Edited version of private advice

Authorisation Number: 1051888576202

Date of advice: 25 August 2021

Ruling

Subject: Capital gains tax

Question 1

Do the pre-capital gains tax (CGT) properties (the properties) acquired by Company A Pty Ltd (the company) before 20 September 1985 meet the requirements of section 149-10 of the Income Tax Assessment Act 1997 (ITAA 1997), such that they continue to be pre-CGT assets of the company?

Answer

Yes

Question 2

Will the execution of the variation deeds for Trust B and Trust C cause subsection 149-30(1) of the ITAA 1997 to apply to treat the properties as having been acquired by the company on the date of execution of the variation deeds?

Answer

No

Question 3

Will the execution of the transfer of shares in the company from Trust C to Trust B cause subsection 149-30(1) of the ITAA 1997 to apply to treat the properties as having been acquired by the company on the date of execution of the share transfer?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

30 June 19XX

Relevant facts and circumstances

Company A Pty Ltd was incorporated before 20 September 1985. It acquired two properties before 20 September 1985.

Trust B is a discretionary trust. The beneficiaries of this trust include D, E, and other family members of D and E. This trust is due to vest in 20XX.

Trust C is a discretionary trust. The beneficiaries of this trust include F, G and other family members of F and G. This trust is due to vest in 20XX.

There are three classes of shares on issue in the company, all of which were created before 20 September 1985:

•         A-class

•         B-class

•         Ordinary shares (ORD).

The A-class shares carry certain rights to income; certain rights to capital; certain rights to votes; and no rights to surplus assets or bonus shares. The A-class shares have preference over B-class shares.

The B-class shares carry certain rights to income; certain rights to capital; certain rights to votes; and no rights to surplus assets or bonus shares.

The ORD-class shares carry rights to income and capital in proportion to shares held, subject to preferential rights; rights to votes not held by preference shares; and rights to surplus assets and bonus shares.

The company was incorporated with D and E as the shareholders; there have been various changes to shareholdings over time, resulting from transfers and share issues.

In 19XX, A-class shares were issued to D and ORD shares were issued to Trust B.

In 19XX, B-class shares were issued to F.

In 19XX, D's ORD shareholdings transferred to F, and D's B-class shareholdings transferred to E.

In 19XX, after 20 September 1985, bonus ORD shares were issued to E, F and Trust B in proportion to ORD shareholdings.

In 19XX, E transferred A-class shares to F.

In 20XX, E's ORD shares transferred to Trust C.

In 20XX, F's A-class shares, B-class shares, and ORD shares transferred to Trust B.

In 20XX, Trust B held A-class shares, B-class shares and ORD shares; Trust C held only ORD shares, and a smaller amount thereof. From incorporation to date, Trust B has always held most of the ORD shares.

Trust B was established for the benefit of the D and E family group and has only ever been administered for members of this family group.

It is proposed that the B and C trust deeds be varied to extend the vesting day from 60 to 80 years, and to expand the class of beneficiaries to include further successive generations of D and E's family group.

It is further proposed that Trust C will transfer all of its ORD shares to Trust B, making Trust B the sole shareholder of the company.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Section 149-10

Income Tax Assessment Act 1997 Section 149-15

Income Tax Assessment Act 1997 Section 149-30

Reasons for decision

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

Under subsection 149-30(1) of the 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 interests in the asset were not held by the ultimate owners who had the majority underlying interests in the asset immediately before 20 September 1985.

Subsection 149-15(1) of the 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.

Rights attaching to shares

The company's constitution provides that the ORD shares carry equal rights to dividends, a return of paid-up capital and to participate in the surplus assets of the company, subject to preferential rights attaching to the A-class and B-class preference shares. These preference shares carry rights to non-cumulative preferential dividends at a specified small nominal percentage per annum of the paid-up capital, and to a return of capital in priority to ORD shares, but no rights to surplus assets; only the return of insignificant paid-up non-cumulative preference share capital.

The preference shares carry only nominal rights to any income or capital distributed by the company. Of all dividends declared, it has been established by the pattern of distributions that the vast majority of amounts paid have been to ORD shareholders.

Changes to shareholdings following the issuing of shares

In 19XX, A-class and ORD shares were issued. Later in 19XX, B-class shares were issued. Later in 19XX, ORD shares were issued.

