Private ruling: Capital Gains Tax and Demutualisation - conversion from company limited by guarantee to company limited by shares
Published: September 2013
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Will the capital gains tax (CGT) rollover provisions of Subdivision 124-E of the Income Tax Assessment Act 1997 (ITAA 1997) regarding the exchange of shares in the same company apply such that no CGT event occurs with respect to the membership interest of the members of the company? | A1: No. | Q2: In the alternative, will the provisions of Division 326 of Schedule 2H of the Income Tax Assessment Act 1936 (ITAA 1936) regarding the demutualisation of non-insurance entities apply such that any gain from the CGT event is disregarded with respect to the membership interest of the members of the company? | A2: No.

Relevant facts and circumstances: The existing entity The company was established in the mid 1990s as a company limited by guarantee, and is governed by memorandum and articles of association (the existing M&A). Membership interests in the company are currently held by resident individuals in equal parcels. The existing M&A provides for a number of classes of members with entitlement to: § dividends as declared or paid by the company, § a percentage of the assets of the company following payment of all liabilities and costs associated with winding up, and § attendance and a number of votes at the general meetings of the company. The company currently has no shareholders capital, other than retained earnings. The company holds investments in shares in other private proprietary companies but does not trade on its own account. The proposed transaction The company is proposing to convert from a company limited by guarantee to a proprietary company, replacing the existing M&A with a standard constitution of a proprietary company. As a consequence of the transaction the membership interests in the company will be converted to ordinary shares in the company as a proprietary company. Shares in the proprietary company would be issued in the same proportions as the existing membership interest currently being held. It is contemplated that initially such shares would not have any paid up share capital. The new shareholders would subsequently contribute proportionately such that capital would be created. The rights of the existing members would be substituted by equivalent rights attaching to their shares such that they would be entitled to dividends, return of capital on winding up, and to vote at annual general meetings.

Relevant legislative provisions: Income Tax Assessment Act 1936 Schedule 2H Division 326, | Income Tax Assessment Act 1936 Schedule 2H paragraph 326-10(1)(c), | Income Tax Assessment Act 1997 Subdivision 124-E, | Income Tax Assessment Act 1997 section 124-240, | Income Tax Assessment Act 1997 paragraph 124-240(e) , | Income Tax Assessment Act 1997 section 960-135, | Income Tax Assessment Act 1997 subsection 995-1(1) and | Income Tax Assessment Act 1997 subsection 975-300(1).

Reasons for decision: Summary: Rollover relief under Subdivision 124-E of the Income Tax Assessment Act 1997 (ITAA 1997) is not available to you in respect of the ending of your membership interests in the company, when it converts from a company limited by guarantee to a company limited by shares. | Detailed Reasoning - Paid up Share Capital: Paragraph 124-240(e) of the ITAA 1997 provides that in order for rollover to be available for an exchange of shares in the same company the paid-up share capital of the company just after the new shares were issued must be the same as just before the original shares were redeemed or cancelled. Paid-up share capital of a company is defined in subsection 995-1(1) of the ITAA 1997 as 'the amount standing to the credit of the company's share capital account reduced by the amount (if any) that represents amounts unpaid on shares'. A company's share capital account is an account that the company keeps of its share capital (subsection 975-300(1) of the ITAA 1997). Share capital is not the same as the capital of the company. The company as a company limited by guarantee has no share capital. As such the requirement in paragraph 124-240(e) of the ITAA 1997 that the paid-up share capital of the company just after the new shares were issued is the same as just before the original shares were redeemed or cancelled is not met. | Detailed Reasoning - Class of share/membership interest: Paragraph 124-240(a) of the ITAA 1997 requires that you own shares (the original shares) of a certain class in a company. Subsection 995-1(1) defines 'share' to mean (a) in a company means a share in the capital of the company and includes stock On face value, it would be difficult for a company with no share capital to argue that there are shares in the capital of the company. The definition under section 960-135 of the ITAA 1997 of 'membership interest in an entity' is: If you are a member of an entity: (a) each interest, or set of interests, in an entity; or (b) each right, or set of rights, in relation to an entity; by virtue of which you are a member of the entity is a membership interest of yours in the entity 'Class' is defined in subsection 995-1(1) of the ITAA 1997 to be: membership interests in a company or trust form a class if the interests have the same or substantially the same rights. A membership interest may exist in terms of the nature of the holding that the individual members have in the company however that does not result in a conclusion that the individual members have a 'share in the capital of a company', when in fact, there is no share capital in the company. Therefore it cannot be applied to satisfy the requirements of paragraph 124-240(a). Therefore, you cannot choose the CGT roll-over under section 124-240 of the ITAA 1997. | Summary: You are not able to apply Division 326 of Schedule 2H of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of the ending of your membership interests in the company, when it converts from a company limited by guarantee to a company limited by shares. | Detailed Reasoning - Detailed reasoning: Schedule 2H of the Income Tax Assessment Act 1936 (ITAA 1936) provides a generic framework for the taxation consequences of non-insurance mutual entities that demutualise For the purposes of Division 326 of Schedule 2H of the ITAA 1936 an entity is a mutual entity if, and only if, immediately before the demutualisation resolution day, it is a body corporate that, among other things, is not carried on for the object of securing a profit or pecuniary gain for its members (paragraph 326-10(1)(c)). Paragraphs 18 of TR 93/39 Income tax: friendly society education funds considers what a profit or gain is, explaining: 18. A profit or gain includes any benefit, direct or indirect, pecuniary or non-pecuniary, capital or revenue, that any person may obtain. 'Gain is something obtained or acquired. It is not limited to pecuniary gain. We should have to add the word "pecuniary" so to limit it. ... [It] is not "gains", but "gain", in the singular. Commercial profits, no doubt, are gain; but I cannot find anything limiting gain simply to a commercial profit.' (Jessel MR in in re Arthur Average Association (1875) LR 10 Ch App 545, at n546-547) A diminution of loss is a gain, and so mutual commercial insurance involves a gain ( re Padstow Total Loss and Collision Insurance Association (1882) 20 Ch D 137), and a gain may be derived indirectly, not merely directly, and includes any benefit, profit or advantage ( R v. James (1903) 6 OLR 35, at 38; Stanger v. Hendon Borough Council [1948] 1 KB 571; re Southside Plaza Merchants' Association [1965] NSWR 1454; in re Riverton Sheep Dip [1943] SASR 344; re Commonwealth Homes and Investment Co Ltd [1943] SASR 211). It is the Commissioner's view that the company operates for the purpose of holding investments in shares in other private proprietary companies. Although it does not trade on its own account, the objective for entering into the investments is to secure profit or pecuniary gain for its members. As such, the company is not a mutual entity and Division 326 of Schedule 2H of the ITAA 1936 will not apply upon the cancellation of the membership interests in the company.