Edited version of private advice

Authorisation Number: 1051949963947

Date of advice: 14 April 2022

Ruling

Subject: CGT - majority underlying interests

Question 1

Will the ordinary shares held by First Trust in Company Bravo be considered pre-CGT assets pursuant to the former subsection 160ZZN(7) of the ITAA 1936?

Answer

Yes

Question 2

Will the CGT assets of Company Bravo retain their pre-CGT status pursuant to Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 3

Was CGT event K6 triggered on First Trust's disposal of shares in Company Bravo?

Answer

No

Question 4

Will the capital gain arising from First Trust's disposal of shares in Company Bravo be disregarded under subsection 104-10(5) of the ITAA 1997 as the shares are pre-CGT assets?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Information provided

You have provided copies of the following documents, which should be read in conjunction with, and form part of the scheme of this ruling:

(i)    First Trust Trust Deed;

(ii)   Second Trust Trust Deed;

(iii)  a history of distributions from the First Trust; and

(iv)  a history of distributions from the Second Trust.

Background

The Business was founded prior to 20 September 1985 by Individual A and Individual B.

Prior to 1 July 1988, the Business was conducted by the First Trust. The First Trust was settled prior to 20 September 1985.

The trustee of the First Trust is an Australian resident private company which was incorporated prior to 20 September 1985 (Company Alpha).

Individual A and Individual B each hold one ordinary share in Company Alpha. Company Alpha does not have any other shares on issue and there are no other shareholders.

Individual A and Individual B have been the directors of Company Alpha since they acquired the shares and have maintained control of Company Alpha since acquisition.

Company Bravo

Company Bravo is a private company which was incorporated after 20 September 1985.

Company Bravo was initially incorporated with two subscriber shares held by Individual A and Individual B on trust for First Trust. These subscriber shares were redeemed and Company Alpha as trustee for First Trust acquired the two ordinary shares on issue.

The initial directors of Company Bravo were Individual A and Individual B, both being appointed at incorporation. At all relevant times, Individual A and Individual B have maintained their director roles.

Transfer of the Business

After 20 September 1985, the Business was transferred by First Trust to Company Bravo. The steps that took place to affect the transfer of the Business to Company Bravo satisfy the capital gains rollover provisions in the former section 160ZZN of the ITAA 1936.

Following the transfer of the Business, it was operated out of Company Bravo.

Expansion of the Business

The Business has undertaken several business acquisitions since it was founded. These acquisitions were made to increase the customer base of the Business. Following each acquisition, the business operations of the acquiree were subsumed into the broader business.

The Business's logo has remained consistent since inception.

Brands and complementary businesses were established by the Business in response to technological updates and emerging changes in market demand. These brands and complementary businesses all sit under the Business umbrella and are identifiable as being associated with the Business.

Disposal of shares in Company Bravo

First Trust disposed of its shares in Company Bravo in Month 20xx to an unrelated party. There is no roll-over for the relevant CGT event.

First Trust

First Trust is a family discretionary trust settled prior to 19 September 1985.

The Trust Deed of First Trust defines 'the beneficiaries' to exclude the nominator and to include particular members of the nominator's family.

The Schedule to the Trust Deed of First Trust provides the nominator is Individual A.

The Trust Deed of First Trust provides that the trustee may distribute income derived from the trust fund to any beneficiary in its absolute discretion.

The Trust Deed of First Trust provides that, upon vesting, the trustee may distribute the capital of the trust fund to any beneficiary in its absolute discretion.

There have been no significant amendments to the terms of the trust deed establishing First Trust since the trust was settled. However, since the settlement of the trust, and at various points in time, new beneficiaries have been appointed as eligible objects of the trust.

Company Charlie

After 20 September 1985, Company Charlie was appointed as a corporate beneficiary of First Trust.

Company Charlie has one share on issue, owned by Individual B.

Company Charlie is not a trustee company.

Company Charlie is a company who is not prevented from distributing to its members.

The shares in Company Charlie are not held on trust by Individual B for any other entity.

