Edited version of private advice

Authorisation Number: 1052364298866

Date of advice: 26 February 2025

Ruling

Subject: CGT event and relief

Question 1

In respect of XXXXX (ACo1) shareholding in Foreign Co Incorporated (ForeignCo), will CGT event C2 happen on XX date pursuant to subsection 104-25(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Does the proposed written declaration to be made by the Foreign Lawyer, being a lawyer employed by ABC Firm (Foreign Lawyer), who facilitated the dissolution of ForeignCo (Proposed Declaration) constitute a valid declaration for the purposes of section 104-145 of the ITAA 1997?

Answer

No.

Question 3

If the answer to question 1 is 'yes', will the active foreign business asset percentage (AFBAP) of ForeignCo, when CGT event C2 happens on XX date, be zero where the AFBAP is worked out by following the method set out in either section 768-520 or section 768-525 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period

Year ending 30 June 20XX

The scheme commenced on

1 January 20XX

Relevant facts and circumstances

Background

1. ACo1 is an Australian public company and resident of Australia for tax purposes.

2. ACo1 is the head company of the ACo1 tax consolidated group (ACo1 Group).

Foreign Co

3.  TheACo1 Group incorporated ForeignCo on YY date.

4.  ForeignCo is a company incorporated in XXX (Foreign Country). The Certificate of Incorporation in Foreign Country was filed on YY date.

5.  ForeignCo is a non-resident of Australia for tax purposes within the meaning in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

6.  TheACo1 Group holds X% of the shares in ForeignCo via XXX Pty Ltd (Sub1Co), a wholly owned Australian subsidiary company. The remaining Y% of shares are held by a third party.

7.  Sub1Co holds the shares in ForeignCo on capital account.

8.  Sub1Co subscribed for a total of $XX million of equity in ForeignCo.

9.  The primary purpose of ForeignCo was to conduct market trials in the Foreign Country, via physical store locations and online sales, for the sale of A Group products. A related purpose was to develop and trial supply chain technology.

10.  A number of 'pop-up' ForeignCo stores were opened and operated in Foreign Country from late 20XX to test e-commerce capabilities and the market for A Group products.

11.  The unforeseen onset of the COVID pandemic began to negatively impact the trial in early 20XX, which led to a decision in mid-20XX to end the stores market trial aspect of the business. Some activity continued in 20XX in relation to supply chain technology.

12.  In late 20XX, the retail technology development work ended, and the decision was made to wind down all Foreign Country operations.

13.  Wind-down and closure activity continued in 20XX, including the decision to dissolve ForeignCo and engage the Foreign Lawyer to act as lawyer for the company and to manage the dissolution of the company.

14.  Pursuant to the Corporation Law of Foreign Country (Foreign Law), ForeignCo was authorised by the directors of the company to be dissolved.

15.  On AA date in 20XX, a Certificate of Dissolution was issued.

16.  On BB date in 20XX, the Foreign Country Department responsible for corporations certified the Certificate of Dissolution.

17.  As at CC date in 20XX, ForeignCo had $XX cash at bank, which was paid to Sub1Co as a return of capital on DD date in 20XX.

18.  ForeignCo had no assets remaining as at DD date following the return of capital.

19. ACo1's anticipated capital loss in relation to the ForeignCo shares is $X million, being the $X million equity investment less the $XX cash return of capital.

20. ACo1 will make a choice to apply either the Market Value method or Book Value method to determine the AFBAP of ForeignCo in accordance with subsection 768-515(3) of the ITAA 1997.

Foreign Lawyer

21.  The Foreign Lawyer was engaged by ForeignCo via the XXX Advisor (XYAd). The Foreign Lawyer was not directly engaged by ForeignCo.

22.  The Foreign Lawyer does not have a written engagement letter with ForeignCo or XYAd. However, the scope of the engagement was outlined to the Commissioner as:

(i)          assist in the incorporation of ForeignCo in Foreign Country, including preparing and filing certificate of incorporation, preparing organisation resolutions and certificates, preparing bylaws;

(ii)          provide annual corporate legal support to ForeignCo, including periodic filings with relevant department, preparation of board and stockholder resolutions, as needed, and general corporate law advice, when requested; and

(iii)          assist in the dissolution of ForeignCo, including preparation of resolutions and dissolution certificates, preparation and filing dissolution with Foreign Country.

23.  The Foreign Lawyer was not appointed under section ZZ of the Foreign Law.

Other matters

24.  ForeignCo will not commence trading or undertake any activities, other than to finalise its dissolution, between the date of this ruling and XX date.

25.  The Foreign Court will not extend ForeignCo's dissolution period beyond Q years.

26.  Foreign Co will not acquire any assets between the date of this ruling and XX date.

27. & If ACo1 chooses to apply section 768-525 of the ITAA 1997 to calculate the AFBAP of ForeignCo, ForeignCo has and will continue to have recognised company accounts between the date of this ruling and XX date.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-25(2)

Income Tax Assessment Act 1997 section 104-145

Income Tax Assessment Act 1997 section 768-520

Income Tax Assessment Act 1997 section 768-525

Does IVA apply to this private ruling?

