Private ruling: Capital Gains Tax and the application of Part IVA
Published: September 2014
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016
Date scheme commenced: 1 July 2014

Ruling: Q1: Is the Trust required to deduct from its reduced cost base under subsection 110-55(7) of the Income Tax Assessment Act 1997 (ITAA 1997) dividends it receives from the Company that are sourced from profits made by the Company before the Trust acquired the shares? | A1: No. | Q2: Will the Trust be entitled to a capital loss on the cancellation of its shares under CGT Event C2 if the Company distributes of all of its retained earnings in the form of taxable dividends to the Trust and is then liquidated or deregistered resulting in the paid up capital of the Company being returned to the Trust as its sole shareholder? | A2: Yes. | Q3: Would the Commissioner apply Part IVA of the Income Tax Assessment Act 1936 to cancel any capital loss that would otherwise arise to the Trust upon the liquidation or deregistration of the Company? | A3: No.

Relevant facts and circumstances: The Company has undergone a number of changes from the time it was incorporated. Originally, the company was owned as follows: - Individual A 1 Ordinary and 1 C Class share - Individual B 1 Ordinary and 1 A Class share - Individual C 1 Ordinary and 1 B Class share - Individual D 1 Ordinary and 1 E Class share - The Trust 1 D Class share The company was initially to be used as a wealth creation vehicle by Individual A in conjunction with their estate planning to build up assets. It was Individual A's understanding that they were the sole shareholder of the Company and it came as a surprise to them when they were advised that the other Individuals had been included as shareholders of the company. Individual A's former accountants had used the company as the corporate beneficiary of the broader Group in prior years which resulted in the significant accumulation of retained earnings in the Company. This was specifically against the intended plans of Individual A as their intention was for this entity to be separate and distinct from the rest of the group of entities. Upon learning of the share ownership of the Company, the Group ceased using the Company as a corporate beneficiary. In order to rectify the situation an independent valuer was appointed to assess the indicative fair market value of the Company. Legal advice was subsequently sought as to the possible gifting of the shares owned by the other three Individuals (B, C and D) to Individual A. Subsequently, the shares owned by Individuals B, C and D in the Company were gifted to Individual A by way of Deed of Gift. As no consideration was paid for these shares and the parties were not dealing with each other at arm's length, the market value substitution rules contained in Section 116-30 of the Income Tax Assessment Act 1997 (ITAA1997) were applied to deem the disposals for market value. Individuals B, C and D returned a gross capital gain in each of their respective individual tax returns for that income year. For the purpose of CGT Event A1, the mid-range of the value assessed was taken as consideration, and each Individual was assessed on their respective capital gain. Individual A and their spouse paid the tax on behalf of Individuals B, C and D. On legal and accounting advice, it was recommended that the company be owned by a trust which would allow flexibility to flow income to the members, personal asset protection and would also allow control of the trust to be managed via the appointorship powers in the Trust Deed rather than via a Will. The Trust was established with Individual A as Appointer. After Individual A's death, their spouse is to become the Appointor of the Trust and after the death of the survivor of Individual A and their spouse, the Appointors will be Individual B, C and D jointly. Subsequently all the shares in the company owned by Individual A were transferred to the Trust. In that financial year, Individual A included a capital gain in their personal income tax return and paid tax. The Trust was the sole shareholder of the Company and the trust owed Individual A an amount of money. That was the Trust's only liability. Subsequently Individual A and their spouse acquired a new property which was intended to become their main residence. In addition to this, they needed to fund the payment of the Capital Gains Tax liabilities of Individual A, B, C and D. In order to fund the above purchase and CGT liabilities, the Trust obtained a loan from the Company (under a complying Division 7A loan agreement) and Individual A was able to draw down on funds owed to them by the Trust. It is intended that the complying Division 7A loan will be repaid via the declaration of dividends from the Company over the relevant years that the loan is in place. The Trust is a discretionary trust and at the end of each financial year, the trustee determines which beneficiaries are entitled to a share of its income. Given that the intention is to never again use the Company as a corporate beneficiary of the group (as there are other entities that are used for this purpose), it is highly likely that the Company will be either liquidated or wound down. The trustee of the Trust may elect to distribute its net income (from the company dividends) to another corporate entity in the group if the Company is wound up. This would allow it to transfer the company's retained earnings to another entity at the same corporate tax rate which will enable the Group to reduce its structure by one entity which no longer serves any active purpose.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-25 | Income Tax Assessment Act 1997 Subsection 104-25(3) | Income Tax Assessment Act 1997 Subsection 110-55(7) | Income Tax Assessment Act 1997 Section 116-30 | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 Section 177A | Income Tax Assessment Act 1936 Subsection 177A(1) | Income Tax Assessment Act 1936 Subsection 177A(5) | Income Tax Assessment Act 1936 Section 177C | Income Tax Assessment Act 1936 Paragraph 177C(1)(ba) | Income Tax Assessment Act 1936 Section 177D | Income Tax Assessment Act 1936 Subsection 177D(1) | Income Tax Assessment Act 1936 Subsection 177D(2) | Income Tax Assessment Act 1936 Section 177F