Individual B is a beneficiary of First Trust.

Individual A is not a shareholder of Company Charlie.

Company Echo

After 20 September 1985, Company Echo was appointed as a corporate beneficiary of First Trust.

Company Echo has one share on issue, owned by Company Foxtrot as trustee for the Second Trust.

Company Echo is a company who is not prevented from distributing to it members.

Second Trust

Second Trust is a hybrid trust which was settled by deed after 20 September 1985.

The trustee of Second Trust is Company Foxtrot.

Company Foxtrot is a private company which was incorporated after 20 September 1985.

Company Foxtrot has two ordinary shares on issue, one owned by Individual A and one owned by Individual B.

The Trust Deed of Second Trust provides a definition clause which also includes the different classes of beneficiaries, Unit Holders and Final Repository.

The Trust Deed of Second Trust provides the discretionary aspects available to the Trustees of the payment and accumulation of income.

The Trust Deed of Second Trust provides how the corpus is distributed on vesting, including to Unit Holders of Ordinary Units and the Final Repository.

The First Schedule of the Trust Deed of Second Trust provides:

The Initial Unit Holders are:

•         1 redeemable unit to Individual A

•         1 redeemable unit to Individual B.

The Final Repository is charitable purposes generally.

There are no Unit Holders of Ordinary Units of Second Trust.

Flow of income

Prior to 20 September 1985, distributions from First Trust flowed through to the individuals included in the class of beneficiaries contained within the Schedule from the Trust Deed of First Trust, either directly or as dividends paid by corporate beneficiaries.

From 20 September 1985, and up until the appointment of Company Echo as a corporate beneficiary of First Trust in Month 20x1, distributions from First Trust continued to flow through to the individuals included in the class of beneficiaries contained within the Schedule from the Trust Deed of First Trust as appointed over time, either directly or as dividends paid by corporate beneficiaries.

A history of dividends paid by Company Bravo to First Trust which flowed through to distributions paid from First Trust to Company Echo have been provided.

A history of dividends paid by Company Echo to Second Trust which flowed through to Individual A and Individual B have been provided.

A history of the retained earnings of Company Echo have been provided.

Relevant legislative provisions

Income Tax Assessment Act 1997

section 109-10

Division 149

Subdivision 149-B

paragraph 149-10

paragraph 149-10(a)

paragraph 149-10(b)

paragraph 149-10(c)

subsection 149-15(1)

subsection 149-15(2)

subsection 149-15(3)

subsection 149-15(4)

subsection 149-15(5)

subsection 149-30(1)

subsection 149-30(2)

Income Tax Assessment Act 1936

section 160ZZS

subsection 160ZZS(1)

Subdivision 20C

Reasons for decision

Questions 1, 2 & 4

Shares

Former subsection 160ZZN(7) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that the shares that constituted the consideration for a disposal by a taxpayer to a company of a roll-over asset, shall, if the asset was acquired before 20 September 1985, be deemed for the purposes of this Part to have been acquired before that date.

In your circumstances

The transfer of the Business from Company Alpha as trustee of First Trust to Company Bravo after 20 September 1985 satisfied the requirements for roll-over relief under the former section 160ZZN of the ITAA 1936. Accordingly, the shares issued in Company Bravo to First Trust are deemed to be acquired prior to 20 September 1985.

Goodwill

Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) explains what goodwill is for the purposes of the definition of a CGT asset. Relevantly, paragraph 17 of TR 1999/16 provides that the whole of the goodwill of a business that commenced before 20 September 1985 remains the same single pre-CGT asset provided the same business continues to be carried on.

Goodwill, or an interest in it, is a CGT asset, pursuant to paragraph 108-5(2)(b).

When goodwill is disposed of CGT event A1 occurs pursuant to subsection 104-10(1).

However, if the taxpayer acquired the goodwill before 20 September 1985, a capital gain or loss arising from the disposal of the goodwill will be disregarded, pursuant to subsection 104-10(5).

