Private ruling: Capital gains tax and disposal of assets by a foreign resident
Date of advice: 6 November 2017
Published: March 2018
Ruling period: 1 July 2017 – 30 June 2017
Date scheme commenced: 1 July 2017

Ruling: Q1: Will the capital gain realised by X from the proposed sale of their shares in Company A be disregarded under section 855-10 of the Income Tax Assessment Act 1997 ? | A1: Yes

Relevant facts and circumstances: Company A is an Australian resident company. Its principal activities are comprised of commercial property and securities investments. X is one of several shareholders in Company A. X is a foreign tax resident and has never been an Australian resident for tax purposes. X holds xx% of Company A’s total shares on issue. The percentages of shareholdings in the remaining yy% are held by Australian shareholders and non-resident shareholders. The shareholders and their respective interests in Company A have remained unchanged for the last 10 years. X is reviewing their affairs for the purposes of estate and succession planning. X intends to sell their shares in Company A to their child for market value consideration (Proposed Sale). Company A’s Australian real property interests as at the date of the application of this private ruling comprise of several properties in NSW. The total market value of these properties is less than the total value of assets which are not Australian real property assets. Company A does not hold any other Australian real property other than the above properties detailed above nor does it intend to acquire any other Australian real property prior to the Proposed Sale. There have been and will be no events which cause material changes to the values and composition of Company A’s Current Assets and Non-current Assets between 31 December 2016 and the date of the Proposed Sale.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 855-10 | Income Tax Assessment Act 1997 subsection 855-10(1)

Reasons for decision: Summary: Division 855 of the ITAA 1997 sets the conditions under which foreign residents are entitled to disregard a capital gain or loss arising from a CGT event. The CGT event that occurs on X’s proposed disposal of their shares in Company A will be CGT event A1 under section 104-10 of the ITAA 1997. Section 855-10 of the ITAA 1997 allows a foreign resident to disregard a capital gain or loss where: …(b) the CGT event happens in relation to a CGT asset that is not taxable Australian property. The definition of taxable Australian property in the table to section 855-15 of the ITAA 1997 consists of five categories of assets being: 1. Item 1: taxable Australian real property (TARP, as defined in section 855-20), 2. Item 2: indirect Australian real property interest (IARPI, as defined in section 855-25) and not covered by Item 5, 3. Item 3: A CGT asset used in carrying on a business through a permanent establishment in Australia, 4. Item 4: an option to acquire a CGT asset covered by the first three items, 5. Item 5: a CGT assets that is covered by subsection 104-165(3) of the ITAA 1997 (choosing to disregard a gain or loss on ceasing to be an Australian resident). Items 3, 4 and 5 are not relevant. Items 1 and 2 are considered below. | Detailed Reasoning - Taxable Australian real property: TARP is defined in section 855-20 of the ITAA 1997 to include ‘real property situated in Australia’ (paragraph 855-20(a)). | Detailed Reasoning - Indirect Australian real property interest: Subsection 855-25(1) of the ITAA 1997 provides that the membership interest of a holding entity in another entity (the test entity) is an IARPI if: (a) The interest passes the non-portfolio interest test (see section 960-195): (i) at that time; or (ii) throughout a 12 month period that began no earlier than 24 months before that time and ended no later than that time; and (b) the interest passes the principal asset test in section 855-30 at that time. | Detailed Reasoning - Non-portfolio interest test: Subdivision 960-GP of the ITAA 1997 provides definitions of ‘total participation interest’, ‘indirect participation interest’ and ‘direct participation interest’. These concepts are used to determine whether a sufficient connection exists between a membership interest being tested under the principal asset test, and the underlying real Australian property. The non-portfolio interest test is satisfied if the sum of direct participation interests held by a foreign resident and its associates in the test entity is 10% or more (section 960-195). | Detailed Reasoning - Principal asset test: The purpose of the principal asset test in section 855-30 of the ITAA 1997 is to define when an entity's underlying value is principally derived from Australian real property (subsection 855-30(1)). Subsection 855-30(2) provides that a membership interest held by the holding entity in the test entity passes the principal asset test if the sum of the market values of the test entity's 'assets' that are TARP exceeds the sum of the market values of its 'assets' that are not TARP. Subsection 855-30(3) provides that for the purposes of subsection (2), an asset of an entity (the 'first entity') that is a membership interest in another entity (the 'other entity') is treated as if it were instead the following two assets: (a) an asset that is taxable Australian real property (the 'TARP asset'); (b) an asset that is not taxable Australian real property (the 'non-TARP asset'). The market values of the TARP assets and the non-TARP assets are worked out according to the table in subsection 855-30(4). | Detailed Reasoning - Application to the present case: As X holds membership interest in Company A, it is necessary to consider if the interest is an IARPI under section 855-25 of the ITAA 1997. The non-portfolio interest test under section 960-195 of the ITAA 1997 is satisfied at the time of CGT event A1 as X has direct control interest (within the meaning of section 350 of the Income Tax Assessment Act 1936 ) in Company A as they holds XX% of the total paid-up share capital of Company A. Accordingly, their direct participation interest in Company A is XX% pursuant to Item 1 of the table under subsection 960-190(1) of the ITAA 1997 at the relevant time. The interest, therefore, passes the non-portfolio interest test. As at 31 December 2016 the market value of Company A’s non-TARP assets is more than the value of market value of TARP assets. These values are not expected to change materially at the time of the Proposed Sale. Accordingly, X’s membership interest in Company A is not an indirect Australian real property interest as it does not pass the principal asset test. Conclusion : Under subsection 855-10(1) of the ITAA 1997, X can disregard any capital gain or loss from CGT event A1 occurring on the disposal of their shares in Company A as the shares are not taxable Australian property.