Private ruling: Capital gains tax - market value substitution rule
Date of advice: 17 March 2020
Published: April 2020
Ruling period: Year ending 30 June 202F
Date scheme commenced: 1 July 201E

Ruling: Q1: Will the assignment of a secured loan by ABC Pty Ltd to the UVW Trust result in CGT event A1 happening pursuant to section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Will subparagraph 116-30(2)(b)(i) of the ITAA 1997 apply to substitute the market value of the secured loan as the capital proceeds for the transfer of the secured loan? | A2: No | Q3: Will the transfer of shares in NOP Pty Ltd by DEF Pty Ltd as trustee for the XYZ Trust (XYZ Trust) to the UVQ Trust result in CGT event A1 happening pursuant to section 104-10 of the ITAA 1997? | A3: Yes | Q4: Will subparagraph 116-30(2)(b)(i) of the ITAA 1997 apply to substitute the market of the shares in NOP Pty Ltd as the capital proceeds for the disposal of the shares? | A4: No | Q5: Will the transfer of shares in QRS Pty Ltd by XYZ Trust to the UVW Trust result in CGT event A1 happening pursuant to section 104-10 of the ITAA 1997? | A5: Yes | Q6: Will subparagraph 116-30(2)(b)(i) of the ITAA 1997 apply to substitute the market of the shares in QRS Pty Ltd as the capital proceeds for the disposal of the shares? | A6: No

Relevant facts and circumstances: Background 1. NOP Pty Ltd carries on business as an earthmoving and specialist civil works contractor. 2. Mr A was the managing director of NOP Pty Ltd at all times from 201A, when the business of NOP Pty Ltd commenced. Since 201A, Mr A has provided guarantees and indemnities to third parties to support the obligations of NOP Pty Ltd (Mr A Support Covenants). 3. XYZ Trust holds shares in NOP Pty Ltd. 4. XYZ Trust is controlled by Mr A. 5. The business of NOP Pty Ltd was established jointly by Mr A and Mr Z. 6. Initial funding for NOP Pty Ltd was provided by Mr Z. Both Mr A and Mr Z have re-invested a substantial portion of NOP Pty Ltd's profits by lending money to NOP Pty Ltd through their respective controlled entities. a) Mr A lent NOP Pty Ltd $X through ABC Pty Ltd b) Mr Z lent NOP Pty Ltd $X through HIJ Pty Ltd 7. The profitability of NOP Pty Ltd was negatively affected by a slowdown in housing construction in State A from 201B. 8. At the end of 201C, Mr Z, Mr A, and other employees of NOP Pty Ltd established QRS Pty Ltd to facilitate the importation of construction materials for use by NOP Pty Ltd. NOP Pty Ltd provided loan funding to QRS Pty Ltd. 9. In 201D, NOP Pty Ltd lost a significant amount of money performing a large construction contract, requiring further shareholder funding to allow NOP Pty Ltd to continue trading. 10. An at call loan from the UVW Trust was provided to NOP Pty Ltd. The call loan was secured against all the assets and undertaking of NOP Pty Ltd, with priority of repayment and security to the ABC Pty Ltd and HIJ Pty Ltd loans. 11. ABC Pty Ltd, XYZ Trust, DEF Pty Ltd and Mr A are not beneficiaries of the UVW Trust. Mr A and his related entities are not a trustee of the UVW Trust. 12. The UVW Trust is controlled by Mr Z. ABC Pty Ltd secured loan 13. The loan from ABC Pty Ltd to NOP Pty Ltd (the ABC Pty Ltd secured loan) of $X is on the following terms: a) The $X of the principal is repayable on late September 202G and $X of the principal is repayable on late April 202H; b) Prior to the principal repayment dates, interest is only payable monthly in arrears; c) Loan is secured against all of the assets and undertaking of NOP Pty Ltd; d) Any repayment of the ABC Pty Ltd loan may only be made at the same time and in the same proportion as any repayment of the $X loan from HIJ Pty Ltd; and e) Priority of the security over the assets and undertaking of NOP Pty Ltd is shared with HIJ Pty Ltd in proportion to the amounts owed by NOP Pty Ltd to ABC Pty Ltd and HIJ Pty Ltd respectively. Shareholdings 14. NOP Pty Ltd has an issued share capital of XYZ ordinary shares held as follows: NOP Pty Ltd Shareholder Number of ordinary shares UVW Trust x XYZ Trust x Associate of Employee A x 625 625 Associate of Employee B x Associate of Employee C x Associate of Employee D x 15. QRS Pty Ltd has issued share capital of XYZ ordinary shares held as follows: QRS Pty Ltd Construction Materials Pty Ltd Shareholder Number of ordinary shares UVW Trust x XYZ Trust x Associate of Employee A x Associate of Employee B x Associate of Employee C x Associate of Employee D x Associate of another NOP Pty Ltd employee x Trading conditions in 201E 16. NOP Pty Ltd suffered losses in 201E which were only covered by the sale of surplus plant and equipment. 