Edited version of private advice

Authorisation Number: 1051647214750

Date of advice: 01 April 2020

Ruling

Subject: capital gains tax (CGT)

Question 1

Would the death of the deceased trigger a capital gains tax (CGT) event for the company?

Answer

No.

Question 2

Will CGT event C2 occur upon the cancellation of the shares?

Answer

Yes.

Question 3

Will the liquidator's distribution form part of the capital proceeds for CGT event C2?

Answer

Yes.

Question 4

If the capital gain from the cancellation of the shares in the company is assessable, can the 50% CGT discount be applied to reduce the capital gain that was held by the trustee for more than 12 months from February 2018?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The deceased and first spouse was directors and shareholders of the company since its incorporation and held shares acquired before 20 September 1985 (pre-CGT).

The deceased's first spouse passed away in 20XX and their 50% shareholding passed to the deceased.

The deceased passed away in 20XX and left a Will.

The deceased appointed executors and trustees that included the deceased's second spouse to administer the deceased's estate.

The will stipulated certain conditions involving the deceased's assets at the time of death and were provided for to the second spouse or on trust. The residuary estate went to a named foundation.

The deceased had two adopted children.

The Will was challenged by the children and second spouse.

The assets owned at date of death in the company were property, cash and shares.

A Deed of Family Arrangement (DOFA) was executed in 20XX. Certain transactions were actioned through the DOFA and distributions occurred in equal share to the children and second spouse.

The property is to be sold and any monies remaining after the administration of the deceased's estate, the net proceeds will be distributed in equal share to the children and second spouse.

When the property is sold the company will be placed into liquidation.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 6(1)

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 104-135(6)

Income Tax Assessment Act 1997 subsection 104-230(6)

Income Tax Assessment Act 1997 section 128-10

Income Tax Assessment Act 1997 section 128-15

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 section 149-30

Reasons for decision

1.    Death and Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997)

Division 149 of ITAA 1997 outlines the rules which govern when an asset acquired by a taxpayer before 20 September 1985 is treated as being acquired after that date for capital gains tax (CGT) purposes.

Subsection 149-15(1) of ITAA 1997 provides that majority underlying interests in a CGT asset consists of:

• more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and
• more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.

Under subsection 149-30(1) of ITAA 1997, a pre-CGT asset of a non-public entity stops being a pre-CGT asset at the earliest time when the majority underlying interest in the asset were not had by the ultimate owners who had the majority underlying interests in the asset immediately before 20 September 1985.

Subsection 149-30(3) of ITAA 1997 provides the effects of a new owner standing in shoes of former owner. As such subsection (4) affects how the major underlying interests in the asset are worked out if the ultimate owner (the new owner) has acquired a percentage (the acquired percentage) of the underlying interests in the assets because of an event that has affected these changes as described in the table below:

Application to your circumstances

In this case, when the deceased (former owner), passed away, their death did not trigger a CGT event, because the majority underlying interests in the CGT assets at this time did not change in accordance with subsections 149-30(3) and (4) of ITAA 1997. The new owner (the trustee of the deceased's estate) still held the same underlying interest of the former owner (the deceased) for the period the former owner held them.

Therefore, no CGT event was triggered when the trustee became the new owner of the company shares.

2.    Liquidation of the company

Liquidator distributions from the capital reserve account sourced from assets acquired prior to 20 September 1985 are, in some circumstances, not taxable as either a deemed dividend under section 47 of ITAA 1936, or a net capital gain under section 104-25 of ITAA 1997. If the assets were acquired prior to 20 September 1985 and a capital gain is disregarded, then these assets maintain the tax-free status of the distribution from the capital profits reserve account.

If a liquidator can identify the source of funds distributed, then those funds retain the character of the source. So, a pre-CGT gain on disposal of land would remain pre-CGT when it was distributed and would therefore be tax free to the shareholders.

