Private ruling: Direct value shift
Date of advice: 24 May 2022
Published: August 2022
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will there be a value shift under Division 725 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the Share Conversion? | A1: Yes.

Relevant facts and circumstances: A owns 100% of the shares in B Co, comprising 60 ordinary shares. C and D are the children of A. They each own 1 ' G Class ' share in B Co. It is proposed that the G Class shares will be converted into 20 ordinary shares each (the Share Conversion). The shareholding of B Co prior to and after the Share Conversion is as follows: Total shares on issue for B Co prior to the Share Conversion: Name Class of shares Number A Ordinary 60 C G Class 1 D G Class 1 Total shares on issue for B Co after the Share Conversion: Name Class of shares Number A Ordinary 60 C Ordinary 20 D Ordinary 20 The estimated market values of both the ordinary shares and G Class shares in B Co prior to and after the Share Conversion are as follows: • Estimated value of the ordinary share prior to the Share Conversion: $XXX per share; • Estimated value of the ordinary shares after the Share Conversion: $XX per share; • Estimated value of the G class shares prior to the Share Conversion: Nil. The G Class shares will be cancelled under the Share Conversion. The total value of holdings in B Co prior to the Share Conversion and after the Share Conversion is as follows: Estimated value of equity interests prior to the Share Conversion (60 ordinary shares @ $XX) ($) Estimated value of equity interests after the Share Conversion (60 ordinary shares @ $XX) ($) Movement ($) A's holdings in B Co X,X00,000 X,XXX,000 (XX0,000) Estimated value of equity interests prior to the Share Conversion (1 G class share @ nil value) ($) Estimated value of equity interests after the Share Conversion (20 ordinary shares @ $XX,000) ($) C's holdings in B Co 0 XXX,000 XXX,000 Estimated value of equity interests prior to the Share Conversion (1 G class share @ nil value) ($) Estimated value of equity interests after the Share Conversion (20 ordinary shares @ $XX,000) ($) D's holdings in B Co 0 XXX,000 XXX,000

Relevant legislative provisions: Income Tax Assessment Act 1936 (ITAA 1936) section 318 | Income Tax Assessment Act 1997 (ITAA 1997) section 725-50 | Income Tax Assessment Act 1997 (ITAA 1997) section 725-55 | Income Tax Assessment Act 1997 (ITAA 1997) section 725-70 | Income Tax Assessment Act 1997 (ITAA 1997) section 725-80 | Income Tax Assessment Act 1997 (ITAA 1997) section 725-90 | Income Tax Assessment Act 1997 (ITAA 1997) section 725-95 | Income Tax Assessment Act 1997 (ITAA 1997) section 725-145 | Income Tax Assessment Act 1997 (ITAA 1997) section 725-150 | Income Tax Assessment Act 1997 (ITAA 1997) section 725-155 | Income Tax Assessment Act 1997 (ITAA 1997) section 727-355 | Income Tax Assessment Act 1997 (ITAA 1997) section 727-520 | Income Tax Assessment Act 1997 (ITAA 1997) section 995-1

