Private ruling: CGT and convertible shares
Date of advice: 21 March 2022
Published: June 2022
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Did the conversion of the preference shares to ordinary shares trigger a Capital Gains Tax (CGT) event? | A1: Yes | Q2: Does the modification of the first element of the cost base as set out in item 1 of the table in subsection 130-60(1) of the Income Tax Assessment Act 1997 apply to the converted shares? | A2: Yes

Relevant facts and circumstances: Company A is an Australian resident company for income tax purposes. It is the parent company of Company B. Company A issued both ordinary shares and preference shares from during the X years after incorporation. The rights attached to the preference shares are set out in the Constitution which states that preference shares shall have the same rights and restrictions as ordinary shares save as to rules regarding liquidation, reclassification of shares and conversion events. The constitution provides that upon liquidation and provides that on a distribution of assets or return of capital preference shareholders shall be paid before ordinary shareholders. The Constitution further provides subject to the Corporations Act and unless the directors determine otherwise in writing, any conversion or reclassification of shares will occur by way of variation of the rights attaching to the relevant shares (and will not cause the cancellation of any existing share or the issue of any new share). The conversion events, rights and restrictions in respect of the preference shares are discussed in the Constitution, which addressed the following: Optional Conversion a) A Preference Shareholder may, by notice in writing to the company ("Conversion Notice") accompanied by the share certificate (or an indemnity for a lost share certificate in a form acceptable to the Board) for the relevant Preference Shares, elect to convert (including by way of a variation of rights) into Ordinary Shares all of its fully paid Preference Shares at any time without the payment of additional consideration. Such Preference Shares shall convert automatically on the date such notice is received by the company. Automatic Conversion a) All outstanding Preference Shares shall automatically be converted into Ordinary Shares upon the earlier of: (i) the date and time, or the occurrence of an event, specified by the written consent of or an affirmative vote (voting as a separate class) of Preference Shareholders who together hold at least X% of the votes that may be cast in respect of the Preference Shares; (ii) one or more underwriters having agreed in writing to underwrite an IPO; (iii) the receipt by Company B of a Restricted ADI Licence permitting it to operate a restricted ADI; or (iv) the company receiving written advice from the company's auditors or a written notice from a Governmental Agency that the company is required to hold Common Equity Tier 1 Capital with a value in excess of $X to satisfy the licencing or other regulatory requirements applicable to the business of the Group. b) The company shall give each Preference Shareholder written notice of a conversion and each Preference Shareholder shall, as soon as practicable and in any event no later than 10 Business Days after the receipt of such written notice, deliver to the company's registered office the share certificate (or an indemnity for a lost share certificate in a form acceptable to the Board) in respect of the Preference Shares held by such Preference Shareholder. The Ordinary Shares resulting from the conversion of Preference Shares will rank equally with the other Ordinary Shares on issue immediately following the conversion. Preference Shares converted in accordance with the Constitution shall be converted into such number of fully paid Ordinary Shares obtained by multiplying the applicable Conversion Rate then in effect by the number of Preference Shares being converted. The Conversion Rate in effect at any time shall be the quotient obtained by dividing the Preference Share Original Issue Price by the Preference Share Conversion Price in effect at the time of conversion ("Preference Share Conversion Rate"). The Preference Share Conversion Price shall be equal to the applicable Preference Share Original Issue Price as adjusted in accordance with the Constitution ("Preference Share Conversion Price"). The Constitution provides regarding Reorganisation Adjustment: a) If the Board forms the view that the number of Ordinary Shares has changed into a different number of shares of any class or classes of shares, whether by recapitalisation, reclassification, sub-division, consolidation or other corporate reorganisation to the share capital of the company (a "Reorganisation"), the Preference Share Conversion Price shall be adjusted as approved by the Board so that the Preference Shares then on issue are convertible into the same percentage of the issued Ordinary Shares (after conversion) as the percentage into which they are convertible immediately prior to the relevant Reorganisation and so that the holders of Preference Shares are neither advantaged nor disadvantaged as a consequence of such Reorganisation. b) Paragraph (a) shall not apply: (i) with the written consent of or an affirmative vote (voting as a separate class) of Preference Shareholders who together hold at least 50% of the votes that may be cast in respect of the Preference Shares; (ii) in respect of an issue of Additional Ordinary Shares at an issue price which is higher than the Preference Share Conversion Price; (iii) in respect of an issue of Additional Ordinary Shares to which paragraph (b) applies; (iv) in respect of an issue of Ordinary Shares to any employee or manager pursuant to any Employee Incentive Plan; and' (v) in respect of an issue of Ordinary Shares issued pursuant to an IPO. The Constitution regarding Price Adjustment provides: a) If the company issues Additional Ordinary Shares, without consideration or for a consideration per share less than the Preference Share Conversion Price in effect immediately prior to such issue, then the Preference Share Conversion Price shall be reduced, concurrently with such issue, to a price (calculated to the nearest one- hundredth of a cent) determined in accordance with the following formula: CP2 = CP1 x (A + B) ÷ (A + C) For purposes of the foregoing formula, the following definitions shall apply: (i) "CP2" shall mean the Preference Share Conversion Price in effect immediately after such issue of Additional Ordinary Shares; (ii) "CP1" shall mean the Preference Share Conversion Price in effect immediately prior to such issue of Additional Ordinary Shares; (iii) "A" shall mean the number of Ordinary Shares outstanding immediately prior to such issue of Additional Ordinary Shares; (iv) "B" shall mean the number of Ordinary Shares that would have been issued if such Additional Ordinary Shares had been issued at a price per share equal to CP1 (determined by dividing the Issue Consideration received by the company in respect of such issue by CP1); (v) "C" shall mean the number of such Additional Ordinary Shares issued in such transaction; and (vi) "Issue Consideration" shall be equal to the consideration received by the company attributable to the issue of the Additional Ordinary Shares and where the consideration is non-cash consideration the value shall be the fair market value of such non-cash consideration as determined by the Board. If the Preference Share Conversion Price is adjusted in accordance with the Constitution, the company shall, upon the written request of a Preference Shareholder, provide a written notice to such Preference Shareholder setting out the adjustment and the new Preference Share Conversion Price. If the calculation for the conversion of Preference Shares results in an entitlement to a fraction of an Ordinary Share, the fraction shall be eliminated by rounding downwards or as otherwise determined by the Board. As soon as practicable following the conversion of a Preference Share, the company shall: (i) update the register of members to record the conversion of the Preference Share; and (ii) subject to the relevant holder having returned the share certificate in respect of the Preference Share (or an indemnity for a lost share certificate in a form acceptable to the Board), issue a new share. "Additional Ordinary Shares" means all Ordinary Shares issued by the company following the date of the issuance of the initial Preference Shares other than Ordinary Shares issued: a) with the written consent of or an affirmative vote (voting as a separate class) of Preference Shareholders who together hold at least 50% of the votes that may be cast in respect of the Preference Shares; b) as a dividend or distribution on Preference Shares; c) to any employee or manager pursuant to any Employee Incentive Plan; d) issued pursuant to an IPO. Company A issued a notice under which it sought the consent of X% of preference shareholders who together hold at least X% of the votes that may be cast in respect of the preference shares (Conversion notice). The conversion notice set out the following proposal: a) The Company hereby seeks your consent to convert your Preference Shares into Ordinary Shares. b) Should the Company receive the requisite consent threshold of X% of the votes that may be cast in respect of the Preference Shares: (i) all outstanding Preference Shares will automatically be converted into Ordinary Shares at the Conversion Time specified in paragraph (d) below; and (ii) you will be entitled to receive the number of Ordinary Shares calculated in accordance with the Constitution at the completion of the Capital Raising (Conversion Shares). a) The Conversion Date is the date that is five (5) Business Days after the date on which the Company notifies the Preference Shareholders in writing of the closing of the First Tranche of the Capital Raising. b) The Conversion Time will be XX:XXam on the Conversion Date. c) The Conversion Shares will be issued as follows: (i) on or around the Conversion Date in respect of all funds received in the First Tranche up to the day before the Conversion Date; and (ii) additional Ordinary Shares will be issued on or around the date of the closing of the Second Tranche in respect of all funds received by the Company between the Conversion Date and the date of closing of the Second Tranche (including any funds not conditional on the receipt of a Minded to Grant Letter received upon obtaining the required members' and/or regulatory approvals). a) If the Company does not give a notice referred to in paragraph 3(c) to the Preference Shareholders by the required date, your consent to convert will automatically expire on that date. b) No amount is payable by you in respect of the Conversion Shares. c) Please indicate your consent to the conversion of your Preference Shares under the Constitution by executing the Consent Form included at Annexure A and returning it to the Company. d) Shortly after the issue of the Conversion Shares, the Company will update its member register for the information of each Shareholder. The required X% consent was obtained two days after the conversion notice was sent, and the conversion occurred on the date set out in the conversion notice. The constitution will be amended to remove all provisions relating to preference shares. Company A will confirm to APRA that they will not be issuing any more Preference shares and as such, pricing flexibility is not required. The most recent consolidated income tax return disclosed losses. There are no dividend or franking credit amounts paid in respect to that income year.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 100-20 | Income Tax Assessment Act 1997 section 102-20 | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 104-155 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 section 130-60 | Income Tax Assessment Act 1997 section 974-75 | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: The conversion of the preference shares to ordinary shares did trigger a Capital Gains Tax (CGT) event C2 however any capital gain or loss is disregarded. No other CGT events were triggered by the conversion. | Detailed Reasoning - Detailed reasoning: Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the general CGT provisions of the income tax law. Section 100-20 of the ITAA 1997 provides that you can make a capital gain or capital loss if and only if a CGT event happens. The capital gain or loss is made at the time of the CGT event (section 102-20 of the ITAA 1997). CGT events are detailed in Division 104 of the ITAA 1997. Most CGT events involve