Issue
If an individual who owns shares in a private company becomes a resident of Australia, and as a consequence the private company becomes a resident, will the shares have the necessary connection with Australia under section 136-25 of the Income Tax Assessment Act 1997 (ITAA 1997) just before that time, such that the exception in paragraph 136-40(1)(a) of the ITAA 1997 applies?
Decision
No. If an individual who owns shares in a private company becomes a resident of Australia, and as a consequence the private company becomes a resident, the shares will not have the necessary connection with Australia under section 136-25 of the ITAA 1997 just before that time.
Facts
An individual taxpayer was a non-resident. A private company which they controlled was also a non-resident although it carried on a business in Australia.
The taxpayer became an Australian resident after 20 September 1985. As a result of the taxpayer becoming a resident, the private company also became a resident because its voting power was now controlled by an Australian resident.
Reasons for Decision
As a general rule, you acquire a CGT asset when you become its owner (section 109-5 of the ITAA 1997).
However, more specific provisions in section 136-40 of the ITAA 1997 apply in respect of assets that do not have the necessary connection with Australia, are acquired on or after 20 September 1985, and are owned by a non-resident just before that person becomes a resident of Australia.
The special acquisition rule in section 136-40 of the ITAA 1997 treats the non-resident taxpayer as having acquired the assets at the time they become a resident of Australia, at market value (subsection 136-40(2)). This is because, generally speaking, gains in respect of those assets accruing prior to the change of residency fall outside the Australian capital gains tax provisions
However, paragraph 136-40(1)(a) of the ITAA 1997 excepts from this acquisition rule any CGT assets having the necessary connection with Australia just before that time. This is because, generally speaking, these assets are already within the ambit of the Australian capital gains tax provisions, and already have an acquisition date and cost base.
Shares in a private company have the necessary connection with Australia if they are '... in a company which is an Australian resident ... for the income year in which the CGT event happens ' (section 136-25 category 3 of the ITAA 1997). Even though these highlighted words may fit neatly when reference is made to section 136-25 in determining the correct outcome in respect of a CGT event, they are incongruous when reference is made to that section in determining the correct outcome in respect of the potential operation of paragraph 136-40(1)(a) of the ITAA 1997 (because there is no CGT event).
To give effect to the policy intent within section 136-40 of the ITAA 1997, it is necessary to simply disregard the final words highlighted above when considering section 136-25 category 3 of the ITAA 1997 in the context of paragraph 136-40(1)(a).
Just before the individual's change of residency the company was not an Australian resident. As such, and pursuant to the preferred reading of section 136-25 category 3 of the ITAA 1997, the individual's shares did not have the necessary connection with Australia at that time.