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Date of advice: 27 March 2017

Ruling

Subject: Pre-CGT asset - Majority underlying interest

Question 1

Did the majority underlying interest in land purchased by Company A before 20 September 1985 change for the purposes of Division 149 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

1 July 2016 to 30 June 2017

1 July 2016 to 30 June 2018

1 July 2016 to 30 June 2019

1 July 2016 to 30 June 2020

1 July 2016 to 30 June 2021

The scheme will commence within five years

Relevant facts and circumstances

The Trust

The Trust was settled in 19XX by the Settlor for the benefit of their grandchild XZ, who was born in that year.

Pursuant to the deed of settlement, the trustee was required to hold the Trust Fund upon trust for XZ until they reached a certain age.

If XZ were not to survive until the specified age, the trustee was required to hold the Trust Fund upon trust for a sibling of XZ until they reached the required age.

The deed of settlement also provided the trustee with the power to add or to revoke any of the trustee's powers or discretions contained in the trust deed and any appointment made by said deed in favour of the beneficiary (XZ). However no such variation, addition or revocation could operate to give beneficial interest in the corpus of the trust fund to any person not related to the Settlor or XZ by blood or marriage.

No discretions were exercised to appoint other beneficiaries or amend the deed.

Shares in Company B formed part of the Trust Fund.

The Trust vested when XZ turned a specific age in 19YY.

Company B

Company B was incorporated in 19XX.

From the time of incorporation to just before 20 September 1985, the company issued A,B,C,D,E and H class shares.

The following rights are attached to the shares:

A Class Shares

● Entitled to be paid out of the profits of Company B a fixed cumulative preferential dividend at the rate of X percent per annum on the capital for the time being paid up or credited as paid up thereon in priority to any payment of dividend on shares on any other classes;

● Entitled in the event of winding up to rank for payment firstly of capital paid up on the shares and secondly for payment of any dividends or arrears in priority to any payment of capital in respect of shares of any other class but without any further right to participate in profits or assets; and

● Entitled to receive notice to attend and vote at any meeting of the company.

B,C,D, and E Class Shares:

● Entitled to such dividends as may be declared from time to time out of profits of the company, subject to the payment of any dividends or arrears of dividends payable on A Class shares;

● No entitlement to receive notice of or to attend or to vote at any meeting of Company B;

● In the event of Company B going into liquidation, the B,C,D and E Class shares rank equally.

H Class Shares:

● Redeemable Preference Shares and have rights to receive dividends, no voting rights and have rights to payment of capital in the event of Company B going into liquidation.

Just before 20 September 1985, the shareholding and beneficial ownership of Company B was as follows:

Share Class	No.	Shareholder	Ultimate Owner
A Class	1	Trustee	XZ
A Class	1	Accountant of Trustee	XZ
B Class	1	Trustee	XZ
C Class	1	Trustee	XZ
D Class	1	XY	XY
E Class	1	Trustee	XZ
H Class	1	Company C	XZ (50%) XY (50%)

All shares held were held in their capacity as trustee for the Trust and held for the benefit of XZ.

The Accountant of the Trustee was the accountant who had arranged for the incorporation of the Company. As was common practice at the time, they held the shares on behalf of and under the instruction of the trustee of the Trust. The accountant had no beneficial interest in the A Class share they held.

XY is the sibling of the Trustee and relative of XZ.

Company C is a company that is 50% owned by XZ and 50% owned by XY.

In late 19YY, The Trustee transferred each A,B,C and E Class to XZ.

In mid 20ZZ, the Accountant of the Trustee transferred the A Class share to XZ.

In late 20ZZ, a share split occurred. Each A,B,C,D, E and H class share was split on a 1 to 1,000 basis. No change in ultimate beneficial ownership occurred.

In mid 20AA, all H Class shares were redeemed by the company.

In mid 20AA, XZ sold the following shares to Company D:

● XXX A Class Shares

● YYY B Class Shares

● YYY C Class Shares

● YYY E Class Shares

No information on the underlying beneficial ownership of Company D was provided.

The current shareholders of Company B are as follows:

Company A

Company A acquired various land (the Land) in State prior to 19 September 1985.

The Land was 100% beneficially owned by Company A from the time of acquisition to the present and therefore the income derived from the land was applied for the benefit of Company A and its shareholders.

Just before 20 September 1985, Company A had the following shares on issue:

In 20ZZ, the redeemable preference shares were reclassified to become Ordinary Shares. Company A therefore had HHHHH Ordinary Shares on issue of which KKKKK were held by Company B

In late 20ZZ, Company C transferred its Ordinary Share to Company B. Since that time, Company A has been a 100% subsidiary of Company B.

