Edited version of private advice

Authorisation Number: 1052373005680

Ruling

Subject: Varying rights to company's shares

Question 1

Will the ruling scheme give rise to a direct value shift under section 725-145?

Answer

No.

Question 2

Will the ruling scheme have consequences under Division 725 because of section 725-50?

Answer

No, but only because we've ruled that there's no direct value shift under section 725-145.

Question 3

Will the ruling scheme give rise to a taxing event generating a gain for down interests as CGT assets under section 745-245, thereby triggering a capital gain under CGT event K8 (section 104-250)?

Answer

No, as we've ruled that there's no direct value shift under section 725-145.

Question 4

On the assumption that there has been no change in majority underlying interests to the pre-CGT assets of the Company to date, will the ruling scheme impact the pre-CGT status of the Company's pre-CGT assets by operation of Division 149?

Answer

No.

This ruling applies for the following period

1 July XXXX to 30 June YYYY

Facts and circumstances

1.  The Company is a proprietary company with indirect property investments. It was incorporated sometime before 20 September 1985. The Company has some income producing assets last acquired before 20 September 1985.

2.  The Company has multiple classes of shares on issue.

3.  All of the Company's shares are now owned by current shareholders, but some of them were formerly held by the late Person B and Person C.

4.  Some of the shares are now 'post-CGT' as they were bequeathed to the current owners as a result of the deaths of first Person B and later Person C on dates after 20 September 1985. Person B formerly held shares in the Company, and bequeathed them on death to Person C. Person C also held other shares in the Company, and bequeathed all shares in the Company he or she held (both held originally, and those inherited from Person B), to current shareholders.

5. Table 1 described the Company's current share structure but has been redacted for privacy reasons.

Table 1: the Company's current share structure redacted for privacy reasons

6.  Paragraph redacted for privacy reasons.

7.  Paragraph redacted for privacy reasons.

Existing shareholder rights under the Company's present memorandum and articles of association.

8.  We'll describe the rights for the share classes.

•                     Only one class of shares ('A' class) currently has rights to excess capital (i.e. excess to paid-up capital) on winding-up. There's only one 'A' class share, held jointly by two of the current shareholders.

•                     All of the remaining classes of shares currently have discretionary rights to dividends.

•                     All of the remaining classes of shares are entitled to paid-up capital in priority to the payment of any capital to the 'A' class, but the remaining classes aren't entitled to excess capital on winding-up.

9.  Paragraph redacted for privacy reasons.

10.  The Company currently has a memorandum of association and articles of association. The applicants gave us copies of these documents. We'll summarise a few provisions for convenience in paragraphs 11 through 15. However, those governing documents are incorporated in the facts of this private ruling and prevail over how they are described in the following paragraphs if there's any inconsistency.

11.  The Company's memorandum of association at Clause X describes the rights attached to the 'A' class share.

12.  Clause X conferred certain rights on Person C to exercise certain voting rights and appoint board members if Person C held the 'A' class share.

13.  Paragraph redacted for privacy reasons.

14.  Paragraph redacted for privacy reasons.

15.  Clause Y of the articles of association describes dividend rights.

•                     The Company may declare dividends in general meeting, but not exceeding amounts recommended by directors.

•                     If there are multiple classes of shares, dividends may be declared and paid on one or more classes to the exclusion of any other class or classes.

•                     If dividends are declared on more than one class, dividends may be paid on any class at a higher or lower rate than other classes.

•                     However, each class is presumed to rank equally for dividends unless the Company resolves otherwise.

16.  Paragraph redacted for privacy reasons.

Proposed changes to shareholder rights under a proposed constitution and shareholders' deed.

17.  Paragraph redacted for privacy reasons.

18.  The group is considering varying the rights attaching to the Company's shares. It proposes to make changes with the following effect.

•                     The 'A' class share will lose dividend rights.

•                     Most of the remaining classes will all hold equal rights to dividends pro-rata to the number of shares held.

•                     One specific class of shares will retain discretionary rights to dividends.

•                     Two specific classes of shares will retain their discretionary rights to dividends, but any dividends will be paid in equal proportions across the two classes.

•                     All post-CGT shares, except for the 'A' class share, will have equal rights to excess returns of capital.

•                     Some classes of shares will only be entitled to a return of paid-up capital on winding-up (in priority to shares carrying rights to excess returns).

•                     Two classes of shares will lose voting rights.

19.  These changes will be achieved by introducing a constitution to replace the Company's current memorandum and articles of association. The applicants gave us a draft copy. For convenience, Table 2 describes what we see as being significant clauses in that constitution. However, the draft constitution is incorporated in the facts of this ruling, and prevails over Table 2 if there's any inconsistency.

