Private ruling: CGT - cash advances and cost base of and reduced cost base of shares
Date of advice: 29 June 2016
Published: August 2016
Ruling period: 1 July 2001 to 30 June 2002 | 1 July 2002 to 30 June 2003 | 1 July 2003 to 30 June 2004 | 1 July 2004 to 30 June 2005 | 1 July 2005 to 30 June 2006 | 1 July 2007 to 30 June 2008 | 1 July 2008 to 30 June 2009 | 1 July 2009 to 30 June 2010 | 1 July 2011 to 30 June 2012 | 1 July 2014 to 30 June 2015

Ruling: Questions and answers | Does the shareholder's capital injection to the Company form part of the cost base/reduced cost base of the shares they hold in the Company? | Yes.

Relevant facts and circumstances: You are a shareholder in the Company and have made a number of cash advances to the Company since its establishment. The Company was established for business purposes with the intention to make a profit. The cash advances made by you to the Company are described as Shareholder loans on the Company's balance sheet. The cash advances were recorded in the Equity Section of the balance sheet because it was considered unlikely that these funds would ever be repaid. You made cash advances to the Company to build the business; to fund operations and to maintain the value of the Company issued shares payments were made from your personal bank account, an overdraft facility and a loan. You cleared both of these loans with your own funds. Creditor invoices were issued to the Company and all payments by you, including wages were essential in keeping the Company solvent. The cash advances did not incur interest nor were shares or membership interests issued in return for the funds injected. Amounts are recorded in the Company general ledger account. No loan agreement was entered into when the cash was advanced. There was no other documentation entered into evidencing an intention to pay interest or repay the principal sum to you. The Company ceased its business operations. The Company transferred a small amount of funds to your bank account in instalments. The Company's assets were sold in preparation for a voluntary deregistration. The Company received $xx.xx from the sale of assets; plant and equipment. From the Company bank account two cheques were made, $xx.xx to repay a loan and $xx.xx was paid to you. The Company has nil assets.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subparagraph 26(g) | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 110-25 | Income Tax Assessment Act 1997 Subsection 110-45(3) | Income Tax Assessment Act 1997 Section 110-55 | Income Tax Assessment Act 1997 Section 40-880 | Income Tax Assessment Act 1997 Subsection 40-880(2) | Income Tax Assessment Act 1997 Paragraph 40-880(2)(a) | Income Tax Assessment Act 1997 Paragraph 40-880(2)(b) | Income Tax Assessment Act 1997 Paragraph 40-880(2)(c) | Income Tax Assessment Act 1997 Paragraph 40-880(2)(d) | Income Tax Assessment Act 1997 Subsection 40-880(4) | Income Tax Assessment Act 1997 Subsection 40-880(5) | Income Tax Assessment Act 1997 Paragraph 40-880(5)(f) | Income Tax Assessment Act 1997 Subsection 40-880(6) | Income Tax Assessment Act 1997 Subsection 40-880(7) | Income Tax Assessment Act 1997 Subsection 40-880(8) | Income Tax Assessment Act 1997 Subsection 40-880(9) | Income Tax Assessment Act 1997 Section 974-20 | Income Tax Assessment Act 1997 Section 974-75

Reasons for decision: Detailed Reasoning - Nature of taxpayer's contribution payment to the company: Our view is that the contribution payment by you is not a debt interest and is unlikely to be an equity interest. Your contribution payment is more in the nature of a gift to the Company. The reasons for this view are explained in the analysis below. | Detailed Reasoning - Contribution payment not a debt Interest: The payment made by you is not a debt interest under Subdivision 974-B of the Income Tax Assessment Act 1997 (ITAA 1997), as it does not pass the debt test stated in section 974-20 of the ITAA 1997. In relation to the debt test in section 974-20 of the ITAA 1997, it is doubtful that subparagraph 974-20(1)(c) of the ITAA 1997 is met, as it is unlikely that the Company had an "effective non- contingent obligation" to pay you. It is also clear that the payment would not fall under subparagraph 974-20(1)(d) of the ITAA 1997, as it is "substantially more likely than not" that the Company (as the Company has ceased trading and has nil assets) would be unable to pay you "at least equal" the amount you contributed to the Company. Accordingly, as the contribution payment does not pass the debt tests in section 974-20 of the ITAA 1997, it cannot be a debt interest for the purposes of the ITAA 1997. The above analysis also conforms with your own submission that no loan agreement or arrangement was made between yourself and the Company. | Detailed Reasoning - Corporations Act 2001: Regardless of the tax debt/equity rules in Division 974, it is also unlikely that your contribution payment would be deemed a debt interest under normal commercial law. Your contribution payment is more in the nature of a gift to the company, so that you can avoid being in breach of section 588G of the Corporations Act 2001. Section 588G states that a company director has a duty to prevent a company trading when insolvent or to prevent a company becoming insolvent by incurring a debt. A