitution and the changes to the share structure are simply for the purpose of confirming the pre-existing equitable rights of the company's shareholders. Therefore, the new shares will have the same market value as the shares that will be cancelled.

Accordingly, the shareholders are able to choose this roll-over.

Does section 124-190 of the ITAA 1997 apply to the shareholder when title to an individual lot is transferred to them?

Under section 124-190 of the ITAA 1997 you can choose to obtain a roll-over if:

(a) you own property that gives you a right to occupy a unit in a building; and

(b) the building's owner subdivides it into stratum units; and

(c) the owner transfers to you the stratum unit that corresponds to the unit you had the right to occupy just before the subdivision.

A stratum unit is a lot or unit (however described in an Australian law or a foreign law relating to strata title or similar title) and any accompanying common property.

The shares provide a right to occupy a particular lot; the company will transfer the lot to the corresponding shareholder. Accordingly, the individual shareholder can choose to obtain the roll-over.