17. Mr Z is of the belief that the market for civil works contracting will improve in a reasonable amount of time and intends to provide further funding to NOP Pty Ltd. This funding will be provided through the UVW Trust on the basis of priority and security over the assets and undertaking of NOP Pty Ltd. Employee A, Employee B, Employee C and Employee D will continue their involvement with NOP Pty Ltd on this basis. 18. Mr A is of the belief that the market for civil works contracting will deteriorate even further and is unable to provide further funding to cover NOP Pty Ltd's losses. 19. Mr A would prefer that the business of NOP Pty Ltd be wound up on an amicable basis so that all creditors are repaid. Mr A only controls 25% of NOP Pty Ltd's shares and is unable to demand this course of action. 20. Mr A is not comfortable continuing his involvement with NOP Pty Ltd. Accordingly, Mr A gave notice of his resignation as managing director of NOP Pty Ltd requesting that Mr Z procure a release of all the Mr A Support Covenants. 21. Mr A and Mr Z have held discussions and negotiations regarding Mr A's exit from NOP Pty Ltd. 22. Mr A and Mr Z have each obtained separate and independent advice about the issues canvassed during those discussions and negotiations. 23. As part of the agreement, Mr Z wished to consolidate his existing control of NOP Pty Ltd to reflect the reality that he we would be the only party continuing to contribute further loan funds to NOP Pty Ltd to facilitate its ongoing operation. Exit Deed 24. On 22 November 201E, Mr A, Mr Z, and their related entities, entered into an Exit Deed. 25. Under the Exit Deed: a) Mr A's employment with NOP Pty Ltd would end in late December 201E; b) Mr Z would do all things necessary and offer his personal guarantees to arrange a release for Mr A in respect of all the Mr A Support Covenants. c) Mr Z would provide complete indemnity to Mr A for all director related liabilities, including the Mr A Support Covenants. d) UVW Trust would purchase all of ABC Pty Ltd's rights under the ABC Pty Ltd secured loan for $X. This would be payable $X on signing and $X in late November 202F supported by a personal guarantee by Mr Z. e) UVW Trust would purchase XYZ Trust's shares in NOP Pty Ltd for $X. f) UVW Trust would purchase XYZ Trust's shares in QRS Pty Ltd for $X. Market value of ABC Pty Ltd secured loan 26. The amount payable under the loan from ABC Pty Ltd to NOP Pty Ltd is $X. The market value of the loan would be affected by the ability of NOP Pty Ltd to repay the principal repayments of $X in late September 2025 and $X on late April 2026 while paying other liabilities such as the loan made by HIJ Pty Ltd. 27. Mr A is of the view that NOP Pty Ltd's ability to make these repayments will be negatively impacted as the market for civil works contracting deteriorates further. 28. Mr A is of the view that an undertaking by UVW Trust to pay $X on signing and $X on 30 November 202F is at least as valuable as the current market value of the ABC Pty Ltd secured loan. Market value of the NOP Pty Ltd shares 29. The net assets of NOP Pty Ltd at late June 201E were $X. Included in that amount is an asset revaluation reserve for the plant & equipment assets of $X. Mr A is of the view that this asset revaluation is significantly overstated. 30. NOP Pty Ltd had an operating loss of $X in the year ended late June 201E. NOP Pty Ltd continues to make monthly losses and no dividends are expected in the foreseeable future. 31. The shares in NOP Pty Ltd are subject to a shareholders agreement, which gives that any sale of shares needs to be offered to the other shareholders. The other shareholders have waived their pre-emptive rights under the shareholders agreement. 32. Mr A is of the view that the value of NOP Pty Ltd's plant and equipment assets and ability to make future profits will be negatively impacted as the market for civil works contracting deteriorates further. 33. Mr A is of the view that the market value of the shares in NOP Pty Ltd is not greater than their paid up capital amount being $X a share. Market value of the QRS Pty Ltd shares 34. The net assets of QRS Pty Ltd at late June 201E were negative $X. 35. QRS Pty Ltd has an operating loss of $X in the year ended 30 June 201E. 36. QRS Pty Ltd has never paid a dividend and is unlikely to in the foreseeable future. 37. The shares in QRS Pty Ltd are subject to pre-emptive rights in its constitution. The other shareholders have waived those pre-emptive rights. 38. Mr A is of the view that QRS Pty Ltd's business with NOP Pty Ltd and its ability to make future profits will be negatively impacted as the market for civil works contracting deteriorates further. 39. Mr A is of the view that the value of the shares in QRS Pty Ltd is not greater than their paid up capital amount being $X a share.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 102-25 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 104-60 | Income Tax Assessment Act 1997 Section 116-5 | Income Tax Assessment Act 1997 Section 116-20 | Income Tax Assessment Act 1997 Section 116-25 | Income Tax Assessment Act 1997 Section 116-30

