Private ruling: Exchange of shares in same company
Published: November 2013
Ruling period: Year ending 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Will the issue to the taxpayer and to the taxpayer's nominee of shares in substitution for other shares now held by them, constitute a roll-over for the purposes of section 124-240 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the shares issued in substitution for the other shares be deemed to have been acquired by the taxpayer before 20 September 1985 if the taxpayer is eligible for and chooses the roll-over provisions under Division 124 of the ITAA 1997? | A2: Yes. | Q3: Will the cancellation of the original shares and the issue of the new shares in substitution for them give rise to a taxing event generating a gain for the purposes of Division 725 (Direct value shifting) of the ITAA 1997? | A3: No. | Q4: Will winding up of the company and the distribution of its surplus assets to the taxpayer shareholder directly and through its nominee, constitute an amount taxable as a dividend under subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) or a taxable capital gain under section 104-25 of the ITAA 1997? | A4: No.

Relevant facts and circumstances: Trust Structure Created The taxpayer was incorporated before 20 September 1985 as part of an estate planning exercise. The structure, set up before 20 September 1985, comprised the taxpayer as trustee of trust one, another entity as trustee of trust two and a company. The arrangements then implemented, involved the transfer by an individual to the first trust, of substantial assets in return for which they were owed a debt by the trustee of the first trust. The individual immediately assigned their debt, at its face value and for cash, to the company. Also, on the same date, the individual entered into an option agreement with the company under which, for an option fee paid by them on that date they acquired an option entitling them (upon the payment of an amount) to call for the issue to them, at par, of all of the unissued ordinary shares in the company. At that time the company had, as its authorised capital, two shares of a particular class and a number of other shares, but the only shares then on issue were, and remain, the shares of the first class, which were fully paid, and which were not, and are not, entitled to share in a distribution of surplus assets upon the winding up of the company, but were, and are, entitled only to a return of paid up capital and accumulated dividends. Those shares were issued, upon the incorporation of the company, to two persons, but from the date of the creation of the second trust they have both been held by the second trust (as to one directly, pursuant to a transfer from the initial shareholder), and as to the other by its nominee who acquired that share pursuant to a transfer. The nominee holds and has at all relevant times held, the share on behalf of the second trust. The option granted by the company was expressed as being exercisable only by them, or their attorney under power. When the individual died the option was unexercised, and, accordingly it lapsed in accordance with its terms on that date. The option fee received by the company is shown in the balance sheet of the company under the heading 'Share and Capital Reserves' as: Reserves Option over unissued shares The only assets held by the second trust apart from the initial settled sum by which the second trust was created, are the shares of a particular class and these are shown in the balance sheet of the second trust as: Issued shares in the company $ Trust structure to be simplified The original trust structure was set up for probate duty and estate planning purposes, and as the original reasons for the creation of the structure no longer exist and in order to reduce administrative costs, the structure is to be simplified and this simplification will involve the eventual winding up the company. As part of the simplification, the trustees for the two trusts have been combined such that the taxpayer is now the trustee for both trusts. The entity that was trustee of trust two has been deregistered. Company's Articles of Association Regulation XX of the Articles of Association of the company reads, relevantly, as follows: The Company may from time to time by ordinary resolution (e) Unless otherwise precluded by law or any provision of the Memorandum and Articles of Association allot shares to a shareholder in substitution for shares held by him ("the former shares") including shares the rights of which differ from those of the former shares and cancel the former shares so however that the amount (if any) unpaid on each share allotted shall be the same as it was in the case of the former shares for which it was substituted. Proposed Cancellation of the Shares Currently Issued and Substitution of New Shares in Lieu It is now proposed that the company, whose authorised capital consists of only the shares of a particular class, and a number of unissued other shares will, cancel the issued shares and substitute for them other shares. Under the Articles of Association the substitute shares are entitled to share in a distribution of surplus assets upon a winding up of the company. The company will be liquidated within 18 months of the payment to the shareholders. The company has never earned income. The market value of the new shares issued will be at least the market value of the existing shares which are being cancelled. None of the shares in the company held by the trust were acquired by the trust for resale at a profit or held as trading stock.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subsection 47(1). | Income Tax Assessment Act 1936 Subsection 47(1A). | Income Tax Assessment Act 1997 Subsection 103-25(1). | Income Tax Assessment Act 1997 Subsection 103-25(2). | Income Tax Assessment Act 1997 Section 104-25. | Income Tax Assessment Act 1997 Subsection 104-25(1). | Income Tax Assessment Act 1997 Subsection 104-25(5). | Income Tax Assessment Act 1997 Section 104-30. | Income Tax Assessment Act 1997 Subsection 124-15(5). | Income Tax Assessment Act 1997 Section 124-240. | Income Tax Assessment Act 1997 Section 725-245.

