Edited version of private advice

Authorisation Number: 1052059608436

Date of advice: 24 November 2022

Ruling

Subject: CGT - shares and units

Question 1

If the current A and B class shares in the company are converted to ordinary shares, will this trigger a CGT event under Division 104 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No, the proposed share class conversion will not trigger a CGT event under Division 104 of the ITAA 1997 because there are no changes to share rights and no change to beneficial ownership of the shares.

Question 2

Will Division 725 of the ITAA 1997 apply and will any purported value shift from one or more classes of shares be offset by the value shift to the other class of shares?

Answer

No, Division 725 of the ITAA 1997 will not apply because there is no direct value shift (DVS).

Question 3

Will the acquisition date of the ordinary shares retain the same acquisition date as the original A and B shares?

Answer

Yes, the converted ordinary shares will retain the same acquisition date as the original A and B shares because no CGT event occurs.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company Pty Ltd (the company) currently has issued 60 A class shares, 60 B class shares and 120 ordinary shares held by the same sole shareholder, being Trustee Pty Ltd as trustee for X Trust.

It is proposed to convert these A and B class shares into ordinary shares but with the shareholder remaining unchanged.

There will not be a cancellation of shares nor an issue of new shares. There will be no change to the rights attaching to the shares on issue.

The rights attaching to the current A and B class shares are identical to the rights attaching to the ordinary shares, per the company's constitution. They have full voting, capital and dividend rights. There will be no change to the beneficial ownership of the shares.

The company's constitution states that the issued shares in the company may include ordinary shares, A and B class shares and each of these classes of shares have the same rights such as the right to vote in all meetings of the company, the right to participate in any dividend declared on the class of shares held and the right to participate in any division or distribution of any surplus assets or profits of the company equally with all other members having similar rights.

For completeness, although the company's constitution allows for additional share classes, there are no other share classes or shares on issue.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 subsection 104-35(1)

Income Tax Assessment Act 1997 subsection 104-155(1)

Income Tax Assessment Act 1997 paragraph 108-5(2)(a)

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 section 725-145

Income Tax Assessment Act 1997 subsection 725-145(1)

Income Tax Assessment Act 1997 subsection 725-145(2)

Income Tax Assessment Act 1997 subsection 725-145(3)

Reasons for decision

Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(2) provides that you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Subsection 104-25(1) of the ITAA 1997 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being redeemed or cancelled, amongst other things.

Subsection 104-35(1) of the ITAA 1997 provides that CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity.

Section 104-155 of the ITAA 1997 considers special receipts for events relating to CGT assets. Subsection 104-155(1) provides that CGT event H2 happens if an act, transaction or event occurs in relation to a CGT asset that you own; and the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base.

The Commissioner's views on whether variations of rights attaching to shares will result in a disposal of shares are discussed in Taxation Ruling TR 94/30 Income tax: capital gains tax implications of varying rights attaching to shares.

This ruling considers Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936). Part IIIA, which dealt with capital gains and losses, has since been repealed and rewritten into the ITAA 1997. Disposals of an asset formerly covered under subsection 160M(1) of the ITAA 1936 are now captured by CGT event A1 under the ITAA 1997.

Paragraph 108-5(2)(a) of the ITAA 1997, which replaces former section 160R of the ITAA 1936, ensures that part disposals of a CGT asset are also captured under CGT event A1.

Paragraph 3(e) of TR 94/30 explains that TR 94/30 considers, amongst variations to share rights, conversions of a share from one class to another.

Paragraph 8 of TR 94/30 states that a variation in rights attaching to a share ... does not result in a full disposal of an asset for the purposes of Part IIIA unless there is a cancellation or redemption of the share. In determining whether a disposal has occurred under Part IIIA, it is not relevant to consider whether the variation is slight (such as a small change to the nominal value of shares) or more significant (such as disposing of the preference to receive dividends).

The proposed conversion of A and B class to ordinary shares will not vary any rights attached to those shares. No shares are being cancelled; no new shares are being issued; there is no change to beneficial ownership of these shares; and no consideration is received as the shareholder remains unchanged. Although there is no variation to any right attaching to the shares, a share conversion may still be an act, transaction or event with respect to that CGT asset (the pre-conversion shares) where there is no adjustment to the cost base or reduced cost base. Notwithstanding, CGT event H2 should not occur if there is no change in beneficial ownership or variation of share rights and in any case, CGT event H2 will not occur where no capital proceeds have been received.

The proposed share conversion of the shares issued in the company will not trigger a CGT event under Division 104 of the ITAA 1997. This is consistent with paragraphs 30, 36 and 39 of Class Ruling CR 2004/119 Income tax: conversion of shares and variation in rights: Golden Circle Limited which discusses share conversions where share rights attaching to different share classes are both varied and not varied.

Division 725 of the ITAA 1997 may apply where there is a DVS under a scheme involving equity interests in an entity.

Section 725-145 considers when there is a DVS. Generally, a DVS happens when there is an increase in the value of the equity or loan interests - or the interests are issued at a discount - and a decrease in the value of other interests in the target entity.

Subsection 725-145(1) provides that there is a direct value shift under a scheme involving equity or loan interests in an entity (the target entity) if:

(a)  there is a decrease in the market value of one or more equity or loan interests in the target entity; and

(b)  the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things, is done; and

(c)   either or both of subsections (2) and (3) are satisfied.

Examples of something done under a scheme are issuing new shares at a discount, buying back shares or changing the voting rights attached to shares.

Subsection 725-145(2) provides that one or more equity or loan interests in the target entity must be issued at a discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

Subsection 725-145(3) provides that, alternatively to subsection 725-145(2), there must be an increase in the market value of one or more equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

Under the proposed share conversion, there will not be a change to the market value of the shares because there will be no changes to any rights attaching to the shares; the shares have identical rights. Therefore, paragraphs 725-145(1)(a) and 725-145(1)(b) of the ITAA 1997 are not satisfied; nor is paragraph 725-145(1)(c). Accordingly, there will not be a DVS under Division 725 caused by the proposed share conversion.

Finally, as discussed above, no CGT event will occur as a result of the share conversion. Because no CGT event occurs, there is no change in the acquisition date of the shares. That is, the acquisition date of the new shares is the same as the acquisition date of the original share or shares to which they relate. This is consistent with paragraph 25 of CR 2004/119.