Reasons for decision: Summary: Subsection 110-55(7) of the ITAA 1997 may apply to reduce the cost base of shares in certain circumstances. As recognised by you, subsection 110-55(7) only applies to corporate tax entities. The Trust is not a corporate tax entity. Thus, this provision does not apply to the Trust. | Detailed Reasoning - Detailed reasoning: Subsection 110-55(7) of the ITAA 1997 may apply to reduce the cost base of shares in certain circumstances. Section 110-55(7) of the ITAA 1997 states: If your CGT asset is a share in a company, its reduced cost base is reduced by the amount calculated under subsection (8) if: (aa) you are a corporate tax entity; and (a) The company makes a distribution to you under an arrangement; and (b) The amount (the attributable amount) representing the distribution or part of it is reasonably attributable to profits derived by the company before you acquired the share; and (c) You are entitled to a tax offset under Division 207 on the part of the distribution that is a dividend (the dividend amount); and (d) You were a controller (for CGT purposes) of the company, or an associate of such a controller, when the arrangement was made or carried out. Given that the Trust is not a corporate tax entity, its reduced cost base is unaffected by the declaration of dividends by the Company, even if the payment represents profits derived by the Company before the Trust became a shareholder. | Summary: Upon CGT event C2 happening, the Trust will be entitled to a capital loss on the cancellation of its shares. | Detailed Reasoning - Detailed reasoning: Section 104-25 of the ITAA 1997 provides that CGT event C2 will happen where the ownership of an intangible CGT asset, such as shares in a company, ends by the asset being cancelled. Subsection 104-25(3) of the ITAA 1997 provides that: You make a capital gain if the *capital proceeds from the ending are more that the asset's *cost base. You make a capital loss if those capital proceeds are less that the asset's *reduced cost base. In the case of a member's voluntary liquidation, the asset comes to an end upon the cancellation of the shares after the distribution of all profits and capital to the company's shareholders. Under the current scenario, the cost base of the shares that the Trust holds in the company is $X and the paid up capital of the company is $Y. In the event the company is liquidated, the Trust would crystallise a capital loss of $X minus the paid up capital of the Company ($Y). As the capital proceeds are less than the reduced cost base, the Trust will make a capital loss in connection with the CGT event pursuant to subsection 104-25(3) of the ITAA 1997. | Summary: Part IVA of the Income Tax Assessment Act 1936 will not apply to cancel the capital loss that would otherwise arise to the Trust upon the liquidation of the Company. | Detailed Reasoning - Detailed reasoning: Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies to transactions if it is reasonable to conclude that a scheme (broadly defined) was entered into by a person for the dominant purpose of obtaining a tax benefit. Section 177F of the ITAA 1936 allows the Commissioner to cancel certain tax benefits which have been obtained, or would but for section 177F have been obtained, by a taxpayer in connection with a scheme to which Part IVA applies. For Part IVA of the ITAA 1936 to apply there must be: 1. A scheme as defined in section 177A; 2. A taxpayer obtaining a 'tax benefit' in connection with the scheme as defined by section 177C; 3. Having regard to the criteria in section 177D it would be concluded that there was a sole or dominant purpose of enabling the taxpayer to obtain a tax benefit; and 4. The Commissioner makes a determination that the whole or part of the amount of the tax benefit is to be included in the taxpayer's assessable income, section 177F(1)(a). | Detailed Reasoning - Is there a scheme?: 'Scheme' is defined in wide terms under subsection 177A(1) of the ITAA 1936 to include: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme, plan, proposal, action, course of action or course of conduct. In this case the scheme would be identified as the capital loss that would arise to the Trust in the event that the Company is liquidated. | Detailed Reasoning - Is there a tax benefit?: For Part IVA of the ITAA 1936 to apply the taxpayer must have obtained, or would but for section 177F of the ITAA 1936 obtain, a tax benefit in connection with the scheme. It must be possible to assert that a tax benefit would not have been obtained if the scheme had not been entered into or carried out, or that it might be reasonably be expected not to have been obtained. The first step is to consider whether a beneficial result will arise for the Trust from the scheme in terms of section 177C of the ITAA 1936. As the scheme relates to a capital loss to be incurred by the Trust, paragraph 177C(1)(ba) of the ITAA 1936 is the relevant provision which states: 'a capital loss being incurred by the taxpayer during a