Private ruling: CGT - value shifting consequences
Date of advice: 1 September 2023
Published: 9 October 2023
Ruling period: 1 July YYYY to 30 June XXXX
Date scheme commenced: 1 July YYYY

Ruling: Q1: Does converting the ordinary shares to an A Class share and a B Class share and allotting the C Class share and D Class share have retrospective effect to the date of incorporation? | A1: The Commissioner can't rule on this question. | Q2: Does converting the ordinary shares to an A Class share and a B Class share have any capital gains tax consequences? | A2: No. | Q3: Does allotting the C Class share and the D Class share have any capital gains tax consequences? | A3: No. | Q4: Does allotting the E Class share have any capital gains tax consequences? | A4: No.

Relevant facts and circumstances: The company's share register doesn't match ASIC records about its share structure. It claims it issued multiple classes of shares with discretionary and differential dividend rights back when the company was incorporated. ASIC records show it has only ordinary shares on issue. 1. The company was registered with ASIC on date X (many years ago). 2. ASIC records show Person A and Person B own 2 ordinary shares (1 each) non-beneficially (ie, on trust). 3. The company's constitution permits the directors to issue different classes of shares which rank equally with ordinary shares or with different rights attached. 4. The client's advisers have been instructed that the clients intended the company to have the following share structure on incorporation, being 4 lots of shares in different classes issued to Person A, Person B, Person C, and Person D: • 1 x A Class share: Person A • 1 x B Class share: Person B • 1 x C Class share: Person C • 1 x D Class share: Person D. 5. The applicants have given the ATO a collection of documents. We summarise these documents in Table 1. Those documents include: • ASIC records showing Person A and Person B as owning ordinary shares non-beneficially • the company's minutes of an inaugural directors' meeting, which record a resolution to convert Person A's ordinary share into an A Class share, and allot B, C, and D Class shares to Person B, Person C, and Person D respectively • the company's member register, which shows Person A, Person B, Person C, and Person D as holding shares • minutes of the company's resolution to pay a dividend on date Y (a few years ago) to the trustee of a family trust • minutes of the company's resolution to pay dividends to the A Class share and B Class share on date Z (in a recent income year). 6. The applicants say it's unclear why the share reclassification and allotment weren't correctly registered with ASIC. 7. Person E was born after date X, and the company intended to issue Person E with 1 x E Class share, but this allotment never happened. 8. The company wishes to rectify the share status by making the following changes with retrospective effect from incorporation: • converting Person A's 1 ordinary share (not beneficially held) to 1 x A Class share (beneficially owned) • converting Person B's 1 ordinary share (not beneficially held) to 1 x B Class share (beneficially owned) • allotting Person C 1 x C Class share (beneficially owned) • allotting Person D 1 x D Class share (beneficially owned). 9. The company also wishes to allot Person E 1 x E Class share with prospective effect in the current income year. 10. <Paragraph removed for privacy reasons.> Applicant's submissions and other comments 11. The applicants submit that the company decided to pay the dividend on date Y to a family trust based on advice from previous accountants. They submit that the accountants assumed that Person A and Person B held the shares on trust, and since there was only one trust in the group, they must have held that on trust for the family trust. This submission is consistent with an email from the company's accountants around that time. 12. The applicants submit that they should be permitted to rectify ASIC records based on the general law doctrine of rectification based on a mistake - the company always intended to issue A, B, C, and D class shares to Person A, Person B, Person C, and Person D (1 each respectively). 13. The applicant gave us copies of the company documents which we summarise in Table 1. Table 1: document summary Table 1: Applicant gave copies of the company documents summarised in Table 1 Document Summary The company's constitution Clause X allows the directors to issue shares in different classes. Clause X says the company doesn't recognise a person as holding a share on trust except as required by law. Clause X says persons entered on the member register are entitled to receive a certificate. Clause X says the directors may declare dividends on one or more classes of shares to the exclusion of other classes and may declare dividends in different proportions. ASIC extract 2 ordinary shares only: • 1 for Person B (beneficially held: no), and • 1 for Person A (beneficially held: no). the company's member register • Accountant F: 1 ordinary share, began at incorporation, ceased a couple of days later (transferring 1 ordinary share). • Person A: 1 share, received by a transfer a couple of days after incorporation. • Person B: 1 share, allotted a couple of days after incorporation. • Person C: 1 share, allotted a couple of days after incorporation. • Person D: 1 share, allotted a couple of days after incorporation. the company's list of applications and allotments • Accountant F: 1 share beginning on incorporation. • Person