Private ruling: Income tax - Capital gains tax - CGT events - CGT event A1 - disposal of a CGT asset
Date of advice: 5 July 2018
Published: September 2018
Ruling period: Year ending 30 June 2018

Ruling: Q1: Is the disposal of the one Private Company (PC) class share (Class Share) by Taxpayer a CGT event under Division 104 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Is the Taxpayer liable for the capital gains on the sale of the Class Share with their capital proceeds being based on the number of shares they held in the Private Company | A2: Yes. | Q3: Is Taxpayer entitled to utilise the small business CGT concessions under Division 152 of the ITAA 1997 in connection with the sale of the Class Share? | A3: No. | Q4: Is Taxpayer entitled to utilise the CGT discount under Division 115 of the ITAA 1997 in connection with the sale of the Class Share? | A4: Yes - as Taxpayer acquired the Class Share more than 12 months before the CGT event happened, where the other conditions are satisfied for a discount capital gain, the capital gain may be reduced by 50% as outlined in Step 3 of section 102-5 of the ITAA 1997. | Q5: Is the amount received under the Family Court Orders that exceeds the capital proceeds from the sale of the PC Class Share assessable income pursuant to Division 6 of the ITAA 1997? | A5: No - the amount is neither ordinary income nor a capital gain.

Relevant facts and circumstances: Taxpayer and Ex-spouse were married. The Taxpayer and Ex-spouse applied for and received consent orders from the Family Court of Australia, prior to the 2018 income year (the Family Court Orders). Taxpayer held a Class Share in a private company (PC). The Class Share had no voting rights. The Ex-spouse held all issued ordinary shares in the PC, which had voting rights. The Family Court Orders require the PC to declare a franked dividend in relation to the Class Share. An unrelated party purchased all the shares in PC during the income year. The sale contract for the purchase of PC shares provides for an undissected total amount to be paid in relation to all classes of the issued capital which were all held by Taxpayer and Ex-spouse. The sales agreement also provides for an earn-out arrangement specific to the Ex-spouse. The Family Court Orders provide that upon the sale of the shares in PC a specified amount is to be paid by the Ex-spouse to the Taxpayer in excess of the capital proceeds that relate to the sale of the Class Share.

Relevant legislative provisions: Income Tax Assessment Act 1997 (ITAA 1997) Section 6-5 of the ITAA 1997 | Section 6-10 of the ITAA 1997 | Section 100-45 of the ITAA 1997 | Section 102-5 of the ITAA 1997 | Section 102-20 of the ITAA 1997 | Subsection 102-20(1) of the ITAA 1997 | Division 104 of the ITAA 1997 | Subsection 104-10(1) of the ITAA 1997 | Subsection 104-10(2) of the ITAA 1997 | Subsection 104-10(3) of the ITAA 1997 | Subsection 104-10(4) of the ITAA 1997 | Section 104-25 of the ITAA 1997 | Subsection 108-5(1) of the ITAA 1997 | Division 115 of the ITAA 1997 | Section 115-10 of the ITAA 1997 | Section 115-15 of the ITAA 1997 | Section 115-20 of the ITAA 1997 | section 115-25 of the ITAA 1997 | Section 116-20 of the ITAA 1997 | Section 116-20(1) of the ITAA 1997 | Section 118-75 of the ITAA 1997 | Division 152 of the ITAA 1997 | Subdivision 152-A of the ITAA 1997 | Subsection 152-10(2) of the ITAA 1997 | Section 152-55 of the ITAA 1997 | Section 152-60 of the ITAA 1997 | Subsection 152-60(a) of the ITAA 1997 | Subsection 152-60(b) of the ITAA 1997 | Section 152-65 of the ITAA 1997 | Section 152-70 of the ITAA 1997 | Section 152-75 of the ITAA 1997

Reasons for decision: Summary: The disposal of the Class Share, owned by the Taxpayer to the third party constitutes a disposal for the purposes of subsection 104-10(1) of the ITAA 1997 and CGT event A1 happened when the Taxpayer entered into the contract for disposal of that share. | Detailed Reasoning - Detailed reasoning: Part 3-1 of the ITAA 1997 contains the general capital gains tax (CGT) provisions of the income tax law. Subsection 102-20(1) of the ITAA 1997 provides that you can make a capital gain or capital loss only if a CGT event happens to an asset in which you have an ownership interest. CGT events are detailed in Division 104 of the ITAA 1997. 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 Class Share is a CGT asset. 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. Subsection 104-10(3) of the ITAA 1997 states the time of the event is: (a) when you enter into the contract for the disposal; or (b) if there is no contract - when the change of ownership occurs. In the present case, the Class Share is a CGT asset. The ownership of the company shares is not affected by the Family Court Orders and the individual shareholders only have ownership interests in their shares (that is, the Family Court Orders do not alter the underlying legal and beneficial ownership of the shares for tax purposes). The disposal of the Class Share, owned by the Taxpayer, to the third party constitutes a disposal for the purposes of subsection 104-10(1) of the ITAA 1997 and CGT event A1 happened when the Taxpayer entered into the contract for disposal of that share. | Summary: The Taxpayer is liable for the capital gains on the sale of the Class Share as CGT event A1 happens when the share is sold and the capital proceeds on the happening of the event is the proportionate amount that share represents in relation to the total number of shares sold on the happening of that event. | Detailed Reasoning - Detailed reasoning: The Taxpayer is liable for the capital gains on the sale of the Class Share with capital proceeds being based on the number of shares they held in the PC. Section 100-45 of the ITAA 