Edited version of your written advice

Authorisation Number: 1051486917712

Date of advice: 25 February 2019

Ruling

Subject: The merger between Foreign Holdings and Foreign Sub

Question 1

Will a CGT event occur under Division 104 of the Income Tax Assessment Act 1997 (ITAA 1997) when the ForeignCo common shares are converted to a single series of common shares and split under the proposed ForeignCo share reorganisation?

Answer

No

Question 2

As a result of the merger between Foreign Holdings and Foreign Sub, are the shares of ForeignCo treated as disposed of by Foreign Sub to Foreign Holdings, thereby resulting in CGT event A1 (per section 104-10 of the ITAA 1997) for the purposes of calculating the attributable income to be included in AusCo’s assessable income under section 456 ITAA 1936?

Answer

Yes

Question 3

As a result of the merger, does CGT event C2 (per section 104-25(1) of the ITAA 1997) happen as a result of Foreign Sub’s shares held by Foreign Holdings being cancelled?

Answer

Yes

Question 4

If the answer to Question 2 is yes, is subdivision 768-G of the ITAA 1997 available to reduce the capital gain for the purpose of calculating the attributable income to be included in AusCo’s assessable income under section 456 of the ITAA 1936?

Answer

Yes

Question 5

If the answer to question 2 is yes, is roll-over relief available under subdivision 126-B of the ITAA 1997 to defer the capital gain arising from CGT event A1?

Answer

Yes

Question 6

If the answer to question 3 is yes, does the market value substitution rule apply under subsection 116-30(1) of the ITAA 1997 to deem capital proceeds to be nil?

Answer

Yes

Question 7

If the answers to questions 2 and 4 are yes, will the first element of Foreign Holding’s tax cost base in the shares in ForeignCo it receives from Foreign Sub in the merger be equal to the market value of those shares for the purposes of paragraph 112-20(1)(a) of the ITAA 1997, assuming no election for roll-over relief under subdivision 126-B is made?

Answer

Yes

Question 8

For the purposes of section 768-505 of the ITAA 1997 will Foreign Holdings be treated as having commenced to hold a direct voting percentage in ForeignCo when the merger happens?

Answer

Yes

This ruling applies for the following period:

The relevant income tax year

The scheme commences on:

The start date

Relevant facts and circumstances

AusCo

AusCo is an Australian resident company for income tax purposes. AusCo is the head company of the AusCo Tax Consolidated Group (AusCo Group).

AusCo Holdings Pty Ltd

AusCo Holdings Pty Ltd (AusCo Holdings) is an Australian resident company for income tax purposes and a subsidiary member of the AusCo Group.

Foreign Holdings

Foreign Holdings was incorporated in the Foreign jurisdiction under the Foreign Jurisdiction Law and is a resident of the foreign jurisdiction for income tax purposes.

Foreign Holdings does not carry on a business in Australia.

Foreign Holdings has one class of ordinary shares on issue and these are all legally and beneficially held by AusCo Holdings.

Foreign Holdings’ sole assets are its shareholdings in Foreign Sub.

Foreign Sub

Foreign Sub was incorporated in Foreign Jurisdiction under the Foreign Jurisdiction Law and is a resident of Foreign Jurisdiction for income tax purposes.

Foreign Sub does not carry on business in Australia.

Foreign Sub’s sole asset is its shareholding in ForeignCo.

ForeignCo

ForeignCo does not carry on a business in Australia.

Divestment of ForeignCo shareholdings

AusCo Group is intending to reorganise and divest its ForeignCo shareholdings.

Under either alternative, the target is a full divestment of AusCo Group’s interest in ForeignCo.

In order to achieve this, Foreign Holdings and Foreign Sub will be merged into a single surviving entity, Foreign Holdings, which would then be liquidated.

ForeignCo share reorganisation

All existing ForeignCo shares will be converted and split into a greater number of shares of a single class. These new shares have identical rights and no separate series.

Each stockholder will surrender its certificate representing its interest in the existing common stock to ForeignCo, however, no shares will be cancelled. That is, only the share certificates will be cancelled and reissued.

