Edited version of private advice

Authorisation Number: 1052062954529

Date of advice: 28 November 2022

Ruling

Subject: No goodwill incorporated professional practice

Question 1

Will the shareholders of Company A ('the Taxpayer') be entitled to administrative treatment of interests in 'no goodwill' incorporated practices for the CGT and employee share scheme consequences which arise from the acquisition and disposal of shares in the Taxpayer?

Answer

Yes, the administrative treatment will apply where the requirements set out in QC 48882 are satisfied.

Question 2

As a consequence of moving to a 'no goodwill' incorporated professional practice, will there be any CGT implications to Mr A ('the Ordinary Shareholder') under the value shifting rules from issuing additional ordinary and class shares to new shareholders in the Taxpayer?

Answer

No.

Question 3

As a consequence of moving to a 'no goodwill' incorporated professional practice, will the Ordinary Shareholder make a capital loss on his ordinary shares under CGT event C2 from the Taxpayer issuing additional ordinary and class shares to new shareholders in the future?

Answer

No.

Question 4

As a consequence of moving to a 'no goodwill' incorporated professional practice, is there any change to the tax cost base of the ordinary shares held by the Ordinary Shareholder?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20YY

Year ended 30 June 20YY

Year ended 30 June 20YY

The scheme commences on:

1 July 20YY

Relevant facts and circumstances

1.    Company A ('the Taxpayer') was incorporated on DD MM YYYY. Prior to incorporation, it was operated as a family business by the A family.

2.    Since early YYYYs the A family had been considering its options to ensure the business would continue to operate into the future, while preserving its history and the legacy they had created.

3.    In this respect, it was decided that non-family members would need to be introduced as future owners of the business, to ensure its ongoing operations. Consequently, it was decided that senior practitioners working in the practice would be invited to receive interests/shares in Taxpayer.

4.    In MM YYYY, the Taxpayer exercised its right to redeem the redeemable class shares of the non-working A family members who still held shares in the Taxpayer. This was with the intention that only senior practitioners who were actively working in the practice would be entitled to be shareholders moving forward.

5.    In early YYYY, the Directors determined that several additional senior practitioners would be invited to acquire interests / shares in the Taxpayer. The intention being that these practitioners would be offered interests in the Taxpayer for nominal consideration on the basis the Taxpayer will be treated as a 'no goodwill' practice moving forward.

6.    The shareholders and directors of The Taxpayer are currently as follows:

6.1.  Mr A

6.1.1.    X ordinary shares

6.1.2.    1 class H share held by a family trust associated with Mr A

6.2.  1 class I share held by a family trust associated with Mr B

7.    Mr A's X ordinary shares were inherited from his parent in YYYY on their passing. The X ordinary shares were held by his parent pre-CGT and had an initial issue price of $1 per share.

8.    The Class H and Class I shares were issued for $1.

9.    The Taxpayer wishes to move to a 'no goodwill' incorporated professional practice. It is intended additional senior practitioners will be invited to participate as new shareholders.

10.  The Taxpayer will operate the 'no goodwill' practice in accordance with the following documents:

10.1.Company Constitution

10.2.Shareholders Agreement

10.3.Directors' Indemnity and Access Agreement

10.4.Employment Agreements

11.  All shareholders (or their associate) of the Taxpayer will be employed by the Taxpayer and will draw a salary personally equivalent to the highest amount paid to senior practitioners who are non-shareholders.

12.  There will be no precondition for shareholders (or their associates) to also be a Director of the Taxpayer. It is envisaged that not all senior practitioners who are invited to take up shares in the Taxpayer will become Directors of it.

13.  There will be no salary paid to Directors who represent the shareholders of the Taxpayer. To the extent the shareholders of the Taxpayer appoints non-shareholder representatives to its Board, these persons may be paid a market value fee.

14.  Under the proposed Shareholders' Agreement, the following terms will apply:

14.1.Issue of both ordinary and class shares to each shareholder (or their associated entity).

14.1.1. It is expected that each shareholder receives only one (1) class share each - each shareholder will have a different class share to the other. No additional class shares shall be issued to an existing shareholder even if their ordinary shares change.

