Private ruling: CGT - cost base of unallocated shares held on Trust
Date of advice: 25 November 2016
Published: April 2017

Ruling: Q1: For the purposes of subsection 112-20(1) of the Income Tax Assessment Act 1997 (ITAA 1997), is XYZ Ltd's first element of the cost base in the unallocated shares the market value of those unallocated shares at a certain date? | A1: Yes. | Q2: For the purposes of section 100-35 of the ITAA 1997, will a disposal of the unallocated shares result in a capital gain to XYZ Ltd, to the extent that the proceeds received or that are entitled to be received from the disposal are greater than the cost base? | A2: Yes.

Relevant facts and circumstances: Employee Share Plan and Allocated Shares: By a certain Trust Deed made (the Deed), XYZ Ltd ('XYZ') established an employee share plan known as the XYZ Share Plan ('the Plan') under which certain employees of XYZ and its associated companies could acquire shares in XYZ's former ultimate holding company, Y Incorporated ('the Holding Company'). A copy of the Trust Deed and the Employee Share Scheme Plan were supplied with the private ruling application. XYZ appointed a third party Trustee ('the trustee') to administer the Plan. The Plan was set up to operate under the provisions of the former Division 13A of the Income Tax Assessment Act 1936 (ITAA 1936) (operating before 1 July 2009) pursuant to which the employee had an election to be taxed upfront on the discount in the year of acquisition or defer taxation on the discount. Clauses of the Deed provide definitions relevant to the Plan and this private ruling. The first transactions within the Plan occurred with shares allocated on a certain date (via on market purchase). Plan participation was offered and taken up by employees throughout the duration of the Plan and was offered either as: 1. Remuneration and incentive payment : as part of the annual bonus arrangements subject to the terms and conditions of the Plan; 2. A Special Share Offer : the selected employees are subject to minimum service and performance criteria. Employees were able to purchase the Shares in the Plan by payroll deduction. The vast majority of Participants were in category # 2 type plan. Unallocated Shares and termination of the Plan: On a certain date the trustee acquired a number of shares in the Holding Company on behalf of the Trust after XYZ remitted cash to the trustee for the acquisition of these shares. At a certain date those shares made up the unallocated shares account (the 'unallocated shares') in the Plan. On a certain date, the Board of XYZ ('the Board')determined that there would be no further offers or allocations of shares under the Plan; and no further offers or allocations of shares have been made under the Plan. The last allocation of shares under the plan was on a certain date. A portion of shares in the Holding Company remained unallocated shares under the Plan. Resulting Trust: From a certain date, a resulting trust was created in favour of XYZ such that XYZ became absolutely entitled to the interest in the trust capital (the 'unallocated shares') from that date. There are no other beneficiaries entitled to the unallocated shares. Assumptions The Board will direct the trustee to dispose of the unallocated shares on the open market during the period covered by the private ruling.

