Issue
Will a foreign resident be taken to have disposed of assets having the necessary connection with Australia under category number 3 in the table in section 136-25 of the Income Tax Assessment Act 1997 (ITAA 1997) if they dispose of all the shares in a foreign resident private company which becomes an Australian resident immediately after the time of the disposal?
Decision
No. The foreign resident will not be taken to have disposed of assets having the necessary connection with Australia under category number 3 in the table in section 136-25 of the ITAA 1997 in these circumstances because the company was not an Australian resident just before the CGT event happened to the shares.
Facts
The taxpayer, who is a foreign resident, owned all the shares in a foreign resident private company. In March 2005, the taxpayer disposed of all the shares in the company to an Australian resident.
As the foreign resident private company had always carried on business in Australia, the acquisition of its shares by the Australian resident had the effect that the company immediately became an Australian resident under the 'voting power' test in the definition of 'resident' in subsection 6(1) of the Income Tax Assessment Act 1936 .
Reasons for Decision
CGT event A1 happens if a taxpayer disposes of a CGT asset: subsection 104-10(1) of the ITAA 1997.
Where a foreign resident taxpayer disposes of shares in a company, the taxpayer will only make a capital gain or capital loss if the shares have the necessary connection with Australia: section 136-10 of the ITAA 1997.
Shares in a private company will have the necessary connection with Australia if category number 3 in the table in section 136-25 of the ITAA 1997 is satisfied.
Category number 3 requires, as one of its tests, that the shares be held in a company that: is an Australian resident...for the income year in which the CGT event happens.
In this case while the foreign resident company became a resident of Australia during the income year in which the CGT event (that is, CGT event A1 in section 104-10 of the ITAA 1997) happened, it did not become an Australian resident until immediately after the CGT event happened.
Generally speaking, CGT assets that do not have the necessary connection with Australia fall outside the scope of the capital gains tax provisions if held by a foreign resident taxpayer. However, if a foreign resident taxpayer becomes an Australian resident, these assets are brought within the scope of the provisions by section 136-40 of the ITAA 1997. At that time, the assets are granted a market value cost base on the basis that gains or losses in respect of those assets accruing prior to the change of residency fall outside the capital gains tax provisions.
Therefore, to give effect to this policy intent, it is considered that shares will have the necessary connection with Australia for the purposes of category number 3 in the table in section 136-25 of the ITAA 1997 only if they are in a company that is an Australian resident just before the CGT event happened.
In this case, when the foreign resident disposed of their shares in the company CGT event A1 happened. Until the event happened, the foreign resident owned all the shares in the company and the company was not an Australian resident for income tax purposes. Therefore, it is considered that the shares would not have had the necessary connection with Australia for the purposes of category number 3 in the table in section 136-25 of the ITAA 1997.