Capital gains tax: direct value shift - active participant in scheme

Is a taxpayer who is issued shares at a discount, in a company of which they are a director, an active participant in the scheme to issue the shares for the purposes of subsection 725-65(2) of the Income Tax Assessment Act 1997 (ITAA 1997), even though the shares were issued at the instigation of the entity that controls the company?

Yes. It is considered that the taxpayer in this case is an active participant in the scheme under subsection 725-65(2) of the ITAA 1997, as the taxpayer had a direct knowledge of the scheme and, as a director of the company, was involved in the decision to issue the additional shares in the company.

A company has two shareholders and two directors. The taxpayer is a shareholder and a director of the company and owns some shares in the company. The other shareholder is also a director of the company and owns the majority of shares in the company. The taxpayer and the majority shareholder are not associates.

In the 2004 income year, the company issued additional shares to the taxpayer at a discount to market value. The additional shares were issued to the taxpayer, as the majority shareholder wished to take a less active role in the company and wanted to encourage the taxpayer to take a more active role in the management of the company. The taxpayer had knowledge of this scheme and as a director of the company was involved in the decision to issue the additional shares in the company.

As a result of the issue of additional shares, a direct value shift within the meaning of the term in section 725-145 of the ITAA 1997 happened.

The sum of the decreases in market value of all the down interests because of the direct value shift is more than $150,000.

An entity will be an active participant in a scheme under subsection 725-65(2) of the ITAA 1997 if: • at some time while the scheme was being carried out, the target entity had less than 300 members, if a company, or less than 300 beneficiaries if a trust • the entity actively participated in, or directly facilitated, the entering into or carrying out of the scheme, and • the entity owned either a down interest or an up interest in the target entity or had an up interest issued to it at a discount in the target entity.

As the company in this case had only two shareholders and the taxpayer had an up interest issued to it at a discount, the taxpayer will be an active participant in the scheme if it actively participated in, or directly facilitated, the entering into or carrying out of the scheme.

The Explanatory Memorandum (the EM) to the Bill which became the New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Act 2002 provides guidance on the circumstances where an entity is considered to have actively participated in, or directly facilitated, the entering into or carrying out of a scheme. Paragraphs 11.124 and 11.125 of the EM provide: 11.124 Generally the existence of a common purpose or agreement between the parties to a scheme will result in the active participation test being satisfied. However, this is not a prerequisite. 11.125 Typically, actions such as voting for a value shift proposal, or arranging for economic benefits to be provided under a scheme, will be actions that amount to active participation in the scheme. These are actions that promote the performance of the scheme.

In this case, the additional shares in the company have been issued as part of a plan for the majority shareholder to take a less active role in the company, and to encourage the taxpayer to take a more active role in the management of the company. The taxpayer had knowledge of the scheme and the reasons why it was undertaken. As a director of the company, the taxpayer was involved in the decision to issue more shares in the company. For these reasons, it is considered that the taxpayer is an active participant in the scheme.