14.1.2. The number of ordinary shares issued to a shareholder will represent their seniority in the practice, thus allowing those with a certain number to appoint a Director to the Board.

14.1.3. There will be scope for additional ordinary shares to be issued in the future (or transferred) to existing shareholders as their seniority changes (either up or down). The intention is to allow for changes in the number of ordinary shares held by senior shareholders over time, so they have greater voting rights and hence a greater say/input into the overall operations of the business.

14.1.4. The issue (or redemption) of shares in the Taxpayer requires 70% approval of the existing ordinary shareholders.

14.1.5. Shareholders will pay $1 per share in respect of their acquisition of ordinary and class shares and will only receive $1 per share in respect of their disposal of ordinary and class shares.

14.2.It is the intention that shareholders will not continue to receive substantial dividends on cessation of their employment with the Taxpayer:

14.2.1. The Agreement provides that no dividends are to be paid on ordinary shares and the Constitution together with the Agreement provide that any exiting shareholder's class shares are able to be redeemed (subject to substantial majority support for the decision to redeem). Furthermore, there are restrictions on who a shareholder can transfer shares to, including current shareholders having first rights to acquire them or not consent to the transfer (including because the acquirer lacks the appropriate skills). In this respect it is still a requirement that any shares only be transferred for $1 each.

14.3.Shareholders with at least a 25% interest in the ordinary shares in the Taxpayer will be granted the right to appoint a Director.

14.4.Determination of dividend payments each year will be done annually in accordance with a written policy agreed to by the shareholders for that year, or if there is no agreement, as determined by a majority decision of the ordinary shareholders:

14.4.1. Under the dividend policy it is intended that newly admitted shareholders shall only participate in the profits generated by the Taxpayer from the date after they were admitted.

15.  In accordance with the Shareholders' Agreement and the Constitution, it is proposed that the Ordinary Shareholder will remain as permanent chair of the Board of Directors of the Taxpayer and have casting vote in the event of a tie between the Directors.

16.  As long-term employees in the Taxpayer, the existing Directors have entitlements to annual leave and long service leave entitlements, which are consistent with commercial practices and applicable State legislation. There are no arrangements whereby the existing Directors, or new shareholders will receive additional benefits (such as pension plan payments funded by the Taxpayer) on their termination of employment in the future.

17.  All historical retained earnings will be paid out as dividends via the Class H and Class I shares to the family trusts associated with Mr A and Mr B.

18.  No formal valuation has been performed on the Taxpayer.

Assumptions

19.  Immediately before the issue of any new shares, the market value of Company A, represented predominantly by its retained earnings, will be less than $150,000.

20.  Immediately before the issue of any new shares, any goodwill associated with Company A is $Nil or immaterial.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 159GZZZQ(2)

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1997 section 83A-20

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 subsection 128-15(4)

Income Tax Assessment Act 1997 section 104-250

Income Tax Assessment Act 1997 section 725-50

Income Tax Assessment Act 1997 section 725-70

Reasons for decision

Question 1

Will the shareholders of Company A ('the Taxpayer') be entitled to administrative treatment of interests in 'no goodwill' incorporated practices for the CGT and employee share scheme consequences which arise from the acquisition and disposal of shares in the Taxpayer?

Summary

Yes, the administrative treatment of interests in 'no goodwill' incorporated practices will apply where the requirements set out in QC 48882 are satisfied. However, the requirements will not be satisfied in respect of the X ordinary shares held by Mr A.

Detailed reasoning

The Commissioner sets out in Administrative treatment: acquisitions and disposals of interests in 'no goodwill' professional partnerships, trusts and incorporated practicesQC 48882 the administrative treatment of the acquisition and disposal of practice interest in 'no goodwill' professional practices.

The administrative treatment will apply in relation to the specific tax issues set out in the table below:

Where the administrative treatment is applied, the following conditions must be met:

•                     it must be applied to all applicable tax issues set out in the table above

•                     the CGT treatment of assets which are exchanged for practice interests subject to the guidelines should be determined on a consistent basis.

The guidelines only apply in relation to the tax issue identified above. They do not apply in relation to other tax issues.