Table 2: selected clauses in the Company's proposed constitution

20.  The group intends to enter a shareholders' deed. The applicants gave us a draft copy. This deed will cover the relationship between the company and shareholders, and the relationships between shareholders. The shareholders' deed will cover topics including:

•                company procedures (including rights to vote at board and shareholder meetings, and whether special majorities are required for resolutions)

•                company dividend policies

•                restrictions about shares (including a restriction on transmission).

For convenience, Table 3 describes what we see as the most significant clauses in that shareholders' deed. However, the draft shareholders' deed is incorporated in the facts of this ruling, and prevails over Table 3 if there's any inconsistency.

Table 3: selected clauses in the Company's proposed shareholders' deed

Assumption

There have been no changes to the Company's shareholdings since immediately before 20 September 1985 other than the transfers mentioned in paragraph 4 (i.e. from Person B to Person C on Person B's death, and from Person C to current shareholders on Person C's death).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-250

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 section 149-30

Income Tax Assessment Act 1997 section 725-45

Income Tax Assessment Act 1997 section 725-50

Income Tax Assessment Act 1997 section 725-55

Income Tax Assessment Act 1997 section 725-65

Income Tax Assessment Act 1997 section 725-70

Income Tax Assessment Act 1997 section 725-90

Income Tax Assessment Act 1997 section 725-95

Income Tax Assessment Act 1997 section 725-145

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1936 section 6

Income Tax Assessment Act 1936 Former section 160ZZS

Income Tax Assessment Act 1936 section 318

In this ruling:

•                     hyphenated legislative provisions (eg, section 725-145) are in the Income Tax Assessment Act 1997

•                     unhyphenated legislative provisions (eg, section 6) are in the Income Tax Assessment Act 1936

•                     Divisions 149 and 725 are both in the Income Tax Assessment Act 1997

•                     'before CGT' means the time immediately before 20 September 1985

•                     'after CGT' means a time on or after 20 September 1985.

Question 1

Will the proposed arrangement give rise to a direct value shift under section 725-145?

Answer

No.

Summary

21.  Speaking broadly, a direct value shift will happen if there's a decrease in the market value of equity interests and an increase in the market value of other equity interests in the same entity.

22.  Both currently and after the proposed changes, the Company's board will have a discretion to pay a dividend on some but not all classes, to pay dividends at different rates to at least some classes, and to decide when to wind up the company.

23.  In those circumstances, we think most of the Company's market value attaches to control rights rather than specific dividend or capital rights attaching to each share or classes of shares.

24.  We don't think the proposed changes cause any single share or class of shares to increase or decrease in value. While the Company's constitution varies the dividend and capital rights attaching to certain shares, the board will retain the power to declare dividends on some shares and not others, and any decision about when to wind up the company will remain at the board's discretion. No individual share or class of shares has or will have market value because any dividend or capital distribution will depend on the company's decisions, and no single share or class of shares carries or will carry rights allowing the holder to control the board.

25.  Since no equity interests will increase in market value, it follows that there will be no direct value shift under the scheme.

Overview of the direct value shifting rules: Division 725 may apply if there's a 'direct value shift' under a scheme which meets several threshold conditions; if Division 725 applies, CGT event K8 may happen, and there may be cost base adjustments.

26.  Section 725-45 says the object of Division 725 is to prevent inappropriate gains and losses arising on the realisation of equity or loan interests in an entity when value is shifted.

27.  Section 725-50 sets threshold conditions for Division 725 to apply.

•                     There must be a direct value shift (as defined under section 725-145).

•                     That direct value shift must be under a scheme involving equity or loan interests in a target entity.

•                     The target entity must be a company or trust at some time during the scheme period.[1]

•                     A controlling entity test in section 725-55 is met.

•                     A 'cause of the value shift' test in section 725-65 is met.

•                     You are an affected owner of a down interest, or an up interest, or both.

•                     The value shift isn't reversed under sections 725-90 or 725-95.

28.  There's an exclusion in section 725-70 for down interests where the market value of decreases in down interests is less than $150,000.

29.  Subdivision 725-D describes the consequences of a direct value shift for CGT assets.

•                     There may be a 'taxing event generating a gain' for the owner of the down interest - this triggers CGT event K8 (in section 104-250).

•                     The cost base of the down interest is reduced and the cost base of the up interest is increased.

(Subdivision 725-E applies where the asset is trading stock or a revenue asset.)

A direct value shift will happen if there's a decrease in the market value of some equity interests and an increase in the market value of other equity interests.

30.  A direct value shift (under a scheme involving equity or loan interests) happens when conditions in section 725-145 are met.

•                     There must be a scheme involving equity or loan interests in the target entity.

•                     There must be a decrease in the market value of equity or loan interests in the target entity.

•                     The decrease must be reasonably attributable to something done under the scheme.

•                     That decrease must happen at or after that thing is done.

•                     Either equity or loan interests in the target entity are issued at a discount, or there's an increase in the market value of equity or loan interests in the target entity.

