Private ruling: CGT - sale of shares and event K6
Date of advice: 2 July 2015
Published: July 2015
Ruling period: 1 July 2012 to 30 June 2013

Ruling: Questions and answers | 1. Can you treat an allotment of the shares held by you in the company as having pre-CGT status in your hands at the time of their disposal? | Yes. | 2. Does Capital Gains Tax Event K6 occur in respect of your disposal of pre-CGT shares in the company? | No. | 3. Does the market value of the 'property' of the company exclude any amount referable to 'know how' on the basis that such amount is not referable to property or a Capital Gains Tax asset, but nonetheless contributed to the market value of the interests in the company for the purposes of Capital Gains Tax Event K6? | Yes.

Relevant facts and circumstances: Prior to 20 September 1985, you commenced work on a project to develop certain devices. Prior to 20 September 1985 you invented an invention and applications were made for patents, registered designs, and trademarks based upon the work commenced. Pre-CGT an application for the Trademark in Australia was made by you and was ultimately registered pre-CGT. The patent applications had imbedded within the original product and patent most of the 'know-how' to that point. Post-CGT a company was incorporated as a 'shelf company' with a number of ordinary shares. Post-CGT the original ordinary shares in the shelf company were acquired by you and your spouse, but the original shares were beneficially owned by you. The original share acquired by your spouse was held by them as nominee for you (under a declaration of trust). The shelf company shortly thereafter changed its name and ultimately came to be called the company. At all times the products produced by the company were marketed under the brand protected from the outset by the Trademark. Post-CGT, under an Agreement you agreed to transfer to the company, in exchange for the allotment of ordinary shares ('exchanged shares') to you in your own right beneficially, all of the following items; • The underlying invention • Intellectual property comprising applications for patents, registered designs, applications for trademarks and all intangible expertise and know how • 'Other property' comprising copyright, improvements, manuals and application rights • A list of customers with respect to the product of the invention. Post-CGT an election under former section 160ZZN(2) of the Income Tax Assessment Act 1936 was executed. Post-CGT you sold or agreed to sell to company P, over half your shares in the company; leaving you with an allotment of the 'exchanged shares' and the original share in the company. Post-CGT you bought back from company P the sold shares which company P acquired. Your spouse purchased from company P the remaining shares held by company P. The original trademark (the formal application for which was transferred to the company by you) has been held by the company at all relevant times and the brand is protected by that trademark. Additional trademark registrations have also been made to widen the protected categories. The original patents (granted under the assigned applications) have since expired and additional patents have been registered in respect of current forms of the device which have been upgraded or enhanced to some degree. The core product which has been produced and marketed and sold by the company is in substance not materially altered from the original invention although some moderate enhancements have facilitated the grant of additional patents. The market value of the post-CGT property of the company (market value of assets less trading stock less know-how which is not property) is less than 75% net value of the company Post-CGT a contract was entered into under which all of the shares held in the company (plus some options to acquire unissued shares which had been issued to employees) were sold to a company Q. Post-CGT the agreement to sell to company Q settled.

Relevant legislative provisions: Income Tax Assessment Act 1936 paragraph 160U(6)(b) | Income Tax Assessment Act 1936 subsection 160ZZN(2) | Income Tax Assessment Act 1936 Section 160ZZS | Income Tax Assessment Act 1936 subsection 160ZZS(1A) | Income Tax Assessment Act 1936 Section 160ZZT | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 paragraph 104-10(5)(a) | Income Tax Assessment Act 1997 Section 104-230 | Income Tax Assessment Act 1997 paragraph 104-230(1)(a) | Income Tax Assessment Act 1997 paragraph 104-230(1)(b) | Income Tax Assessment Act 1997 paragraph 104-230(1)(c) | Income Tax Assessment Act 1997 subsection 104-230(2) | Income Tax Assessment Act 1997 Section 108-5