ForeignCo will issue in uncertified form, in the form of book-entry nominations, the converted shares and such shares will be duly registered on the books of ForeignCo in the name of the appropriate stockholder.

The converted shares will have the same market value, voting and participation rights and ownership interests percentage as the original shares.

There is no change in the total share capital pre and immediately post the ForeignCo share reorganisation and the proportion of equity held by each shareholder in the share capital account is maintained.

The reorganisation will have effect by amendment of ForeignCo’s certificate of incorporation.

Merger process under the Foreign Jurisdiction Law

The merger of Foreign Holdings and Foreign Sub will occur under the Foreign Jurisdiction Law.

The merger will take place as being between a holding company (Foreign Holdings) and one of its wholly owned subsidiaries (Foreign Sub).

Foreign Holdings will be the surviving entity after the merger. The shares of Foreign Sub will be cancelled by operation of the Foreign Jurisdiction Law, without any repayment of capital or other consideration.

Foreign Sub’s sole asset, being its shareholding in ForeignCo, will vest in Foreign Holdings under the Foreign Jurisdiction Law.

Relevant legislative provisions

Income Tax Assessment Act 1936 – Section 317

Income Tax Assessment Act 1936 – Section 361

Income Tax Assessment Act 1936 – Section 382

Income Tax Assessment Act 1936 – Section 383

Income Tax Assessment Act 1936 – Section 384

Income Tax Assessment Act 1936 – Subsection 386(2)

Income Tax Assessment Act 1936 – Section 446

Income Tax Assessment Act 1936 – Section 456

Income Tax Assessment Act 1997 – Division 104

Income Tax Assessment Act 1997 – Subsection 104-10(1)

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

Income Tax Assessment Act 1997 – Subsection 104-25(1)

Income Tax Assessment Act 1997 – Subsection 110-25(2)

Income Tax Assessment Act 1997 – Paragraph 112-20(1)(a)

Income Tax Assessment Act 1997 – Subsection 116-30(1)

Income Tax Assessment Act 1997 – Subsection 116-30(3A)

Income Tax Assessment Act 1997 – Section 126-40

Income Tax Assessment Act 1997 – Section 126-45

Income Tax Assessment Act 1997 – Subsection 126-50(1)

Income Tax Assessment Act 1997 – Subsection 126-50(2)

Income Tax Assessment Act 1997 – Subsection 126-50(3)

Income Tax Assessment Act 1997 – Subsection 126-50(3A)

Income Tax Assessment Act 1997 – Subsection 126-50(4)

Income Tax Assessment Act 1997 – Subsection 126-50(5)

Income Tax Assessment Act 1997 – Subsection 126-50(6)

Income Tax Assessment Act 1997 – Subsection 126-50(7)

Income Tax Assessment Act 1997 – Subsection 126-50(8)

Income Tax Assessment Act 1997 – Subsection 126-50(9)

Income Tax Assessment Act 1997 – Subsection 419(1)

Income Tax Assessment Act 1997 – Section 768-505

Income Tax Assessment Act 1997 – Section 768-550

Income Tax Assessment Act 1997 – Section 975-500

Income Tax Assessment Act 1997 – Section 995-1

Reasons for decision

Question 1

Summary

No CGT event happens to the shareholder’s original shares under Division 104 of the ITAA 1997 as the original shares are not cancelled or redeemed and there is no change in the total amount allocated to the share capital account and the proportion of equity owned by each shareholder in the share capital account is maintained.

Detailed reasoning

The Commissioner states in Taxation Determination 2000/10 Income tax: capital gains: what are the CGT consequences for a shareholder if a company converts its shares into a larger or smaller number of shares (TD 2000/10) at paragraph 1 that –

1. If a company converts its shares into a larger of smaller number of shares (‘the converted shares’) in accordance with section 245H of the Corporations Law (‘C Law’) in that:

(a) the original shares are not cancelled or redeemed in terms of the C Law;

(b) there is no change in the total amount allocated to the share capital account of the company; and

(c) the proportion of equity owned by each shareholder in the share capital account is maintained;

no CGT event happens to the shareholder’s original shares for capital gains purposes. While there is a change in the form of the original shares, there is no change in their beneficial ownership. The issue of roll-over relief under section 124-240 of the Income Tax Assessment Act 1997 (‘the 1997 Act’) does not arise because no CGT event happens to the shares.