31.  Section 995-1 says 'equity interest' in the case of a company, has the meaning given by Subdivision 974-C.

32.  Skipping over some details that aren't presently relevant, an interest in a company will be an equity interest under Subdivision 974-C (section 974-75) if it:

•                     is an interest as a member of stockholder

•                     is an interest carrying a variable or fixed return that's contingent on the company's economic performance

•                     carries a right to a return at the discretion of the company.

33.  There's no proposal to issue equity interests here; the issue is just whether there will be a decrease and an increase in the market value of the Company's shares, reasonably attributable to anything done under this scheme.

34.  To work that out, we need to identify if any change in isolation, or any combination of changes across the entire scheme, will change the market value of any classes of shares.

'Market value' means the price that an asset can be bought and sold for by fully informed buyers and sellers when bargaining at arm's length.

35.  ATO guidance says 'market value' is the price that an asset can be bought and sold by willing (but not anxious) informed buyers and sellers when bargaining at arm's length.[2]

36.  There's no ATO guidance on what 'market value' means in the value shifting context for valuing shares with discretionary rights.

37.  However, the ATO's guide to the general value shifting regime[3] briefly addresses discretionary trust interests. In the FAQ section (Chapter 8) at page 164, it asks 'can the interests of a discretionary object or default beneficiary in a discretionary trust be subject to adjustment under the entity interest direct value shifting rules?' It answers 'not usually.' It explains that interests in a discretionary trust could only be down or up interests if their value is 'capable of being affected by a value shift'. It says the value of an interest would not normally be affected if the interest holder can only benefit from the trust through the exercise of the trustee's discretion.

38.  We think under the Company's existing memorandum and articles of association, the powers and rights specified in Clause X of the memorandum ended on Person C's death. Clause X says while the share is registered in Person C's name it confers the specified powers and rights on the holder. While it doesn't expressly say those rights end on Person C's death, it does specify that the executors or trustee of Person C's will may exercise some rights or powers. That provision would be unnecessary if the powers would pass automatically to any future holder on death.

The value of the Company's shares attaches to control rights, rather than the specific dividend or capital rights attaching to each class, because the board has an effective discretion about which classes benefit.

39.  In our view, it's impossible to attribute market value to any classes of shares here because the board may discriminate between them at their discretion. Both before and after the changes, the board may pay dividends on some classes to the exclusion of others, and some share classes may receive dividends at different rates. In these circumstances, shares, whatever their class, would only have value to a shareholder where the shareholder had the power to control board decisions. Without that control, both dividend and capital return rights would have no value: the board could exclude the shareholder from a dividend, refuse to wind up the company, or deplete company capital to reduce their potential return on winding-up. Therefore, a prospective purchaser acting at arm's length would only buy shares where they would control the board and could pay themselves dividends or wind-up the company as they saw fit. Market value would therefore attach to control rights, rather than dividend or capital rights on any particular class of shares. Without control, no single share or class of shares would have market value.

Currently, no single class of shares have market value to a purchaser.

40.  We'll begin by considering the market value of each class of shares at the beginning of the scheme.

41.  As mentioned at paragraph 38, we think that the extensive rights and powers attaching to the 'A' class share ended on Person C's death, and the remaining rights are a single right to vote (one vote for the single share), discretionary dividend rights, and a right to residual capital on winding-up.

42.  The remaining shares have discretionary dividend rights, voting rights (one vote for each share), and rights to a priority return of paid-up capital.

43.  We think the 'A' class share rights would have little or no value to a third-party purchaser.

•                     The share would carry a single vote among over X votes in general meeting.

•                     The discretionary dividend rights would have no value. The holder of the 'A' class share would only receive a dividend at the board's discretion.

•                     The same applies to the residual capital rights on winding-up. The board would decide both a) whether the company retained capital, and b) whether the company voluntarily wound up. A third-party purchaser's potential return of residual capital would depend on decisions outside its control: for example, the board might pay large dividends and retain minimal capital, or even deplete capital by selling assets to fund dividends or other activities, or might decide never to wind up the company voluntarily. In those cases the 'A' class shareholder may never receive any residual capital payment.

•                     We think a shareholder with discretionary dividend rights, without majority control, is essentially in the same position as a beneficiary under a discretionary trust: it has a mere right to be considered, but no guarantee of receiving any payment.

•                     We think it follows that the 'A' class share has no market value. Without majority control, a third-party purchaser would have no guarantee it would receive any dividend or receive any return of capital on a future winding-up. We don't think any third-party acting at arm's length would pay anything for the 'A' class share unless it also bought or held enough shares in other classes to control the board.

44.  The same reasoning applies to the discretionary dividend rights attaching to the remaining shares.

•                     We don't think the discretionary dividend rights have market value to a third-party purchaser for the same reasons as the 'A' class share.