year of income where the whole or a part of that capital loss would not have been, or might reasonably be expected not to have been, incurred by the taxpayer during the year of income if the scheme had not been entered into or carried out.' In this instance the relevant tax benefit would be the capital loss that would arise to the Trust as a result of CGT event C2. | Detailed Reasoning - Is there a dominant purpose?: Subsections 177D(1) and 177D(2) (which replaced paragraphs 177D(a) and 177D(b) with effect from 16 November 2012) of the ITAA 1936 state: | Detailed Reasoning - 177D(1): This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of: a) enabling a taxpayer (a relevant taxpayer ) to obtain a tax benefit in connection with the scheme; or (b) enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme; whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers. | Detailed Reasoning - 177D(2): For the purpose of subsection (1), have regard to the following matters: (a) the manner in which the scheme was entered into or carried out; (b) the form and substance of the scheme; (c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; (e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; (f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; (g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out; (h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f). Paragraphs 79 to 82 of Law Administration Practice Statement PS LA 2005/24 Application of General Anti-Avoidance Rules provide further guidance on the application of 177D of the ITAA 1936: 79. Section 177D provides that Part IVA applies to a scheme in connection with which the taxpayer has obtained a tax benefit if, after having regard to eight specified factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling the taxpayer to obtain the tax benefit. 80. The objective test in paragraph 177D(b) is the core of Part IVA and has been described by the High Court as the 'pivot' or 'fulcrum' on which Part IVA turns. It is frequently referred to as the 'statutory predication test'. 81. Section 177D refers to 'the purpose' of the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme. The person need not be the taxpayer. Subsection 177A(5) clarifies that the 'purpose' includes the dominant purpose where there are two or more purposes. 82. The dominant of two or more purposes is the ruling, prevailing or most influential purpose. It is evident from the relevant facts provided that there are two purposes for the proposal of the scheme: 1. To use the Trust to ensure estate planning and asset protection; and 2. To allow the Trust to obtain a tax benefit of a capital loss. The Commissioner, by having regard to each of the eight factors in subsection 177D(2) of the ITAA 1936, will now determine whether or not the Trust's dominant purpose in carrying out the scheme is for the Trust to obtain a tax benefit. (a) manner in which the scheme was entered into or carried out Paragraphs 93 and 94 of PS LA 2005/24 relevantly state: 93. …The first factor…enables contrivance and artificiality to be identified by comparing the manner in which the scheme was entered into or carried out with the manner in which the counterfactual would have been implemented, for example, by the presence of a step or steps in a relevant transaction or arrangement that would not be expected to be present in a more straightforward or ordinary method of achieving the outcome of the transaction or arrangement. Conversely, if a scheme is entered into and carried out in the manner in which ordinary business or family dealings are conducted, the manner of the scheme will not indicate the purpose of obtaining a tax benefit. 94. The identification of any step or aspect of the scheme that is apparently explicable for no purpose but a tax purpose will go to the manner in which the scheme was entered into or carried out. … The creation of the Trust was to allow flexibility to flow income to the beneficiaries, personal asset protection and would also allow control of the Trust to be managed via the appointorship powers in the Trust Deed rather than via a Will. The change in ownership of the Company was to rectify previous poor tax planning advice. However, the Commissioner accepts that it is unlikely that any ordinary family dealing would contemplate an arrangement which would pose an asset protection risk. Therefore, the Commissioner accepts that this factor does not indicate the requisite purpose of obtaining a tax benefit. (b) the form and substance of the scheme Paragraph 95 of PS LA 2005/24 relevantly states: 95. The second factor…requires that substance, rather than form, be the subject of inquiry. Put simply the factor directs attention to whether there is a discrepancy between the form of the scheme and its substance, meaning its commercial and economic substance. A discrepancy…may well indicate the scheme has been implemented in a particular form as the means to obtain a tax benefit if the substance of the scheme may be achieved…by some other more straightforward or commercial transaction or dealing. The substance of the scheme is that all the shares of the Company, owned by Individual A, were transferred to the Trust. The consideration paid for the transfer of the shares was based on an independent market valuation. In order to fund the Capital Gains Tax liabilities of Individual A, B, C and D plus the acquisition of a new property which Individual A intends to use as their main residence, the Trust obtained a loan from the Company (under a complying Division 7A loan agreement) and Individual A was able to draw down on the funds owed to them by the Trust. It is intended