Administrative treatment requirements

In order for the administrative treatment to apply, all the following requirements must be satisfied:

Practitioner entity

The practitioner entity must carry on or participate in the carrying on of a professional practice, and be one of the following - a:

•                     partner in a partnership carrying on that practice

•                     shareholder in a company carrying on that practice

•                     beneficiary of a trust (including a unit holder) carrying on that practice.

Applicable circumstances

The dealings and relationships between the parties satisfy all of the following conditions:

1.    the governing documents of the practice provide

a.            in the case of a partnership - that consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest in goodwill will be nil or a nominal amount; or

b.            in any other case - that consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest will be determined on the assumption that the value of goodwill is nil or a nominal amount; and

2.    the governing documents have no further provision relating to consideration for practice interests; or such documents provide

a.            in the case of a partnership - that consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest in assets other than goodwill will be nil or a particular amount; or

b.            in any other case - that consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest will be determined on the assumption that the value of certain assets other than goodwill will be nil or a particular amount; and

3.    An acquisition and/or disposal occurs in the circumstances covered above

4.    The following parties have an arm's length relationship with one another immediately before the acquisition or disposal

a.            the acquiring entity (if any); and

b.            each practitioner entity (if any) who disposes of a practice interest which the acquired interest represents or is reasonably attributable to

5.    The evidence reasonably supports the conclusion that the following represent arm's length dealings

a.            the governing documents; and

b.            the acquisition and/or disposal transaction

6.    The practitioner entity applies the treatment in these guidelines to all acquisitions or disposals covered above.

Application to your circumstances

Practitioner Entity

The practitioner entity in this circumstance is Company A with its current and future shareholders. As the shareholders and proposed shareholders participate in the carrying of the professional practice in the company, the practitioner entity requirement is satisfied.

Applicable Circumstances

•         Mr A's ordinary shares

Mr A's X ordinary shares were inherited from his parent who held them pre-CGT prior to the determination that the practice would operate on a 'no goodwill' incorporated practice. The cost base of those shares will be determined under item 1 of the table in subsection 128-15(4) of the ITAA 1997, as the market value of the shares on the date of death.

Therefore, condition 3 and condition 6 above would not be satisfied for these shares.

•         Class H and Class I shares on issue

Mr A and Mr B's class shares were acquired for $1 and the sale of those shares will be governed by the Shareholder's Agreement ie a nominal amount. Therefore, conditions 1 to 3 would be satisfied for these shares.

•         Future acquisitions and disposals of shares

The proposed Shareholders' Agreement outlines that all shares in the Taxpayer to be acquired for $1 and disposed of for $1. No other provisions in the Shareholders' Agreement or other documents relate to the consideration payable or receivable for share in the Taxpayer. Therefore, conditions 1 to 3 are satisfied.

•         Arm's length dealings - conditions 4 and 5

Based on the facts and our review of the documents provided, the Commissioner is satisfied that Mr A, Mr B and the proposed shareholders have an arm's length relationship and will conduct arm's length dealings. Therefore, conditions 4 and 5 would be satisfied.

•         Condition 6

Aside from Mr A's X ordinary shares inherited from his parent as discussed above, all other acquisitions and disposals proposed under the arrangement will satisfy condition 6 of the guidelines.

Conclusion

As the guidelines will not be used to determine Mr A's cost base of the X ordinary shares on acquisition, the guidelines cannot be used in calculating the capital proceeds on their disposal.

The non-availability of the administrative treatment to Mr A for his X ordinary shares will not impact the availability of the administrative treatment to the other shareholders and proposed shareholder, nor does it preclude him from utilising the administrative treatment in respect to his Class I shares or new issues of ordinary shares.

The requirements for the administrative treatment would be satisfied for all future acquisitions of shares and disposals that meet the guidelines in QC 48882 while they remain in place, in the ordinary course of business of the Taxpayer, excluding the future disposal of Mr A's X ordinary shares.

Question 2

As a consequence of moving to a 'no goodwill' incorporated professional practice, will there be any CGT implications to Mr A ('the Ordinary Shareholder') under the value shifting rules from issuing additional ordinary and class shares to new shareholders in the Taxpayer?

