Edited version of private advice

Authorisation Number: 1052217212276

Date of advice: 15 March 2024

Ruling

Subject: CGT - disposal of shares

Question 1

Does the disposal of shares in Company D by Company C give rise to CGT event A1 happening (per section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)), that could give rise to a capital gain to be included in calculating the attributable income to be included in Company A's assessable income under section 456 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 2

If the answer to question one is 'Yes', can Subdivision 768-G of the ITAA 1997 apply to reduce the capital gain for the purpose of calculating the attributable income to be included in Company A's assessable income under section 456 of the ITAA 1936?

Answer

Yes.

Question 3

If the answer to question two is 'Yes', can Subdivision 126-B of the ITAA 1997, as modified by section 419 of the ITAA 1936, apply to disregard the reduced capital gain, if any, if Company C and Company A choose a roll-over under that Subdivision?

Answer

Yes.

This ruling applies for the following period:

Year ending 31 March 20YY

The scheme commences on:

1 April 20YY

Relevant facts and circumstances

Company A was incorporated in Australia and is a Part X Australian resident as that term is defined in section 317 of the ITAA 1936.

Company A is the parent company of the global group and is the head company of an income tax consolidated group.

Company A holds 100% of the ordinary shares in Company B, Company B holds 100% of the ordinary shares in Company C, and Company C holds 100% of the ordinary shares in Company D. Company B, Company C and Company D are tax resident in a foreign country. The above shareholding structure has been in place since 20XX. All shares held by Company A, Company B and Company C in their respective subsidiaries above are ordinary shares.

In recent years, Company A has been conducting an entity rationalisation process to wind up redundant entities that have arisen from the evolution of the business and integration of acquisitions. To date more than X entities have been wound up.

As both Company B and Company C no longer serve their original purpose and will become effectively redundant to the group, it is currently proposed that both are wound up. This would be achieved by:

•         Company C selling its shares in Company D to Company A.

•         Company C and Company B will repatriate the proceeds received as a result of the above step by way of dividends and/or returns of capital.

•         Company B will transfer all assets, liabilities and employees associated with its current business to a newly incorporated entity appropriately positioned in the group as a subsidiary of Company D.

•         Company B and Company C will be liquidated and deregistered.

The proposed restructure will simplify the structure by transferring the ownership of Company D to Company A. This will assist in reducing the complexity, risk and costs of the global structure and achieve the objectives of the entity rationalisation project by removing redundant entities from the group.

Assumptions

•         For the purposes of computing the attributable income for Company A under section 456 of the ITAA 1936, Company C fails the active income test in section 432 of the ITAA 1936.

•         If CGT event A1 were to occur for Company C on disposal of its interests in Company D, it would make a capital gain (and not a capital loss) before the application of Subdivision 768-G or Subdivision 126-B of the ITAA 1997 as applied in determining Company C's attributable income.

•         The Active Foreign Business Asset Percentage (AFBAP) of Company D for the purposes of applying section 768-505 of the ITAA 1997 to the capital gain to be made by Company C is less than 90%.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 6

Income Tax Assessment Act 1936 section 317

Income Tax Assessment Act 1936 section 320

Income Tax Assessment Act 1936 section 327

Income Tax Assessment Act 1936 section 327A

Income Tax Assessment Act 1936 section 334A

Income Tax Assessment Act 1936 section 340

Income Tax Assessment Act 1936 paragraph 361(1)(a)

Income Tax Assessment Act 1936 section 382

Income Tax Assessment Act 1936 section 383

Income Tax Assessment Act 1936 paragraph 383(a)

Income Tax Assessment Act 1936 section 384

Income Tax Assessment Act 1936 section 386

Income Tax Assessment Act 1936 subsection 386 (1)

Income Tax Assessment Act 1936 paragraph 386(2)(a)

Income Tax Assessment Act 1936 section 419

Income Tax Assessment Act 1936 subsection 419(1)

Income Tax Assessment Act 1936 subsection 419(2)

Income Tax Assessment Act 1936 section 432

Income Tax Assessment Act 1936 section 446

Income Tax Assessment Act 1936 paragraph 446(1)(k)

Income Tax Assessment Act 1936 section 456

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 104-10

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

Income Tax Assessment Act 1997 Subdivision 126-B

Income Tax Assessment Act 1997 paragraph 126-45(2)(a)

Income Tax Assessment Act 1997 section 126-50

Income Tax Assessment Act 1997 subsection 126-50(1)

Income Tax Assessment Act 1997 subsection 126-50(2)

Income Tax Assessment Act 1997 subsection 126-50(3)

Income Tax Assessment Act 1997 subsection 126-50(3A)

Income Tax Assessment Act 1997 subsection 126-50(4)

Income Tax Assessment Act 1997 subsection 126-50(5)

Income Tax Assessment Act 1997 subsection 126-50(6)

