1 Will any gain on the disposal of the shares in Company B be included as assessable income of Company A under subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?
No. Question 2 Will any capital gain on disposal of the shares in Company B be disregarded by Company A under subsection 855-10(1) of the ITAA 1997? Answer Yes. This ruling applies for the following period : Year Ending 30 June 20XX The scheme commenced on: 1 July 20XX
Company A 1. Company A is the direct holding company for Company B. Its principal activity is to act as the holding company of Company B. 2. Company A is incorporated in Country A and is a resident of Country A for purposes. Company A is not an Australian tax resident. 3. The central management and control of Company A is not located in Australia. 4. Company A does not carry on business in Australia through a permanent establishment situated in Australia. 5. Company A was established to hold ABC Group via its shares in Company B. 6. All the shares in Company A were acquired by Global Co in 20XX, to effect the acquisition of ABC Group. Company B Company B is a tax resident of Australia for Australian tax purposes. Company B was established as a wholly owned subsidiary of Company A to acquire the ABC Group from an unrelated entity in 20XX. Company B is the head company of the ABC Group's Australian income tax consolidated group (TCG) and the global head company of the ABC Group. Company B directly or indirectly owns all the shares of the ABC Group subsidiary entities. The ABC Group has operations in Australia and multiple other countries.
The primary business operations of the ABC Group include the development and production of solutions to service its customers. 12. Company B's main assets consist of the shares in the ABC Group subsidiary entities. The ABC Group does not own any land or buildings in Australia. However, it does lease Australian premises. The ABC Group's assets include: i. Cash and cash equivalents ii. Inventories iii. Prepayments iv. Receivables v. Property, plant and equipment. vi. Intangible assets. A market value calculation (the Valuation) of Company A's assets that were taxable Australian real property (TARP) for the purposes of section 855-30 of the ITAA 1997, was less than 50% of the book value of all of its assets. Global Co 14. Global Co is a global group headquartered in Country B and is listed on the stock exchange in Country B. 15. Global Co has global operations carried on through legal entities in a number of jurisdictions, including Australia. It has a preference to establish a dedicated local holding company. 16. The Australian subsidiaries of Global Co are part of an Australian income TCG.
17. Global Co undertakes all of its Australian operations through its Australian entities and not at or through a permanent establishment of non-Australian Global Co companies. 18. The primary business operations of the Global Co group include the development and production of equipment, applications and digital solutions to service its customers. 19. Global Co's business strategy is to accelerate growth by making acquisitions of existing businesses. Global Co's business strategy does not include the acquisition of shares in companies with the intention of selling those shares in a relatively short period of time to derive a profit or a gain. The acquisition 20. A subsidiary entity of Global Co acquired the shares in Company A to effect the acquisition of the ABC Group. 21. The subsidiary is an entity in Country B for both legal and tax purposes. 22. Global Co acquired the ABC Group as a bolt-on acquisition to bolster its existing offerings and for long term investment and capital growth. The restructure 23. Global Co is proposing to undertake an internal restructure of the ABC Group entities post-acquisition to achieve the following:
i. Minimise the number of holding companies in the Global Co. ii. Rationalise dormant entities - This would involve the deregistration/liquidation of certain ABC Group entities in Australia, and other entities. Company A would also be deregistered/liquidated as it would no longer be required as a holding company post-restructure. iii. Alignment of ABC Group entities with existing Global Co entities in relevant jurisdictions within the global group. iv. Streamline and simplify reporting requirements and tax compliance obligations. 24. The Company B shares will be transferred from Company A to a subsidiary of Global Co. 25. The transfer of Company B shares will be for fair market value consideration. 26. As a result, Company B and its wholly owned subsidiary companies will join the Global Co Australian income TCG. 27. The contract for the transfer of the shares in Company B by Company A to Global Co will be negotiated and concluded outside of Australia.
28. The restructure is solely related to the acquisition of the ABC Group by Global Co and is not part of a broader Global Co group restructure. Neither will it involve the disposal of ABC Group entities or assets to any third parties. 29. The restructure is expected to occur sometime in the calendar year 20XX.