breach of section 588G could lead to penalties under the Criminal Code. Based on the above analysis, it is therefore our considered view that the contribution payment made by you is not a debt interest either under Division 974 of the ITAA 1997 or under normal commercial law. | Detailed Reasoning - Contribution payment unlikely to be an equity interest: Your contribution payment is unlikely to be an equity interest under Division 974 either, as a non-scrip share capital contribution or as a non-share equity interest. | Detailed Reasoning - Contribution unlikely to be a non-scrip share capital contribution: Your contribution payment is unlikely to be a non-scrip share capital contribution, as it is probable that non-scrip share capital contributions are not legal under Australian law. Non-scrip share capital contributions are discussed in Taxation Determination TD 2004/2 Income tax: capital gains: is reflection in the 'value' of an asset sufficient to constitute reflection in its 'state' or 'nature' for the fourth element of cost base and reduced cost base (subsections 110-25(5) and 110-55(2) of the ITAA 1997 and what are the implications of this issue for a shareholder that makes a non-scrip share capital contribution to a company? (now withdrawn but still considered relevant for these purposes) The probability that non-scrip share capital contributions are not legally possible in Australia is mentioned in paragraph 13 of TD 2004/2 where it states: Advice has been received from the Attorney General's Department of the Australian Government that it has probably not been possible, whether before or after the changes in the Company Law Review Act 1998, to make a direct contribution to the share capital of a company registered in Australia without an issue of scrip. Although TD 2004/2 does provide advice on whether non-scrip share capital contributions can form part of the fourth element of cost base and reduced cost base under subsections 110-25(5) and 110-55(2) of the ITAA 1997 respectively, this is for the benefit of overseas companies whose jurisdictions legally allow this type of contribution to exist. | Detailed Reasoning - Contribution unlikely to be a non-share equity interest: The contribution payment is unlikely to be deemed a separate non-share equity interest. This is supported by the wording in subsection 974-75 of the ITAA 1997, which states; that a scheme satisfies the equity test if it gives rise to an interest set out in the following table. In this case however, it appears that your contribution payment gave rise to no new equity interest. Also the ATO ID's (ATO ID 2002/794, ATO ID 2003/901 & ATO ID 2004/56) which provide guidance on what constitutes a non-share equity interest, all indicate fact situations where a company has issued some form of instrument or document to the holder, either a financing instrument, an equity interest with a number of related interests at least one of which is not a share, or an unsecured note. In your case however, the company provided nothing for your contribution payment. | Detailed Reasoning - Contribution payment more in the nature of a gift: Based on the facts provided by you, it is submitted that the most plausible view as to the nature of your contribution payment is that it is akin to a gift from yourself to the Company. This is supported by the obvious concerns you had of breaching section 588 of the Corporations Act (which imposes a duty on directors to prevent a company trading when insolvent or to prevent a company becoming insolvent by incurring a debt). | Detailed Reasoning - Application to your circumstances: Based on the analysis above it is our view that your payment is not a debt interest and is unlikely to be an equity interest. It is considered that your contribution payment is in the nature of a gift to the Company. | Detailed Reasoning - Capital gains tax: The five elements of the cost base and reduced cost base are set out in sections 110-25 and 110-55 of the ITAA 1997. The only element within which the expenditure could potentially be included is the fourth element under subsection 110-25(5) of the ITAA 1997. Taxation Determination TD 2004/2 (now withdrawn but still considered relevant for these purposes) deals with the fourth element in relation to a non-scrip share capital contribution to a company. However, the determination deals with the requirements of subsection 110-25(5) of the ITAA 1997 in effect at that time. The provision was amended to broaden its application, with respect to Capital Gains Tax (CGT) events happening on or after 1 July 2005 ( Tax Laws Amendment (2006 Measures No. 1) Act 2006 ). Under the rewritten provision, all that is required is that the amount ...is capital expenditure you incurred (a) the purpose or the expected effect of which is to increase or preserve the asset's value None of the terms used in the provision are defined; however their meaning has been judicially considered in other contexts. The meaning of 'value' is discussed in TD 2004/2 where paragraph 8 states that the 'value' of a CGT asset is normally its 'material or monetary worth', or its 'worth … as measured by the amount of other things for which it can be exchanged, or as estimated in terms of a medium of exchange'. | Detailed Reasoning - Purpose of the expenditure: In Newton v FCT (1958) 