1997 explains how to calculate the capital gain or loss for most CGT events. For most CGT events, the capital gain is the difference between the capital proceeds and the cost base of the CGT asset. The general rules about capital proceeds from a CGT event are set out in section 116-20 of the ITAA 1997. Under subsection 116-20(1) of the ITAA 1997, the capital proceeds from a CGT event are the total of the money received (or entitled to be received) and the market value of property received (or entitled to be received) in respect of the event happening. In relation to CGT Event A1, subsection 104-10(4) of the ITAA 1997 provides that you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base - and you make a capital loss if those capital proceeds are less than the asset 's reduced cost base. In this case the sales contract does not dissect the lump sum received in relation to the arm’s length sale of all classes of shares of PC. Consequently, it is necessary to determine a fair and reasonable method of apportioning the lump sum to ascertain the capital proceeds from the disposal of the Taxpayer’s Class Share. Pursuant to the sale agreement a lump sum amount was paid in relation to all shares on issue of the PC. Taxpayer and Ex-spouse received a total amount for the capital proceeds for the sale of all the shares held. Further the sales contract provided for an Earn-out amount which is payable to the Ex-spouse only. As there is no separate allocation of amounts applicable to the purchase under the sale agreement it is fair and reasonable to allocate the capital proceeds from the sale of all the shares on a per share basis. The Earn-out amount does not affect the calculation of allocation of capital proceeds to the Class Share held by the Taxpayer. A fair and reasonable value attributable to the Class Share sold by the Taxpayer is calculated per the following formula: Class Share capital proceeds = Number of shares held by the taxpayer/ total number of shares x capital proceeds. | Summary: The rights attached to the Class Share do not meet the requirements in section 152-10 of the ITAA 1997 for the Taxpayer to be a ‘concession stakeholder’. Consequently, the Taxpayer is ineligible to access the small business CGT concessions in Division 152-A of the ITAA 1997 for this CGT event. | Detailed Reasoning - Basic conditions in Subdivision 152-A: For the small business CGT relief to apply the basic conditions in Subdivision 152-A of the ITAA 1997 must be satisfied, as well as any relevant specific conditions. In this case, irrespective of whether all of the relevant basic conditions in Subdivision 152-A of the ITAA 997 are satisfied, as the CGT asset is a share in a company, one of the additional basic conditions in subsection 152-10(2) of the ITAA 1997 must also be satisfied. Under subsection 152-10(2) of the ITAA 1997, where the CGT asset is a share in a company or an interest in a trust, one of these additional basic conditions must be met just before the CGT event: • the taxpayer claiming the concession must be a ‘CGT concession stakeholder’ in the company or trust: or • CGT concession stakeholders in the company or trust together have a small business participation percentage in the interposed entity of at least 90% (the 90% test). An individual is a CGT concession stakeholder of a company if they are a ‘significant individual’ in the company, or the spouse of a significant individual, if the spouse has a ‘small business participation percentage’ in the company at that time that is greater than zero (section 152-60 of the ITAA 1997). Significant individual An individual is a significant individual in a company if they have a small business participation percentage in the company of at least 20% (section 152-55 of the ITAA 1997). This 20% can be made up of direct and indirect percentages. Small business participation percentage An entity's small business participation percentage in another entity at a time is the percentage that is the sum of: • the entity's direct small business participation percentage in the other entity at that time, and • the entity's indirect small business participation percentage in the other entity at that time (section 152-65 of the ITAA 1997). An entity's direct small business participation percentage in a company is the percentage of: • voting power that the entity is entitled to exercise; • any dividend payment that the entity is entitled to receive, or • any capital distribution that the entity is entitled to receive. Where a shareholder owns different percentages of voting rights, dividend rights and capital distribution rights in a company, the small business participation percentage will be the smallest percentage - for example, if an individual owns shares in a company that entitle them to 40% of any dividend and capital distributions from the company, but those shares do not carry any voting rights, the individual’s small business participation percentage will be zero because the individual’s voting rights is 0% and that would be the smallest percentage in voting, dividend and capital distribution rights. An entity's indirect small business participation percentage in a company is calculated by multiplying together the entity's direct participation percentage in an interposed entity, and the interposed entity's total participation percentage (both direct and indirect) in the company (section 152-75 of the ITAA 1997). | Detailed Reasoning - Application to the Taxpayer’s circumstances: In the Taxpayer’s case, the Class Share held in the company was sold. As the CGT asset was a share, the Taxpayer is also required to satisfy one of the additional basic conditions set out in subsection 152-10(2) of the ITAA 1997 to be eligible for the small business