Edited version of private advice

Authorisation Number: 1051829680614

Date of advice: 30 July 2021

Ruling

Subject: CGT on the disposal of the pre-CGT shares

Question 1

Does the Commissioner agree that any sale proceeds to be received on the disposal of the shares in XXXX Pty Ltd should be attributed to the shares held by XXXX and not the shares held by the remaining shareholders?

Answer

Yes

Question 2

To the extent that the Commissioner answers no to (a), we request the Commissioner confirms that, having regard to the rights attaching to the various share classes and XXXX voting powers in XXXX Pty Limited, the sale proceeds are not to be attributed to the post CGT shares (A and E class shares) held by the XXXX Trust?

Answer

Not applicable as the answer to Question 1 is yes

Question 3

Will a capital gain arise under CGT event K6 as set out in section 104-230 of the Income Tax Assessment Act 1997 (ITAA 1997) on the disposal of the pre-CGT shares held in XXXX Pty Ltd?

Answer

No, but the market value has to be determined at the time of sale.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Your tax agent advised that:

The XXXX Group are fund managers who specialise in the acquisition, management and value add to property portfolio assets in State A. The XXXX Group have extensive experience in the development and upgrade to property in XXXX CBD.

The XXXX Group have subsequently made a cash offer to acquire 100% of the shares in XXXX Pty Limited. This transaction would result in the ownership of XXXX Pty Limited and its subsidiary entities, including the four properties held by those entities, ceasing to be owned and controlled by the XXXX Family. The XXXX Family would have no ongoing involvement with the entities or the property assets.

The XXXX Group is controlled by the XXXX family and includes members of the XXXX family, XXXX Pty Limited and subsidiary companies, the XXXX Family Trust and the XXXX Trust (collectively referred to as the "XXXX Group").

The XXXX family consists of XXXX and XXX children XXXX.

The XXXX Family created its wealth during a period of more than XX years through various businesses operated by the late XXXX and investment in property. XXXX died in XXXX.

XXXX Pty Limited and its subsidiary companies own XXX properties.

There have not been any material changes to the group structure since XXXX passing.

XXXXhistorical property dealings:

•         The properties have historically been used to derive passive rental income. The rental income is the only source of third party income that is currently derived by the XXXX Group. This is reflected in historical income tax return lodgements.

•         The value of the properties have increased during the period of ownership. Whilst there have been capital works of a rectification and/or compliance nature (e.g. fire compliance on a heritage building), there has not been any substantial improvement to the properties.

•         In this regard, the XXXX Group and the XXXX lack sufficient access to capital required to support any material capital expenditure on the properties which is required in order to continue to properly maintain the properties going forward.

•         The XXXX has not undertaken any "active" development in relation to the properties. Whilst offers to enter into joint ventures have been made by third parties in the past, the XXXX did not enter into these joint ventures as the XXXX did not have the experience or the required risk appetite to enter into transactions that it had perceived as complex and high risk. The XXXX should be considered a conservative taxpayer with a desire for simplified financial affairs since the various businesses operated by XXXX ceased operations.

•         An example of the XXXX reluctance to complicate its affairs and minimise its risk include its dealings in relation to XXXX Street. The XXXX engaged XXXX and XXXX in XXXX to determine the cost of upgrading the building at XXXX Street. The report indicated that the cost and scope of capital works required were significant and complex due to the heritage façade of the building. The XXXX did not have the available cash flow and capital to invest into the upgrade. Given XXXX age and the family's risk tolerance, the XXXX was not comfortable taking on bank debt to fund the upgrade due to the risk of unanticipated costs. The upgrade did not proceed.

•         A further example of the XXXX reluctance to complicate its affairs and minimise its risk includes dealings in relation to a property previously owned at XXXX (a former business premises). The XXXX was approached by a third party to enter into a joint venture arrangement to develop the XXXX Street property which required an upgrade. The XXXX Group decided at the time to sell the property without entering into a joint venture arrangement as they were not in the business of developing property and had always opted for low risk and minimum complexity in their affairs.

XXXXlegacy:

•         XXXX is XX years of age and remains the main decision maker of the XXXX.

•         As XXXX continues to grow older, XXXX is finding it more and more difficult to manage the financial affairs.

•         XXXX has expressed a desire to simplify the financial affairs as part of the succession plan and estate planning. XXXX has a strong desire to financially support the children with the view to providing them with financial freedom during XXXX lifetime.

