Private ruling: CGT - value shifting
Published: January 2014

Ruling: A. Will the proposed variation of rights attaching to preference shares held by Individual 3 in Company H trigger CGT event K8 pursuant to section 104-250 and Division 725 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) for Individual 1 and Individual 2 in respect of the ordinary shares they own in Company H? | Yes | B. Will the capital gain arising from CGT event K8 be disregarded pursuant to subsection 104-250(5) of the ITAA 1997 on the basis that the shares held by Individual 1 and Individual 2 in Company H are pre-CGT assets? | Yes | C. Will the proposed transaction trigger CGT event K6 pursuant to section 104-230 of the ITAA 1997 for Individual 1 and Individual 2 in respect of the shares they own in Company H? | No | Year ended 30 June 2014 | 01 July 2013

Relevant facts and circumstances: Background - Company G Individual 1 and Individual 2 have operated a business. On or about 1 July 1998, Individual 1 and Individual 2s child Individual 3 joined the business. Recently Individual 1 and Individual 2, retired. The Business operates from two properties owned by Company G. One property was acquired before 20 September 1985, the second after 20 September 1985. Company G - incorporation and history of shareholdings Company G is a private company. The current directors of Company G are Individual 1 and Individual 3. There are currently X ordinary shares on issue in the company. Individual 1 owns an ordinary share and Company H owns the remaining ordinary shares all shares were acquired prior to 20 September 1985. Since before 20 September 1985, Company G has not declared any dividends to its shareholders nor made any distributions of capital. Company H - incorporation and history of shareholdings Company H is a private company. The current directors of Company H are Individual 1, Individual 2 and Individual 3. The current shareholders in Company H are Individual 1, Individual 2, Individual 3 and Individual 4. Individual 1 and Individual 2 each own ordinary shares in the company (Ordinary Shares) and Individual 3 and Individual 4 each own preference shares (Preference Shares), all shares were acquired prior to 20 September 1985. The ordinary shares in Company H carried equal voting, dividend and capital rights in accordance with the company's Memorandum of Association and Articles of Association. The Preference Shares carry no voting rights. They have fixed entitlements to a preference dividend every year at D% (or such higher amount as the directors decide) of the amount paid up (Cumulative Dividends). For all other dividends, the Directors may determine to pay dividends as between the share classes at their discretion, but subject to any special rights attaching to any shares. On a wind up of Company H, the Preference Shares are entitled to a return of the paid up share capital, plus all unpaid cumulative dividends. The Preference Shares have no rights to surplus capital. Since before 20 September 1985, Company H has not declared any dividends to its shareholders nor made any distributions of capital. In particular, no preferential dividends have been declared in respect of the Preference Shares. Furthermore, as Company H has never traded nor derived income or capital gains, it does not have an ABN or TFN and has never lodged income tax returns. Proposed Transaction - Share Buy-back and Conversion It has been proposed that the following changes in the shareholdings of Company H take place (Proposed Transaction): · Company H to undertake a selective share buy-back to buy back and cancel the Preference Shares owned by Individual 4. The shares owned by Individual 4 will be bought back for their current market value. · Company H, with the consent of the directors and the members of the company, to vary the rights attaching to Individual 3's Preference Shares to convert them back to ordinary shares (Share Conversion). Thereafter, Individual 3's shares will carry equal rights to voting and distributions of income and capital of Company H, alongside the ordinary shares owned by Individual 1 and Individual 2. The proposed transaction will effectively transfer X% of the control of Company H (i.e. via the voting rights), and X% of all future distributions of income and capital of the company, to Individual 3. The private ruling application and all annexure form part of the facts