•                     Any shareholder who didn't also own a majority of voting shares couldn't decide to pay themselves a dividend or wind up the company to return their paid-up capital.

•                     A shareholder with discretionary dividend rights is in the same position as a beneficiary under a discretionary trust: they wouldn't be guaranteed any payment and would be at the mercy of the board and majority shareholder.

•                     A third party acting at arm's length wouldn't pay for a mere right to be considered, which means the rights have no market value.

45.  We also think the capital rights (attaching to the remaining shares) don't have market value because their right to repayment depends on board decisions outside the shareholders' control.

•                     The remaining shares have rights to a return of paid-up capital on winding-up.

•                     On one view, other shares may have some value because they have a right to a return of capital in priority to other shareholders.

•                     Those rights would have value if you could control when the company was wound up. If you can decide to wind the company up, you would be guaranteed some payment so long as it had net assets after repaying all liabilities and liquidation expenses.

•                     But if you can't control the board, you'd have no control over when the company was wound up.

46.  In our view, that lack of control makes the rights almost worthless. The company might have no capital remaining after repaying its debts on winding-up. The company might never voluntarily wind up, or if it does, that mightn't happen for many years. The right is a bare return of capital, so the contingent sum wouldn't appreciate to keep pace with inflation. A third-party acting at arm's length wouldn't pay anything for a right to repayment of a principal sum on an uncertain event that could happen at a time outside their control. Almost any alternative investment would be preferable.

47.  Market value wouldn't be significantly different considered from a current shareholder's perspective.

•                     As explained above, the voting and dividend rights attaching to any single class of shares would be worthless without majority control, and the capital rights would be worthless without the special majority needed to wind up the company.

•                     Conceivably shares would have value to a current shareholder if they bought enough shares to secure majority control. For example, Person D could buy out X of Person E's shares to secure a majority of shareholder votes, and this could allow Person D to pay out dividends on any given class of shares at Person D's discretion.

•                     But many possible combinations could secure that majority. For example, if Person D wanted to secure a simple majority, he or she could buy a simple majority in all classes of shares, or buy all the shares in some classes to the exclusion of other classes.

•                     Given those options, no single share or class of shares has market value to a current shareholder: a combination of shares in other classes could give a potential buyer majority control, and once that majority is secured, the remainder would be worthless.

48.  For similar reasons, we don't think shares should be valued as if they were part of a package giving the purchaser majority control. Conceivably a given share or class of shares would have value to a purchaser (whether a third party or a current shareholder) if the purchaser was also buying enough shares in other classes to secure majority control. But as mentioned in paragraph 47, there would be multiple possible combinations of shares that would secure majority control. Where a share would only have market value with majority control, it's arbitrary to assign market value to any given share or class of shares given it would always be possible to secure majority control through another combination that didn't include that class.

49.  In summary then, currently no share or class of shares have market value. No potential purchaser would be prepared to pay for the remaining shares since their prospects of receiving dividends or capital payments would be at the mercy of decisions outside their control.

The proposed changes won't decrease or increase the market value of any shares: Person D and Person E will control the company under the shareholders' deed, and can determine any dividend or capital distribution decision, regardless of their shareholding.

50.  Given our conclusion that no single share or class of shares currently has market value, it's impossible for the market value of any shares to decrease further.

51. & The proposed changes don't appear to increase the market value of any other share or class of shares for a third-party purchaser.

•                     We don't see how removing dividend rights on the 'A' class share could increase market value.

•                     Replacing discretionary dividend rights with equal dividend rights for the post-CGT shares won't increase market value because the company could still elect to pay dividends on shares which retained discretionary rights without paying dividends on the post-CGT shares.

•                     Making dividend rights equal between two specific classes wouldn't affect value because the company could instead elect to pay dividends on other pre-CGT shares or all the post-CGT shares (or both).

•                     We're not convinced that replacing rights to paid-up capital with residual capital rights would increase market value. Without majority control, the purchaser couldn't decide to wind-up the company while there was surplus available. The board might decide to pay out all profits as dividends and not accumulate any surplus capital. Alternatively, it might never wind up the company voluntarily, or at least not within the purchaser's lifetime.

•                     Under these circumstances, we don't think a third-party purchaser would pay anything for a share or class of shares unless they also bought enough voting shares to secure a majority.

•                     Even in that case, we think value would attach to majority control rather than any particular share or class of shares: the purchaser may be able to achieve majority control without buying any shares within any given class.

52.  We don't think the proposed changes would increase the market value of any other share or class of shares for a current shareholder either. While they remain the only shareholders, they must agree unanimously on any dividend decision. Winding-up requires a special majority board resolution. Neither, acting at arm's length, would have an incentive to buy any single share or class of shares without also buying enough shares in other classes to secure a special majority. Again, in that case, value would attach to control rather than any given class of shares, as there would be many possible combinations of shares that could secure a special majority without including any shares in the given class.