98 CLR 1 (the Newton case), the Privy Council held that the word 'purpose' means; not motive, but the effect which it is sought to achieve-the end in view. On the question of establishing the purpose of a payment, paragraph 9 of Miscellaneous Tax Ruling 2005/1 cites the decision of the Full Federal Court case Raymor Contractors Pty Ltd v Commissioner of Taxation (1991) 91 ATC 4259; 21 ATR 1410. Hill J considered that; in the context of the purpose of a taxpayer in making a particular payment … purpose is the object which the taxpayer has in view or in mind. In your application, you advised that the funds were contributed; to the Company to build a winery for the purpose of making wine; to fund operations and to maintain the value of the Company issued shares… Given the facts provided by you, it is reasonable to accept that the object you had in view in incurring the expenditure was to either increase the value of the shares in the Company or at least attempt to preserve the value of the share you held in the Company. The entire amount contributed was used for this purpose. | Detailed Reasoning - Expected effect of the expenditure: In the Newton case the Privy Council held that the 'word "effect" means the end accomplished or achieved' . In Carrier Air Conditioning Pty Ltd v Kurda & Ors (1993) 11 ACSR 247, the Supreme Court of South Australia considered the meaning of 'expect' 'is to be understood according to its usage in ordinary parlance, namely, ``to regard as likely to happen'' or ``to expect to find'' or ``to expect that it will turn out that'. In this case, the expected effect of the expenditure was to either increase or preserve the value of the shares in the Company held by you. | Detailed Reasoning - Application to your circumstances: Consequently, your contribution satisfies the requirement of subsection 110-25(5) of the ITAA 1997 that the expected effect of the expenditure was to increase or preserve the value of the shares, and is included in the 4 th element of your cost base. | Detailed Reasoning - Application of Section 40-880 of the ITAA 1997: Section 40-880 of the ITAA 1997 potentially applies to the expenditure the subject of this ruling because the majority of the expenditure was incurred on or after 1 July 2005: see section 3 and Schedule 2 Item 51(1) of the Tax Laws Amendment (2006 Measures No.1) Act 2006 . Subject to the limitations and exceptions contained in subsections 40-880(3) to (9), subsection 40-880(2) of the ITAA 1997 provides that you can deduct, in equal proportions over a period of five income years starting in the year in which you incur it, capital expenditure you incur: (a) in relation to your business; or (b) in relation to a business that used to be carried on; or (c) in relation to a business proposed to be carried on; or (d) to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business. On the facts of this case, the relevant paragraph to consider is paragraph 40-880(2)(a) of the ITAA 1997 because the expenditure was incurred while carrying on the business in question. In considering the phrase 'in relation to' contained within subsection 40-880(2) of the ITAA 1997, paragraph 2.25 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 (the EM) states: The provision is concerned with expenditure that has the character of a business expense because it is relevantly related to the business. The concept used to establish this character or requisite relationship between the expenditure incurred by the taxpayer and the business carried on (current, past or prospective) is 'in relation to'. In First Provincial Building Society Limited v. FC of T 95 ATC 4145; 30 ATR 207, Hill J considered the phrase 'in relation to ' within the context of paragraph 26(g) of the Income Tax Assessment Act 1936 . He considered the words 'in relation to' in that context included a relationship that may either be direct or indirect, provided that the relationship consisted of a real connection, but that a merely remote relationship is insufficient (at ATC 4155; ATR 218). It is therefore necessary to consider the legislative context of subsection 40-880(2) of the ITAA 1997 in order to determine whether there is a sufficient and relevant connection between the expenditure incurred and a particular business. In discussing the types of business capital expenditure to which subsection 40-880(2) of the ITAA 1997 applies, the EM states: 2.19. Expenditure on the structure by which an entity carries on (or used to or proposes to carry on) their business and on the profit yielding structure of the business would ordinarily be expected to be of a capital nature. Capital expenditure can also relate to a business's trading operations or the entity that will carry on the business. 