Income Tax Assessment Act 1997 Section 6-5 Income Tax Assessment Act 1997 Section 855-10
Question 1 Will any gain on the disposal of the shares in Company B be included as assessable income of Company A under subsection 6-5(3) of the ITAA 1997? Summary Any profits or gains arising to Company A in respect of its disposal of the shares in Company B will not be included as assessable income of Company A under subsection 6-5(3) of the ITAA 1997. Detailed reasoning Subsection 6-5(3) of the ITAA 1997 states: If you are a foreign resident, your assessable income includes: (a) The *ordinary income you *derived directly or indirectly from all *Australian sources during the income year; and (b) Other *ordinary income that a provision includes in your assessable income for the income year on some basis other than having an *Australian source. If, on an assessment of all the facts, the disposal of the investment is a normal operation in the course of carrying on a business of investment, any gain will be income according to ordinary concepts ( London Australia Investment Co Ltd v. Federal Commissioner of Taxation
(1977) 138 CLR 106; 77 ATC 4398; (1977) 7 ATR 757). Where income is determined to be Australian sourced ordinary income, any gain will prima facie be assessable income under subsection 6-5(3) of the ITAA 1997. However, this is subject to any limitations imposed on Australia's right to tax that income by any double tax agreements (DTAs). Consideration is first given below to whether the disposal of shares in Company B by Company A is ordinary income and therefore, any gain is made on revenue account. Income tax characterisation The decision in Commissioner of Taxation (Cth) v The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693( Myer Emporium ) provides guidance in determining when profits from a disposal of an asset will be on revenue account and assessable as ordinary income under section 6-5 of the ITAA 1997. Myer Emporium at ATC 4366 and ATC 4367 states:
Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a "one-off" transaction preclude it from being properly characterized as income (
F.C. of T. v. Whitfords Beach Pty. Ltd. 82 ATC 4031 at pp. 4036-4037, 4042; (1982) 150 C.L.R. 355 at pp. 366-367, 376). The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. In TR 92/3 the Commissioner provides guidance in relation to transactions with a profit-making purpose at paragraph 15 and 16, which state: 15. If a taxpayer carrying on a business makes a profit from a transaction or operation, that profit is income if the transaction or operation:
(a) is in the ordinary course of the taxpayer's business (see paragraph 32 for an explanation of the circumstances in which a transaction is in the ordinary course of business) - provided that any gross receipt from the transaction or operation is not income; or (b) is in the course of the taxpayer's business, although not within the ordinary course of that business, and the taxpayer entered the transaction or operation with the intention or purpose of making a profit; or (c) is not in the course of the taxpayer's business, but (i) the intention or purpose of the taxpayer in entering into the transaction or operation was to make a profit or gain; and (ii) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. 16. If a taxpayer not carrying on a business makes a profit, that profit is income if: (a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and (b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.
In the present circumstances, determining if a gain from the disposal of Company B shares will be held on revenue account requires consideration of whether the gain is in the ordinary course business or an isolated business transaction. Profits or gains in the ordinary course of business The Commissioner considers that there are two types of profits or gains made in the ordinary course of carrying on a business. At paragraph 32 of TR 92/3 the Commissioner states: 32. It is not completely clear what the High Court meant in referring to 'profits or gains made in the ordinary course of carrying on a business'. However, we consider that there are two types of profits or gains which come within that description, namely: (i) a profit or gain arising from a transaction which is itself a part of the ordinary business of a taxpayer (judged by reference to the transactions in which the taxpayer usually engages) - provided that the gross receipts from the transaction lack the character of income ( Commercial and General Acceptance Ltd v. FC of T (1977) 137 CLR 373 at 381; 77 ATC 4375 at 4380; 7 ATR 716 at 722); and
(ii) a profit or gain arising from a transaction which is an ordinary incident of the business activity of the taxpayer, although not a transaction entered into directly in its main business activity e.g. profits of insurance companies and banks on the sale of investments are generally income ( Chamber of Manufactures Insurance Ltd v. FC of T (1984) 2 FCR 455; 84 ATC 4315; 15 ATR 599 and C of T v. Commercial Banking Co. of Sydney (1927) 27 SR(NSW) 231). (Support for this view is found in the judgment of Hill J in Westfield Ltd v. FC of T 91 ATC 4234; (1991) 21 ATR 1398.)
