Private ruling: Application of a CGT event K6, Subdivision 124-E roll-over relief and the liquidator’s distribution
Date of advice: 6 June 2018
Published: August 2018
Ruling period: Year ended 30 June 2018 | Year ended 30 June 2019
Date scheme commenced: DDMMYY

Ruling: Q1: Will a capital gain be realised by the shareholders of Company A on disposal of their shareholding, as a result of the crystallisation of CGT event K6 where the market value and cost base of the underlying post-CGT assets are equal under section 104-230 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. K6 event will occur, however no capital gain will arise. | Q2: Is Company B being the shareholder of Company A, entitled to rollover relief pursuant to subdivision 124-E of the ITAA 1997 on the redemption and cancellation of their current shareholding in Company A in exchange for a different class of share in Company A under section 124-240 of the ITAA 1997? | A2: Yes. | Q3: Is the non-frankable capital distribution included under subsection 110-55(7) ITAA 1997? | A3: No.

Relevant facts and circumstances: Company C Company C was incorporated in 19XX. At the time of incorporation Company A held 50% of the shares in Company B. There have been no changes to the shareholding of Company C since its incorporation. Accordingly, Company A still holds 50% of the shares in Company C on a pre-CGT basis. Company C is a passive company. According to the Balance Sheet as at 30 June 201X, the assets of Company C comprise of cash at bank of $X and unsecured loans to related parties of $X. The total assets are $X. There are no liabilities. Pursuant to the latest available financial statements, and as evidenced by the statement of financial position as at 30 June 201X, the assets of Company C are comprised of cash and related party loans. The retained earnings totalled $X, which can be broken down as follows: Unappropriated profits $X Pre-CGT reserves $X Total retained earnings $X In the 201X-1X income year Company C paid dividends of $X and had a loss before income tax of $X. For the year ended 30 June 201X, Company Cs retained earnings are $X, broken down as follows: Unappropriated profits $X Pre-CGT reserves $X Total retained earnings $X It is estimated that the market value is equal to the net assets value of Company C as per the Balance sheet at 30 June 201X, being $X. The pre-CGT reserve arises mainly from the gain made on the disposal of the properties A and B, in 201X. This property was acquired by Company C prior to CGT legislation. The franking account balance of Company C as at 30 June 201X was $X. Company A Company A was incorporated prior to CGT legislation and is a passive company. There has been no change to the above shareholding of Company A since the introduction of capital gains tax (CGT) on 20 September 1985 and all shares in Company A are held on a pre-CGT basis. The assets of Company A predominantly consist of cash, shares in Company C and related party loans. The shareholders of Company A, who indirectly hold 50% of the shares in Company C, are listed below: Shareholder Shares held Shareholder A 50 A Class Ordinary Shares Shareholder B 50 B Class Ordinary Shares Shareholder C 50 C Class Ordinary Shares Shareholder D 50 D Class Ordinary Shares Shareholder E 50 E Class Ordinary Shares The rights attached to each class of shares in Company A are as follows: (a) Rights to capital The holders of A, B, C, D and E Class Ordinary Shares can participate equally in the capital of the Company. The Articles of Association at clauses 136(1) and (2) state” If the Company is wound up whether voluntarily or otherwise the liquidator may with the sanction of an extraordinary resolution divide among the members in specie or kind all or any part of the assets of the Company in trustees upon such trusts for the benefit of the members or any of them as the liquidator with the like sanction shall think fit. If thought expedient any such division may be otherwise than in accordance with the legal rights of the members of the Company and in particular any class may be given preferential or special rights or may be excluded altogether or in part. (b) Other rights i. A Class Ordinary Shares The holders of A Class shares are entitled to vote in meetings. The holders of A Class shares are entitled to dividends at the discretion of the Directors. Dividends can be exclusive to other classes of shareholders and the amount declared for each class of shares can be different. ii. B Class Ordinary Shares The holders of B Class shares are entitled to vote in meetings. The holders of B Class shares are entitled to dividends at the discretion of the Directors. Dividends can be exclusive to other classes of shareholders and the amount declared for each class of shares can be different. iii. C Class Ordinary Shares The holders of C Class