Reasons for decision: Summary: CGT event A1 happens when the secured loan made by ABC Pty Ltd to NOP Pty Ltd is assigned to the UVW Trust. | Detailed Reasoning - CGT event A1: 40. Subsection 104-10(1) of the ITAA 1997 gives that CGT event A1 happens if you dispose of a CGT asset. 41. Subsection 104-10(2) of the ITAA 1997 gives that you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner. 42. Subsection 104-10(3) of the ITAA 1997 gives that the time of the event is: (a) when you enter into the contract for the disposal; or (b) if there is no contract - when the change of ownership occurs. | Detailed Reasoning - CGT event E2: 43. Subsections 104-60(1) to (5) of the ITAA 1997 state: (1) CGT event E2 happens if you transfer a *CGT asset to an existing trust. (2) The time of the event is when the asset is transferred. (3) You make a capital gain if the capital proceeds from the transfer are more than the asset's *cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base. (4) If you are the trustee of the trust and no beneficiary is absolutely entitled to the asset as against you (disregarding any legal disability), the first element of the asset's cost base and reduced cost base in your hands is its market value when the asset is transferred. (5) CGT event E2 does not happen if you are the sole beneficiary of the trust and: (a) you are absolutely entitled to the asset as against the trustee (disregarding any legal disability); and (b) the trust is not a unit trust. | Detailed Reasoning - Most specific CGT event: 44. As per subsection 102-25(1) of the ITAA 1997, if more than one CGT event can happen, the event that is the most specific to the situation is to be selected. 45. ATO ID 2003/559 Income Tax: Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2 gives that: However, it is considered that CGT event A1 (rather than CGT event E2) is the most specific event where, as in this case, an asset is transferred to another party and the transferor is indifferent as to the identity of that party. That is, CGT event A1 is the most specific event where the parties are completely unconnected and are dealing with each other at arm's length. ...CGT event A1 is considered the most specific event whenever the parties are unconnected. It would be inappropriate for a different CGT event to apply depending on whether the vendor knew the capacity in which the purchaser was acquiring the asset. On the other hand, CGT event E2 will be the most specific event if, for example, an asset is transferred to a trust of which the transferor or an associate is a beneficiary or object. | Detailed Reasoning - Connection between vendor and purchaser: 46. In this case, ABC Pty Ltd is transferring the asset to the UVW Trust. ABC Pty Ltd is not a beneficiary or trustee of the UVW Trust. There is nothing to otherwise suggest that ABC Pty Ltd is connected to the UVW Trust. | Detailed Reasoning - Arm's length dealing: 47. There are several relevant provisions of law emerging from the cases which are summarised at paragraph 26 of the judgment of Justice Dowsett in Commissioner of Taxation v AXA Asia Pacific Holdings Ltd [2010] FCAFC 134 as follows: (a) in determining whether parties have dealt with each other at arm's length in a particular transaction, one may have regard to the relationship between them; (b) one must also examine the circumstances of the transaction and the context in which it occurred; (c) one should do so with a view to determining whether or not the parties have conducted the transaction in a way which one would expect of parties dealing at arm's length in such a transaction; (d) relevant factors which may emerge include existing mutual duties, liabilities, obligations, cross-ownership of assets, or identity of interests which might enable either party to influence or control the other, or induce either party to serve a common interest and so modify the terms on which strangers would deal; (e) where the parties are not in an arm's length relationship, one may infer that they did not deal with each other at arm's length, and that the resultant transaction is not at arm's length; (f) however, related parties may, in some circumstances, so conduct a dealing as to displace any inference based on the relationship; (g) un-related parties may, on occasions, deal with each other in such a way that the resultant transaction may not properly be considered to be at arm's length. 