In mid 20AA, Company B and Company A formed a tax consolidated Group.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 149-30

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1936 former section 160ZZS

Income Tax Assessment Act 1936 former subsection 160ZZS(1)

Income Tax Assessment Act 1936 former subsection 160ZZRR(1)

Reasons for decision

Division 149 of the ITAA 1997 (Division 149) contains the rules stipulating when an asset stops being a pre-CGT asset.

Section 149-10 of the ITAA 1997 defines what is meant by a pre-CGT asset:

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 Income Tax Assessment Act 1936; or

(ii) Subdivision C of Division 20 of former Part IIIA of that Act;

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.

Therefore, once it is established that the asset has been acquired before 20 September 1985, it is necessary to consider if former subsection 160ZZS(1) of the ITAA 1936 would apply. This subsection deals with changes in majority ownership of an asset, between 19 September 1985 and 30 June 1998. It states the following:

For the purposes of the application of this Part in relation to a taxpayer, an asset acquired by the taxpayer on or before 19 September 1985 shall be deemed to have been acquired by the taxpayer after that date unless the Commissioner is satisfied, or considers it reasonable to assume, that, at all times after that date when the asset was held by the taxpayer, majority underlying interests in the asset were held by natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset.

The terms 'majority underlying interests' is defined in subsection 160ZZRR(1) of the ITAA 1936:

majority underlying interests , in relation to an asset, means more than one-half of:

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

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

Note that this subsection requires that the majority underlying interest be traced to a natural person.

The Commissioner can 'look through' an entity to determine who are the natural persons who hold beneficial interests in assets, as stated in paragraph 2 of Income Tax Ruling IT 2340 (IT 2340):

'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 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. However for the purposes of Division 149, the beneficiary of a discretionary trust is taken to have a beneficial interest in the assets of a company.

IT 2340 states the following at par 5 and 6:

In relation to what are generally referred to as discretionary trusts, i.e. family trusts, the trustees of which have discretionary owners 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.

Where a trustee continues to administer a trust for the benefit of members of a particular family, for example it will not bring section 160ZZ 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.

ATO Interpretive Decision ATO ID 2003/778 (ATO ID 2003/778) further clarifies this:

'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.

Taxation Ruling IT 2340 reflects on an approach of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936), which preceded Division 149 of the ITAA 1997, is reflected in Taxation Ruling IT 2340. Among other issues, IT 2340 deals with questions regarding the application of section 160ZZS of the ITAA 1936 'to assets held by trustees of family trusts where the trustees are vested with discretionary powers as to distributions from the trusts.'

….

Taxation Ruling IT 2340 correctly reflects the position that section 160ZZS of the ITAA 1936, by its terms, necessarily supplants normal legal concepts of interests in assets. For the purposes of section 160ZZS, a beneficiary of a discretionary trust is treated as having a beneficial interest in the trust's assets. Likewise, a shareholder is treated for the purposes of section 160ZZS of the ITAA 1936 as having a beneficial interest in the company' assets.'

If it has been determined that the the entity was not taken under former subsection 160ZZS(1) of the ITAA 1936; to have acquired the asset on or after 20 September 1985, then Section 149-15 of the ITAA 1997 must be considered to determine whether the asset will continue to be a pre-CGT asset.

(Note that subdivision C of Division 20 of former part IIIA of the ITAA 1936 applies to public entities and does not apply to the current circumstances.)

In relation to the income years from 1999 onwards, subsection 149-15(1) of the ITAA 1997 defines “majority underlying ownership” 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 income that may be derived from that asset.'

Subsection 149-15(2) defines an underlying interest as a beneficial interest, directly or indirectly, in the asset or any ordinary income that may be derived from the asset.

An 'ultimate owner' is defined to include an individual - refer subsection 149-15(3) of the ITAA 1997.

Subsections 149-15(4) and (5) describes an indirect beneficial interest:

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.

             (5)  An * ultimate owner indirectly has a beneficial interest in ordinary income that may be derived from 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 a dividend or income if:

                     (a)  the other entity were to pay that dividend, or otherwise distribute that income; and

                     (b)  the dividend or income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner.

A change in the proportions in which majority underlying interests are held in a pre-CGT asset will not cause the land to stop being a pre-CGT asset. This is demonstrated in para10 of Income Tax Ruling IT 2530 (IT 2530):

If natural persons who immediately before 20 September 1985 held more than one half of the underlying interests in an asset continue to hold more than one half of the underlying interests at all times on and after that date, there will be no change in the majority underlying interests in the asset for the purposes of section 160ZZS. In these circumstances a change in the proportions in which the natural persons held interests in the asset would not have a bearing on the application of section 160ZZS. The following example illustrates this point:

● Immediately before 20 September 1985 underlying interests in an asset of a company were owned by four natural persons in the following proportions -

 A - 90%

 B - 5%

 C - 3%

 D - 2%.

