Edited version of your written advice

Authorisation Number: 1051340371992

Date of advice: 20 February 2018

Ruling

Subject: Continuity of ownership

Question 1

Will capital and revenue losses incurred by X Pty Ltd be taken to satisfy the continuity of ownership test by the application of the provisions of section 165-205 of the Income Tax Assessment Act 1997, if the rights which attach to the Life Governor’s Share are amended in accordance with the Notice of Meeting and the Special Resolution?

Answer

Yes - the continuity of ownership test will be satisfied.

Subject: Value Shifting

Question 2

Will an amendment to the Articles of Association of X Pty Ltd, in accordance with the Notice of Meeting, and the Special Resolution, give rise to a capital gain under section 725-245 or a taxable gain under section 725-335 of the Income Tax Assessment Act 1997, on a revenue asset or trading stock?

Answer

No – the value shifting provisions will not apply.

This ruling applies for the following periods:

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

The scheme commences on:

1 July 2017

Relevant facts and circumstances

● X Pty Ltd (X) was incorporated on DDMMYY. It is the Head Company of a tax consolidated group.

● The original Memorandum of Association and Articles of Association are dated DDMMYY. The Articles of Association were amended in December 199X.

● The original authorised capital of the Company is $1 million divided into 1 million shares of $1 each, of which:

● Share Number 111 shall be known as ‘the Life Governor’s Share’

● Share Number 112 shall be known as ‘the A Share’

● Share Numbers 1 to 110 and 113 to 1,000,000 (both numbers inclusive) shall, until otherwise decided by the Directors or by the Company in General Meeting be Ordinary Shares.

● The issued capital is held as follows:

● The Life Governor’s Share is held by Y. This share has the right in every general meeting and on every poll to seventy six votes out of every one hundred votes cast

● The A Class Share is held by Z. The A Class Share has no special rights, so it is treated for all purposes as an ordinary share

● 538 ordinary shares, held as follows

● 178 by Z

● 360 by the six adult children of Y and Z who each hold 60 shares.

● Under Article 5 of the X Articles of Association, upon the death of Y, the rights attaching to the Life Governor’s Share terminate and the Life Governor’s Share becomes a Special Share. Under Article 5A, a Special Share has the following rights:

● the right to receive a non-cumulative dividend of 5 per cent per annum on the paid up capital after all other dividends have been paid

● a right to a return of capital after all other capital is repaid

● no right to vote.

● You have proposed to amend the Articles of Association to delete the restrictions on the Life Governor’s Share, so that the rights attaching to the share do not terminate on death of Y or on Y disposing of the share.

● The methods you have proposed to amend the Articles of Association are:

● a Notice of Meeting in relation to the proposed amendment of shares, and

● a Special Resolution in relation to the changes to rights attaching to the Life Governor’s Share, and deleting Article 5A which applies to Special Shares.

● Article 5 of the Articles of Association would be amended to read

“The Life Governor’s Share shall have attached to it the rights qualities and privileges following that is to say:

(a) The right for the holder at any time by notice in writing to the Company to nominate a person to take office as a Director and to hold such office so long as the holder allows and at any time by notice in writing to the Company to remove, replace or resign, and at any time to take office again and whilst holding such office to be Chairman of the Board and to exercise all of the powers authorities and discretions vested in the Directors generally, and all the other Directors, if any, for the time being of the Company shall be under his control and shall be bound to conform to his directions in regard to the Company’s business.

(b) The right for the holder from time to time and at any time by notice in writing to the Company to appoint any other persons to be Directors of the Company and to define limit and restrict their powers and (subject to the approval of the Company in General Meeting) to fix and determine their remuneration and duties and by notice in writing to the Company at any time to remove any director howsoever appointed.

(c) The right, whether the holder is or is not a director, for the holder through its nominee to attend and vote either in person or by proxy at all meetings of the Directors of the Company and to have due notice of all such meetings but any proxy must be appointed in writing under the hand of the appointor.

(d) The right at any time to convene a general meeting.

(e) The right in every respect of the Life Governor’s Share at any general meeting and on every poll to seventy six votes out of every one hundred votes cast.

(f) The right at any time to take up any unissued shares in the original capital of the Company.

(g) The right quality or privilege that it shall not be extinguished on a reduction of the capital of the Company without the consent in writing of the holder.

