Private ruling: Pre-CGT assets
Date of advice: 17 December 2018
Published: April 2019
Ruling period: 1 July 2017 to 30 June 2018.
Date scheme commenced: A day during the 2018 income year.

Ruling: Q1: Are the majority underlying interests in the pre-CGT assets of Company A still held by the ultimate owners who held them before 20 September 1985 in accordance with Division 149 of the Income Tax Assessment Act 1997 (‘ITAA 1997’): a. before the appointment of shares by Trust A? b. at the time of appointment? c. at the time that Company A’s shares were disposed of? | A1: Yes, except for at the time that Company A’s shares were disposed of. | Q2: If the majority underlying interests in the pre-CGT assets of Company A are not still held by the ultimate owners who held them before 20 September 1985, will the shares in Company A receive market value cost base in accordance with section 149-35 of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: Group history Company A was a subsidiary member of a tax consolidated group (‘the Group’). The Group’s operations and activities were controlled by an individual from the incorporation of the individual companies until a number of years ago. Beneficiary One has been involved in the businesses of the Group for more than many decades, and was the manager of the businesses who conducted and oversaw the operations and activities of the Group in accordance with the direction set by the controlling individual. Trust A Trust A was settled multiple decades ago under the terms set out in the deed of settlement between the settlor and the trustee. Trust A is a discretionary trust, and must exercise its discretion to make an beneficiary presently entitled to capital or income. Trust A has multiple default beneficiaries that would receive a proportion of the trust’s capital upon vesting of the trust. Intentions of the trustee Trust A was settled for the purpose of benefiting the default beneficiaries. One sole individual was the controlling mind of Trust A, either directly or indirectly. On many occasions this individual expressed how they intended the assets and income of the trust to be split between the default beneficiaries. The individual’s intention was for Beneficiary One to receive more than 50% of the assets of Trust A, and more than 50% of the income derived from those assets. Distributions to beneficiaries Since its settlement, out of all the default beneficiaries, Trust A has only made Beneficiary One presently entitled to income of the trust. Dispute settlement Some years prior to the 2017 income year, the default beneficiaries entered into a settlement deed to settle a dispute between them about how the assets of the trust should be administered. The settlement deed resulted in the trustee exercising its discretion and appointing an amount of capital to all default beneficiaries other than Beneficiary One. Group restructure Following execution of the settlement deed, a restructure was undertaken. The restructure undertaken moved the entities carrying on the businesses of the Group from being owned by Trust A, to being owned by a new structure. The restructure was effected by appointing all assets of Trust A to Beneficiary One (being the shares it held in the Group) and Beneficiary One disposing of shares in Company A. Trust B has a wide class of eligible beneficiaries, including Beneficiary One. A beneficiary of Trust B is only entitled to income or capital of Trust B if the trustee exercises its discretion in their favour. Transfer of assets In the 2017 income year, Trust A appointed the shares it held in the Group to Beneficiary One. Some months later, Company A disposed of the shares it held in Company B to an entity ultimately owned by Trust B.

Relevant legislative provisions: Subdivision 110-A of the Income Tax Assessment Act 1997 Division 112 of the Income Tax Assessment Act 1997 . | Subsection 149-15(1) of the Income Tax Assessment Act 1997 | Subsection 149-15(3) of the Income Tax Assessment Act 1997 | Subsection 149-30(1) of the Income Tax Assessment Act 1997 | Subsection 149-30(2) of the Income Tax Assessment Act 1997 | Section 149-35 of the Income Tax Assessment Act 1997

Reasons for decision: Summary: Division 149 of the ITAA 1997 contains the provisions under which an asset acquired before 20 September 1985 is treated as having been acquired after that date, that is, the asset stops being a pre-CGT asset. Subdivision 149-B provides for when the asset of an entity stops being a pre-CGT asset for entities that are not covered by section 149-50. Effectively, Subdivision 149-B deals with non-public entities. A factual test is used to determine when an asset of a non-public entity stops being a pre-CGT asset. Under the test, an asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985 (‘the factual test’). | Detailed Reasoning - What are the majority underlying interests?: The ‘majority underlying interests’ in a CGT asset consist of more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset and any ordinary income that may be derived from the asset. Therefore, in considering whether the majority underlying interests in the pre-CGT assets of Company A have changed, the Commissioner must determine who the ultimate owners are. | Detailed Reasoning - Who are the ultimate owners?: An ultimate owner is: (a) an individual; or (b) a company whose constitution prevents it from making any distribution, whether in money, property or otherwise, to its members; or (c) the Commonwealth, a State or a Territory; or (d) a municipal corporation; or (e) a local governing body; or (f) the government of a foreign country, or of part of a foreign country. All shares in Company A were held by the head company of the Group, which in turn were ultimately held by Trust A. During the 2017 income year, Trust A exercised its discretion and appointed all of the shares it held in the Group to Beneficiary One. | Detailed Reasoning - Is the factual test passed prior to the appointment of shares?: There is no way to determine with certainty who all the ultimate owners of Trust A’s pre-CGT assets are prior to the appointment because no beneficiary of Trust A holds an interest in any asset of the trust or in the ordinary income derived from the assets