Reasons for decision: Detailed Reasoning - The Share Conversion satisfies the definition of a direct value shift as set out in section 725-145 of the ITAA 1997: Section 725-145 of the ITAA 1997 sets out the definition of a direct value shift as follows: 725-145(1) There is a direct value shift under a * scheme involving * equity or loan interests in an entity (the target entity) if: (a) there is a decrease in the *market value of one or more equity or loan interests in the target entity; and (b) the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things, is done; and (c) either or both of subsections (2) and (3) are satisfied. Examples of something done under a scheme are issuing new shares at a * discount, buying back shares or changing the voting rights attached to shares. 725-145(2) One or more * equity or loan interests in the target entity must be issued at a * discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph. Example: A company runs a family business. There are 2 shares originally issued for $2 each. They are owned by husband and wife. The market value of the shares is much greater (represented by the value of the assets of the company less its liabilities). The company issues one more share for $2 to their son. Caution is needed in such a situation. The example would result in a large CGT liability for the husband and wife under this Division, because they have shifted 1/3 of the value of their own shares to their son. No such liability would arise if the share had been issued for its market value. 725-145(3) Or, there must be an increase in the *market value of one or more * equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph. Under section 995-1 of the ITAA 1997, " equity or loan interest " is defined as having "the meaning given by section 727-520 ". Section 727-520 of the ITAA 1997 sets out the meaning of an " equity or loan interest " as follows: (1) An equity or loan interest in an entity is a * primary interest, or a * secondary interest, in the entity. (2) A primary interest in an entity is a * primary equity interest, or a * primary loan interest, in the entity. (3) The meaning of primary equity interest in an entity is set out in the table. Table: Primary equity interests Item In the case of this kind of entity : Primary equity interest means: 1 a company a share in the company ; ..... Paragraphs (a), (b) and (c) of section 725-145(1) of the ITAA 1997 will be satisfied, as: • In regard to section 725-145(1)(a), there will be a decrease of $960,000 in the market value of the ordinary shares held by A in B Co; and • In regard to section 725-145(1)(b) this decrease in value will be due to the Share Conversion; and • In regard to section 725-1451(1)(c), section 725-145(2) is satisfied as the ordinary shares issued to C and D will be issued at a discount as defined section 725-150 of the ITAA 1997. Section 725-150 states: 725-150(1) An equity or loan interest is issued at a discount if, and only if, the market value of the interest when issued exceeds the amount of the payment that the issuing entity receives. The excess is the amount of the discount. 725-150(2) The payment that the issuing entity receives can include property. If it does, use the market value of the property in working out the amount of the payment. The market value of the ordinary shares issued to C and D, being $24,000 per share, exceeds the value of the cancelled G Class shares (nil value). Therefore there will be a direct value shift under the proposed Share Conversion. The Share Conversion will satisfy limbs (a), (b), (c), (d) and (e) of Section 725-50 of the ITAA 1997 and there will be a material decrease in accordance with Section 725-70 of the ITAA 1997 Section 725-50 of the ITAA 1997 sets out when a direct value shift has consequences under Division 725. Section 725-50 of the ITAA 1997 states the following: A * direct value shift under a * scheme involving * equity or loan interests in an entity (the target entity) has consequences for you under this Division if, and only if: (a) the target entity is a company or trust at some time during the * scheme period; and (b) section 725-55 (Controlling entity test) is satisfied; and (c) section 725-65 (Cause of the value shift) is satisfied; and (d) you are an * affected owner of a * down interest, or an * affected owner of an * up interest, or both; and (e) neither of sections 725-90 and 725-95 (about direct value shifts that are reversed) applies. Note: For a down interest of which you are an affected owner, the direct value shift has consequences under this Division only if section 725-70 (about material decrease in market value) is satisfied. The Share Conversion will satisfy the limbs (a), (b), (c), (d) and (e) of section 725-50 of the ITAA 1997, as follows: • Section 725-50(a) will be met as the target entity, B Co, is a company; • Section 725-50(b) will be satisfied as the ' controlling entity test ' in section 725-55 of the ITAA 1197 will be met, for the following reasons: ­ The test in section 725-55 requires that an entity (the controller) ' control (for value shifting purposes) ' the target entity at some time during the scheme period. ­ Under subsection 727-355(1), an entity 'c ontrols (for value shifting purposes) a company ' if it, or it and its associates between them, ' can exercise, or can control the exercise of, at least 50% of the voting power in the company (either directly, or indirectly through one or more interposed entities) '. Section 995-1 of the ITAA 1997 defines " associate " as having " the meaning given by section 318 of the Income Tax Assessment Act 1936 ". Section 318(1) of the ITAA 1936 states: Associates (1) For the purposes of this Part, the following are associates of an entity (in this subsection called the primary entity) that is a natural person (otherwise than in the capacity of trustee): (a) a relative of the primary entity;..." In this case, A, together with his ' associates ', C and D, will own 100% of the shares in B Co at the time of the Share Conversion. Therefore A will be deemed to ' control (for value shifting purposes) ' the target entity, B Co, during the scheme period. • Section 725-50(c) will be satisfied as the ' cause of the value shift ' requirement in section 725-65 will be satisfied, for the following reasons: ­ A, as the ' controller ', will do under the Share Conversion things which result in the ' decrease in the market value of the down interests '. ­ The concept of ' down interest ' is defined in section 725-155 of the ITAA 1997. An equity or loan interest in the target entity is a down interest if a decrease in its market value is reasonably attributable to the one or more things referred to in paragraph 725-145(1)(b) and occurs at or after the time referred to in that paragraph. The time when the decrease happens is called the " decrease time " for that interest. In this case the ' down interest ' will be the ordinary share in B Co as: ­ there will be a decrease in the market value of the ordinary shares; and ­ the decrease is attributable to the Share Conversion (being the ' thing done under the scheme ' referred to in paragraph 725-145(1)(b)). • Section 725-50(d) will be satisfied as A will meet the definition of an ' affected owner of a down interest ' as set out in section 725-80 of the ITAA 1997. In this regard: ­ Section 725-80 states thatan entity is an affected owner of a down interest " if, and only if, the entity owns the down interest at the decrease time " and the entity is the controller. ­ A (as the ' controller ') will own the relevant ' down interests ' (being the ordinary shares in B Co) at the ' decrease time ' (being the time of the Share Conversion). • In relation to section 725-50(e) it is assumed that neither sections 725-90 of the ITAA 1997 and 725-95 of the ITAA 1997 would apply. Further there will be a material decrease in A's down interest, in accordance with section 725-70 of the ITAA 1997, as the decrease in value in A's interest in B Co due to the Share Conversion will be greater than $XXX,000.