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 160ZZS(1) | Income Tax Assessment Act 1936 subdivision C of Division 20 | Income Tax Assessment Act 1997 section 104-250 | Income Tax Assessment Act 1997 subsection 104-250(5) | Income Tax Assessment Act 1997 division 149 | Income Tax Assessment Act 1997 section 149-10 | Income Tax Assessment Act 1997 section 725-155 | Income Tax Assessment Act 1997 section 725-210 | Income Tax Assessment Act 1997 section 725-240 | Income Tax Assessment Act 1997 section 725-245 | Income Tax Assessment Act 1997 section 725-250 | Income Tax Assessment Act 1997 section 725-375

Reasons for decision: Summary: The proposed variation of rights attaching to preference shares held by Individual 3 in Company H will trigger CGT event K8 pursuant to section 104-250 and Division 725 for Individual 1 and Individual 2 in respect of the ordinary shares they own in Company H. The capital gain arising from CGT event K8 will be disregarded pursuant to section 104-250(5) on the basis that the shares held by Individual 1 and Individual 2 in Company H are pre-CGT assets. The proposed transaction will not trigger CGT event K6 pursuant to section 104-230 for Individual 1 and Individual 2 in respect of the shares they own in Company H. | Detailed Reasoning - Detailed reasoning: Question A - Does CGT event K8 happen? Section 104-250 provides that CGT event K8 happens where there is a taxing event generating a gain for a down interest under section 725-245. You make a capital gain equal to the gain generated from the taxing event. However, any capital gain is disregarded if the down interest is a pre-CGT asset. Item 4 of the table in section 725-245 applies where you own a down interest that have a pre-shift gain and the up interest is owned by other affected owners. Sections 725-210 and 725-240 provide there is a pre-shift gain where the market value of the Ordinary Shares is greater than their cost base. As the Ordinary Shares have a nominal cost base and the market value of the shares prior to the Proposed Transaction will exceed that cost base, the Ordinary Shares have pre-shift gains. Section 725-155 provides that a down interest includes a decrease in the market value of an equity interest in the target entity that is reasonably attributable to one or more things done under the scheme. Under the Proposed Transaction, the voting, income and capital rights of Individual 1's and Individual 2's ordinary Shares will be diluted. X% of the value will be shifted to Individual 3's Shares. The Share Conversion will thus result in a decrease in the market value of Individual 1's and Individual 2's Ordinary Shares. The Ordinary Shares are equity interests and the decrease will be reasonably attributable to the Share Conversion, being a thing done under the scheme As there is a taxing event generating a gain for the down interest on the Ordinary Shares CGT event K8 happens (section 104-250). Question B - Is the capital gain from CGT event K8 disregarded? Subsection 104-250(5) provides any capital gain resulting from CGT event K8 is disregarded if the down interest is a pre-CGT asset. Section 149-10 defines a pre-CGT asset as: · one last acquired before 20 September 1985; and · was not, immediately before the start of the 1998-99 income year, taken under: o former subsection 160ZZS(1) of the ITAA 1936; or o subdivision C of Division 20 of former Part IIIA of the ITAA 1936; to have been acquired on or after 20 September 1985; and · not stopped being a pre-CGT asset because of Division 149. The ordinary shares were originally acquired in 1970, subsection 160ZZS(1), subdivision C of Division 20 and Division 149 did/do not apply to assets owned by individuals. In addition, none of the subsequent changes to shares issue by Company H changed the nature, nor the acquisition date of the Ordinary Shares. Accordingly the Ordinary Shares were acquired before 20 September 1985. Therefore, any capital gain made under CGT event K8 will be disregarded. Question C - Does CGT event K6 apply? CGT event K6 applies to pre-CGT shares and happens if: · CGT event A1, C2, E1, E2, E3, E5, E6, E7, J1 or K3 happens in relation to the share; and · there is no roll-over for the other CGT event: and · the market value of property acquired by the company on or after 20 September 1985 is at least 75% of the net value of the company. The Ordinary Shares have not been sold, transferred, lost or destroyed; they are not and have never been held in trust nor has Company H stopped being a member of a group. Accordingly CGT event K6 has not happened in relation to the Ordinary Shares.