48. Although Dowsett J dissented in the application of those propositions in that case, Edmonds and Gordon JJ did not disapprove of his summary of those propositions. In that case, Edmonds and Gordon JJ further stated at paragraph 105 that: "Any assessment of whether parties were dealing at arm's length involves 'an assessment [of] whether in respect of that dealing they dealt with each other as arm's length parties would normally do, so that the outcome of their dealing is a matter of real bargaining': Trustee for the Estate of the late AW Furse No 5 Will Trust v FCT (1991) 21 ATR 1123 at 1132 per Hill J" 49. The matter was expanded upon by Justice McKerracher in Healey v Commissioner of Taxation [2012] FCA 269 at paragraph 95: 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]). 50. The assignment of the ABC Pty Ltd secured loan formed part of the Exit Deed entered into on 22 November 201E. ABC Pty Ltd is controlled by Mr A. 51. The Exit Deed was entered into to facilitate the exit of Mr A from the ongoing operations of NOP Pty Ltd. 52. Mr A wished to exit the business of NOP Pty Ltd because he believed that he would not be able to provide further funding to cover losses that may arise from deteriorating market conditions for civil works contracting. 53. This represented a difference of opinion with Mr Z who believed that civil works contracting would become more profitable in a reasonable amount of time. 54. Prima facie, Mr A and Mr Z have an arm's length relationship. They share a business relationship and do not share a family relationship. 55. The Exit Deed was a result of ongoing discussions and negotiations between Mr A and Mr Z. Both Mr A and Mr Z sought separate and independent advice about the issues arising from these discussions and negotiations. 56. Entry into the Exit Deed made commercial sense for Mr A, Mr Z and their related entities. The terms of the Exit Deed were informed by the party's own perception of the commercial reality of the NOP Pty Ltd and QRS Pty Ltd businesses, and by separate, independent advice. 57. There is no evidence that the parties were dealing on a non-arm's length basis. 58. Therefore, in accordance with ATO ID 2003/559 Income Tax: Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2 , CGT event A1 is considered more specific than CGT event E2 for the assignment of the ABC Pty Ltd secured loan. | Summary: 59. Subparagraph 116-30(2)(b)(i) of the ITAA 1997 will not apply to substitute the market value of the secured loan as the proceeds for the transfer of the secured loan because the parties dealt on an arm's length basis. | Detailed Reasoning - Market value substitution: 60. Section 116-5 of the ITAA 1997 provides that section 116-20 of the ITAA 1997 sets out the general rules about capital proceeds. It applies to CGT event A1. 61. Section 116-20 of the ITAA 1997 provides that the capital proceeds from a CGT event are the total of: (a) the money you have received, or are entitled to receive, in respect of the event happening; and (b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). 62. Section 116-25 of the ITAA 1997 provides a table of modifications to the general rules. Modifications 1, 2, 3, 4, 5 and 6 can apply to CGT event A1. 63. Modification 1, the market value substitution rule, contained in section 116-30(2) of the ITAA 1997 will apply if there are proceeds from the disposal of a CGT asset the subject of CGT event A1 and: (b) those capital proceeds are more or less than the market value of the asset and: (i) you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event; or (ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings). 64. ABC Pty Ltd will receive $X for the assignment of the secured loan to the UVW Trust with $X payable on signing of the Exit Deed and $X payable on 30 November. The amount payable is supported by a personal guarantee from Mr Z. 65. The face value of the loan is $X. If the market for civil works contracting deteriorates, then the ability of NOP Pty Ltd to repay the loan would have been negatively impacted. 