ATO ID 2010/121: Capital gains tax: amalgamation of controlled foreign companies - cancellation of shares - capital proceeds for CGT event C2
Date of decision: 7 May 2010
Year of income: Year ended 30 June 2004
Business line: Public Groups and International

Issue
What are the capital proceeds under Division 116 of the Income Tax Assessment Act 1997 ( ITAA 1997) from the cancellation of shares in a controlled foreign company as a result of the company amalgamating with another controlled foreign company in accordance with specific legislation in their jurisdiction of residence?

Decision
The capital proceeds are nil. Having regard to the legislation governing the amalgamation, no money or property is received, or entitled to be received, in respect of the cancellation of the shares for the purposes of section 116-20 of the ITAA 1997. While the market value substitution rule in subsection 116-30(1) of the ITAA 1997 applies to treat the capital proceeds received from the cancellation of the shares as equal to their market value at the time of the event, each share's market value, worked out in accordance with subsection 116-30(3A) of the ITAA 1997, is nil.

Facts
A resident company wholly owns a non-resident subsidiary (Z Co). Z Co wholly owns another non-resident subsidiary (Y Co). Z Co and Y Co amalgamate in accordance with specific legislation in the jurisdiction in which they both reside. Z Co will continue as the amalgamated company. The relevant legislation provides that the amalgamation has the effect that Z Co succeeds to all the assets, liabilities and obligations of Y Co. It further provides that the shares of each amalgamating company, other than the amalgamated company (that is, Z Co), will be cancelled without payment or other consideration. The share cancellation and asset succession all occur on the date that the amalgamation comes into effect. CGT event C2 in section 104-25 of the ITAA 1997 happens to Z Co upon the cancellation of the shares it owns in Y Co.

Reasons for decision
Summary: Under subsection 116-20(1) of the ITAA 1997, the capital proceeds from a CGT event are the total of the money received (or entitled to be received) and the market value of property received (or entitled to be received) in respect of the event happening. As the relevant legislation prohibits Z Co from receiving any payment or other consideration for the cancellation of the Y Co shares, the property transferred to Z Co from Y Co is not considered to be received in respect of CGT event C2 happening to those shares. As a result, the actual capital proceeds received from the CGT event are nil. Where no capital proceeds are received from a CGT event, the market value substitution rule in subsection 116-30(1) of the ITAA 1997 applies to substitute the market value of the CGT asset (worked out at the time of the event) as the capital proceeds. As the CGT event that happens to Z Co is CGT event C2, the market value of the shares is to be worked out on the basis that the share cancellation had not occurred and was never proposed to occur: subsection 116-30(3A) of the ITAA 1997. Where a company transfers assets to a shareholder as part of an arrangement involving the cancellation of their shares, subsection 116-30(3A) of the ITAA 1997 would ordinarily have the effect that the transfer of those assets is disregarded in working out the market value of the shares. However, in this case, the amalgamation legislation treats the transfer of the assets, liabilities and obligations to Z Co as separate and unrelated to the share cancellation. Because of this, it is considered that in working out the market value of the Y Co shares, subsection 116-30(3A) of the ITAA 1997 does not require Z Co to disregard the transfer to it of all of Y Co's assets, liabilities and obligations in compliance with the relevant amalgamation legislation. This is the case even though the cancellation of the shares and the transfer of the assets, liabilities and obligations are part of the one amalgamation arrangement. On this basis, it is accepted that the market value of the shares in Y Co at the time of CGT event C2 will be nil. Thus the market value substitution rule in subsection 116-30(1) of the ITAA 1997 will treat Z Co as having received nil capital proceeds.

Legislative references: Income Tax Assessment Act 1997 section 104-25 Division 116 section 116-20 subsection 116-20(1) subsection 116-30(1) subsection 116-30(3A) Division 727
Related ATO interpretative decisions: ATO ID 2006/265 | ATO ID 2006/266
Subject references: Capital gains Capital gains tax CGT capital proceeds CGT capital proceeds modification market value substitution rule CGT events CGT events C1-C3 - end of a CGT asset