The ATO view on goodwill for the purposes of CGT is explained in Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16), which discusses the implications of the decision of the High Court of Australia in FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129, (FC of T v Murry). Goodwill in TR 1999/16 is described as follows:

Goodwill is the product of combining and using the tangible, intangible and human assets of a business for such purposes and in such ways that custom is drawn to it. The attraction of custom is central to the legal concept of goodwill. Goodwill is a quality or attribute that derives among other things from using or applying other assets of a business.

The meaning of goodwill has three different aspects namely property, sources and value.

It is something that attaches to a business and is inseparable from the conduct of a business. It cannot be dealt with separately from the business with which it is associated. A business owner cannot dispose of goodwill separately from the business to which it attaches.

Goodwill is a composite thing. It is an indivisible item of property that is legally distinct from the sources from which it emanates.

The whole of the goodwill of a business is either pre-CGT goodwill or post-CGT goodwill. 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 ITAA 1997- about when an asset stops being a pre-CGT asset) provided the same business continues to be carried on.

What goodwill means, depends on the character and nature of the business to which is attached. Goodwill differs in its composition in different trades or industries and in different businesses in the same trade or industry.

Paragraph 52 of TR 1999/16 provides that:

If a taxpayer commences business and starts to create goodwill, the goodwill of the business is acquired when the taxpayer starts work that result in the creation of the goodwill (subsection 109-10, item 1). When 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.

A business may change to such an extent that it becomes a new business with new goodwill. In FC of T v Murry it is stated that, in determining whether the same business is being carried on, the sources of the goodwill may have changed so much that, although the business is of the same kind as previously conducted, it cannot be said to be the same business.

Paragraphs 21 - 24 of TR 1999/16 state that if the essential nature or character of the business is not changed, the business remains the same business for the CGT goodwill provisions. The business 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 it retains its essential nature or character. Organic growth, expansion or diversification of a business by, for example:

•              adopting new, compatible operations; or

•              servicing different clients; or

•              offering improved products or services

does not of itself cause it to be new business provided the business retains its essential nature or character.

It is a question of fact and degree whether the goodwill of a business is the same asset as it was when it was acquired.

The same business is not carried on if:

•              through a planned or systematic process of change within a reasonable period of time, a business changes its essential nature or character; or

•              there is a sudden and dramatic change in the business brought about by either the acquisition or the shedding of activities on a considerable scale.

Paragraphs 60 - 62 of TR 1999/16 discuss internally generated goodwill and state the following:

60. 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-GGT goodwill.

61. If an introduced business activity is a new business, the goodwill attaching to that business is a new asset separate from the goodwill of the existing business.

62. Whether an increase in business operations or in the scale of activity constitutes an expansion of an existing business, or a new and separate business, is a question of fact dependent on the circumstances of each case. Factors that need to be considered in determining whether the business operation or activity is part of the existing business or is a new business include the nature of the new business operation or activity, the types of customers that the business operation or activity attracts and the extent to which the business operation or activity:

(a) is subject to the same integrated management and control as the existing business;

(b) is treated for banking and accounting purposes as an extension of the existing business or as a separate business;

(c) uses one or more different trading names; and

(d) is related to or dependent on the existing business in a practical, economic or commercial sense.

The question of whether a business has changed to such an extent that it is no longer the same business so that the goodwill of the old business ceases and goodwill of a new business is acquired is one of fact and degree. The following factors have to be considered as set out in paragraph 91:

•                nature or character of the business;

•                its location and size;

•                the extent of changes in the assets and resources of the business;

•                the activities of the business; and

•                the way in which the business is structured, carried on, managed and controlled.

Paragraph 93 of TR 1999/16 states that for the CGT goodwill provisions, the same business is carried on and no new goodwill asset is created if the business retains its same essential nature or character. It offers the following example:

A business of a printer may have changed over time due to the purchase of new equipment and the adoption of improved technologies. The printer may now attract a different type of client such as large corporate clients (due to the capacity to produce high quality public relations material, annual reports, etc.). Formerly, the printer may only have provided services to small local businesses (e.g. business cards, calendars, invoice books and stationery.) No new business has been commenced. It is not a different business and the goodwill remains the same CGT asset. The printer is still conducting a printing business of the same essential nature or character, albeit one serving different clients.