Part IVA was not considered as part of this private ruling.

Reasons for decision

Question 1

Summary

In relation to ACo1's shareholding in ForeignCo, CGT event C2 will happen on XX date pursuant to subsection 104-25(2) of the ITAA 1997.

Detailed reasoning

Section 104-25 of the ITAA 1997 states:

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

(a)        being redeemed or cancelled; or

       ...

(2)          The time of the event is:

(a)        when you enter into the contract that results in the asset ending; or

(b)        if there is no contract - when the asset ends.

Subsection 108-5(1) of the ITAA 1997 states 'a CGT asset is: (a) any kind of property' and Note 1 to section 108-5 of the ITAA 1997 provides that an example of a CGT asset is shares in a company.

Accordingly, the shares held by ACo1 in ForeignCo are a CGT asset for the purposes of subsection 108-5(1) of the ITAA 1997.

As there was no contract that resulted in the shares in ForeignCo ending, the time of the CGT event is when the shares in ForeignCo end.

As ForeignCo is a company, the shares in ForeignCo end when ForeignCo ceases to exist by virtue of the shares being cancelled. Therefore, the timing of CGT event C2 under paragraph 104-25(1)(a) of the ITAA 1997 is when ForeignCo ceases to exist.

Taxation Determination TD 2000/7 Income tax: capital gains: when does a CGT event happen to shares in a company, for the purposes of Part 3-1 and Part 3-3 of the Income Tax Assessment Act 1997, if the company is deregistered under the Corporations Law? (TD 2000/7) contains the Commissioner's view on when a CGT event happens with respect to shares in a company for the purposes of Part 3-1 of the ITAA 1997. Relevantly, TD 2000/7 states at paragraph 1:

A CGT event happens for the purposes of Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 ('the 1997 Act'), when the company is deregistered in accordance with the Corporations Law ('C Law'). A company ceases to exist on deregistration.

Section 601AA of the Corporations Act 2001 (Cth)(Corporations Act) contains the provisions concerning voluntary deregistration of Australian companies and states:

Who may apply for deregistration

(1)          An application to deregister a company may be lodged with ASIC by:

(a)        the company; or

(b)        a director or member of the company; or

(c)        a liquidator of the company.

If the company lodges the application, it must nominate a person to be given notice of the deregistration.

Circumstances in which application can be made

(2)          A person may apply only if:

(a)        all the members of the company agree to the deregistration; and

(b)        the company is not carrying on business; and

(c)        the company's assets are worth less than $1,000; and

(d)        the company has paid all fees and penalties payable under this Act; and

(e)        the company has no outstanding liabilities; and

(f)        the company is not a party to any legal proceedings.

...

Deregistration procedure

(4)          If:

(a)        ASIC decides to deregister the company under this section; and

(b)        ASIC is not aware of any failure to comply with subsections (1) to (3);

ASIC must:

(c)        give notice of the proposed deregistration on ASIC database; and

(d)        publish notice of the proposed deregistration in the prescribed manner.

(4A)          When 2 months have passed since the publication of the notice under paragraph (4)(d), ASIC may deregister the company.

With respect to Australian companies that are voluntarily wound up and deregistered, TD 2000/7 states at paragraphs 4 and 5:

Deregistration following amalgamation or winding up

         ...

4.          If a company is wound up voluntarily, it is deregistered three months after the liquidator lodges a return of the holding of the final meeting of members and creditors (subsection 509(5) of the C Law) or on such other date as a Court, by order, specifies (subsection 509(6) of the C Law). A CGT event (usually CGT event C2 in section 104-25 of the 1997 Act) happens to the members' shares for the purposes of Parts 3-1 and 3-3 of the 1997 Act, either 3 months after the return is lodged or on the date specified in the Court order, subsections 509(5) and (6).

Deregistration that is voluntary

5.          If the ASIC decides on an application being made in accordance with subsection 601AA(1) of the C Law to deregister a company and publishes a notice to this effect in the Commonwealth of Australia Gazette ('Gazette'), it may deregister the company when 2 months have passed since the Gazette notice. We take the view that a CGT event (usually CGT event C2 in section 104-25 of the 1997 Act) happens in respect of a member's shares, for the purposes of Parts 3-1 and 3-3 of the 1997 Act, when the company is deregistered in accordance with subsection 601AA(4) of the C Law.

In both of the above scenarios, the Commissioner is of the view that CGT event C2 happens, in respect of a shareholder's shares in a company following its winding up, on the date the company is deregistered by the Australian Securities and Investment Commission (ASIC). That is, after the liquidation or deregistration process and the requisite notification period.

ForeignCo is a company incorporated in Foreign Country and therefore not governed by the Corporations Act or ASIC. Accordingly, it is necessary to consider the application of the Foreign Corporations (Application of Laws) Act 1989 (Cth)(Foreign Corporations Act), which outlines how the law is to be applied in determining certain questions relating to foreign corporations.

