Edited version of private advice

Authorisation Number: 1051963843926

Date of advice: 29 March 2022

Ruling

Subject: CGT - deceased estate

Question 1

Is the first element of cost base or reduced cost base of the shares of the company their market value on the date of the deceased's death in accordance with section 128-15 of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

Does Division 149 of the ITAA 1997 apply to treat the company's shareholdings as post-CGT from the deceased's date of death?

Answer

No

Question 3

Will the cost base of the shares in the company be reduced by liquidator's distributions made in the course of winding up the company?

Answer

No

Question 4

Will the beneficiaries make a capital loss under subsection 104-25(3) of the ITAA 1997 as a result of the company being deregistered?

Answer

Yes

Question 5

Will the payment of dividends and liquidation of the company constitute a scheme or arrangement to which section 177E or section 177D of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) or section 207-155 of the ITAA 1997 apply?

Answer

No

Question 6

Will the capital loss arising on liquidation be cancelled by operation of section 177F of part IVA of the ITAA 1936?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Company (the company) was incorporated before 20 September 1985.

The deceased (the deceased) held all cumulative preference shares (XXX shares) and XXX ordinary shares in the company until their death on XX September 20XX.

All of the deceased's shares in the company were acquired prior to 20 September 1985.

The remaining X ordinary share in the company was held on trust for the deceased firstly by Person 1. Upon Person 1's death on XX January 19XX, the ordinary share was transferred to Person 2 and then further transferred to Person 3 on XX March 20XX. Person 2 and Person 3 also held the share on trust for the deceased.

All shares in the company were beneficially held by the deceased until their death.

The shares in the company are being administered by the Executors of the deceased's estate.

Probate of the deceased's Will and Codicil (the Will) was granted on XX March 20XX.

The Will specified that all assets not specifically dealt with by other provisions of the Will will be distributed in equal proportions to the X named beneficiaries.

One named beneficiary did not outlive the deceased and under the Will the assets are to be distributed to the X remaining beneficiaries.

It was a wish in the Will that the company be dissolved and placed into liquidation if possible within X years of the deceased's death.

As per the Will, the Executors of the deceased's estate plan to voluntarily liquidate the company and distribute all dividends and proceeds to each of the X beneficiaries in equal proportions.

As the share capital of the company was not divisible by X, additional shares were issued on XX February 20XX as follows:

•         X ordinary share was issued for every X existing ordinary shares; and

•         X preference share was issued for every X existing preference shares.

The shares were held by the estate until XX March 20XX at which time X ordinary shares and X preference shares were transferred to each of the X beneficiaries.

Assets owned by the company consist solely of shares in listed companies (shareholdings) and cash. The shareholdings have been disposed of prior to liquidation.

Market Value of the shares in the company as at XX September 20XX have been calculated as $X, being the net assets of the company at market value at that time.

The company ceased purchasing shares a number of years ago and has engaged in a selldown of assets with the ultimate intention of liquidating the company. The only acquisitions made have been those arising from existing dividend reinvestment programs entered into prior to the deceased's death.

Dividends paid prior to the appointment of the liquidator have been paid in the normal course of distributing the profits of the company. Profits arising on the sale of post-CGT shareholdings (retained profits) have been distributed and assessed in the hands of the shareholders (beneficiaries).

X Dividends paid to shareholders in the last X financial years totalling $X have all been paid out of retained earnings.

During the wind-up program, the company disposed of non-current assets and liabilities in preparation for a Liquidator to be appointed.

The entire balance of the reserves account relates to realised gains on the disposal of shareholdings acquired prior to 20 September 1985.

A Liquidator is yet to be appointed.