Businesses may naturally evolve by serving different clients or clients in different markets and offering improved products or services.

Unless the facts are such that it can be established that a new business has commenced - rather than an existing business continued - the goodwill of the business is not different from that existing when the business was originally acquired or commenced.

In your circumstances

Although the Business has experienced growth via acquisition and internal development, the underlying services, nature and character of the Business have remained the same since its beginning prior to 20 September 1985:

•           Whilst it has expanded through acquisition, all acquisitions have been to increase market presence in its existing sector. Any asset which was acquired throughout these years has been embedded in the business and ultimately, the Business has continued to be known in the market for its presence in its original sector.

•           The Business has maintained a largely unchanged logo and has carried this through all forms of advertising and branding, from letterhead, to brochures and its online presence.

•           The Business did dispose of an arm of the business in order to focus on another arm of the business. The disposed of arm was not a large part of the business and have only been used by customers in limited circumstances. This change did not substantially change the services provided.

•           The introduction of an on-line presence was undertaken to ensure the business was keeping up with technological advancements and ensure the business remained competitive and up-to-date with the latest solutions in the sector. This represents an expansion of the business and did not represent a change in the services offered to the market.

•           The acquisitions and development of any new technology over the years was done to ensure the business remained efficient, up-to-date and enable a stable environment for customers to interact with the business.

•           The Business is a family business with the founders still in control of the business. There is no evidence of substantial change in the way in which the business is carried on, managed and controlled.

Therefore, the Commissioner is satisfied that the goodwill of the Business was acquired when the Business commenced in prior to 20 September 1985 and remains a pre-CGT asset subject to the requirements of Division 149.

Division 149

The shares owned by First Trust in Company Bravo and the goodwill held by the Business will only remain a pre-CGT asset if the majority underlying interests in the both assets are held by the same ultimate owners who had the majority underlying interests in the assets immediately before 20 September 1985.

Division 149 contains provisions which govern when an asset held by an entity stops being a pre-CGT asset and is treated as having been acquired after that date.

Subsection 149-30(1) provides that an asset 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 held the majority underlying interests in the asset immediately before 20 September 1985.

However, subsection 149-30(2) provides that where the Commissioner is satisfied, or thinks it reasonable to assume, that at all times after 20 September 1985 and before a particular time, majority underlying interests in the asset were held by ultimate owners who had majority underlying interests immediately before that date, then subsection 149-30(1) applies as if that were in fact the case.

In other words, for the purpose of subsection 149-30(2), the Commissioner has to be satisfied, or consider it reasonable to assume, that the majority underlying interests in the assets have not changed.

Majority underlying interests

'Majority underlying interests' is defined in subsection 149-15(1) as consisting of more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in:

•           the asset; and

•           in any ordinary income that may be derived from the asset.

Subsection 149-15(2) defines 'underlying interests' in a CGT asset is the 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.

An 'ultimate owner' is defined to mean an entity listed in subsection 149-15(3). Relevantly, paragraph 149-15(3)(a) includes an individual and paragraph 149-15(3)(b) includes a company whose constitution prevents it from making any distribution, whether in money, property or otherwise, to its members.

Subsection 149-15(4) provides that an ultimate owner indirectly has a beneficial interest in a CGT asset of another entity if they would receive for their own benefit any of the capital if the other entity were to distribute any of its capital and the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

Similarly, subsection 149-15(5) provides that an ultimate owner indirectly has a beneficial interest in ordinary income that may be derived from a CGT asset of another entity if they would receive for their own benefit any of the income if the other entity were to distribute that income and the income were then successively distributed by each entity interposed between the other entity and the ultimate owner.