•         The XXXX Group derives a relatively low income from the assets that it owns and, as a result, XXXX would like to sell all the investment assets which XXXX owns or controls in an efficient and timely manner and divide the proceeds equally among XXXX's XXX children for their own benefit and for the benefit of XXXX's grandchildren.

•         XXXX's children have differing financial circumstances and personal needs. The provision of capital to the children by XXXX will allow the children the opportunity to be more financially independent and to provide greater support to their own children whilst fulfilling a lifetime objective and goal of XXXX and XXXX's late husband XXXX to provide financial stability for future generations.

XXXX's powers under the XXXXPty Ltd Company Constitution ("Constitution") as sole director and sole voting member:

•         XXXX is the sole director and sole voting member of XXXX Holdings Pty Ltd. The Constitution provides the director and voting member with the following rights:

o   The company is able to be a single director company.

o   The power to appoint and remove a director is conferred on the member of the issued shares with voting rights.

o   For any business to be transacted at any general meeting there must be a quorum of members present at the time when the meeting proceeds to business. The presence of the member entitled to attend and vote at general meetings will constitute a quorum.

o   The quorum for a board meeting is one director if the company has only one director. A resolution is passed by a majority of votes cast by directors. In the case of a single director company, the director has the casting vote on the resolution.

o   Written resolutions can only be passed by a member that is entitled to vote.

o   The Board has the power to dispose of shares on terms and rights which they determine and at the times they think fit. The Board means the sole director, being XXXX.

o   A request to transfer a share by a member can be refused by the Board in its absolute discretion.

The director can declare a dividend be paid to members with dividend rights. They can also determine that dividends be paid on one class of share but not on another class.

Classes and rights of shares

The following table provides a summary of the share classes on issue:

Based on the above summary of the share class structure, the proceeds from any future disposal of the shares in XXXX Holdings Pty Ltd are expected to be ascribed to XXXX's B and F class shares based on the following:

•         XXXX holds the B class share, being the only share with voting rights.

•         The B class share is the controlling share as it has the right to appoint or remove the director who controls and manages the business of the company. XXXX is currently the sole director of the company.

•         The dividend shareholders (E and F class shareholders) only obtain the benefits of dividend income if the director resolves to distribute a dividend. There are no dividend rights that attach to the E or F shares on a standalone basis.

•         In this respect the holder of these shares does not have an entitlement to receive a dividend distribution in its own right (i.e. the director has to determine that dividends are to be paid in respect of the share class).

•         The voting shareholder has the power to appoint the director and XXXX is currently both the voting shareholder and the sole director.

•         XXXX has both voting rights (B class) and dividend rights (F class). Consequently, as sole director, XXXX has the power to declare a dividend on the F class share to the exclusion of E class shareholders.

Relevant legislative provisions

Income Tax Assessment Act 1997, s104-10

Income Tax Assessment Act 1997, s108-5

Income Tax Assessment Act 1997, s104-230

Income Tax Assessment Act 1997, s149-30

Income Tax Assessment Act 1997, s109-10

Income Tax Assessment Act 1997, s126-5

Income Tax Assessment Act 1997, s149-15

Income Tax Assessment Act 1997, s149-30

Income Tax Assessment Act 1997, s295-90

Further issues for you to consider

We have limited our ruling to the questions raised in your application. There may be related issues that you should consider including:

The market value of the properties at the time of sale that may change the 75% test for the purposes of CGT event K6.

Reasons for Decision

Summary

Capital gains tax on the disposal of the pre-CGT shares.

Detailed reasoning

Generally, when a taxpayer who holds their shares on capital account disposes of pre-CGT shares (these are shares that you acquired before 20 September 1985) the CGT regime does not apply and therefore no taxable gain or loss arises from the disposal.

However if the market value of property acquired by the Company post 20 September 1985 (post-CGT) is at least 75% of its net value at the time of that disposal, then a CGT event can happen. This CGT event is known as K6. If CGT event K6 happens, there will only be a capital gain where the capital proceeds received from your shares can be said to be attributable to a gain on post-CGT property owned by you. Shareholders cannot make a capital loss from CGT event K6.

However paragraph 15 of TR 2004/18 - Income tax: capital gains: application of CGT event states the following:

An exception applies where the CGT asset is treated as having been acquired post-CGT because of the operation of Division 149 of the ITAA 1997. In this case, the item of property continues to be treated as having been acquired pre-CGT for the purposes of CGT event K6.

Therefore, for the purposes of calculating a CGT K6 event capital gain after the sale of the shares that it owned in Company A, any change in majority underlying ownership that resulted from the application of Division 149 of the ITAA 1997 at the time of the disposal by Company B, will be ignored.

