Private ruling: Company Restructure
Date of advice: 9 December 2016
Published: June 2017

Ruling: Division 6 of the ITAA 1997 sets out what amounts are included in the taxpayer's assessable income. It provides that the following amounts are included: | ● income according to ordinary concepts; that is, ordinary income (section 6-5 of the ITAA 1997), or | ● an amount which is included by a specific provision about assessable income; that is, statutory income (section 6-10 of the ITAA 1997). | Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. | Ordinary income has generally been held by case law to include three categories, namely, income from rendering personal service, income from property and income from carrying on a business. | Subsection 6-10(4) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes statutory income derived directly or indirectly from all sources during the income year. | Section 10-5 of the ITAA 1997 lists provisions which include statutory income in a taxpayer's assessable income. Included in this list are capital gains under section 102-5 of the ITAA 1997. | Subsection 102-5(1) of the ITAA 1997 provides that a taxpayer's assessable income includes their net capital gain for the income year. | Where a transaction gives rise to both ordinary income and a capital gain for capital gains tax (CGT) purposes, the full amount of ordinary income is included in assessable income and the capital gain is reduced by that amount (as per section 118-20 of the ITAA 1997). | Ordinary income | The common law has identified a number of indicators that are relevant in determining whether a taxpayer's activities constitute the carrying on of a business. The question whether a taxpayer's activities should be characterised as a business is primarily a matter of general impression and degree ( Ferguson v. Federal Commissioner of Taxation ). | The courts have held that the following indicators are relevant to the question of whether a taxpayer's activities amount to the carrying on of a business: | (a) whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators; | (b) whether the taxpayer has more than just an intention to engage in business; | (c) whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity; | (d) whether there is repetition and regularity of the activity; | (e) whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business; | (f) whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit; | (g) the size, scale and permanency of the activity; and | (h) whether the activity is better described as a hobby, a form of recreation or a sporting activity. | The Commissioner considers that a profit from an isolated transaction is considered ordinary income when there is a profit making intention and the transaction was entered into, and the profit was made, in carrying out a business operation or commercial transaction (see Taxation Ruling TR 92/3 Income Tax: whether profits on isolated transactions are income , FCT v The Myer Emporium Ltd ( Myer ); Californian Copper Syndicate (limited and reduced) v Harris ; Whitfords Beach Pty Ltd v FCT (Whitfords Beach) ). | In Myer , the High Court stated: | Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a "one-off" transaction preclude it from being properly characterized as income ( Whitfords Beach 150 CLR at 366-367, 376; 82 ATC at 4036-4037, 4042; 12 ATR at 695-696, 705). The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit. | The relevant intention or purpose of the taxpayer in respect of making a profit or gain is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. This is implicit in what the Court said in the above extract from Myer . This approach was followed in Raymor Contractors Pty Ltd v Commissioner of Taxation (Cth) . In that case, Hill J said (at 4270), “[G]enerally speaking a person will be said to intend the natural and probable consequences of his acts and likewise his purpose may be inferred from them”. | A profit-making intention or purpose does not have to be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose: FC of T v Cooling ; Commissioner of Taxation v Stone. | It is not necessary that a taxpayer have a purpose of profit-making at the time of acquiring an asset. Where a taxpayer acquires an asset with the intention of using it for personal enjoyment, for example, but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the profit from that activity will be will be ordinary income: Whitfords Beach . | Paragraphs 13 and 49 of TR 92/3 explain that generally a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations. Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following: | (a) the nature of the entity undertaking the operation or transaction; | (b) the nature and scale of other activities undertaken by the taxpayer; | (c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained; | (d) the nature, scale and complexity of the operation or transaction; | (e) the manner in which the operation or transaction was entered into or carried out; | (f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction; | (g) if the transaction involves the acquisition and disposal of property, the nature of that property; and | (a) the timing of the transaction or the various steps in the transaction. | An example of where the Commissioner considers it would be objectively concluded that there was a commercial transaction for the purpose of profit-making is arbitrage transactions (see paragraph 28 of TR 2005/ 15 Income Tax: tax consequences of financial contracts for differences ). This is because the exploitation of a market imperfection is