The expression 'beneficial interests' as used in the definition of 'majority underlying interests' is not defined. Where there is a discretionary trust, under ordinary legal concepts, 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. As such, it would not be possible for the beneficiary of a discretionary trust to satisfy either subsection 149-15(4) or 149-15(5). It is therefore not be possible for a discretionary trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1).

This is addressed 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), which discusses the Commissioner's approach to determining whether majority underlying interests in the pre-CGT asset have changed in the context of the former section 160ZZS of the ITAA 1936. Although IT 2340 contains references to repealed legislation, the Commissioner considers it administratively binding for the purpose of Division 149.

Paragraph 2 of IT 2340 explains that the clear policy of the law permits and requires that, for the purpose of the relevant provisions, chains of companies, partnerships and trusts are to be 'looked through' in order to determine whether there has been a change in the effective interests of individuals in the assets. Paragraph 3 of IT 2340 subsequently notes that questions were raised as to how the 'look-through' approach applies to trusts where the trustees are vested with discretionary powers as to distributions.

Therefore, in relation to assets that were acquired by the trustee of a discretionary trust before 20 September 1985, paragraphs 5 to 8 explain the Commissioner's concessionary approach and provides that the Commissioner will take into account the way in which the discretionary powers of the trustees are exercised. Where the trustee continues to administer the trust for the benefit of members of a particular family, for example, it would not bring the former Division 149 into application merely because distributions to family members are made in such amounts and to such beneficiaries as the trustee determines in his discretion. Rather, in such a case, the Commissioner would find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed, such that, assets acquired by the trustee before 20 September 1985 would remain outside the scope of the CGT regime.

However, where, by the exercise of a trustee's discretionary powers to appoint beneficiaries or by amendment of the trust deed, there is in practical effect a change of 50% or more in the underlying interests in the trust assets, the section will have its intended application as described.

The issue of what constitutes 'one family' for the purposes of IT 2340 was discussed at the National Tax Liaison Group (NTLG) subcommittee on 28 November 2001.

On that occasion, the Minutes reflect that the ATO stated that, whilst dependant on the facts of the particular case:

What is often described as an 'extended' family (that is, including grandparents, children, grandchildren and their spouses) would ordinarily qualify as a 'family' for these purposes. Further, if the distributions are made to post 19 September 1985 additions to a family (for example, the birth of new family members and new persons joining a family through marriage), the 'family' distribution criteria would ordinarily be satisfied.

In your circumstances

Due to satisfying the requirements of the CGT roll-over provisions, First Trust acquired its shares in Company Bravo when the Business commenced prior to 20 September 1985 such that the shares are pre-CGT assets of First Trust, subject to the application of Division 149.

Pursuant to subsection 149-30(1), the shares held in Company Bravo stop being a pre-CGT asset at the earliest time when the majority underlying interests in the shares were not held by the ultimate owners who held the majority underlying interests in it immediately before 20 September 1985.

The Business acquired its goodwill when it commenced its business prior to 20 September 1985 such that the goodwill is a pre-CGT asset of the Business, subject to the application of Division 149.

Pursuant to subsection 149-30(1), the goodwill of the Business stops being a pre-CGT asset at the earliest time when the majority underlying interests in the goodwill were not held by the ultimate owners who held the majority underlying interests in it immediately before 20 September 1985.

For the purposes of the tests in subsections 149-15(4) and (5), and in the case of the goodwill of Company Bravo, it is clear that if Company Bravo were to pay a dividend or distribute any of its capital, it would be paid to First Trust. However, as First Trust is a discretionary trust, whereby no beneficiary has a beneficial interest in the income or capital of the trust, it cannot be said that the dividend or distribution of capital would be received by any particular ultimate owner. Similarly, it is not possible for First Trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1), in respect of the shares in Company Bravo.

