Private ruling: CGT and the methodology for calculating the gain
Date of advice: 17 October 2018
Published: December 2018
Ruling period: Income year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: For the purposes of working out the discount capital gain arising from CGT event K6 under subsection 104-230(6) of the Income Tax assessment Act 1997 (ITAA 1997), does the Commissioner accept that the proposed methodology results in the calculation of a capital gain that is not “manifestly and materially unreasonable?” | A1: Yes

Relevant facts and circumstances: The Company was established prior to 20 September 1985. The Company is a private company and has X ordinary shares on issue each of which prior to the Transfer Date (after 20 September 1985) where beneficially held by you (you) and another. Since the date the company was established until just before the transfer date, there has been no change to either the number of shares on issue, the rights attached to the shares, the identity of the shareholders, or the number of shareholders. There has not been any underlying change in the ownership of your share and the operation of Division 149 of the ITAA 1997 has not been invoked. On the Transfer Date, you disposed of your ordinary shares in the Company to a third party at the other shareholder’s direction. The transaction was non-arm’s length, in that market value consideration was not paid to you in exchange for the disposal of your share. The Company was active in the areas of the business operations, but in the last few years, the shareholders, who are approaching retirement age, have been winding down the business operations, to the point where as at the Transfer Date, the Company no longer carries on an active enterprise but has been transformed into a passive entity that invests, and has otherwise lent its operating capital to related private companies. At the time that CGT event A1 happened, the assets of the Company comprised the following classes of asset; 1. Cash; 2. Loans to related private companies that do not invoke the provisions of Division 7A; 3. Property, plant and equipment; and 4. Real Property With the exception of the Real Property, the market value of the nominated assets is equal to, or less than, the cost base of those assets, as at the Transfer Date. All assets held by the Company are post-CGT property. The market value of the share is equal to (or at least very close to) the net market value of half of the assets of the Company. The Company is a single tiered structure (for the purposes of TR 2004/18).

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 104-230 | Income Tax Assessment Act 1997 Section 116-30 | Income Tax Assessment Act 1997 Section 115-25

Reasons for decision: Summary: The capital gain has to be calculated in accordance with subsection 104-230(6) of the ITAA 1997, which states: 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. In your case, the transaction was non-arm’s length, in that market value consideration was not paid to you in exchange for the disposal of your share. The market value substitution rule in section 116-30 of the ITAA 1997 applies in those circumstances (Paragraph 38 of TR 2004/18). Therefore, you will need to substitute the market value of your share in the Company (as at the Transfer date) in place of the actual capital proceeds you received. In relation to performing the calculation described in subsection 104-230(6), the capital proceeds in this case will be the market value of the share as at the Transfer date. As all the assets of the Company were post-CGT assets as at the Transfer date, all of the capital proceeds from the disposal of the share relates to the post-CGT property of the Company (per step 1 at paragraph 29 of TR 2004/18). Following step 2 in TR 2004/18, you will need to calculate the amount by which the market value of all of the property of the Company exceeds the cost base of that property. As the market value of the cash, loans and property, plant and equipment (PP&E) is equal to the cost base of those assets, then the market value excess will be equal to the difference between the market value and the cost base of the land. You have stated that the market value of the other assets is the same as (or less than) the cost base of those assets, if the market value of those assets was less than their cost bases, this would reduce the capital gain calculated under K6. Step 2 then requires you to multiply the market value of the share by the market value excess divided by the market value of property of the Company. If the net market value of all of the property of the company is equal to the market value of the shares (and the market value excess is equal to the unrealised gain in the real property), then this results in the same number as you are proposing with your calculation. That is, you are proposing to divide the unrealised gain relating to the real property by 2. Therefore in conclusion, the calculation you are proposing is considered reasonable.