Reasons for decision: Summary: Taxation Ruling IT 2484 on the former paragraph 160U(6)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) states; Paragraph 160U(6)(b) provides that where an asset is created otherwise than pursuant to a contract under which the person created the asset for another person, the asset is taken to have been acquired at the time of commencement of the work that resulted in the creation of the asset Under the former subsection 160ZZN(2) of the ITAA 1936, transfer of asset to a wholly-owned company, it states; Where- (a) one of the following subparagraphs applies: (i) a taxpayer (other than a company or a taxpayer in the capacity of a trustee) who is a resident of Australia disposes of an asset (in this section called a ``roll-over asset'' ) to a company that is a resident of Australia; (b) subject to subsection (5A), the consideration in respect of the disposal consists only of non- redeemable shares in the company; (ba) the market value of the shares is substantially the same as the market value of the roll-over asset, reduced, if the company assumes in connection with the disposal a liability or liabilities in respect of the roll-over asset, by the amount of the liability or the total of the amounts of the liabilities; (c) immediately after the disposal the taxpayer is the beneficial owner of all the shares in the company; (d) the taxpayer has, by notice in writing given to the Commissioner on or before the date of lodgment of the return of income of the taxpayer for the year of income in which the disposal took place, or within such further period as the Commissioner allows, elected that this subsection is to apply in respect of the disposal, this Part (other than this section) does not apply in respect of the disposal and- (e) if the roll-over asset was acquired by the taxpayer before 20 September 1985 - the company shall be deemed, for the purposes of this Part, to have acquired the roll-over asset before that date; Under the former subsection 160ZZS of the ITAA 1936, changes in majority underlying interests in assets of taxpayers other than public entities it states; For the purposes of the application of this Part in relation to a taxpayer, an asset acquired by the taxpayer on or before 19 September 1985 shall be deemed to have been acquired by the taxpayer after that date unless the Commissioner is satisfied, or considers it reasonable to assume, that, at all times after that date when the asset was held by the taxpayer, majority underlying interests in the asset were held by natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset. Subsection 160ZZS(1A) of the ITAA 1936 provides that; If subsection (1) applies so as to deem an asset to have been acquired by a taxpayer after 19 September 1985: (a) the time when the taxpayer is taken, for the purposes of this Part, to have acquired the asset is the time when the natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset ceased, or first ceased, to hold those interests; and (b) the taxpayer is taken to have acquired the asset for a consideration equal to the market value of the asset as at the time mentioned in paragraph (a). Former Taxation Ruling IT 2363, paragraph 5, states; Where in application of section 160ZZS an asset is taken to have been acquired by a taxpayer (e.g. a company) after 19 September 1985, that fact does not require the asset also to be treated as one acquired after that date for the purposes of the application of section 160ZZT in relation to another taxpayer (e.g. shareholder) on disposal of an interest (such as shares) in the first taxpayer. Section 160ZZT of the ITAA 1936 is now covered by section 104-230 of the Income Tax Assessment Act 1997 (ITAA 1997); Capital Gains Tax (CGT) event K6. Under section 104-10 of the ITAA 1997 CGT event A1 happens if you dispose of a CGT asset. Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property or a legal or equitable right that is not property. A disposal of a CGT asset occurs when there is a change of ownership from one entity to another entity. Under paragraph 104-10(5)(a) of the ITAA 1997 a capital gain or capital loss from CGT event A1 is disregarded if the relevant asset was acquired before 20 September 1985. CGT event K6 in section 104-230 of the ITAA 1997 happens if all of the following conditions are satisfied: • a specific CGT event happens in relation to shares in a company or an interest in a trust you acquired pre-CGT (paragraph 104-230(1)(a) and 104-230(1)(b) of the ITAA 1997); • there is no roll-over for the other CGT event (paragraph 104-230(1)(c) of the ITAA 1997); and • immediately before the other event happens the market value of the post-CGT property of the company or trust is at least 75 per cent of the net value of the company or trust (paragraph 104-230(1)(d) and subsection 104-230(2) of the ITAA 1997). Taxation Ruling TD 2000/33 states that know-how is not a CGT asset because it is neither a form of property nor a legal or equitable right. Know-how is knowledge or information rather than a CGT asset. | Detailed Reasoning - Application to your circumstances: Pre- CGT you commenced work on an invention and as per Taxation Ruling IT 2484 the asset is deemed a pre-CGT asset. Post-CGT, under an agreement, you transferred to the company the invention, intellectual property, other property and list of customers, in exchange for an allotment of ordinary shares to you in your own right beneficially,. You were the beneficial owner of all the shares in the company immediately after disposal of the assets to the company and you executed the election under the former subsection 160ZZN(2) of the ITAA 1936. Accordingly, the shares acquired by you in exchange for the assets, maintain a pre-CGT status in your hands. The assets received by the company will also have a pre-CGT status. Post-CGT you sold to company P more than half your shares in the company. Accordingly, as a result of the application of subsection 160ZZS(1A) of the ITAA 1936 the pre-CGT assets held by the company were deemed to have been acquired by the company after 20 September 1985 and are post-CGT assets in the company. However, for you, in accordance with Taxation Ruling IT 2363 the operation of 160ZZS of the ITAA 1936 on the assets did not trigger the operation of 160ZZT of the ITAA 1936 on your pre-CGT shares in the company and as a consequence some of your shares maintained their pre-CGT status. When you disposed of the pre-CGT shares to company Q; for the purpose of calculating CGT event K6, the market value of the assets, which the company acquired on or after 20 September 1985, post-CGT, other than its trading stock, were valued at less than 75% of the company's net value. While the original pre- CGT property held by the company are deemed to be post CGT for its purposes, for the purposes of the K6 calculation upon your sale of pre-CGT shares that property is taken to be pre-CGT property as per IT 2363. Therefore CGT event K6 in section 104-230 of the ITAA 1997 did not happen when you sold the shares acquired before 20 September 1985 in the company. As per Taxation Ruling TD 2000/33 know-how is not a CGT asset and therefore for the purpose of the CGT event K6 calculation, when the shares were sold to company Q, no amount of property referable to 'know-how' is included in the market value of the 'property' of the company.

Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not considered the application of Part IVA to the arrangement you asked us to rule on.