B: 1 'B' Class beginning on incorporation. • Person C: 1 'C' Class beginning on incorporation. • Person D: 1 'D' Class beginning on incorporation. the company's share certificates Copies of subscriptions and share certificates for Person C and Person D dated a few days after incorporation. the company's inaugural directors meeting • Share transfer of 1 ordinary share from Accountant F to Person A. • Reclassification of that share to a Class A share. • Resolved to make the following allotments: o 1 B Class share to Person B o 1 C Class share to Person C o 1 D Class share to Person D. the company's annual return lodged in the year of incorporation Copy of annual return lodged few days after incorporation records 2 ordinary shares owned by Person A and Person B (beneficially owned). the company's dividend resolution - date Y the company's shareholder distribution statement - day following date Y The company resolved to pay (and paid) a dividend on date Y to ordinary shares (to the trustee for the family trust). the company's dividend resolution - shortly before date Z Dividends to the A Class and B Class shares. Assumptions Despite ASIC records, Person A and Person B always held their shares beneficially, not on trust for any other person. Before making any changes, the company won't have any agreement or understanding with any or all of its shareholders that it will declare amounts or proportions of dividends on particular classes of shares. After the steps proposed by the ruling scheme, no single shareholder will have rights (in their capacity as a shareholder) to determine whether the company declares a dividend, or how any dividend is allocated between shareholders or share classes.

Relevant legislative provisions: Schedule 1 to the Taxation Administration Act 1953 | Section 357-55 | Section 359-5 | Income Tax Assessment Act 1997 Section 102-25 | Section 104-10 | Section 104-20 | Section 104-25 | Section 104-35 | Section 104-55 | Section 104-60 | Section 104-155 | Section 104-250 | Section 108-5 | Section 116-30 | Section 723-1 | Section 723-10 | Section 723-15 | Section 725-50 | Section 725-70 | Section 725-90 | Section 725-145 | Section 725-150 | Section 727-5 | Section 727-100 | Section 727-105 | Section 727-110 | Section 727-150 | Section 727-155 | Section 727-400 | Section 727-520 | Section 977-5 | Section 995-1

Reasons for decision: Detailed Reasoning - Detailed reasoning: The Commissioner can't rule on this question because it's about general law, not a provision in an Act or regulation of which the Commissioner has the general administration. 14. Section 359-5 of Sch 1 to the TAA says the Commissioner may issue a private ruling on the way in which he or she considers a relevant provision applies or would apply to you in relation to a specified scheme. 15. Section 357-55 of Sch 1 to the TAA says provisions of Acts and regulations of which the Commissioner has the general administration are relevant for rulings if they are about listed topics, which include tax, other taxes, duties, and levies, and their administration or collection. 16. Section 995-1 says 'tax' means income tax. 17. The company's internal records suggest four family members have always held shares since incorporation consistent with their proposed rectification. The company's minutes of its inaugural directors' meeting show it resolved to convert Person A's ordinary share into an A Class share, and allot shares to Person B (1x B Class), Person C (1x C Class), and Person D (1x D Class). The company's member register and share certificates are consistent with that record. 18. However, ASIC records show Person A and Person B as each holding 1 ordinary share (2 in total) but not as beneficial holders - ie, on trust. 19. The applicants haven't explained why the company's internal records and ASIC records are inconsistent. 20. Determining whether the company's intended share structure (of having Person A, Person B, Person C, and Person D as each owning one class share) took effect from incorporation is a question of general law, not tax law. This question could require the decision maker to determine whether: • the company's member register or ASIC records have priority (or whether either is conclusive) in establishing its share structure • (if ASIC records have priority) it's possible to amend ASIC records to reflect the company's records - either through company law provisions or the general law doctrine of rectification • any amendment to ASIC records could operate retrospectively to incorporation. 21. The Commissioner can't rule on those questions because they aren't about relevant provisions. They don't involve provisions of acts or regulations of which the Commissioner has general administration and aren't about topics listed in section 357-55 of Sch 1 to the TAA (taxes, duties, levies, or their administration). | Detailed Reasoning - Question 2: Does converting the ordinary shares to A Class and B Class shares have any capital gains tax consequences? | Detailed Reasoning - Answer: No. | Detailed Reasoning - Question 3: Does allotting the C Class share and the D Class share have any capital gains tax consequences? | Detailed Reasoning - Answer: No. | Detailed Reasoning - Question 4: Does allotting the E Class share have any capital gains tax consequences? | Detailed Reasoning - Answer: No. | Summary: 22. The company's proposal won't have any capital gains tax consequences under the scheme - there won't be either a capital gain or loss or a value shift. • The only possible CGT event is