Edited version of private advice

Authorisation Number: 1051988315245

Date of advice: 9 June 2022

Ruling

Subject: CGT - shares and units - majority underlying interests

Question 1

Will the Commissioner be satisfied, or think it reasonable to assume that at all times on and after 20 September 1985, and up to and including the date of the contract of sale of the property by ultimate owners who had majority underlying interests in the property immediately before that day, such that Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997) will not stop the property being a pre-capital gains tax (CGT) asset on the date of entering the contract of sale?

Answer

Yes, the Commissioner thinks it is reasonable to assume that at all times on and after 20 September 1985 up to and including the contract date of the property sale, the majority underlying interests in the asset were held by the same ultimate owners such that Division 149 of the ITAA will not stop the property being a pre-CGT asset on the contract date of sale.

Question 2

If the answer to Question 1 is yes, can any capital gain or capital loss resulting from the disposal of the property be disregarded under paragraph 104-10(5)(a) of the ITAA 1997?

Answer

Yes, any capital gain or loss resulting from the disposal of the property will be disregarded under paragraph 104-10(5)(a) of the ITAA 1997.

Question 3

Are the capital improvements made to the property taken to be separate CGT assets under either subsection 108-70(2) or 108-70(3) of the ITAA 1997 upon the disposal of the property?

Answer

No, the capital improvements made to the property are not taken to be separate CGT assets under either subsection 108-70(2) or 108-70(3) of the ITAA 1997.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Unit Trust

M is the parent of R, A and J; K is J's spouse.

The Unit Trust (UT) was established pre-CGT. The unitholders were the M Family Trust (MFT), the R Family Trust (RFT) and the A Family Trust (AFT), each holding 1 unit.

UT's corporate trustee since establishment is N Pty Ltd (NPL). The original directors and shareholders of NPL were replaced by R and A pre-CGT; M also became a director. Post-CGT, J replaced R and M, and became a director and shareholder.

UT acquired real property (the property) pre-CGT and disposed of it post-CGT.

In 20XX, UT resolved to split each of the 3 issued units, valued at $10 each, into 10 units valued at $1 each. On the same day, RFT redeemed its 10 units; 8 were allotted to AFT and 2 were allotted to the J Family Trust (JFT).

In 20XX, MFT redeemed its 10 units; these were allotted to JSFT.

Unitholder - MFT

MFT is a discretionary trust established pre-CGT. Its trustee was initially NPL, later replaced by M, J and K.

The primary beneficiaries are M and M's spouse. The general beneficiaries are M's children and grandchildren. From MFT's establishment up until it disposed of its units in UT, M was the only beneficiary presently entitled to the income and capital of MFT. There have been no changes to any class of beneficiaries of MFT in this time.

Unitholder - RFT

RFT is a discretionary trust established pre-CGT. Its trustee was initially NPL, later replaced by R Pty Ltd.

The primary beneficiaries are R and R's spouse. The general beneficiaries are R's children and grandchildren. From RFT's establishment up until it disposed of its units in UT, R was the only beneficiary presently entitled to the income and capital of RFT. There have been no changes to any class of beneficiaries of RFT in this time.

Unitholder - AFT

AFT is a discretionary trust established pre-CGT. Its trustee was initially NPL, later replaced by A and J, who were later replaced by V Pty Ltd. A is the sole director and shareholder of V Pty Ltd since incorporation.

The primary beneficiaries are A and A's spouse. The general beneficiaries are A's children and grandchildren. From AFT's establishment, the only beneficiaries presently entitled to the income and capital of AFT have been A, A's children and grandchildren. There have been no changes to any class of beneficiaries of AFT, although in 20XX a deed variation was executed to exclude a particular class of person from being a beneficiary.

Unitholder - JFT

JFT is a discretionary trust established post-CGT. Its trustee was initially D Pty Ltd, later replaced by RR Pty Ltd. J and A are shareholders and directors of D Pty Ltd; J is the sole director and shareholder of RR Pty Ltd since incorporation.

The primary beneficiaries are J, J's spouse, and any corporation or trust that may be nominated by JFT to be a primary beneficiary. The general beneficiaries are J's children and grandchildren. From JFT's establishment, the only beneficiaries presently entitled to the income and capital of the trust have been J and J's spouse. There have been no changes to any class of beneficiaries of JFT, although in 20XX a deed variation was executed to exclude a particular class of person from being a beneficiary.

Since establishment of the trusts up to and including the contract date of the property disposal, all beneficiaries of the unitholding trusts presently entitled to income and capital have been individual members of the same family group.

The property

The property was acquired pre-CGT for $X and comprised of land which had a building constructed on it. The property was acquired to derive commercial rental income. Three structural improvements were made to the building, post-CGT, during ownership. The property was sold post-CGT.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 paragraph 104-10(5)(a)

Income Tax Assessment Act 1997 section 108-70

Income Tax Assessment Act 1997 subsection 108-70(2)

Income Tax Assessment Act 1997 subsection 108-70(3)

Income Tax Assessment Act 1997 section 108-80

Income Tax Assessment Act 1997 section 108-85

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 section 149-15

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

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(2)

Reasons for decision

Division 149 of the ITAA 1997 contains the rules which govern when an asset acquired by a taxpayer before 20 September 1985 is treated as having been acquired after that date for CGT purposes.

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

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

•         more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.