Section 7 of the Foreign Corporations Act states:

Law applied in place of incorporation applicable law in determining questions relating to status of foreign corporations etc.

(1)          This section applies in relation to the determination of a question arising under Australian law (including a question arising in a proceeding in an Australian court) where it is necessary to determine the question by reference to a system of law other than Australian law.

         ...

(3)          Any question relating to:

(a)        the status of a foreign corporation (including its identity as a legal entity and its legal capacity and powers); or

(b)        the membership of a foreign corporation; or

(c)        the shareholders of a foreign corporation having a share capital; or

(d)        the officers of a foreign corporation; or

(e)        the rights and liabilities of the members or officers of a foreign corporation, or the shareholders of a foreign corporation having a share capital, in relation to the corporation;

(f)        the existence, nature or extent of any other interest in a foreign corporation; or

(g)        the internal management and proceedings of a foreign corporation; or

(h)        the validity of a foreign corporation's dealings otherwise than with outsiders;

is to be determined by reference to the law applied by the people in the place in which the foreign corporation was incorporated.

As ForeignCo was incorporated in Foreign Country, it is considered a 'foreign corporation' as defined in section 3 of the Foreign Corporations Act.

The time of CGT event C2 under subsection 104-25(2) of the ITAA 1997 is 'the determination of a question arising under Australian law... where it is necessary to determine the question by reference to a system of law other than Australian law' as required by subsection 7(1) of the Foreign Corporations Act.

Whether a foreign corporation exists at a particular time is a question relating to 'the status of a foreign corporation' within the meaning of paragraph 7(3)(a) of the Foreign Corporations Act.

Therefore, subsection 7(3) of the Foreign Corporations Act requires the Commissioner to determine the point at which ForeignCo is deregistered by reference to the law applied by the people in the place in which ForeignCo was incorporated, being Foreign Country.

Section XX of the Foreign Law contains the general dissolution procedures for companies incorporated in Foreign Country and provides that a company shall be dissolved when a certificate of dissolution is filed in accordance with the Foreign Law. However, section YY of the Foreign Law provides that companies continue to exist for a period of Q years after dissolution for purposes which include winding up all activities.

The effect of section YY of the Foreign Law is that a company that has been dissolved under section XX of the Foreign Law continues to exist for a period of Q years to enable it to fulfil specific purposes. Such specific purposes include but are not limited to, the company distributing any remaining assets to its shareholders. Relevantly, shareholders will continue to hold their shares and can still receive benefits in their capacity as shareholders during the post-dissolution Q-year period.

Accordingly, it is considered that the date on which a company actually ceases to exist is at the end of the Q-year period, with that being the relevant date on which a shareholder ceases to hold shares.

Whilst ForeignCo was dissolved on BB date in 20XX under section XX of the Foreign Law, ForeignCo will continue to exist in accordance with section YY of the Foreign Law for a period of Q years, in the absence of the Foreign Court otherwise extending that period, until XX date.

Accordingly, ACo1 will continue to be a shareholder of ForeignCo until XX date, at which point its shares in ForeignCo will be cancelled upon ForeignCo ceasing to exist.

Therefore, in relation to ACo1's shareholding in ForeignCo, CGT event C2 will happen on XX date under subsection 104-25(2) of the ITAA 1997.

Question 2

Summary

The Proposed Declaration does not constitute a valid declaration for the purposes of section 104-145 of the ITAA 1997.

Detailed reasoning

Section 104-145 of the ITAA 1997 outlines when CGT event G3 occurs and provides a mechanism for a shareholder to make a capital loss on worthless shares in a company before the time of deregistration.

Subsections 104-145(1) and (2) of the ITAA 1997 state:

(1)          CGT event G3 happens if you own shares in a company, or financial instruments used by or created by or in relation to a company, and a liquidator or administrator of the company declares in writing that the liquidator or administrator has reasonable grounds to believe (as at the time of the declaration) that:

(a)          for shares - there is no likelihood that shareholders in the company, or shareholders of the relevant class of shares, will receive any further distribution for their shares; or

(b)          for financial instruments - the instruments, or a class of instruments that includes instruments of that kind, have no value or have only negligible value.

(2)          The time of the event is when the declaration was made.

With respect to shares in a company, CGT event G3 therefore happens when a liquidator or administrator of the company makes a written declaration that there is no likelihood that shareholders in the company will receive any further distribution for their shares.

The Explanatory Memorandum to the Tax Laws Amendment (2004 Measures No. 6) Bill 2004 (G3 EM) discusses the most recent amendments to section 104-145 of the ITAA 1997, which expanded the scope of the provision from declarations made by liquidators only, to declarations made by administrators as well.