CGT event D1 when Person A and Person B's ordinary shares convert into A Class and B Class shares. • That event won't create a capital gain because the company will have no capital proceeds from the transaction. • The value shifting rules won't apply either. There's no direct value shift because, absent any agreement or arrangement about future dividends, the class shares have no market value. • The indirect value shifting rules don't apply because the potential gaining shareholders aren't companies or trusts. • The rules in Division 723 won't apply to reduce any capital loss because the relevant conditions won't be met. | Detailed Reasoning - Detailed reasoning: Since we won't determine whether the company's share register or ASIC records correctly show the company's share structure, we've considered how the tax law applies under both possibilities. 23. We explained in Question 1 that we can't determine whether the company's true shareholding, since registration, is reflected in ASIC records (2 ordinary shares, one each to Person A and Person B) or in the company's internal company records (4 class shares, one each to Person A, Person B, Person C, and Person D). 24. We therefore have addressed what the tax implications would be under each scenario. 25. In these reasons: • Scenario 1 refers to the proposed scheme, dealt with under the assumption that the changes to the company's share register described in paragraph 4 of the ruling facts happened shortly after incorporation with effect from that time • Scenario 2 refers to the proposed scheme, dealt with under the assumption that those changes didn't happen shortly after incorporation, but will only take effect prospectively if the company takes appropriate corrective steps. 26. We have assumed that Person A and Person B have always held their shares beneficially for themselves, not on trust. | Detailed Reasoning - The CGT rules calculate gains and losses from CGT events and include net capital gains in assessable income.: 27. Very broadly, the CGT rules calculate gains and losses from CGT events and include net capital gains in assessable income. • Division 102 includes a net capital gain for an income year, determined by netting gains and losses from CGT events, in your assessable income. • Division 104 is about CGT events. • Many CGT events happen in respect of CGT assets. • CGT assets include shares in companies: see Note 1 to section 108-5. • Generally, you determine capital gains and capital losses by comparing the capital proceeds (usually worked out under Division 116) with the asset's cost base (usually worked out under Divisions 110 and 112) unless varied by specific provisions. 28. The rules about CGT events took effect in 1998. They are in Part 3-1 of the Income Tax Assessment Act 1997 , which commenced in June 1998, [1] replacing former rules in Part IIIA of the Income Tax Assessment Act 1936 . 29. We won't address how the previous CGT rules would have applied shortly after incorporation when the relevant shares were transferred, converted, or allotted. [2] 30. We summarise and apply some potentially relevant CGT events in Table 2. 31. We haven't addressed CGT events relevant to trusts. Very broadly, CGT events E1 and E2 may happen if you create a trust over a CGT asset or transfer a CGT asset to a trust: see sections 104-55 and 104-60. We have assumed that Person A and Person B always held their shares beneficially, not on trust. The facts don't suggest that any shareholder holds, will begin to their shares on trust for anyone else under the proposed scheme, or will transfer shares to any trust. Therefore, CGT events E1 and E2 aren't relevant. The proposed scheme may cause CGT event D1 to happen under Scenario 2, but not otherwise. Converting ordinary shares into A and B Class shares will create new rights in Person A and Person B but issuing new shares doesn't trigger a CGT event. But CGT event D1 won't happen today if Person A and Person B's shares were converted shortly after incorporation. Table 2: CGT events potentially relevant to this ruling Table 2: CGT events potentially relevant to this ruling | Detailed Reasoning - Discussion: CGT event A1 - disposal of a CGT asset: section 104-10. Subsection 104-10(1) says CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(2) says you dispose of a CGT asset if there's a change of ownership from you to another entity. (The ATO view is that CGT event A1 requires a change in beneficial ownership, but not necessarily legal ownership. [3] ) | Detailed Reasoning - Scenario 1: CGT event A1 won't happen under the proposed scheme under this scenario. Under scenario 1, A, B, C, and D Class shares were converted or allotted to certain parties shortly after incorporation and the same parties continue to hold them today. Shares are CGT assets, but the shares won't change ownership. We've assumed that Person A and Person B always held their shares beneficially, not on trust, so there won't be any change of ownership from themselves as trustees to themselves beneficially. | Detailed Reasoning - Scenario 2: CGT event A1 won't happen under Scenario 2 either. Converting Person A and Person B's ordinary shares into A and B Class shares won't change ownership from themselves to another entity. As for Scenario 1, there won't be any change of ownership from themselves as trustees to themselves beneficially. There also won't be a change of ownership from one entity to another for the allotments; the company will be creating creates shares in itself by allotting them to Person