2.20. The structure covers the legal entity (such as a company) or the legal relationship (such as a partnership or trust) that is the entity that carries on the business for a taxable purpose and that holds the business assets. These paragraphs indicate that capital expenditure incurred on the structure by which an entity carries on, or used to or proposes to carry on their business, on the profit yielding structure of the business, or relating to the business's trading operations, are capable of being described as capital expenditure incurred 'in relation to' that business for the purposes of subsection 40-880(2) of the ITAA 1997. Whether such capital expenditure is incurred 'in relation to' the particular business will depend on whether there is a sufficient and relevant connection between the incurring of the expenditure and that business on the facts of the particular case. The capital expenditure in question is the payment described as a capital injection to the Company made by you. As shown in the company accounts, the effect of this expenditure was to increase the share capital of the Company, through which the business was conducted. The character of the expenditure is therefore a contribution to the structure by which the business was conducted. As there is a sufficient and relevant connection between the expenditure and the structure of the Company, by which the business, at the time, was being carried on, the expenditure in question was capital expenditure incurred 'in relation' to your business, for the purposes of paragraph 40-880(2)(a). However, any deduction under subsection 40-880(2) of the ITAA 1997 is subject to the limitations and exceptions contained in subsections 40-880(3) to 40-880(9) of the ITAA 1997. | Detailed Reasoning - Limitations and Exceptions: Limitations under subsection 40-880(3) of the ITAA 1997 The capital expenditure that is the subject of this ruling is incurred by you in relation to a business that, at the time was being carried on by the Company, another entity. Subsection 40-880(3) of the ITAA 1997 states: You can only deduct the expenditure, for a business that you carry on, used to carry on or propose to carry on, to the extent that the business is carried on, was carried on or is proposed to be carried on for a *taxable purpose. Therefore, any deduction to you under section 40-880 of the ITAA 1997 is subject to the limitations set out in subsection 40-880(3) of the ITAA 1997. As the expenditure was incurred in connection with a business that, at the time was being carried on wholly for a taxable purpose and from which the taxpayer was entitled to receive assessable income, subsection 40-880(3) of the ITAA 1997 does not apply to limit the amount you can deduct under section 40-880 of the ITAA 1997 for the capital injection that you made to the Company. However, subsections 40-880(5) to (9) of the ITAA 1997 set out further limitations and exclusions to deductibility under section 40-880 of the ITAA 1997. On the facts of this case, only paragraph 40-880(5)(f) of the ITAA 1997 and subsection 40-880(6) of the ITAA 1997 need be considered. Subsection 40-880(5) of the ITAA 1997 On the facts of this case, only paragraph 40-880(5)(f) of the ITAA 1997 needs to be considered. Paragraph 40-880(5)(f) of the ITAA 1997 provides that you cannot deduct anything under section 40-880 of the ITAA 1997 for an amount of expenditure you incur to the extent that it could, apart from that section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event. As outlined in this ruling, the expenditure that is incurred by you is included in the cost base and reduced cost base of CGT assets, your shares in the Company. As this amount could be taken into account in working out the amount of a capital gain or capital loss from a CGT event affecting your shares in the Company, no part of that expenditure is deductible under section 40-880 of the ITAA 1997. Subsection 40-880(6) of the ITAA 1997 Subsection 40-880(6) of the ITAA 1997 provides that the exception in subsection 40-880(5)(f) of the ITAA 1997 does not apply to expenditure that is incurred to preserve (but not enhance) the value of goodwill if the expenditure is incurred in relation to a legal or equitable right and the value to the taxpayer of the right in question is solely attributable to the effect that the right has on goodwill. In other words, the right in question can have no value to the taxpayer other than its effect on goodwill and that effect can only be to preserve the value of existing goodwill. In this case, irrespective of its effect on any goodwill, the expenditure results in the increase in value of your shares in the Company (as discussed in this ruling). It follows that you acquire economic benefits in the form of an increased value of your shares as a result of the expenditure on the capital injection beyond the value that may be attributable to any effect on any goodwill. Accordingly, the economic benefits that you acquire as a consequence of the payment of the capital injection do not have a value to you that is solely attributable to the effect they have on any goodwill. Consequently, subsection 40-880(6) of the ITAA 1997 does not apply to prevent paragraph 40-880(5)(f) of the ITAA 1997 from applying to this expenditure. | Detailed Reasoning - Application to your circumstances: Paragraph 40-880(5)(f) of the ITAA 1997 has effect to deny a deduction for any part of the expenditure that you incurred on the capital injection to the Company under section 40-880 of the ITAA 1997. As subsection 40-880(6) of the ITAA 1997 does not apply to prevent the application of paragraph 40-880(5)(f) of the ITAA 1997, no deduction is allowed under section 40-880 for the capital injection paid by you to the Company.

Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not considered the application of Part IVA to the arrangement you asked us to rule on.