Once appointed, the liquidator will have $X to distribute to shareholders of the company (beneficiaries), made up of Retained Earnings, Share Capital and Reserves in the process of liquidating the company.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1936 subsection 47(1)

Income Tax Assessment Act 1936 subsection 47(1A)

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 paragraph 177D(2)(a)

Income Tax Assessment Act 1936 paragraph 177D(2)(b)

Income Tax Assessment Act 1936 paragraph 177D(2)(c)

Income Tax Assessment Act 1936 paragraph 177D(2)(d)

Income Tax Assessment Act 1936 paragraph 177D(2)(e)

Income Tax Assessment Act 1936 paragraph 177D(2)(f)

Income Tax Assessment Act 1936 paragraph 177D(2)(g)

Income Tax Assessment Act 1936 paragraph 177D(2)(h)

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 paragraph 177E(1)(a)

Income Tax Assessment Act 1936 paragraph 177E(1)(b)

Income Tax Assessment Act 1936 paragraph 177E(1)(c)

Income Tax Assessment Act 1936 paragraph 177E(1)(d)

Income Tax Assessment Act 1936 paragraph 177E(1)(e)

Income Tax Assessment Act 1936 paragraph 177E(1)(f)

Income Tax Assessment Act 1936 paragraph 177E(1)(g)

Income Tax Assessment Act 1936 paragraph 177E(2)(a)

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1997 section 128-15

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 section 149-30

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

Income Tax Assessment Act 1997 subsection 149-30(3)

Income Tax Assessment Act 1997 subsection 149-30(4)

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 104-25(3)

Income Tax Assessment Act 1997 section 207-155

Reasons for decision

Question 1

Is the first element of cost base or reduced cost base of the shares of the company their market value on the date of the deceased's death in accordance with section 128-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Detailed reasoning

Section 128-15 of the ITAA 1997 sets out the treatment of a CGT asset held by the deceased just prior to their death. Where a CGT asset passes to a beneficiary of a deceased estate, the beneficiary is taken to have acquired the asset on the date of the deceased's death. Where the CGT asset is acquired by the deceased before 20 September 1985, the first element of cost base (and reduced cost base) of the CGT asset in the hands of the beneficiary will be the market value of the asset on the day of the deceased's death.

In your case, the shares in the company were acquired by the deceased prior to 20 September 1985. The beneficiaries are taken to have acquired the shares in the company on the deceased's date of death, being XX September 20XX with the market value of the shares on that day being the first element of cost base for the beneficiaries.

Question 2

Does Division 149 of the ITAA 1997 apply to treat the company's shareholdings as post-CGT from the deceased's date of death?

Detailed reasoning

Division 149 of the ITAA 1997 provides when an asset stops being a pre-CGT asset. Under section 149-30 of the ITAA 1997 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.

Subsection 149-30(3) and 149-30(4) of the ITAA 1997 provides that if an ultimate owner (new owner) has acquired an interest in an asset because it was transferred to the new owner by way of a marriage breakdown rollover or because of the death of a person (former owner), the new owner is treated as having held the underlying interest of the former owner for the period the former owner held them.

ATO Interpretative Decision 2003/779 (ATO ID 2003/779) provides guidance on majority underlying ownership and continuity of interest during the period of administration of a deceased estate. ATO ID 2003/779 provides that "to give subsections 149-30(3) and 149-30(4) of the ITAA 1997 their intended effect, it is necessary to apply subsection 149-30(1) of the ITAA 1997 as if the beneficiary had beneficial interests in the assets of the estate from the date of the deceased person's death until the time the estate has been fully administered. Subsections 149-30(3) and 149-30(4) could never achieve their purpose if the period of administration were treated as a period when no one had any beneficial interests."

In this case, the beneficiaries acquired the shares in the company as a result of the deceased's death, as such they will be taken to have beneficial interests in the shares in the company from XX September 20XX, not XX February 20XX when the shares in the company were transferred to the beneficiaries, in order to enable the deemed continuity of underlying interests provisions in subsections 149-30(3) and 149-30(4) of the ITAA 1997 to have effect. As such, there will be no change in the underlying ownership interests of the company, allowing retention of the pre-CGT status for the pre-CGT shareholdings owned by the company.

Question 3

Will the cost base of the shares in the company be reduced by liquidator's distributions made in the course of winding up the company?

Detailed reasoning

Subsection 47(1) of the ITAA 1936 provides that

"distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it."

Subsection 47(1A) of the ITAA 1936 provides that income derived by a company includes:

(a)  Any amount that is included in the assessable income of the company otherwise than under the capital gains tax provisions; and

(b)  The amount of any capital gain for the purposes of the capital gains tax provisions, calculated without regard to capital losses and indexation.

