Private ruling: CGT, sale of shares and Maximum Net Asset Value Test
Published: May 2014
Ruling period: 1July 2012 to 30 June 2013
Date scheme commenced: During income year 2012- 2013

Ruling: Q1: Is the disposal of shares in Company A by you as trustee for The X Trust to Company B a CGT event A1 under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. The disposal of the CGT asset, being the right created over the options, happens pursuant to CGT event C2 under paragraph 104-25(1)(e). | Q2: What is the timing of the disposal of shares under subsection 104-10(3) of the ITAA 1997? | A2: The CGT event C2 happened on the date the contract was entered into. | Q3: Does the Commissioner consider the taxpayer or any of its affiliates had control of Company A under subsection 328-125(6) of the ITAA 1997 when the option was exercised? | A3: No

Relevant facts and circumstances: You are a discretionary trust. The primary beneficiaries of the trust are D and E and their two children. D is the only person who controls the taxpayer as they have received at least 40% share in the income or capital paid or applied on of on the previous 4 income years. The couple, D and E, are directors and equal shareholders in the trustee company. The trust acquired 100% of the shareholdings in Company A when the company was incorporated. You previously divested 55% of your interest in Company A to Company B and your remaining shareholding is 45%. Company B is a wholly owned subsidiary of a listed entity. Pursuant to a shareholders agreement, the board of directors shall comprise of 3 directors, namely E representing the interest of the trust and two others nominated by the other shareholder of Company A, namely Company B. Under the agreement, the board is responsible for approval of the annual operating budget amount other key decisions of the company, all of which must be carried by a unanimous vote. The shareholders agreement prohibits the transfer of shares in Company A by the taxpayer unless the transfer is to the other majority shareholder or is approved by it in writing. You were granted a right in a share sale agreement which was later amended by an amendment deed. Under clause x of the amendment deed Company B grants to you an option to require Company B to buy your Option Securities. Subclause xx of the amendment deed states that the option granted under clause x must be exercised by you by written notice to Company B given at any time during the relevant Option Period. A notice may be given under this clause only in respect of all of your Option Securities. The option period has been defined in the amendment deed as the period commencing 1 June 2012 and ending 3pm (Sydney time) on 30 June 2012. You did not provide a written notice in that time period. During the option period, you and Company B commenced further negotiations regarding the put call options under the amended agreement to clarify the operation of the put-call options and sale terms. During the further negotiations, it became necessary to extend the notice period for the put-call option until the negotiations were concluded. During the further negotiations, the parties verbally agreed to extend the rights each party had under the amended agreement. The parties did not sign a written variation or new agreement and failed to reach agreement on the proposed terms. E sent an email in their capacity as a director of the corporate trustee to representatives of Company B early in 2013 agreeing to exercise the option to sell the shares held in Company A as at 30 June 2013, inter alia on the same terms and conditions as outlined in the amendment deed. The email was acknowledged by the other party two days later. The final transfer of shares in Company A occurred during the recent income year.

Relevant legislative provisions: subsection 104-10(1) ITAA 1997 | subsection 104-10(3) ITAA 1997 | subsection 104-25(1) ITAA 1997 | paragraph 104-25(2)(a) ITAA 1997 | subsection 152-10(1) ITAA 1997 | section 152-15 ITAA 1997 | subsection 328-125(1) ITAA 1997 | subsection 328-125(3) ITAA 1997 | subsection 328-125(4) ITAA 1997 | subsection 328-125(6) ITAA 1997 | subsection 328-130(1) ITAA 1997 | subsection 328-130(2) ITAA 1997 | subsection 995-1(1) ITAA 1997

