Edited version of private advice

Authorisation Number: 1052246223536

Date of advice: 2 May 2024

Ruling

Subject: CGT - xxxx Island residents

Question 1

Will the assets held by the Company before DD MM YYYY be exempt from CGT provisions under section 102-25 of Income Tax (Transitional Provisions) Act 1997 (ITPA 1997)?

Answer

Yes.

Question 2

Are any distributions in relation to the disposal of pre-CGT assets made to the shareholders of the Company in the course of the member's voluntary winding up included in the assessable income of the shareholders under subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the purpose of section 44 of the ITAA 1936?

Answer

No.

This ruling applies for the following period:

30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The company was registered under the XXXX Island Companies Act 1985 during the 20XX income year.

An extract from the Memorandum of Association shows that two subscriber shares were allotted to Spouse A and Spouse B both at the time, residents of XXXX Island.

During the 20XX income year there was an allotment of shares.

Spouse A left the island in the 20XX income year.

Under reforms contained within The Territories Legislation Amendment Act 2020, the operations of the Corporations Act 2001 (Corporations Act) were extended to XXXX Island and on 2 August 20XX the registration for all eligible XXXX Island companies were transferred to the Corporations Act (ASIC) and the company was issued with an Australian Company Number (ACN).

Post October 20YY, the Company purchased fixtures and furnishings, plant and equipment with regards to the operations of the business.

The company also undertook leasehold improvements in according with the lease.

Once the business is sold it is expected there will be no further use for the Company and the intention is to wind up the business via a member's voluntary liquidation.

The sale will comprise goodwill, fixtures, furniture and fittings, plant and equipment, motor vehicles and inventory items.

Relevant legislative provisions

Income Tax Assessment Act 1997 Parts 3-1 and 3-3

Income Tax Assessment Act 1997 Division 149

Income Tax (Transitional Provisions) Act 1997 subsection 102-25(2)

Income Tax Assessment Act 1936 subsection 47(1)

Income Tax Assessment Act 1936 section 24D (repealed)

Transitional capital gains tax provisions for certain Cocos (Keeling) Islands and XXXX Island assets section 102-25

Tax Laws Amendment (XXXX Island CGT Exemption) Act 2016 (20 of 2016)

Reasons for decision

Question 1

Will the assets held by the Company before DD MM YYYY be exempt from CGT provisions under section 102-25 of Income Tax (Transitional Provisions) Act 1997 (ITPA 1997)?

Summary

The CGT assets held by XXXX Island residents before DD MM YYYY will be disregarded if the XXXX Island resident would have been entitled to an exemption on those gains under the law that existed before 1 July YYYY

Detailed reasoning

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 19YY 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.

Specifically, the legislation states:

If:

a)            an entity was a prescribed person (within the meaning of former Division 1A of Part III of the Income Tax Assessment Act 1936) because of residence in XXXX Island on or before 23 October 2015; and

b)            the entity acquired a CGT asset on or before that day; and

c)            the asset is not a pre-CGT asset; and

d)            had a CGT event happened in relation to the asset immediately before DD MM YYYY, any capital gain or capital loss from the event would have been disregarded because the entity was a prescribed person;

then Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 apply in relation to the asset as if references in those Parts to 20 September 1985 were references to DD MM YYYY.

Prior to DD MM YYYY, there was no CGT regime for assets held by residents of XXXX Island. Under subsection 102-25(2) of the Income Tax (Transitional Provisions) Act 1997, capital gains or losses on CGT assets held by XXXX Island residents before DD MM YYYY will be disregarded if the XXXX Island resident would have been entitled to an exemption on those gains under the law that existed before 1 July 2016. These CGT assets will be treated for the purpose of the relevant provisions of the income tax law as if they had been acquired before 20 September 1985.

Under repealed section 24D of the Income Tax Assessment Act 1936, a company is a territory company if:

a)            the company was incorporated in a prescribed Territory;

b)            at all times during the year of income the company was managed and controlled wholly and exclusively in that Territory and was so managed and controlled by a person who was a Territory resident or by persons who were Territory residents;

c)            at no time during the year of income was a shareholding interest in the company held by a person (not being a company) who was not a Territory resident;

d)            at no time during the year of income was a person, or were 2 or more persons, in a position to affect any rights in connexion with the company of the holder of a shareholding interest in the company; and

e)            no agreement was entered into before or during the year of income by virtue of which a person or persons would be in a position after the year of income to affect any rights in connexion with the company of the holder of a shareholding interest in the company.