Income Tax Assessment Act 1997 paragraph 126-50(6)(a)

Income Tax Assessment Act 1997 paragraph 126-50(6)(b)

Income Tax Assessment Act 1997 subsection 126-50(7)

Income Tax Assessment Act 1997 subsection 126-50(8)

Income Tax Assessment Act 1997 subsection 126-50(9)

Income Tax Assessment Act 1997 section 126-55

Income Tax Assessment Act 1997 section 126-60

Income Tax Assessment Act 1997 subsection 126-60(1)

Income Tax Assessment Act 1997 paragraph 126-60(2)(a)

Income Tax Assessment Act 1997 paragraph 126-60(2)(b)

Income Tax Assessment Act 1997 section 703-10

Income Tax Assessment Act 1997 Subdivision 768-G

Income Tax Assessment Act 1997 section 768-505

Income Tax Assessment Act 1997 subsection 768-505(1)

Income Tax Assessment Act 1997 subsection 768-505(2)

Income Tax Assessment Act 1997 section 768-550

Income Tax Assessment Act 1997 section 975-500

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

CGT event A1 happens when Company C disposes of the shares in Company D and any capital gain may be included in the calculation of Company A's attributable income under section 456 of the ITAA 1936.

Detailed reasoning

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income are called statutory income. Included in the list of provisions about statutory income under section 10-5 of the ITAA 1997 are sections 456 to 459A of the ITAA 1936 which deal with the attribution of income.

Section 456 of the ITAA 1936 provides that where a Controlled Foreign Company (CFC) has attributable income for a statutory accounting period in respect of an attributable taxpayer, the taxpayer's attribution percentage of the attributable income is included in the assessable income for the year of income in which the CFC's statutory accounting period ends.

Under paragraph 361(1)(a) of the ITAA 1936 an entity will be an attributable taxpayer in relation to a CFC where that entity is an Australian entity whose associate-inclusive control interest in the CFC is at least 10%.

Company A is the parent company of the group and owns 100% of the ordinary shares in Company B. Company B in turn owns 100% of the ordinary shares in Company C. Company C in turn owns 100% of the ordinary shares in Company D.

As Company A, being the head entity of the Australian tax consolidated group, has a 100% associate-inclusive control interest in Company B, Company C and Company D, these foreign resident companies will each be CFCs per section 340 of the ITAA 1936.

Company A will be an attributable taxpayer under paragraph 361(1)(a) of the ITAA 1936 as it has an associate-inclusive control interest in Company B, Company C and Company D of more than 10%.

Under section 382 of the ITAA 1936, the attributable income is the amount that would be the CFC's taxable income for the statutory accounting period (referred to as the 'eligible period') if certain assumptions were made. For the purposes of describing those assumptions, amounts of assessable income, allowable deductions and exempt income are referred to as respectively as notional assessable income, notional allowable deductions and notional exempt income.

Section 383 of the ITAA 1936 lists the basic assumptions that apply in the calculation of attributable income for a CFC:

•         the CFC is a taxpayer and a resident (within the meaning of section 6 of the ITAA 1936), during the whole of the eligible period

•         the eligible period is a year of income, being the year of income of the attributable taxpayer in which the eligible period ends

•         that the Act is modified in accordance with Subdivisions B to E of Division 7 of Part X of the ITAA 1936, these subdivisions covering the general modifications of Australian tax law, modifications relating to Australian capital gains tax, modifications relating to losses and modifications relating to the application of former Part XI, and

•         whichever of the assumptions in section 384 of the ITAA 1936 (for an unlisted country) or section 385 (for a listed country) apply.

Company C is resident of an unlisted country as defined in section 320 of the ITAA 1936. Relevantly, this means that the additional assumptions from section 384 apply as follows:

(1) Where the eligible CFC is a resident of an unlisted country at the end of the eligible period, it is to be assumed:

(a) that the only amounts of notional assessable income are those to which subsection (2) applies; and

(b) that all other income is notional exempt income.

(2) The amounts of notional assessable income are:

(a) where the eligible CFC does not pass the active income test for the eligible period in relation to the eligible taxpayer-amounts that would be included in its notional assessable income for the period under this Act as modified in accordance with Subdivisions B to E if the only income or other amounts derived by it during the eligible period, and any earlier statutory accounting period, were adjusted tainted income (within the meaning of section 386); and

...

As Company C does not pass the active income test for the eligible period its notional assessable income includes income or other amounts derived by it that are 'adjusted tainted income' within the meaning of section 386 of the ITAA 1936.

Subsection 386(1) of the ITAA 1936 states that 'adjusted tainted income' refers to amounts that would be passive income, tainted sales income or tainted services income if certain modifications were made to the provisions of Division 8 of Part X of the ITAA 1936.