until the trustee’s discretion is exercised. Consequently it is inherently impossible for the pre-CGT assets of Company A to pass the factual test whilst Trust A is the sole shareholder. It cannot be said that the majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985 because the identity of all the ultimate owners cannot be determined. However, where it is not possible to identify with certainty the majority underlying interests in an asset, the Commissioner can exercise his discretion and the asset will continue to be a pre-CGT asset. The Commissioner can only exercise this discretion where he is satisfied, or thinks it reasonable to assume, that majority underlying interests have not changed. | Detailed Reasoning - Is the Commissioner satisfied, or thinks it reasonable to assume, that majority underlying interests have not changed?: Taxation Ruling IT 2340 Income tax: capital gain: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date sets out the Commissioner’s views in respect of discretionary trusts and the application of section 160ZZS of the Income Tax Assessment Act 1936 . Section 160ZZS has been repealed, but was an anti-avoidance provision aimed at preventing circumvention of the limitation of the tax on capital gains on assets acquired on or after 20 September 1985. Although IT 2340 does not set out the Commissioner’s views on the application of Division 149 to discretionary trusts, it provides some principles that may be relevant when the Commissioner is considering when deciding whether to exercise the discretion in the context of beneficiary trusts. Similarly to Division 149 of the ITAA 1997, section 160ZZS applied to treat an asset as having been acquired on or after 20 September 1985 where there was a change of 50% or more in the underlying ownership of an asset. IT 2340 provides that it is important to consider the way in which the trustee exercises its powers. Where a trustee administered a discretionary trust for the benefit of members of a particular family, even if the amounts distributed and the recipient beneficiaries varied from time to time, the Commissioner would find it reasonable to assume there has been no change in the underlying interests in the assets of the trust and would not seek to apply section 160ZZS. However, if by way of change to beneficiaries there is in practical effect a change of 50% or more in the underlying interests in the trust assets, section 160ZZS would have its intended application. Whilst IT 2340 may provide some guidance, before the Commissioner can exercise his discretion, he must have regard to the totality of the circumstances. The Commissioner must be satisfied, or think it reasonable to assume, that majority underlying interests in the assets have not changed before he can exercise his discretion so that the assets can continue to be pre-CGT assets. Trust A was settled for the purpose of benefiting a family group, and had multiple default beneficiaries, which were entitled to entitled them to income and capital at the trustee’s discretion, as well as an equal share of the Trust A’s capital upon its vesting. However, in 2016, some of the default beneficiaries disclaimed any interest they had in the capital or income of Trust A. This disclaimer removed a number of people the trust was primarily established to benefit. This significant change in the beneficiaries of the trust means that the principle in IT 2340 where, if a trustee administered a discretionary trust for the benefit of members of a particular family, the Commissioner would find it reasonable to assume there has been no change in the underlying interests in the assets, is not entirely applicable here. The Commissioner therefore must turn his mind to whether the change in beneficiaries was, in practical effect, a change of 50% or more in the underlying interests in the assets of Company A. It is prudent to consider circumstances leading up to and surrounding the disclaimer of any interest in Trust A, as well as how the trustee has administered the trust. Circumstances of the disclaimer The trust deed of Trust A gives the trustee the power to distribute income and appoint capital to the beneficiaries in its absolute discretion. The deed provides that upon vesting of Trust A, the capital of the trust is to be split between the default beneficiaries. From Trust A’s settlement until the appointment, an individual was the sole controlling mind of Trust A and its assets, either directly or indirectly. Due to disagreements between the default beneficiaries on how the assets of the trust should be administered, they entered into a settlement deed. This resulted in the trustee exercising its discretion and appointing an amount of capital to all default beneficiaries other than Beneficiary One. The trustee’s administration of Trust A As one individual was the controlling mind of Trust A, the Commissioner considers it necessary to review both the actions of the trustee and the individual’s intentions as they went about administering the trust. The individual’s intentions throughout administering the trust was that Beneficiary One was to receive the benefit of more than 50% of the assets of the trust, and more than 50% of the income derived from those assets. Beneficiary One is the only default beneficiary for which the trustee exercised its discretion in their favour. Discussion Trust A was established for the primary purpose of benefiting the default beneficiaries. This is evidenced by defining them as default beneficiaries as well as their entitlement to the capital of Trust A upon its vesting. However, as Trust A is a discretionary trust, consideration must be given to how the trustee administered the trust. One sole individual was the controlling mind of Trust A. On many occasions this individual expressed how they would like the assets and income of the trust to be split between the default beneficiaries, and this intention was the basis upon which they administered Trust A. Ultimately, the individual’s intention was for Beneficiary One to receive more than 50% of the assets of Trust A, and more than 50% of the income derived from those assets. Conclusion The Commissioner thinks it reasonable to assume that the majority underlying interests in the