Edited version of private advice

Authorisation Number: 1052105602913

Date of advice: 17 April 2023

Ruling

Subject: Pre-CGT asset

Issues

Question 1

Are the Properties 'pre-CGT asset' of the Company as set out in section 149-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

1 July XXXX to 30 June XXXX

Relevant facts and circumstances

The Rulee's background

The Company was incorporated prior to 20 September 1985.

The Company acquired XX properties (collectively described as the Properties) prior to 20 September 1985.

1 X Class share was issued to Individual A prior to 20 September 1985 (pre-CGT date).

1 Y Class share was issued to Individual B prior to 20 September 1985 (pre-CGT date).

2 Ordinary shares were issued to Individual B prior to 20 September 1985 (pre-CGT date).

1 Ordinary share was issued to Individual C prior to 20 September 1985 (pre-CGT date).

1 Ordinary share was issued to Individual D prior to 20 September 1985 (pre-CGT date).

1 Special Preference share was issued to Individual A, which only carried voting rights.

Individual A and Individual B had a relationship breakdown. Individual B's 2 Ordinary and 1 Y Class share were transferred to Individual A after 20 September 1985. Consent orders were agreed to by Individual A and Individual B before the Family Court.

Individual C passed away after 20 September 1985. In accordance with their Will, their 1 Ordinary share was transferred to their surviving spouse.

The 1 Y Class share held by Individual A was converted to an Ordinary share after 20 September 1985.

Individual A passed away after 20 September 1985. In accordance with the Articles of Association of the Company, upon the death of Individual A, the X Class Share was converted to an Ordinary share. Individual A's estate has not been fully administered.

Relevant legislative provisions

Income Tax Assessment Act 1936 former section 160ZZM

Income Tax Assessment Act 1936 former section 160ZZS

Income Tax Assessment Act 1997 Division 149

Reasons for decision

Question 1

Summary

The assets acquired before 20 September 1985 are pre-CGT assets of the Company pursuant to section 149-10 of the ITAA 1997.

Detailed reasoning

Division 149 of the ITAA 1997

Division 149 of the ITAA 1997 contains the provisions under which an asset acquired before 20 September 1985 is treated as having been acquired after that date, that is, the asset stops being a pre-CGT asset. Subdivision 149-B of the ITAA 1997 provides for when the asset of an entity stops being a pre-CGT asset for entities that are not covered by section 149-50 of the ITAA 1997.

Subdivision 149-B of the ITAA 1997 contains provisions which govern when an asset of non-public entity stops being a pre-CGT asset.

A CGT asset is defined in subsection 108-5(1) of the ITAA 1997 as any kind of property or a legal or equitable right that is not property. A CGT asset is a pre-CGT asset if it was last acquired before 20 September 1985 and no income tax provision has operated to treat it as having been acquired after that date.

Section 149-10 of the ITAA 1997 provides as follows:

A CGT asset that an entity owns is a pre-CGT asset if, and only if:

(a) the entity last acquired the asset before 20 September 1985; and

(b) the entity was not, immediately before the start of the 1998-99 income year, taken under:

(i) former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or

(ii) Subdivision C of Division 20 of former Part IIIA of that Act;

to have acquired the asset on or after 20 September 1985; and

(c) the asset has not stopped being a pre-CGT asset of the entity because of this Division.

Section 149-30 of the ITAA 1997 provides that an asset of a non-public entity stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

The test to determine when an asset of a non-public entity stops being a pre-CGT asset is a factual test. Under the test, the asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not maintained. Therefore, an entity must examine the underlying interests in its pre-CGT assets on an on-going basis to ensure that majority underlying interests in them have been maintained when there has been a change, direct or indirect, in its shareholdings, unitholdings or other membership interests.

Subsection 149-15(3) of the ITAA 1997 relevantly defines an 'ultimate owner' to include an individual. It does not include companies that pay dividends to their members, or trusts.

Special rules apply to work out majority underlying interests in an asset if an ultimate owner acquired an underlying interest in it because of the death of the former owner.

Subsection 149-30(3) 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 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. In this case 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.