The issue of ORD shares did not change ownership of the ORD shares. The ORD shares were issued to the ordinary shareholders in proportion to their ORD shares held at the time of the shares issue. The transfer of E's ORD shares to Trust C did not dilute the proportion of ORD shares held by Trust B. The transfer of F's ORD shares to Trust B increased its proportion of ORD shares held.

Paragraphs 6 and 7 of Taxation Ruling IT 2530 Income tax: capital gains: change in the underlying ownership of assets in a publicly traded unit trust: issue of new units in unit trusts and new shares in companies: interposed entities: calculation of change in majority underlying interests discuss the effects of additional shares in a company being issued, and the application of the former section 160ZZS of the Income Tax Assessment Act 1936 (now Division 149 of the ITAA 1997):

6. The issue of additional units in a unit trust or additional shares in a company is for these purposes considered not to be part of normal trading of units or shares. Where there is such an issue it will be appropriate to carry out a factual examination to determine whether there has been a continuity of majority underlying interests in the assets of the unit trust or company. Where, as a result of the issue of additional units in a unit trust or additional shares in a company, a change of 50 per cent or more occurs in the underlying ownership of assets of the unit trust or company, section 160ZZS would operate to deem assets of the unit trust or company which were acquired before 20 September 1985 to have been acquired on or after that date.

7. As noted in Taxation Ruling No. IT 2340, where an asset is deemed by section 160ZZS to have been acquired after 19 September 1985, the asset will be taken to have been acquired on the date on which the continuity of beneficial ownership in the asset of more than 50 per cent ceased to be maintained. The cost base for the purposes of determining future capital gains and losses on realisation of such an asset will be the market value of the asset on the date on which the asset is taken to have been acquired by the application of section 160ZZS.

From immediately before 20 September 1985, to date, Trust B has been the majority shareholder of ORD shares in the company, and it has therefore held the rights to more than 50% of income and capital distributed by the company.

Changes to shareholdings following the death of a shareholder

Subsection 149-30(4) of the ITAA 1997 provides that if an ultimate owner (new owner) has acquired an interest in an asset which is transferred to them as a result of the death of a person (the former owner), the new owner is treated as having held the underlying interest of the former owner over the years. Effectively the new owner will stand in the shoes of the former owners.

In 19XX, on account of the death of D, F received D's ORD shareholdings and E received D's A-class shareholdings in the company. In 20XX, on account of the death of E, Trust C received E's ORD shareholdings.

In accordance with section 149-30 of the ITAA 1997, the changes in shareholdings that occurred following the deaths of D and E did not change the majority underlying interests in the company's assets, as the new owners have been taken to stand in the shoes of the former owners.

Majority underlying interests held by discretionary trusts; vesting of the trust

Trust B is a discretionary trust, with the trustee having discretionary rights to distribute income and capital to beneficiaries. Where shares in a company are held by a discretionary trust, a beneficiary to the trust could not be said to have a beneficial interest in the income or assets of the trust.

However, paragraphs 5 to 7 of Taxation Ruling IT 2340 Income tax: capital gains: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date discuss what happens in respect of non-fixed family trusts, and the application of the former section 160ZZS of the Income Tax Assessment Act 1936 (now Division 149 of the ITAA 1997):

5. In relation to what are generally referred to as discretionary trusts, i.e., family trusts, the trustees of which have discretionary powers as to the distribution of trust income or property to beneficiaries, in considering the question of whether majority underlying interests have been maintained in the assets of the trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised.

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. That is consistent with the role of the section to close potential avenues for avoidance of tax in cases where there is a substantial change in underlying ownership of assets and the legislative guidance contained in Subdivision G of Division 3 of Part III of the Act. On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act.

Trust B acquired shares in the company prior to 20 September 1985. Distributions of income of the trust have been made to beneficiaries in accordance with the trust deed. Additionally, no variation of the trust deed had the practical effect of a change of 50% or more in the underlying interests in the assets of the trust. The variation to the deed extends the vesting date and expands the classes of beneficiaries to include further lineal descendants; or in other words, to enable the trustee to continue to administer the trust for the benefit of members of a particular family.

Taking into account the principals contained in IT 2340, the beneficial interest in the company's shares is taken to have not changed as a result of the deed of variation. Therefore, the variation of the trust deed will not change the majority underlying interests in the company's assets.

Conclusion

As it is taken that the majority underlying interests have not changed as a result of any of the above events, assets held by the company that were acquired prior to 20 September 1985 retain their pre-CGT status subject to the variations of the trust deeds and the deaths of D and E.