Summary

No, as the market value of a value shift would be less than $150,000, the value shifting rules will not apply.

Detailed reasoning

Division 725 of the ITAA 1997 provides that the direct value shifting rules apply if, under a scheme, value is shifted from equity or loan interests in a company or trust to other equity or loan interests in the same company or trust. A direct value shift may result from issuing new shares or trust units at a discount, buying back shares at less than market value or changing the voting rights attached to shares.

The rules are designed to prevent losses or gains from arising on realisation of the interests by:

•         adjusting the value of those interests for income tax purposes to take account of material changes in market value that are attributable to the value shift; and

•         treating the value shift as a partial realisation to the extent that value is shifted either between interests held by different owners, from post-CGT to pre-CGT assets or between interests of a different character.

Where the direct value shifting rules apply, they can operate to either adjust the value (e.g. cost base) of those equity or loan interests, or to treat the value shift as a partial realisation, which in turn may give rise to a taxable capital gain to the holder of the interest, pursuant to CGT event K8 under section 104-250 of the ITAA 1997.

Section 725-70(1) of the ITAA 1997 contains a de minimus rule, so that where the market value of the direct value shift is less than $150,000, the value shifting rules would not apply.

Section 725-70(2) of the ITAA 1997 provides that where the sole or main reason for a direct value shift occurring under a different scheme was to take advantage of the $150,000 threshold, the de minimis rule does not apply.

Application to this case

As discussed in question 1 above, the administrative treatment applies only in relation to the specific tax provisions outlined in the table above. In this regard, the administrative treatment will not apply to deem the market value any new shares at $1 for the purposes of the value shifting rules in Division 725.

The historical retained earnings will be paid out as dividends via the Class H and Class I shares to the family trusts associated with Mr A and Mr B prior to the commencement of this arrangement. This action reduces the value of the ordinary shares Mr A inherited from his parent. Whilst the proposed issue of new shares is likely to result in a direct value shift, as the market value of the company before any new share issue will be less than $150,000, any value shift would also be less than $150,000.

There is nothing to indicate that a scheme to take advantage of the $150,000 threshold exists to exclude the operation of the de minimis rule. Therefore, per section 725-70(1) of the ITAA 1997 the value shifting rules in Division 725 will not apply.

Question 3

As a consequence of moving to a 'no goodwill' incorporated professional practice, will the Ordinary Shareholder make a capital loss on his ordinary shares under CGT event C2 from the Taxpayer issuing additional ordinary and class shares to new shareholders in the future?

Summary

No. As long as the Ordinary Shareholder continues to hold his shares, CGT Event C2 concerning the cancellation, surrender or similar of a CGT asset, does not apply.

Detailed reasoning

Section 104-25 of the Income Tax Assessment Act 1997 outlines when a CGT event C2 happens. It states:

(1) CGT event C2 happens if your ownership of an intangible * CGT asset ends by the asset:

(a) being redeemed or cancelled; or

(b) being released, discharged or satisfied; or

(c) expiring; or

(d) being abandoned, surrendered or forfeited; or

(e) if the asset is an option-being exercised; or

(f) if the asset is a convertible interest-being converted.

On the issue of additional ordinary and class shares to new shareholders in the future, the Ordinary Shareholder intends to continue to hold his X ordinary shares whilst he continues to work in the practice.

As the move to a 'no goodwill' practice does not result in a cancellation, surrender or similar of his X ordinary shares, no CGT event arises under CGT event C2.

Therefore, no capital loss would arise under CGT event C2.

Question 4

As a consequence of moving to a 'no goodwill' incorporated professional practice, is there any change to the tax cost base of the ordinary shares held by the Ordinary Shareholder?

Summary

No, the cost base of the ordinary shares held by the Ordinary Shareholder does not change as a consequence of moving to a 'no goodwill' incorporated professional practice.

Detailed reasoning

As discussed above at question 1, the administrative treatment would not apply to Mr A's X ordinary shares inherited from his parent who held them pre-CGT.

The cost base of those shares will be determined under item 1 of the table in subsection 128-15(4) of the ITAA 1997, as the market value of the shares on the date of death.