66. There is not sufficient information to support the view that $X represents the market value of the assignment of the loan. | Detailed Reasoning - Arm's length dealing: 67. Whether ABC Pty Ltd and the UVW Trust dealt with each other on an arm's length basis regarding the assignment of the ABC Pty Ltd secured loan is considered above in paragraphs 47 to 58. 68. There is no evidence that the parties were dealing no a non-arm's length basis. Therefore subparagraph 116-30(2)(b)(i) of the ITAA 1997 will not apply to substitute the market value of the secured loan as the proceeds for the transfer of the secured loan. | Summary: 69. CGT event A1 happens when the shares in NOP Pty Ltd are transferred by XYZ Trust to the UVW Trust. | Detailed Reasoning - CGT event A1: 70. Subsection 104-10(1) of the ITAA 1997 gives that CGT event A1 happens if you dispose of a CGT asset. 71. Subsection 104-10(2) of the ITAA 1997 gives that you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner. 72. Subsection 104-10(3) of the ITAA 1997 gives that the time of the event is: (a) when you enter into the contract for the disposal; or (b) if there is no contract - when the change of ownership occurs. | Detailed Reasoning - CGT event E2: 73. Subsections 104-60(1) to (5) of the ITAA 1997 state: (1) CGT event E2 happens if you transfer a *CGT asset to an existing trust. (2) The time of the event is when the asset is transferred. (3) You make a capital gain if the capital proceeds from the transfer are more than the asset's *cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base. (4) If you are the trustee of the trust and no beneficiary is absolutely entitled to the asset as against you (disregarding any legal disability), the first element of the asset's cost base and reduced cost base in your hands is its market value when the asset is transferred. (5) CGT event E2 does not happen if you are the sole beneficiary of the trust and: (a) you are absolutely entitled to the asset as against the trustee (disregarding any legal disability); and (b) the trust is not a unit trust. | Detailed Reasoning - Most specific CGT event: 74. As per subsection 102-25(1) of the ITAA 1997, if more than one CGT event can happen, the event that is the most specific to the situation is to be selected. 75. ATO ID 2003/559 Income Tax : Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2 gives that: However, it is considered that CGT event A1 (rather than CGT event E2) is the most specific event where, as in this case, an asset is transferred to another party and the transferor is indifferent as to the identity of that party. That is, CGT event A1 is the most specific event where the parties are completely unconnected and are dealing with each other at arm's length. ...CGT event A1 is considered the most specific event whenever the parties are unconnected. It would be inappropriate for a different CGT event to apply depending on whether the vendor knew the capacity in which the purchaser was acquiring the asset. On the other hand, CGT event E2 will be the most specific event if, for example, an asset is transferred to a trust of which the transferor or an associate is a beneficiary or object. | Detailed Reasoning - Connection between vendor and purchaser: 76. In this case, XYZ Trust is transferring the asset to the UVW Trust. None of XYZ Trust, its beneficiaries, or its trustee is a beneficiary of trustee of the UVW Trust. There is nothing to otherwise suggest that XYZ Trust is connected to the UVW Trust. | Detailed Reasoning - Arm's length dealing: 77. There are several relevant provisions of law emerging from the cases which are summarised at paragraph 26 of the judgment of Justice Dowsett in Commissioner of Taxation v AXA Asia Pacific Holdings Ltd [2010] FCAFC 134 as follows: (a) in determining whether parties have dealt with each other at arm's length in a particular transaction, one may have regard to the relationship between them; (b) one must also examine the circumstances of the transaction and the context in which it occurred; (c) one should do so with a view to determining whether or not the parties have conducted the transaction in a way which one would expect of parties dealing at arm's length in such a transaction; (d) relevant factors which may emerge include existing mutual duties, liabilities, obligations, cross-ownership of assets, or identity of interests which might enable either party to influence or control the other, or induce either party to serve a common interest and so modify the terms on which strangers would deal; (e) where the parties are not in an arm's length relationship, one may infer that they did not deal with each other at arm's length, and that the resultant transaction is not at arm's length; (f) however, related parties may, in some circumstances, so conduct a dealing as to displace any inference based on the relationship; (g) un-related parties may, on occasions, deal with each other in such a way that the resultant transaction may not properly be considered to be at arm's length. 