Private ruling: CGT cost base rules - Whether a non scrip capital contribution can be included in the cost base of shares under subsection 110-25(5) of the ITAA 1997
Published: May 2013
Ruling period: The relevant income year
Date scheme commenced: The relevant income year

Ruling: Q1: Will section 110-25 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the amounts to be contributed by Entity A as head company of the consolidated group to Entity B, by way of a non-scrip capital contribution, such that the amounts contributed will be included in the cost base of the shares held in Entity B by Entity A? | A1: Yes

Relevant facts and circumstances: Entities involved Entity A is the head company of the income tax consolidated group. Entity B is an investment holding company and has not been a subsidiary member of Entity A at any time, on the basis it is not an Australian resident entity. Entity C is the sole shareholder of Entity B, a company incorporated in Australia and a subsidiary of Entity A. The non-scrip capital contribution It is expected that Entity C will make a capital contribution to Entity B. No shares will be issued by Entity B under this capitalisation. The contributed surplus account in the shareholder's equity section of Entity B's balance sheet will be increased immediately after the capital contribution, and the value of the shares in Entity B will be increased as a result of the receipt of the capital contribution. It is expected that as at the date of the capital contribution, Entity B will have a positive market value. Entity C's shareholder rights will not be affected as a result of the capital contribution. The distributions Entity C will or may receive or is entitled to receive from Entity B will not change or be changed as a result of the capital contribution. There will be no change to the par value of the existing Entity B shares as a result of the capital contribution, as no additional shares will be issued to Entity C. The capital contribution will not result in any changes to the type or class of shares in Entity B, nor any of the rights attaching to the Entity B shares. There will be no amendments, restatements and/or revisions made to Entity B's constitution as a result of the capital contribution. The amount of the capital contribution will be part of, and will increase the contributed surplus of Entity B. The purpose of the non-share capital contribution is to fund Entity B's ongoing working capital requirements. The capital contribution by Entity C will not be a loan. Entity C will not be provided with any financial instrument or document, nor enter into any separate agreement or undertaking with Entity B for the capital contribution. There are no terms and/or conditions attached and/or linked to the capital contribution. As Entity B does not have a bank account, Entity B will give a legal direction to Entity D to receive cash on its behalf, in exchange for which Entity B will obtain a receivable due on demand. Entity D will recognise this cash in its books and record a corresponding intercompany liability to Entity B. Journal entries Journal entries will be made in the accounts of Entity A, Entity B, Entity C and Entity D to record the transaction. Future non-scrip capital contributions It is expected that further capital contributions will be made by Entity C to Entity B at one or more dates in the future.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 110-25(5) | Income Tax Assessment Act 1997 paragraph 110-25(5)(a)

Reasons for decision: Summary: The non-scrip capital contribution made by Entity A to Entity B can be included in the fourth element of the cost base of shares held in Entity B by Entity A under subsection 110-25(5) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: The cost base and reduced cost base of a CGT asset consists of five elements. In relation to the fourth element of the cost base subsection 110-25(5) of the ITAA 1997 states: The fourth element is capital expenditure you incurred: (a) the purpose or the expected effect of which is to increase or preserve the asset's value; or (b) that relates to installing or moving the asset. The expenditure can include giving property: see section 103-5. The first limb (paragraph 110-25(5)(a) of the ITAA 1997) is relevant here as the non-scrip capital contribution by Entity A to Entity B will be credited to the contributed surplus account and become part of share capital. Without an issue of scrip the expected effect of the capital contribution is to increase share capital over the same number of shares on issue. That is it will increase or preserve the asset's value, being the shares on issue. The non-scrip capital contribution will be achieved by Entity C (the subsidiary of Entity A) making a cash contribution to Entity B. Entity B will give a legal direction to Entity D to receive the cash contribution on its behalf and obtain a receivable on demand. Entity D will recognise the cash contribution in its books and record a corresponding intercompany liability to Entity B. The meanings of the terms 'purpose', expected effect' and 'asset's value' used in paragraph 110-25(5)(a) of the ITAA 1997 are not defined. However, the terms have been judicially considered in other contexts and are considered below. Purpose of the expenditure In Newton v FCT (1958) 98 CLR 1 at 8 ( Newton ), the Privy Council held that the word 'purpose' means 'not motive, but the effect which it is sought to achieve the end in view'. On the question of establishing the purpose of a payment, in the decision of the Full Federal Court case Raymore Contractors Pty Ltd v Commissioner of Taxation (1991) 91 ATC 4259 at 1423-47;21 ATR 1410, Hill J considered that 'in the context of the purpose of a taxpayer in making a particular payment … purpose is the object which the taxpayer has in view or in mind'. Expected effect of the expenditure In Newton at paragraph 8, the Privy Council held that the word 'effect' means the end accomplishment or achieved'. In Carrier Air Conditioning Pty Ltd v Kurda & Ors (1993) 11 ACSR 247 at 248, the Supreme Court of South Australia considered the meaning of 'expect' is to be understood according to its usage in ordinary parlance, namely, 'to regard as likely to happen' or 'to expect to find' or 'to expect that it will turn out that'. Asset's Value Taxation Determination TD 2004/2 Income tax: capital gains: is reflection in the 'value' of an asset sufficient to constitute reflection in its 'state' or 'nature' for the fourth element of cost base and reduced cost base (subsections 110-25(5) and 110-55(2) of the Income Tax Assessment Act 1997 and what are the implications of this issue for a shareholder that makes a non-scrip share capital contribution to a company ? (TD 2004/2W) was withdrawn following the majority decision of the Full Court of the Federal Court in National Mutual Life Association of Australia v. Federal Commissioner of Taxation [2009] FCAFC 96 (National Mutual). The Decision Impact Statement for National Mutual (impact statement) states that the decision would have limited impact for CGT events occurring on or after 1 July 2005 as the equivalent provision in the ITAA 1997 has been amended. Due to subsequent amendment of subsection 110-25(5) of the ITAA 1997 there is no requirement that the expenditure be reflected in the "state or nature" of the asset at the time of the CGT event in order for the expenditure to be included in the cost base. That is, the requirement has been broadened so that the "purpose or expected effect be to increase or preserve the assets value". The impact statement states: the majority of the Full Federal Court concluded that the added 'value' of a share, in this case reflected by way of an increase in shareholders' equity, could not be separated from the rights that made up that share, and the 'state' of those rights reflected the enhanced value at the time of the disposal of the share Further, the Macquarie Dictionary relevantly defines 'value' as 'material or monetary worth' or 'worth of a thing as measured by the amount of other things for which it can be exchanged, or as estimated in terms of a medium of exchange'. The purpose of the capital contribution to Entity B is to fund the on-going capital requirements of Entity B. The capital contribution will form part of Entity B's shareholder equity. The expected effect of this increase in shareholders equity over the same number of shares on issue is that the value of the shares on issue for Entity B would be increased. Conclusion The capital contribution to Entity B satisfies the requirement of paragraph 110-25(5)(a) that the expected effect of the expenditure is to increase or preserve the value of the shares (being the relevant asset) in Entity B. The expenditure can be included in the fourth element of the cost base of the shares held in Entity B by Entity A.

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