shares are entitled to vote in meetings. The holders of C Class shares are entitled to dividends at the discretion of the Directors. Dividends can be exclusive to other classes of shareholders and the amount declared for each class of shares can be different. iv. D Class Ordinary Shares The holders of D Class shares are entitled to vote in meetings. The holders of D Class shares are entitled to dividends at the discretion of the Directors. Dividends can be exclusive to other classes of shareholders and the amount declared for each class of shares can be different. v. E Class Ordinary Shares The holders of E Class shares are entitled to vote in meetings. The holders of E Class shares are entitled to dividends at the discretion of the Directors. Dividends can be exclusive to other classes of shareholders and the amount declared for each class of shares can be different. The assets of Company A predominately comprise cash and a related party loan. It is estimated that the market value of Company A based on the value of its net assets as provided in the financial statements as at 30 June 201X, adjusted for its 50% share in Company C is $X, calculated as follows: Company A net assets as per financial statements $X Add Net assets of Company C ($X X 50%) $X $X Less Cost of shares $ X Total market value $X The franking account balance of Company A as at 30 June 201X was $X. Company B In 201X Company B was incorporated. Shareholder’s A and B children are the joint shareholders. Company B has a share capital of $X. No income has been derived by Company B and it has not incurred any expenses. There are no loans at present from Company B to Company A’s shareholders. The arrangement Sharerholder’s A and B are both elderly and have recently entered into a nursing home. Shareholder’s A and B are seeking to exit the X family group due to wanting to simplify their lives and undertake estate planning. For asset protection purposes, Shareholder’s A and B children would prefer to continue to manage some of their wealth in a company structure. Accordingly, Company B was incorporated in 201X, with shareholder’s A and B children as its joint shareholders. It is proposed that Company C and Company A will be liquidated. The Company A liquidation distribution will flow to Company B. To simplify the X family group structure, and to effect the liquidation of both Company C and Company A the following steps will be undertaken: 1. Company C is liquidated When Company C is liquidated, the Liquidator will declare and make distributions of 50% of the Company C assets from Company C to Company A. 2. On liquidation of Company C, Company A (as holder of 50% of the shares in Company C) is entitled to 50% of the liquidator’s distribution in Company C (crystallising a pre-CGT gain in Company A) The liquidator’s distribution from Company C to Company A will be as follows: ● Pre-CGT Capital Profit Reserve (one-half share) $X ● Return of capital $X ● Unappropriated profit $ X (one half share of $X less estimated cost of liquidation) The required amount of franking credits attaching to the unappropriated profit portion will be $X for a fully franked dividend to be paid. The amount of franking credits in the Company C franking account is $X. A fully franked dividend will be paid. After liquidation of Company C, Company A will only hold cash assets and related party loans, being worth only their face value. The market value of Company A will be the same as the net assets of the company. 3. The shareholders of Company A will sell 100% of their shares to Company B at market value for loan consideration. 4. The different classes of shares in Company A, which are now wholly owned by Company B, will be exchanged for a new single class of shares (with the former class of shares being cancelled). The new single class of shares will all have the same rights attached after the restructure. 5. Company A is liquidated. 6. On liquidation of Company A, Company B is entitled to 100% of the liquidator’s distribution which will allow the loans referred to in (3.) to be repaid. Distributions to be made by the liquidator of Company A will be as follows: ● Return of capital $X ● Other disregarded capital gain $X ● Pre CGT capital profit (from Company A) $X ● Unappropriated profit $X (balance at 30 June 201X: $X rounded to $X after costs) The amount of franking credits available is $X. The amount of franking credits required to pay a fully franked dividend for the unappropriated profit portion is $X. The unappropriated profit can be distributed as a fully franked dividend. The loans will be distributed in-specie as part of the liquidation process to the company’s shareholders. The case has been advanced to the shareholders (companies) and the in-specie distribution of the loans will extinguish a liability from each of the shareholder companies.