Subsections 149-30(3) and 149-30(4) of the ITAA 1997 also provide if an ultimate owner (new owner) has acquired an interest in an asset because it was transferred to the new owner by former owner as result of marriage breakdown covered by Subdivision 126-A of the ITAA 1997, the new owner is treated as having held the underlying interest of the former owner for the period the former owner held them.

Relevantly, the transfer of CGT assets as a result of a marriage breakdown prior to 20 January 1997 was dealt with under former section 160ZZS of the ITAA 1936.

CGT Determination Number 42 TD 42 Capital Gains: Will section 160ZZS apply where pre-CGT shares in a company are transferred to a spouse and the shares are eligible for roll-over relief under section 160ZZM? confirms that where former section 160ZZM of the ITAA 1997 deems the spouse to have acquired the shares before 20 September 1985, the Commissioner will also consider that the spouse held those interests in the company before 20 September 1985 for the purpose of applying former section 160ZZS of the ITAA 1936

Taxation Determination TD 1999/49 Income tax: capital gains: is roll-over under sections 126-5 and 126-15 of the Income Tax Assessment Act 1997 dependent on there being a marriage breakdown between the spouses? confirms that that former section 160ZZM of the ITAA1936 (now rewritten as section 126-5 of the ITAA 1997) affords roll-over to asset transfers between spouses 'upon the breakdown of their marriage'

Relevantly, paragraph 160ZZM (1)(a) of the ITAA 1936 applied where a taxpayer disposes of an asset to his or her spouse pursuant to an order of a court under the Family Law Act 1975 or under a corresponding law of a foreign country

Taxation Determination TD 1999/47 Income tax: capital gains: is there roll-over under section 126-5 or 126-15 of the Income Tax Assessment Act 1997 if a CGT event happens because of a court order under the Family Law Act 1975 made by consent? explains that an order made by consent is a 'court order' in terms of paragraphs 126-5(1)(a) and 126-15(1)(a) of the ITAA 1997.

Subsection 149-15(2) of the ITAA 1997 defines an 'underlying interest' in a CGT asset as a 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.

Subsection 149-15(1) of the ITAA 1997 defines majority underlying interests. It requires ultimate owners to hold more than 50% of the beneficial interests (either directly or indirectly through one or more interposed companies, trusts or partnerships) in the CGT asset and in any ordinary income that may be derived from the asset.

Subsections 149-15(4) and (5) of the ITAA 1997 provide that an ultimate owner has an indirect beneficial interest in a CGT asset of another entity if they would receive for their own benefit any capital or ordinary income distributed by the entity through interposed entities.

Under subsection 149-30(2) of the ITAA 1997, if the Commissioner is satisfied, or thinks it reasonable to assume, that the majority underlying interests in the asset have not changed up to a particular time, then subsections 149-30(1) and (1A) of the ITAA 1997 apply and the asset continues to be a pre-CGT Asset. Simply put, subsection 149-30(2) of the ITAA 1997 requires that the Commissioner has to be satisfied that the majority underlying interests in the assets have not changed, otherwise the asset is deemed to have been acquired at the time that the change in majority underlying interests in that asset happened.

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 explains calculating changes in majority underlying interests:

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 following example illustrates this point:

Immediately before 20 September 1985 underlying interests in an asset of a company were owned by four natural persons in the following proportions -

A - 90%

B - 5%

C - 3%

D - 2%.

Following a change in the shareholding of the company after 20 September 1985, the underlying interests in the asset were owned by natural persons in the following proportions -

A - 1%

B - 2%

C - 48%

D - 0%

E - 49%.

The natural persons who owned underlying interests both immediately before 20 September 1985 and after the change in ownership were A, B and C. Immediately before 20 September 1985 A, B and C between them owned more than one half of the underlying interests (i.e., 98%). After the change A, B and C between them still owned more than one half of the underlying interests (i.e., 51%). Accordingly, more than one half of the underlying interests in the company's asset continued to be held by the same persons. Section 160ZZS would therefore not apply to deem the asset acquired by the company before 20 September 1985 to have been acquired on or after that date.

Different classes of shares will not necessarily mean that the company cannot satisfy the requirements of subsection 149-30(1) of the ITAA 1997. Rather, the company will only fail because the discretion to stream may mean that the original owners will not receive more than 50% of the income derived from the asset. As such, there will be no issues where the company does not introduce new shareholders, or if it were to introduce new shareholders, the new shareholders cannot receive more than 49% of the income derived by the asset.

