Edited version of your written advice

Authorisation Number: 5010047180045

Date of advice: 20 December 2017

Ruling

Subject: CGT Concessions

Question 1

Is the taxpayer entitled to the 50% general discount in Division 115 of the Income Tax Assessment Act 1997 (ITAA 1997) (with particular reference to section 115-45 ITAA 97 on the disposal of shares in Company B in the 201Z financial year?

Answer 1

Yes

Question 2

Is Trust X a capital gains tax (CGT) small business entity for the purpose of satisfying the basic conditions in Subdivision 152-A of the ITAA 199797 to enable the entity to access the small business CGT concessions in Division 152 of the ITAA 97?

Answer 2

No

This ruling applies for the following period:

Year ending 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

Company A as trustee for Trust X commenced its activities in 200X.

Trust X carries on a number of commercial activities including renting out property and carrying on a business.

The business generally derives a gross sales income (ordinary income) of less than $75,000 each year.

Trust X receives trust distributions from Trust Y.

Company B was incorporated in 201X with the sole purpose of developing and operating a business.

All ordinary shares in Company B were allocated to Company A also trading for the Trust X when the company was incorporated.

Company B entered into a development licence agreement in 201Y with the owner of the land.

The objective of the development licence agreement is to provide Company B sufficient time to determine the feasibility of the development of their business on the site.

There was a 60 month period of determining feasibility of the project including gaining development approval.

If the project was feasible Company B would be entitled to enter into a 31 year lease with an option for an additional 30 year lease.

Trust X signed a binding heads of agreement for the sale of all its shares in Company B, with a formal share purchase agreement to be signed formalising the agreement.

The share purchase agreement was signed with the same essential terms as set out in the binding heads of agreement.

The value of the sale of shares was in excess of $6,000,000.

Trust X received distributions in excess of XX% of the total distributed in one of the last four years from Trust Y.

Trust Y holds a XXX% shareholding in Company C.

Trust Y holds a XX% shareholding in Company D.

Company C holds a XX% shareholding in Company D.

Company D has an annual turnover in excess of $2,000,000.00.

In the day to day and strategic operation of Company D, each of the shareholders has one equal vote, regardless of their capital ownership. This is an informal arrangement.

Each shareholder acts independently, and they meet monthly to review management reports and yearly to review the strategic plan and yearly budget.

The Shareholders Agreement provides that Trust Y and Company C are considered one and the same in the case of default of either entity.

Any shareholder has the ability to take the matter to a vote under the constitution, which would be by ownership percentages. This has never happened.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 160U

Income Tax Assessment Act 1997 Subdivision 115-A

Income Tax Assessment Act 1997 Section 115-10

Income Tax Assessment Act 1997 Section 115-15

Income Tax Assessment Act 1997 Section 115-20

Income Tax Assessment Act 1997 Section 115-25

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 115-45

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Section 328-125

Sustainable Planning Act 2009 Section 245

Reasons for decision

Question 1

Summary

Trust X meets the relevant conditions to access the general 50% discount for its sale of shares in Company B.

Detailed reasoning

Basic Conditions of CGT Discount

Subdivision 115-A of the Income Tax Assessment Act 1997 (ITAA 1997) sets out the basic requirements of the 50% discount capital gain. The following criteria are relevant to your situation:

● The capital gain must be made by a trust (subsection 115-10(c) of the ITAA 1997)

● The capital gain must result from a capital gains tax (CGT) event after 11.45 am on 21 September 1999 (subsection 115-15 ITAA 1997)

● The discount capital gain must not have an indexed cost base (subsection 115-20 of the ITAA 1997)

● The discount capital gain must be on an asset acquired at least 12 months before (subsection 115-25 of the ITAA 1997)

Trust X obtained the shares on DDMMYY and held them for more than 12 months before disposing of them. The indexed cost base would need not to be applied for the basic conditions to be met. The timing of the CGT event also needs to be considered.