Paragraph 8.1 contains the chapter outline and states:

Schedule 8 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to extend the scope of CGT event G3 so that an administrator (in addition to a liquidator) of a company can declare shares and financial instruments in the company to be worthless for capital gains tax (CGT) purposes. The declaration permits taxpayers who hold those shares or financial instruments to choose to make a capital loss.

Further context for the amendments provides reasons for the scope of the provision extending to declarations made by administrators, and states at paragraphs 8.4 and 8.5:

8.4 In addition, commercial factors may cause a company to appoint an administrator (rather than a liquidator) to conduct external administration proceedings. An administrator is unable to make a declaration that causes CGT event G3 to happen even though he or she may be in a similar position to a liquidator to make judgement that shares or financial instruments in the company are worthless.

8.5 Therefore, the amendments will allow administrators to make a declaration that causes CGT event G3 to happen and allow the declaration to cover both shares and financial instruments. This will reduce compliance costs for affected taxpayers and allow them to more easily claim a capital loss in respect of their shares or financial instruments.

The policy objective is outlined at paragraph 8.29, which states the 'objective is to allow taxpayers to more easily claim a capital loss on their worthless shares or financial instruments.'

The implementation options are outlined at paragraphs 8.30 and 8.31:

8.30 Given the framework for CGT event G3 and the nature of the representations from taxpayers, only one broad implementation approach was considered. That is, to amend section 104-145 to allow a wider range of insolvency practitioners to be able to make the relevant declaration in relation to shares or financial instruments.

8.31 However, insolvency practitioners other than administrators and liquidators are often appointed for a short period of time or for a specific purpose and are not usually in a position to make a declaration. As a result, it was considered that it would not be viable for practitioners other than administrators and liquidators to make the declaration, so only the option of allowing administrators and liquidators to be able to make the relevant declaration has been considered further.

Relevantly, paragraph 8.42 states:

Stakeholders generally supported the proposed measure. Some stakeholders suggested that a wider range of insolvency practitioners should be able to make a declaration, but this was not considered to be practical for the reasons indicated earlier.

Accordingly, only a liquidator or an administrator can make a declaration for section 104-145 of the ITAA 1997 purposes. The provision specifically does not extend to other practitioners, which prima facie precludes the Foreign Lawyer. Accordingly, whether the Proposed Declaration is valid depends on the Foreign Lawyer being a 'liquidator' or 'administrator' within the meaning of the terms as intended by the provision.

The terms 'liquidator' and 'administrator' are not defined in the ITAA 1997. Whilst 'liquidator' is defined in section 6 of the ITAA 1936 as 'the person who, whether or not appointed as liquidator, is the person required by law to carry out the winding-up of a company', this definition is precluded from applying to the ITAA 1997 by the operation of subsection 6(1AA) of the ITAA 1936.

The High Court stated in Aubrey v R [2017] HCA 18 at [34]:

...in cases where words used in an Act have acquired a legal meaning prior to enactment, it may be presumed that the legislature intends them to have that meaning unless a contrary intention appears from the context.

Accordingly, the definitions of liquidator and administrator in the Corporations Act should be presumed to apply to the ITAA 1997. Further, the G3 EM provides some guidance on how the terms are to be interpreted and states at paragraphs 8.10 and 8.11:

8.10 A liquidator is appointed under Chapter 5 of the Corporations Act 2001 to wind up a company.

8.11 An administrator is appointed under Part 5.3A of the Corporations Act 2001 to conduct external administration proceedings. An administrator of a company would require a comprehensive grasp of all of the company's affairs in order to have reasonable grounds to make a declaration for the purposes of CGT event G3. Generally only an administrator appointed in relation to a deed of company arrangement will be in a position to reasonably make this assessment.

Chapter 5 of the Corporations Act concerns external administration. Accordingly, only liquidators and administrators that are appointed to undertake an external administration of a company are capable of making a determination for section 104-145 of the ITAA 1997 purposes. This is arguably suggesting that liquidators and administrators that have not been 'appointed' or have been engaged otherwise than to undertake an external administration are not considered capable of making a declaration for section 104-145 of the ITAA 1997 purposes.

Under sections XX and YY of the Foreign Law, as referred to above under Question 1 of this Ruling, no one is 'appointed' to wind up the company. Rather, the company (through its directors and management) winds up itself.

Whilst section ZZ of the Foreign Law does provide a mechanism for a trustee or receiver to be appointed to dissolve a company, the Foreign Lawyer was not appointed under such provision.

In this instance, the Foreign Lawyer has been engaged by ForeignCo to assist with dissolving the company. Critically, the Foreign Lawyer has not been 'appointed'. In that regard, the Foreign Lawyer cannot be an 'appointed liquidator' or 'appointed administrator' and is not capable of making a valid declaration under section 104-145 of the ITAA 1997.

Question 3

Summary

The AFBAP of ForeignCo will be zero at the time of CGT event C2 on XX date where the AFBAP is worked out using one of either methods in sections 768-520 or 768-525 of the ITAA 1997.

