Edited version of private advice

Authorisation Number: 1052292680189

Date of advice: 18 September 2024

Subject: CGT rollover

Issues

Question 1

Are the replacement roll-over relief requirements under Subdivision 122-A of the Income Tax Assessment Act 1997 (ITAA 1997) satisfied if the shares owned by Individual A in Company are transferred to New Company?

Answer 1

Yes

Question 2

Will the Commissioner make a determination under subsection 177EA(5) of the Income Tax Assessment Act 1936 (ITAA 1936) with respect to the franked distribution under the Restructure?

Answer 2

No

This ruling applies for the following periods:

1 July XXXX to 30 June XXXX

Relevant facts and circumstances

Individual A and Individual B formally separated and are currently in the process of

separating their commercial and financial interests.

Individual A and Individual B each hold 50% of the shares, being ordinary shares, in Company. All of the shares were acquired after 20 September 1985.

Individual A and Individual B are also currently directors of Company

Company has been used as a corporate beneficiary for Individual A and Individual B's family group to fund investment activities.

Company has retained earnings of approximately $X as at 30 June XXXX.

Historically, Company has paid fully franked dividends for several years.

Given Individual A and Individual B's matrimonial breakdown, they have determined that Company is no longer an appropriate long term investment vehicle for their financial affairs.

In separating Individual A and Individual B's financial affairs, Individual A's interest will be managed in the following terms (Restructure):

a)       Individual A incorporated New Company on XXXX. Individual A holds a 100% shareholding in New Company and is its sole director. New Company has nominal assets and no revenue or capital losses.

b)       Individual A will transfer their respective shareholding in Company to New Company. Individual A will not receive any consideration for the respective transfer of shares in Company other than further ordinary shares in New Company. The shares issued to Individual A in New Company will have substantially the same market value as the shares in Company transferred by Individual A. New Company will not be discharging any liabilities with respect to Company shares.

c)       ny will declare and pay its retained earnings as a fully franked dividend to its shareholders (with New Company to receive 50% of the proposed dividend). The dividends declared by Company will be retained in New Company for future investment activities.

d)       Company will be deregistered.

Individual A, Company and New Company are all Australian residents for tax purposes.

Company and New Company are not tax exempt entities.

The shares Company and New Company are held on capital account.

New Company will have a distributable surplus under section 109Y of the ITAA 1936 sufficient to fully cover any loans made by the company and any such loans will be on terms that comply with the requirements of section 109N of the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 122-A

Income Tax Assessment Act 1997 section 122-40

Income Tax Assessment Act 1997 section 122-70

Income Tax Assessment Act 1936 section 177EA

Reasons for decision

Question 1

Summary

Individual A may choose to obtain a roll-over under section 122-15 of the ITAA 1997, as the relevant roll-over requirements will be met where Company shares are transferred to New Company in the manner described in the Restructure.

Pursuant to subsection 124-40(1) of the ITAA 1997, any capital gain arising to Individual A on disposal of Company shares, with respect to the transfer of those shares to New Company, will be disregarded.

Individual A will obtain an aggregated cost base in their shares in New Company equal to their cost base for the shares in Company for the purposes of subsection 124-40(2) of the ITAA 1997.

The first element of the Company share in the hands of New Company is the Company share's cost base when Individual A transferred the Company share to New Company under subsection 122-70(2) of the ITAA 1997.

Detailed reasoning

Capital gains tax roll-over relief

Generally, Subdivision 122-A of the ITAA 1997 allows for the roll-over of a capital gain or loss when an individual or trustee disposes of a capital gains tax (CGT) asset to a company in which, just after the disposal, the individual or trustee owns all the shares.

Disposal or creation of assets - wholly owned company

In order for an individual or trustee to obtain roll-over relief under Subdivision 122-A of the ITAA 1997, the CGT event which triggers the capital gain or loss must be one listed in the table of section 122-15. CGT event A1, being the disposal of a CGT asset, is one of the trigger events listed in the table.

Under subsection 104-10(1) of the ITAA 1997, CGT event A1 happens if you dispose of a CGT asset. Under subsection 104-10(2) you dispose of a CGT asset if a change of ownership occurs from you to another entity. Shares in a company are CGT assets (section 108-5 of the ITAA 1997).

Application in these circumstances

The transfer of Individual A's shares in Company to New Company will trigger CGT event A1 as a change of ownership will occur, effecting a disposal of the shares.

Therefore, the requirement in section 122-15 of the ITAA 1997 is satisfied.