C, Person D, and Person E, not disposing something it already owned. CGT event C1 - loss or destruction of a CGT asset: section 104-20. Subsection 104-20(1) says CGT event C1 happens if a CGT asset you own is lost or destroyed. | Detailed Reasoning - Scenario 1: CGT event C1 won't happen. The A, B, C, and D Class shares still exist with the same rights and haven't changed since shortly after incorporation. Allotting a new E Class share to Person E today won't destroy a share or other CGT asset. | Detailed Reasoning - Scenario 2: CGT event C1 won't happen. Person A and Person B will convert their ordinary shares into A and B Class shares. That conversion will change their rights to dividends: as ordinary shareholders, they would have shared equally in any dividend. As A and B Class shareholders, they may receive dividends in different proportions or to the exclusion of other classes, but may equally be excluded. However, they will still hold the same shares, just with different rights, so they won't have a CGT asset end. CGT event C2 - cancellation, surrender, and similar endings: section 104-25. Subsection 104-25(1) says CGT event C2 happens if your ownership of an intangible CGT asset ends in specified circumstances, including the CGT asset being released, discharged, or satisfied, or being abandoned, surrendered, or forfeited. The Macquarie Dictionary says 'intangible asset' means an asset with value but without physical properties. [4] | Detailed Reasoning - Scenario 1 and 2: CGT event C2 won't happen for the same reasons as CGT event C1 won't happen: see the previous row in this table. CGT event D1 - creating contractual or legal or equitable rights: section 104-35. Subsection 104-35(1) says CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. Paragraph (5)(c) says this doesn't happen if a company issues or allots equity interests or non-equity shares, in the company. Note: CGT event D1 only applies if no other CGT event (except CGT event H2) happens: see subsection 102-25(3). | Detailed Reasoning - Scenario 1: CGT event D1 won't happen. For the A, B, C, and D Class shares, no rights have been created because nothing has happened since shortly after incorporation. The company will create rights in Person E by issuing him or her with a share, but paragraph 104-35(5)(c) prevents this causing CGT event D1 to happen. | Detailed Reasoning - Scenario 2: CGT event D1 will happen when Person A and Person B convert their ordinary shares into A and B Class shares. When the company converts their shares, they will change their rights to dividends: as ordinary shareholders, they would have shared equally in any dividend. As A and B Class shareholders, they may receive dividends in different proportions or to the exclusion of other classes but may equally be excluded. That creates fresh rights in Person A and Person B. However, this won't cause the company, Person A, or Person B to have a capital gain for reasons we discuss in paragraphs 32 to 36. CGT event H2 - receipt for event relating to a CGT asset: section 104-155. Subsection 104-155(1) says CGT event H2 happens if an act, transaction, or event occurs in relation to a CGT asset that you own, and the act, transaction, or event doesn't result in an adjustment being made to the asset's cost base or reduced cost base. However, subsection 104-150(5) says CGT event H2 doesn't happen in listed circumstances, including where the act, transaction, or event requires you to do something that's another CGT event that happens to you, or where the company issues or allots equity interests or non-equity interests in the company. Note: CGT event H2 only applies if no other CGT event happens: see subsection 102-25(3). | Detailed Reasoning - Scenario 1: CGT event H2 won't happen. For the A, B, C, and D Class shares, no act, transaction, or event has happened since shortly after incorporation. Allotting an E Class share to Person E won't cause CGT event H2 to happen because this event doesn't happen for allotting shares. | Detailed Reasoning - Scenario 2: CGT event H2 won't apply. Converting Person A and Person B's shares from ordinary shares to A and B Class shares would be an act, transaction, or event - it isn't immediately clear to us whether that transaction would result in adjustments to the cost base, so it's possible CGT event H2 could happen. But we've concluded that CGT event D1 will happen for the conversion, so CGT event H2 won't apply even if it did happen. CGT event H2 won't happen when the company allots the C, D, and E Class shares. CGT event K8 (direct value shifts affecting your equity or loan interest in a company or trust): section 104-250. Subsection 104-250(1) says CGT event K8 happens if there's a taxing event generating a gain for a down interest under section 725-245. Broadly, section 725-245 says a taxing event generating a gain happens to the extent that a direct value shift is from down interests to up interests in circumstances listed in a table in that section. | Detailed Reasoning - Scenario 1 and 2: We conclude in paragraphs 40 to 53 that a direct value shift won't happen under either scenario. Therefore, CGT event K8 won't happen. While CGT event D1 will happen under Scenario 2, it won't cause anyone to have a capital gain or loss. 32. For CGT event D1, subsection 104-35(3) says you make a capital gain if the capital proceeds from creating the right are more than the incidental costs you incurred relating to the event, and a capital loss if the capital proceeds are less. 33. Very broadly, capital proceeds are normally the money and the market value of property you receive in respect of a CGT event happening: section 116-20. 