Edited version of private advice

Authorisation Number: 1051895822817

Date of advice: 6 September 2021

Ruling

Subject: Majority underlying interests

Question

Is the Commissioner satisfied, or thinks it is reasonable to assume, that the goodwill of the Company remained a pre-CGT asset of the Company after the restructure pursuant to subsection 149-30(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period periods:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Company was incorporated before 20 September 1985.

The Company has, at all times since incorporation, been carrying on a business, with no material change in the nature or character of the business.

Just before 20 September 1985 the shareholders of the Company were a husband and wife (each holding one share each) and their family trust (holding XX shares).

The family trust is a discretionary trust. The specified beneficiaries of the family trust are the children of the married couple. The class of beneficiaries also includes the individuals and family members related to the specified beneficiaries.

The married couple had XX children, XX of whom never received distributions from the family trust and were not involved in the running of the business.

In 20XX the family restructured the share capital of the Company. The following transaction occurred:

•                     the individuals transferred their two ordinary shares to the trust of one of their children (Child A Trust)

•                     the family trust transferred a large portion of its ordinary shares to Child A Trust, and

•                     the family trust transferred its remaining shares to a trust of the other child involved in the business (Child B Trust)

The beneficiaries of Child A Trust include the child of the original individual shareholders and any family members.

The income and corpus beneficiaries of Child B Trust includes the other child of the original individual shareholders and any family members.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 109-10

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Sub-division 149-B

Income Tax Assessment Act 1997 paragraph 149-10

Income Tax Assessment Act 1997 paragraph 149-10(a)

Income Tax Assessment Act 1997 paragraph 149-10(b)

Income Tax Assessment Act 1997 paragraph 149-10(c)

Income Tax Assessment Act 1997 subsection 149-15(1)

Income Tax Assessment Act 1997 subsection 149-15(2)

Income Tax Assessment Act 1997 Subsection 149-15(3)

Income Tax Assessment Act 1997 Subsection 149-15(4)

Income Tax Assessment Act 1997 Subsection 149-15(5)

Income Tax Assessment Act 1997 Subsection 149-30(1)

Income Tax Assessment Act 1997 Subsection 149-30(2)

Income Tax Assessment Act 1936 section 160ZZS

Income Tax Assessment Act 1936 subsection 160ZZS(1)

Income Tax Assessment Act 1936 Subdivision 20C

Reasons for decision

CGT asset acquired without a CGT event

Section 109-10 sets out the rules for when you acquire a CGT asset without a CGT event happening. Where a taxpayer commences business the goodwill of the business is acquired when the taxpayer starts the work that results in the creation of the goodwill.[1]

Whether a taxpayer starts the work resulting in the creation of goodwill of a business is a question of fact dependent on the circumstances of each particular case. In the present case, as the Company commenced its business before 20 September 1985, the goodwill of the business would be taken to have been acquired at that time. Therefore, the goodwill of the Company is considered to originally to have created pre-20 September 1985, as it is deemed to have been acquired when the business commenced.

Division 149 - majority underlying interests

Division 149 determines when an asset acquired on or before 19 September 1985 stops being a pre-CGT asset.

Section 149-10 states:

A CGT asset that an entity owns is a pre-CGT asset if, and only if:

(a) the entity last acquired the asset before 20 September 1985; and

(b)          the entity was not, immediately before the start of the 1998-99 income year, taken under:

(i)            former subsection 160ZZS(1) of the Income Tax Assessment Act 1936 (ITAA 1936); or

(ii) Subdivision C of Division 20 of former Part IIIA of that Act;

to have acquired the asset on or after 20 September 1985; and

(c) the asset has not stopped being a pre-CGT asset of the entity because of this Division.

In the present case, the pre-CGT asset is the goodwill of the business carried on by the Company, as it is taken to have been acquired pre-20 September 1985.

Paragraph 149-10(a)

As the Company commenced carrying on its business pre-20 September 1985, this requirement is satisfied as the goodwill is taken to have been acquired before 20 September 1985.

Paragraph 149-10(b)

This requirement is satisfied as there were no changes to the shareholdings in the Company between 20 September 1985 and 30 June 1998.

Paragraph 149-10(c)

In respect of this provision, it must be determined whether the asset has not stopped being a pre-CGT asset because of Division 149.

Subdivision 149-B contains provisions which govern when an asset of a non-public entity stops being a pre-CGT asset.

Subsection 149-30(1) provides that the asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

The test to determine when an asset of a non-public entity stops being a pre-CGT asset is a factual test. Under the test, the asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not maintained. Therefore, an entity must examine the underlying interests in its pre-CGT asset on an on-going basis to ensure that majority underlying interests in that asset has been maintained when there has been a change, direct or indirect, in its shareholdings, unit holdings or other membership interests.