Reasons for decision: Detailed Reasoning - Exchange of shares in the same company: A taxpayer may choose a replacement asset roll-over where a company redeems or cancels shares held by the taxpayer, and issues new shares in substitution for the redeemed or cancelled shares, provided the following conditions of section 124-240 of the ITAA 1997 are satisfied: · the company redeems or cancels all of the shares in a particular class of shares held by the taxpayer · the company issues new shares to the taxpayer in substitution for the shares that have been redeemed or cancelled · the taxpayer receives nothing else from the company in the course of the redemption/cancellation and reissue · the market value of the new shares issued to the taxpayer, immediately after their issue, is at least equal to the market value of the original shares immediately before their redemption or cancellation · the paid-up share capital of the company does not change as a result of the redemption/cancellation and reissue of the share, and · either: o the taxpayer was an Australian resident at the time of the redemption or cancellation, or o if the taxpayer was not an Australian resident at that time, the redeemed or cancelled shares have the necessary connection with Australia. | Detailed Reasoning - Redemption or cancellation of the shares: The cancellation of the shares held by the taxpayer in the company results in CGT event C2 under section 104-25 of the ITAA 1997. The time which the event occurs is when the taxpayer enters into a contract that results in the shares being redeemed or cancelled or, if there is no contract, when the shares are actually redeemed or cancelled (subsection 104-25(2) of the ITAA 1997). | Detailed Reasoning - The company issues new shares to the taxpayer in substitution for the shares that have been redeemed or cancelled: The company will issue new shares in substitution for the shares which will be cancelled by the company. Under the Articles of Association of the company, the replacement shares are entitled to share in a distribution of surplus assets on the winding up of the company. | Detailed Reasoning - The taxpayer receives nothing else from the company in the course of the redemption/cancellation and reissue: Under the Articles of Association of the company, the shares received for the existing shares are entitled to share in a distribution of surplus assets on the winding up of the company. Although the new shares have different rights attached to the shares, the rights are not considered to be a separate asset from the new shares. Taxation Ruling TR 94/30 paragraphs 21 to 26 provide: 21. The rights of each shareholder in relation to each class of share are usually contained in the memorandum and articles of association of the company. The rights attaching to a share are not ordinarily thought of as a separate piece of property. 22. An often-used description of a share is that it is an aliquot interest of a shareholder in a company as measured by a sum of money. (An 'aliquot' part is part of a total such that, if the total is divided by that part, there is no remainder. For example, 5 is an aliquot part of 15.) Farwell J followed this interpretation when describing the legal nature of a share in Borland's Trustee v. Steele Bros & Co Ltd [1901] 1 Ch 279 at 288: 'The contract contained in the articles of association is one of the original incidents of the share. A share is not a sum of money settled in the way suggested, but is an interest measured by a sum of money and made up of various rights contained in the contract, including the right to a sum of money of a more or less amount.' 23. This description was endorsed by Williams J in the High Court decision of Archibald Howie and Others v. Commissioner of Stamp Duties (NSW) (1948) 77 CLR 143 at 156. Dixon J at 152 also endorsed this approach in the following terms: 'While a shareholder has not a proprietary right or interest in the assets of an incorporated company, his "share" is after all an aliquot proportion of the company's share capital with reference to which he has certain rights.' 24. The Corporations Law defines a share as personal property which is transferable or transmissible and, subject to the articles, able to be devolved (section 1085). 