Private ruling: Income tax - Capital gains tax - Small business relief - Maximum net asset value test
Date of advice: 20 May 2019
Published: July 2019
Ruling period: Year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: For the purposes of the maximum net asset value test in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997), was the Company an entity ‘connected with’ the Taxpayer just before the CGT event that consisted of the entry into the contract for the sale of all the shares in the Company? | A1: Yes. | Q2: Will the Commissioner determine that the Taxpayer did not control the Company just before the CGT event that comprised the entry into the contract for the sale of all of the shares in the Company? | A2: No.

Relevant facts and circumstances: The business of the Company involved the development of a number of products. All of the shares in the Company were sold to Company X pursuant to a Share Sale Agreement. The Taxpayer was one of the founding investors of the Company and was also the CEO of the Company. Immediately prior to the sale of the Company, the Taxpayer held ordinary shares in the Company and Preference Shares (which carried voting rights). In total, those shares carried a percentage of the voting power in the Company. None of the other shareholders in the Company were affiliates of the Taxpayer. During the negotiations leading up to the entry into the Share Sale Agreement, one of the other selling shareholders (Shareholder B) was not willing to provide the vendor warranties required by Company X. In order to enable the sale of the Company to proceed, the Taxpayer entered into an arrangement under which he would acquire the shares in the Company held by Shareholder B (the B Shares) from Shareholder B immediately before completion of the Share Sale Agreement. The B Shares would therefore be included in the parcel of shares that the Taxpayer gave vendor warranties in respect of, and sold, under the Share Sale Agreement. This arrangement was documented under an ‘Agreement for Sale of Shares’ between Shareholder B, the Taxpayer, the Company and Company X (the Side Agreement). As a result of the Taxpayer acquiring the B Shares, the Taxpayer was shown in a Schedule to the Share Sale Agreement as owning greater than 50% of the shares in the Company. As one of the selling shareholders, the Taxpayer was required to provide a vendor warranty that they were the legal and beneficial owner of that percentage of the Company’s shares free of all security interests. The execution of the Side Agreement and the Share Sale Agreement happened on the same day. The side agreement and the share sale agreement were provided for the purposes of this private binding ruling.

Relevant legislative provisions: Income Tax Assessment Act 1997 , section 152-15 | Income Tax Assessment Act 1997 , section 328-125 | Income Tax Assessment Act 1997 , paragraph 328-125(2)(b) | Income Tax Assessment Act 1997 , subsection 328-125(6)

Reasons for decision: Summary: The Company is an entity ‘connected with’ the Taxpayer just before the CGT event that consisted of the entry into the contract for the sale of all of the shares in the Company. | Detailed Reasoning - Detailed reasoning: The maximum net asset value test in section 152-15 is satisfied if, just before the CGT event, the sum of the net value of the CGT assets of yours, the net value of the CGT assets of any entities connected with you, and the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates, does not exceed $6,000,000. | Detailed Reasoning - ‘Connected with’: Section 328-125 provides the meaning of ‘connected with’ an entity. It states that an entity is connected with another entity if either entity controls the other entity in a way described in section 328-125. If the other entity is a company, paragraph 328-125(2)(b) states that an entity controls a company if the entity owns, or has the right to acquire the ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage that is at least 40% of the voting power in the company. | Detailed Reasoning - ‘Just before’: Before the contemplation of the sale of the Company, the Taxpayer held shares that carried a percentage of the voting power in the Company. However, during the negotiations leading up to the entry into the Share Sale Agreement, one of the other selling shareholders, Shareholder B, was not willing to provide the vendor warranties required by Company X. The Taxpayer entered into the Side Agreement whereby the Taxpayer acquired the B Shares from Shareholder B immediately before completion of the Share Sale Agreement. The Side Agreement indicates that the sale of the B Shares to the Taxpayer occurred before the sale of the Taxpayer’s shares in the Company. This intention is also reflected in the recitals in the Side Agreement and key clauses of both agreements. Some key clauses and definitions of the Side Agreement and the Share Sale Agreement provided that the entry into the Share Sale Agreement was a condition subsequent to the Side Agreement and that risk and title to the B Shares passes to the Taxpayer immediately before Completion of the sale. From reading the Side Agreement and the Share Sale Agreement, the operation of both contracts is intended to first enter and execute the Side Agreement before entering and executing the Share Sale Agreement. This has the effect of completing the transfer of the B Shares to the Taxpayer, who has full legal title and rights to them immediately before the execution of the Share Sale Agreement. ATO ID 2003/744 Income Tax CGT small business relief: maximum net asset value test – ‘just before’ the time of the CGT event (ATO ID 2003/744) provides the ATO view that, for the purposes of the maximum net asset value test in section 152-15, the reference to ‘just before the CGT event’ refers to just before the time of the CGT event. ATO ID 2003/745 Income Tax CGT small business relief: maximum net asset value test – ‘just before’ the CGT event – immediately before (ATO ID 2003/745) provides the ATO view that the words ‘just before’ in section 152-15 effectively mean ‘immediately before’. The relevant time to determine the Taxpayer’s voting power is therefore immediately before they enter into the Share Sale Agreement. It has been determined that the Taxpayer entered into and executed the Side Agreement immediately before entering into the Share Sale Agreement. | Detailed Reasoning - Conclusion: Prior to the contemplation of the sale of the Company, the Taxpayer held shares in the Company that constituted a percentage of the voting power in the Company. The Taxpayer acquired shares in the Company from Shareholder B immediately before completion of the Share Sale Agreement. As a result, the Taxpayer was shown in a Schedule to the Share Sale Agreement as owning shares in the Company which constituted greater than 50% of the voting power in the Company. As the Taxpayer had shares in the Company that gave him the right to exercise, or control the exercise of, more than 40% of the voting power in the Company, it is considered that the Taxpayer was ‘connected with’ the Company just before the CGT event. | Summary: The Commissioner will not determine that the Taxpayer did not control the Company just before the CGT event that comprised the entry into the contract for the sale of all of the shares in the Company. | Detailed Reasoning - Detailed reasoning: Subsection 328-125(6) provides that the Commissioner may determine that an entity does not control another entity if the control percentage referred to in subsection (2) or (4) is at least 40%, but less than 50%, if the Commissioner thinks that the other entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates. As explained in the detailed reasoning for the answer to Question 1, the B Shares were included in the Taxpayer’s parcel of shares in the Company and as a result, on entering into the Share Sale Agreement, the Taxpayer owned shares that carried greater than 50% of the voting power in the Company. As the Taxpayer had greater than 50% of the voting power in the Company just before entering into the Share Sale Agreement, the Commissioner is not able to determine that another entity controlled the Company under subsection 328-125(6).