Timing of the transfer of property

Capital gains tax event A1 in section 104-10 of the ITAA 1997 happens if you dispose of an asset, that is, if a change of ownership occurs from you to another entity: subsections 104-10(1) and (2) of the ITAA 1997. The event occurs when you enter into the contract for the disposal or, if there is no contract, when the change of ownership occurs: subsection 104-10(3) of the ITAA 1997.

To work out how the timing rules in CGT event A1 apply on the facts of this case, it is necessary to consider whether any sale contract either verbal or written was entered into prior to the transfer of the property to satisfy the description 'contract for the disposal' in paragraph 104-10(3)(a) of the ITAA 1997.

Meaning of 'contract for the disposal'

Subsection 160U(3) of the Income Tax Assessment Act 1936 (ITAA 1936) was rewritten in part from subsection 104-10(3) ITAA 1997. The words 'contract for the disposal' in paragraph 104-10(3)(a) rephrased the requirement in subsection 160U(3) that a disposal or acquisition took place 'under a contract'.

In considering the meaning of the words 'under a contract' for the purposes of subsection 160U(3) of the ITAA 1936, we must look to Federal Commissioner of Taxation v. Sara Lee Household & Body Care (Aust) (2000) 201 CLR 520; 2000, ATC 4378; (2000) 44 ATR 370 (Sara Lee Case). Under subsection 104-10(3)(a) of the ITAA 1997, the time of disposal of a CGT asset under a contract is taken to be the time of entry into the contract. In relation to the CGT rules, it was held in the Sara Lee Case that, where two or more contracts are relevant to a disposal of assets:

...the identification of the contract under which the assets were disposed of, for the purpose of applying s 160U of the ITAA 1936, requires a judgment as to which of the contracts is properly to be seen as the source of the obligation to effect the disposal.

Masters v Cameron (1954) 91 CLR353; 28 ALJ 438 set out the when agreements will become enforceable in three categories:

1. The parties have agreed to the terms and intend to be bound but wish to restate the agreement in a more precise or complex manner.

2. The parties have agreed to the terms but the performance is condition on an event, like the execution of a formal agreement.

3. The parties’ intention is not to agree or finalise the terms until they execute a formal agreement.

The first two cases create binding agreements whereas the third does not.

Trust X signed a binding heads of agreement in June 201Z which was later formalised in a share purchase agreement. The terms of the share purchase agreement were the same as those in the binding heads of agreement and there was a clear intention of forming a contract at that time, as set out in a clause in the agreement. This is a case of the first category, where they had agreed to the terms of the contract and intended to be bound but wished to restate the agreement in a more precise manner. The CGT event happened in the in the 2016-17 financial year.

Capital gain from equity in an entity with newly acquired assets

Section 115-45 of the ITAA 1997 is concerned with the integrity of the CGT discount. Broadly, this section prevents a capital gain on a share from being a discount capital gain if the owner of the share, assuming they owned the assets underlying the share and had sold them rather than the share, would not have had discount capital gains on the majority of CGT assets (by cost and value) underlying the share.

Specifically, subsection 115-45(2) of the ITAA 1997 provides that a capital gain made from a CGT event happening to a share in a company is not a discount capital gain if the following conditions are all satisfied:

1. Just before the CGT event the taxpayer and their associates beneficially owned at least 10% by value of the shares in the company (subsection 115-45(3) of the ITAA 1997);

2. The total of the cost bases of CGT assets that the company owned at the time of the CGT event and had acquired less than 12 months before then is more than half of the total of the cost bases of all the CGT assets that the company owned at the time of the CGT event (subsection 115-45(4) of the ITAA 1997); and

3. The notional net capital gain of the company worked out under subsection 115-45(6) is more than half of the notional capital gain worked out under subsection 115-45(7) of the ITAA 1997 (subsection 115-45(5) of the ITAA 1997).

As to the first point, Trust X was the beneficial owner of all of the shares in Company B, so therefore meet the first criteria.