Section 47 of ITAA 1936 specifically deems certain amounts to be dividends paid to the shareholders out of the profits derived by the Company.

Specifically, subsection 47(1) of ITAA 1936 provides that:

Distributions to shareholders of a company by a liquidator in the course of winding-up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.

The use of the term "income" in the context of subsection 47(1) of the ITAA 1936 has been interpreted in Gibb v FCT (1966) 118 CLR 628 as meaning income according to ordinary concepts rather than "assessable income". Hence, amounts that are deemed to be assessable income but are not of an income or revenue character are not considered, for the purposes of subsection 47(1) to be "income".

Subsection 47(1A) of the ITAA 1936 includes in the reference in subsection 47(1) to income derived by a Company a reference to an amount included in the Company's assessable income or a net capital gain that would be included in the Company's assessable income if the required net capital gain is worked out in accordance with the method statement contained in paragraph 47(1A)(b) of the ITAA 1936.

The effect of subsection 47(1A) of the ITAA 1936 is that it only includes in income the net capital gains that are included in assessable income (without indexation) under Part 3-3 of the ITAA 1997. Capital gains that are disregarded or otherwise not within the concept of a net capital gain included in the assessable income of the Company are also not within the meaning of the word "income".

Application to your circumstances

As the property is considered to be pre-CGT and the majority underlying interest of the company have not changed, the distribution from the liquidators to the shareholders that represents proceeds from the sale of the property will not be assessable under section 47(1) of the ITAA 1936. This is because this amount does not form part of 'income' as defined by subsection 47(1A) of the ITAA 1936.

3.    CGT event C2

Section 104-25 of the ITAA 1997 provides that CGT event C2 happens if the ownership of an intangible CGT asset ends by the asset:

a) being redeemed or cancelled

b) being released, discharged or satisfied

c) expiring; or

d) being abandoned, surrendered or forfeited

The time of the event is when you enter into the contract, that results in the asset ending or if there is no contract, when the asset ends.

Taxation Determination TD 2001/27 provides that section 104-25 of the ITAA 1997 applies to the full amount of distribution made by a liquidator on the winding-up of a company as it constitutes capital proceeds from the happening of a CGT event C2 when the company ceases to exist in accordance with the Corporations Act 2001 after the winding-up. However, under section 104-135 an interim distribution not taken to be a dividend under section 47 of the ITAA 1936 may be at the time of payment a CGT G1 event and the non-assessable part may result in a capital gain if more than the share's cost base. But section 104-135 does not apply to a payment by a liquidator by virtue of subsection 104-135(6) if the company ceases to exist within 18 months of the payment.

Application to your circumstances

The shareholdings at the deceased's time of death were:

a)    shares held by the deceased before 20 September 1985

b)    shares held by the deceased received post 20 September 1985.

When the deceased's first spouse passed away, their 50% shareholding transferred to the deceased giving 100% ownership in the company shareholding. The deceased then owned 50% of the shares pre-CGT and 50% were considered to be acquired after 20 September 1985.

When the deceased passed away all of the shares are then considered to be post-CGT assets, and acquired after 20 September 1985 in accordance with subsection 128-15(4) of ITAA 1997. The shares that were owned prior to 20 September 1985 will have a cost base equal to the market value at the date of death of the deceased. The shares acquired from the deceased's first spouse which were then considered post-CGT assets by the deceased will acquire the deceased cost base in accordance with subsection 128-15(4) of ITAA 1997.

When calculating the capital gain, the distribution by the liquidator will form part of the capital proceeds for the cancellation of the shares which is a CGT event C2.

50% discount

The CGT discount under Division 115 of the ITAA 1997 is available to an individual or trust where a CGT event happens to the asset the entity owns and the asset was acquired at least 12 months before the CGT event occurs. CGT event C2 happens when cancellation, surrender similar endings occurs to an asset you own ends. The 50% discount can be applied as the shares were cancelled 12 months after the date of death of the deceased.