What is received for the trigger event

Under subsection 122-20(1) of the ITAA 1997, the consideration received (if any) for the disposal of the shares must be only shares in the wholly owned company or in addition to shares in the wholly owned company, the company undertaking to discharge any liabilities in respect of the shares.

Section 122-20 of the ITAA 1997 does not require that consideration must be received for the disposal of an asset to a company in order to obtain the roll-over. Rather, it provides that if there is consideration received for the disposal, then that consideration must be either non-redeemable shares in the company or non-redeemable shares in the company and the company's undertaking to discharge any liabilities in respect of the asset (refer to ATO Interpretative Decision ATO ID 2004/94 Income Tax - Capital gains tax: Subdivision 122-A rollover: no consideration received).

Subsection 122-20(2) of the ITAA 1997 requires that the shares received in the wholly owned company cannot be redeemable shares.

Under subsection 122-20(3) of the ITAA 1997, the market value of the shares must be substantially the same as the market value of the shares disposed of, less any liabilities the company undertakes to discharge.

Application in these circumstances

The market value of the further shares in New Company will be substantially the same as the market value of the shares in Company.

Therefore, the requirement in section 122-20 of the ITAA 1997 is satisfied.

Other requirements that must be satisfied

Section 122-25 of the ITAA 1997 lists further requirements that must also be satisfied for roll-over relief to be available under Subdivision 122-A, relevantly being that:

a)       the individual or trustee must own all the shares in the company just after the time of the disposal of their shares to the company - and they must own the shares in the same capacity as they owned or created the assets that the company now owns (subsection 122-25(1))

b)       the disposal of the asset is not one listed in the table in subsection 122-25(2)

c)       rdinary and statutory income of the recipient company must not be exempt from income tax because it is an exempt entity for the income year the roll-over occurs (subsection 122-25(5)), and

d)       the company and individual are Australian residents at the time of disposal (paragraph 122-25(6)(a)).

Application in these circumstances

Individual A will own 100% of the shares in New Company just after the share transfer.

Individual A will own the shares in New Company in the same capacity, i.e. as an individual, as they owned the Company shares. Therefore, the requirement in subsection 122-25(1) of the ITAA 1997 be satisfied.

None of the exceptions in the table in subsection 122-25(2) of the ITAA 1997, which lists certain assets for which the roll-over is not available, apply to these circumstances.

Subsection 122-25(5) of the ITAA 1997 is satisfied as the ordinary or statutory income of New Company will not be exempt from income tax as New Company will not be an exempt entity in the year the roll-over occurs.

The residency requirement under paragraph 122-25(6)(a) of the ITAA 1997 is satisfied as both Individual A and New Company are Australian residents at the time of the share transfer.

Company undertakes to discharge a liability

Section 122-35 of the ITAA 1997 provides additional requirements if a CGT asset has been disposed of and the company has undertaken to discharge a liability in respect of it.

Application in these circumstances

Section 122-35 of the ITAA 1997 does not apply in these circumstances as New Company is not discharging a liability in respect of the Company shares.

Conclusion

The transfer of the Company shares from Individual A to New Company will enable Individual A to roll-over any capital gain or loss as specified in Subdivision 122-A of the ITAA 1997 should they so choose. The choice to obtain roll-over relief under Subdivision 122-A of the ITAA 1997 does not require a specific election. The way in which the income tax return for Individual A is prepared is sufficient evidence of making the choice, pursuant to subsection 103-25(2) of the ITAA 1997.

Consequences if a choice is made to obtain a roll-over

Section 122-40 of the ITAA 1997 sets out the consequences for the transferor where a single CGT asset is transferred to a wholly-owned company and the transferor chooses roll-over relief under Subdivision 122-A.

The capital gain or loss from the transfer of Individual A's Company shares to New Company is disregarded (subsection 122-40(1) of the ITAA 1997).

If the transferred asset is acquired by the transferor on or after 20 September 1985, the first element of the cost base/reduced cost base (as appropriate) of each share received by the transferor as consideration for the asset transfer is the cost base/reduced cost base (as appropriate) of the asset when transferred (less any liabilities the company undertakes to discharge in respect of the asset), divided by the number of shares (subsection 122-40(2) of the ITAA 1997). Broadly, the first element of the cost base of each of Individual A's shares in New Company will be worked out pursuant to paragraph 122-40(2)(a), being the aggregate cost base of Company shares transferred to New Company by Individual A at the time of the transfer, divided by the number of shares issued to Individual A by New Company in exchange. The first element of each of New Company's share's reduced cost base will be worked out similarly (paragraph 122-40(2)(b) of the ITAA 1997).