Liquidator distributions from the reserves account sourced from assets acquired prior to 20 September 1985 are, in some circumstances, not taxable as either a deemed dividend under section 47 of the ITAA 1936, or a net capital gain under section 104-25 of the ITAA 1997. If the assets were acquired prior to 20 September 1985 and a capital gain is disregarded, then these assets maintain the tax-free status of the distribution from the reserves account.

Archer Bros Pty Ltd (In Vol Liq) v. FCT (1953) 90 CLR 140; 27 ALJ 353; 10 ATD 192 (Archers Case) discusses distributions. In a joint judgement, the Full High Court of Australia in Archers Case observed by way of obiter dicta:

'By a proper system of bookkeeping the liquidator, in the same way as the accountant of a private company which is a going concern, could so keep his accounts that...distributions could be made wholly and exclusively out of...particular profits...or income...'

Taxation Determination TD 95/10 Income tax: what is the significance of the Archer Brothers principle in the context of liquidation distributions? discusses the significance of the "Archer Brothers principle" in the context of liquidation distributions:

The observations in Archers Case have given rise to what is known as the Archer Brothers principle. The principle is that if a liquidator appropriates a particular fund of profit or income in making a distribution, that appropriation ordinarily determines the character of the distributed amount for the purposes of the Income Tax Assessment Act. Generally, a liquidator may rely on the Archer Brothers principle, except where a specific provision produces a different result.

Archers Case refers to 'profits' or 'income'. However, if a liquidator ostensibly distributes an amount representing capital, we accept that the distribution is treated as a non-dividend return of capital.

Provided the liquidator is able to identify the source from which a particular distribution is made, we will accept a liquidators' nominated appropriation. For example, identifying pre-CGT non-assessable profits separately to post-CGT capital gains.

The distribution of the reserves account that was sourced from pre-CGT capital gains made will not be considered as 'income' and therefore will not be deemed to be a dividend under section 47 of the ITAA 1936. While the distribution of the pre-CGT capital gain will not be treated as an assessable liquidator's dividend, it will be considered a return of capital (capital proceeds) for the cancellation of the beneficiary's shares in the company under CGT event C2 (section 104-25 of the ITAA 1997). As long as the company ceases to exist within 18 months of the liquidator's distributions, the proceeds from the reserves account will not reduce the cost base. However if the company still exists 18 months after the distribution, CGT event G1 will trigger (section 104-135 of the ITAA 1997) and the cost base of the share will be reduced by the non-assessable part of the payment (capital proceeds).

The portion of the liquidator's distribution which is sourced from share capital will be considered a return of capital for the cancellation of the beneficiary's shares in the company under CGT event C2 and are treated in the same manner as the pre-CGT reserves account portion of the distribution and as such will not reduce the cost base of the shares unless the company does not cease to exist in 18 months from the distribution and CGT event G1 is triggered.

The portion of the liquidator's distribution sourced from retained earnings will be assessed as a section 47 of the ITAA 1936 dividend and will not be considered capital proceeds for the cancellation of the beneficiary's shares in the company under CGT event C2. This amount will not reduce the cost base of the shares in the company.

The full amount of the liquidator's distributions in the course of winding up (in the 18 months prior to the company ceasing to exist) and the final distribution is considered capital proceeds under C2, reduced by section 118-20 of the ITAA 1997 to the extent that the distributions were assessed as a section 47 of the ITAA 1936 dividend. As long as the company ceases to exist within 18 months of the liquidator's distributions the proceeds from the reserves account (pre-CGT) and the share capital will not reduce the cost base of the beneficiaries shares in the company.

Question 4

Will the beneficiaries make a capital loss under subsection 104-25(3) of the ITAA 1997 as a result of the company being deregistered?

Detailed reasoning

Upon deregistration of the company, CGT event C2 will happen and the distributions made by the liquidator will be capital proceeds (return of capital) reduced to the extent that the distribution was assessed as a section 47 of the ITAA 1936 dividend (income and capital gains (no indexing).

The beneficiaries acquired their shares in the company with a cost base of market value at the time of the deceased's death on XX September 20XX which was calculated as $X.

