Private ruling: Market value substitution rule
Date of advice: 12 December 2019
Published: February 2020
Ruling period: 01 July 20XX to 30 June 20XX
Date scheme commenced: 01 July 20XX

Ruling: Q1: In relation to the proposed acquisition of the asset by the taxpayer, would the cost base be modified by the market value substitution rule under section 112-20 of the Income Tax Assessment Act 1997 ? | A1: No.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. The taxpayer proposes to acquire certain asset at the proposed price. Market value of the asset could be greater than the proposed price. The taxpayer and the owner of the asset are not related to each other in any way nor have they dealt with each other in other dealings. Both parties are independently represented and have obtained advice from their own advisors in connection with the proposed acquisition.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 102 | Income Tax Assessment Act 1997 Division 104 | Income Tax Assessment Act 1997 Division 100 | Income Tax Assessment Act 1997 Division 110 | Income Tax Assessment Act 1997 Division 112

Reasons for decision: Summary: Unless otherwise stated, all legislative references under Issue 1 are to the Income Tax Assessment Act 1997 (ITAA 1997). Under section 102-20, capital gain or loss can only arise if a CGT event happens. The gain or loss is made at the time of the event. CGT event A1 happens if a taxpayer disposes of a CGT asset: section 104-10. A CGT asset is any kind of property, or a legal or equitable right that is not property: section 108-5. Shares in a company are an example of a CGT asset under subsection 100-25(2). The cost base of a CGT asset is often relevant in finding out if a capital gain has been made from a CGT event which happens in relation to that asset. General rules about cost base are provided in section 110-25. The cost base of a CGT asset consists of five elements: subsection 110-25(1). The first element is the total of: · the money paid, or required to be paid, in respect of acquiring the CGT asset; and · the market value of any other property given, or required to be given, in respect of acquiring the CGT asset: subsection 110-25(2). However, the market value substitution rule in subsection 112-20(1) modifies the general rule by replacing the first element of the cost base and reduced cost base of a CGT asset acquired from another entity with its market value (at the time of acquisition) if: (a) the taxpayer did not incur expenditure to acquire it, except where the 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 incurred to acquire it cannot be valued; or (c) the taxpayer did not deal at arm's length with the other entity in connection with the acquisition. Further, despite paragraph 112-20(1)(c), subsection 112-20(2) states that, if (a) you did not deal at arm ' s length with the other entity; and (b) your acquisition of the CGT asset resulted from another entity doing something that did not constitute a CGT event happening; the market value is substituted only if what you paid to acquire the CGT asset was more than its market value (at the time of acquisition). Subsection 995-1(1) defines 'arm's length' as follows: ...in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance. In Healey v. FC of T (2012) FCA 269 , in determining whether parties deal at arm's length with one another, it was held that the authorities establish the following principles: On the facts, should the proposed acquisition proceed, the taxpayer will make payment of an amount at the proposed price, accordingly, paragraphs 112-20(1)(a) and 112-20(1)(b) do not apply. Based on the facts and circumstances in the case, it is considered that, the taxpayer and the owner deal with each other at arm's length in respect of the proposed acquisition, paragraph 112-20(1)(c) and subsection 112-20(2) are not satisfied. Accordingly, the market value substitution rule in section 112-20 does not apply.

Whether the parties dealt at arm's length is a question of fact: Trustee for the Estate of the late AW Furse No 5 Will Trust v Commissioner of Taxation 91 ATC 4007 (at 4017); Granby Pty Ltd v Federal Commissioner of Taxation 95 ATC 4240; (1995) 129 ALR 503 (at 507); Commissioner of Taxation v AXA Asia Pacific Holdings Ltd 2010 ATC ¶20-224; (2010) 189 FCR 204 (at [106]). | There is a distinction between dealing at arm's length and an arm's length relationship: ACI Operations Pty Ltd v Berri Ltd (2005) 15 VR 312 (at [224]) . Whether the parties did not deal at arm's length is not to be decided by answering whether the parties were not in an arm's length relationship. The fact that the parties are themselves not at arm's length does not mean that they have not, in respect of a particular dealing, dealt with each other at arm's length: Re Hains; Barnsdall v Commissioner of Taxation 88 ATC 4565; (1988) 81 ALR 173 (at 177) ; Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4014-4015) . | Whether the parties dealt at arm's length involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction: Granby Pty Ltd v Federal Commissioner of Taxation 95 ATC 4240; (1995) 129 ALR 503. | At issue is whether the parties have acted separately and independently in forming their bargain: Granby (at 507) ; ACI Operations Pty Ltd (at [226]) (did the parties apply "independent separate wills"); AXA Pacific Holdings Ltd (at [105]) . There should be an assessment of whether the parties dealt with each other as arm's length parties would be expected to behave so that the outcome is a matter of real bargaining: Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4015); Granby (at 506 and 507); AXA Pacific Holdings Ltd (at [105]) . | It is relevant to consider the nature of any relationship between the parties : Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4015); Granby (at 506). | If the parties are not at arm's length the inference may be drawn that they did not deal with each other at arm's length : Granby (at 506); ACI Operations Pty Ltd (at [225]).