Detailed reasoning

In certain circumstances, Subdivision 768-G of the ITAA 1997 applies to reduce the capital gain or capital loss a company makes from specified CGT events happening to shares in a foreign company to the extent that the foreign company has an underlying active business.

Section 768-500 of the ITAA 1997 outlines what the subdivision is about and states:

If:

(a)          a company has a capital gain or capital loss arising from a CGT event that happens in relation to a share in a foreign company; and

(b)          the company holds a direct voting percentage of 10% or more in the foreign company for a certain period before the CGT event happens;

the gain or loss is reduced by a percentage that reflects the degree to which the assets of the foreign company are used in an active business.

Section 768-505 of the ITAA 1997 contains the operative provisions and 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, B1, C2, E1, E2, G3, J1, K4, K6, K10 or K11.

(2)          The gain or loss is reduced by the active foreign business asset percentage (see sections 768-510, 568-530 and 768-535) of the foreign disposal company in relation to the holding company at the time of the CGT event.

The AFBAP is intended to reflect the degree to which the assets of the foreign subsidiary company are used in an active business. The AFBAP is worked out in accordance with section 768-510 of the ITAA 1997, which states:

(1)          Theactive foreign business asset percentage of a company (the foreign company) that is a foreign resident, in relation to the holding company mentioned in section 768-505, at the time of the CGT event mentioned in that section, is worked out in accordance with this section.

Market value method

(2)          Work out that percentage under section 768-520 if:

(a)        the holding company has made a choice under subsection 768-515(1) in relation to the foreign company for that time; and

(b)        there is sufficient evidence of the market value at that time of:

(i)       all assets included in the total assets of the foreign company at that time; and

(ii)       all active foreign business assets of the foreign company at that time.

Book value method

(3)          Work out that percentage under section 768-525 if:

(a)        the holding company has made a choice under subsection 768-515(2) in relation to the foreign company for that time; and

(b)        there are recognised company accounts of the foreign company for a period that ends no later than that time, but no more than 12 months before that time; and

(c)        if the foreign company was in existence before the start of the period mentioned in paragraph (b) - there are recognised company accounts of the foreign company for a period that ends at least 6 months, but no more than 18 months, before the end of the period mention in paragraph (b).

Default method

(4)          Otherwise, that percentage is:

(a)        100% (if this section is being applied for the purposes of section 767-505 to reduce a capital loss of the holding company); or

(b)        zero (in any other case).

Section 768-515 of the ITAA 1997 provides that a choice must be made to apply either the Market Value or Book Value methods and states:

Choice for market value method

(1)          The holding company may choose to work out the active foreign business asset percentage of the foreign company for the time of the CGT event under section 768-520.

Choice for book value method

(2)          The holding company may choose to work out the active foreign business asset percentage of the foreign company for the time of the CGT event under section 768-525.

Method of making choice

(3)          The way an entity making a choice under subsection (1) or (2) prepares its income tax return is sufficient evidence of the making of the choice.

Note: If an entity does not make a choice under subsection (1) or (2), it will work out the active foreign business asset percentage of the foreign company in accordance with the default method in subsection 768-510(4).

To summarise, if an entity does not make a choice to apply either the Market Value or Book Value methods, the Default method will automatically apply. As ACo1 intends to make a choice to apply one of either the Market Value or Book Value methods, the AFBAP of ForeignCo will be considered under both methods below.

Market Value method

Subsection 768-520(1) of the ITAA 1997 contains the method statement for working out the AFBAP under the Market Value method and states:

The active foreign business asset percentage of the foreign company in relation to the holding company, at the time of the CGT event, is worked out under this section in this way.

Method statement

Step 1.

Work out the market value at the time of all assets included in the total assets of the foreign company at that time.

Step 2.

Work out the market value (see subsection (2)) at that time of all active foreign business assets of the foreign company at that time.

Step 3.

Divide the result of step 2 by the result of step 1.

Step 4.

Express the result of step 3 as a percentage, and round that percentage to the nearest whole percentage point (rounding a number ending in.5 upwards).

Step 5.

The active foreign business asset percentage is:

(a)          if the result of step 4 is less than 10% - zero; or

(b)        if the result of step 4 is 10% or more, but less than 90% - that result; or

(c)        if the result of step 4 is 90% or more - 100%.

...

'Market value' is defined in subsection 995-1(1) of the ITAA 1997 as 'has a meaning affected by Subdivision 960-S.'

Section 960-400 of the ITAA 1997 states 'The expression "market value" is often used in this Act with its ordinary meaning. However, in some cases that expression has a meaning affected by this Subdivision...'

'Active foreign business asset' is defined in subsection 995-1(1) of the ITAA 1997 as 'has the meaning given by section 768-540.'

