Edited version of private advice

Authorisation Number: 1052394240134

Date of advice: 23 May 2025

Ruling

Subject: CGT - concession stakeholder

Question 1

Were the taxpayers capital gains tax (CGT) concession stakeholders in the Company just before they sold their respective shares in the Company pursuant to section 152-60 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to cancel any tax benefit the taxpayers obtain from the sale of their shares?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The shareholders in the Company at the time of incorporation were:

Table 1: Company shareholders

Under the Company's constitution, there are various types of shares comprising the capital of the company in addition to the shares held by the shareholders, including Ordinary share. Ordinary shares, A, B, C and D shares, entitle their holders to receive notice and to vote at general meetings. Other classes of shares do not carry voting rights. Other types of shares don't carry voting rights. The Company's constitution also provides that dividend declared, or distribution of capitalised profits may be made on the shares on more than one class and paid in different amounts on different classes of shares if the shareholders so wished.

The shareholders' agreement sets out the capitalisation, financing, management and operation of the Company. It provides that the balance of available profits will be distributed to the ordinary shareholders according to the number of ordinary shares held by them, and if any of those shares are partly paid, having regard to the extent to which those shares are paid up.

Notwithstanding the above agreement, dividends were paid to the four shareholders in equal proportion for at least the past 5 years.

In 202X, the shareholders in the Company discussed the idea of the Company selling its business and obtained a valuation of their business.

The shareholders had discussion with a potential buyer, however, the deal fell through as the parties could not agree on the terms of the sale contract.

Consequently, C and D offered to buy A and B's shares and take over the Company. The sale price would be determined with reference to the valuation obtained and offered purchase price.

Amendment of the Company constitution and shareholders' agreement

Prior to entering into a contract for the disposal of the shares, the Company sought tax advice from their tax advisors on the proposed disposal of shares. After reviewing the Company's constitution and shareholders' agreement, the shareholders were advised that contrary to the shareholders' understanding, the shares held by the shareholders did not carry an entitlement to 25% of the dividends.

To rectify the error, the Company constitution and the shareholders' agreement had been amended to reflect the true intention of the shareholders as it has been the belief and understanding of the shareholders that each share held carry rights to 25% of the dividends.

The amendments to the Company's constitution and the shareholders' agreement entitle the shareholders to equal portion of dividend distribution.

After the amendments were made, A and B's shares were sold to C and D, respectively. A and B intend to access the CGT concession.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 section 152-70

Income Tax Assessment Act 1997 section 152-75

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177F

Reasons for decision

Question 1

Summary

A and B have small business participation percentage in the company of at least 20% respectively and are considered significant individuals under section 152-55 of the ITAA 1997. Therefore, they are considered CGT concession stakeholders just before the CGT event pursuant to section 152-60 of the ITAA 1997.

Detailed reasoning

Section 152-10 of the ITAA 1997 contains the basic conditions you must satisfy to be eligible for the small business CGT concessions. These conditions are:

(a)          a CGT event happens in relation to a CGT asset in an income year.

(b)          the event would have resulted in the gain

(c)          at least one of the following applies:

(i)        you are a small business entity for the income year

(ii)        you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

(iii)        you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or

(iv)       the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(d)          the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

If the CGT asset is a share in a company or an interest in a trust (the object entity), the taxpayer must satisfy additional basic conditions in subsection 152-10(2) in order to access small business CGT relief in Div 152. One of these additional basic conditions must be satisfied just before the CGT event:

•                     the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or

•                     CGT concession stakeholders in the company or trust together have a small business participation percentage in the interposed entity of at least 90% (the 90% test).

Section 152-60 of the ITAA 1997 provides that an individual is a CGT concession stakeholder of a company or trust at a time if the individual is:

a)          a significant individual in the company or trust; or

b)          a spouse of a significant individual in the company or trust, if the spouse has a small business participation percentage in the company or trust at the time that is greater than zero

Under section 152-55 of the ITAA 1997 an individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. This 20% can be made up of direct and indirect percentages.

Small business participation percentage

Under section 152-65 of the ITAA 1997 an entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

•                     the entity's direct small business participation percentage in the other entity at that time, and

•                     the entity's indirect small business participation percentage in the other entity at that time.