The liquidators have approximately $X available to distribute to the beneficiaries as the distribution of capital proceeds in the process of winding up the company. This amount will be reduced by $X (retained earnings) as the portion of the distribution will be reduced by the amount assessed as a section 47 of the ITAA 1936 divided. The remaining $X of the distribution will be considered capital proceeds for the cancellation of the beneficiary's shares in the company under CGT event C2.

As the first element of cost base of the beneficiary's shares in the company were $X at the time of acquisition and the expected capital proceeds received under CGT event C2 are less than the first element of cost base, it is reasonable to expect that the beneficiaries will make a capital loss as a result of the company being deregistered.

Question 5

Will the payment of dividends and liquidation of the company constitute a scheme or arrangement to which section 177E or section 177D of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) or section 207-155 of the ITAA 1997 apply?

Detailed reasoning

Section 177E of Part IVA of the ITAA 1936 can apply to a scheme where a taxpayer (a shareholder) receives profits of a company in a substantially tax advantaged form thus avoiding tax that would be payable if the profits were paid as a dividend.

A scheme is defined in subsection 177A(1) of the ITAA 1936 as:

(a)  Any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, by legal proceedings; and

(b)  Any scheme, plan, proposal, action, course of action or course of conduct.

Section 177D of Part IVA of the ITAA 1936 can apply to any scheme where a taxpayer obtains a tax benefit in connection with the scheme and it can be concluded that the scheme was entered into or carried out for the dominant purpose of enabling a tax benefit to be obtained. Section 177D of the ITAA 1936 can apply to a scheme notwithstanding that section 177E of the ITAA 1936 does not apply to the scheme.

Section 207-155 of the ITAA 1997 will apply where a distribution is made to a taxpayer (a shareholder) as part of a dividend stripping operation.

Section 177E

Section 177E of the ITAA 1936 can apply to a scheme by way of or in the nature of dividend stripping. If paragraphs 177E(1)(a) to (d) of the ITAA 1936 are satisfied, paragraphs 177E(1)(e) to (g) have effect and the scheme is taken to be a scheme to which Part IVA of the ITAA 1936 applies.

Broadly section 177E of the ITAA 1936 will apply where:

•         there is scheme by or in the nature of dividend stripping involving the disposal of property of a company (paragraph 177E(1)(a) of the ITAA 1936)

•         in the opinion of the Commissioner the disposal represents a distribution of profits (paragraph 177E(1)(b) of the ITAA 1936)

•         if the company had paid a dividend out of profits instead, the dividend would be included in the assessable income of the shareholder (paragraph 177E(1)(c) of the ITAA 1936), and

•         the scheme commenced after 27 May 1981 (paragraph 177E(1)(d) of the ITAA 1936).

Paragraph 177E(1)(a) of the ITAA 1936

Paragraph 177E(1)(a) of the ITAA 1936 requires property of the company to be disposed of under a scheme that is a scheme by way of or in the nature of dividend stripping; or a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping.

Scheme is defined in subsection 177A(1) of the ITAA 1936. The definition is very broad and encompasses one step or a series of steps which together can be said to constitute a scheme, plan, course of action or conduct.

The term dividend stripping is not defined nor does it have a precise legal meaning. Nonetheless, it can be said that in its traditional sense a dividend stripping scheme would include a scheme under which a company with accumulated or current years' profits that are represented by cash or other readily realisable asset, releases those profits to its shareholders in a non-taxable form. At its broadest, it involves the release of profits to shareholders in a tax advantaged form, regardless of the method used to achieve it. (Taxation Ruling IT 2627.)

The term disposal of property of the company is defined in paragraph 177E(2)(a) of the ITAA 1936. The definition is very broad and includes the payment of a dividend by the company.

Paragraph 177E(1)(b) of the ITAA 1936

Paragraph 177E(1)(b) of the ITAA 1936 requires that the Commissioner form an opinion that the disposal of property represents, in whole or in part, a distribution of profits of the company in any accounting period (a current, earlier or later accounting period).

Paragraph 177E(1)(c) of the ITAA 1936

Paragraph 177E(1)(c) of the ITAA 1936 looks at whether the amount determined by the Commissioner to be a distribution of profits represented by the disposal of the property would have been included (or might reasonably be expected to have been included) in the assessable income of a taxpayer of a year of income if that amount had been paid as a dividend instead.