While the share split did not occur under section 254H of the Corporations Act 2001 (which replaced 254H of the Corporations Law) the Commissioner considers that so long as the same test is met where the conversion was undertaken under a foreign law, there will be no CGT event.

ForeignCo has seven series of shares on issue, each with identical voting and participation rights. All of these shares will be converted and split into a greater number of shares with of a single class all containing identical rights.

The existing shares are not cancelled or redeemed.

There is no change in the total share capital either before or immediately after the ForeignCo share reorganisation. The proportion of equity held by each shareholder in the share capital account is maintained.

Conclusion

Therefore, as the original shares are not cancelled or redeemed and there is no change in the total amount allocated to the share capital account and the proportion of equity owned by each shareholder in the share capital account is maintained, then no CGT event happens to the shareholder’s original shares under Division 104 of the ITAA 1997.

Question 2

Summary

CGT event A1 happens to Foreign Sub when the ownership of ForeignCo shares changes from Foreign Sub to Foreign Holdings due to the merger as the shares in ForeignCo are considered to be disposed of under the relevant Foreign Jurisdiction law pertaining to mergers.

Detailed reasoning

Section 456 of the Income Tax Assessment Act 1936 (ITAA1936) states –

456(1) [Assessable income]

Subject to subsection (2), where a CFC has attributable income for a statutory accounting period in respect of an attributable taxpayer, the taxpayer’s attributable income is included in the assessable income of the taxpayer of the year of income in which the end of the statutory accounting period occurs.

456(2) [Assessability re changes of residence]

Where section 457 applies in relation to the attributable taxpayer in relation to one or more changes of residence by the CRC during the statutory accounting period, then only so much of the attributable income of the CFC as relates to:

(a) where the CFC is a resident of an unlisted country at the end of the period:

(i) any part of the period when the CFC was a resident of a listed country; or

(ii) the part of the period, since the change of residence or last change of residence, as the case requires, when the CFC was a resident of the unlisted country; or

(b) where the CFC is a resident of a listed country at the end of the period – any part of the period when the CFC was a resident of the listed country or any other listed country;

is to be taken into account under subsection (1).

Section 361 of the ITAA 1936 states –

361(1)

An entity (in the subsection called the test entity) is an attributable taxpayer in relation to a CFC at a particular time if, at that time:

(a) the test entity is an Australian entity whose associate-inclusive control interest in the CFC is at least 10%; or

(b) all of the following subparagraphs apply;

(i) the CFC is a CFC at that time only because of paragraph 340(c);

(ii) the CFC is controlled by any group of 5 or fewer Australian entities, either alone or together with associates (whether or not any associate is also an Australian entity);

361(2)

…

361(3)

Subsections (1) and (2) have effect subject to section 768-960 of the Income Tax Assessment Act 1997.

AusCo is the head entity of the AusCo Group and owns 100% of Foreign Holdings.

Foreign Holdings in turn owns Foreign Sub.

Therefore, AusCo is an attributable taxpayer pursuant to section 361 of the ITAA 1936 as it has an associate-inclusive control interest in both Foreign Holdings, Foreign Sub and ForeignCo of more than 10%.

Section 382 of the ITAA 1936 states –

382(1) [Amount of attributable income]

The attributable income is the amount that would be the eligible CFC’s taxable income for the eligible period if certain assumptions were made.

382(2) [Notional assessable income, notional allowable deductions, notional exempt income]

For the purposes of describing those assumptions, amounts of assessable income, allowable deductions and exempt income that are to be taken into account in calculating the taxable income are referred to respectively as notional assessable income, notional allowable deductions and notional exempt income.

Section 383 of the ITAA 1936 outlines the basic assumptions to be used in the calculation of attributable income of a CFC as follows –

383 BASIC ASSUMPTIONS

The assumptions are:

(a) that the eligible CFC is a taxpayer and a resident, within the meaning of section 6, during the whole of the eligible period; and

(b) that the eligible period is a year of income, being the year of income of the eligible taxpayer in which the eligible period ends; and

(c) that this Act is modified in accordance with Subdivisions B to E; and

(d) whichever of the assumptions in section 384 or 385 applies.