Company B only had one asset which was the licence agreement and the rights associated with that. They acquired the lease in 201Y, which is more than 12 months before Trust X’s sale of the shares. The only other asset that may be considered is the development application, however once the application is approved it vests in the land; Sustainable Planning Act 2009 section 245. It is unnecessary to look to the third test as all three must be met to make the event ineligible to meet the CGT discount rules.

Conclusion

The sale of shares in Company B meets the basic conditions to be eligible for the CGT discount and the CGT event looks to happen in the 201Z financial year. The CGT event doesn’t meet the three criteria set out in Section 115-45 of the ITAA 1997. Therefore it is eligible for the general CGT discount.

Question 2

Summary

Trust X will not be a small business CGT entity as its aggregated turnover will be above $2 million.

Detailed reasoning

CGT small business entity

Subsection 152-10(1AA) of the ITAA 1997 sets out that you are a CGT small business entity for the income year if you are a small business entity and if under section 328-110 of the ITAA 1997 you were a small business entity if each reference to $10 million were a reference to $2 million.

The modified rule in section 328-110 sets out that you must carry on a business in the current year. Also, the aggregated turnover in the previous year or current year must be less than $2 million. Your aggregated turnover is the relevant annual turnovers for any entities that are connected to you during the income year.

Entity ‘connected with’ you

Subsection 328-125(1) of the ITAA 1997 explains that an entity is connected with another entity if:

a) either entity controls the other entity in a way described in this section; or

b) both entities are controlled in a way described in this section by the same third entity.

An entity will control a discretionary trust for an income year if in any of the four income years before that year the trustee paid to the entity an amount of income or capital from the trust that was in excess of XX% of the income or capital paid by the trust for that year: section 328-125(4) of the ITAA 1997.

As Trust X has received XXX% of Trust Y distributions in the 201Y financial year, it controls Trust Y.

Subsection 328-125(2) of the ITAA 1997 provides that an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates: beneficially owns, or has the right to acquire beneficial ownership of, interest in the other entity that give the right to receive at least XX% (the control percentage) of any distribution of income or capital by the other entity. As Trust Y is the XXX% shareholder of Company C, it will control Company C.

Section 328-125(7) of the ITAA 1997 sets out that the control tests for the ‘connected with’ rules are designed to look through business structures that include interposed entities. If an entity (the first entity) directly controls a second entity, and the second entity controls (whether directly or indirectly) a third entity, the first entity is also taken to control the third entity. Therefore Trust X will also be considered to control Company C.

The aggregated shareholding by Company C and Trust Y of Company D will total XX%, which means that Trust X will be considered to control Company D for the purposes of the tests set out in the Act.

However, as the control percentage is below 50%, subsection 328-125(6) of the ITAA 1997 sets out that this is a rebuttable position. To show this there must be another entity or group of entities that has control as it is determined under the division.

In working out the third entity's control percentage, the interests of any affiliates of the third entity are taken into account. The third entity must control the company in the way described in section 328-125 of the ITAA 1997. Unless those conditions are met, the Commissioner cannot determine that the first entity does not control the company.

Company D has multiple shareholders. Company C and Trust Y are considered to hold the same combined shareholding in the company. None of the other shareholders are affiliated or connected with each other and act independently. The reviews and strategic planning are done with each shareholder getting a single vote. Any shareholder can initiate a vote under the constitution whereby their votes are weighted according to their equity ownership, but this has never happened. Each of the shareholders acts independently.

As no other entity has control of Company D for the purposes of section 328-125 of the ITAA 1997, Trust X would control Company D. This means that Trust X would include Company D’s turnover in its aggregated turnover, which puts them above the $2 million threshold and they do not qualify as a small business CGT entity.

Conclusion

Trust X does not meet the test to be considered a small business CGT entity for the purposes of subdivision 152-A of the ITAA 1997 and would not be able meet the basic conditions for relief on those grounds.