Section 446 of the ITAA 1936 defines 'passive income' of a CFC in a statutory accounting period. In particular paragraph 446(1)(k) provides that passive income includes:

(k) net gains that accrued to the CFC in the statutory accounting period in respect of the disposal of tainted assets;

For the purposes of determining notional assessable income, paragraph 386(2)(a) of the ITAA 1936 modifies paragraph 446(1)(k) by replacing it with:

(k) amounts derived from the disposal of tainted assets;

Under section 317 of the ITAA 1936, a 'tainted asset' includes shares in a company, or a right or option in respect of such a share.

Therefore, the shares that Company C owns in Company D are tainted assets. Amounts derived by Company C from the disposal of the shares in Company D are amounts derived from the disposal of tainted assets and will be included in the calculation of Company C's notional assessable income.

When this disposal occurs, CGT event A1 happens per subsection 104-10(1) of the ITAA 1997 and the capital gain may be included in the calculation of Company A's attributable income under section 456 of the ITAA 1936.

Question 2

Subdivision 768-G can apply to reduce the capital gain for the purpose of calculating the attributable income to be included in Company A's assessable income under section 456 of the ITAA 1997.

Detailed reasoning

Under Subdivision 768-G of the ITAA 1997, a capital gain or capital loss made by an Australian resident company on the disposal of a share in a foreign company can be reduced or disregarded to the extent that the foreign company has an underlying active business. Section 768-505 states:

(1) The *capital gain or *capital loss a company (the holding company) that is an Australian resident makes from a *CGT event that happened at a particular time (the time of the CGT event) to a *share in a company (the foreign disposal company) that is a foreign resident is reduced if:

(a) the holding company held a *direct voting percentage of 10% or more in the foreign disposal company throughout a 12 month period that:

(i) began no earlier than 24 months before the time of the CGT event; and

(ii) ended no later than that time; and

(b) the share is not:

(i) an eligible finance share (within the meaning of Part X of the Income Tax Assessment Act 1936); or

(ii) a widely distributed finance share (within the meaning of that Part); and

(c) the CGT event is CGT event A1 ...

(2) The gain or loss is reduced by the *active foreign business asset percentage (see sections 768-510, 768-530 and 768-535) of the foreign disposal company in relation to the holding company at the time of the CGT event.

Company C is assumed to be an Australian resident when determining its attributable income in accordance with section 383 of the ITAA 1936. For the purposes of section 768-505 of the ITAA 1997 Company C is considered the 'holding company' while Company D will be the 'foreign disposal company'.

An entity's 'direct voting percentage' in a company is defined in subsection 955-1(1) of the ITAA 1997, as having the meaning given by section 768-550 of the ITAA 1997, as being the entity's 'voting interest' percentage in the company. The term 'voting interest' is further defined in section 334A of the ITAA 1936 and considers arrangements that may affect those voting rights which are not applicable here.

Company C owns 100% of the ordinary shares in Company D and has maintained this holding through the previous 24 months. The ordinary shares in Company D do not meet the definition of an eligible finance share or a widely distributed finance share per sections 327 and 327A of the ITAA 1936 respectively. As per question 1, the disposal of the ordinary shares by Company C in Company D gives rise to CGT event A1.

As Company C satisfies the conditions of subsection 768-505(1) of the ITAA 1997, then subsection 768-505(2) operates to reduce the capital gain by the AFBAP of Company D in accordance with Subdivision 768-G.

Question 3

Subdivision 126-B, as modified by section 419 of the ITAA 1936, can apply to disregard the capital gain, if any, if Company C and Company D both choose to apply it.

Detailed reasoning

A Subdivision 126-B roll-over may be available for the transfer of a CGT asset between two companies where both companies are members of the same wholly-owned group and at least one of the companies is a foreign resident.

Under paragraph 126-45(2)(a) of the ITAA 1997, CGT event A1 is a specified CGT event that is eligible for a Subdivision 126-B roll-over. As per question 1, the disposal of the ordinary shares in Company D by Company C (a foreign resident and the originating company), to Company A (an Australian resident and the recipient company), gives rise to CGT event A1 so this condition is satisfied.

The conditions in section 126-50 of the ITAA 1997 must be met for the roll-over to apply.

Members of the same wholly-owned group

Subsection 126-50(1) of the ITAA 1997 states:

(1) The originating company and recipient company must be members of the same *wholly-owned group at the time of the trigger event.

The term 'wholly-owned group' is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by section 975-500 of the ITAA 1997:

Two companies are members of the same wholly-owned group if:

(a) one of the companies is a *100% subsidiary of the other company; or

(b) each of the companies is a *100% subsidiary of the same third company.

Company C is a 100% subsidiary of Company A at the time of the disposal of the shares in Company D so both are members of the same wholly-owned group. Therefore, subsection 126-50(1) of the ITAA 1997 is satisfied.

