Private ruling: Transfer of pre-CGT shares
Date of advice: 27 November 2018
Published: April 2019
Ruling period: Year ended 30 June 2019.
Date scheme commenced: Year ended 30 June 2019.

Ruling: Q1: Will Division 149 of the ITAA 1997 apply to reset the value of Current Holding Co’s investment in X Co, i.e. its tax cost base, to market value at the time underlying ownership passes from X (as the majority shareholder amongst the others) to the beneficiaries of Proposed Trust X? | A1: Yes | Q2: For the purposes of applying subsection 705-65(1) of the ITAA 1997, will the cost of Current Holding Co’s membership interest in the X Co shares be the market value as determined under Division 149 of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: Current Holding Co owns all the shares in X Co. These shares were acquired prior to 20 September 1985. The shareholding of Current Holding Co is as follows: ● Trust A is a discretionary family trust and holds all its assets for certain members of family A. It acquired the shares in X Co prior to 20 September 1985. ● Trust B is a discretionary family trust and holds all its assets for certain other members of family A. It acquired the shares in X Co prior to 20 September 1985. ● X acquired the majority of management shares and some ordinary shares in X Co prior to 20 September 1985. ● B acquired some ordinary shares in in X Co prior to 20 September 1985; some ordinary shares in X Co after 20 September 1985; and a management share in X Co after 20 September 1985. ● Some ordinary shares were held by Y as trustee for beneficiary X. Upon beneficiary X’s passing after 1985, these shares were transferred to X and B, divided equally. ● The management shares of Current Holding Co carry the following rights and characteristics: ● They have twice the votes of all ordinary shares on issue. ● They carry rights to dividends as declared from time to time by the directors with reference to that class. ● They can be converted to ordinary shares at the discretion of the shareholder and upon acceptance by the company. ● If the shareholder holds the management shares beneficially, then upon that shareholder’s death, the management shares convert to ordinary shares. ● There is no restriction on the transfer of these shares. ● Current Holding Co has had a history of paying dividends. Dividends were paid on both ordinary shares and management shares. Recently dividends were paid only on the management shares. X Co has a history of paying dividends with the practice of transferring retained profits from a subsidiary trading entity which is regarded as ‘ at-risk ’. X proposes to sell all his management shares and ordinary shares in Current Holding Co to New Holding Co. The sole shareholder of New Holding Co is Proposed Trust X.

Relevant legislative provisions: Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997) | Section 149-15 of the ITAA 1997 | Section 149-30 of the ITAA 1997 | Section 149-35 of the ITAA 1997 | Subsection 705-65(1) of the ITAA 1997