Section 384 relevantly states –

384(1) [Notional exempt income]

Where the eligible CFC is a resident of an unlisted country at the end of the eligible period, it is to be assumed:

(a) that the only amounts of notional assessable income are those to which subsection (2) applies; and

(b) that all the other income is notional exempt income.

384(2) [ Notional assessable income]

The amounts of notional assessable income are:

(a) where the eligible CFC does not pass the active income test for the eligible period in relation to the eligible taxpayer – amounts that would be included in its notional assessable income for the eligible period under this Act as modified in accordance with Subdivisions B to E if the only income or other amounts derived by it during the eligible period, and any earlier statutory accounting period, were adjusted tainted income (within the meaning of section 386); and

(aa) …

(b) amounts included in the notional assessable income of the eligible CFC for the eligible period under section 102AAZD of this Act as modified in accordance with Subdivisions B to E; and

(c) amounts included in the notional assessable income of the eligible CFC for the eligible period under Division 6 of Part III of this Act as so modified; and

(ca) …

(d) amounts that would be included in the notional assessable income of the eligible CFC for the eligible period under Division 5 of Part III of this Act, as modified in accordance with Subdivisions B to E of this Division, in relation to any partnership if its net income included only:

(i) where the eligible CFC does not pass the active income test for the eligible period in relation to the eligible taxpayer – amounts that would be included if the partnership derived only adjusted tainted income (within the meaning of section 386); and

(ia) …

(ii) amounts included under section 102AAZD of this Act as modified in accordance with Subdivisions B to E of this Division; and

(iii) amounts included under Division 6 of Part III of this Act as so modified.

(iv) …

(e) …

Therefore, Foreign Sub and Foreign Holdings are both taxpayers and residents of Australia for tax purposes under paragraph 383(1) of the ITAA 1936.

Foreign Holdings and Foreign Sub are both tax residents of an unlisted country (Foreign Jurisdiction) and do not pass the active income test and therefore the notional assessable income includes only income or other amounts derived by the CFC that are ‘adjusted tainted income’ within the meaning of section 386 of the ITAA 1936.

Adjusted tainted income is defined in subsection 386(1) of the ITAA 1936 as ‘passive income, tainted sales income or tainted services income if certain modifications were made to the provisions of Division 8’.

Section 446 of the ITAA 1936 relevantly defines amounts that are ‘passive income’ of a CFC in a statutory accounting period. In particular, paragraph 446(1)(k) provides that passive income includes  –

(k) net gains that accrued to the company during the statutory account period in respect of the disposal of tainted assets;

Subsection 386(2) of the ITAA 1936 modifies paragraph 446(1)(k) of the ITAA 1936 by replacing it with –

(k) amounts derived from the disposal of tainted assets;

Section 317 of the ITAA 1936 relevantly defines a tainted asset to include shares in a company, or a right or option in respect of shares in a company.

Therefore, the shares that Foreign Sub owns in ForeignCo are a tainted asset. Any amounts derived by the disposal of the shares in ForeignCo are amounts derived from the disposal of tainted assets.

Treatment of the merger under Australian law

The ITAA 1936 and ITAA 1997 do not recognise the concept of a ‘merger’.

In Gold and Resource Developments NL v Australian Stock Exchange Ltd & Anor (1998) 30 ACSR 105, the Supreme Court of Western Australia stated (at 107) that:

where foreign law creates a transaction or procedure which has no Australian counterpart, it is necessary to look to the foreign law for the meaning and effect of that transaction or procedure. Once that is understood, the procedure or transaction is then to be tested against [the Australian legal definition].

The merger will take place in accordance with the Foreign Jurisdiction Law resulting in the assets and liabilities of Foreign Sub vesting in Foreign Holdings in accordance with paragraph 109(2)(a). Foreign Sub’s sole asset is its shareholding in ForeignCo.