Company A was established in 20XX as the holding company for the ABC Group via its shares in Company B., The ABC Group was acquired by Global Co via the acquisition of the shares in Company A, and Company A remains the holding company for the ABC Group. Prima facie, as a holding company the ordinary business of Company A is to hold the shares in Company B. However, from a broader perspective, Company A is a wholly owned subsidiary of Global Co and forms part of its global business activities. Moreover, Company A does not perform any business activities, operations or functions outside of being the direct holding company for Company B. Therefore, Company A's ordinary business should be construed with reference to Global Co's ordinary business activities rather than considering solely Company A's current activities or activities prior to Global Co's acquisition of Company A.
Global Co is a global group listed on the stock exchange in Country B. The primary business operations of the Global Co group include the development and production of equipment, applications and digital solutions to service its customers. Global Co's business also includes the strategic acquisition of existing businesses to accelerate growth. The Commissioner considers that any profit or gain from Company A's disposal of shares in Company B are not made in the ordinary course of carrying on a business. This is because: Global Co acquired the ABC Group as a bolt-on acquisition to grow and enhance its profit-making structure through expanding the products and services offered to customers in line with its existing business strategy to accelerate growth. Global Co's and Company B's ordinary business activities both include the development and production of equipment, applications and digital solutions. Global Co expects to earn dividend income from the ordinary business activities of the ABC Group.
Global Co's business strategy does not include an objective to acquire the shares in companies and subsequently sell those shares within a short period of time with the purpose of deriving a profit or a gain. The holding structure of the ABC Group with Company A as the holding company for Company B was established prior to Global Co's acquisition of the business. The disposal of Company B shares by Company A does not represent the buying and selling of the ABC Group business for a profit, rather the disposal is to effect an internal restructure which brings the ABC Group into the existing Global Co holding structure in Australia and globally. Profits or gains from an isolated transaction Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( Myer Emporium ). TR 92/3 provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income.
Pursuant to paragraph 1 of TR 92/3, the term 'isolated transactions' in refers to: (a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and (b) those transactions entered into by non-business taxpayers. Paragraph 6 of TR 92/3 states: 6. Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, a profit from an isolated transaction is generally income when both of the following elements are present: (a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and (b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. In the course of carrying on a business In respect of whether a transaction is entered into in the course of carrying on a business, paragraph 45 of TR 92/3 states:
45. The transaction may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business. As the Full High Court said in Myer at 163 CLR 215; 82 ATC 4370; 18 ATR 701: 'If the profits be made in the course of carrying on a business that in itself is a fact of telling significance. It does not detract from its significance that the particular transaction is unusual or extraordinary, judged by reference to the transactions in which the taxpayer usually engages, if it be entered into in the course of carrying on the taxpayer's business.' As discussed above, Company A is the holding company for Company B and was acquired by Global Co when it acquired ABC Group. However, as Company A's purpose is to act principally as the holding company for Company B, whether the disposal of Company A shares is entered into in the course of carrying on a business should be considered with reference to Global Co.
Global Co is carrying on a business which includes the development and production of equipment, applications and digital solutions to service its customers. Global Co's business also includes the strategic acquisition of existing businesses to accelerate growth. Whilst an internal restructure, which includes the disposal of the Company B shares by Company A is an unusual or extraordinary transaction when considering Global Co's ordinary business, the restructure is still undertaken by Global Co in the course of carrying on its business. Intention or purpose Paragraphs 7 and 9 of TR 92/3 provide further guidance in respect of the phrase 'intention or purpose' stating: 7. The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. ...
9. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. When considering intention or purpose, paragraph 39 of TR 92/3 outlines, in line with FC of T v. Whitfords Beach Pty Ltd (H.C.) (1982) 150 CLR 355; 82 ATC 4031; 12 ATR 692 ( Whitfords Beach ), that if the taxpayer is a company, the purposes of those who control it are its purposes. Whitfords Beach at ATC 4039 states: In the present case I gravely doubt whether the profits resulting from the development, subdivision and sale of the land would have been taxable if it had not been for the events that occurred on 20th December 1967. Had those events not occurred, the situation of the taxpayer would have been analogous to that of the company in Scottish Australian Mining Co. Ltd. v. F.C. of T
. However, on 20th December 1967, the taxpayer was transformed from a company which held land for the domestic purposes of its shareholders to a company whose purpose was to engage in a commercial venture with a view to profit. Counsel for the taxpayer submitted that it was not permissible to blur the distinction between the company and its shareholders. That of course is true, but in deciding whether what was done was an operation of business, it is relevant to consider the purpose with which the taxpayer acted, and, since the taxpayer is a company, the purposes of those who control it are its purposes. In Ruhamah Property Co. Ltd. v. F.C. of T. the majority of the Court regarded as important, if not decisive, the purposes with which the shareholders and directors of the company acted, although Isaacs J., who dissented, thought it erroneous to consider a company merely as machinery for carrying out individual purposes: see at pp. 160, 162 and 166. However, in my opinion Isaacs J. took too rigid a view of the effect of Salomon v. Salomon & Co.