Reasons for decision: Summary: Division 149 of the ITAA 1997 will apply to reset the value of Current Holding Co’s investment in X Co, i.e. its tax cost base, to market value at the time underlying ownership passes from X (as the majority shareholder amongst the others) to the beneficiaries of Proposed Trust X. | Detailed Reasoning - Detailed reasoning: Subsection 149-30(1) of the ITAA 1997 provides that, in respect of pre-CGT assets: The asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. ‘Majority underlying interests’ is in turn defined in section 149-15 as follows: | Detailed Reasoning - 149-15(1): Majority underlying interests in a CGT asset consist of: (a) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and (b) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset. The assets to which the question relate is Current Holding Co’s shares in X Co. Current Holding Co holds ordinary shares in X Co which were acquired before 20 September 1985. These shares are pre-CGT assets under section 149-10 of the ITAA. | Detailed Reasoning - Underlying interests prior to 20 September 1985: Prior to 20 September 1985, the ultimate owners of the X Co shares held by Current Holding Co were: ● The beneficiaries of Trust A. ● The beneficiaries of Trust B. ● X. ● B. ● Beneficiary X through the trustee, Y. By virtue of this shareholding, the abovementioned shareholders have an indirect beneficial interest in Current Holding Co’s shares in X Co pursuant to subsection 149-15(4) and subsection 149-15(5). | Detailed Reasoning - Underlying interests after 20 September 1985: The following events affected the ownership of Current Holding Co after 20 September 1985: ● B acquired 1 management share on after 20 September 1985; and some ordinary shares were transferred to her in after 20 September 1985. ● Some ordinary shares were transferred to X and B after 20 September 1985. The transfer of ordinary shares was as a result of the passing of Beneficiary X. On the occurrence of that event, the ordinary shares held for Beneficiary X were transferred to X and B, divided equally. Subsections 149-30(3) and 149-30(4) provide that where a former ultimate owner has passed away, the new owner of the underlying interest in the asset is - broadly speaking - taken to stand in the shoes of the former owner. In essence there is no change in majority underlying interests in Current Holding Co’s shares in Company X from the event. The acquisition of 1 management share by B does not result in a change in the majority underlying interests in Current Holding Co’s shares in X Co. The same ultimate holders who held the interests before 20 September 1985 currently (together) hold all interests in the shares. In respect of the holding of 300 shares each by the Trust A and Trust B, the Commissioner’s approach to the concept of ‘underlying interests’ held by ‘ultimate owners’ in respect of discretionary trusts is stated in IT 2340 as follows: 5. In relation to what are generally referred to as discretionary trusts, i.e., family trusts, the trustees of which have discretionary powers as to the distribution of trust income or property to beneficiaries, in considering the question of whether majority underlying interests have been maintained in the assets of the trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised. 6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion. 7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. As beneficiaries named in the Trust A and Trust B have not changed since their establishment, the Commissioner adopts the pragmatic approach outlined in IT 2340 that, for all practical purposes, the majority underlying interests in the trust assets have also not changed. | Detailed Reasoning - Underlying interests following implementation of the proposal: It is proposed that X will sell his shares in Current Holding Co to New Holding Co. The sole shareholder New Holding Co is Proposed Trust X. Specifically, the New Holding Co will acquire 100% of X’s management shares and ordinary shares in Current Holding Co. If and when implemented, the shares in X Co held by Current Holding Co will cease being pre-CGT assets. This is because the majority underlying interest in those shares would no longer be held by the ultimate owners who had majority underlying interests before 20 September 1985. The reasons for this are as follows: ● The shares in Current Holding Co carry a broad discretionary right to dividends. ● Its history of dividend distributions reflects this. Recently, dividends were paid only on the management shares. In total, a significantly larger amount of dividends was paid on the management shares. ● Where a company’s shares carry a discretionary right to dividends, the issue of a new share with a discretionary right to dividends to a new shareholder would result in the failure of the ‘ majority underlying ownership ’ test. This position is established in ATO ID 2011/107, which takes the view on the basis that, due to the discretionary right to dividends which all such shares carry, the company can distribute the dividends to the new shareholder to the exclusion of the other shareholders. ● In the present case, no new share is issued to the new entity New Holding Co, but there will be a transfer of the majority of management shares to it. ● Apart from a consideration of the value of the shares transferred (which would result in New Holding Co owning the highest value of shares in total, of all shareholders in Current Holding Co), it is a key factor that following the implementation of the proposal, New Holding Co will be the entity to which potentially all or most dividends could be issued; the amounts of which in turn may be further distributed ultimately to one or more of the beneficiaries of the Proposed Trust X. ● Therefore consistently with the approach taken in ATO ID 2011/107, the transfer of the shares to New Holding Co will result in the majority underlying interests in the X Co shares not being ‘had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985’. As the shares in X Co will stop being a pre-CGT asset under the terms of section 149-30, section 149-35 will apply to deem the first element of the cost base and reduced cost base of the shares to be their market value at the time of the transfer. | Summary: For the purposes of applying subsection 705-65(1) of the ITAA 1997, the cost of Current Holding Co’s membership interest in the X Co shares will be the market value as determined under Division 149 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subsection 705-65(1) provides as follows: For the purposes of step 1 in the table in section 705-60, the step 1 amount is the sum of the following amounts for each membership interest that members of the joined group hold in the joining entity at the joining time: | Detailed Reasoning - Note:: If the joining entity is a trust, the step 1 amount may be increased by section 713-20 for settled capital that could be distributed tax free in respect of discretionary interests in the trust. | Detailed Reasoning - The amount is...: 1 equal to or greater than its cost base its cost base 2 less than its cost base but greater than its reduced cost base its market value 3 less than or equal to its reduced cost base its reduced cost base As determined under question 1, section 149-35 will apply to deem the first element of the cost base and reduced cost base of the shares to be their market value at the time of the transfer of shares to New Holding Co. As the market value of the membership interest would be equal to its cost base, item 1 of the table in subsection 705-65(1) applies. As such, the step 1 amount for ‘ each membership interest that members of the joined group hold in the joining entity’ – being in this case Current Holding Co’s membership interest in the X Co’s shares – is, ultimately, the market value of the shares.