Share reclassification

The reclassification of a particular class of share into ordinary share involves a variation of the rights that make up that class of share. The share is not cancelled or redeemed on reclassification.

The reclassification does not involve the ownership of the reclassified share ending for the purposes of section 104-25 of the ITAA 1997 - nor is it a disposal of the share for the purposes of section 104-10 of the ITAA 1997. Taxation Ruling TR 94/30 Income tax: capital gains tax implications of varying rights attaching to shares provides that a variation of rights attaching to shares does not result in a full or part disposal of the share.

The reclassification of a class of share into ordinary share did not give rise to a CGT event.

Where the original shares are reclassified, the beneficial owner of each original share will be the beneficial owner of the reclassified shares. Accordingly, with the reclassification of the shares there is no change in the acquisition date of the shares. That is, the acquisition date of the reclassified shares is the same as the acquisition date of the original shares to which they relate.

Application in these circumstances

The Commissioner accepts that in this case it is reasonable to assume that the majority underlying interests in the Properties have been held by the same ultimate owners who held such interests immediately before 20 September 1985 for the purposes of Division 149 of the ITAA 1997 for the following reasons. Relevantly:

•                     No new shareholders, except via death, have gained any entitlements since 20 September 1985. As such, no new person has gained the right (or potential right) to more than 50% of the ordinary income and capital that may be derived from the Properties. By virtue of the pooling concept (as set out in IT 2530) and the special rule that applies to the transfer of shares as result of marriage breakdown and death, in broad terms Individual A (and then the Legal Representative and to whomever Individual A's shares are transferred as a result of their death), Individual C (and then their surviving spouse) and Individual D have collectively held more than 50% of the shares in the Company at all times.

•                     Individual A continuously held their I X Class share in the Company from the pre-CGT date to the date of death.

•                     Upon their death, after 20 September 1985, their 1 X Class share was reclassified as an Ordinary share.

•                     The reclassification of A Class share into ordinary share did not give rise to a CGT event for the legal personal representative of A' estate. The acquisition date of the Ordinary share is the same as the acquisition date of the X Class share to which it relates.

•                     Notwithstanding Individual A's share has not been transferred to a new owner, pursuant to sections 149-30(3) and (4) of the ITAA 1997 the legal personal representative of Individual A's estate and then the new owner will hold the underlying interests in the Properties associated with that share since the pre-CGT Date, given Individual A held it at that date.

Accordingly, the underlying interests Individual A held in the Properties through the X Class share and then the legal personal representative held in the Properties through the reclassified X Class share as an Ordinary share in the Company will count in the majority underlying interests calculation.

Individual B's shares

Individual B's shares were transferred to Individual A following the breakdown in their marriage.

Individual A would have been taken pursuant to former section 160ZZS of the ITAA 1936 (rewritten as subsections 149-30(3) and (4) of the ITAA 1997) to have held the underlying interests in the Properties associated with that share since the pre-CGT Date, given Individual B held it at that date.

As discussed above, the reclassification of the Y Class share to an Ordinary share does not affect the acquisition date.

Accordingly, the underlying interests Individual A held through the transfer of Individual B's shares will count in the majority underlying interests calculation.

Individual C continuously held their I Ordinary share in the Company from the pre-CGT date to the date of death. Upon their death, their 1 Ordinary share was bequeathed to their surviving spouse.

The surviving spouse would have been taken pursuant to sections 149-30(3) and (4) of the ITAA 1997 to have held the underlying interests in the Properties associated with that share since the pre-CGT Date, given Individual C held it at that date. Accordingly, the underlying interests Individual Cand then the surviving spouse held in the Properties through the Ordinary share in the Company will count in the majority underlying interests calculation.

Individual D has continuously held their I Ordinary share in the Company from the pre-CGT date. Accordingly, the underlying interests D held in the Properties through the Ordinary share in the Company will count in the majority underlying interests calculation.

Conclusion

The majority underlying interests in the Property have been maintained from the pre-CGT date.

Division 149 of the ITAA 1997 will not apply to treat the Properties as having been acquired after 20 September 1985.