Direct value shifting - exclusions

Will subsection 725-70(1) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to preclude from consequences under Division 725 of the ITAA 1997, the direct value shift that results when the taxpayer is issued shares at a discount to market value in a company that they wholly own?

Yes. Subsection 725-70(1) of the ITAA 1997 will preclude the arrangement from consequences under Division 725 because the sum of the decreases in market value of the existing shares attributable to the direct value shift will be less than $150,000.

The taxpayer purchased an asset (the original asset) before 20 September 1985. The original asset is now valued at approximately $400,000.

The taxpayer plans to sell the original asset to a company that is incorporated by them (Target Co). The consideration for this transfer will be the issue of 400,000 fully paid $1.00 shares to the taxpayer. The only significant asset in Target Co will be the original asset. Target Co has at present 100 existing ordinary shares which have a total market value of $1,000.

There is a direct value shift under section 725-145 of the ITAA 1997 if, as a result of things done under a scheme, there is a decrease in the market value of one of more equity or loan interests in a company (the down interests) and either: • equity or loan interests in the company are issued at a discount (the up interests), or • there is an increase in the market value of one or more equity or loan interests in the company (the up interests).

A direct value shift may result in consequences under Division 725 of the ITAA 1997 which would include a realignment of the value of the equity or loan interests for tax purposes to reflect changes in market value attributable to the direct value shift and, in some cases, a capital gain being generated on the down interests.

A direct value shift will not have consequences under Division 725 of the ITAA 1997 if the sum of the decreases in market value of all the down interests under the same scheme does not exceed $150,000 (subsection 725-70(1)).

Under the arrangement, shares will be issued in Target Co for a consideration of $1 per share to be satisfied by the transfer of the original asset to the company. As a result, the new market value of Target Co will be $401,000 - being the market value of Target Co prior to the transfer of the original asset ($1,000) plus the market value of the asset transferred ($400,000). Effectively the arrangement will result in the shares being issued at a discount to market value as the market value of each share when issued will be $1.0022494 - being the market value of the company ($401,000) divided by the number of shares in Target Co (400,100). The shares will be issued for a total discount of $899.76 - being the total market value of the shares when issued ($400,899.76) less the consideration paid for their issue ($400,000).

The total decrease in market value of the 100 existing shares that is attributable to the direct value shift will be $899.78 - being the total market value of those shares before the value shift ($1,000) less the total market value of those shares after the value shift ($100.22). The total decrease in the market value of the existing shares is less than the threshold of $150,000 in subsection 725-70(1) of the ITAA 1997.

As the total decrease in market value of the existing shares attributable to the direct value shift is less than $150,000, subsection 725-70(1) of the ITAA 1997 will preclude the arrangement from any consequences under the direct value shifting rules in Division 725.