Nevertheless, per subsection 149-30(2), if the Commissioner is satisfied, or thinks it reasonable to assume, that at all times after 20 September 1985 and before a particular time, majority underlying interests in the shares held by First Trust and the goodwill of the Business were held by ultimate owners who had majority underlying interests in it immediately before that date, then subsection 149-30(1) will apply as if that were the case. That is, the shares and the goodwill, which are pre-CGT assets, will not stop being pre-CGT assets pursuant to subsection 149-30(1).

In this regard, as First Trust is a pre-CGT family discretionary trust that acquired the shares in Company Bravo prior to 20 September 1985, the Commissioner will apply the pragmatic approach provided for in IT 2340 in determining whether he is satisfied, or thinks it reasonable to assume, that at all times after 20 September 1985 majority underlying interests have been maintained.

Just prior to 20 September 1985

The definition of beneficiary specifically excluded the nominator from being a beneficiary, and as Individual A was the nominator, Individual A was specifically excluded as a beneficiary of First Trust immediately before 20 September 1985.

Therefore, Individual A could not, and did not, receive any income or capital distributions directly from First Trust at any time prior to 20 September 1985.

Furthermore, Individual A did not have any ownership interest in any corporate or other beneficiary of First Trust prior to 20 September 1985. Therefore, Individual A could not, and did not, receive any income or capital distributions indirectly from First Trust, via any interposed entity, at any time prior to 20 September 1985.

After 20 September 1985 to 30 June 20xx

In each of the years from the year ended 30 June 1986 until the year ended 30 June 20xx, distributions from First Trust were paid to individuals who fell within the class of beneficiaries within the Schedule in the Trust Deed of the First Trust. Each of these beneficiaries are individual and as such, are capable of being ultimate owners under paragraph 149-15(3)(a).

In accordance with the guidance provided for in IT 2340, the Commissioner has taken into account the manner in which the trustee of First Trust has exercised their discretion and the Commissioner accepts that the trustee of First Trust has continued to administer the trust for the benefit of members of the Family up to and including the year ended 30 June 20xx. Therefore, the Commissioner is satisfied, or finds it reasonable to assume that, for all practical purposes, the majority underlying interests in the assets of First Trust had not changed at any time prior to 30 June 20xx.

From 1 July 20xx to 30 June 20x1

The first change to the beneficiaries occurred after 20 September 1985 when Company Charlie was appointed as a corporate beneficiary of First Trust. The entirety of Company Charlie's shareholding is held by Individual B. As Company Charlie is a company which is not prevented from distributing to its members, it is not capable of being an ultimate owner under subsection 149-15(3). As the holder of the shareholding, Individual B has a direct ownership interest in the income and capital of Company Charlie. Individual B is an individual and as such, is capable of being an ultimate owner under paragraph 149-15(3)(a).

In the year ended 30 June 20x1, Company Charlie received distributions from First Trust. Further, other individuals who fell within the class of beneficiaries within the Schedule in the Trust Deed of First Trust also received distributions from First Trust. In accordance with IT 2340, the Commissioner has taken into account the manner in which the trustee of First Trust has exercised their discretion and the Commissioner accepts that the trustee of First Trust has continued to administer the trust for the benefit of members of the Family as at the year ended 30 June 20x1. Therefore, the Commissioner is satisfied, or finds it reasonable to assume that, for all practical purposes, the majority underlying interests in the assets of First Trust had not changed as at 30 June 20x1.

From 1 July 20x2

The second change to the beneficiaries occurred after 20 September 1985 when Company Echo was appointed a corporate beneficiary of First Trust. Company Echo has one shareholder, Company Foxtrot as trustee for the Second Trust.

Second Trust is a hybrid trust; it has both Unit Holders and discretionary income and capital beneficiaries. The only Unit Holders are Individual A and Individual B, who each hold one redeemable units in Second Trust. There have never been any Ordinary Unit Holders.

Distributions to Company Echo

In the year ended 30 June 20x1, Company Echo received a distribution of income from First Trust. The amount of the distribution equated to more than 50% of the income distributions paid by First Trust, with less than 50% of the income distributions paid to the remaining beneficiaries. Company Echo did not declare a dividend and retained the entirety of the income distribution.

