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Where a direct value shift is neutral for a taxpayer (a shareholder in a company) under subsection 725-220(1) of the Income Tax Assessment Act 1997 (ITAA 1997), is the gain that arises to the taxpayer worked out differently under section 725-365 of the ITAA 1997 than it would have been, had the direct value shift not been neutral?

Yes. The gain is worked out differently because where a direct value shift is neutral for a taxpayer, subsection 725-220(2) of the ITAA 1997 allows for the gain to be worked out under section 725-365 of the ITAA 1997, taking into account only those interests that are owned by the taxpayer.

A company has A and B class shares. The taxpayer (X) and the remaining shareholders, Y and Z, are all associates. X, Y and Z each own 10,000 A class shares. X owns 5,000 shares acquired before 20 September 1985 (pre-CGT shares) and 5,000 post-CGT shares. All of Y's and Z's A class shares are pre-CGT. The market value of each A class share is $60.

All of the B class shares are post-CGT with a market value of $2,000 per share. X owns 400, Y owns 200 and Z owns 600 of the B class shares. The cost base of each of the B class shares is $1,500.

A scheme is entered into after 30 June 2002 in which the rights attaching to the shares are varied. The variation causes a fall in market value of each B class share to $1000 and an increase in market value of the A class shares to $100 per share. The effects of the variation are not expected to reverse.

As the sum of decreases in market value of X's B class shares (down interests) is equal to the increases in market value of X's A class shares (up interests), the scheme results in a direct value shift that is neutral for X under subsection 725-220(1). As X, Y and Z are all associates, X qualifies as an affected owner under Division 725 of the ITAA 1997.

None of X's shares were acquired for resale at a profit, nor were they held as trading stock.

The rules in Subdivisions 725-C to 725-F of the ITAA 1997 set out the consequences that may happen for certain direct value shifts occurring after 30 June 2002. Under those rules, the adjustable values of interests owned by affected owners may be modified to take account of material changes in market value that are attributable to the direct value shift. The rules may also generate a gain on the interests that have decreased in market value (down interests).

Where there is a direct value shift that has consequences under Division 725 of the ITAA 1997, the Division generally applies on the basis that the direct value shift is from each of the down interests to each of the up interests: subsection 725-160(3) of the ITAA 1997. An exception applies where a direct value shift is neutral for a particular affected owner. In that case, the consequences under Subdivisions 725-C to 725-F of the ITAA 1997 apply to the affected owner as if the value shift is from that owner's down interests to that owner's up interests: subsection 725-220(2). As the value shift is neutral in this case for X, Subdivisions 725-C to 725-F apply to X as if value is shifted only from X's down interests (the B class shares) to X's up interests (the A class shares).

As X holds both the A class shares and the B class shares only as CGT assets, the consequences of the value shift are worked out under Subdivision 725-D of the ITAA 1997.

The consequences under Subdivision 725-D depend on whether the down interests have a pre-shift gain or a pre-shift loss. In this case, as the market value of each B class share ($2,000) is greater than its cost base ($1,500), each down interest has a pre-shift gain: section 725-210 of the ITAA 1997.

The table in section 725-245 of the ITAA 1997 sets out the circumstances where there is a taxing event generating a gain as a result of a direct value shift. As the direct value shift is neutral for X, the table in section 725-245 applies to X as if the direct value shift only involves a shift in value from X's B class shares to X's A class shares. Item 1 of the table in section 725-245 has been satisfied in relation to a shift in value from X's post-CGT B class shares to X's pre-CGT A class shares. The amount of the gain in relation to that value shift is worked out under section 725-365 of the ITAA 1997.

There is not a taxing event generating a gain for the value shifted from X's post-CGT B class shares to X's post-CGT A class shares, because value is shifted from shares of the same owner that also have the same character; consequently none of the items in the table in section 725-245 of the ITAA 1997 are met.

Had the direct value shift not been neutral for X, the table in section 725-245 of the ITAA 1997 would apply to X as if the direct value shift involved not only a value shift from X's B class shares to its A class shares, but also a value shift from its B class shares to the A class shares held by Y and Z. As a result, item 4 in the table would also be satisfied by X, had the value shift not been neutral. The amount of that gain to X would also have been worked out under section 725-365 of the ITAA 1997.

Because the value shift is neutral for X, in working out the gain under section 725-365 of the ITAA 1997 in relation to the value shifted from X's post-CGT B class shares to X's pre-CGT A class shares, section 725-365 applies as if the direct value shift only involves value shifted from X's B class shares to X's A class shares. This would mean that the only down interests taken into account would be the 400 B class shares owned by X and the only up interests taken into account would be the 10,000 A class shares owned by X.

Accordingly, the amount of a gain for a taxpayer is worked out differently under section 725-365 of the ITAA 1997 where the direct value shift is neutral for that taxpayer.