(1897) A.C. 22 if he thought that in determining the purpose with which a company acted it was not permissible to have regard to the intentions of the directors who controlled it. In the present case, the three companies which became the shareholders, or the two which became the managers (it matters not which), represented the directing mind and will of the taxpayer and controlled what it did, and their state of mind was the state of mind of the taxpayer... Moreover, paragraph 42 of TR 92/3 provides examples where a purpose that does not include profit making at the time of acquiring a property may not exclude a conclusion that a transaction has a profit-making intention or purpose. Paragraph 45 of TR 92/3 states: 42. For example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either: (a) as the capital of a business; or (b) into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction,
the activity of the taxpayer constitutes the carrying on of a business or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset. It is also relevant that the profit need not be obtained by a means specifically contemplated at the time when the taxpayer initially entered into the transaction. Rather, it is sufficient that the taxpayer enters into the transaction with the purpose of making a profit in the most advantageous way and that a profit is later obtained by any means which implements the initial profit-making purpose. It is also sufficient if a taxpayer enters into the transaction with the purpose of making a profit by one particular means but actually obtains the profit by a different means (paragraph 14 of TR 92/3). Whether there must be a purpose of profit-making by the very means by which the profit was in fact made is considered in more detail at paragraphs 51 to 58 of TR 92/3. Specifically, at paragraphs 56 and 57 of TR 92/3, the Commissioner states:
56. In our view a profit made in either of the following situations is income: (a) a taxpayer acquires property with a purpose of making a profit by which ever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose ( Steinberg ; Premier Automatic Ticket Issuers Ltd v. FC of T (1933) 50 CLR 268 at 300; Myer , especially at 163 CLR 211; 87 ATC 4367; 18 ATR 698); or (b) a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit. 57. We also consider that an assessable profit arises if a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means. Thus, a taxpayer may contemplate making a profit by sale but may ultimately obtain it by other means (such as compulsory acquisition, through a company liquidation or a distribution in specie) that were not originally contemplated.
However, profit that arises from a transaction not specifically intended at the time of acquiring an investment is not always found to be an isolated transaction where profits or gains are ordinary income. This is evidenced in Example 6 of TR 92/3 which states: Example 6 83. Conglomerate Ltd, a large public company, made a takeover bid for Awful Ltd, the owner of lands containing a large mineral deposit. Conglomerate intended to obtain control of Awful and expedite the mining of the deposit. The takeover bid was unsuccessful and Awful did not commence mining operations. Conglomerate held its Awful shares for about 2 years before selling the shares at a profit. 84. Assuming that the unsuccessful takeover bid was not made in the ordinary course of Conglomerate's business, the profit on the sale of the shares is not income. The evidence shows that Conglomerate acquired the shares to obtain control of Awful and derive dividends generated by mining activities of that company, not to make a profit from the sale of the shares. This can be contrasted to Example 5 of TR 92/3 which outlines an example where multiple methods of profit were contemplated as follows: Example 5
80. Hungry Ltd, a public company, made a takeover bid for another public company, Morsel Ltd, in which it already held a 15% interest. Shortly after, Ravenous Ltd also made a takeover bid for Morsel. Ravenous' takeover bid was successful and Hungry's failed. Hungry sold to Ravenous the shares it had acquired in Morsel at a large profit. 81. Hungry was a holding company in a group of companies. Many of the entities in the company group had previously been involved in takeovers of other companies. Hungry had not previously been involved in a takeover attempt and had only disposed of shares in the course of restructuring the company group. From the time Hungry began to acquire shares in Morsel the directors of Hungry had hoped to acquire control of Morsel - they were not interested in a 'passive investment'. The contingency plan of the directors in the event that control could not be obtained was to dispose of the shares in Morsel at a profit.