Section 122-70 of the ITAA 1997 sets out the consequences for the company when an asset is disposed of and the transferor chooses roll-over relief under Subdivision 122-A of the ITAA 1997.

If the transferred asset is acquired by the transferor on or after 20 September 1985, the first element of the cost base/reduced cost base (as appropriate) of each share in the hands of the company is the cost base/reduced cost base (as appropriate) of the asset when the transferor disposes of the asset (subsection 122-70(2) of the ITAA 1997).

The first element of the cost base in the hands of New Company of each of the Company share transferred to New Company by Individual A will equal the cost base of the share at the time Individual A transferred the Company share pursuant to paragraph 122-70(2)(a) of the ITAA 1997.The first element of each of Company share's reduced cost base (in the hands of New Company will equal their reduced cost base at the time of their transfer (paragraph 122-70(2)(b) of the ITAA 1997).

Question 2

Summary

The Commissioner will not exercise his discretion to make a determination pursuant to paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in New Company's franking account in respect of the whole or part of the franked dividend component of the distribution.

Based on the information provided and the qualifications set out in this Ruling, the Commissioner's consideration of all of the relevant circumstances of the scheme would not, on balance, lead to a conclusion that the purpose of enabling participating shareholders to obtain imputation benefits is more than incidental. Relevantly, the same shareholder in Company will own all the shares in New Company (with respect to their 50% shareholding in Company). The imputation benefit will eventually flow through to Individual A, and they will not be receiving an imputation benefit that would not have otherwise been available to them.

Detailed reasoning

Imputation benefits

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes designed to obtain imputation benefits. In essence, it applies to schemes for the disposition of shares or an interest in shares, where a franked distribution is paid or payable in respect of the shares or an interest in shares. The purpose of the section is to protect the imputation system from abuse and ensure that the benefits of the imputation system flow to the economic owners of the share which is the source of the franked distribution.

Subsection 177EA(3) of the ITAA 1936 sets out the circumstances in which 177EA will apply:

a)       there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

b)       either

i)        a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

ii)       nkable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

c)       istribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

d)       except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

e)       having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

Subsection 177EA(14) provides that a scheme for a disposition of membership interests, or an interest in membership interests, involves (but is not limited to) the following:

a)       issuing the membership interests or creating the interest in membership interests;

b)       entering into any contract, arrangement, transaction or dealing that changes or otherwise affects the legal or equitable ownership of the membership interests or interest in membership interests;

c)       ing, varying or revoking a trust in relation to the membership interests or interest in membership interests;

d)       creating, altering or extinguishing a right, power of liability attaching to, or otherwise relating to, the membership interest or interest in the membership interests;

e)       substantially altering any of the risks of loss, or opportunities for profit or gain, involved in holding or owing the membership interests or having the interest in the membership interest;

f)        the membership interests or interests in the membership interests beginning to be included, or ceasing to be included, in any of the insurance funds of a life assurance company.

Application in these circumstances

Under the proposed scheme, Individual A will transfer their ownership interests, being the shares in Company, to New Company (of which they have full control). Company will then pay fully franked dividends to New Company, causing all the assets in Company to pass to New Company, and Company will be wound up.

Under the scheme there is a disposition of membership interests (ownership in the shares of Company pass from Individual A to New Company) in accordance with subsection 177EA(14) of the ITAA 1936, franked distributions will be paid from Company to New Company, the new shareholder, and the franking account of New Company will be credited with the franking credit received from Company (subsection 205-5(2) of the ITAA 1997 provides that the receipt of a franked distribution by an entity from another corporate tax entity will generate a franking credit).

Consequently, the conditions of paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 would be satisfied in respect of the distributions.

Commissioner to determine franking debit or deny franking credit

Where section 177EA of the ITAA 1936 applies, the Commissioner has the discretion to make a determination to debit a company's franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936.

In making the determination, the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17) of the ITAA 1936. The relevant circumstances listed in subsection 177EA(17) of the ITAA 1936 encompass a range of circumstances which, taken individually or collectively, could indicate the requisite purpose.