The CGT assets must not be trading stock or a registered emission unit of the recipient company immediately after disposal

Subsections 126-50(2), 126-50(3) and 126-50(3A) of the ITAA 1997 state that the assets must not be trading stock or a registered emission unit of the recipient company immediately after disposal.

The ordinary shares in Company D will not be trading stock or a registered emission unit of Company A immediately after the disposal and so this condition is satisfied.

The ordinary income and statutory income of the recipient company not be exempt

Subsection 126-50(4) of the ITAA 1997 states that the ordinary income and statutory income of the recipient company must not be exempt from income tax because it is an exempt entity in the income year of the trigger event.

The term 'exempt entity' is defined in subsection 995-1(1) of the ITAA 1997 as:

(a) an entity all of whose *ordinary income and *statutory income is exempt from income tax because of this Act or because of another *Commonwealth law, no matter what kind of ordinary income or statutory income the entity might have; or

(b) an *untaxable Commonwealth entity.

The ordinary and statutory income of Company A, being the recipient company, is subject to Australian income tax under the ITAA 1997 and so Company A is not an exempt entity. Therefore, subsection 126-50(4) is satisfied.

Resident of an unlisted country at the time of the trigger event

Subsection 126-50(5) of the ITAA 1997 provides that one of the requirements in the table must be satisfied.

Relevantly, for the purposes of calculating the attributable income of a CFC, subsection 419(1) of the ITAA 1936 has effect as if the table in subsection 126-50(5) of the ITAA 1997 were omitted and the following table was substituted:

Table 1: Calculating the attributable income of a CFC.

Subsection 419(2) of the ITAA 1936 states that the residency assumption as per paragraph 383(a) of the ITAA 1936 is ignored for the purposes of applying the table in subsection 419(1).

By ignoring the residency assumption, item 3 of the table is satisfied as:

•         Company C, as the originating company, is resident in an unlisted country

•         Company A, as the recipient company, is resident in Australia, and

•         the ordinary shares in Company D meet the asset requirement (noting in this instance it does not matter what the roll-over asset is).

Originating company or recipient company that is an Australian resident

Subsection 126-50(6) of the ITAA 1997 states:

(6) If the originating company or the recipient company is an Australian resident at the time of the trigger event, that company must:

(a) be a *member of a consolidated group or *MEC group at that time; or

(b) not be a member of a *consolidatable group at that time.

The residency assumption as per paragraph 383(a) of the ITAA 1936, is reapplied for the purposes of subsection 126-50(6) of the ITAA 1997. Company C, as the originating company, is deemed an Australian resident at the time of the trigger event and satisfies paragraph 126-50(6)(b) as it is not a member of a consolidatable group at that time, as the term is defined in section 703-10 of the ITAA 1997.

Company A, as the recipient company, is also an Australian resident at the time of the trigger event and satisfies paragraph 126-50(6)(a) of the ITAA 1997 as it is a member of a consolidated group at that time, being the head entity.

Additional conditions where originating company is foreign resident and asset subject to previous application of this Subdivision

Subsections 126-50(7), 126-50(8) and 126-50(9) of the ITAA 1997 operate to restrict the availability of roll-over relief where the originating company is a foreign resident, and the asset has previously been subject to one or more roll-overs under Subdivision 126-B.

Company C, as the originating company, is assumed to be Australian resident as per paragraph 383(a) of the ITAA 1936. Therefore, these subsections do not have application in this instance and can be ignored.

When there is a roll-over and consequences

Section 126-55 of the ITAA 1997 provides that there is a roll-over where the trigger event would have resulted in the originating company making a capital gain or making no capital loss and not being entitled to a deduction (or the roll-over asset was acquired pre-CGT), and both originating company and recipient company choose to obtain it.

The relevant trigger event in this instance would result in Company C making a capital gain. Per question 2, this capital gain is reduced under Subdivision 768-G of the ITAA 1997 by the AFBAP for Company D. However, as the AFBAP for Company D is less than 90%, there will be some capital gain remaining after the application of Subdivision 768-G.

Accordingly, Company C and Company A can choose to obtain roll-over relief under section 126-55 of the ITAA 1997.

The consequences under section 126-60 of the ITAA 1997 are:

•         the capital gain that Company C makes from the disposal of the ordinary shares in Company D is disregarded per subsection 126-60(1) of the ITAA 1997

•         the first element of the cost base of the ordinary shares in Company D in the hands of Company A is the cost base of the shares when Company C acquired them per paragraph 126-60(2)(a) of the ITAA 1997, and

•         the first element of the reduced cost base of the shares in the hands of Company A is worked out similarly, as per paragraph 126-60(2)(b) of the ITAA 1997.

The fact that the capital gain has been reduced, but not disregarded, by the application of Subdivision 768-G of the ITAA 1997 does not impact the operation of Subdivision 126-B of the ITAA 1997 for the group.