82. The profit on the sale of the shares is income. A substantial, but not dominant, purpose of Hungry in acquiring the shares was to dispose of them at a profit because the contingency plan was to dispose of the shares at a profit. Furthermore, the acquisition and sale of the shares was effected in the course of the taxpayer's business. Additionally, whilst not applicable to Company A's circumstances, Taxation Determination TD 2010/21 Income tax: can the profit on the sale of shares in a company group acquired in a leveraged buyout be included in the assessable income of the vendor under subsection 6-5(3) of the Income Tax Assessment Act 1997? (TD 2010/21) outlines that the profit from the disposal of shares in a company group acquired in a leveraged buyout (LBO) may be included in the assessable income of the vendor under subsection 6-5(3) of the ITAA 1997. Relevantly, Example 2 of TD 2010/21 provides an example where profits from an isolated transaction do not constitute ordinary income as follows: Example 2
7. An off-shore pooled investment trust mainly comprising investors that are non-resident superannuation and pension funds acquired a controlling interest in an Australian entity that holds large scale infrastructure assets through an on-market acquisition. The trust is open-ended and is not required to return funds to investors within a particular or indicative timeframe. The manager of the trust, whilst having sufficient controlling interest, does not directly participate in the management of the Australian entity but encourages the acquired entity to act independently to maximize long-term returns and value by making operational improvements. There was no pre-conceived plan to dispose of the controlling interest at a profit at the time of acquiring the interest. Due to changing financial circumstances arising from the need to fund the retirement of non-residents from the trust and adjust to increases in the cost of capital arising from the global financial crisis, the trust decides to dispose of its interests in the Australian entity. In these circumstances the profit would constitute a capital receipt rather than income according to ordinary concepts and would not be assessable under section 6-5.
Prima facie, in applying the above principles to Company A's circumstances, Company A's purpose or intention at the time it acquired the shares in Company B is an important factor in determining whether the disposal of its shares is undertaken with a profit-making purpose or intention. However, consistent with earlier considerations, the Commissioner considers that the purpose or intention of Company A should be determined with reference to Global Co rather than solely Company A. This is because: It is not always the case that the purpose or intention at the time of acquiring property, determines whether a transaction is undertaken with a profit-making purpose or intention (paragraph 9 of TR 92/3). As Company A is a company, the purposes of those who control it are its purposes (paragraph 39 of TR 92/3).
Global Co's purpose or intention in relation to the shares in Company B is evidenced by its intentions at the time it acquired the ABC Group via its acquisition of the shares in Company A. Global Co acquired the ABC Group as a bolt-on acquisition to grow and enhance its profit-making structure through expanding the products and services offered to customers in line with its existing business strategy to accelerate growth. Global Co expects to earn dividend income from the ordinary business activities of the ABC Group. Whilst at the time of acquiring the ABC Group, Global Co did have a purpose or intention of profit making, this intention was to make profit from the ordinary business activities of the ABC Group and a sale of the shares in Company B for a profit was not contemplated. The disposal of the shares in Company B is not a disposal entered into with a profit-making purpose and can be distinguished from an isolated transaction that is entered into with a profit-making purpose or intention within the meaning outlined by TR 92/3 for the following reasons:
• The disposal of Company B shares by Company A does not represent the buying and selling of the ABC Group business for a profit, rather the disposal is to effect an internal restructure which brings the ABC Group into the existing Global Co holding structure in Australia and globally. • Global Co's intention when acquiring the ABC Group and following the internal restructure remains to make a profit from the ABC Group's ordinary business activities. • Global Co's business strategy does not include an intention to acquire the shares in companies with the further objective of selling those shares in a relatively short period of time to derive a profit or a gain. Country A Convention As discussed above, Australia's taxing rights under section 6-5 of the ITAA 1997 are subject to any applicable DTAs.