Relevant legislative provisions: Income Tax Assessment Act 1997, Section 100-35 | Income Tax Assessment Act 1997, Section 100-40 | Income Tax Assessment Act 1997, Section 104-5 | Income Tax Assessment Act 1997, Section 104-75 | Income Tax Assessment Act 1997, Subsection 104-75(1) | Income Tax Assessment Act 1997, Section 106-50 | Income Tax Assessment Act 1997, Section 108-5 | Income Tax Assessment Act 1997, Section 109-5 | Income Tax Assessment Act 1997 , Section 110-25 | Income Tax Assessment Act 1997, Subsection 112-20(1) Question 1 | Summary | Section 110-25 of the Act contains the general rules about the cost base of a CGT asset. For the purposes of that section, the first element of the cost base of a CGT asset is the money paid or that was required to be paid, and the market value of any other property that was given or required to be given, in respect of acquiring the asset, at the time it was acquired. | However, in certain circumstances the modification rules in Division 112 of the Act will override section 110-25 in the calculation of the cost base and reduced cost base of a CGT asset. In this case, the market value substitution rule at subsection 112-20(1) will apply, meaning the cost base or reduced cost base of the unallocated shares will be the market value of those unallocated shares at the time XYZ acquired them on a certain date. Detailed reasoning | At a certain date, the Board made a determination that there would be no further allocations of shares to participants under the XYZ Share Plan ('the Plan'). At that point in time the express trust failed and a resulting trust arose. From that point onwards, the interest in the trust capital (the “unallocated shares”) has been held by the trustee on resulting trust for XYZ. There are no other beneficiaries entitled to the unallocated shares. | Section 108-5 of the Act provides that a CGT asset is any kind of property; or a legal or equitable right that is not property. Shares in a company are an example of a CGT asset. The 'unallocated shares' are therefore a CGT asset for the purposes of section 108-5. | Section 109-5 sets out the specific rules for the circumstances in, and the time at which, you acquire a CGT asset. As per the table at subsection 109-5(2), for CGT purposes, from the time where you as the beneficiary under a Trust become absolutely entitled to a CGT asset as against the trustee, the asset is treated as being your asset (instead of the asset of the trust). Effectively, from just after the time you become absolutely entitled to a CGT asset as against the trustee, any act done in relation to the asset by the trustee is treated as if it had been done by you instead of the trustee. | At the time the express trust failed and a resulting trust arose in favour of XYZ, XYZ became absolutely entitled to the interest in the trust capital (the unallocated shares). Accordingly, the unallocated shares are treated as being the asset of XYZ from the time of acquisition, being a certain date. Any act done in relation to those unallocated shares for CGT purposes will be treated as being done by XYZ rather than the trustee from that date onwards. | It is assumed for the purposes of this private ruling that XYZ will direct the trustee to dispose of the unallocated shares on market during the period covered by this private ruling. As this disposal of a CGT asset will trigger a CGT event, it will be necessary for XYZ to determine the cost base of the unallocated shares. | Section 110-25 of the Act gives the general rules about cost base. For the purposes of this ruling, the Commissioner has considered only the first element of the cost base. The provision states that the first element of the cost base in a CGT asset is the total the money you paid or that was required to be paid in respect of acquiring the asset; and the market value of any other property that was given or required to be given, in respect of acquiring the asset, at the time of acquiring it. | Division 112 contains rules about modifications to the cost base. Specifically, subsection 112-20(1) contains a market value substitution rule. This provides that, in certain circumstances, the first element of your cost base and reduced cost base of a CGT asset you acquire from another entity is its market value (at the time of acquisition). This applies if: | a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from: | i) CGT event D1 happening; or | ii) another entity doing something that did not constitute a CGT event happening; or | b) some or all of the expenditure you incurred to acquire it cannot be valued; or | c) you did not deal at arm's length with the other entity in connection with the acquisition. | In this case, subsection 112-20(1) will apply to the unallocated shares as, upon acquiring the asset at the date specified, XYZ did not incur any expenditure but rather became absolutely entitled to the asset. None of the exceptions in Subsection 112-20(1) apply. Therefore, the first element of the cost base and reduced cost base of the unallocated shares that XYZ acquired when it became absolutely entitled to the trust capital, will be the market value of those unallocated shares at the date specified. | Accordingly, while an entity would generally work out the cost base or reduced cost base of the unallocated shares on disposal in accordance with Section 110-25, in this case the market value substitution rule contained in Subsection 112-20(1) also applies such that XYZ's cost base or reduced cost base in the unallocated shares will be the market value of those unallocated shares at the date specified. | Question 2 | Summary | For the purposes of section 100-35 of the Act , a disposal of the unallocated shares will result in a capital gain to XYZ to the extent that the proceeds received, or are entitled to be received, from the disposal are greater than the cost base. This is because the disposal of the unallocated shares will be a CGT event that is treated as happening to XYZ; and as a result of a CGT event a capital gain will be calculated by subtracting the cost base of the asset from the capital proceeds. Where the capital proceeds are greater than the cost base, there will be a capital gain. Detailed reasoning | Section 100-35 provides that for most CGT events, you make a capital gain if you receive (or are entitled to receive) capital amounts from the CGT event which exceed your total costs associated with that event. | Section 100-40 provides that for most CGT events, the capital amounts you receive (or are entitled to receive) from the event are called the capital proceeds. For most CGT events, when calculating a capital gain your total costs associated with the event are called the cost base of the CGT asset. | To calculate the capital gain or loss resulting from a CGT event, the cost base is subtracted from the capital proceeds (in accordance with Section 100-45 of the Act). If the proceeds exceed the cost base, the difference is your capital gain. As discussed above, the application of section 109-5 means the unallocated shares are treated as being the asset of XYZ from the time of acquisition, being the date specified. Any act done in relation to those unallocated shares for CGT purposes will be treated as being done by XYZ rather than the trustee from that date onwards. This includes the direction by XYZ of the trustee to dispose of the unallocated shares on the open market. | The unallocated shares are a CGT asset for the purposes of section 108-5. The disposal of a CGT asset is a CGT event (event number A1), as provided by section 104-5 of the Act. Therefore, the disposal of the 'unallocated shares' on market will be a CGT event which is treated as being done by XYZ. | Consequently, if XYZ receives or is entitled to receive capital proceeds from the disposal of those unallocated shares that are greater than the cost base of the unallocated shares, the disposal will result in a capital gain for the purposes of section 100-35 of the Act.