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Edited version of private advice
Authorisation Number: 1051588648978
Date of advice: 11 October 2019
Ruling
Subject: Division 855 of the ITAA 1997
Question
Will section 855-10 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to disregard any capital gain or capital loss on the disposal of shares by the entity in the Australian Company?
Answer
Yes.
This ruling applies for the following period:
Year ending 30 June 20XX
Year ending 30 June 20XX
The scheme commences on:
1 July 20XX
Relevant facts and circumstances
The entity is a private company that was incorporated in a foreign country and is not a 'resident of Australia' as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).
The entity researches and manufactures products in the foreign country.
The entity established an Australian Company for the purpose of increasing its market share.
The entity wholly owns Australian Company.
The entity exclusively manages its shares in their Australian Company.
The Australian company's operations consist of development of similar products to the entity.
The Australian Company does not hold interests in 'Australian real property' as defined in section 855-20 of the Income Tax Assessment Act 1997 (ITAA 1997). It owns intellectual property rights.
The entity entered into a Share Purchase Deed for the sale of 100% of the shares in the Australian Company. The sale is conditional on the grant of approvals. The sale will occur five business days from the satisfaction of these conditions.
Relevant legislative provisions
Income Tax Assessment Act 1997 Subdivision 855-A
Reasons for decision
Question
Will section 855-10 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to disregard any capital gain or capital loss on the disposal of shares by the entity in the Australian Company?
Detailed Reasoning
Legislative references in this Ruling are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.
Subsection 855-10(1) provides that a foreign resident can disregard a capital gain or capital loss from a capital gains tax (CGT) event happening unless the event relates to a CGT asset that is 'taxable Australian property'.
There are five categories of CGT assets that are taxable Australian property. The categories are set out in the table in Section 855-15 as follows:
|
Item |
Description |
|
1 |
Taxable Australian real property (see section 855-20) |
|
2 |
A CGT asset that: (a) is an indirect Australian real property interest (see section 855-25); and (b) is not covered by item 5 of this table |
|
3 |
A CGT asset that: (a) you have used at any time in carrying on a business through: (i) if you are a resident in a country that has entered into an international tax agreement with Australia containing a permanent establishment article--a permanent establishment (within the meaning of the relevant international tax agreement) in Australia; or (ii) otherwise--a permanent establishment in Australia; and (b) is not covered by item 1, 2 or 5 of this table |
|
4 |
An option or right to acquire a CGT asset covered by item 1, 2 or 3 of this table |
|
5 |
A CGT asset that is covered by subsection 104-165(3) (choosing to disregard a gain or loss on ceasing to be an Australian resident). |
In relation to the entities' sale of their 100% interest in the shares of the Australian Company, Items 1, 4 and 5 contained in section 855-15 are not considered in more detail as:
· the shares do not represent a direct interest in taxable Australian real property (TARP) (Item 1)
· the shares do not represent an option or right to acquire a CGT asset (Item 4), and
· section 104-165(3) only applies to individuals who choose to disregard a gain covered by CGT event I1 (Item 5).
Consequently, Items 2 and 3 contained in section 855-15 are considered in detail below.
Item 2 - Indirect Australian real property interest
Subsection 855-25(1) broadly provides that a membership interest held by an entity in another entity at a time is an indirect Australian real property interest at that time if the interest passes:
· the non-portfolio interest test (per section 960-195), and
· the principal asset test (per section 855-30).
Non-portfolio interest test
Section 960-195 explains the non-portfolio interest test will be passed where:
An interest held by an entity (the holding entity) in another entity (the test entity) passes the non-portfolio interest test at a time if the sum of the direct participation interests held by the holding entity and its associates in the test entity at that time is 10% or more.
Direct participation interest is defined in section 960-190 as the direct control interest that the first entity holds in the other entity. Section 350 provides that a direct control interest includes the percentage an entity holds in another entity of the total paid-up share capital or the total rights of shareholders to vote.
In these circumstances, the entity holds 100% of the share capital in the Australian Company. Thus, the entities' direct participation interest will equal 100%. Therefore, as the entity has a direct participation interest of greater than 10% in the Australian Company the non-portfolio interest test is satisfied.
Principal asset test
According to subsection 855-30(2) the principal asset test will be satisfied if the sum of the market values of the test entity's assets that are TARP exceed the market values of the test entity's assets that are not attributable to TARP.
Subsections 855-30(3) and 855-30(4) provide that where an asset of the first entity is a membership interest in another entity and those membership interests comprise a non-portfolio interest in the other entity, the first entity is treated as holding two separate assets. That is:
· a TARP asset that is equal to the sum of the market value of the underlying TARP assets of the other entity multiplied by the percentage interest in the other entity, and
· a non-TARP asset equal to the sum of the market values of the underlying non-TARP assets of the other entity multiplied by the percentage interest in the other entity.
The Australian Company does not hold interests in Australian real property; mining, quarrying or prospecting rights to minerals, or; petroleum or quarry materials situated in Australia. Consequently, the principle asset test will not be passed and Item 2 contained in section 855-15 will not apply.
Item 3 - Permanent establishment
Item 3 of section 855-15 applies to a CGT asset that is used at any time in carrying on a business through a permanent establishment in Australia.
As the shares in the Australian Company are considered CGT assets, they must be used in carrying on a business by a permanent establishment in Australia of the entity for Item 3 of section 855-15 to apply.
Item 3(a)(i) contained in section 855-15 states a CGT asset will be taxable Australian property if:
(a) you have used at any time in carrying on a business through:
(i) if you are a resident in a country that has entered into an international tax agreement with Australia containing a permanent establishment article--a permanent establishment (within the meaning of the relevant international tax agreement) in Australia...
The Agreement between the Australian Commerce and Industry Office and the Foreign Country applies to companies who are residents of one or both of Foreign Country and Australia.
Foreign Country Agreement - Residence
For the purposes of the Foreign Country Agreement, a person is a resident of a territory if the person is a resident of that territory for the purposes of its tax.
The entity is a company incorporated in a Foreign Country, thus will be liable to tax in the Foreign Country. Accordingly, the Foreign Country Agreement will apply to the entity as a resident of the Foreign Country.
Foreign Country Agreement - Permanent establishment
The Foreign Country Agreement provides a permanent establishment means a fixed place of business through which the business of the enterprise is wholly or partly carried on.
Pursuant to the above, a subsidiary company operating in Australia that is owned by an overseas entity does not of itself make the subsidiary a permanent establishment in Australia. The Australian company is a wholly-owned subsidiary of the entity. As a consequence, the Australian company is not a permanent establishment of the entity. Additionally, the entity does not have any other Australia operations other than its interest in the Australian Company. Accordingly, the shares in the Australian Company are not used in the business of an Australian permanent establishment of the entity.
Consequently, as no share itself is being used in carrying on a business at or through a permanent establishment in Australia, the shares in the Australian Company are not considered TARP under Item 3 of section 855-15.
Conclusion
Based on the reasons above, section 855-15 does not apply to limit the application of Division 855. Accordingly, as the entity is a foreign resident, section 855-10 will apply to disregard the capital gain or capital loss made by the entity at the time they sell their interest in the Australian Company.