The relevant circumstances of a scheme include the following:

•       xtent and duration of the risks of loss, and the opportunities for profit or gain, from holding membership interests, or having interests in membership interests, in the corporate tax entity that are respectively borne by or accrue to the parties to the scheme, and whether there has been any change in those risks and opportunities for the relevant taxpayer or any other party to the scheme (for example, a change resulting from the making of any contract, the granting of any option or the entering into of any arrangement with respect to any membership interests, or interests in membership interests, in the corporate tax entity);

•       er the relevant taxpayer would, in the year of income in which the distribution is made, or if the distribution flows indirectly to the relevant taxpayer, in the year in which the distribution flows indirectly to the relevant taxpayer, derive a greater benefit from franking credits than other entities who hold membership interests, or have interests in membership interests, in the corporate tax entity;

•       er, apart from the scheme, the corporate tax entity would have retained the franking credits or exempting credits or would have used the franking credits or exempting credits to pay a franked distribution to another entity referred to in paragraph (b);

•       er, apart from the scheme, a franked distribution would have flowed indirectly to another entity referred to in paragraph (b);

•       e scheme involves the issue of a non-share equity interest to which section 215-10 of the Income Tax Assessment Act 1997 applies - whether the corporate tax entity has issued, or is likely to issue, equity interests in the corporate tax entity:

•       are similar, from a commercial point of view, to the non-share equity interest; and

•       ibutions in respect of which are frankable;

•       er any consideration paid or given by or on behalf of, or received by or on behalf of, the relevant taxpayer in connection with the scheme (for example, the amount of any interest on a loan) was calculated by reference to the imputation benefits to be received by the relevant taxpayer;

•       er a deduction is allowable or a capital loss is incurred in connection with a distribution that is made or that flows indirectly under the scheme;

•       er a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is sourced, directly or indirectly, from unrealised or untaxed profits;

•       er a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is equivalent to the receipt by the relevant taxpayer of interest or of an amount in the nature of, or similar to, interest;

•       eriod for which the relevant taxpayer held membership interests, or had an interest in membership interests, in the corporate tax entity;

•       f the matters referred to in subsection 177D(2).

Application to these circumstances

The circumstances giving rise to the proposed scheme is the separation of Individual A and Individual B from a matrimonial relationship. Company is currently an investment vehicle for Individual A and Individual B who both own shares in Company and have equal control of the company.

Individual A and Individual B want to separate their financial affairs. Individual A wishes to maintain their investment in a corporate structure. To achieve this, Individual A has set up a separate company of which they have sole control. Following payment of the fully franked dividend by Company, it will be wound up and Individual A will continue with their investment activities from New Company.

The Explanatory Memorandum to the Taxation Law Amendment Bill (No.3) 1998 which inserted section 177EA states the following explanation about the dividend imputation system:

One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process transferring the franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax exempts) to others who can fully use them undermines the principle. Similarly, dividend streaming (ie. the streaming of franking credits to select shareholders undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings (paragraph 8.124).

Under the scheme, there is no change in the individual that would obtain the benefit in the franking credits (as it relates to Individual A's 50% interest in Company). The transfer of shares in Company to New Company to facilitate the separation of the assets of Individual A and Individual B, and the ongoing investment of Individual A's share in the assets (as it relates to the retaining earnings) in a corporate structure. The scheme will cause franking credits to transfer between corporate entities but ultimately the same individual (Individual A) controls the corporate entities (through their joint ownership of Company and sole ownership of New Company and will be required to pay top-up tax on any franked distribution from Company. The arrangement defers Individual A's entitlement to franking credits but does not change their ultimate entitlement to the franking credits (as sole shareholder the franking credit of New Company will pass through to Individual A). The scheme does not cause the risk owners (relevantly, Individual A) to receive a greater or lesser imputation benefit.

The circumstances of the scheme show that while the scheme will give rise to imputation benefits, in the form of franking credits for New Company that will receive dividends from Company, it is considered that obtaining those imputation benefits will merely be an incidental purpose of each of the entities that will enter into or carry out the scheme.

The proposed restructure involving the distributions is not being carried out for a more than incidental purpose of enabling taxpayers to obtain an imputation benefit. As a result, and having regard to the relevant circumstances of the scheme, the five conditions in 177EA(3) of the ITAA 1936 have not been satisfied and section 177EA of the ITAA 1936 will not apply to any fully franked distribution under the proposed restructure.

Where section 177EA of the ITAA 1936 does not apply, the Commissioner does not have discretion to make a determination to debit a corporate tax entity's franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936. Nor does the Commissioner have the discretion under paragraph 177EA(5)(b) of the ITAA 1936 to deny the whole, or part, of the imputation benefits received in relation to the dividend.

Therefore, in this case, the Commissioner will not be empowered to use his discretion in such a way as to debit the New Company's franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936. Nor will the Commissioner be empowered to make a determination under paragraph 177EA(5)(b) to deny the whole, or part, of the imputation benefits received in relation to the dividend in these circumstances.

Note: the Commissioner has not considered the potential application of section 177E of the ITAA 1936 to the proposed arrangement.