a commercial transaction and its purpose is to make a profit. Similarly speculative transactions are also considered to come within the Myer principle where there is a profit-making purpose and the transaction is commercial. | The nature of the proposed transactions does not indicate a profit making intention, the land has remained the same and the nature of the exercise undertaken by the Company is to ensure that the shareholders can have a level of exclusivity to their respective parcels therefore any income made will not be assessable under section 6-5 of the ITAA 1936. | Will a CGT event happen for the company when the company constitution is modified? | Part 3-1 of the ITAA 1997 contains the general CGT provisions of the income tax law. | Section 102-20 of the ITAA 1997 provides that you can make a capital gain or capital loss if and only if a CGT event happens. The capital gain or loss is made at the time of the CGT event. CGT events are detailed in Division 104 of the ITAA 1997. | Most CGT events involve a CGT asset. Subsection 108-5(1) of the ITAA 1997 provides that a CGT asset is any kind of property; or a legal or equitable right that is not property. The Land and the shares in the company are CGT assets. | CGT Event A1 | Subsection 104-10(1) of the ITAA 1997 provides that: | CGT event A1 happens if you dispose of a CGT asset. | Subsection 104-10(2) of the ITAA 1997 provides that: | You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner. | As noted above, the Land and the shares are CGT assets. The Company only has ownership interest in the Land. The amendments to the Constitution will not result in a change of ownership of the Land. | However, the amendments to the Constitution will vary the rights attaching to the shares in the Company. Therefore, the relevant question is whether this variation of rights will constitute a disposal for the purposes of subsection 104-10(1) of the ITAA 1997. | The Commissioner has provided his opinion on whether a variation of rights attaching to shares will result in a disposal of shares in Taxation Ruling TR 94/30 Income tax: capital gains tax implications of varying rights attaching to shares . This ruling concerns Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936). Part IIIA which dealt with capital gains and losses has since been repealed and rewritten into the ITAA 1997. | In particular, disposals of an asset formerly covered under subsection 160M(1) of the ITAA 1936 are now captured by CGT event A1 under the ITAA 1997. Similarly, paragraph 108-5(2)(a) of the ITAA 1997, which replaces former section 160R of the ITAA 1936, ensures that part disposals of a CGT asset are also captured under CGT event A1. | In respect of former subsection 160M(1) and former section 160R of the ITAA 1936, paragraphs 8 to 9 of TR 94/30 state that: | 8. A variation in rights attaching to a share... does not result in a full disposal of an asset for the purposes of Part IIIA unless there is a cancellation or redemption of the share. In determining whether a disposal has occurred under Part IIIA, it is not relevant to consider whether the variation is slight (such as a small change to the nominal value of shares) or more significant (such as disposing of the preference to receive dividends). | 9. A variation in rights attaching to shares does not result in a part disposal of an asset under section 160R. | The amendments to Constitution will result in a variation of rights attaching to the shares. However, these variations will not result in a disposal of all or part of the shares in the Company. Therefore, the amendments to the Constitution will not cause CGT event A1 to happen. | CGT Event D1 | Subsection 104-35(1) of the ITAA 1997 states that: | CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. | The amendments to the Constitution will not result in the creation of a contractual right or legal or equitable right in another entity. The amendments will vary the rights attaching to the shares. However, this variation will not result in the creation of a relevant right in another entity for the purposes of CGT event D1. | In this respect, paragraph 10 of TR 94/30 provides that a variation in rights attaching to shares does not constitute a deemed disposal of shares under former subsection 160M(6) of the ITAA 1936. Former subsection 160M(6) of the ITAA 1936 has been rewritten into CGT event D1. | In relation to former subsection 160M(6) of the ITAA 1936, TR 94/30 further states at paragraph 45 that: | …The broad criteria which trigger the new subsections 160M(6) to 160M(6D) are that a person must create an asset, not being corporeal property, which on its creation is vested in another person. As all these requirements are not present when a company resolves to vary the rights attaching to its shares, the subsection will not apply. | Accordingly, the variation in rights attached to the shares will not result in the creation of a contractual right, or other legal or equitable right in another entity for the purposes of subsection 104-35(1) of the ITAA 1997 and CGT event D1 will not happen. | CGT Event K8 | CGT event K8 occurs under certain direct value shift scenarios where value is shifted from equity or loan interests in a company or trust to other equity or loan interests in the same company or a trust. The equity or loan interest from which value is shifted away from is referred to as the 'down interest' and the equity or loan interest to which value is shifted to is referred to as the 'up interest' | Subsection 104-250(1) of the ITAA 1997 provides that: | CGT event K8 happens