53.  To broadly summarise, we don't think any single share class will have market value where specific rights attaching to any given class only have value if the holder also has majority control.

If there's no change in the market value of any share or class of shares, there won't be a direct value shift under the scheme.

54.  Having reached these conclusions about the effect of market value, we can test whether there's a direct value shift by applying the conditions in section 725-145. To repeat, those conditions were that:

•                     there's a scheme involving equity or loan interests in the target entity

•                     there's a decrease in the market value of equity or loan interests in the target entity

•                     the decrease must be reasonably attributable to something done under the scheme

•                     that decrease must happen at or after that thing is done

•                     either equity or loan interests in the target entity are issued at a discount, orthere's an increase in the market value of equity or loan interests in the target entity.

55.  One condition is met: the scheme involves equity interests in the Company, being the target entity. Shares give the holder an interest as a member in the Company. In most cases, the shares would also carry a return (dividends or capital distributions) that would either depend on the Company's performance or be at the Company's discretion. The shares will be equity interests under Subdivision 974-C.

56.  But the remaining conditions aren't met. We concluded at paragraphs 50 to 53 that there will be neither a decrease nor an increase in the market value of any share or classes of shares under the scheme. Further, no interests are issued at a discount, because this scheme doesn't involve issuing any equity or loan interests.

Conclusion on Question 1: no direct value shift.

57.         Since the conditions for a value shift aren't met, there will be no value shift under the scheme.

58.         Since we've concluded that there's no value shift, the direct value shifting rules won't apply.

Question 2

Will the proposed arrangement have consequences under Division 725 because of section 725-50?

Answer

No, but only because we've ruled that there's no direct value shift under section 725-145.

Summary

59.  Section 725-50 imposes threshold conditions which must be met for a direct value shift to have consequences under the direct value shifting rules in Division 725.

60.  Since we concluded in Question 1 that the scheme won't result in a direct value shift, Division 725 won't apply.

Explanation

The direct value shifting rules in Division 725 only have consequences for a direct value shift when threshold conditions in section 725-50 apply.

61.  Section 725-50 sets threshold conditions for Division 725 to apply. It says a direct value shift under a scheme involving equity or loan interests in a target entity only has consequences under Division 725 if:

•                     the target entity is a company or trust at some time during the scheme period

•                     a controlling entity test in section 725-55 is met

•                     a 'cause of the value shift' condition in section 725-65 is met

•                     you are an affected owner of a down interest, or an up interest, or both

•                     the value shift isn't reversed under sections 725-90 or 725-95.

62.  The opening words of section 725-50 effectively add two extra conditions. Division 725 will only apply where there's a direct value shift, and that direct value shift happens under a scheme involving equity or loan interests in a target entity.

63.  Since we've concluded that there's no direct value shift, the conditions in section 725-50 aren't relevant and Division 725 won't apply.

Question 3

Will the proposed arrangement give rise to a taxing event generating a gain for down interests as CGT assets under section 745-245, thereby triggering a capital gain under CGT event K8 (section 104-250)?

Answer

No, because we've ruled that there won't be a direct value shift under section 725-145.

Explanation

64.  A direct value shift will generally result in a taxing event generating a gain (triggering CGT event K8) if there's a shift from your down interests with pre-shift gains to up interests held by other affected owners.

65.  A taxing event generating a gain won't happen here because we've ruled there's no direct value shift under section 725-145.

Question 4

On the assumption that there has been no change in majority underlying interests to the pre-CGT assets of the Company to date, will the proposed arrangement impact the pre-CGT status of the Company's pre-CGT assets by operation of Division 149?

Answer

No.

Summary

66.  Division 149 is about when pre-CGT assets stop being pre-CGT assets because of certain ownership changes in the holding entity. Broadly, Division 149 stops assets held by non-public entities being pre-CGT assets where the ultimate owners who held majority underlying interests before CGT stop holding them. Speaking loosely, ultimate owners means individuals, and majority underlying interests means more than 50% of the beneficial interests in the asset (effectively rights to income and capital that might be generated from the asset). For the purposes of Division 149, an inheritance rule applies to treat beneficial interests you acquire on the death of a former owner as if you held equivalent interests during the former owner's holding period.

67.  Division 149 hasn't applied to make the Company's pre-CGT assets stop being pre-CGT assets. While no single shareholder or class of shares can calculate their individual entitlement to capital or income, Person B, Person C, and the current shareholders held all the shares and must have held all beneficial interests between them before CGT. Today, the current shareholders hold all the shares between them, but are treated as having held the remaining shares they acquired from Person B and Person C since before CGT. That means the current shareholders together are treated as having held majority underlying interests since before CGT. Assuming no other shareholding changes, that would mean Division 149 hasn't applied so far.

