Edited version of private advice

Authorisation Number: 1051755358396

Date of advice: 22 September 2020

Ruling

Subject: Capital gains tax - market value substitution rule

Question

Will the first element of Sub Co's cost base (or reduced cost base) of the shares in Sibling Co it acquires from Parent Co under the proposed restructure be equal to their market value at the time of their acquisition in accordance with paragraph 112-20(1)(c) of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commences on:

A particular date

Relevant facts and circumstances

Parent Co is a foreign company and tax resident.

Parent Co wholly owns Sibling Co which is also a foreign company and tax resident.

Parent Co also owns Sub Co which is an Australian company and tax resident. Sub Co is the head company of the Australian income tax consolidated group.

Under the proposed restructure:

1.    Sub Co will incorporate a new Australian subsidiary, New Aus Co

2.    Sub Co will acquire all the shares in Sibling Co by issuing shares to Parent Co as consideration. The total consideration amount is expected to be lower than the market value of the Sibling Co shares; and

3.    Sub Co will then transfer the shares in Sibling Co to New Aus Co in exchange for additional shares in New Aus Co.

The transfer of Sibling Co does not involve any bargaining or negotiation between Sub Co and Parent Co.

Relevant legislative provisions

Section 110-25 of the Income Tax Assessment Act 1997

Section 110-55 of the Income Tax Assessment Act 1997

Section 112-20 of the Income Tax Assessment Act 1997

Section 995-1 of the Income Tax Assessment Act 1997

Reasons for decision

Unless otherwise stated, all legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997).

Subsection 110-25(1) provides that the cost base of a CGT asset consists of 5 elements.

Subsection 110-25(2) provides that the first element of a CGT asset 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 as at the time of the acquisition).

The first element of the reduced cost base of a CGT asset's reduced cost base is the same as that for the cost base (subsection 110-55(2)).

However, paragraph 112-20(1)(c) provides that 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 you did not deal at arm's length with the other entity in connection with the acquisition.

Despite paragraph 112-20(1)(c), subsection 112-20(2) states that, if you did not deal at arm's length with the other entity and your acquisition of the CGT asset resulted from another entity doing something that did not constitute a CGT event happening; the market value is substituted only if what you paid to acquire the CGT asset was more than its market value (at the time of acquisition).

Further, subsection 112-20(3) sets out some situations in which the market value substitution rule does not apply.

Subsection 995-1(1) defines 'arm's length' as follows:

...in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

In Healey v. Commissioner of Taxation [2012] FCA 269, in determining whether parties deal at arm's length with one another, it was held that the authorities establish the following principles:

1. Whether the parties dealt at arm's length is a question of fact: Trustee for the Estate of the late AW Furse No 5 Will Trust v Commissioner of Taxation (1990) 91 ATC 4007 (at 4017); Granby Pty Ltd v Federal Commissioner of Taxation (1995) 129 ALR 503 (at 507); Commissioner of Taxation v AXA Asia Pacific Holdings Ltd (2010) 189 FCR 204 (at [106])
2. There is a distinction between dealing at arm's length and an arm's length relationship: ACI Operations Pty Ltd v Berri Ltd (2005) 15 VR 312 (at [224]). Whether the parties did not deal at arm's length is not to be decided by answering whether the parties were not in an arm's length relationship. The fact that the parties are themselves not at arm's length does not mean that they have not, in respect of a particular dealing, dealt with each other at arm's length: Re Hains; Barnsdall v Commissioner of Taxation 88 ATC 4565; (1988) 81 ALR 173 (at 177); Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4014-4015)
3. Whether the parties dealt at arm's length involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction: Granby (at 506)
4. At issue is whether the parties have acted separately and independently in forming their bargain: Granby (at 507); ACI Operations Pty Ltd (at [226])(did the parties apply "independent separate wills"); AXA Pacific Holdings Ltd (at [105]). There should be an assessment of whether the parties dealt with each other as arm's length parties would be expected to behave so that the outcome is a matter of real bargaining: Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4015); Granby (at 506 and 507); AXA Pacific Holdings Ltd (at [105])
5. It is relevant to consider the nature of any relationship between the parties: Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4015); Granby (at 506); and
6. If the parties are not at arm's length the inference may be drawn that they did not deal with each other at arm's length: Granby (at 506); ACI Operations Pty Ltd (at [225]).

Based on the facts provided, it is considered that Sub Co will not be dealing at arm's length with Parent Co in connection with Sub Co's acquisition of the shares in Sibling Co.

Accordingly, paragraph 112-20(1)(c) will apply and the first element of Sub Co's cost base or reduced cost base of the Sibling Co shares it acquires from Parent Co is the market value of those Sibling Co shares at the time of acquisition.

Subsection 112-20(2) will not apply as the proposed transaction will involve Parent Co disposing its interest in Sibling Co to Sub Co and CGT event A1 should happen for Parent Co under section 104-10.

Further, the exceptions to the market value substitution rule in subsection 112-20(3) do not apply.