Subsections 104-10(1) and (2) of the ITAA 1997 relevantly states –

104-10(1)

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

104-10(2)

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.

Conclusion

CGT event A1 happens to Foreign Sub when the ownership of ForeignCo shares changes from Foreign Sub to Foreign Holdings as a result of the relevant Foreign Jurisdiction law pertaining to mergers as those shares are considered to be disposed of under the relevant foreign law.

Question 3

Summary

The ownership of the shares in Foreign Sub will be redeemed under the Foreign Jurisdiction Law, triggering section 104-25 causing CGT event C2 to happen to Foreign Holdings.

Detailed reasoning

Section 104-25 of the ITAA 1997 relevantly states –

104-25(1)

CGT event C2 happens if your ownership of an intangible *CGT asset ends by the asset:

(a) being redeemed or cancelled; or

(b) …

In this situation, section 104-25 will be triggered causing CGT event C2 to happen to Foreign Holdings as its ownership of the shares in Foreign Sub will be redeemed under the Foreign Jurisdiction Law.

Question 4

Summary

The conditions in subsection 768-505(1) are satisfied meaning subdivision 768-G will apply to reduce any capital gain or capital loss arising from CGT event A1 happening in relation to the disposal of ForeignCo shares from Foreign Sub to Foreign Holdings.

Detailed reasoning

Subsection 768-505 of the ITAA 1997 relevantly states that –

768-505(1)

The *capital gain or *capital loss a company (the holding company) that is an Australian resident makes from a *CGT event that happened at a particular time (the time of the CGT event) to a *share in a company (the foreign disposal company) that is a foreign resident is reduced if:

(a) the holding company held a *direct voting percentage of 10% or more in the foreign disposal company through a 12 month period that:

(i) began no earlier than 24 months before the time of the CGT event; and

(ii) ended no later than that time; and

(b) the share is not:

(i) an eligible finance share (within the meaning of Part X of the Income Tax Assessment Act 1936); or

(ii) a widely distributed finance share (within the meaning of that Part); and

(c) the CGT event is CGT event A1…

768-505(2)

The gain or loss is reduced by the *active foreign business asset percentage (see sections 768-510, 768-530 and 768-535) of the foreign disposal company in relation to the holding company at the time of the CGT event.

As discussed at question 2 above, Foreign Sub is a CFC. Foreign Sub is the ‘holding company’ with ForeignCo being the ‘foreign disposal company’ for the purpose of 768-505 of the ITAA 1997.

It is necessary for the conditions outlined in paragraphs 768-505(1)(a), (b) and (c) of the ITAA 1997 to be satisfied in order for any capital gain or loss which is made on the disposal of ForeignCo shares from Foreign Sub to Foreign Holdings to be reduced.

768-505(1)(a)

Direct voting percentage is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by section 768-550.

Subsection 768-550(1) of the ITAA 1997 states –

768-550(1)

An entity’s direct voting percentage at a particular time in a company is:

(a) if the entity has a voting interest (within the meaning of section 334A of the Income Tax Assessment Act 1936) in the foreign company at that time amounting to a percentage of the voting power of the company – that percentage; or

(b) otherwise – zero.

Foreign Sub holds more than a 10% direct voting interest in ForeignCo and has maintained a more than 10% direct voting interest in ForeignCo continuously for the previous 24 months. Accordingly, paragraph 768-501(1)(a) is satisfied.

768-505(1)(b)

The shares held in ForeignCo do not meet the definition of eligible finance shares or widely distributed finance shares per section 327 and 327A of the ITAA 1936. Accordingly, the condition in 768-505(a)(b) is satisfied.

768-505(c)

The disposal of shares in ForeignCo gives rise to CGT even A1 as per the reasoning in question 1 above. Accordingly, the condition in subsection 768-505(1)(c) is satisfied.

Conclusion

As the conditions in subsection 768-505(1) are satisfied, then subdivision 768-G will reduce any capital gain or loss arising from CGT event A1 happening in relation to the disposal of ForeignCo shares from Foreign Sub to Foreign Holdings.

Question 5

Summary

As the requirements in section 126-50 of the ITAA 1997 are met in relation to the merger, Foreign Sub and Foreign Holdings may choose roll-over relief under Subdivision 126-B of the ITAA 1997.