68.  The changes to share rights under the proposed arrangement won't cause Division 149 to stop the Company's pre-CGT assets being pre-CGT assets. Both before and after the scheme, no single shareholder or class of shares can calculate their individual entitlement to capital or income. But the current shareholders are treated as having all the interests in capital and income since before CGT and will continue to do so because they will hold all the shares between them after the scheme. Therefore, there won't be any change in majority underlying interests.

69.  The death of any of the current shareholders won't necessarily trigger Division 149, so long as their shares in the Company pass to other individuals because of their death (such as under their will or under succession law).

Explanation

Division 149 applies so that assets held by non-public entities stop being pre-CGT assets where the ultimate owners who held majority underlying interests before CGT stop holding them.

70.  Section 149-10 says a CGT asset is a pre-CGT asset if the owning entity last acquired it before 20 September 1985, and the entity wasn't taken under Division 149 or predecessor provisions to have acquired it after that time.

71.  Section 149-30 is about when assets held by non-public entities stop being CGT assets under Division 149.

•                     Subsection 149-30(1) says an asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

•                     Subsection 149-30(2) says if the Commissioner is satisfied, or thinks it reasonable to assume, that at all times on and after 20 September 1985, and before a particular time, majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day, subsections (1) and (1A) apply as if that were in fact the case.

•                     Subsections 149-30(3) and (4) are modified rules applying on death or relationship breakdowns, which we'll address later in these reasons.

72.  Section 149-15 has rules relevant to determining majority underlying interests.

•                     Subsection 149-15(1) says majority underlying interests in a CGT asset consist of more than 50% of the beneficial interests that ultimate owners have (directly or indirectly) in the asset, and in any ordinary income that may be derived from the asset.

•                     'Underlying interests' means beneficial interests that ultimate owners have in the asset or in any ordinary income that may be derived from it: see subsection 149-15(2).

•                     'Ultimate owners' include individuals: see paragraph 149-15(3)(a).

73.  ATO ID 2011/101[4] says that shares with discretionary rights to dividends won't cause a change in majority underlying interests when there's no change in the membership of the group which collectively holds all the shares between them.

74.  However, ATO ID 2011/107[5] says that when a share with discretionary dividend rights is issued to a new shareholder, that will mean majority underlying interests are no longer had by the same ultimate owners; due to the discretionary rights, it's possible that the company could distribute 100% of dividends to the new shareholder.

Person B, Person C, and the current shareholders held majority underlying interests before CGT; while none can quantify their percentage, they were the only shareholders, so the group between them must have received 100% of any dividend or capital distribution.

75.  All shares in the Company would be treated as underlying interests for Division 149 purposes. All shares, between them, carry certain rights to receive dividends and capital from the Company. If the Company declared dividends, or distributed capital, all the dividends or capital would flow to the entire group between them. Applying subsections 149-15(1), (2), and (3), the Company's shareholders would be treated as having beneficial interestsin the Company's CGT assets, and hence underlying interests.

76.  It's impossible to quantify each share's percentage interest in income or capital. Because of the discretionary dividend rights for each class, and the board's ability to pay dividends of differing amounts on each class, each class may receive a dividend, but isn't guaranteed any dividend or a specific percentage of any dividend if one was paid. The same applies to capital; the mix of rights to surplus capital and mere repayment of paid-up capital mean each share's percentage of capital would depend on how much surplus capital was available for distribution on winding-up. A share carrying surplus capital rights would receive no capital if there's no surplus but may receive a substantial share if there's a large surplus, and vice versa for shares carrying a right to repayment of paid-up capital. This means it's impossible to calculate what each class's percentage interest in capital would be (at least until the liquidator presents the final accounts on winding-up).

77.  Nevertheless, Person B, Person C, and the current shareholders had majority underlying interests since before CGT. Before CGT, none of them could quantify their percentage interest in income because of the discretionary and exclusionary income rights attaching to each class and differences in capital rights between each class. But between them, they held all the shares. If any dividend was declared, or any capital distributed, it could only have flowed to Person B, Person C, and the current shareholders. Considered as an indivisible group, that group must have received more than 50% of any income or capital from the Company's asset. Therefore, that group held majority underlying interests before CGT.

78.  Next, we need to determine whether any of the events in the ruling scheme either have caused or will cause a change in those majority underlying interests.

79.  We'll address those events in order:

•                     Person B and Person C's deaths, with the shares passing to current shareholders on death

•                     the proposed new constitution and shareholders' deed, including the varied rights for any shares

•                     the prospect of any current shareholder dying and passing interests to other individuals on death.

Person B and Person C's deaths won't cause a change in majority underlying interests: current shareholders are treated under the inheritance rule as having held beneficial interests corresponding to the inherited shares for the period Person B and Person C held them.

80.  After CGT, Person B's shares passed to Person C on Person B's death, and Person C's shares (including those inherited from Person B) passed to current shareholders on Person C's death.