Under subsection 152-70(1) of the ITAA 1997 an entity's direct small business participation percentage in a company is the percentage of:

•                     voting power that the entity is entitled to exercise

•                     any dividend payment that the entity is entitled to receive, or

•                     any capital distribution that the entity is entitled to receive, or

•                     if they are different, the smallest of the three definitions above.

Section 152-75 of the ITAA 1997 details that an entity's indirect small business participation percentage in a company or trust is calculated by multiplying together the entity's direct participation percentage in an interposed entity, and the interposed entity's total participation percentage (both direct and indirect) in the company or trust.

The determination of whether an individual is a CGT concession stakeholder is relevant to the small business 15-year exemption and the basic conditions for the CGT small business concessions for a CGT asset that is a share in a company or an interest in a trust.

Application to the taxpayers' circumstances

In this case, the Company's constitution and shareholders' agreement that will entitle the shareholders to equal rights and distribution to dividends. Additional clause was inserted which effectively mean that if any distribution of capitalised profits is declared and no Ordinary shares are on issue, then each class A, B, C and D shares will entitle the holders to an equal portion of such distribution. The shareholders' agreement was also amended to the effect that the balance of the available profits will be distributed to the shareholders according to the number of shares held by them.

The amendments made clear the voting and dividend rights of the shareholders and had been made to give effect to the true intention of the shareholders since incorporation. As a result of the amendments, A and B have a small business participation percentage 25% in the company, hence are considered significant individuals under section 152-55 of the ITAA 1997. Accordingly, they are considered CGT concession stakeholders just before the CGT event pursuant to section 152-60 of the ITAA 1997.

Question 2

Summary

We consider that the transaction does not form a scheme entered into for the dominant purpose of obtaining a tax benefit, for the purposes of Part IVA. Therefore, the Commissioner will not make a determination under section 177F of the ITAA 1936.

Detailed reasoning

Broadly, section 177F of the ITAA 1936 allows the Commissioner to cancel a tax benefit to which Part IVA applies. The effect of section 177D of the ITAA 1936 is that Part IVA will apply to a scheme, if it would be concluded that the person/s entered into or carried out a scheme for the purpose (or dominant, if there are two or more purposes) of obtaining a tax benefit.

The starting point for applying the general provisions in Part IVA is the dominant purpose test in section 177D of the ITAA 1936. Section 177D(1) provides:

'Section 177D Schemes to which this Part applies

Scheme for purpose of obtaining a tax benefit

177D(1) This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of:

(a)          enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme; or

(b)          enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme;

whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers...'

Broadly, the three key requirements of subsection 177D(1) are:

•                     a 'scheme', which is given wide definition in subsection 177A(1);

•                     a 'tax benefit in connection with the scheme', as defined in section 177C together with section 177CB; and

•                     the requisite purpose, the subject matter of section 177D.

Each of the requirements is considered further below.

Scheme

Subsection 177A(1) of the ITAA 1936 defines 'scheme' broadly as follows:

'scheme means

(a)          any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b)          any scheme, plan, proposal, action, course of action or course of conduct...'

Paragraph (b) of the above definition extends to unilateral schemes, plans, proposals, actions, course of action or course of conduct (subsection 177A(3)).

As highlighted in Practice Statement Law Administration PS LA 2005/24 (PS LA 2005/24) Part IVA must be construed as a whole. What constitutes a scheme is ultimately meaningful only in relation to the tax benefit that has been obtained since the tax benefit must be obtained in connection with the scheme. A scheme can comprise a series of interrelated acts by a person or persons over a period of time, or, within a wider scheme there could also be an alternative narrower scheme that meets the requirement of Part IVA.

In the present case, one approach may be to define the scheme within the broader context of the entry into the sale agreement, which is accepted as the implementation of XXXX and XXXX primary commercial objective to realise their investment in the Company. It is the manner in which this objective could be achieved that would be the subject of the Part IVA question.

The arrangement in this case is generally:

•                     The Company's constitution and shareholders' agreement, upon identification from their tax representative that shareholder's voting rights are not as they had been operating nor as they had intended and operating by, being amended that effectively gives each shareholder of the company equal voting rights and equal portion of dividend distribution.