As Company Echo is a company who is not prevented from distributing to its members, it is not capable of being an ultimate owner under subsection 149-15(3) and accordingly, not capable of being among the ultimate owners of First Trust. Therefore, it is necessary to apply the look-through approach provided for in subsections 149-15(4) and 149-15(5) to ascertain the ultimate owner of MBS.

Second Trust

Second Trust is a hybrid discretionary trust and the 100% shareholder of Company Echo. A discretionary trust is not an entity listed under subsection 149-15(3) as an 'ultimate owner.' As discussed above, under ordinary legal concepts, no beneficiary of a discretionary trust has an interest in the assets of the trust or the ordinary income of the trust until the trustee exercises its discretion to distribute income.

IT 2340 makes clear that the concessionary approach it provides only applies to pre-CGT assets acquired by discretionary trusts settled prior to 20 September 1985. The guidance in IT 2340 does not apply to assess the beneficial interest of beneficiaries in the assets of, or ordinary income of, discretionary trusts which have been settled after 20 September 1985 for the purpose assessing majority underlying interests.

Therefore, when applying the tests in 149-15(4) and 149-15(5) to identify the ultimate owners with an indirect interest in the CGT assets of First Trust (or Company Bravo depending on the question), ordinary legal principles apply to Second Trust, such that no beneficiary can be said to have an interest in the assets of Second Trust or in the ordinary income of Second Trust until the trustee exercises its discretion to distribute income or capital.

Discretionary nature of Second Trust

The Trust Deed of Second Trust provides that a beneficiary may include an Eligible Corporation, which by the terms of the Trust Deed, only requires a Beneficiary to either hold at least one share in a corporation or be a member, director or secretary of that corporation to make it an Eligible Corporation. It is possible for an Eligible Corporation to have a number of shares on issue, with only one of those shares held by a Beneficiary of Second Trust and receive a distribution from Second Trust. It is equally possible for a Beneficiary of Second Trust to merely be a director or secretary of a corporation for that corporation to be an Eligible Corporation and receive a distribution from Second Trust. In such a case, the Beneficiary would have no beneficial interest in the income or capital of the eligible corporation.

The Trust Deed of Second Trust also provides that a beneficiary may also include an Eligible Trust, which by the terms of the Trust Deed, only requires a Unit Holder to have some interest in the trust including the discretionary power of the trustee to be considered for a distribution of income or capital. Thus, Second Trust may distribute income to a discretionary trust of which a Unit Holder is an eligible beneficiary, however that discretionary trust may distribute 100% of the income to any other beneficiaries to the exclusion of the Unit Holder.

By virtue of the discretionary nature of Second Trust, a beneficiary may be excluded from a distribution of income, or it may be that no Unit Holder receives a distribution of income.

Indeed, the Trustee of Second Trust may exercise its discretion to distribute its income to an Eligible Corporation of which no Unit Holder has a beneficial interest in. Similarly, if Second Trust were to distribute to an Eligible Trust, as discussed previously, under ordinary legal concepts, no beneficiary of a discretionary trust has an interest in the income or the capital of the trust until the trustee exercises its discretion to distribute the income or the capital. Although the Unit Holder of Second Trust is entitled to be considered for a distribution of income or capital from an Eligible Trust, there is no guarantee that the Unit Holder of Second Trust will receive any distribution from the Eligible Trust. It is possible for an Eligible Trust to receive a distribution from Second Trust and distribute it to its beneficiaries, potentially to the exclusion of the ultimate owners who between them collectively held the majority underlying interests in the assets of First Trust immediately before 20 September 1985.

Thus, in light of the above, for the purpose of subsections 149-15(4) and 149-15(5), it cannot be said that that any beneficiary of Second Trust would receive for his, her or its own benefit, any income (or capital) if First Trust were to distribute that income (or capital) to company Echo, and then Company Echo then successively paid the income (or capital) to Second Trust which then subsequently made a distribution. Rather, the possibility exists that the Trustee of Second Trust could distribute all of the income received from Company Echo to a wide variety of beneficiaries, or even to resolve to accumulate the income to the Corpus, to the exclusion of the ultimate owners who held majority underlying interests immediately prior to 20 September 1985.