81.  Subsections 149-30(3) and (4) are modified rules which apply on death or a relationship breakdown. The rules apply where a new owner acquires a 'percentage' of the underlying interests because of 'an event'; the listed events include certain CGT events where a relationship breakdown roll-over is available, and the death of a person. Where one of those events happens, section 149-30 applies as if the new owner had a percentage equal to the former owner's percentage of the underlying interests (or the acquired interests, whichever is less) when the former owner held them.

82.  An ATO ID gives guidance on how the inheritance rules in subsections 149-30(3) and (4) apply when an interest passes to a testamentary trust. ATO ID 2003/778[6] says that when a testamentary trust with discretionary powers (that have been and continue to be exercised for the benefit of the same family) acquires shares from a former owner, subsections 149-30(3) and (4) apply to treat the beneficiaries under that trust as having a beneficial interest in the trust assets, and therefore as 'new owners'.

83.  We'll discuss how subsections 149-30(3) and (4) apply here.

84.  One preliminary question is whether the inheritance rule applies to any beneficial interests, or only beneficial interests holding a quantifiable 'percentage'. Could subsections 149-30(3) and (4) be limited to cases where the inheriting shareholder can demonstrate that they acquired a specific or quantifiable percentage in the income or capital? Do they exclude discretionary rights where the shareholder can be excluded from a dividend or can't determine their percentage share of the total dividend if declared? If that's right, current shareholders may not be being treated as having held inherited shares from Person B and Person C during the former owners' holding periods.

85.  We think the answer is no: the inheritance rule should apply to any beneficial interests, even if the percentage can't be determined.

•                     The Macquarie Dictionary says 'percentage' meanings include a rate or proportion per hundred, or a proportion in general.[7]

•                     That implies the ordinary meaning of 'percentage' could include any share in a total amount, even an unascertainable share, not necessarily implying a quantifiable amount out of a hundred.

•                     ATO ID 2003/778 suggests a beneficiary under a discretionary trust can be a new owner for subsection 149-30(3) and (4) purposes.

•                     A beneficiary under a discretionary trust doesn't have a quantifiable percentage interest in income - it could be 0% or 100% or anywhere in between.

•                     That suggests 'percentage' could mean any interest in income, even an unquantifiable amount.

•                     Therefore, subsections 149-30(3) and (4) should extend to treat ultimate owner who acquires interests from a share carrying discretionary rights on the death of a former owner as 'new owners' notwithstanding that the amount isn't quantifiable.

86.  Given that conclusion, the inheritance rule will apply to treat current shareholders as having held their inherited shares since before CGT.

•                     Person B and Person C held shares since before CGT.

•                     Those shares carried rights to capital and income from the Company's assets, and therefore underlying interests in the Company's assets.

•                     While the discretionary and exclusionary rights attaching to those shares mean the exact percentages of income and capital are unquantifiable, we accept that they would be treated as having held 'a percentage' of those underlying interests for the purposes of subsections 149-30(3) and (4).

•                     Current shareholders acquired the shares in the Company, and thus a percentage of beneficial interests in the Company's assets, from Person B and Person C on Person C's death.

87.  It follows that the current shareholders are treated as having held majority underlying interests since before CGT.

•                     Person B, Person C, and the current shareholders held all the shares between them before CGT.

•                     While no individual or narrower combination of individuals can demonstrate that they held more than 50% of both beneficial interests in income and capital, together, the entire group held 100%.

•                     We concluded that current shareholders will be treated under the inheritance rule in subsections 149-30(3) and (4) as having held beneficial interests equal to the shares they acquired from Person B and Person C since before CGT.

•                     That means that together, the current shareholders will be treated as having held 100% of beneficial interests in income and capital before CGT, and therefore as having held majority underlying interests.

•                     Assuming that there have been no intervening changes to shareholdings since before CGT, the current shareholders continue to hold majority underlying interests.

The proposed changes in the constitution and shareholders' deed won't cause a change in majority underlying interests: the current shareholders continue to hold all the shares, so between them, they hold more than 50% of the beneficial interests in the Company's income and capital.

88.  To briefly reiterate, the proposed changes:

•                     remove excess capital rights (on winding-up) for the 'A' class shares

•                     replace rights to a priority return of capital for the remaining post-CGT shares with excess capital rights (on winding-up)

•                     make dividend rights equal for all classes on the post-CGT shares

•                     preserve discretionary dividend rights for the some classes of shares

•                     make dividends equal between two specific classes of shares.

89.  The changes mean it's still impossible to calculate a percentage share of income. Some classes will have equal dividend rights, and others will retain discretionary dividend rights. It's possible that anywhere from 0 to 100% of the dividends could be paid to the classes with discretionary rights (in at least some combination between them). The remaining shareholders would receive a proportionate share of any ordinary dividend, but the share of the total would depend on whether discretionary dividends were paid to the classes carrying discretionary rights.