Detailed reasoning

Section 126-40 of the ITAA 1997 states –

126-40 What this Subdivision is about

A roll-over may be available for the transfer of a CGT asset between 2 companies, or the creation of a CGT asset by one company in another, if:

(a) both companies are members of the same wholly-owned group; and

(b) at least one of the companies is a foreign resident.

Section 126-45 of the ITAA 1997 relevantly states –

126-45(1)

There may be a roll-over if a *CGT event (the trigger event) happens involving a company (the originating company) and another company (the recipient company) in the circumstances set out in section 126-50.

126-45(2)

Only these *CGT events are relevant:

(A) CGT events A1…; and

(b) …

In this case, CGT event A1 happens to Foreign Sub when the ownership of ForeignCo shares changes from Foreign Sub to Foreign Holdings as discussed in the detailed reasoning contained in Question 2 of this private ruling.

Therefore, CGT roll-over relief will be available where the requirements of section 126-50 of the ITAA 1997 are met.

Members of the same wholly-owned group

Subsection 126-50(1) of the ITAA 1997 states -

126-50(1)

The originating company and recipient company must be members of the same *wholly-owned group at the time of the trigger event.

The term wholly-owned group is defined by subsection 995-1(1) of the ITAA 1997 as having the meaning given by section 975-500.

Section 975-500 of the ITAA 1997 states –

975-500

Two companies are members of the same wholly-owned group if:

(a) one of the companies is a *100% subsidiary of the other company; or

(b) each of the companies is a *100% subsidiary of the same third company.

Foreign Sub is a 100% subsidiary of Foreign Holdings at the time of the disposal of the shares in ForeignCo. Therefore, subsection 126-50(1) of the ITAA 1997 is satisfied.

The CGT assets not be trading stock or a registered emission unit of the recipient company immediately after disposal

Subsections 126-50(2), (3) and (3A) state that the assets must not be trading stock or a registered emission unit of the recipient company immediately after disposal.

The relevant CGT assets are the shares in ForeignCo which are not trading stock or a registered emission unit of Foreign Sub immediately after the disposal.

Therefore, this condition is satisfied.

The ordinary income and statutory income of the recipient company not exempt

Subsection 126-50(4) states -

126-50(4)

The *ordinary income and *statutory income of the recipient company must not be exempt from income tax because it is an *exempt entity for the income year of the trigger event.

Subsection 995-1(1) of the ITAA 1997 defines an exempt entity as –

(a) an entity all of whose *ordinary income and *statutory income is exempt from income tax because of this Act of because of another *Commonwealth law, no matter what kind of ordinary income or statutory income the entity might have; or

(b) an *untaxable Commonwealth entity.

Note:

See section 11-5 for a list of entities of the kind referred to in paragraph (a).

Any Australian sourced income of Foreign Holdings (the recipient company) is subject to Australian income tax under the ITAA 1997 and is therefore not an exempt entity for the purposes of subsection 126-50(4). Therefore, subsection 126-50(4) is satisfied.

Resident of an unlisted country at the time of the trigger event

Subsection 126-50(5) of the ITAA 1997 states –

126-50(5)

The requirements in one of the items in this table must be satisfied.

Subsection 419(1) of the ITAA 1936 states –

419(1)

For the purposes of applying this Act in calculating the attributable income of the eligible CFC, Subdivision 126-B of the Income Tax Assessment Act 1997 has effect as if the table in subsection 126-50(5) of that Act were omitted and the following table were substituted:

Additional requirements
Item	The originating CFC’s residency status	The recipient company’s residency status	This requirement must be satisfied
1	A resident of a listed country at the time of the trigger event	Either: (a) a resident of that listed country at that time; or (b) an Australian resident at that time	It does not matter what the roll-over asset is
2	A resident of a listed country at the time of the trigger event	A resident of a particular unlisted country at that time	The asset must have been used (just before that time) in connection with a permanent establishment of the originating CFC in any unlisted country at or through which the originating CFC carried on business just before that time
3	A resident of an unlisted country at the time of the trigger event	Either: (a) a resident of an unlisted country at that time; or (b) an Australian resident at that time	It does not matter what the roll-over asset is

Both Foreign Sub (the originating company) and Foreign Holdings (the recipient company) are residents of the Foreign Jurisdiction, an unlisted country, meeting the requirements in Item 3 of the table. Therefore, subsection 126-50(5) is satisfied.

