Private ruling: Capital gains tax implications on transfer of shares
Published: April 2013
Ruling period: Year ending 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to disregard any capital gain made on the transfer of ownership of the shares from the Estate to the beneficiary under subsection 128-15(3) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No

Relevant facts and circumstances: The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: · your application for private ruling · copy of the deceased's will (including first and second codicils) Company X is a private company. The shareholders at incorporation and at all times since have been: · The deceased - holding a number of X shares · Child of the deceased - holding a number of Y shares All shares have proportionate rights to dividends and to capital (including surplus on winding up). Only the X shares have voting rights The company has at all times carried on a business on properties owned by the deceased. Pursuant to clause X of the deceased's will, the child of the deceased was left a percentage of the deceased's X shares in Company X, subject to and provided the child of the deceased entered into a shareholders agreement with the trustees of the Estate. Pursuant to clause X of the will, the remaining X shares in the company, are to be held, on trust for the benefit of the child of the deceased. This is conditional on the child of the deceased entering into a shareholders agreement with the trustees of the Estate as outlined in clause X. Clause X of the will states that if the trustees and the child of the deceased enter into a shareholders agreement, such shares and property are to be charged with a payment, by the child of the deceased, to the trustees of $X in equal annual instalments. The shares in Company X have been valued as at the date of death by a firm of independent experienced valuers. You state that under the terms of the will, the executors hold the shares on trust for the child of the deceased subject to: a) Payment of the expenses rateably attributable to the child's interest in the shares b) Payment of the charged amount to the estate, and c) Compliance with the shareholders agreement until the charge amount is paid out. You state that the child's interest in the shares is currently vested in interest but not in possession and is liable to be divested if the conditions referred to (see above) are not satisfied. You state that provided the shareholders agreement is not terminated against the child for breach, the child's interest will vest in possession upon them paying out the charged amount. You state the child of the deceased intends to pay out the $X charge amount in a single lump sum as soon as possible, at which time the shares will vest in possession. There will be no contract of sale for the transfer of the shares.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 128 | Income Tax Assessment Act 1997 Section 128-15 | Income Tax Assessment Act 1997 Section 128-20 | Income Tax Assessment Act 1997 Section 104-40 | Income Tax Assessment Act 1997 Section 134-1 | Income Tax Assessment Act 1997 Section 104-10

Reasons for decision: Summary: The capital gains tax provisions that deal with the effect of death are located in Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997). When a person dies, the assets that make up their estate can: · pass directly to a beneficiary (or beneficiaries), or · pass directly to their legal personal representative (for example, their executor) who may dispose of the assets or pass them to the beneficiary (or beneficiaries). A legal personal representative can be either: · the executor of a deceased estate (that is, a person appointed to wind up the estate in accordance with the will) · an administrator appointed to wind up the estate if the person does not leave a will. Subsection 128-15(1) and 128-15(2) of the ITAA 1997 explain that if a CGT asset you owned just before dying devolves to your legal representative or passes to a beneficiary in your estate, the legal personal representative, or beneficiary, is taken to have acquired the asset on the day you died. Subsection 128-15(3) of the ITAA 1997 provides that any capital gain or loss the legal personal representative makes if the asset passes to a beneficiary in your estate is disregarded. Subsection 128-20(1) of the ITAA 1997 states that a CGT asset passes to a beneficiary in your estate if the beneficiary becomes the owner of the asset: a) under your will, or that will as varied by a court order; or b) by operation of an intestacy law, or such a law as varied by a court order; or c) because it is appropriated to the beneficiary by your legal personal representative in satisfaction of a pecuniary legacy or some other interest or share in your estate; or d) under a deed of arrangement if: i. the beneficiary entered into the deed to settle a claim to participate in the distribution of your estate; and ii. any consideration given by the beneficiary for the asset consisted only of the variation or waiver of a claim to one or more other CGT assets that formed part of your estate Subsection 128-20(2) of the ITAA 1997 provides that a CGT asset does not pass to a beneficiary in your estate if the beneficiary becomes the owner of the asset because your legal personal representative transfers it under a power of sale. We consider this would also be the case if such a sale happens because the beneficiary exercises an option granted by the deceased's will. A testamentary option is given by a deceased person by will, or their will as amended by a deed of arrangement, to another person (a grantee) to purchase property forming part of the deceased estate. In your case, the deceased's will bequeaths X number of X shares in Company X to the child of the deceased subject to the child and the trustees of the estate entering into a 'shareholder's agreement'. Therefore on entering into the 'shareholder's agreement' the X number of X shares will 'pass' to the beneficiary under the deceased's will and, accordingly, subsection 128-15(3) of the ITAA 1997 will apply to disregard any capital gain made by the legal personal representative. However, in relation to the remaining X number of X shares, the deceased's will provides that they are to be held on trust for the child of the deceased provided that the child enters into the 'shareholder's agreement' and makes payment of a charge of $X on these assets. Once this payment is made the shares will transfer to the child. The amounts received from this payment are to be shared between the other children of the deceased, with the balance of the estate to be shared between the all the children of the deceased. Importantly, the will states that if the child fails to enter into the 'shareholder's agreement' with the trustees of the estate, or, breaches a condition of the 'shareholder's agreement' then the trustees shall take steps to wind up the company and any interest upon the winding up of the company shall form part of the residuary of the deceased's estate and be shared between all the children of the deceased. The shares, therefore, will not be transferred to the child unless the payment of the charge amount is made. Accordingly, it is considered that the obligation of the child to make a payment of the charged amount creates a testamentary option or right to acquire the shares. On entering into the shareholder's agreement, and making the payment of the charged amount, the child has acquired two assets. The first asset was the option to purchase the shares. When the child exercises that option and pays $X, they acquire a second asset, being the shares. While the option to purchase the shares is an asset that came to the child as a beneficiary of the deceased's will, the child will obtain full ownership of the shares as a purchaser (via the exercise of the testamentary option) and not as a beneficiary. Therefore, we consider that in this situation the shares will not pass to the beneficiary under the deceased's will as per subsection 128-20(1) of the ITAA 1997, but instead will be transferred to the beneficiary under a power of sale as per subsection 128-20(2) of the ITAA 1997. When an option is granted CGT event D2 happens (section 104-40 of the ITAA 1997). If that option is subsequently exercised by the grantee, any capital gain or capital loss made the grantor (subsection 104-40(5) of the ITAA 1997) and grantee (subsection 134-1(4) of the ITAA 1997) is disregarded. CGT event A1 will occur when the ownership of the shares are transferred to the beneficiary (subsection 104-10(2) of the ITAA 1997). The time of the event is taken to be the time when the change of ownership occurs (subsection 104-10(3) of the ITAA 1997) as you have advised that there will be no sale contract for the disposal. As the shares will be transferred to the child as a purchaser under a power of sale and will not 'pass' to the them 'under the deceased's will', subsection 128-15(3) of the ITAA 1997 will not apply to disregard the capital gain made by the executor on the transfer of ownership of the shares. Therefore, the executor will be liable for any capital gain made on the transfer.