if there is a taxing event generating a gain for a down interest under section 725-245. | See below for discussion on Division 725 of the ITAA 1997. | Will the modification of the company constitution give rise to a direct value shift under Division 725 of the ITAA 1997? | Will the issue of new shares give rise to a direct value shift under Division 725 of the ITAA 1997? | A direct value shift: section 725-145 of the ITAA 1997 | Direct value shift is defined in section 725-145 of the ITAA 1997. | Subsection 725-145(1) states: | There is a direct value shift under a scheme involving equity or loan interests in an entity (the target entity ) if: | (a) there is a decrease in the market value of one or more equity or loan interests in the target entity; and | (b) the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things, is done; and | (c) either or both of subsections (2) or (3) are satisfied. | Subsections 725-145(2) and 725-145(3) of the ITAA 1997 continue that: | One or more * equity or loan interests in the target entity must be issued at a * discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph. | Or, there must be an increase in the *market value of one or more * equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph. | 'Scheme' is defined broadly in section 995-1 of the ITAA 1997 to mean any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. In the present case, there is a scheme. | Under the scheme, the value of the Class A shares will remain unchanged. Each Class A share gives the right to use common property, as every Class A share will have the same right that currently exists there will be no change in the value of these shares. | Under the scheme, the Class D shares will be cancelled and new shares will issue with a specific right to a particular lot. The right attached to the existing Class D shares include the underlying right to a specified portion of the assets of the Company. As there are currently XX D class shares each share has the underlying right to 1/1XX th of the assets of the Company, i.e. 1/XX th right to the value of Land. If the topographic properties of each notional lot was the same, given the different size of the lots, the underlying value of a share issued for any particular lot is likely to be different to 1/XX th value of the Land. This proposition that the value of the individual lots is unlikely to be 1/XX th of the Land value also holds given the different topographical nature of land. Therefore, the value shareholders are entitled to under the scheme is likely to change when new shares are issued. | Thus, there is a direct value shift under the scheme in accordance with section 725-145 of the ITAA 1997. | Consequences for a direct value shift: section 725-50 of the ITAA 1997 | There can be consequences for a direct value shift where the conditions in section 725-50 of the ITAA 1997 are met. The section states: | A direct value shift under a scheme involving equity or loan interests in an entity (the target entity ) has consequences for you under this Division if, and only if: | a. the target entity is a company or trust at some time during the * scheme period; and | b. section 725-55 (Controlling entity test) is satisfied; and | c. section 725-65 (Cause of the value shift) is satisfied; and | d. you are an *affected owner of a *down interest, or an *affected owner of an *up interest, or both; and | e. neither of sections 725-90 and 725-95 (about direct value shifts that are reversed) applies. | Note: For a down interest of which you are an affected owner, the direct value shift has consequences under this Division only if section 725-70 (about material decrease in market value) is satisfied. | Paragraph 725-50(a) of the ITAA 1997 | The Company is the target entity during the scheme. | Paragraph 725-50(b) of the ITAA 1997 | Section 725-55 of the ITAA 1997 contains the Controlling entity test and provides: | An entity (the controller) must *control (for value shifting purposes) the target entity at some time during the period starting when the *scheme is entered into and ending when it has been carried out. (The period is the scheme period) | Section 727-355 of the ITAA 1997 defines Control (for value shifting purposes) of a company. It provides three tests to determine Control: | 1. 50% stake test | 2. 40% stake test | 3. Actual control test | The 50% stake test is described in subsection 727-355(1) of the ITAA 1997 and provides that an entity controls a company if the entity, or the entity and its associates between them: | a. can exercise, or can control the exercise of, at least 50% of the voting power in the company (either directly, or indirectly through one or more interposed entities); or | b. have the right to receive (either directly, or indirectly through one or more interposed entities) at least 50% of any dividends that the company may pay; or | c. have the right to receive (either directly, or indirectly through one or more interposed entities) at least 50% of any distribution of capital of the company. | The 40% stake test is described in subsection 727-355(2) of the ITAA 1997 and provides that an entity controls a company if the entity, or the entity and its associates between them: | a. can exercise, or can control the exercise of, at least 40% of the voting power in the company (either directly, or indirectly through one or more interposed entities); or | b. have the right to receive (either directly, or indirectly through one or more interposed entities) at least 40% of any dividends that the company may pay; or | c. have the right to receive (either