Question 1

Generally, each Ordinary Share, "A" Class Share and "B" Class Share confers upon its holder the right to receive notice of, attend and vote at a meeting of members. Each "C" Class Share, "D" Class Share, "E" Class Share and "F" Class Share confers on its holder no right to receive notice of, attend or vote at a meeting of members.

Furthermore, all the types of shares confers upon its holder the right, ranking after any Preference Shares but ranking equally with all other classes of Shares, to payment in cash of the amount then paid up on the share on a winding up of the Company, to payment of any dividend determined to be paid on that class by the directors and the right to participate in the surplus assets or profits in the company.

In your case, the "A" and "E" class shares are held by XXXX Trust and as a result, it is considered reasonable to assume the value should be ascribed to the B class alone or the B class and F class as a collective as XXXX owns those shares (and the F class shares are able to receive a dividend). The E class share held by the XXXX Testamentary Trust should not have any value in its own right as any ability to receive dividend distributions is solely dependent on the decision of the company director.

There is no obligation to make any distribution on the E class shares and furthermore as XXXX does not hold those shares it would be unreasonable to assume that value should be attributed to shares that XXXX does not own. In this respect we note if XXXX continues to hold the B class shares then it is questionable whether any other classes of share being sold on their own should be valuable in their own right.

If XXXX were to sell the B class shares, the buyer does not have the benefit of any control because the control rights only have application whilst XXXX holds the share. As a result it would be unlikely that any value would be attributed to those shares by a purchaser of the B class shares (with no dividend or capital rights and no control).

On XXXX ceasing to have ownership of the B class share then voting rights revert to the Ordinary shares (which are also considered pre-CGT shares). In any event, in our view, the E class shares (which are post CGT shares) have no value in their own right as long as XXXX remains the holder of the B class shares. Furthermore, in the event XXXX were to no longer hold the B class shares it should not be assumed that the value in any way reverts to the E class shares.

The time of CGT event A1 will be when the option is exercised and the Share Sale Agreement is entered into. Subsection 104-10(4) states that you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base.

In your circumstances, according to the share class structure, the proceeds from any future disposal of the shares in XXXX Pty Ltd are expected to be ascribed to XXXX's B and F class shares based on the following:

•         XXXX holds the B class share, being the only share with voting rights.

•         The B class share is the controlling share as it has the right to appoint or remove the director who controls and manages the business of the company. XXXX is currently the sole director of the company.

•         The dividend shareholders (E and F class shareholders) only obtain the benefits of dividend income if the director resolves to distribute a dividend. There are no dividend rights that attach to the E or F shares on a standalone basis. In this respect we understand that the holder of these shares does not have an entitlement to receive a dividend distribution in its own right.

As XXXX is currently both the voting shareholder and the sole director, the voting shareholder has the power to appoint the director.

In these circumstances, the sale proceeds on the disposal of shares in XXXX Pty Ltd will be attributed to shares held by XXXX and any capital gains will be attributed to XXXX.

Question 3

The sale by the Shareholders of their respective shares in the Company to a purchaser will result in CGT event A1 happening pursuant to subsection 104-10(1). Subsection 104-10(1) provides that CGT event A1 happens if you dispose of a CGT asset.

Shares in a company are a CGT asset as defined in section 108-5.

Subsection 104-10(2) provides that a disposal happens when there is a change of ownership from you to another entity. The sale of the Shareholders' shares to a purchaser will constitute a disposal. Therefore, the sale by the Shareholders of their respective shares in the Company to a purchaser will result in CGT event A1 happening.

Subsection 104-10(3) provides that the time of the event is when you enter into the contract for the disposal. As the Shareholders are proposing to sell their shares in the Company, the time of CGT event A1 will be when the Share Sale Agreement is entered into.

While capital gains and capital losses on the sale of pre-CGT shares are generally disregarded, a capital gain may be made under CGT event K6.

CGT event K6 is set out in section 104-230 of the Income Tax Assessment Act 1997 (ITAA 1997), and happens if:

(a) you own shares in a company that you acquired pre-CGT;

(b) CGT event A1, C2, E1, E2, E3, E5, E6, E7, E8, J1 or K3 (the other event) happens in relation to the shares;

(c) there is no roll-over for the other event; and

(d) one of the requirements in section 104-230(2) is satisfied (subsection 104-230(1)).

If CGT event K6 happens you make a capital gain as set out in subsection 104-230(6) of the ITAA 1997.