Company A is incorporated in Country A and is a tax resident of Country A for Country A tax purposes. Therefore, the Country A Convention will apply to Company A. However, as it has been established that Company A did not have a profit-making intention or purpose in relation the disposal of Company B shares, any gain is not ordinarily income under subsection 6-5(3) of the ITAA 1997. Accordingly, the application of the Country A Convention to any gain as ordinary income is not considered further. Conclusion Accordingly, any profits or gains from Company A's disposal of its shares in Company B are not considered to be made in the ordinary course of carrying on a business, or profits arising from an isolated business or commercial transaction where the purpose or intention in entering into the transaction was to make a profit. Therefore, any profits or gains arising to Company A in respect of the sale of its shares in Company B will not be on revenue account or Australian sourced ordinary income for the purposes of subsection 6-5(3) of the ITAA 1997. Question 2
Will any capital gain on disposal of the shares in Company B be disregarded by Company A under subsection 855-10(1) of the ITAA 1997? Summary Any capital gains arising to Company A in respect of its disposal of shares in Company B will be disregarded under subsection 855-10(1) of the ITAA 1997. Detailed reasoning Subsection 855-10(1) of the ITAA 1997 provides that a foreign resident can disregard a capital gain or capital loss arising from a capital gains tax (CGT) event, provided that the CGT event happens in relation to a CGT asset that is not 'taxable Australian property'. Section 108-5 of the ITAA 1997 provides the meaning of a CGT asset to include any kind of property, including shares in a company. Company A's interest in Company B shares are CGT assets. Section 100-20 of the ITAA 1997 provides: (1) You can make a capital gain or loss only if a CGT event happens. Subsection 104-10(1) of the ITAA 1997 provides: CGT event A1 happens if you * dispose of a * CGT asset. Taxable Australian Property There are five categories of CGT assets that are taxable Australian property. The categories are set out in the table in section 855-15 of the ITAA 1997 as follows:
Table 1: There are 5 categories of CGT assets that are taxable Australian property. The categories are set out in the table in section 855-15 of the ITAA 1997 as follows: Item Description 1 Taxable Australian real property (see section 855-20) 2 A CGT asset that: (a) is an indirect Australian real property interest (see section 855-25); and (b) is not covered by item 5 of this table 3 A CGT asset that: (a) you have used at any time in carrying on a business through: (i) if you are a resident in a country that has entered into an international tax agreement with Australia containing a permanent establishment article--a permanent establishment (within the meaning of the relevant international tax agreement) in Australia; or (ii) otherwise--a permanent establishment in Australia; and (b) is not covered by item 1, 2 or 5 of this table 4 An option or right to acquire a CGT asset covered by item 1, 2 or 3 of this table 5 A CGT asset that is covered by subsection 104-165(3) (choosing to disregard a gain or loss on ceasing to be an Australian resident).
In relation to Company A's disposal of their interest in the shares of Company B, Items 1, 3, 4 and 5 contained in section 855-15 of the ITAA 1997 are not considered in more detail as: the shares do not represent a direct interest in TARP (Item 1). the shares are not used in carrying on a business through a permanent establishment in Australia (Item 3). the shares do not represent an option or right to acquire a CGT asset (Item 4), and section 104-165(3) of the ITAA 1997 only applies to individuals who choose to disregard a gain covered by CGT event I1 (Item 5). Consequently, Item 2 contained in section 855-15 of the ITAA 1997 are considered in detail below. Item 2 - Indirect Australian real property interest Subsection 855-25(1) of the ITAA 1997 broadly provides that an indirect Australian real property interest will exist if the membership interest held passes: the non-portfolio interest test (per section 960-195 of the ITAA 1997), and the principal asset test (per section 855-30 of the ITAA 1997). Non-portfolio interest test Section 960-195 of the ITAA 1997 explains that the non-portfolio interest test will be passed where:
An interest held by an entity (the holding entity) in another entity (the test entity) passes the non-portfolio interest test at a time if the sum of the direct participation interests held by the holding entity and its associates in the test entity at that time is 10% or more. Direct participation interest is defined in section 960-190 of the ITAA 1997 as the direct control interest that the first entity holds in the other entity. Section 350 of the ITAA 1936 provides that a direct control interest includes the percentage an entity holds in another entity of the total paid-up share capital or the total rights of shareholders to vote. In these circumstances, Company A (the holding entity) holds 100% of the share capital in Company B (the test entity). This means that Company A's direct participation interest is 100%. As Company A has a direct participation interest of greater than 10% in Company B the non-portfolio interest test is satisfied. Principal Asset Test Relevantly, subsections 855-30(2), 855-30(3) and 855-30(4) of the ITAA 1997 provide:
(2) A *membership interest held by an entity (the holding entity) in another entity (the test entity) passes the principal asset test if the sum of the *market values of the test entity's assets that are *taxable Australian real property exceeds the sum of the *market values of its assets that are not taxable Australian real property. (3) For the purposes of subsection (2), treat an asset of an entity (the first entity ) that is a *membership interest in another entity (the other entity ) as if it were instead the following 2 assets: (a) an asset that is *taxable Australian real property (the TARP asset ); (b) an asset that is not taxable Australian real property (the non-TARP asset ) (4) For the purposes of subsection (2), treat the *market value of the TARP asset and the non-TARP asset according to the following table. Table 2: For the purposes of subsection (2), treat the *market value of the TARP asset and the non-TARP asset according to the following table: Market value of the TARP asset and the non-TARP asset Item If: the market value of the TARP asset is: the market value of the non-TARP asset is: 1
(a) the first entity's *direct participation interest in the other entity is less than 10%; or (b) the holding entity's *total participation interest in the other entity is less than 10% zero the *market value of the *membership interest mentioned in subsection (3) 2 item 1 does not apply the product of: (a) the sum of the *market values of all the assets of the other entity that are *taxable Australian real property; and (b) the first entity's *direct participation interest in the other entity the product of: (a) the sum of the market values of all the assets of the other entity that are not taxable Australian real property; and (b) the first entity's direct participation interest in the other entity Note 1: For the purposes of item 2 of the table, it is necessary to work out the market value of any TARP assets and non-TARP assets in relation to any membership interests held by the other entity before working out the value of the TARP asset and non-TARP asset held by the first entity. Note 2:
The market value of an asset of the other entity that is not taxable Australian real property, and is duplicated within the other entity's corporate group, could be disregarded (see section 855-32). TARP TARP is defined in section 855-20 of the ITAA 1997 as: (a) real property situated in Australia (including a lease of land, if the land is situated in Australia); (b) a mining, quarrying or prospecting right (to the extent that the right is not real property), if the minerals, petroleum or quarry materials are situated in Australia. 'Real property' is not defined in the ITAA 1997. The Explanatory Memorandum to the Tax Law Amendment (2006 Measures No.4) Act 2006 ( the EM ) , which introduced Division 855, provides: Taxable Australian real property generally refers to real property, within the ordinary meaning of that term, that is situated in Australia. ... The Macquarie Dictionary online defines 'real property' as follows: ...tangible and immovable property such as land and houses, buildings or any such structures on the land, and any rights attached to the ownership of the land, such as mineral rights (but excluding leasehold interests). Additionally, the EM states:
Where an Australian tax treaty applies to a foreign resident in relation to a CGT event, in accordance with existing practice, the definition of real property should be read in conjunction with the definition as stated in the treaty. This outcome results from the application of section 4 of the International Tax Agreements Act 1953. Accordingly, the Country A Convention is considered below. Relevantly, under the Country A Convention the term 'real property' includes a lease of land or any other interest in or over land. The ABC Group does not own any land or buildings in Australia. However, it does lease Australian premises. The ABC group also has property, plant and equipment assets in Australia which are used as part of its normal business operations. The principal asset test is not satisfied The Valuation of Company B's assets that were TARP for the purposes of section 855-30 of the ITAA 1997, was less than 50% of the book value of all of its assets. Therefore, according to the Valuation, the market value of Company B's TARP assets was less than 50% of the market value of Company B's non-TARP assets. The TARP value equates to approximately 3% of the total asset value.
As a consequence, the principal asset test contained in section 855-30 of the ITAA 1997 is not passed and Item 2 of section 855-15 of the ITAA 1997 will not apply to limit the application of Division 855 in respect of the sale of shares in Company B by Company A. Conclusion Based on the reasons above, section 855-15 of the ITAA 1997 does not apply to limit the application of Division 855 of the ITAA 1997. Accordingly, as Company A is a foreign resident, Division 855 of the ITAA 1997 will apply to disregard the gain or loss made by Company A in relation to the disposal of its shares in Company B.