34. There's a market value substation rule which applies to capital proceeds. Subsection 116-30(1) says if you received no capital proceeds from a CGT event, you are taken to have received the market value of the CGT asset that's the subject of the event. Subsection 116-30(2) says your capital proceeds are replaced with the market value if some of the proceeds cannot be valued, or the capital proceeds are more or less than the market value and you weren't dealing at arm's length, or the event is CGT event C2. However, subsection (1) doesn't apply to CGT event D1: see paragraph 116-30(3)(b). 35. Under Scenario 2, CGT event D1 will happen for the conversion, but no entity will have a capital gain. Under CGT event D1, the entity creating the rights has the capital gain or loss, not the recipient. The company is the one creating rights in Person A and Person B by converting ordinary shares to A and B Class shares; Person A and Person B as recipients won't have a gain or loss. The company won't receive any money or property for the conversion. That means it won't have any capital proceeds, so the relevant market value substitution rule is in subsection 116-30(1). But that rule doesn't apply to CGT event D1. The rule in subsection 116-30(2) only applies where you have some proceeds, but they are either different to market value or can't be valued. The company's incidental costs for the conversion are likely to be nil or minimal. It follows that the company won't have a capital gain and won't have a significant capital loss. 36. It follows that the scheme (under either Scenario 1 or 2) won't have capital gains or losses from CGT events. | Detailed Reasoning - The value shifting rules recognise gains or adjust cost base where events shift economic value between entities.: 37. Very broadly, the value shifting rules adjust tax consequences (by creating gains or adjusting cost base) where certain events to do with companies or trusts shift economic value between different entities. 38. There are two types of value shifts: direct value shifts under Division 725, and indirect value shifts under Division 727. • Direct value shifts happen when a scheme causes a decrease in the market value of some interests in an entity and either a) an increase in the market value of other interests in that entity or b) the issue of equity interests in the entity at a discount. • Indirect value shifts broadly apply to transactions that shift economic value between entities that have a common controller or owner. 39. There are also rules in Division 723 for reducing losses caused by certain realisation events. Direct value shifts happen when a scheme reduces the market value of some of an entity's equity or loan interests, while either increasing the market value of other interests, or issuing new interests at a discount. 40. Section 725-50 explains when a direct value shift has consequences under Division 725. It says a direct value shift under a scheme involving equity or loan interests in a target entity only has consequences if conditions listed in that section are met. 41. Section 725-50 is only relevant to a direct value shift. 42. Section 725-145 is about when there's a direct value shift. Subsection 725-145(1) says there's a direct value shift under a scheme involving equity or loan interests in a target entity if three conditions are met. We'll describe and apply them in Table 3. 43. 'Equity or loan interest' includes shares in companies. Section 727-520 says an equity or loan interest in an entity includes primary equity interests. Item 1 of the table in subsection 727-520(3) says for a company, 'primary equity interests' include shares in that company. 44. The company's scenario is an arrangement involving equity interests in an entity: the company proposes to convert or issue shares in itself - shares in the company are 'primary equity interests' and therefore 'equity or loan interests' as defined. 45. For completeness, we'll address two excluding rules. • A direct value shift will only have consequences under Division 725 if the sum of decreases in market value under the scheme is at least $150,000: see subsection 725-70(1). • Broadly, a direct value shift won't have consequences under Division 725 if the direct value shift depends on a state of affairs which will cease to exist within 4 years: see section 725-90. A direct value shift won't happen because the condition that equity or loan interests must be issued at a discount, or have their market value increase under the scheme, won't be met. Table 3: Conditions for a direct value shift (section 725-145) Table 3: Conditions for a direct value shift (section 725-145) | Detailed Reasoning - Discussion: First condition:there's a decrease in the market value of one or more equity or loan interests in the target entity: paragraph (1)(a) | Detailed Reasoning - Scenario 1: Not met. Before the scheme, the company has four classes of shares with discretionary and differential dividend rights. After issuing the E Class share, it will have five classes of shares with similar discretionary and differential rights. We explain at paragraph 50 that the class shares won't have any market value. It follows that the change from four to five classes won't cause any decrease in market value. | Detailed Reasoning - Scenario 2: Met, because the market value of Person A and Person B's shares will decrease. Before the scheme, the