Edited version of private advice

Authorisation Number: 1051919443676

Date of advice: 9 November 2021

Ruling

Subject: CGT - change in majority underlying interests

Question 1

Will Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997) operate to deem that a change in the majority underlying interests of the company has occurred?

Answer

No.

Question 2

Is the goodwill of the company's business considered to have been acquired before 20 September 1985?

Answer

Yes.

Question 3

Will any capital gain or loss arising from CGT event A1 occurring from the proposed disposal of the shares in thee company be disregarded?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

D commenced business as a sole trader around 19XX. The business had a focus on a particular activity. This business was conducted on a particular lot of real property and has been continuously conducted on this property to present day. D acquired this property in 19XX and remains the legal and beneficial owner.

Around 19XX D and M expanded business activity to include a related activity.

By 20 September 1985, the business had fully transitioned from its original activity to other related activities. One such activity briefly traded under a different trading name but was rebranded in 19XX to reference the original trading name of the business.

A third party operated a business on land adjacent to D's business. The third party's business activity was related in nature to D's business, even having a similar trading name which caused customers to believe the separate businesses shared the same owners and management.

Company Pty Ltd (the company) was incorporated in 19XX with D and M holding class-A and class-B shares respectively. Around 19XX the business was transferred from D to the company.

In 19XX, X C were each issued redeemable preference shares (RPS). The class-A and class-B shares carry rights to participate in capital and voting but each class may receive dividends to the exclusion of shares in the other class. The RPS have voting rights; rights to dividends on a discretionary basis and the right to return of paid-up capital in priority on winding up; but no further right to capital.

In 20XX, C was appointed as a director of the company.

In 20XX, X's RPS were redeemed. In 20XX, C's husband Y was issued RPS. Apart from these changes, there have been no other changes to the company's share structure.

Since the RPS were issued to Y, the company declared dividends in most years between all share classes. The greatest percentage of any declared dividend was to Y in the 20XX financial year.

In 20XX, D and M acquired, through a related trust, the adjacent land used by the business. Due to this business' poor performance, the acquisition was for land only and not the business or its goodwill. Since acquisition of this land, the property has been refurbished and expanded. This business was immediately subsumed into the company's business. The separate but related activities are promoted to the public via a single website, and the business has a single reception area where customers of all activity types are greeted in the same area, regardless of which part of the business they are attending.

It is proposed that the RPS will be redeemed, and that the class-A and class-B shares are converted into ordinary shares.

It is further proposed that D and M transfer their shares in the company to a related trust controlled by C and Y.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-230

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 109-5

Income Tax Assessment Act 1997 section 109-10

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 section 149-30

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question1

Will Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997) operate to deem that a change in the majority underlying interests of the company has occurred?

Summary

It is not considered that there has been a change in the majority underlying interests of the company.

Detailed reasoning

Division 149 of the ITAA 1997 provides that pre-CGT assets will be deemed to be post-CGT where there has been a change in the majority underlying ownership of the assets.

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

(a) more than 50% of the beneficial interests that *ultimate owners have (whether directly or *indirectly) in the asset; and

(b) 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.

Paragraph 6 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 provides that where, as a result of the issue of additional shares in a company, a change of 50 per cent or more occurs in the underlying ownership of assets of the company, the former section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936), now Division 149 of the ITAA 1997, would operate to deem assets of the company which were acquired before 20 September 1985 to have been acquired on or after that date.

Paragraph 7 provides that, as noted 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, where an asset is deemed by the former 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.

Paragraph 10 provides that if natural persons who immediately before 20 September 1985 held more than one half of the underlying interests in an asset continue to hold more than one half of the underlying interests at all times on and after that date, there will be no change in the majority underlying interests in the asset for the purposes of the former section 160ZZS.

IT 2340 discusses the Commissioner's views on the application, in relation to family trusts, of the former section 160ZZS of the ITAA 1936. Paragraph 6 of IT 2340 provides that where a trustee continues to administer a trust for the benefit of members of a particular family, it will not bring the former section 160ZZS of theITAA 1936 into application.

Paragraph 7 of IT 2340 provides that in such cases, the Commissioner would find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. Paragraph 8 provides that the former section 160ZZS of the ITAA 1936 would apply where members of a new family are substituted as distribution recipients and there is, in practical effect, a change of 50% or more in the underlying interests in the trust assets. It is considered that D's family group has, at all times since 19XX, owned majority underlying interests the assets of the company.

The only changes in shareholdings in the company since 20 September 1985 were the redemption of X's RPS in 20XX, and the subsequent issue of RPS to Y in 20XX. The RPS issued in 20XX is 50% of the issued RPS in the company.

The RPS have a discretionary element, being discretionary rights to dividends.

Just before 20 September 1985, D, M, C and X collectively held all the beneficial interest in ordinary income. When X's RPS were redeemed in 20XX, both D and M were potentially entitled to a 100% distribution of income, and C also became potentially entitled to a 100% distribution of income.

The redemption of X's RPS in 20XX did not result in a change in the majority underlying ownership of the company's assets because D, M and C still collectively held more than 50% of the beneficial interests in ordinary income, with D and M maintaining capital rights.

When Y was issued RPS in 20XX, the potential distribution of income for D and M did not change but C reverted to a 50% potential dividend entitlement. Due to the dividend rights attaching to the RPS, the company was able to pay 100% of a dividend on RPS which would be 50% each to C and Y. Therefore, C retained the right to exactly 50% of any dividend declared on RPS.