The rights qualities and privileges attached to the Life Governor’s Share or conferred upon the holder shall be fundamental and shall not be altered varied abrogated or diminished except with the previous consent in writing of the holder.”

● You have proposed, that by the terms of a Codicil to Y’s Will, that when Y dies, the Life Governor’s Share, as an asset in his estate, will pass to V Pty Ltd legally and beneficially as a beneficiary under Y’s Will.

● X has capital losses and income tax losses.

Relevant legislative provisions

Income Tax Assessment Act 1997

Division 165

Section 165-205

Division 725

Section 725-245

Section 725-335

Section 995-1

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Under the company loss deduction rules contained in Division 165 of the Income Tax Assessment Act 1997 (ITAA 1997), a company is able to deduct prior year losses, or apply capital losses, only if it satisfies the continuity of ownership test or the same business test.

When determining whether a company can utilise prior year losses under the continuity of ownership test, the ownership test period commences at the start of the year in which the losses were incurred, and ceases at the end of the year in which the losses are being recouped.

Private companies must be able to demonstrate that they satisfy the primary test.

To satisfy the continuity of ownership test, the same persons must have:

● more than 50% of the company's voting power; and

● the rights to more than 50% of the company's dividends; and

● the rights to more than 50% of the company's capital distributions.

The three conditions are cumulative and failure to satisfy any one of them will lead to a failure of the continuity of ownership test, and disallowance of the prior year losses.

Under the ‘same share’ test, a person's share in the company is only counted for the continuity of ownership test if the person holds exactly the same shares throughout the relevant period. ‘Share’ is defined in section 995-1 of the ITAA 1997 as a share in the capital of the company.

The death of a shareholder does not necessarily break the continuity of ownership test.

Under section 165-205 of the ITAA 1997, shares beneficially owned by a person who dies are taken to continue to be beneficially owned by the deceased, so long as they are owned by the trustee of the deceased’s estate or are beneficially owned by a person who receives the shares as a beneficiary of the estate. The deceased person is also taken to have retained all voting power, dividend entitlements, and rights to capital distributions.

Y’s Life Governor’s Share, whilst Y remains alive, entitles Y to seventy six votes out of every one hundred votes cast, and upon Y’s death the Life Governor’s Share reverts to a Special Share with no right to vote. Therefore the requirement for the right to exercise more than 50% of the voting power in the company is failed, and as one condition of the test is failed, the continuity of ownership test is failed.

You have proposed an amendment to the X Articles of Association to delete the restrictions on the Life Governor’s Share, so that the rights attaching to the share do not terminate on the death of Y or on Y disposing of the share. Consequently, Article 5A, which relates to Special Shares, would become redundant.

Based on your proposal, Article 5 would be amended (by a Special Resolution) and the whole of Article 5A would be deleted.

You have proposed that by the terms of a Codicil to Y’s Will, when Y dies, the Life Governor’s Share is to pass to V Pty Ltd legally and beneficially.

Accordingly, X will satisfy the continuity of ownership test and will be able to deduct prior year revenue and capital losses. This is because section 165-205 of the ITAA 1997 deems Y as continuing to be the beneficial owner of the Life Governor’s Share, retaining all voting power, dividend entitlements, and rights to capital distributions conferred by it.

The question then arises whether the passage of a Special Resolution of shareholders to effect the amendments to Article 5 and 5A constitutes a value shift under Division 725 of the ITAA 1997.

The main object of the direct value shifting provisions contained in Division 725 of the ITAA 1997, is to prevent inappropriate losses from arising on the realisation of equity or loan interests, from which value has been shifted to other equity or loan interests in the same entity, and to prevent inappropriate gains from arising on the realisation of equity or loan interests in the same entity to which the value has been shifted.

Broadly, a value shift occurs when something is done, that results in the value of one asset decreasing and the value of another increasing.

The value of the Life Governor’s Share, issued at a subscription price of one dollar, does not have any value shifted out of it on the passing of the proposed Special Resolution. Under the proposed Special Resolution, the value of the share will continue to be what is was prior to the passing of the Special Resolution, as will the voting rights. There is no variation of share rights for one class of shares but not another. Given that the value of the share remains the same, there is neither a down interest, nor an up interest.

The provisions of Division 725 of the ITAA 1997 do not apply to the variation of rights in relation to the Life Governor’s Share upon the passing of the Special Resolution.