Subsection 149-30(1) of the ITAA 1997 provides that an 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(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) apply as if that were in fact the case.

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

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

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS of the ITAA 1936 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) of the ITAA 1936, find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. That is consistent with the role of the section to close potential avenues for avoidance of tax in cases where there is a substantial change in underlying ownership of assets and the legislative guidance contained in Subdivision G of Division 3 of Part III of the Act. On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act.

Taxation Ruling IT 2530 Income tax: capital gains: change in the underlying ownership of assets in a publicly traded unit trust: issue of new units in unit trusts and new shares in companies: interposed entities: calculation of change in majority underlying interests discuss the Commissioner's views on changes in unitholdings in publicly traded unit trusts.

Although IT 2530 discusses public unit trusts, the commentary in paragraphs 6 and 7, and the analysis in paragraph 10, apply to this case.

6. ...it will be appropriate to carry out a factual examination to determine whether there has been a continuity of majority underlying interests in the assets of the unit trust... Where, as a result of the issue of additional units in a unit trust or additional shares in a company, a change of 50 per cent or more occurs in the underlying ownership of assets of the unit trust or company, section 160ZZS would operate to deem assets of the unit trust or company which were acquired before 20 September 1985 to have been acquired on or after that date.

7. As noted in Taxation Ruling No. IT 2340, where an asset is deemed by section 160ZZS to have been acquired after 19 September 1985, the asset will be taken to have been acquired on the date on which the continuity of beneficial ownership in the asset of more than 50 per cent ceased to be maintained.

10. 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 section 160ZZS. In these circumstances a change in the proportions in which the natural persons held interests in the asset would not have a bearing on the application of section 160ZZS.

The analysis required is demonstrated in paragraph 10 of IT 2530. The ultimate individual beneficiaries must collectively continue to hold more than 50% of the beneficial interests in the underlying asset (the property) and in any ordinary income that may be derived from the asset. As long as they collectively continue to hold the majority underlying interests in the asset, the asset will retain its pre-CGT status.

Application to your circumstances

The Commissioner's views in IT 2340 and IT 2530 apply to your case such that the discretionary trusts holding units in UT have all been administered for the benefit of members of a particular family group, and all beneficiaries of the discretionary trusts who have been presently entitled to the income and capital of these trusts have all been individual members of that same family group. Any variations to deeds to the discretionary trusts have not resulted in new beneficiaries or changes to beneficiary classes.

Consistent with the example provided in paragraph 10 of IT 2530, while there have been changes to the proportions of unitholdings in UT by the discretionary trusts, the ultimate individual beneficiaries to the discretionary trusts have collectively maintained more than 50% of the beneficial interests in the property such that it is not considered that there has been a change in the majority underlying ownership of the pre-CGT real property held by UT up to the date of disposal. Therefore, Division 149 of the ITAA 1997 will not apply to deem the property to have been acquired post-CGT by the trustee of UT.

Paragraph 104-10(5)(a) of the ITAA 1997 provides that a capital gain or loss you make is disregarded if you acquired the asset before 20 September 1985.

The trustee of UT acquired the property before 20 September 1985, and the property is not deemed to have been acquired by the trustee after that date. Therefore, any capital gain or loss made by the trustee will be disregarded.

Section 108-70 of the ITAA 1997 discusses when a capital improvement to a CGT asset is itself a separate asset. Subsections 108-70(2) and 108-70(3) discuss unrelated and related improvements to pre-CGT assets respectively.

Subsection 108-70(2) provides that a capital improvement to a CGT asset (the original asset) that you acquired before 20 September 1985 (that is not related to any other capital improvement to the asset) is taken to be a separate CGT asset if its cost base (assuming it were a separate CGT asset) when a CGT event happens (except one that happens because of your death) in relation to the original asset is:

(a) more than the improvement threshold for the income year in which the event happened; and

(b) more than 5% of the capital proceeds from the event.

Subsection 108-70(3) provides that capital improvements to a CGT asset (the original asset) that you acquired before 20 September 1985 that are related to each other are taken to be a separate CGT asset if the total of their cost bases (assuming each one were a separate CGT asset) when a CGT event happens in relation to the original asset is:

(a) more than the improvement threshold for the income year in which the event happened; and

(b) more than 5% of the capital proceeds from the event.

The improvement thresholds are found in section 108-85 of the ITAA 1997.

The note to subsection 108-70(2) of the ITAA 1997 refers to section 108-80 of the ITAA 1997, which sets out the factors for deciding whether capital improvements are related to each other. Section 108-80 of the ITAA 1997 provides that, in deciding whether capital improvements are related to each other, the factors to be considered include:

(a) the nature of the CGT asset to which the improvements are made; and

(b) the nature, location, size, value, quality, composition and utility of each improvement; and

(c) whether an improvement depends in a physical, economic, commercial or practical sense on another improvement; and

(d) whether the improvements are part of an overall project; and

(e) whether the improvements are of the same kind; and

(f) whether the improvements are made within a reasonable period of time of each other.

In this case, it is not considered that the capital improvements made to the property are related to each other. Subsection 108-70(2) of the ITAA 1997 will therefore be applicable to this case instead of subsection 108-70(3).

The cost bases of the improvements to the property are less than the improvement threshold for the relevant income year, and less than 5% of the capital proceeds from the property disposal. Per subsection 108-70(2) of the ITAA 1997, these capital improvements are not considered to be separate CGT assets to the property.