Originating company or recipient company that is an Australian resident

Subsection 126-50(6) of the ITAA 1997 states –

126-50(6)

If the originating company or the recipient company is an Australian resident at the time of the trigger event, that company must:

(a) be a *member of a *consolidated group or *MEC group at that time; or

(b) not be a member of a *consolidatable group at that time.

Foreign Holding (the recipient company) and Foreign Sub (the originating company)are deemed to be residents of Australia pursuant to the basic assumptions contained in section 383 of the ITAA 1936. Foreign Sub and Foreign Holdings are not members of a consolidated group, a MEC group, or a consolidatable group.

Subsections 126-50(7) to (9)

As Foreign Sub (the originating company) is deemed to be a resident of Australia pursuant to the assumptions contained in section 383 of the ITAA 1936 when determining their attributable income and as the ForeignCo shares were not acquired by the originating company because of a previous roll-over, the requirements of subsections 126-50(7), (8) and (9) are satisfied.

Conclusion

CGT event A1 happens to Foreign Sub when the ownership of ForeignCo shares changes from Foreign Sub to Foreign Holdings due to the merger under the Foreign Jurisdiction law. Further, as the requirements in section 126-50 of the ITAA 1997 are met in relation to the merger, Foreign Sub and Foreign Holdings may choose roll-over relief under Subdivision 126-B of the ITAA 1997.

Question 6

Summary

Under the Foreign Jurisdiction Law, the transfer of the ForeignCo shares is separate and unrelated to the cancellation of the shares in Foreign Sub due to the upstream merger. Therefore, the Foreign Sub shares held by Foreign Holdings will have nil value after the market value substitution rule in subsection 116-30(1) is applied.

Detailed reasoning

For the reasons given in question 3 of this private ruling, the cancellation of the shares in Foreign Sub triggers CGT event C2.

Subsection 116-30(1) of the ITAA 1997 states –

116-30(1)

If you received no *capital proceeds from a *CGT event, you are taken to have received the *market value of the *CGT asset that is the subject of the event. (The market value is worked out as at the time of the event).

Example:

You give a CGT asset to another entity. You are taken to have received the market value of the CGT asset

Subsection 116-30(3A) relevantly applies to CGT event C2 and states –

116-30(3A)

If you need to work out the *market value of a *CGT asset that is the subject of *CGT event C2, work it out as if the event had not occurred and was never proposed to occur.

Example:

A company cancels shares you own in it. You work out the market value of the shares by disregarding the cancellation.

In calculating the capital gain or loss in relation to a CGT event, where that CGT event occurs for nil consideration, the total capital proceeds will be the market value of the asset under subsection 116-30(1) of the ITAA 1997. Further, as the CGT event is C2, the market value of the relevant CGT asset is worked out as if the event had not occurred and was never proposed to occur.

The shares of Foreign Sub are cancelled without any consideration under the merger with Foreign Holdings. That is, the Foreign Jurisdiction Law treats the transfer of the Foreign Co shares as separate and unrelated to the share cancellation. In this case, it is considered that in working out the market value of the Foreign Sub shares, subsection 116-30(3A) of the ITAA 1936 does not require Foreign Holdings to disregard the transfer to it of all of Foreign Sub’s assets in compliance with the Foreign Jurisdiction Law. This is the case even though the transfer of the assets is part of the one arrangement.

On this basis, the Commissioner accepts that the market value of the Foreign Sub shares at the time of CGT event C2 will be nil.

Conclusion

The Foreign Sub shares held by Foreign Holdings will have nil value after the market value substitution rule in subsection 116-30(1) is applied. This is because under the Foreign Jurisdiction Law the transfer of the shares in ForeignCo are separate and unrelated to the cancellation of the shares in Foreign Sub due to the upstream merger.