ATO ID 2011/107

The Commissioner considers that this reflects the view provided in ATO Interpretative Decision ATO ID 2011/107 Income Tax: Capital Gains Tax: Division 149 majority underlying interests - new shareholder, which contains a factual scenario that is analogous to your case.

In that fact scenario, a company owned a pre-CGT asset. All the shares held in the company had discretionary rights to dividends. An additional share, also with discretionary rights to dividends, was issued after 20 September 1985 to a new shareholder, being the trustee of a discretionary trust. As all the shares only had a discretionary right to dividends, the company could distribute dividends to one shareholder to the exclusion of some or all of the other shareholders. Similarly, if a dividend was paid to the new trustee shareholder, it could, in turn, be distributed to any of the individuals who were members of the class of beneficiaries. Accordingly, the possibility exists that the ultimate owners who between them collectively held majority underlying interests in the asset immediately before 20 September 1985 may receive less than 50% of the ordinary income that may be derived by the company from the asset. Therefore, the Commissioner could not be satisfied, or find it reasonable to assume, that there had been a continuity of majority underlying interests in the asset for the purpose of subsection 149-30(2).

Therefore, although the Commissioner is applying the concessionary approach provided for in IT 2340 to assess majority underlying interests in First Trust, once First Trust distributed more than 50% of its income to Company Echo in the 20x1 income year, the Commissioner considers that First Trust no longer fell within the scope of the limited factual exception contained in IT 2340. That is, upon the distribution of more than 50% of the income of First Trust to Company Echo, there was a change in more than 50% of the beneficial interest in the income of First Trust such that the Commissioner is not satisfied, nor considers it reasonable to assume that majority underlying interests in the income of First Trust was had by the same ultimate owners who held such interests immediately before 20 September 1985.

The Commissioner is therefore not satisfied, and does not find it reasonable to assume, that majority underlying interests have been maintained in the assets of the First Trust for the purposes of subsection 149-30(2). Accordingly, for the purposes of subsection 149-30(1), both the pre-CGT assets of Company Bravo and the shares in Company Bravo stopped being pre-CGT asset at the time First Trust distributed more than 50% of its income to Company Echo in the 20x1 income year. This was the earliest time when majority underlying interests in the assets of First Trust were not held by the ultimate owners who had the majority underlying interest immediately before 20 September 1985. As a result, the capital gain arising from the disposal of the shares in Company Bravo will not be disregarded under subsection 104-10(5).

Question 3

CGT event K6 can result in capital gains if certain CGT events happen to pre-CGT shares in a 'private' company where the market value of its post-CGT property is at least 75% of its net value (the 75% test).

Section 104-230 provides that CGT event K6 happens if you own shares in a company you acquired before 20 September 1985, a relevant CGT event happens in relation to the shares, there is no roll-over for the relevant CGT event and the 75% net value test, contained in subsection 149-230(2), is satisfied.

In determining if the shares were acquired prior to 20 September 1985, the Commissioner is required to consider the provisions of Division 109.

Section 109-55 provides a table of some of the acquisition rules that apply. Item 14 in that table provides that where you acquired a CGT asset before 20 September 1985 and there has since been a change in the majority underlying interests in the asset, the CGT assets was acquired at the time of the change. Item 14 refers us to Division 149 to assess this condition.

In your circumstances

CGT event A1 happened when First Trust disposed of its shares in Company Bravo and there was no roll-over for this CGT event.

As discussed above, the Commissioner considers that for the purpose of subsection 149-30(1), the shares owned by First Trust stopped being a pre-CGT asset. The shares have no longer been acquired prior to 20 September 1985.

As the shares in Company Bravo were not acquired prior to 20 September 1985, CGT event K6 cannot be triggered.