78. Although Dowsett J dissented in the application of those propositions in that case, Edmonds and Gordon JJ did not disapprove of his summary of those propositions. In that case, Edmonds and Gordon JJ further stated at paragraph 105 that: "Any assessment of whether parties were dealing at arm's length involves 'an assessment [of] whether in respect of that dealing they dealt with each other as arm's length parties would normally do, so that the outcome of their dealing is a matter of real bargaining': Trustee for the Estate of the late AW Furse No 5 Will Trust v FCT (1991) 21 ATR 1123 at 1132 per Hill J" 79. The matter was expanded upon by Justice McKerracher in Healey v Commissioner of Taxation [2012] FCA 269 at paragraph 95: 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]). 80. The transfer of the shares in NOP Pty Ltd by XYZ Trust formed part of the Exit Deed entered into on 22 November 201E. XYZ Trust is controlled by Mr A. 81. The Exit Deed was entered into to facilitate the exit of Mr A from the ongoing operations of NOP Pty Ltd. 82. Mr A wished to exit the business of NOP Pty Ltd because he believed that he would not be able to provide further funding to cover losses that may arise from deteriorating market conditions for civil works contracting. 83. This represented a difference of opinion with Mr Z who believed that civil works contracting would become more profitable in a reasonable amount of time. 84. Prima facie, Mr A and Mr Z have an arm's length relationship. They share a business relationship and do not share a family relationship. 85. The Exit Deed was a result of ongoing discussions and negotiations between Mr A and Mr Z. Both Mr A and Mr Z sought separate and independent advice about the issues arising from these discussions and negotiations. 86. Entry into the Exit Deed made commercial sense for Mr A, Mr Z and their related entities. The terms of the Exit Deed were informed by the party's own perception of the commercial reality of the NOP Pty Ltd and QRS Pty Ltd businesses, and by separate, independent advice. 87. There is no evidence that the parties were dealing on a non-arm's length basis. 88. Therefore, in accordance with ATO ID 2003/559 Income Tax - Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2 , CGT event A1 is considered more specific than CGT event E2 for the transfer of the NOP Pty Ltd shares. | Summary: 89. Subparagraph 116-30(2)(b)(i) of the ITAA 1997 will not apply to substitute the market value of the shares in NOP Pty Ltd for the transfer of those shares because the parties dealt on an arm's length basis. | Detailed Reasoning - Market value substitution: 90. Section 116-5 of the ITAA 1997 provides that section 116-20 of the ITAA 1997 sets out the general rules about capital proceeds. It applies to CGT event A1. 91. Section 116-20 of the ITAA 1997 provides that the capital proceeds from a CGT event are the total of: (a) the money you have received, or are entitled to receive, in respect of the event happening; and (b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). 92. Section 116-25 of the ITAA 1997 provides a table of modifications to the general rules. Modifications 1, 2, 3, 4, 5 and 6 can apply to CGT event A1. 93. Modification 1, the market value substitution rule, contained in section 116-30(2) of the ITAA 1997 will apply if there are proceeds from the disposal of a CGT asset the subject of CGT event A1 and: (b) those capital proceeds are more or less than the market value of the asset and: (i) you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event; or (ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings). 94. XYZ Trust will receive $X for the sale to the UVW Trust of X shares in NOP Pty Ltd. This is equal to the paid up capital amount of the shares. 95. There is not sufficient evidence to show that $X represents the market value of the shares in NOP Pty Ltd. | Detailed Reasoning - Arm's length dealing: 96. Whether XYZ Trust and the UVW Trust dealt with each other on an arm's length basis regarding the sale of the shares in NOP Pty Ltd is considered above in paragraphs 77 to 88. 