25. The nature of a share was considered in the death duty case of Re Alex Russell, deceased [1968] VR 285. McInerney J of the Supreme Court of Victoria considered the question of whether the right to convert a preference share to an ordinary share could be transferred at death. His Honour found that this right was still 'locked up' and it could not be separated out of the actual estate. Also examined was the question of whether the right to convert could be separated out from the preference shares. McInerney J commented at 299-300: 'It follows that while it is correct to speak of the testator's preference shares as consisting of a bundle or congeries of rights, it is not correct to speak of a shareholder owning each of those rights as a separate piece of property, or as a separate chose in action ... It is not permissible, therefore to separate out the various rights appertaining to the holder of preference shares and to treat some of those rights as "actual estate" and others as "notional estate".' 26. Accordingly while shares are comprised of a bundle of rights, those rights are not separate pieces of property capable of being divided out and held separately. | Detailed Reasoning - Market value of the shares: The market value of the new shares immediately after they are issued will not be less than the market value of the original shares immediately before the cancellation. | Detailed Reasoning - Paid-up share capital of the company: The paid-up share capital of the company does not change as a result of the cancellation and reissue of the new ordinary shares. The paid up share capital of the company will remain the same. | Detailed Reasoning - Residency: The shareholder of the company is an Australian resident. | Detailed Reasoning - Conclusion: As the taxpayer meets the requirements of section 124-240 of the ITAA 1997 they may choose the roll-over under Division 124 of the ITAA 1997. The choice must be made by the day on which the taxpayer lodges their return for the income year in which the relevant CGT event occurs, or within any further time allowed by the Commissioner (subsection 103-25(1) of the ITAA 1997). The way the taxpayer prepares their tax return is sufficient evidence of whether a choice has been made (subsection 103-25(2) of the ITAA 1997). As the original shares were acquired before 20 September 1985, the taxpayer is taken to have acquired the new replacement shares before that date (subsection 124-15(5) of the ITAA 1997). | Detailed Reasoning - Division 725 Direct value shifting affecting interests in companies and trusts: The direct value shifting rules may apply if: · under a scheme some interests in a company or trust (for example, shares, units or other interests or loans to those entities) decrease in value and other interests in the entity increase in value or are issued at a discount - if the interests are issued at market value the rules do not apply · there is a controller (or more than one controller) of the entity at some time during the scheme, and · the total reduction in market value of the interests under the scheme is at least $150,000. A direct value shift may result in a taxing event generating a gain or cost base adjustments. Section 725-245 of the ITAA 1997 sets out all the circumstances in which direct value shifts affecting CGT assets result in a taxing event generating a gain. In this case, the proposed cancellation of the original shares and the issue of the new shares in substitution does not fall into any of the circumstances set out in section 725-245 of the ITAA 1997. Therefore, the proposed arrangement will not give rise to a taxing event generating a gain for the purposes of Division 725 of the ITAA 1997. Also, even if there are any cost base adjustments, as discussed previously the taxpayer may choose the replacement asset roll-over under Division 124 of the ITAA 1997 which would result in the new shares being taken to have been acquired before 20 September 1985. That is, there will be no CGT gain either when the original shares are cancelled or when the new shares are disposed of. | Detailed Reasoning - Assessability of distribution as a dividend: Under subsection 47(1) of the ITAA 1936, a liquidator's distribution is considered to be a dividend paid out of profits to the extent that it represents 'income' derived by the company (whether before or during liquidation) other than income properly applied to replace a loss of share capital. Income takes its ordinary meaning although subsection 47(1A) of the ITAA 1936 treats as income certain statutory income including net capital gains. | Detailed Reasoning - Calculating a net capital gain for purposes of subsection 47(1A): For the purposes of subsection 47(1A) of the ITAA 1936 a net capital gain is worked out as follows: Step 1: Work out each capital gain (except a capital gain that is disregarded) that the company made during that year of income. Do so without indexing any amount used to work out the cost base of a CGT asset. Step 2: Total the capital gain or gains worked out under Step 1. The result is the net capital gain for that year of income. | Detailed Reasoning - The lapsing of the option granted to the