Relevant legislative provisions: Section 104-230 of the Income Tax Assessment Act 1997 | Section 124-240 of the Income Tax Assessment Act 1997 | Section 110-55 of the Income Tax Assessment Act 1997

Reasons for decision: Summary: Summary CGT event K6 will happen when you liquidate the shares in Company C. However, as the assets held by Company C consist of cash and loans, the cost base of your post CGT property is equal to the market value, there is no capital gain made as a result of CGT event K6. Detailed reasoning CGT event K6 is designed to stop the potential avoidance of CGT where, instead of an entity disposing of an asset it acquired on or after 20 September 1985, the owners of pre-CGT interests in the interposed entity dispose of those interests. Both direct and indirect interests are caught. Under subsection 104-230(1), CGT event K6 happens if: a) a taxpayer owns shares in a company …acquired before 20 September 1985; b) a relevant CGT event happens in relation to the shares; c) there is no roll-over for the other CGT event, and d) the applicable requirement in subsection 104-230(2) is met. Section 104-230(2) requirement: the 75% test The test in subsection 104-230(2) is satisfied only if one or both of the following tests are met: a) The market value of property of the company or trust that was acquired post-CGT equals or exceeds 75% of the net value of the company; b) The market value of interests the company or trust owned through interposed companies or trusts in property that was acquired post-CGT equals or exceeds 75% of the net value of the company. CGT event K6 can result in capital gains only. The time of the CGT event K6 is when the other event happens. You make a capital gain equal to that part of the capital proceeds from the share or interest that is reasonably attributable to the amount by which the market value of the property referred to in subsection (2) is more than the sum of the cost bases of that property. Application to your situation: CGT event K6 will happen when you liquidate your shares in Company C (CGT event C2 also happens at this time which is a relevant CGT event under subparagraph 104-230(1)(b)) and the market value of your post CGT property is more than 75% of the net value of the company. However, as the assets held by Company C consists of cash and loans, the cost base of your post CGT property is equal to the market value, there is no capital gain made as a result of CGT event K6. Summary Company B is entitled to choose rollover relief pursuant to subdivision 124-E on the redemption and cancellation of their current shareholding in Company A in exchange for a different class of share in Company A under section 124-240. Detailed reasoning You can choose to obtain a rollover under section 124-240 where the following conditions are met: a) you own shares (the original shares ) of a certain class in a company; and; b) the company redeems or cancels all shares of that class; and c) The company issues you with new shares (and you receive nothing else) in substitution for the original shares; and d) the market value of the new shares just after they were issued is at least equal to the market value of the original shares just before they were redeemed or cancelled; and e) the paid up share capital of the company just after the new shares were issues is the same as just before the original shares were redeemed or cancelled; and f) the taxpayer is a resident of Australia at the time of the redemption or cancellation or, if not, the original shares were taxable Australian property when they are issued. Application to your situation Company A will redeem and cancel all classes of its shares on issue and reissue a single class of shares. At this time the sole shareholder of Company A will continue to be Company B. CGT event C2 will happen upon the cancellation of the shares in Company A for Company B. The event will occur at the time that Company B enters into a contract to redeem/cancel the shares or, if there is no contract, when the shares are actually redeemed/cancelled. The following rights attach to the interests in Company A prior to the redemption/cancellation of the shares: a) 10% Cumulative Preference shares (formerly A and B Class shares) The Articles of Association at clause 7(c)(A) state: “The right in a winding up to the return of the capital paid thereon and payment of all arrears of dividends whether earned or declared or not up to the date of the winding up in priority to all other shares but with no further right to participate in the profit or assets of the company”. The Articles of Association at clause 7(c)(C) state: “ The holders of the preference shares shall have the rights of attending and voting either in person or by proxy or attorney at any general meeting or special general meeting” b) C,D & E Class Ordinary Shares | Detailed Reasoning - i. Rights to capital: The holders of C,D and E Class Ordinary Shares can participate equally in the capital of the Company. The Articles of Association at clauses 136(1) and (2) state” “If the Company is wound up whether voluntarily or otherwise the liquidator may with the sanction of an extraordinary resolution divide among the members in specie or kind all or any part of the assets of the Company in trustees upon such trusts for the benefit of the members or any of them as the liquidator with the like sanction shall think fit. If thought expedient any such division may be otherwise than in accordance with the legal rights of the members of the Company and in particular any class may be given preferential or special rights or may be excluded altogether or in part”. | Detailed Reasoning - ii. Other Rights: a) C Class Ordinary Shares The holders of C Class shares are not entitled to vote. The holders of C Class shares are entitled to dividends at the discretion of the Directors. Dividends can be exclusive to other classes of shareholders and the amount declared for each class of shares can be different. b) D Class Ordinary Shares The holders of D Class shares are not entitled to vote. The holders of D Class shares are entitled to dividends at the discretion of the Directors. Dividends can be exclusive to other classes of shareholders and the amount declared for each class of shares can be different. c) E Class Ordinary Shares The holders of E Class shares are not entitled to vote. The holders of E Class shares are entitled to dividends at the discretion of the Directors. Dividends can be exclusive to other classes of shareholders and the amount declared for each class of shares can be different. On conversion, the cancelled shares will be replaced with a single class of new shares in Company A. You have stated that the new shares will have the same rights as the existing shares. Further, the market value of the new shares just after they were issued is at least equal to the market value of the original shares just before they were redeemed or cancelled and the paid up share capital of the company just after the new shares were issued is the same as just before the original shares were redeemed or cancelled. As the taxpayer is a resident of Australia at the time of the redemption or cancellation, the requirements for rollover under section 124-240 are met and Company B is entitled to choose rollover in respect of the cancellation/redemption of the shares. | Detailed Reasoning - Question 3: Summary The non-frankable capital distribution is not included in the reduced cost base under subsection 110-55(7) ITAA 1997. Application to your situation As outlined in your submission, Company B will acquire 100% of the shares in Company A at market value. On subsequent liquidation of Company A, Company B will be entitled to 100% of the liquidator’s distribution which will include pre-acquisition profits and realised Pre-CGT Reserves. Receipt of a liquidatior’s distribution can result in a reduction of the cost base if the criteria outlined in subsection 110-55(7) of the ITAA 1997 are satisfied. Referring to the conditions in section 110-55(7) of the ITAA 1997, these conditions are met by Company B as outlined below; (aa) Company B is a corporate entity (a) Company A makes a distribution to Company BI under an arrangement (the liquidation) (b) An amount representing part of the distribution is reasonably attributable to profits derived by Company A before Company B acquired the shares in Company A (c) Company B is entitled to a tax offset equal to the franking credit it applies to the deemed dividend; and (d) Company B is the controller of Company A at the time of the distribution. Therefore, the reduced cost base of Company A shares that Company B holds is reduced by the amount worked out under the formula in subsection 110-55(8). This formula (section 110-55(8)) prevents the benefit Company B obtains from applying the tax offset from also being included in the reduced coat base of the shares.

Reasons for decision: All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.