'Majority underlying interests' in a CGT asset consist of more than 50% of:

(a)          the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset, and

(b)          the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.[2]

An 'underlying interest' in a CGT asset is a beneficial interest that an ultimate owner has (whether directly or indirectly) in the asset or in any ordinary income that may be derived from the asset.[3]

An 'ultimate owner' is defined in subsection 149-15(3) and includes:

•                      an individual

•                      a company whose constitution prevents it from making any distribution, whether in money, property or otherwise, to its members

•                      the Commonwealth, a state or a territory

•                      a municipal corporation

•                      a local governing body, or

•                      the government of a foreign country, or of part of a foreign country

Subsection 149-15(4) states:

An ultimate owner indirectly has a beneficial interest in a CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of the capital of the other entity if:

(a)          the other entity were to distribute any of its capital, and

(b)          the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

Subsection 149-15(5) states:

An ultimate owner indirectly has a beneficial interest in ordinary income that may be derived from a CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of a dividend or income if:

(a)          the other entity were to pay that dividend or otherwise distribute that income, and

(b)          the dividend or income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner.

The expression 'beneficial interest' as used in the definition of 'majority underlying interests' is not defined. Under ordinary legal concepts, where there is a discretionary trust deed, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. Consequently, due the nature of a discretionary trust, it cannot be shown that majority underlying interests have been held by ultimate owners who have held such interests at all times since 20 September 1985 as it is not possible for beneficiaries of the discretionary trust who are ultimate owners to satisfy the terms of subsections 149-15(4) and (5).

As the beneficiary of a discretionary trust does not hold an interest in any asset of the trust or in the ordinary income derived from the asset until the trustee's discretion is exercised, it would not be possible for a discretionary trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1).

Commissioner's discretion

Subsection 149-30(2) provides a discretion to overlook the factual test in subsection 149-30(1) if the Commissioner is satisfied, or thinks it reasonable to assume, that at all times after 20 September 1985 when the asset was held by the taxpayer, majority underlying interests in the asset was held by a natural person who, immediately before that date, held majority underlying interests in the asset.

Simply put, subsection 149-30(2) requires that the Commissioner be satisfied that the majority underlying interests in the assets have not changed, otherwise the asset is deemed to have been acquired at the time that the change in majority underlying interests in that asset happened.

Therefore, in the case of a discretionary trust, Division 149 can only be satisfied if the discretion in subsection 149-30(2) applies, that is, the Commissioner is satisfied, or thinks it reasonable to assume, that majority underlying interests in the asset have been held by ultimate owners who have held such interests at all times since 20 September 1985.

In the present case, the pre-CGT goodwill was created in a business that is being carried on by a company, whose shares were held by two individuals and a discretionary trust (the family trust).

In respect of the shares held by the family trust, the Commissioner has outlined a pragmatic approach in 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 (IT 2340). In IT 2340, the Commissioner sets out when he would be satisfied, or think it reasonable to assume, that majority underlying interests have been held by ultimate owners who have held such interests at all times since 20 September 1985. Whilst IT 2340 refers to the former section 160ZZS of the Income Tax Assessment Act 1936, it equally applies to the rewritten provision contained in Division 149. In essence, the Commissioner would form such a view where the trustee of the trust in question continues to distribute each year to beneficiaries who are all members of the same family group. As a starting point, IT 2340 assumes a beneficiary of a discretionary trust as having a beneficial interest in the trust's assets.

IT 2340 states:

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. (Emphasis added)

The reference in these paragraphs in IT 2340 to 'a trust' and 'the trust', makes clear that the view expressed in IT 2340 only applies where the trust in question is the same trust that held the assets as at 20 September 1985. That is, the trustee must continue to administer the trust in question at all times from 20 September 1985.

In the present case, the family trust held its shares in the Company from incorporation until 20XX when the restructure occurred. The shares were then transferred to Child A Trust and Child B Trust in 20XX. Although the trustees of those respective trusts may have continued to administer those trusts for the benefit of members of the family group, it is clear that these trusts are not the same trust (being the family trust) that held the goodwill as at 20 September 1985. The view in IT 2340 therefore cannot be applied to the present case.

The guidance in IT 2340 would therefore have no application in a case where the pre-CGT asset in question is held by some other entity which the trustee of the discretionary trust has a direct or indirect interest in.

Therefore, the situation in IT 2340 that sets out when the Commissioner would exercise his discretion in subsection 149-30(2) is not applicable in this case. All shares in the Company were transferred to different entities in 20XX. Consequently, the Commissioner is not satisfied, or thinks it reasonable to assume, that majority underlying interests in the goodwill of the business of the Company have been held by ultimate owners who have held such interests at all times since 20 September 1985. The goodwill stopped being a pre-CGT asset at this time as majority underlying interests in the asset were not maintained. Therefore, the requirement in paragraph 149-10(c) is not satisfied.

Since paragraph 149-10(c) is not satisfied, the goodwill of the business of the Company will cease to be a pre-CGT asset at the time of the 20XX restructure pursuant to the operation of section 149-10.

[1] Section 109-10, item 1.

[2] Subsection 149-15(1)

[3] Subsection 149-15(2)