company has two ordinary shares, with Person A and Person B holding one each. They would have a quantifiable market value as their dividend and capital rights are equal and determinable. Each would receive 50% of any dividend, and 50% of any capital distribution. After the scheme, their ordinary shares will become A and B Class shares, with discretionary and differential rights. We explain at paragraph 50 that the class shares won't have any market value. It follows that changing their ordinary shares under the scheme will decrease the market value of their shares to nil. Second condition:the decrease is reasonably attributable to one or more things done under the scheme, and it occurs at or after the time when the thing (or first of those things) is done: paragraph (1)(b) | Detailed Reasoning - Scenario 1: Not met, because we concluded in row 1 that there's no decrease in market value under the scheme. | Detailed Reasoning - Scenario 2: Met. The decrease in market value we identified in row 1 in this table will happen because the company will change its ownership from where all shares having equal rights, into multiple share classes, each with discretionary and differential dividend rights. That change causes the market value of the former ordinary shares to reduce to nil. Third condition:either (or both) subsections (2) or (3) are satisfied: paragraph (1)(c). | Detailed Reasoning - Scenario 1 and 2: Not met. Subsection (2) requires that: • one or more equity interests in the target entity are issued at a discount • the issue is attributable, or reasonably attributable, to at least one of the relevant things • the issue occurs at or after that time. | Detailed Reasoning - Scenario 1 and 2: Not met. The scheme, under both Scenario 1 and Scenario 2, will involve issuing at least one equity interest: C, D, and E Class shares for Scenario 1, and the E Class share for Scenario 2. However, none of those shares will be issued at a discount for reasons we explain in paragraphs 46 to 51. Subsection (3) requires that: • there's an increase in the market value of one or more equity or loan interests in the target entity • the increase is reasonably attributable, to at least one of the relevant things • occurs at or after that time. | Detailed Reasoning - Scenario 1 and 2: Not met. Neither Scenario 1 nor Scenario 2 will involve the market value of any existing shares increasing. Absent any special understanding, arrangement, or agreement, (or shareholder rights or control over dividend decisions) issuing new classes of shares with discretionary and differential dividend rights could only decrease value for existing ordinary shareholders. For Scenario 1, existing A, B, C, and D Class shareholders would have no market value before or after the E Class shares are issued, so that won't cause the market value of any existing shares to increase. For Scenario 2, converting shares from ordinary to A and B Class would only reduce the market value of Person A and Person B's shares. Issuing new shares with discretionary and differential dividend rights won't cause a value shift: each class of share will have no market value, and won't be issued at a discount, because nobody would buy the shares without some agreement or understanding that they will be paid dividends. 46. The concept of 'market value' is relevant to determining whether a direct value shift has happened. A direct value shift under section 725-145 will only happen if the scheme causes a decrease in the market value of existing equity or loan interests, and either new equity or loan interests are issued at a discount, or it causes an increase in the market value of other equity or loan interests. Section 725-150 says equity or loan interests are issued at a discount if the market value of the interest exceeds the amount the issuing entity receives; the discount is that excess. 47. The ATO website [5] says that market value is an asset's estimated monetary worth on the open market at a particular time. It's based on the most valuable use of the asset, based on the amount that a willing buyer and a willing seller would agree to in an arm's length transaction. 48. Here, the company proposes to issue at least one class of shares with discretionary and differential dividend rights: C, D, and E Class under Scenario 1, and E Class under Scenario 2. The effect of clause 75 of the constitution is that where there are multiple share classes, dividends can be paid on each class in different proportions to others or to the exclusion of others. That means if a dividend is paid, no class of share has any guarantee of receiving any proportion of a dividend, if one is declared, or indeed any dividend at all. 49. Under Scenario 2, ordinary shareholders will initially have identifiable market value. Before the scheme, the company has two ordinary shares, with Person A and Person B holding one each. They would have a quantifiable value as their dividend and capital rights are equal and determinable. Each share would receive 50% of any dividend, and 50% of any capital distribution. A willing buyer and seller, acting at arm's length, could determine a fair price based on that percentage and the value of the company's assets. 