97. There is no evidence that the parties were dealing no a non-arm's length basis. Therefore subparagraph 116-30(2)(b)(i) of the ITAA 1997 will not apply to substitute the market value of the shares in NOP Pty Ltd for the transfer of those shares. | Summary: 98. CGT event A1 happens when the shares in QRS Pty Ltd are transferred by XYZ Trust to the UVW Trust. | Detailed Reasoning - CGT event A1: 99. Subsection 104-10(1) of the ITAA 1997 gives that CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(2) of the ITAA 1997 gives that you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner. 100. Subsection 104-10(3) of the ITAA 1997 gives that the time of the event is: (a) when you enter into the contract for the disposal; or (b) if there is no contract - when the change of ownership occurs. | Detailed Reasoning - CGT event E2: 101. Subsections 104-60(1) to (5) of the ITAA 1997 state: (1) CGT event E2 happens if you transfer a *CGT asset to an existing trust. (2) The time of the event is when the asset is transferred. (3) You make a capital gain if the capital proceeds from the transfer are more than the asset's *cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base. (4) If you are the trustee of the trust and no beneficiary is absolutely entitled to the asset as against you (disregarding any legal disability), the first element of the asset's cost base and reduced cost base in your hands is its market value when the asset is transferred. (5) CGT event E2 does not happen if you are the sole beneficiary of the trust and: (a) you are absolutely entitled to the asset as against the trustee (disregarding any legal disability); and (b) the trust is not a unit trust. | Detailed Reasoning - Most specific CGT event: 102. As per subsection 102-25(1) of the ITAA 1997, if more than one CGT event can happen, the event that is the most specific to the situation is to be selected. 103. ATO ID 2003/559 Income Tax: Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2 gives that: However, it is considered that CGT event A1 (rather than CGT event E2) is the most specific event where, as in this case, an asset is transferred to another party and the transferor is indifferent as to the identity of that party. That is, CGT event A1 is the most specific event where the parties are completely unconnected and are dealing with each other at arm's length. ...CGT event A1 is considered the most specific event whenever the parties are unconnected. It would be inappropriate for a different CGT event to apply depending on whether the vendor knew the capacity in which the purchaser was acquiring the asset. On the other hand, CGT event E2 will be the most specific event if, for example, an asset is transferred to a trust of which the transferor or an associate is a beneficiary or object. | Detailed Reasoning - Connection between vendor and purchaser: 104. In this case, XYZ Trust is transferring the asset to the UVW Trust. None of XYZ Trust, its beneficiaries, or its trustee is a beneficiary of trustee of the UVW Trust. There is nothing to otherwise suggest that XYZ Trust is connected to the UVW Trust. | Detailed Reasoning - Arm's length dealing: 105. There are several relevant provisions of law emerging from the cases which are summarised at paragraph 26 of the judgment of Justice Dowsett in Commissioner of Taxation v AXA Asia Pacific Holdings Ltd [2010] FCAFC 134 as follows: (a) in determining whether parties have dealt with each other at arm's length in a particular transaction, one may have regard to the relationship between them; (b) one must also examine the circumstances of the transaction and the context in which it occurred; (c) one should do so with a view to determining whether or not the parties have conducted the transaction in a way which one would expect of parties dealing at arm's length in such a transaction; (d) relevant factors which may emerge include existing mutual duties, liabilities, obligations, cross-ownership of assets, or identity of interests which might enable either party to influence or control the other, or induce either party to serve a common interest and so modify the terms on which strangers would deal; (e) where the parties are not in an arm's length relationship, one may infer that they did not deal with each other at arm's length, and that the resultant transaction is not at arm's length; (f) however, related parties may, in some circumstances, so conduct a dealing as to displace any inference based on the relationship; (g) un-related parties may, on occasions, deal with each other in such a way that the resultant transaction may not properly be considered to be at arm's length. 