a CGT asset. A 'CGT asset' is defined in section 108-5 of the ITAA 1997 and includes any kind of property. Note 1 to section 108-5 gives examples of CGT assets, which specifically include shares in a company. | Detailed Reasoning - CGT Event A1: Subsection 104-10(1) of the ITAA 1997 provides that a CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(2) of the ITAA 1997 provides: 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. The creation of the new ordinary shares will be given effect through a conversion of preference shares to ordinary shares and bonus shares through the application of the Constitution. The rights attached to the shares will change as the holders of the preference shares will no longer have a preference over other shares in the event of liquidation. The Commissioner has provided his opinion on whether a variation of rights attaching to shares will result in a disposal of shares in Taxation Ruling TR 94/30 Income tax: capital gains tax implications of varying rights attaching to shares . This ruling concerns Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936). Part IIIA which dealt with capital gains and losses has since been repealed and rewritten into the ITAA 1997. In particular, disposals of an asset formerly covered under subsection 160M(1) of the ITAA 1936 are now captured by CGT event A1 under the ITAA 1997. Similarly, paragraph 108-5(2)(a) of the ITAA 1997, which replaces former section 160R of the ITAA 1936, ensures that part disposals of a CGT asset are also captured under CGT event A1. In respect of former subsection 160M(1)of the ITAA 1936, paragraph 8 of TR 94/30 states: 8. A variation in rights attaching to a share... does not result in a full disposal of an asset for the purposes of Part IIIA unless there is a cancellation or redemption of the share. In determining whether a disposal has occurred under Part IIIA, it is not relevant to consider whether the variation is slight (such as a small change to the nominal value of shares) or more significant (such as disposing of the preference to receive dividends). The variation to convert the preference shares, with only a variation to preference should the company liquidate, will not cause a full disposal for the purposes of section 104-10 of the ITAA 1997. Therefore, the conversion of the shares from preference shares to ordinary shares will not give rise to CGT Event A1, as there has been no change in the beneficial ownership of the shares. | Detailed Reasoning - CGT event H2: CGT event H2 in subsection 104-155(1) of the ITAA 1997 happens if an act, transaction, or event occurs in relation to a CGT asset and the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base. Paragraph 10 of TR 94/30 provides that a variation in rights for money or other consideration, may give rise to a deemed disposal under subsection 160M(7) of the ITAA 1936 where the other requirements of the subsection are met. That subsection has been rewritten as CGT event H2. The conversion of the shares from preference shares to ordinary shares will constitute an act, transaction or event in relation to a CGT asset. The conversion of the shares will result in an adjustment being to the cost base or reduced cost base of the units in accordance with sections 112-70 and 130-60 of the ITAA 1997. Therefore, as the cost base will be adjusted, the conversion did not trigger a CGT event H2. | Detailed Reasoning - CGT Event C2: Section 104-25 of the ITAA 1997 provides the circumstances in which a CGT event C2 happens. CGT event C2 happens if your ownership of an intangible CGT asset ends because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered, or forfeited, or if the asset is a convertible interest, being converted (subsection 104-25(1) of the ITAA 1997). The time of the event is when a taxpayer enters into the contract that results in the asset ending. If there is no contract, the time of the event is when the asset ends (subsection 104-25(2) of the ITAA 1997). A convertible interest in a company is an interest of the kind referred to in item 4 of the table in subsection 974-75(1) of the ITAA 1997. Item 4 of the table in subsection 974-75(1) of the ITAA 1997 provides: An interest issued by the company that: (a) gives its holder (or a connected entity of the holder) a right to be issued with an equity interest in the company or a connected entity of the company; or (b) is an interest that will, or may, convert into an equity interest in the company or a connected entity of the company. The preference shares meet the definition of a convertible interest, as they give its holder a right to be issued with an equity interest in Company A. Note 1 in section 104-25 states there are other exceptions if you acquire shares by converting a convertible interest, see section 130-60. Note 1 in section 130-60 of the ITAA 1997 provides that the conversion of the convertible interest would be an example of CGT event C2, however subsection 130-60(3) of the ITAA 1997 provides that a capital gain or loss you make from converting a convertible interest is disregarded. As such converting the preference shares to ordinary shares is a C2 CGT event, however any capital gain or loss is disregarded. | Summary: Item 1 in the table in subsection 103-60(1) of the ITAA 1997 applies to the converted preference shares. | Detailed Reasoning - Detailed reasoning: The table in subsection 130-60(1) of the ITAA 1997 sets out the modification rules about cost base and reduced cost base is you acquire shares by converting a convertible interest. The preference shares are an interest in Company A and gives its holder a right to be issued with an equity interest in the company. Item 1 of the table in subsection 130-60(1) applies if the convertible interest that has been converted is a traditional security. Shares are a traditional security and the preference shares that have been converted are convertible interests. Therefore, the first element of the cost base of the shares is the sum of: (a) the cost base of the convertible interest at the time of conversion; and (b) any amount paid to convert the convertible interest, except to the extent that the amount is represented in the paragraph (a) amount; and (c) all the amounts to be added under subsection (1A). The first element of their reduced cost base is worked out similarly.