directly, or indirectly through one or more interposed entities) at least 40% of any distribution of capital of the company; | unless an entity (other than the first entity and its associates) either alone or together with its associates in fact controls the company. | The actual control test is found in subsection 727-355(3) of the ITAA 1997 and provides that an entity controls (for value shifting purposes) a company if the entity, either alone or together with its associates, in fact controls the company. | As none of the shareholders and their associates meets the 40% stake test, nor do they actually control the Company, the controlling entity test is not satisfied, therefore any direct value shift under the scheme has no consequences. | Conclusion | Since the direct value shift has no consequences in this case as shown above, there is no CGT event K8. | Will the Commissioner exercise his discretion under subsection 103A(5) of the Income Tax Assessment Act 1936 (ITAA 1936) to treat the company as a public company? | Under subsection 103A(5) the Commissioner has the discretion to treat a private company as a public company for income tax purposes even though the company does not satisfy one or more of the prescribed tests contained in section 103A. | Subsection 103A(5) lists certain specific factors that need to be taken into account when determining whether or not the discretion should be exercised. The main question to be considered when exercising the discretion is whether the company reasonably falls within the general concept of a public company. | There are four factors in subsection 103A(5) that the Commissioner will consider in making a determination: | (a) the number of persons who were, at any time during the year of income, capable of controlling the company and whether any of those persons was a public company; | (b) the market value of the shares issued by the company before the end of the year of income; | (c) the number of persons who beneficially owned shares in the company at the end of the year of income; and | (d) any other matters that he thinks relevant, | (a) the number of persons who were, at any time during the year of income, capable of controlling the company and whether any of those persons was a public company | The High Court in WP Keighery Pty Ltd v FC of T (1957) 100 CLR 66, 11 ATD 359 held that the control of a company resides in the voting power of its shareholders to carry out a resolution at a general meeting of the company. In British American Tobacco C Ltd v IRC (1942) 29 TC 49, it was held that company A might indirectly control company C through its control of company B which controls company C. | In this case there are X persons who are shareholders. | (b) the market value of the shares issued by the company before the end of the year of income | The market value of the ordinary shares issued by the Company would be represented by the market value of the only asset the company owns, the Land. Given that 2/XX th of the shares were sold in late 20XX for $XXX,,000 it can be estimated that the current market value of all the shares issued by the Company is approximately $XX. | (c) the number of persons who beneficially owned shares in the company at the end of the year of income | As the shares in the Company are owned by Xindividual persons, there are X beneficial owners of the shares. | (d) any other matters that he thinks relevant | Regard must be made to the overall position of the company. An unlisted company with several hundred shareholders and a paid up capital of $XXX,,000 would generally be more likely to be accepted as a public company than a company with X shareholders and a paid up capital of $XX,000. | The Commissioner must be satisfied that the Company qualifies for public company status by showing that it has characteristics of what could reasonably be expected of a public company. Based on the information provided, the Company does not exhibit any characteristics of what is normally expected of a public company. | In TR 2015/3 the Commissioner explains that the discretion under subsection 103A(5) will be exercised in circumstances where a strata title body is in substantial compliance with its obligations and responsibilities as set out in the applicable governing legislation. This results in a strata title body being treated as a public company for income tax purposes. A strata title body may also be called a 'strata title body corporate', 'body corporate', 'strata corporation', 'owners corporation' and 'community corporation'. | The Application of the discretion | Having considered the overall circumstances, the Commissioner will not exercise his discretion under subsection 103A(5) to treat the Company as a public company before the scheme is completed. However, once the scheme is completed, the constitution is changed and shares are issued giving rights to specific lots the Commissioner will exercise his discretion. | Can the company disregard any capital gain under section 118-42 of the ITAA 1997 when title to individual lots is transferred to the shareholders? | Provisions separate the tax effect for the current legal owner of the property from the tax effect that applies to the recipients of stratum units under the subdivision. | For the current legal owner (normally a company) or legal owners, once it has been determined that the lots transferred are stratum units and that they have been transferred to entities that had the right to occupy those lots before the subdivision, any capital gain or capital loss made as a result of the transfer is disregarded. This