Question 7

Summary

As the condition under paragraph 112-20(1)(a) is met then the first element of Foreign Holdings cost base or reduced cost base in its ForeignCo shares will be equal to their market value at the time of acquisition.

Detailed reasoning

Subsection 110-25(2) of the ITAA 1997 states –

110-25(2)

The first element is the total of:

(a) the money you paid, or are required to pay, in respect of *acquiring it; and

(b) the *market value of any other property you gave, or are required to give, in respect of acquiring it (worked out at the time of the acquisition).

Note 1:

…

Note 2:

This element is replaced with another amount in many situations: see Division 112.

For the reasons given in question 6 above, the transfer of ForeignCo’s shares from Foreign Sub to Foreign Holdings as a result of the upstream merger is for nil consideration. In addition, there will be no other property given as part of the asset transfer.

The market value substitution rule contained in paragraph 112-20(1)(a) of the ITAA 1997 states –

112-20(1)(a)

The first element of your *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:

(a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from:

(i) *CGT event D1 happening; or

(ii) another entity doing something that did not constitute a CGT event happening; or…

Foreign Holdings acquired the ForeignSub shares for no consideration as part of the upstream merger. Foreign Holding’s acquisition of the ForeignCo shares did not result from CGT event D1 as the acquisition resulted from a CGT event A1 happening to Foreign Sub.

Conclusion

Therefore, the condition under paragraph 112-20(1)(a) is met and the first element of Foreign Holdings cost base or reduced cost base in its ForeignCo shares will be equal to their market value at the time of acquisition.

Question 8

Summary

Foreign Holdings will only start to hold a direct voting interest in ForeignCo of more than 10% from the date it acquires the shares in ForeignCo due to the upstream merger. That is, the requirements of subsection 768-505(1) will not be met at the time of the merger as Foreign Holdings will be treated as having commenced to hold a direct percentage in ForeignCo when the merger happens.

Detailed reasoning

Subsection 768-505(1) of the ITAA 1997 states –

768-505(1)

The *capital gain or *capital loss of a company (the holding company) that is an Australian resident makes from a *CGT event that happened at a particular time (the time of the CGT event) to a *share in a company (the foreign disposal company) that is a foreign resident is reduced if:

(a) the holding company held a *direct voting percentage of 10% or more in the foreign disposal company throughout a 12 month period that:

(i) began no earlier than 24 months before the time of the CGT event; and

(ii) ended no later than that time; and

(b) the share is not:

(i) an eligible finance share (within the meaning of Part X of the Income Tax Assessment Act 1936); or

(ii) a widely distributed finance share (within the meaning of that Part); and

(c) the CGT event is CGT event A1, B1, C2, E1, E2, G3, J1, K4, K6, K10 or K11.

That is, in order to qualify for the participation exemption under subdivision 768-G, Foreign Holdings is required to have had a direct voting interest of at least 10% throughout a 12 month period within the previous 24 months before the CGT event occurred.

Subsection 995-1(1) of the ITAA 1997 defines ‘direct voting percentage’ as having the meaning given by section 768-550.

Section 768-550 of the ITAA 1997 relevantly states –

768-550(1)

An entity’s direct voting percentage at a particular time in a company is:

(a) if the entity has a voting interest (within the meaning of section 334A of the Income Tax Assessment Act 1936) in the foreign company at that time amounting to a percentage of the voting power of the company – that percentage; or

(b) otherwise – zero.

Foreign Holdings did not have a voting interest in ForeignCo’s shares prior to the upstream merger taking place. Therefore, prior to the upstream merger, Foreign Holdings had a direct voting percentage of zero pursuant to subsection 768-550(1) of the ITAA 1997.

After the upstream merger, Foreign Holdings will gain a direct voting interest in ForeignCo’s shares of greater than 10%.

Conclusion

Therefore, Foreign Holdings will only start to hold direct voting interest in ForeignCo from the date it acquires the shares in ForeignCo due to the upstream merger. That is, the requirements of subsection 768-505(1) will not be met at the time of the merger as Foreign Holdings will be treated as having commenced to hold a direct percentage in ForeignCo when the merger happens.