Capital gains tax: majority underlying interests - transfer of pre-CGT asset

For the purposes of applying section 149-30 of the Income Tax Assessment Act 1997 (ITAA 1997), can a change in the direct ownership of a CGT asset on or after 20 September 1985 result in a change to the ultimate owners who had majority underlying interests in the asset immediately before that date?

No. The ultimate owners of an asset immediately before 20 September 1985 are those who at that time held beneficial interests (directly or indirectly): (i) in the asset; and (ii) in any ordinary income that may be derived from the asset.

Immediately before 20 September 1985, asset P is directly owned by A Co, a wholly owned subsidiary of Hold Co.

In March 2000, A Co transfers the asset to B Co, another wholly owned subsidiary of Hold Co. Subdivision 126-B of the ITAA 1997 roll-over is claimed for the transfer with the effect that the asset is taken to have been acquired by B Co before 20 September 1985.

At all times the shares in Hold Co have equal rights to income and capital, and are owned by two individuals X (as to 40%) and Y (as to 60%).

B Co was incorporated in 1980. Hold Co acquired all of the shares in B Co from the original shareholders of B Co [X (99%) and K (1%)] in 1997.

At all relevant times B Co is not an entity described in subsection 149-50(1) of the ITAA 1997.

Division 149 of the ITAA 1997 determines when a pre-CGT asset will be taken to be acquired after 19 September 1985.

In accordance with section 149-30 of the ITAA 1997, an asset will stop being a pre-CGT asset at the earliest time when majority underlying interests in the asset are not held by ultimate owners who held such interests just before 20 September 1985.

The terms 'ultimate owner' and 'majority underlying interest' are central to the operation of Division 149 of the ITAA 1997. • Ultimate owner is defined in subsection 149-15(3) of the ITAA 1997 to include individuals and companies whose constitutions prevent them from making distributions of any kind to their members. • Majority underlying interests is defined in subsection 149-15(1) of the ITAA 1997 to mean more than 50% of the beneficial interests that ultimate owners have, whether directly or indirectly, in the asset and in any ordinary income that may be derived from the asset.

Subsections 149-15(4) and 149-15(5) of the ITAA 1997 establish when an ultimate owner indirectly has a beneficial interest in the pre-CGT asset of another entity or ordinary income that may be derived from that asset. To have a beneficial interest, the ultimate owner must be entitled to receive for their own benefit any distribution of capital or income if: (a) the other entity were to distribute any of its capital or income; and (b) the capital and income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner.

It is possible for the ultimate owners to alter the way in which they hold their pre-20 September 1985 interest in an asset (or in the income derived from it) without affecting the pre-CGT status of that asset. For example, a new entity could be interposed between the entity that directly owns the asset and the ultimate owners. Or a pre-CGT asset could be transferred to another entity who is taken to have acquired the asset just before 20 September 1985 under a CGT same asset roll-over.

In the latter case, it has been suggested that, for subsequent testing of majority underlying interests, the ultimate owners who indirectly held beneficial interests just before 20 September 1985 are those who would have held such interests if the asset's new owner had made a distribution of income and capital at that time. On the current facts, this approach would mean that, for testing at or after the time when the transfer happens, the pre-20 September 1985 ultimate owners would be X (99%) and K (1%). There would be a failure of the majority underlying interests test.

We do not agree with this approach.

In the absence of express statutory modification (see for example subsection 149-30(3) of the ITAA 1997), the identification of the ultimate owners who held beneficial interests in the asset, and in any income derived from its use, just before 20 September 1985 is not affected by any changes which happen following that time. Subsection 149-30(1) of the ITAA 1997 refers to the majority underlying interests in the asset immediately before 20 September 1985. These are worked out by applying the definitions in section 149-15 of the ITAA 1997 to the facts in existence at that time.

On the facts of this case, majority underlying interests in the asset continue to be maintained. This is because the ultimate owners (X and Y) who held more than 50% of the beneficial interests in the asset, and in any income derived from it, just before 20 September 1985 continue to hold more than 50% of such interests just after the transfer time. As noted above, changes in ownership in B Co that happened before it became the owner of asset P are not relevant. Note: we would adopt the same view in applying Subdivision 149-C of the ITAA 1997.