Edited version of private advice

Authorisation Number: 1051597728103

Date of advice: 24 October 2019

Ruling

Subject: General value shifting regime

Question

Will the proposed issue of the Redeemable Preference shares (RPS) result in a direct value shift under Division 725 of the Income Tax Assessment Act 1997 (ITAA 1997) and result in CGT event K8 happening under section 104-250 of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances:

The Company is a privately-owned.

There are currently 7 employees in the Company.

Proposed transaction

The Director of the Company is planning to issue RPS to employees.

The RPS will be issued at the Market Value of $1 being paid by the employees.

Holders of RPS have:

(i)            no right to vote at any meeting of the Company;

(ii)           the right to participate in any dividend declared on the class of shares held; and

(iii)          no right to participate in the division of any surplus assets or profits of the Company

The Company at any time redeem all or redeem any one of more RPS. If the Company elects to do so:

(i)            the Company will give the holder of the shares to be redeemed seven days written notice of the redemption;

(ii)           the redemption may only be exercise by resolution of the Directors.;

(iii)          the notice must be signed by a Director and will be delivered or posted to the Notice Address for the holder of those shares with a cheque for the amount paid up in respect of those shares; and

(iv)         any redemption under this Rule will be effective immediately upon the expiry of seven days from the delivery or posting of the notice or redemption

The proposed arrangement aims to retain key employees and provide remuneration incentives where the incentive is positively correlated with the value added to the Company.

The dividends will be fully franked.

The RPS dividends may be paid in preference to the ordinary shareholders.

The RPS will only be redeemed in limited circumstances, for example termination/resignation of employment.

The amount of the discretionary dividend on the RPS may equal a percentage of net profit; however this will not exceed a specified amount per annum per employee.

The dividends will be paid to individual persons only and will not be paid into a trust account or a company own by the individual employee. All of the issued shares are post CGT assets and the shares are held on capital account and do not form part of the trading stock. The allocation of shares under the scheme will not be to an associated person or family member and there are no loan arrangements relating to the loans under this arrangement. The arrangement will not replace salary, wages or bonuses of the employees under the arrangement.

If the employee leaves or the shares are cancelled in terms of the RPS, they can be redeemed at the Market Value of a $1.

Relevant legislative provisions:

Income Tax Assessment Act 1997 section 104-250

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 section 725-145

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Summary

The proposed transaction will not give rise to a direct value shift (DVS) under Division 725 of the ITAA 1997 and therefore CGT event K8 under section 104-250 of the ITAA 1997 will not happen.

Detailed reasoning

Division 725 of the ITAA 1997 may apply where there is a DVS under a scheme involving equity interests in an entity.

Section 725-145 of the ITAA 1997 considers when there is a DVS. Generally, a DVS happens when there is an increase in the value of the equity or loan interests - or the interests are issued at a discount - and a decrease in the value of other interests in the target entity.

Subsection 725-145(1) of the ITAA 1997 states that direct value shift under a scheme involving equity or loan interests in an entity (the target entity) if:

(a) there is a decrease in the market value of one or more equity or loan interests in the target entity; and

(b) the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things, is done; and

(c) either or both of subsections (2) and (3) are satisfied.

Subsection 725-145(2) of the ITAA 1997 states that one or more equity or loan interests in the target entity must be issued at a discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

Subsection 725-145(3) of the ITAA 1997 states that there must be an increase in the market value of one or more equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

An interest is issued at a discount where the market value of the interest when issued exceeds the amount of the payment that the issuing entity receives.

In the current circumstances, the Company intends to issue the RPS for $1 each. You have contended that the issue price reflects the market value of this interest taking into consideration the entitlements attaching to the RPS, and there will not be a decrease in the market value of all the ordinary shares in the Company as a result of the issue of the RPS.

Further, a DVS will not have consequences under Division 725 of the ITAA 1997 if the sum of the decreases in market value of all the down interests (the ordinary shares) under the same scheme does not exceed $150,000: subsection 725-70(1) of the ITAA 1997.

In this regard, subsection 725-70(1) of the ITAA 1997 specifically states:

For a down interest of which you are an affected owner, the direct value shift has consequences under this Division only if the sum of the decreases in the market value of all down interests because of direct value shifts under the same scheme as the direct value shift is at least $150,000.

Based on the facts, it is considered that the issue of the RPS would not cause a DVS, which is reasonably attributable to an increase in the market value of the RPS. In any case, the effect of the de minimis rule in section 725-70 of the ITAA 1997 is that only a decrease in the market value of all down interests (and corresponding increase to the market value of all up interests) of $150,000 or more would result in the proposed transaction having DVS tax consequences. Based on facts, it is considered that the issue of the RPS would not decrease the market value of the ordinary shares in the Company in the amount required to exceed the de minimis rule.

CGT Event K8

Section 104-250 of the ITAA 1997 states:

104-250(1) CGT event K8 happens if there is a taxing event generating a gain for a down interest under section 725-245.

Note: That section sets out some of the CGT consequences of a direct value shift for affected owners of down interests. See also the rest of Division 725.

104-250(2) The time of the event is the decrease time for the down interest.

104-250(3) You make a capital gain equal to the gain generated for the taxing event.

104-250(4) If, because of the same direct value shift, there are 2 or more taxing events generating a gain that are covered by subsection (1), CGT event K8 happens for each of those taxing events, and you make a separate capital gain for each.

Exceptions

104-250(5) A capital gain is disregarded if the down interest is a pre-CGT asset.

In accordance with section 104-250 of the ITAA 1997, CGT event K8 happens if there is a taxing event generating a gain for a down interest under section 725-245 of the ITAA 1997.

As the issue of the RPS will not generate a gain under the DVS shifting rules in section 725-245 of the ITAA 1997 it will not result in CGT event K8 happening under section 104-250 of the ITAA 1997.