Section 768-540 of the ITAA 1997 states:

(1)          An asset is, at a particular time, an active foreign business asset of a company (the foreign company) that is a foreign resident if, at that time:

(a)        the asset is an asset included in the total assets of the company; and

(b)        the asset satisfies any of these conditions:

(i)       the asset is used, or held ready for use, by the company in the course of carrying on a business;

(ii)       the asset is goodwill;

(iii)      the asset is a share; and

(c)          the asset is not any of the following:

(i)        taxable Australian property;

(ii)        a membership interest in a company that is an Australian resident;

(iii)        a membership interest in a resident trust for CGT purposes;

(iv)        an option or right to acquire a membership interest mentioned in subparagraph (ii) or (iii); and

...

As determined under Question 1 of this ruling, CGT event C2 will happen in relation to ACo1's shareholding in ForeignCo on XX date pursuant to subsection 104-25(2) of the ITAA 1997.

Accordingly, XX date is the relevant time for working out the AFBAP of ForeignCo and the method statement in subsection 768-520(1) of the ITAA 1997 applies as follows:

Step 1

ForeignCo had no assets as at DD date and it is assumed that ForeignCo will not acquire any assets between February 20YY and XX date.

On that basis, the market value of all the assets of ForeignCo at the time of CGT event C2 will be zero.

Step 2

As ForeignCo will have no assets as at XX date, it cannot have any active foreign business assets.

Accordingly, the market value of ForeignCo's active foreign business assets will be zero at the time of CGT event C2.

Step 3

Step 3 of the method statement requires the result of step 2, being zero, to be divided by the result of step 1, being zero.

The result is 0/0, which technically produces an undefined number as it is not mathematically possible to divide a number by zero.

Step 4

Step 4 requires the result of Step 3 to be expressed as a percentage, which is not technically possible in this instance as Step 3 produced an undefined number which cannot be expressed as a percentage.

Step 5

As the result of Step 3 cannot be expressed as a percentage for the purposes of Step 4, it follows that there is no 'result' for the purposes of Step 5, which states the AFBAP is:

(a)          if the result of step 4 is less than 10% - zero, or

(b)          if the result of step 4 is 10% or more, bust less than 90% - that result, or

(c)          if the result of step 4 is 90% or more - 100%.

The result of the above gives rise to the question of whether the Market Value method is available to work out the AFBAP of a foreign company that has no assets at the time of the relevant CGT event, and if it is, the secondary question of what the AFBAP would be where the result of Step 3 in the method statement produces an undefined number.

Subdivision 768-G of the ITAA 1997 and the Explanatory Memorandum to the New International Tax Arrangements (Participation Exemption and Other Measures) Bill 2004 (AFBAP EM) are both silent on how the Market Value method is intended to apply if there are no assets. This is arguably suggesting the legislature either did not turn its mind to the possibility that the market value of a company's assets might be nil or that there would be an undefined number under Step 3.

Section 15AA of the Acts Interpretation Act 1901 states:

In interpreting a provision of an Act, the interpretation that would best achieve the purpose or object of the Act (whether or not that purpose or object is expressly stated in the Act) is to be preferred to each other interpretation.

The majority of the High Court in CIC Insurance Ltd v Bankstown Football Club Ltd (1997) 187 CLR 384 defined the modern approach to statutory interpretation, stating at 408:

Moreover, the modern approach to statutory interpretation (a) insists that the context be considered in the first instance, not merely at some later stage when ambiguity might be thought to arise, and (b) uses 'context' in its widest sense to include such things as the existing state of the law and the mischief which, by legitimate means such as those just mentioned, one may discern the statute was intended to remedy.

Earlier, in Cooper Brookes (Wollongong) Pty Ltd v Commissioner of Taxation (1981)147 CLR 297, the High Court said at 320:

Generally speaking, mere inconvenience of result in itself is not a ground for departing from the natural and ordinary sense of the language read in its context. But there are cases in which inconvenience of result or improbability of result assists the court in concluding that an alternative construction which is reasonably open is to be preferred to the literal meaning because the alternative interpretation more closely conforms to the legislative intent discernible from other provisions in the statute.

Further in Project Blue Sky Inc v Australian Broadcasting Authority [1998] HCA 28 the High Court said at [78]:

[T]he duty of a court is to give the words of a statutory provision the meaning that the legislature is taken to have intended them to have. Ordinarily, that meaning (the legal meaning) will correspond with the grammatical meaning of the provision. But not always. The context of the words, the consequences of a literal or grammatical construction, the purpose of the statute or the canons of construction may require the words of a legislative provision be read in a way that does not correspond with the literal or grammatical meaning.

Therefore, it is necessary and proper to consider the context and legislative purpose of Subdivision 768-G of the ITAA 1997 in order to determine whether the Market Value method is intended to apply to foreign companies that have no assets, and what the legislature intended the AFBAP to be in such circumstances.

Paragraphs 1.51 and 1.52 of the AFBAP EM state:

1.51 The concept of active foreign business asset percentage has been developed to determine the extent to which the foreign company carries on an active business.

1.52 An assessment of the nature of the assets held by a foreign company is considered to be the most practical representation of the extent to which that company is carrying on an active business. An underlying assumption of this measure is therefore that the assets characterised as active for the purpose of calculating the active foreign business asset percentage are used by the company in carrying on an active business.