● Following a change in the shareholding of the company after 20 September 1985, the underlying interests in the asset were owned by natural persons in the following proportions -

 A - 1%

 B - 2%

 C - 48%

 D - 0%

 E - 49%.

● The natural persons who owned underlying interests both immediately before 20 September 1985 and after the change in ownership were A, B and C. Immediately before 20 September 1985 A, B and C between them owned more than one half of the underlying interests (i.e., 98%). After the change A, B and C between them still owned more than one half of the underlying interests (i.e., 51%). Accordingly, more than one half of the underlying interests in the company's asset continued to be held by the same persons. Section 160ZZS would therefore not apply to deem the asset acquired by the company before 20 September 1985 to have been acquired on or after that date.

Application to your circumstances:

(i) The Land

The Land was purchased by Company A prior to 20 September 1985. It was beneficially owned by Company A and therefore the income derived from the land was applied for the benefit of Company A and its owner, Company B. The indirect beneficial interest in the Land and the ordinary income that may be derived from it belongs to the shareholders of Company B.

(ii) The vesting of the Trust

The Trust was set up for the benefit of XZ in 1962. Shares in Company B, held by the Trustee and the Accountant of the Trustee formed part of the trust fund.

Although the deed of settlement provided the Trustee to appoint additional or alternative beneficiaries, these beneficiaries could only be relatives of XZ or her grandfather, the Settlor. However he trustee did not exercise a discretion to appoint any beneficiary other than XZ.

Therefore, in accordance with IT 2340 and ATO ID 2003/778, XZ maintained the underlying beneficial ownership in the shares in Company B included in the trust fund - and accordingly in the Land - from the date of settlement of the Trust. The vesting of the Trust in 1992 did not lead to a change in underlying ownership.

There was no change in underlying ownership between 19 September 1985 and 30 June 1988 for the purposes of former subsection 160ZZS(1) of the ITAA 1936.

The subsequent transfer of shares in Company B from the Trustee and the Accountant of the Trustee to XZ in 1998 and 20ZZ, giving effect to the vesting of the Trust, also did not lead to a change in underlying ownership.

(iii) Change in ownership as a result of the sale of shares to Company D

Just before 20 September 1985, the shareholdings in Company A and Company B were as follows:

Company A:

Share Class	No.	Shareholder	Ultimate Owner
Ordinary	EEEEE	Company B	XZ and XY
Redeemable Preference	FFFFF	Company B	XZ and XY
Redeemable Preference	1	Company C (owned by XZ and XY at 50% each)	XZ and XY

Company B:

Share Class	No.	Shareholder	Ultimate Owner	Majority Underlying Interest of share class
A Class	1	The Trustee	XZ	100%
A Class	1	Accountant to the Trustee	XZ	100%
B Class	1	The Trustee	XZ	100%
C Class	1	The Trustee	XZ	100%
D Class	1	XY	XY	100%
E Class	1	The Trustee	XZ	100%
H Class	1	Company C	XZ (50%) XY (50%)	50% 50%

XZ and XY were the ultimate owners of 100% of the shares and therefore held 100% of the underlying beneficial interest in the Land.

In mid 20AA, XZ sold a number of shares to Company D, and since then the share ownership in Company A and Company B is as follows:

Company A: 100% held by Company B.

Company B:

Share Class	Total shares on issue	Ultimate Owner	Shares held	Underlying Interest of share class
A Class	CCCC	XZ Company D	AAAA XXX	51% 49%
B Class	DDDD	XZ Company D	BBB YYY	51% 49%
C Class	DDDD	XZ Company D	BBB YYY	51% 49%
D Class	DDDD	XY	DDDD	100%
E Class	DDDD	XZ Company D	BBB YYY	51% 49%
H Class	0	-	-	n/a

There are different rights attached to Class A shares as opposed to class B,C, D and E shares as set out in the facts. Therefore the classes of shares do not carry equal weight in determining underlying beneficial ownership of the Land and income derived from it.

However, in each of the share classes of Company B, the percentage holding by XZ and/or XY is at least 51% at present. As Company B owns 100% of shares in Company A, XZ and XY continue to hold more than 50% of the underlying beneficial ownership of the Land.

The majority underlying ownership in the Land has been maintained in accordance with Section 149-15 of the ITAA 1997. Accordingly, as the requirements of Section149-10 are satisfied the Land continues to be a pre-CGT asset for the purposes of Division 149 of the ITAA 1997.