Edited version of your written advice

Authorisation Number: 1051360328762

Date of advice: 12 April 2018

Ruling

Subject: Capital gains tax

Question 1

Is the cost base of the shares acquired by the trustee on 1 July 2017 determined with reference to their market value at the time of acquisition for the purposes of the market value substitution rule in paragraph 112-20(1)(a) of the ITAA 1997?

Answer

Yes

Question 2

Will the Commissioner accept that the cost base of the shares acquired by the trustee on 1 July 2017, for the purpose of paragraph 112-20(1)(a) of the ITAA 1997, is the market value per the valuation report obtained?

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

A parcel of shares was transferred to the trustee on 1 July 20XX when it obtained a properly executed off-market share transfer form in registrable form.

Shareholders pre the transfer of their shares are unconnected with the trustee of the trust.

The shares are not listed on the ASX.

The trustee has provided a market valuation report which recommends a particular market value per share on 1 July 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997

subsection 102-25(1)

Division 104

subsection 104-10(1)

subsection 104-10(2)

subsection 104-10(3)

subsection 104-60(1)

subsection 104-60(2)

subsection 109-5(2)

paragraph 112-20(1)(a)

Reasons for decision

Question 1

Summary

Yes. For the purposes of the market value substitution rule in paragraph 112-20(1)(a) of the ITAA 1997 the cost base of the shares acquired by the trustee on 1 July 2017 is determined with reference to their market value on that date.

Detailed reasoning

Paragraph 112-20(1)(a) of the ITAA 1997 relevantly provides that the first element of the cost base and reduced cost base of a CGT asset you acquire from another entity is its market value (at the time of acquisition) if you did not incur expenditure to acquire it.

CGT event A1 happens if a taxpayer disposes of a CGT asset (subsection 104-10(1) of the ITAA 1997). There is a disposal of a CGT asset if a change of ownership occurs to another entity, whether because of some act or event or by operation of law (subsection 104-10(2)). If the disposal is not made under a contract, then CGT event A1 happens when the change of ownership occurs (subsection 104-10(3)). The time of acquisition of the asset by the trustee is when the disposal contract is entered into or, if none, when the entity stops being the asset's owner (subsection 109-5(2)).

CGT event E2 of the ITAA 1997 happens if a taxpayer transfers a CGT asset to an existing trust (subsection 104-60(1)). The time of the CGT event E2 is when the asset is transferred (subsection 104-60(2)). The time of the acquisition of the asset by the trustee is when the asset is transferred (subsection 109-5(2)).

Subsection 102-25(1) of the ITAA 1997 provides that where more than one of the CGT events outlined in Division 104 of the ITAA 1997 can apply in a situation, you use the CGT event that is most specific to your situation.

ATO ID 2003/559 provides an ATO view in relation to which of CGT event A1 or CGT event E2 of the ITAA 1997 is the most specific CGT event. It relevantly provides that:

On its face, CGT event E2 happens whenever an asset is transferred to a trust and is therefore the applicable event in this case. However, it is considered that CGT event A1 (rather than CGT event E2) is the most specific event where, as in this case, an asset is transferred to another party and the transferor is indifferent as to the identity of that party. That is, CGT event A1 is the most specific event where the parties are completely unconnected and are dealing with each other at arm's length.

In this case, the vendor knew that the purchaser was acting in a trustee capacity. But that will not always be the case. For example, the purchaser may be a nominee company formed for the purpose of acquiring property on behalf of others who do not want their identity revealed. Clearly, CGT event A1 is the most specific event in that case. There can be no question of CGT event E2 being the most specific event if the vendor does not know that the asset has been disposed of to a person acting in a trustee capacity.

Consistent with that outcome, CGT event A1 is considered the most specific event whenever the parties are unconnected. It would be inappropriate for a different CGT event to apply depending on whether the vendor knew the capacity in which the purchaser was acquiring the asset.

On the other hand, CGT event E2 will be the most specific event if, for example, an asset is transferred to a trust of which the transferor or an associate is a beneficiary or object.

In the facts at hand the shareholders pre the transfer of their shares are unconnected with the trustee of the trust. Therefore, CGT event A1 of the ITAA 1997 is the most specific CGT event in these circumstances.

Conclusion

The time of acquisition of the shares by the trustee is when the disposal contract is entered into or, if none, when the entity stops being the asset's owner (subsection 109-5(2) of the ITAA 1997). The trustee acquired the beneficial ownership of the shares, and the previous shareholders stopped owning them, when the trustee obtained a properly executed off-market share transfer form in registrable form (paragraph 24 of TR 2010/1) on 1 July 2017.

Paragraph 112-20(1)(a) of the ITAA 1997 relevantly provides that the first element of the cost base and reduced cost base of a CGT asset you acquire from another entity is its market value (at the time of acquisition) if you did not incur expenditure to acquire it.

Therefore, for the purposes of the market value substitution rule in paragraph 112-20(1)(a) of the ITAA 1997 the cost base of the shares acquired by the trustee on 1 July 2017 is determined with reference to their market value on that date.

Question 2

Summary

Yes. As the market valuation report satisfies the requirements of the ATO publication ‘Market valuation for tax purposes’ it is reasonable to accept the market valuation in that report.

Detailed reasoning

Guidance on the process to establish a market value for various taxation purposes is contained in the ATO publication ‘Market valuation for tax purposes’.

The shares in the company are unlisted. In relation to valuing unlisted shares the ATO website relevantly states (Valuation of securities) that when valuing an unlisted share, the ATO would expect a number of factors to be taken into account which may have an effect on market value, including many of the factors described in the ATO guidance on the valuation of a business.

In relation to the question of the market value of the shares on 1 July 2017 it is noted that the process undertaken by the valuer in the preparation of its market valuation report satisfies the requirements of the ATO publication ‘Market valuation for tax purposes’ as:

● The valuation was undertaken by a valuer that holds an AFS Licence allowing them to operate a financial services business and provide financial product advice on, amongst other things, securities.

● The valuer is an approved valuer on the ATO valuation panel, and the employees involved in preparing the valuation report have appropriate professional qualifications.

● The valuation process has been adequately documented.

● The valuation has been prepared on an objective basis and independent of the interests of the party commissioning the report.

● The valuation has determined the market value on the basis of the 'highest and best use' of the asset.

● The ordinary meaning of the term ‘market value’ as per Spencer’s case has been correctly incorporated having regard to the fact that the off-market share transfers occurred between arm’s length parties acting at arm’s length.

● The valuation takes an approach that is consistent with ATO guidance on the valuation of a business as recommended by the ATO in relation to valuing unlisted shares. In this regard, the valuation has considered a number of factors that may affect the market value and has produced a reasonable and defensible view of the market value.

As the market valuation report satisfies the requirements of the ATO guidelines as espoused in the publication ‘Market valuation for tax purposes’, it is reasonable to accept that the market value of a share on 1 July 2017 as concluded in the market valuation report.