Reasons for decision: Summary: Section 102-25 of the ITAA 1997 establishes the order of application of CGT events. In particular, subsection (1) of that section provides that you work out if a CGT event (except CGT events D1 and H2) happens to your situation. If more than one event can happen, the one you use is the one that is most specific to your situation. Subdivision 104-A of the ITAA 1997 deals with circumstances involving the disposal of an asset. Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if your dispose of a CGT asset. However, in your case, the relevant CGT asset under consideration is not the actual shares but rather the put and call option granted to you by the sale agreement and the subsequent amended deed. Section 104-25 (1) of the ITAA 1997 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset: a) being redeemed or cancelled; or b) being released, discharged or satisfied; or c) expiring; or d) being abandoned, surrendered or forfeited; or e) if the asset is an option - being exercised ; or f) if the asset is a convertible interest - being converted. Section 104-25 then continues: 104-25(2) The time of the event is: a) when you enter into the contract that results in the asset ending; or b) if there is no contract - when the asset ends. You have exercised the put and call option granted to you and as a result there has been a change in the shareholding of Company A. CGT event C2 has therefore happened to your asset. You entered into the sale agreement and amended deed and these agreements created your right over the underlying CGT asset, being the options. Whilst the amended deed determined the option exercise period to be any time between 1 June 2012 and 30 June 2012, there was an unwritten agreement between all parties that negotiations would continue after this period ended without the options expiring until 30 June 2013. The Commissioner therefore considers that the email sent by E, in their capacity as director of the corporate trustee of the trust, to the representatives of Company B was the entering into of a contract to exercise the relevant options. Alternatively, it could be more appropriately argued that the contract was entered into two days later when the representatives of Company B agreed, inter alia, to the exercise. Therefore the CGT event C2 happened 2 days after the spouse exercised the option. Section 152-10 of the ITAA 1997 provides the basic conditions which an entity must satisfy in order to access certain capital gains concessions. Subsection 152-10(1) of the ITAA 1997 states that a capital gain (except a capital gain from CGT event K7) that you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain: (a) a CGT event happens in relation to a CGT asset of yours in an income year, (b) the event would (apart from this Division) have resulted in the gain, (c) at least one of the following applies: (i) you are a small business entity for the income year, (ii) you satisfy the maximum net asset value test, (iii) you are a partner in a partnership that is a small business entity for the income year and CGT asset is an interest in an asset of the partnership (iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year, (d) the CGT asset satisfies the active asset test. Section 152-15 of the ITAA 1997 establishes the criteria for the maximum net asset value test. It states: 152-15 You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000: (a) the net value of the CGT assets of yours; (b) the net value of the CGT assets of any entities connected with you; (c) the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)) | Detailed Reasoning - Connected with: The term 'connected with' is defined in subsection 995-1(1) of the ITAA 1997 as: an entity is connected with you in the circumstances described in section 328-125. Subsection 328-125(1) of the ITAA 1997 states that an entity is connected with another entity if: (a) either entity controls the other entity in a way described in this section, or (b) both entities are controlled in a way described in this section by the same third entity. | Detailed Reasoning - Control: Subsection 328-125(3) of the ITAA 1997 considers the direct control of a discretionary trust. It states that an entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could be reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates or the first entity together with its affiliates. Subsection 328-125(4) of the ITAA 1997 then goes on to state that an entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year: (a) the trustee of the trust paid to, or applied for the benefit of: (i) the first entity, (ii) any of the first entity's or (iii) the first entity and any of its affiliates, any of the income or capital of the trust, and (b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year. Subsection 328-125(6) of the ITAA 1997 states if the control percentage referred to in subsection (2) or (4) is at least 40% but less that 50%, the Commissioner may determine that the first entity does not control the other entity if the Commissioner thinks that the entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates. | Detailed Reasoning - Affiliate: The term 'affiliate' is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 328-130. Subsection 328-130(1) of the ITAA 1997 states that an individual or a company is an affiliate of yours if the individual or company acts or could reasonably be expected to act, in accordance with your directions or wishes, on in concert with you, in relation to the affairs of the business of the individual or company. Subsection 328-130(2) of the ITAA 1997 states that however, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share A partner in a partnership would not be an affiliate of another partner merely because the first partner acts or could reasonably be expected to act, in accordance with the directions or wishes of the second partner or in concert with the second partner, in relation to the affairs to the partnership. Directors of the same company, or the company and a director of that company, would be in a similar position. Application to your circumstances You have requested the Commissioner to determine whether subsection 328-125(6) applies to your circumstances, in particular in relation to the maximum net asset value test. You acknowledge in your private ruling application that: • The couple equally controlled the trustee company for the X Family Trust as both directors and equal shareholders in the trustee company (subsection 328-125(3) of the ITAA 1997), and • D is the only person who controls the taxpayer as D has received at least 40% share in the income or capital paid or applied on of on the previous 4 income years (subsection 328-125(4) of the ITAA 1997). The Commissioner accepts as a fact that D has control of the trust in the relevant year because of the pattern of distributions made to them, and D is therefore connected to you. The net value of any CGT assets owned by D at the time just before the CGT event will be required to be included in calculating the maximum net asset value test for you. It is then necessary to determine what entities are affiliates of you and/or D in particular whether Company A is considered to be your affiliate. You have stated in your application that E is a joint director and equal shareholder in the corporate trustee along with D. It is also apparent from the information provided in the ruling application that the E undertakes a significant role in Company A, to the extent that it was E who, on your behalf, actually exercised the options. The Commissioner therefore considers that E is an affiliate of you and that the net value of any CGT assets owned by E at the time just before the CGT event will be required to be included in calculating the maximum net asset value test for you. It is also necessary to determine whether Company A is an affiliate of you and this necessitates the consideration of the nature and amount of control any of your affiliates may be in a position to exert over the business of that company. You have a 45% shareholding in Company A and the remaining 55% is held by Company B. E sits on the 3 member board of Company A and the remaining two members of the board are nominated by Company B. The make-up of the board is governed by the Shareholders Agreement. Under the agreement, the board is responsible for approval of the annual operating budget among other key decisions of the company, all of which must be carried by a unanimous vote. In addition, the shareholder agreement prohibits the transfer of shares in Company A by you unless the transfer is to the majority shareholder (Company B) or is approved by it in writing. E is employed by Company A under a service contract as the Chief Executive Officer. The operational business of Company A is undertaken by the CEO alongside 3 other Directors, a General Manager and the two other shareholder representatives. As previously stated, subsection 328-130(1) of the ITAA 1997 provides that (inter alia) a company is an affiliate of you if the company acts, or could reasonably be expected to act, in accordance with your directions or wishes. Based on this, the Commissioner accepts that although E plays a major role in the day to day running of the business of Company A , E does not have the sufficient control, being only the representative of a 45% shareholding and one of three board members, to cause Company A to act in accordance with your directions or wishes. As such, Company A is not an affiliate of you.