pre-CGT assets of Company A have not changed at any time between 20 September 1985 and the time immediately prior to the appointment of the shares. That is because Trust A was administered in such a way that Beneficiary One was always intended to receive greater than 50% of the beneficial interests in the assets of Trust A and any ordinary income that may be derived from those assets. The Commissioner will exercise his discretion pursuant to subsection 149-30(2) of the ITAA 1997 and the pre-CGT assets of Company A will continue to be pre-CGT assets for the period 20 September 1985 to immediately before the appointment of shares. | Detailed Reasoning - Is the factual test passed when the shares are appointed, and when Company A’s shares are disposed of?: When Trust A appoints its shares in Company A to Beneficiary One, Beneficiary One becomes the ultimate owner of the pre-CGT assets of Company A for the purposes of Division 149. The Commissioner must therefore consider whether the majority underlying interests in the pre-CGT assets of Company A are still held by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. As mentioned earlier, it is not possible to identify the ultimate owner of the majority underlying interests immediately before 20 September 1985 because Trust A is a discretionary trust. However, in conjunction with the reasons why the Commissioner thinks it reasonable to assume the majority underlying interests in the pre-CGT assets of Company A have not changed up until the appointment of shares, the Commissioner thinks it reasonable to assume that when Trust A appoints its shares in Company A to Beneficiary One, the majority underlying interests have not changed. That is because Trust A was administered in such a way that Beneficiary One was always intended to receive greater than 50% of beneficial interests in the assets as well as the ordinary income derived from those assets. The Commissioner will exercise his discretion pursuant to subsection 149-30(2) of the ITAA 1997 and the pre-CGT assets of Company A will continue to be pre-CGT assets at the time that Trust A appoints its assets to Beneficiary One. There is no way to determine with certainty who all the ultimate owners of Company A’s pre-CGT assets at the time that its shares are disposed of to an entity ultimately owned by Trust B because no beneficiary of Trust B holds an interest in any asset of the trust or in the ordinary income derived from the assets until the trustee’s discretion is exercised. Consequently, it is inherently impossible for the pre-CGT assets of Company A to pass the factual test whilst Trust B is the ultimate owner. However, similarly to when the ultimate owner of Company A was Trust A, where it is not possible to identify with certainty the majority underlying interests in an asset, the Commissioner can exercise his discretion and the asset will continue to be a pre-CGT asset. The Commissioner can only exercise this discretion where he is satisfied, or thinks it reasonable to assume, that majority underlying interests have not changed. Similarly to the Commissioner’s consideration of the application of Division 149 at the other times, IT 2340 provides some guidance, but before the Commissioner can exercise his discretion, he must have regard to the totality of the circumstances. The Commissioner must be satisfied, or think it reasonable to assume, that majority underlying interests in the assets have not changed before he can exercise his discretion so that the assets can continue to be pre-CGT assets. Trust B’s deed has a wide class of beneficiaries. The trustee of Trust B has the ability to appoint capital or income to any beneficiary in its absolute discretion. The deed of Trust B does not entitle any beneficiary to any income or capital until the trustee exercises its discretion. There are no factors that suggest that Trust B is to be administered in any way other than in accordance with its deed. Conclusion Trust B does not entitle Beneficiary One to any income or capital. Beneficiary One will only become presently entitled to income or capital of Trust B if the trustee exercises its discretion in a manner that favours them. This is in contrast to how Trust A was administered, which was in such a way that meant Beneficiary One was always intended to receive greater than 50% of beneficial interests in the assets as well as the ordinary income derived from those assets. Consequently, the reasons why the Commissioner decided to exercise his discretion at the other times do not apply here. It cannot be said that at the time that Company A’s shares were disposed of, Beneficiary One had more than 50% of beneficial interests in the pre-CGT assets of Company A as well as the ordinary income derived from those assets. The pre-CGT assets of Company A stop being pre-CGT assets at the time that its shares are disposed of. That is because the pre-CGT assets of Company A will fail the factual test and the Commissioner is not satisfied, nor thinks it reasonable to assume, that majority underlying interests have not changed. | Detailed Reasoning - Question 2: Subdivision 110-A of the ITAA 1997 contains the rules for working out the cost base of a CGT asset. The cost base consists of five elements. The first element is the amount of any money or the market value of any property the taxpayer paid or gave, or was required to pay or give, in respect of the acquisition of the asset. The other elements are expenditure in respect of the asset and otherwise non-deductible costs of ownership. The cost base of an asset may be modified in certain circumstances. One of these circumstances is when an asset of a non-public entity stops being a pre-CGT asset. If an asset stops being a pre-CGT asset, the first element of its cost base and reduced cost base is the asset’s market value at the time it becomes a post-CGT asset. The first element of the Company A shares acquired will be the market value of those shares at the time that the new owner acquired those shares. That is because the shares issued by Company A stop being a pre-CGT asset at the time that they were disposed of those shares to an entity ultimately owned by Trust B because the majority underlying interests in those shares have changed.