Subsection 149-30(2) of the ITAA 1997 provides that if the Commissioner is satisfied, or thinks it reasonable to assume, that at all times on and after 20 September 1985 and before a particular time *majority underlying interests in the asset were had by *ultimate owners who had *majority underlying interests in the asset immediately before that day, subsections (1) and (1A) of the ITAA 1997 apply as if that were in fact the case.

In your circumstances, the Commissioner finds it reasonable to assume that the majority underlying interests have been held after 20 September 1985 by the same ultimate owners who held the interests immediately before 20 September 1985. Consequently, the interests in the company retain their pre-CGT status.

Question 2

Is the goodwill of the company's business considered to have been acquired before 20 September 19XX?

Summary

The goodwill of the company's business is considered to have been acquired before 20 September 19XX.

Detailed reasoning

Goodwill as a single CGT asset

Paragraph 108-5(2)(b) of the ITAA 1997 provides that goodwill is specifically a CGT asset.

Paragraph 17 of Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business provides that the whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset (subject to Division 149 of the ITAA 1997) provided the same business continues to be carried on.

Acquisition or expansion of goodwill

Paragraph 21 of TR 1999/16 provides that the business does not need to be identical from its acquisition to its disposal. If the essential nature or character of the business is not changed, the business remains the same business for the CGT goodwill provisions. A business owner may expand or contract activities, or change the way in which a business is carried on, without ceasing to carry on the same business provided the business retains its essential nature or character.

Paragraph 27 of TR 1999/16 provides that goodwill is one CGT asset separate and distinct from other assets of the business such as...items of intellectual property (for example, a trade mark, a patent, copyright or registered design.)

Paragraph 60 of TR 1999/16 provides that if a new business operation or activity introduced by a taxpayer is an expansion of an existing business (whether it commenced before or after 20 September 1985), any goodwill built up in conducting the expanded business is merely an expansion of the existing goodwill of the business. If a business which commenced before 20 September 1985 (a 'pre-CGT business') is expanded, goodwill generated in conducting the expanded business is merely an accretion to the pre-CGT goodwill.

Paragraph 64 of TR 1999/16 provides that if a pre-CGT business is combined with another business acquired post-CGT and they are conducted as one business without the pre-CGT business losing its essential nature or character, the goodwill of the post-CGT business is subsumed into the goodwill of the pre-CGT business and all of the goodwill of the business is taken to have been acquired before 20 September 1985.

Application to your circumstances and discussion of "same business"

Paragraph 89 of TR 1999/16 provides that the goodwill of a business that commenced before 20 September 1985 remains a pre-CGT asset provided the same business continues to be carried on...For a business that commenced before 20 September 1985, any accretion to its goodwill since 20 September 1985 is not a post-CGT asset.

The company's business has expanded and evolved over time where now it operates a business comprising several related activities. The company has always conducted its nature of business since its incorporation in 19XX, but since September 1985 there have been various changes to the business. Immediately prior to 20 September 1985, it conducted other related activities. Prior to 1985, the business was primarily focused on particular related activities. Since 1985, the business had shed its original related activities and has expanded to include additional related operations.

There have been no periods of discontinuance or temporary cessation of the business since its inception. No part of the business or any of the company's material business assets have been disposed of since the business commenced.

The most recently expanded business activity has always been treated for banking and accounting purposes as an extension of the pre-existing business. The same accounting methods, bank accounts, finance teams and administrative support have been applied across the entire business. The acquisition of the adjacent land was not the acquisition or commencement of a separate and distinct business, but rather an expansion of the existing business with the acquired assets being immediately subsumed into the company's existing business.

D and M identified a strategic opportunity to acquire the adjacent land if a suitable opportunity arose, which occurred in 20XX. No goodwill was acquired in this transaction. The separate but related business activity was subsumed into the existing business and the subsequent conduct of these additional operations by the company was an expansion of the business.

All of the company's activities have been subject to the same integrated management and control. All of the activities have been treated for banking and accounting purposes as part of the same business. The same accounting methods (single ledger for the whole business), bank accounts, finance teams and administrative support have also been utilised for all activities of the business.

Although the company's business expanded, the core activities of the company's business remained the same and it is considered that there was no further acquisition of goodwill, merely an accretion of pre-existing goodwill, and therefore the goodwill of the company's business is considered to have retained its pre-CGT status.

Question 3

Will any capital gain or loss arising from CGT event A1 occurring from the proposed disposal of the shares in the company be disregarded?

Summary

Any capital gain or loss arising from CGT event A1 occurring from the proposed disposal of the shares in the company will be disregarded.

Detailed reasoning

Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when you dispose of a CGT asset. Section 108-5 of the ITAA 1997 provides that shares in a company are CGT assets. However, subsection 104-10(5) of the ITAA 1997 provides that a capital gain or loss you make from CGT event A1 is disregarded if you acquired the asset before 20 September 1985.

The proposed transfer of the company's shares to the new trust will result in CGT event A1 occurring for both D and M under section 104-10(1) of the ITAA 1997. However, a capital gain or loss from CGT event A1 will be disregarded if the shares were acquired before 20 September 1985, per s104-10(5) of the ITAA 1997.