Taxation Ruling TR 2004/18 Income tax: capital gains: application of CGT event K6 (about pre-CGT shares and pre-CGT trust interests) in section 104-230 of the Income Tax Assessment Act 1997 (TR 2004/18) discusses CGT event K6 and the tests in subsection 104-230(2) of the ITAA 1997 (the 75% tests).

CGT event A1 happens if you dispose of a CGT asset such as shares (subsection 104-10(1) of the ITAA 1997. You dispose of a CGT asset if a change of ownership occurs from you to another entity (subsection 104-10(2).

CGT event A1 will happen when you enter into a contract to sell the shares, or when the ownership of the shares changes (section 104-10(3) of the ITAA 1997).

Paragraph 104-230(1)(d) of the ITAA 1997

Section 104-230(2) of the ITAA 1997 requires that, 'just before the other event happened':

(a) the market value of the post-CGT properties (excluding trading stock) are at least 75% of the net value of those properties; or

(b) the market value of the interests in post-CGT property of interposed companies or trusts (excluding trading stock) is at least 75% of the net value.

As stated above, the relevant time for determining the relevant market values and net values for the purpose of the 75% tests is 'just before the 'other CGT event' happens'.

In this case that is just before CGT event A1 happens - when you enter into a contract to sell the shares or, if there is no contract, when the change of ownership occurs on settlement of the transaction (section 104-10(3) of the ITAA 1997).

TR 2004/18 paragraphs 12 and 13 further states what is meant by the term ''property'' for CGT event K6 purposes.For the purpose of the 75% tests, the term 'property' has its ordinary legal meaning. It does not mean 'asset' or 'CGT asset'. As such, although some income tax law treats a single item of property as two CGT assets, for the 75% tests there is one item of property and one acquisition date.

For the purpose of paragraph 104-230(2)(a) of the ITAA 1997, post-CGT 'property' can include post-CGT shares in, or loans to, subsidiary companies and trusts (TR 2004/18, paragraph 17).

For the test in paragraph 104-230(2)(b) of the ITAA 1997 it is the post-CGT property of a company's subsidiary companies and trusts that is relevant:

•         All subsidiaries post-CGT property is taken into account, regardless of whether the subsidiary's shares or units were acquired pre-CGT or post-CGT, and

•         The market values of the subsidiaries' shares or units are excluded, even where those shares were acquired post-CGT (TR 2004/18, paragraph 19).

For both limbs of the 75% test, the 'net value' of the test company is the amount by which the sum of the market values of its assets exceeds the sum of its liabilities (subsection 995-1(1) of the ITAA 1997). In the context of "net value", the word "assets" means property and other economic resources of the company that the entity is capable of turning to account, even if they are not property (paragraph 20 of TR 2004/18).

Accordingly, for the purposes of calculating an entity's net value, "assets" would include trading stock, off-balance sheet assets (eg depreciated plant and internally generated goodwill) and pre-CGT assets. In other words, it would cover all the entity's CGT assets, off-balance sheet assets and identifiable assets in terms of accounting standards. However, it does not include "tax benefits" and non-proprietary assets.

"Liabilities" takes its ordinary meaning, and extends to a legally enforceable debt that is due for payment and to a presently existing obligation to pay either a sum certain or an ascertainable sum. It does not extend to a contingent liability or to a future obligation or expectancy (TR 2004/18 at paragraph 21).

Property, assets and liabilities owned by foreign residents are included in the calculations of post-CGT property and 'net value' for the purpose of the 75% tests. Subsection 104-230(7) of the ITAA 1997 provides for an adjustment to the acquisition date of certain property owned by foreign residents in certain circumstances.

For the purpose of CGT event K6, Division 149 of the ITAA 1997 does not apply to treat property as acquired post-CGT (paragraph 15 of TR 2004/18).

Furthermore, the conventional test of market value is the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length.

This conventional test is derived from the decision of the High Court in Spencer v The Commonwealth of Australia (1907) 5 CLR 418. In that case, Griffith CJ commented that:

"... the test of value of land is to be determined, not by inquiring what price a man desiring to sell could have obtained for it on a given day, i.e. whether there was, in fact, on that day a willing buyer, but by inquiring: What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?"

Based on the asset and liability values detailed in the facts as at XXXX 2020, the post-CGT properties are less than 75% of total net value of all the properties. Therefore, a capital gain would not arise on disposal of your pre-CGT shares as CGT event K6 would not happen on that date.

We understand that this would change due to the market value at the time of sale where the value of post-CGT properties could potentially be more than 75% of the total net value of the properties. In this circumstance it may give rise to a CGT event K6, that will be required to be calculated at that time.