50. But the class shares, either under Scenario 1 or Scenario 2, won't have market value. Rather, each share class has discretionary and differential dividend rights at the director's discretion. We've assumed that before the scheme, there's no understanding or agreement that specified amounts or proportions of dividends will be paid on particular classes of shares. We've also assumed that after the steps proposed by the ruling scheme, no single shareholder will have rights to determine whether the company declares a dividend, or how any dividend is allocated between shareholders or share classes. Under those assumptions, no buyer, acting at arm's length from the seller, would pay anything for a single class share, because they'd be subject to the risk that the directors would declare dividends on other classes and exclude their class. For example, an arm's length buyer of the A Class share may never receive any dividend if the directors choose to pay dividends on the other classes instead. The A Class shareholder would also have no guarantee of receiving definite amounts of capital on winding up because the directors could choose to diminish the company's wealth as dividends. No class shares will have market value because an arm's length buyer, absent any special understanding or agreement or rights about dividends, wouldn't pay anything for them. 51. It follows that the class shares won't be issued at a discount under the scheme. The class shares (E Class under Scenario 1, and C, D, and E Class under Scenario 2) won't have market value, so their issue price (whatever it is) wouldn't be less than market value. 52. This means there's no direct value shift under section 725-145. Neither subsection 725-145(2) nor subsection 725-145(3) will be met under either Scenario 1 or 2. Shares won't be issued at a discount, and the market value of existing shares won't increase, because none of the class shares will have market value. This means that the third direct value shift condition in paragraph 725-145(1)(c) won't be met. 53. Since there's no direct value shift, the scheme won't have consequences under Division 725. The indirect value shifting rules apply when there's a shift of economic benefits from a 'losing entity' to a 'gaining entity' in specified circumstances, including where both losing and gaining entities have common ownership or control. 54. Broadly, the indirect value shifting rules in Division 727 apply where there's a net shift of value from one entity to another: see the objects clause in section 727-5. 55. The indirect value shift rules apply if five conditions in section 727-100 are met. We'll loosely paraphrase them. • First, there must be an indirect value shift under section 727-150. • Second, there must be a losing entity, which is a company or trust. • Third, the losing entity and gaining entity aren't dealing with each other at arm's length under the scheme. • Fourth, either the 'ultimate controller' test in section 727-105, or the 'common ownership nexus' test in section 727-110, must be satisfied. • Fifth, no exclusion in Subdivision 727-C applies to prevent the indirect value rules applying. 56. Broadly, an indirect value shift happens when a losing entity provides economic benefits with greater market value to the gaining entity than the gaining entity gives the losing entity in return: see section 727-150. 57. Section 727-155 says a company issuing shares can be an example of providing an economic benefit. 58. We'll briefly explain the 'ultimate controller' test and 'common ownership nexus' tests. • The ultimate controller test in section 727-105 is met where both the losing entity and the gaining entity have the same ultimate controller (or one controls the other). • Section 727-350 says an ultimate controller is an entity who controls another entity for value shifting purposes, and there's no third entity who controls both entities. • The effect of section 727-355 is that you control a company for value shifting purposes if you, together with your associates, control at least 40% [6] of the company's voting power, dividend rights, or rights to capital contributions, or you (together with your associates) control it in fact. • Section 727-110 says the common ownership nexus test is met where neither the losing entity nor gaining entity have 300 or more members or beneficiaries, and they have a common-ownership nexus in the indirect value shift period. • Section 727-400 sets out rules for determining when 2 entities (which must be either companies or trusts or one of each) have a common-ownership nexus. The indirect value shifting rules won't apply because the relevant gaining entities are individuals who won't pass the tests about common ownership and control. 59. We don't think an indirect value shift will happen under either Scenario 1 or 2. The company is giving at least one class share to new shareholders: E Class under Scenario 1, and C, D, and E Class under Scenario 2. We determined at paragraph 50 that the class shares won't have market value. It follows that the company (a potential losing entity) won't be giving greater market value to the shareholders (potential gaining entities) than it receives in return. 60. Even if there was an indirect value shift, that indirect value shift wouldn't have consequences under Division 727. The fourth condition in section 727-100 is that the losing and gaining entities must meet either the ultimate controller test or the common ownership nexus test. Here, the potential losing entity is the company, and the potential gaining entities are either Person E (for Scenario 1), or Person C, Person D, and Person E (for Scenario 2). The gaining entities are all individuals, not companies or trusts, so they can't have an 'ultimate controller' or a 'common-ownership' nexus. Therefore, the fourth condition won't be met. 61. It follows that the proposed scheme, under either Scenario 1 or Scenario 2, won't have any consequences under the indirect value shifting rules. Division 723 reduces losses caused by realisation events where you previously created a right in an associate where your capital proceeds were less than the right's market value. 