Paragraph 177E(1)(d) of the ITAA 1936

Paragraph 177E(1)(d) of the ITAA 1936 requires the scheme to have been entered into after 27 May 1981.

Application to your circumstances

There was a scheme as described in subsection 177A(1) of the ITAA 1936. The scheme was entered into after 27 May 1981 as required by paragraph 177E(1)(d) of the ITAA 1936.

Dividends paid by the company during the period prior to a liquidator being appointed were paid in the normal course of distributing the profits of the company. Such actions do not constitute a dividend stripping scheme for the purposes of paragraph 177E(1)(a) of the ITAA 1936.

The Liquidator distributions will be made in the normal course of winding up the company. The distributions will be sourced from share capital, the pre-CGT capital profits reserve and retained earnings. The amounts sourced from share capital and the pre-CGT capital profits reserve will not be assessable as income as that portion of the distribution will be a return of capital. Again, such actions do not constitute a dividend stripping scheme for the purposes of paragraph 177E(1)(a) of the ITAA 1936.

As paragraph 177E(1)(a) of the ITAA 1936 is not satisfied, the provisions under paragraph 177E(1)(e) to 177E(1)(g) will not have effect.

Section 177D

Section 177D of the ITAA 1936 can apply to any scheme that has been entered into after 27 May 1981. The matters to be taken into account in determining whether Part IVA should apply are:

•         the manner in which the scheme was entered into or carried out; (paragraph 177D(2)(a) of the ITAA 1936)

•         the form and substance of the scheme; (paragraph 177D(2)(b) of the ITAA 1936)

•         the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (paragraph 177D(2)(c) of the ITAA 1936)

•         the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; (paragraph 177D(2)(d) of the ITAA 1936)

•         any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; (paragraph 177D(2)(e) of the ITAA 1936)

•         any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; (paragraph 177D(2)(f) of the ITAA 1936)

•         any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out (paragraph 177D(2)(g) of the ITAA 1936); and

•         the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f) (paragraph 177D(2)(h) of the ITAA 1936).

Application to your circumstances

•         Scheme commenced after 27 May 1981.

•         Scheme entered into in the ordinary and expected course of winding up a private investment company, consistent with a gradual winding up of a company.

•         Shareholders will receive all retained profits of the company at the time they inherited their shares, along with all profits earned subsequent to that time.

•         Profits received as dividends assessed in the hands of the shareholders (beneficiaries).

•         Pre-CGT reserve represent profits earned over the life of the company on sale of pre-CGT assets, not assessable under any provision of ITAA 1936 or ITAA 1997. Distributed as capital proceeds in accordance with section 104-25 of the ITAA 1997 (CGT event C2).

•         Only tax benefit obtained as a result of the scheme is the capital loss arising on liquidation and the cancellation of the shares in the company as a result of difference between market value of shares upon deceased's death and the capital proceeds received.

As such, section 177D of the ITAA 1936 will not apply.

Section 207-155

Section 207-155 of the ITAA 1997 will apply where a distribution is made to a taxpayer (a shareholder) as part of a dividend stripping operation.

A distribution made to a shareholder is taken to be made as part of a dividend stripping operation if the distribution arose out of a scheme that was by way of or in the nature of dividend stripping or a scheme having substantially the same effect.

Application to your circumstances

As previously discussed, the actions of the company do not constitute a dividend stripping scheme for the purposes of paragraph 177E(1)(a) of the ITAA 1936. Therefore, the distributions made by the company and the distributions to be made by the liquidator to the shareholders (beneficiaries) are not taken to be made out of part of a dividend stripping operation and section 207-155 of the ITAA 1997 will not apply.

Question 6

Will the capital loss arising on liquidation be cancelled by operation of section 177F of Part IVA of the ITAA 1936?

Detailed reasoning

Under section 177F of Part IVA of the ITAA 1936, the Commissioner is given the power to cancel a tax benefit arising under a scheme to which Part IVA applies. As it has been determined that there is not a scheme to which Part IVA applies, section 177F will not apply.