exemption is automatic, it is not a choice. | For the recipients of lots transferred under such a subdivision, a rollover choice is available. If chosen, any capital gain or capital loss made from ownership of the original asset ending is disregarded, if the original asset was acquired before 20 September 1985, the acquisition date of the stratum unit transferred to the recipient is taken to be before 20 September 1985, and where the original asset was acquired after 19 September 1985, its cost base is substituted as the cost base of the stratum unit. | For example, the original asset may be a share in a company or a long term lease. | Therefore, the Company is entitled will disregard any capital gain. | Will the transfer of the individual lots to shareholders be a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999? | Section 9-10 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) states: | (1) A supply is any form of supply whatsoever. | (2) Without limiting subsection (1), supply includes any of these: | (a)… | (d) a grant, assignment or surrender of *real property; | …' | The disposal of land falls within paragraph (c) of subsection 9-10(2) of the GST Act; and therefore, constitutes a supply. The sale will be a taxable supply if the supply satisfies the requirements of section 9-5 of the GST Act. | Section 9-5 of the GST Act defines a taxable supply. It states: | You make a *taxable supply if: | (a) you make the supply for *consideration; and | (b) the supply is made in the course or furtherance of an *enterprise that you *carry on; and | (c) the supply is *connected with the indirect tax zone; and | (d) you are *registered, or *required to be registered. | However, the supply is not a *taxable supply to the extent that it is *GST-free or *input taxed. | (Words denoted by asterisks are defined in section 195-1of the GST Act) | The Company submits that section 9-5 of the GST Act will not apply in respect of this disposal because it is not registered or not required to be registered for GST. We agree with this submission. | Section 23-5 of the GST Act states: | You are required to be registered under this Act if: | (a) you are *carrying on an *enterprise; and | (b) your * GST turnover meets the *registration turnover threshold. | The term 'enterprise' is defined in subsection 9-20(1) of the GST Act. It states (amongst other things): | An enterprise is an activity, or series of activities, done: | (a) in the form of a *business; or | (b) in the form of an adventure or concern in the nature of trade; | (c) … | Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number discusses when an entity can be said to be carrying on an enterprise . Goods and Services Tax Determination GSTD 2006/6 Goods and services tax: does MT2006/1 have equal application to the meaning of 'entity' and 'enterprise' for the purposes of the A New Tax System (Goods and Services Tax) Act 1999? GSTD 2006/6 provides that the reasons in MT 2006/1 are considered to apply equally to the term 'enterprise' in the GST Act and can be relied on for GST purposes. | Paragraph 154 of MT 2006/1 provides that it is necessary to identify one activity or a series of activities that amount to an enterprise. Paragraph 159 provides that whether or not an activity or series of activities amounts to an enterprise is a question of fact and degree having regard to all of the circumstances of the case. Example 15 in MT 2006/1 provides that an activity such as the selling of an asset may not of itself amount to an enterprise but account should also be taken of the other activities leading up to the sale to determine if an enterprise has been carried on. | In the form of a business | An enterprise includes an activity, or series of activities, done in the form of business. MT 2006/1 presents some indicators of business derived from case law. There is no single test to determine whether a business is being carried on. | In the form of an adventure or concern in the nature of trade | There is also no single test to determine as to what is an adventure or concern in the nature of trade. MT 2006/1 recognises case law stipulating that an adventure or concern in the nature of trade implies a commercial, profit-making undertaking or scheme. | Paragraph 244 of MT 2006/1 provides that this undertaking must have the characteristics of a business deal and be of a revenue nature. Paragraph 247 of MT 2006/1 provides that where the property being sold provides personal enjoyment to the owner it is more likely to be an investment rather than a trading asset. Paragraphs 249 to 255 of MT 2006/1 provide that the length of ownership, the frequency of the transactions, supplementary work on the property, the circumstances that were responsible for the realisation and the motive are also relevant factors when determining whether an activity is in the form of an adventure or concern in the nature of trade. | In this case there is no profit motive. Neither is there a business as outlined in our response to question 1 above. The land has remained the same and the nature of the exercise undertaken by the Company is to ensure that the shareholders can have a level of exclusivity to their respective parcels. Taking these factors into consideration we are of the view that the disposal of the respective lots to shareholders is a mere realisation of a capital asset that is not made in the course or furtherance of the Company's enterprise. | As the requirements in section 9-5 of the GST Act are not met the sale of your land is not a taxable supply. There is no requirement to register for GST.