individual and the CGT consequences for the company. CGT event C3: end of option to acquire shares etc.: Under section 104-30 of the ITAA 1997, CGT event C3. happens if a company or the trustee of a unit trust grants an option to an entity to acquire a CGT asset that is shares in the company, units in the unit trust or debentures of the company or unit trust and the option ends because it is not exercised by the latest time for exercise, it is cancelled or the entity releases or abandons it. The time of the event is when the option ends. The company or trustee makes a capital gain if the capital proceeds from the grant of the option are more than the expenditure incurred in granting it. It makes a capital loss if those capital proceeds are less. A capital gain or capital loss the company or trustee makes is disregarded if it granted the option before 20 September 1985. Before 20 September 1985 the company granted the individual the option to acquire shares in the company. The option granted by the company to the individual was expressed as being exercisable only by them, or their attorney under power. When the individual died, the option was unexercised and accordingly it lapsed in accordance with its terms on that date. As the company granted the option before 20 September 1985, the capital gain or capital loss the company makes under CGT event C3 is disregarded (subsection 104-30(5) of the ITAA 1997). | Detailed Reasoning - CGT consequences for the company of non-cash distribution: Cash distributions generally have no CGT implications for the company. It is more likely that a capital gain or capital loss may arise to the company, on the distribution of non-cash assets by the liquidator. A capital gain or capital loss could arise to the company, depending on the market value of the asset when distributed and its cost base or reduced cost base. Depending on circumstances, any capital gain or capital loss may be disregarded (eg. because the asset was acquired by the company pre-CGT) or CGT roll-over may be available (eg. because the asset is distributed to its 100% owning parent). In this case, the distribution of the assets to the shareholder will not result in a capital gain or capital loss to the company as the asset being the loan to the first trust was acquired by the company pre-CGT and the market value of the asset (loan) being distributed is the same as the asset's cost base and reduced cost base. Therefore, the transfer of the assets to the shareholders does not result in a capital gain to be included in the calculation of dividends for the purposes of subsection 47(1) of the ITAA 1936. | Detailed Reasoning - Capital gains that are disregarded for the calculation of deemed dividends: Capital gains made, but disregarded, are not included in the calculation of a net capital under gain under subsection 47(1A) of the ITAA 1936. Disregarded capital gains include those from the disposal of pre-CGT assets or where there has been a roll-over. The capital gain made on the end of the option to acquire shares is not included in the calculation of dividends for the purposes of section 47(1) of the ITAA 1936 and there is no capital gain made on the transfer of the assets to the shareholders. The company does not have any profits current or retained, therefore the distribution of the net assets of the company to the shareholders will not be dividends for the purpose of subsection 47(1) of the ITAA 1936. | Detailed Reasoning - CGT event C2: ending of shares on deregistration of the company: Paragraph 104-25(1)(a) of the ITAA 1997 provides that CGT event C2 happens if a taxpayer's ownership of an intangible CGT asset ends because it is redeemed or cancelled. The cancellation of shares will trigger CGT event C2. Under subsection 104-25(5) of the ITAA 1997 a capital gain or capital loss you make is disregarded if you acquired the asset before 20 September 1985. The time a company is deregistered differs under the Corporations Act 2001 depending on the particular winding-up process involved. For example, following a compulsory winding-up, deregistration occurs on the date the court so orders, whereas in the case of a voluntary winding up, deregistration happens either three months after the liquidator lodges a return of the holding of the final meeting of members, or members and creditors, or deregistration happens on such other date as the Court specifies. | Detailed Reasoning - Conclusion: As the ordinary shares are taken to have been acquired by the taxpayer before 20 September 1985 under subsection 124-15(5) of the ITAA 1997, any capital gain or capital loss made by the taxpayer on the cancellation of the shares will be disregarded under subsection 104-25(5) of the ITAA 1997.