The AFBAP EM further states at paragraph 1.57:

1.57 Where the active foreign business asset percentage is less than 10%, all capital gains arising from certain CGT events happening to an eligible interest in a foreign company will be taxable. Similarly, all capital losses that arise from those CGT events happening to an eligible interest in a foreign company will be available to be deducted from any other capital gains or carried forward to be used against future capital gains. The main reason for the threshold at the lower end is that the situation where the overwhelming majority of the company's assets are not active is taken to be reflective of the fact that the business being carried on by the company is itself not of a sufficiently active nature to warrant application of this measure.

Whilst the above paragraph does not explicitly refer to the situation where a foreign company has no assets, it does cater for the situation where the overwhelming majority of a company's assets are not active, in which case the measure should not apply to reduce the capital loss.

The above explains that the intention is to determine the extent to which assets of the company are used in an active business and that this is based on the nature of the assets held. Based on that measure, if a foreign company does not have any assets at the time of the relevant CGT event, it cannot be said to have an active business to any extent. This is true even though it is not carrying on any non-active business either. The provisions do not focus on the extent to which there is a non-active business. Therefore, consistent with the intentions of the provisions, the AFBAP should be 0%.

In the context of the Method Statement in section 768-520 of the ITAA 1997, this means that if the dividend (numerator) under Step 3 is zero, the result should be zero, regardless of whether the divisor (denominator) is also zero. This accords with the result of dividing zero by any other number and is an interpretation that more closely conforms to the legislative purpose and avoids the irrational outcome of an undefined AFBAP.

InCommissioner of Taxation v Douglas [2020] FCAFC 220 at [90-91], the Full Federal Court stated, with reference to Taylor v The Owners - Strata Plan No 11564 [2014] HCA 9; 253 CLR 531 and Kingston v Keprose Pty Ltd (1987) 11 NSWLR 404:

90. If the target of a legislative provision is clear, the court's duty is to ensure that it is hit rather than to record that it has been missed.

91. Once the object or purpose of the legislation is delineated, the duty of the Court is to give effect to it in so far as, by addition or omission or clarification, the relevant provision is capable of achieving that purpose or object. Where the court can see the purpose of a provision from an examination of its terms, little difficulty should be met in giving effect to that purpose. The days are gone when judges, having identified the purpose of a particular statutory provision, can legitimately say..."The legislature has plainly missed fire"... "if... the Courts can identify the target of Parliamentary legislation their proper function is to see that it is hit: not merely to record that it has been missed".

Paragraphs 1,13, 1.63, 1.101 and 1.102 of the AFBAP EM also support this view by stating that where the choice is made to apply the Market Value or Book Value methods and the particular criteria are met, the Default method is not intended to apply:

1.13 Where the taxpayer is unable to, or chooses not to, apply either the market value or book value method to calculate the active foreign business asset percentage of a foreign company, the taxpayer will be required to apply a default rule. Under the default rule, the result is that all of a loss is disregarded where a capital loss has arisen on the happening of the CGT event, or none of a gain is disregarded where a capital gain has arisen.

...

1.63 The default active foreign business asset percentage, or third choice, is made by:

•                    not making the formal choice to apply book or market valuations; or

•                    formally choosing book or market valuation but not satisfying the particular criteria for using the chosen method.

...

1.101 It is intended that the default method will apply in the cases where, for example:

•                    taxpayers cannot get access to appropriate financial information in relation to a foreign company to use either the market value or the book value method; or

•                    the taxpayer does not make a choice to use either the book or market value method and is unwilling to incur compliance costs in relation to a foreign company (e.g. where the capital gain or loss that arises from the relevant CGT event happening is small).

1.102 The default rule has been included as an incentive for taxpayers to take all reasonable steps to use either the market value method or the book value method. In particular, the default rule is an integrity measure that aims to prevent a company that has made a capital loss under this measure from gaining a benefit just because it has chosen not to calculate the active foreign business asset percentage.

The above paragraphs confirm that where the Market Value method is not able to be applied, the Default Method will apply and result in a capital loss being completely disregarded.

It is highly unlikely the legislature intended for the Market Value method to be unavailable where a foreign company has no assets, with the corresponding result being that the Default Method applies. Such a result would lead to a company having to fully disregard a capital loss, rather than fully utilising the capital loss which would otherwise be consistent with the object of Subdivision 768-G of the ITAA 1997.

Therefore, it is the Commissioner's view that the Market Value method can be used, where ACo1 makes a choice under subsection 768-515(1) of the ITAA 1997 and has sufficient evidence of the market value of ForeignCo's assets at the time of CGT event C2 happening, and that ForeignCo's AFBAP will be 0%.

Book Value method

Subsection 768-525(1) of the ITAA 1997 contains the method statement for working out the AFBAP under the Book Value method and states:

The active foreign business asset percentage of the foreign company in relation to the holding company, at the time of the CGT event, is worked out under this section in this way.