CGT concessions. The Taxpayer is not a significant individual as the rights attached to the Class Share do not amount to a small business participation percentage of 20% or more such that Taxpayer is a ‘significant individual’. The Class Share does not have voting rights. The Taxpayer’s entitlement to vote reflects a zero small business participation percentage - therefore, making this the ‘determining' measure for section 152-70 of the ITAA 1997. As Taxpayer’s small business participation percentage for this measure is less than the 20% requirement tabled in section 152-70 of the ITAA 1997, the Taxpayer is not a significant individual of that company. Therefore Taxpayer is not a significant individual under subsection 152-60(a) of the ITAA 1997. Further, even if Ex-spouse was a significant individual and the Taxpayer was the spouse of Ex-spouse just before the CGT event, the small business participation percentage of the Taxpayer is zero and therefore would not satisfy the subsection 152-60(b) of the ITAA 1997 requirements just before the CGT event. Consequently, the Taxpayer is not a ‘concession stakeholder’ for the purposes of section 152-10(2) of the ITAA 1997, and is therefore ineligible to access the small business CGT concessions in Division 152-A of the ITAA 1997. | Summary: To the extent that all the other requirements are met, as the Taxpayer has held the Class Share more than 12 months before the CGT event happened, then they may be entitled to the CGT discount under Division 115 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: The CGT discount under Division 115 of the ITAA 1997 is available to an individual where: ● a CGT event happens to an asset the entity owns; ● the capital gain is made by an individual (section 115-10 of the ITAA 1997); ● the CGT event happened after 11.45am (by legal time in the ACT) on 21 September 1999 (section 115-15 of the ITAA 1997); ● the indexation method was not used to calculate the cost base.(section 115-20 of the ITAA 1997);and ● the asset was acquired at least 12 months before the CGT event (Section 115-25 of the ITAA 1997). For an individual, the capital gain is reduced by the discount percentage of 50%. However, the capital gain can only be reduced after all the capital losses for the year and any unapplied net capital losses from earlier years have been applied (section 102-5 of the ITAA 1997). As the Taxpayer acquired the Class Share more than 12 months before the CGT event happened, where the other conditions are satisfied for a discount capital gain, the capital gain may be reduced by 50% as outlined in Step 3 of section 102-5 of the ITAA 1997. | Summary: The amount the Taxpayer is entitled to under the Family Court Orders as a cash payment that exceeds the capital proceeds for the sale of the Class Share is not ordinary income or statutory income under Division 6 of the ITAA 1997 and is not subject to income tax. | Detailed Reasoning - Detailed reasoning: Assessable income includes ordinary income under section 6-5 of the ITAA 1997 and statutory income as defined in section 6-10 of the ITAA 1997. | Detailed Reasoning - Ordinary income: Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. Generally, amounts that are periodic, regular or recurrent and relied upon by the recipient for their regular expenditure are likely to be ordinary income, as are amounts that are the product of any employment of, or services rendered by, the recipient. Further, amounts which compensate for lost income or serve as a substitute for other income are themselves income according to ordinary concepts. Receipts that are capital in nature are not assessable as ordinary income. | Detailed Reasoning - Statutory income: Section 102-20 of the ITAA 1997 provides that you only make a capital gain or loss if a capital gains tax (CGT) event happens to a CGT asset. Section 104-25 of the ITAA 1997 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends when the asset is released, discharged or satisfied. Section 118-75 of the ITAA 1997 provides that a capital gain or loss you make as a result of CGT event C2 happening is disregarded if: a) you make the gain or loss in relation to a right that directly relates to the breakdown of a relationship between spouses; and b) at the time of the CGT event: (i) you and your spouse or former spouse are separated; and (ii) there is no reasonable likelihood of cohabitation being resumed. | Detailed Reasoning - Application to Taxpayer’s circumstances: The lump sum amount received from the Ex-spouse is in accordance with the Orders of the Family Court as it relates to the breakdown of the marriage between the Taxpayer and their Ex-Spouse. This payment is considered to be capital in nature. Accordingly, the settlement amount received by the Taxpayer is not ordinary income. When the Taxpayer entered into the agreement with their Ex-spouse, as it related to the sale of the shares in PC, it gave rise to a legally enforceable right to receive a lump sum payment on the happening of the specified event. This legally enforceable right is an intangible CGT asset. When Taxpayer received the final lump sum amount, their ownership of the asset ended by the asset being released, discharged or satisfied and CGT event C2 occurred. However, as CGT event C2 occurred as a result of a marriage breakdown and Taxpayer meets the conditions under section 118-75 of the ITAA 1997, any capital gain or loss is disregarded. Consequently, the Taxpayer is entitled to disregard any capital gain or loss that resulted from the receipt of the settlement amount. Therefore the amount received from the Ex-spouse in excess of the capital proceeds from the sale of the Class Share will not be ordinary income or statutory income of the Taxpayer.