62. Speaking very loosely, Division 723 reduces losses caused by realisation events happening to certain non-depreciating assets where relevant entities created rights over the asset which shifted value. The objects clause in section 723-1 says the Division's purpose is to reduce a loss that would otherwise be realised by a realisation event happening to an asset, except a depreciating asset, where value was shifted out of the asset by creating a right over the asset in an associate, and that value shift wasn't taxed. The operative rules are in sections 723-10 and 723-15. 63. We'll quickly list some relevant conditions common to both of those provisions. See subsections 723-10(1) and 723-15(1). • A realisation event must happen to a CGT asset. The effect of section 977-5 is that a 'realisation event', for a CGT asset, is a CGT event (except E1, E10, and G1). • You must create a right in an associate (or another entity but your associate owns it immediately before the realisation time if you created the right before that time). • Creating the right must have involved a CGT event whose capital proceeds were less than the market value of the right when created. 64. Where the provisions apply, they reduce realisation losses: see subsections 723-10(2) through (4) and 723-15(2) and (3). Division 723 won't apply: the only potential realisation event is CGT event D1 when the ordinary shares are converted; here, the market value of the created rights and capital proceeds for that event were both nil. 65. Division 723 won't apply to the scheme. We concluded in Table 2 that the only CGT event which will happen is under Scenario 2, when Person A and Person B's ordinary shares are converted into A and B Class shares will cause CGT event D1 to happen. That's the only potential realisation event. That conversion involved creating rights that will cause a decrease in the shares' market value from a quantifiable amount to nil. We concluded at paragraph 50 that the market value of the A and B Class shares is nil. Therefore, the market value of the rights created by the conversion would also be nil. That means the company's capital proceeds for creating the right (nil) and the market value of the right (also nil) were the same. It follows that Division 723 won't apply to reduce any losses. | Detailed Reasoning - Conclusion: the proposed transactions won't have CGT consequences.: 66. We conclude that the proposed conversions and allotments under the scheme (under either Scenario 1 or Scenario 2 won't have capital gains tax consequences. • The only possible CGT event is CGT event D1 under Scenario 2 when Person A and Person B's ordinary shares convert into A Class and B Class shares. That event won't create a capital gain because the company will have no capital proceeds from the transaction. • The value shifting rules won't apply either. There's no direct value shift because, absent any agreement or arrangement about future dividends (or shareholder rights or control over dividend decisions), the class shares have no market value. The indirect value shifting rules don't apply because the potential gaining shareholders aren't companies or trusts. The rules in Division 723 won't apply to reduce any capital loss because the relevant conditions won't be met. [1] Introduced by the Tax Law Improvement Act (No. 1) 1998 (No. 46 of 1998), commencing on the Royal Assent date of 23 June 1998 - see section 2. [2] We'll make two points for completeness. First, Accountant F may have disposed his or her ordinary share to Person A immediately after registration but wouldn't have had any significant capital gain or loss because the company's value would have likely been nil at that time. Second, under scenario 2, if issuing or converting shares was treated as a disposal under the former CGT rules, there wouldn't have been any significant capital gain or capital loss for the same reason. Taxation Ruling TR 2006/11 Private Rulings says the Commissioner may decline to rule on a question if it doesn't have practical consequences for the client: see paragraph 39. [3] Decision impact statement on Sandini Pty Ltd atf the Karratha Rigging Unit trust & Ors v Ellison & Ors [2018] FCAFC 44; see also Jagot J's judgment in that decision at paragraph [93]. [4] Macquarie Dictionary Publishers (2023), Macquarie Dictionary online, <entry for 'intangible asset'> accessed at https://www.macquariedictionary.com.au on 4 August 2023. [5] ATO (June 2023) 'Market valuation of assets' accessed at https://www.ato.gov.au on 31 July 2023. [6] An entity with at least 40% but less than 50% of rights to votes, dividends, or capital distributions wouldn't control where another entity (together with any associates) in fact controls the company: see subsection 727-355(2).

• hyphenated provisions (eg, section 104-10) are in the Income Tax Assessment Act 1997, except where we mention another act | • Divisions 207, 723, 725, and 727 are in the Income Tax Assessment Act 1997 | • Sch 1 to the TAA means Schedule 1 to the Taxation Administration Act 1953. | Does converting the ordinary shares to an A Class share and a B Class share and allotting the C Class and D Class shares have retrospective effect to the date of incorporation?