106. Although Dowsett J dissented in the application of those propositions in that case, Edmonds and Gordon JJ did not disapprove of his summary of those propositions. In that case, Edmonds and Gordon JJ further stated at paragraph 105 that: "Any assessment of whether parties were dealing at arm's length involves 'an assessment [of] whether in respect of that dealing they dealt with each other as arm's length parties would normally do, so that the outcome of their dealing is a matter of real bargaining': Trustee for the Estate of the late AW Furse No 5 Will Trust v FCT (1991) 21 ATR 1123 at 1132 per Hill J" 107. The matter was expanded upon by Justice McKerracher in Healey v Commissioner of Taxation [2012] FCA 269 at paragraph 95: 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]). 108. The transfer of the shares in QRS Pty Ltd by XYZ Trust formed part of the Exit Deed entered into on 22 November 201E. XYZ Trust is controlled by Mr A. 109. The Exit Deed was entered into to facilitate the exit of Mr A from the ongoing operations of NOP Pty Ltd. 110. Mr A wished to exit the business of NOP Pty Ltd because he believed that he would not be able to provide further funding to cover losses that may arise from deteriorating market conditions for civil works contracting. 111. This represented a difference of opinion with Mr Z who believed that civil works contracting would become more profitable in a reasonable amount of time. 112. Prima facie, Mr A and Mr Z have an arm's length relationship. They share a business relationship and do not share a family relationship. 113. The Exit Deed was a result of ongoing discussions and negotiations between Mr A and Mr Z. Both Mr A and Mr Z sought separate and independent advice about the issues arising from these discussions and negotiations. 114. Entry into the Exit Deed makes commercial sense for Mr A, Mr Z and their related entities. The terms of the Exit Deed were informed by the party's own perception of the commercial reality of the NOP Pty Ltd and QRS Pty Ltd businesses, and by separate, independent advice. 115. There is no evidence that the parties were dealing on a non-arm's length basis. 116. Therefore, in accordance with ATO ID 2003/559 Income Tax - Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2 , CGT event A1 will be considered more specific than CGT event E2 for the transfer of the QRS Pty Ltd shares. | Summary: 117. Subparagraph 116-30(2)(b)(i) of the ITAA 1997 will not apply to substitute the market value of the shares in QRS Pty Ltd for the transfer of those shares because the parties dealt on an arm's length basis. | Detailed Reasoning - Market value substitution: 118. Section 116-5 of the ITAA 1997 provides that section 116-20 of the ITAA 1997 sets out the general rules about capital proceeds. It applies to CGT event A1. 119. Section 116-20 of the ITAA 1997 provides that the capital proceeds from a CGT event are the total of: (a) the money you have received, or are entitled to receive, in respect of the event happening; and (b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). 120. Section 116-25 of the ITAA 1997 provides a table of modifications to the general rules. Modifications 1, 2, 3, 4, 5 and 6 can apply to CGT event A1. 121. Modification 1, the market value substitution rule, contained in section 116-30(2) of the ITAA 1997 will apply if there are proceeds from the disposal of a CGT asset the subject of CGT event A1 and: (b) those capital proceeds are more or less than the market value of the asset and: (i) you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event; or (ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings). 122. XYZ Trust will receive $X for the sale to the UVW Trust t of X shares in QRS Pty Ltd. This is equal to the paid up capital amount of the shares. 123. There is not sufficient evidence to show that $X represents the market value of the shares in QRS Pty Ltd. | Detailed Reasoning - Arm's length dealing: 124. Whether XYZ Trust and the UVW Trust dealt with each other on an arm's length basis regarding the sale of the shares in QRS Pty Ltd is considered above in paragraphs 106 to 117. 125. There is no evidence that the parties were dealing no a non-arm's length basis. Therefore subparagraph 116-30(2)(b)(i) of the ITAA 1997 will not apply to substitute the market value of the shares in QRS Pty Ltd for the transfer of those shares.