Method statement

Step 1.

Work out the foreign company's average value of total assets at that time under subsection (2).

Step 2.

Work out the foreign company's average value of active foreign business assets at that time under subsection (3).

Step 3.

Divide the result of step 2 by the result of step 1.

Step 4.

Express the result of step 3 as a percentage, and round that percentage to the nearest whole percentage point (rounding a number ending in.5 upwards).

Step 5.

The active foreign business asset percentage is:

(a)          if the result of step 4 is less than 10% - zero; or

(b)          if the result of step 4 is 10% or more, but less than 90% - that result; or

(c)          if the result of step 4 is 90% or more - 100%.

...

The method statement in subsection 768-525(1) of the ITAA 1997 applies as follows:

Step 1

The average value of ForeignCo's total assets is determined in accordance with the method statement in subsection 768-525(2) of the ITAA 1997, which states:

The foreign company's average value of total assets at the time of the CGT event is worked out in this way.

Method statement

Step 1.

Work out the sum of the values (see subsection (5)) of every asset included in the total assets of the foreign company at the end of the most recent period:

(a)          that ends no later than that time, but no more than 12 months before that time; and

(b)          for which the foreign company has recognised company accounts.

Step 2.

Work out the sum of the values (see subsection (5)) of every asset included in the total assets of the foreign company at the end of the most recent period:

(a)          that ends at least 6 months, but no more than 18 months, before the end of the period mentioned in step 1; and

(b)          for which the foreign company has recognised company accounts.

Note: See subsection (6) if the foreign company does not have recognised company accounts for a period mentioned in this step.

Step 3.

Work out the sum of the results of steps 1 and steps 2, and divide that sum by 2.

As determined under Question 1 of this ruling, CGT event C2 will happen in relation to ACo1's shareholding in ForeignCo on XX date. ForeignCo ceased to have any assets as at DD date and will continue to have no assets until XX date.

Accordingly, the sum of the values of ForeignCo's assets under both Step 1 and Step 2 will be zero, as ForeignCo will have no assets during the periods specified under both steps.

As the result of Step 1 and Step 2 is zero, the result of Step 3 is zero divided by zero, being an undefined number.

Step 2

The average value of ForeignCo's active foreign business assets is determined in accordance with subsection 768-525(3) of the ITAA 1997, which states:

The foreign company's average value of active foreign business assets at that time is worked out in this way.

Method statement

Step 1.

Work out the sum of the values (see subsections (4) and (5)) of every active foreign business asset of the foreign company at the end of the most recent period:

(a)          that ends no later than that time, but no more than 12 months before that time; and

(b)          for which the foreign company has recognised company accounts.

Step 2.

Work out the sum of the values (see subsection (4) and (5)) of every active foreign business asset of the foreign company at the end of the most recent period:

(a)          that ends at least 6 months, but no more than 18 months, before the end of the period mentioned in step 1; and

(b)          for which the foreign company has recognised company accounts

Note: See subsection (6) if the foreign company does not have recognised company accounts for a period mentioned in this step.

Step 3.

Work out the sum of the results of steps 1 and 2, and divide that sum by 2.

...

For the same reasons outlined above under Step 1 of the method statement in subsection 768-525(1) of the ITAA 1997, the result of Step 3 in subsection 768-525(3) of the ITAA 1997 will also be an undefined number.

Step 3

Step 3 of the method statement requires the result of step 2, being zero, to be divided by the result of step 1, being zero.

The result is 0/0, which technically produces an undefined number as it is not mathematically possible to divide a number by zero.

Step 4

Step 4 requires the result of Step 3 to be expressed as a percentage, which is not technically possible in this instance as Step 3 produced an undefined number which cannot be expressed as a percentage.

Step 5

As the result of Step 3 cannot be expressed as a percentage for the purposes of Step 4, it follows that there is no 'result' for the purposes of Step 5, which states the AFBAP is:

(a)          if the result of step 4 is less than 10% - zero, or

(b)          if the result of step 4 is 10% or more, bust less than 90% - that result, or

(c)          if the result of step 4 is 90% or more - 100%.

The result of the above gives rise to the question of whether the Book Value method is available to work out the AFBAP of a foreign company that has no assets at the time of the relevant CGT event, and if it is, the secondary question of what the AFBAP would be where the result of Step 3 in the method statement produces an undefined number.

However, and for the reasons outlined above confirming that the Market Value method can apply with respect to a foreign company with no assets to determine an AFBAP of 0%, it is the Commissioner's view that the Book Value method can alternatively apply to calculate an AFBAP of 0% where the result of Step 3 in the method statement in subsection 768-525(2) of the ITAA 1997 is 0/0.

Therefore, it is the Commissioner's view that the Book Value method can be used, where ACo1 makes a choice under subsection 768-515(2) of the ITAA 1997 and has the relevant recognised company accounts, and that ForeignCo's AFBAP will be 0%.