•                     The amendment to the Company's constitution and shareholder's agreement effectively allowed them to be considered CGT concession stakeholders just before the CGT event pursuant to section 152-60 of the ITAA 1997.

•                     After the amendments, A and B sold their shares to C and D.

•                     A and B intend to access the small business CGT concession under Division 152 of the ITAA 1997. If eligible, may result in nil capital gain.

The above steps, taken together and as applied against the relevant tax provisions, are necessary elements that would result in what might be argued to be the effective circumvention of the full amount of capital gain that would otherwise have been incurred from the simple disposal of the shares.

Tax benefit in connection with the scheme

The reference in section 177D to the obtaining by a taxpayer of a tax benefit in connection with a scheme is defined in section 177C. Of particular relevance in this case is the following extract from section 177C:

'Section 177C Tax benefits

(1)          Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:

(a)         an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; ...

and, for the purposes of this Part, the amount of the tax benefit shall be taken to be:

(c)         in a case to which paragraph (a) applies - the amount referred to in that paragraph;...'

For schemes entered into on or after 16 November 20YY, section 177CB also applies in determining the tax benefit. Section 177CB states:

Section 177CB The bases for identifying tax benefits

(1)          This section applies to deciding, under section 177C, whether any of the following (tax effects) would have occurred, or might reasonably be expected to have occurred, if a scheme had not been entered into or carried out.

(a)         an amount being included in the assessable income of the taxpayer...

(2)          A decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme).

(3)          A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme

(4)          In determining for the purposes of subsection (3) whether a postulate is such a reasonable alternative:

(a)         have particular regard to:

(i)        the substance of the scheme; and

(ii)        any result or consequence for the taxpayer that is or would be achieved by the scheme (other than a result in relation to the operation of this Act); but

(b)         disregard any result in relation to the operation of this Act that would be achieved by the postulate for any person (whether or not a party to the scheme)

When postulating what the tax effects would have been absent the scheme, the events and circumstances comprising the scheme must be assumed not to have happened.

The sale of A and B's shares would result in a capital gain and would be included in their assessable income. They would likely only be entitled to the discount capital gain had the amendments to the Company constitution and shareholders' agreement not been made. Because of the amendments, the effect is that A and B are considered CGT concession stakeholders who may be eligible for the small business CGT concession. There is no tax benefit identified unless and until A and B access the small business CGT concession (assuming all conditions are satisfied in subdivision 152-A of the ITAA 1997). In this case, the tax benefit would be the amount of capital gain that would be further reduced or be exempt.

Dominant Purpose

Subsection 177A(5) clarifies that the 'purpose' referred to in Part IVA includes the dominant purpose where there are two or more purposes.

Section 177D(1) of the ITAA 1936 requires the matters in subsection (2) to be considered in forming the conclusion as to purpose:

177D(2) For the purpose of subsection (1), have regard to the following matters:

(a)          the manner in which the scheme was entered into or carried out;

(b)          the form and substance of the scheme;

(c)          the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(d)          the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(e)          any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(f)          any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(g)          any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

(h)          the nature of any connection (whether or a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Although the section requires the Commissioner to have regard to each of the eight matters in subsection 177D(2) in reaching an objective conclusion about purpose, not all of the matters will be equally relevant in every case.

When considered in conjunction with the factors in paragraph 177D(b) of the ITAA 1936, all these factors either point against the application of Part IVA or are neutral. In particular:

•                     The main purpose of amending the Company's constitution and the shareholders' agreement was to rectify the error and align with what the shareholders' true intention since the incorporation of the Company in terms of voting rights and dividend distribution. The error could have been rectified had they discovered it earlier and before the intended sale, as it has always been the intention of the shareholders to receive equal dividend distribution.

•                     Further evidence of this intention is the fact that the shareholders have consistently received equal dividend payments in the past years.

Having regard to the form, substance and effect of the steps of the scheme as a whole, and for the reasons expressed in the ruling, it is considered that the scheme is not tax-driven, and weighing up all the factors, the dominate purpose is not motivated to obtain a tax benefit but rather give effect and align with true intention of the four shareholders in their commercial business agreement. This is further supported by the distributions made in the past. As such, the purpose requirement in section 177D is not met. The transaction will not constitute a scheme to which Part IVA of the ITAA 1936 applies.