There are several exceptions to the principle that capital gains or losses made on CGT assets acquired before DD MM YYYY are disregarded, detailed below. For XXXX Island residents, these exceptions will apply as if references to 20 September 1985 are references to DD MM YYYY.

The first exception applies to CGT assets that a company or trust acquired before 20 September 1985. These assets will be treated as having been acquired on or after 20 September 1985 (and so liable to CGT) if there has been a change in the ultimate owners who have more than 50 per cent of the beneficial interests, directly or indirectly, in both the asset and any ordinary income that may be derived from the asset, since the time immediately before 20 September 1985 (Division 149 of the ITAA 1997).

The second exception applies to shares in a private company or interests in a private trust that were acquired before 20 September 1985. A capital gain may not be disregarded where the market value of either:

•         the property of the company or trust (other than trading stock) acquired on or after 20 September 1985; or

•         the interests the company or trust owned through interposed companies or trusts in property (other than trading stock) acquired on or after 20 September 1985,

is at least 75 per cent of the net value of the company or trust just before the relevant CGT event happens (section 104-230 of the ITAA 1997). This only applies when certain CGT events happen and does not apply to capital losses.

Under subsections 149-30(3) and 149-30(4) of the ITAA 1997 - 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. This means that the asset will remain pre-CGT asset.

In your case, both shareholders in the company were XXXX Island residents and the company was incorporated prior to DD MM YYYY (including allotment of shares in December 20XX) therefore the shares are a pre-CGT asset and the CGT assets held by XXXX Island residents before 24 October 2015 will be disregarded for capital gains tax purposes.

Question 2

Are any distributions in relation to the disposal of pre-CGT assets made to the shareholders of the Company in the course of the member's voluntary winding up included in the assessable income of the shareholders under subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the purpose of section 44 of the ITAA 1936?

Summary

Distributions relating to the sale of a pre-CGT asset will become ordinary income unless the distribution is made by a liquidator. Distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.

Detailed reasoning

Proceeds from the sale of a pre-CGT asset is not taxable to the company. However, when it comes to distribution, the amount will become ordinary income, and thus, assessable for tax purposes, if a company simply declares a dividend to its shareholders - that is, those benefits will be lost or reduced.

However, an exception to that rule applies when the distribution is made by a liquidator. That is, if a liquidator distributes a capital gain from a pre-CGT asset sale, then that gain remains tax free for the shareholders.

Subsection 47(1) of the ITAA 1936 deems certain amounts distributed to shareholders by a liquidator in the course of winding up a company to be a dividend, where the amounts distributed by the liquidator represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital.

Subsection 47(1A) of the ITAA 1936 determines that income referred to in subsection 47(1) includes:

a)            an amount (except a net capital gain) included in the company's assessable income for a year of income; or

b)            a net capital gain that would be included in the company's assessable income for a year of income if the ITAA 1997 required a net capital gain to be worked out as follows:

Step 1: Work out each capital gain (except a capital gain that is disregarded) that the company made during that year of income without indexation.

Step 2: Total the capital gains worked out under step 1. The result is the net capital gain for that year of income.

Therefore, a capital gain disregarded under subsection 104-10(5) of the ITAA 1997 will not be included in the deemed dividend distributed to shareholders in the course of the winding up of a company.

However, in order for the non-taxable gains to retain their character when distributed to the shareholders, upon winding up of the company, it must be clear that it is from a non-taxable source.

Subsection 47(2A) of the ITAA 1936 provides that a distribution made under an informal winding up of a company is also treated for the purposes of section 47 of the ITAA 1936 as a distribution to the shareholders by a liquidator in the course of winding up the company.

Paragraph 44(1)(a) ITAA 1936

The assessable income of a shareholder in a company (whether the company is a resident or a non-resident) includes:

(a)          if the shareholder is a resident:

(i)           dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source; and

(ii)           all non-share dividends paid to the shareholder by the company;

As you have stated that there are post CGT assets that have been acquired, only those pre-CGT profits held in the capital profits reserve would be exempt from the CGT provisions after the sale of the business.