90.  The same is true of capital. All classes have rights to share in residual capital, except for two specific classes of shares. 'That means each of those classes will receive a proportionate share of excess capital, but their percentage depends on the amount of the residual (if any) after the relevant classes of shares have their share of paid-up capital returned to them. If there isn't any residual capital, those classes could have 100% of capital between them. But if there's substantial residual capital, those classes could have a much smaller share, and the residual capital classes would have a significant share.

91.  However, we think the current shareholders will still hold majority underlying interests after the change.

•                     While each shareholder can't quantify their share of income, all shareholders together must hold 100% of the income rights between them.

•                     The same applies to capital. No shareholder can quantify their share of capital, but all together must hold 100% of the capital rights between them.

•                     Therefore, the ultimate owners who had majority underlying interests in the CGT asset before CGT will continue to hold them after the change.

•                     This means Division 149 won't apply to treat the Company's assets as stopping being a pre-CGT asset just because of this change.

The future death of a shareholder wouldn't necessarily cause Division 149 to apply.

92.  If any of the current shareholders die, and their shares pass to another individual because of their deaths, subsections 149-30(3) and (4) would apply to treat the inheriting individual as having held a percentage of underlying interests corresponding to the inherited shares since before CGT.

93.  This means that the death of any of the Company's current shareholders, won't, in itself, cause Division 149 to apply, where the shares pass directly on their death, such as under the terms of their will or under succession law.

94.  However, it's possible that the death of a current shareholder, in combination with other events outside the facts and circumstances of the scheme, may trigger Division 149. For example, if a current shareholder transferred shares to another entity before their death, or the Company cancelled shares on their death, then subsections 149-30(3) and (4) wouldn't apply to treat the new shareholder as having held the relevant percentage of underlying interests before CGT. It's therefore possible that the combination of events could cause majority underlying interests to change, causing the relevant CGT assets to stop being pre-CGT assets.

Conclusion on Question 4: no change to majority underlying interests, so Division 149 doesn't apply to stop the Company's assets being pre-CGT assets.

95.  We conclude that the changes under the proposed scheme won't cause the Company's assets to stop being pre-CGT assets.

•                     Person B, Person C, and the current shareholders between them held majority underlying interests before CGT.

•                     The effect of the inheritance rule in subsections 149-30(3) and (4) is that the current shareholders are treated as having held majority underlying interests before CGT.

•                     The proposed changes to share rights won't trigger a change in majority underlying interests. While the proposed constitution and shareholders' deeds will substantially vary rights attaching to each share class, the current shareholders are treated as acquiring their beneficial interests before CGT and will continue to hold all the beneficial interests in the Company's assets after the change.

•                     The death of any of the current shareholders won't trigger a change in majority underlying interests if there are no intervening changes and their shares pass to another entity on their death.

[1] Section 725-55 says the 'scheme period' is the period starting when the scheme is entered into and ending when it has been carried out.

[2] See Taxation Ruling TR 2006/13 Income tax: sale and leasebacks at paragraph 21; Taxation Ruling TR 2004/18 Income tax: capital gains: application of CGT event K6 (about pre-CGT shares and pre-CGT trust interests) in section 104-230 of the Income Tax Assessment Act 1997 at paragraph 156; Taxation Ruling IT 2378 Income tax: capital gains: disposal of prospecting or mining right: disposal of right to receive income: farm-out arrangements at paragraph 13; Taxation Determination TD 2007/1 Income tax: consolidation: in working out the market value of the goodwill of each business of an entity that becomes a subsidiary member of a consolidated group, should the value of related party transactions of each business of the entity be recognised on an arm's length basis? at paragraphs 12 to 16; ATO (June 2023) 'Market valuation of assets' accessed at ato.gov.au <QC 66067> on 14 March 2024; ATO (August 2023) 'Market valuation for tax purposes' accessed at ato.gov.au (legal database) on 14 March 2024.

[3] ATO (March 2006) Guide to the general value shifting regime, available at https://caat-p-001.sitecorecontenthub.cloud/api/public/content/af46dba9-7178-47cb-b880-5e376131282b_65c68c14_2407_475c_a289_dcb12d7066c1_pdf accessed 19 March 2024.

[4] ATO Interpretative Decision ATO ID 2011/101 Income Tax: Capital Gains Tax: Division 149 majority underlying interests - no new shareholders.

[5] ATO Interpretative Decision ATO ID 2011/107 Income Tax: Capital Gains Tax: Division 149 majority underlying interests -new shareholder.

[6] ATO Interpretative Decision ATO ID 2003/778 Income Tax: CGT: majority underlying ownership and deceased estate - discretionary trust - beneficiary a 'new owner'.

[7] Macquarie Dictionary Publishers (2024), The Macquarie Dictionary online, accessed at https://app.macquariedictionary.com.au on 17 April 2024, entry for 'percentage'.