that the complying Division 7A loan will be repaid via the declaration of dividends from the Company over the relevant years that the loan is in place. The Commissioner is of the view that the form of this arrangement is not only to obtain a tax benefit, but also to use the Trust for personal asset protection and a family wealth creation vehicle. Therefore, the Commissioner accepts that this factor does not indicate the requisite purpose of obtaining a tax benefit. (c) the timing at which the scheme was entered into and the length of the period during which the scheme was carried out Paragraph 101 of PS LA 2005/24 relevantly states: 101. This factor will enable consideration of the extent to which the timing and duration of the scheme go towards delivering the relevant tax benefit or are related to commercial opportunities or requirements. The timing and duration of the scheme is not a relevant factor to the taxation benefit that will be obtained. This is because the tax benefit will be solely the capital loss generated by the change of ownership of the Company to fix a problem generated by bad financial advice in the past. Therefore, the Commissioner accepts that this factor does not indicate the requisite purpose of obtaining a tax benefit. Indeed the timing of the capital loss, which can only be fully used after several years, would suggest nothing artificial or contrived insofar as the timing is concerned. (d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme Paragraph 105 of PS LA 2005/24 states: 105. The fourth factor expressly focuses on the tax benefit and any other tax consequence resulting from the scheme. As stated previously, a tax benefit of a capital loss will be generated. However, prior to this loss the Individuals listed have crystallised a significant up-front capital gain. Given the size of the likely capital loss, you argue that it may take many years for it to be used as the Group's past strategy has been to accumulate assets rather than sell them. Therefore, the Commissioner is of the view that this factor does indicate the requisite purpose of obtaining a tax benefit. (e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme (f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme (g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out Paragraphs 106, 107 and 108 of PS LA 2005/24 relevantly state: 106. The fifth, sixth and seventh factors focus on the non-tax effects of the scheme, not only for the relevant taxpayer, but also for all connected parties. These factors look to the practical financial, legal, economic and any other outcomes achieved by the scheme for the taxpayer and connected parties. … 107. The fifth, sixth and seventh factors involve identifying changes in financial position or any other consequences that may be reasonably expected to result from the scheme, not just changes that have resulted or will result. … 108. The absence of any practical change in the overall financial, legal or economic position of a taxpayer and connected parties that are affected by the scheme is likely to add weight to the dominance of the tax purpose when all the paragraph 177D(b) factors are weighed together. … The scheme will not only produce the previously stated tax benefit for the Trust, but it will also result in non-tax effects arising to the taxpayer and connected parties. More specifically, these non-tax effects will be as follows: • Given that the intention of the Family is to never again use the Company as a corporate beneficiary of the group, it is highly likely that the company will be liquidated. • The Trustee of the Trust may elect to distribute its net income (from the company dividends) to another corporate entity in the Group if the company is liquidated. This would allow it to transfer the company's retained earnings to another entity at the same corporate tax rate which will enable the family to reduce its structure by one entity which no longer serves any active purpose to the Group. The above non-tax effects are evidence that the scheme was not entered into by Individual A for the dominant purpose of the Trust obtaining a tax benefit. (h) The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f) Paragraph 111 of PS LA 2005/24 states: 111. This factor requires attention to be paid to the existence of any family relationship between the taxpayer and the persons who are affected in any way by the scheme. This could assist a taxpayer in some cases. Many dealings which would be decidedly odd between strangers may be entirely explicable between family members. For example, a businessman who gives assets to strangers for less than they are worth may be subject to suspicion but a gift to his family could stand in a different light. Of course, it would be a different matter again if the family members do not benefit in substance from the arrangement. Taking into account the non-tax benefits referred to that will be obtained by Individual A, B, C and D under factor (g) above, it is reasonable for the Commissioner to form the view that the creation of the capital loss by the Trust are required to ensure that the desired outcomes of these dealings, being asset protection. Therefore, the Commissioner accepts that this factor does not indicate the requisite purpose of obtaining a tax benefit. | Detailed Reasoning - Conclusion: In conclusion, after having regard to all eight factors in subsection 177D(2) of the ITAA 1936, the Commissioner accepts that the dominant purpose for the Trust carrying out the scheme under subsection 177D(1) of the ITAA 1997 is not to obtain the stated tax benefit, and therefore Part IVA of the ITAA 1936 will not apply.