1 Is the interest in Property A (the Asset) owned by the Company a pre-CGT asset on the basis that it meets the requirements under section 149-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?
1 Yes Question 2 To the extent any part of the interests owned by the Company in other properties is not treated as a separate asset pursuant to the operation of Subdivision 108-D of the ITAA 1997, are those interests pre-CGT assets on the basis that they meet the requirements under section 149-10 of the ITAA 1997? Answer 2 Yes This ruling applies for the following periods : Year ending 30 June 20XX Year ending 30 June 20XX Year ending 30 June 20XX
The Company was registered in Australia by Person A in the 19XXs. Since incorporation, the directors of the Company have been members of the G family, specifically Person A and their spouse Person B, and then on the passing of Person A, their children X and Y. At all relevant times, the Company has carried out real estate investment activities for the benefit of its shareholders. Relevantly, the Company holds a X% interest in several real estate properties via a Partnership. The Partnership comprises X companies, each of which holds a X% interest in the Partnership. The Partnership holds X real estate properties in metropolitan Melbourne ( the Properties ), each held as a passive investment from which rental income is derived. All Properties were acquired in the 19XXs. There have been no significant capital improvements which have been made to the Properties since their acquisition, except for renovation works to one property (not Property A) for an approximate cost of $XX, nor have any additional buildings been built on the Properties since their acquisition. There are no current plans to develop or otherwise significantly improve any of the Properties.
As of the date of this ruling, the Company is contemplating the sale of the Asset (i.e. its X% interest in Property A). It is envisaged that the Company will realise a capital gain in relation to a CGT event A1 on the disposal of the Asset. Shareholding history of the company Immediately prior to 20 September 1985, the shareholding of the Company was: • X ordinary shares (spread across classes A, B, C and D) held by Person A and Person B (in different proportions); and • 2 Z class redeemable preference shares held by the trustee for the Family Trust. No new shares have been issued in the Company on or after 20 September 1985. The Articles of Association of the Company contain the following relevant provisions in relation to share classes: 7. The Directors may at any time and from time to time issue any of the unissued shares as Ordinary shares or as Preference Shares and the Ordinary shares and the Preference shares shall be issued as one of the following classes. ....
8. (a) The holders of Ordinary shares of any one of such classes referred to in Article 7 herein shall be entitled to such dividend, to be distributed pro rata amongst the holders of the shares of that class, according to the amount of capital paid up on their shares as the Directors may from time to time declare in respect of such class, and shall have no further or other right to dividends. The Directors may declare such a dividend in respect of any one of such classes of Ordinary shares without declaring a dividend of like amount or any dividend in respect of any other Ordinary Shares, and to the extent such dividends are so declared they shall not require to be distributed pro rata according to the amount of capital paid up on all ordinary shares. (b) The holder of Preference shares of any one of such classes as referred to in Article 7 herein shall in addition to this right to receive dividends in respect of such shares be entitled during their lifetime to receive such additional dividends as the Directors may from time to time declare in respect thereof and their right to receive such additional dividends shall be limited to their lifetime.
9. Subject to the provisions of the act with respect to the consent of the shareholders affected, and without prejudice to any special rights previously conferred on the holders of existing shares, any share may be issued with such preferred, deferred or other special rights, or such restrictions, whether in regard to dividend, voting, return of share capital or other matter, as the Directors may from time to time determine. .... 127. (a) If the Company is wound up whether voluntarily or otherwise the liquidator may with the sanction of [a] special resolution divide among the members in specie or kind all or any part of the assets of the Company in trustees upon such trusts for the benefit of the members or any of them as the liquidator with the like sanction shall think fit. (b) If thought expedient any such division may otherwise than in accordance with the legal rights of the members of the Company and in particular any class may be given preferential or special rights or may be excluded altogether or in part. A special resolution was passed a few years later to amend the Articles of Association of the Company to include the following:
• The allocation of Z class redeemable preference shares at $X each. • The holders of Z class redeemable preference shares shall have the non-cumulative right to receive such dividend (if any) as the directors may from time to time think fit. • Upon the winding up of the Company, holders of Z class redeemable preference shares shall have the right to have the capital of the Company applied first in paying off the capital paid-up on those shares but shall not be entitled to participate in any surplus. No other shares issued in the Company have been issued with preferred, deferred or other special rights or restrictions (per article 9 of the Company's Articles of Association). Since 20 September 1985, transfers of shares in the Company are as follows: Table 1: share changes Transfer Date Details 198N Share Changes Following Person A's death, their shares were transferred to Person B pursuant to their will. 199M Share Changes Transfer of Person B's C class ordinary shares to X. Transfer of Person B's D class ordinary shares to Y. 202P Share Changes
Person B passed away in 20XX. Their shares were transferred to the executors of her deceased estate (being X and Y), then to the X testamentary trusts (the X Estate Trust and the Y Estate Trust, collectively the Estate Trusts ) in equal shares pursuant to Person B's will. The family trust The Family Trust is a discretionary trust established via a deed of settlement in the 19XXs. The current directors and shareholders (with equal shares) of its corporate trustee are the X children of X. Under the terms of the deed for the Family Trust, the beneficiaries of the Family Trust are limited to Person A, Person B and their descendants. While the deed for the Family Trust has been subject to a number of variations, there have been no changes to the beneficiaries. Estate trust The Estate Trusts were established in or around August 20XX, are controlled by X and Y respectively and are administered for the benefit of their respective families. Distribution histories
Between them, the records held by the Company and the ATO in relation to the Company's dividend history dates back to the 20XX income year. The Company did not pay any dividends in the 20XX to 20XX income years. A dividend of $XX was paid by the Company in the 20XX income year (according to its income tax return for that year) but the Company is unable to locate records to identify the shareholder(s) to whom that dividend was paid. In the 20XX income year, the Company paid a dividend on ordinary share classes A, B, C and D (to the X Estate Trust, Y Estate Trust, X and Y respectively). Between them, the records held by the Family Trust and the ATO in relation to the Family Trust's distribution history dates back to the 20XX income year. Since the 20XX income year, all income distributions of the Family Trust were made to Person B, to X and to X's children. The Family Trust has made no distributions of capital since the 20XX income year. Since the establishment of the X Estate Trust, income of the trust has been distributed to X and to X's grandchildren.
Since the establishment of the Y Estate Trust, income of the trust has been distributed to Y, to Y's children and to Y's grandchildren. Neither of the Estate Trusts have made distributions of capital. Assumption There will be no change to the majority underlying interests in the Company between the date of the ruling and just before the sale of the Asset or any of the interests in other Properties owned by the Company.
Income Tax Assessment Act 1936 former subsection 160ZZRR(1) Income Tax Assessment Act 1936 former section 160ZZRU Income Tax Assessment Act 1936 former section 160ZZS Income Tax Assessment Act 1936 former subsection 160ZZS(1) Income Tax Assessment Act 1936 Subdivision C of Division 20 of former Part III Income Tax Assessment Act 1997 Subdivision 108-D Income Tax Assessment Act 1997 Division 149 Income Tax Assessment Act 1997 section 149-10 Income Tax Assessment Act 1997 paragraph 149-10(a) Income Tax Assessment Act 1997 paragraph 149-10(b) Income Tax Assessment Act 1997 paragraph 149-10(c) Income Tax Assessment Act 1997 subsection 149-15(1) Income Tax Assessment Act 1997 subsection 149-15(2) Income Tax Assessment Act 1997 subsection 149-15(3) Income Tax Assessment Act 1997 subsection 149-1
All subsequent legislative references are to the ITAA 1997, unless otherwise indicated. Question 1 Is the Asset owned by the Company a pre-CGT asset on the basis that it meets the requirements under section 149-10? Summary Yes, the Asset owned by the Company is a pre-CGT asset on the basis that it meets the requirements under section 149-10. Detailed reasoning A CGT asset is a pre-CGT asset if it was last acquired before 20 September 1985, and no income tax provision has operated to treat it as having been acquired after that date. Division 149 contains provisions, applicable to the 19XX and later income years, which govern when an asset acquired by an entity before 20 September 1985 stops being a pre-CGT asset. Section 149-10 provides: A CGT asset that an entity owns is a pre-CGT asset if, and only if: (a) the entity last acquired the asset before 20 September 1985; and (b) the entity was not, immediately before the start of the 1998-99 income year, taken under: (i) former subsection 160ZZS(1) of the Income Tax Assessment Act 1936 ; or (ii) Subdivision C of Division 20 of former Part IIIA of that Act; to have acquired the asset on or after 20 September 1985; and
(c) the asset has not stopped being a pre-CGT asset of the entity because of this Division. Former subsection 160ZZS(1) of the Income Tax Assessment Act 1936 (ITAA 1936) Former subsection 160ZZS(1) of the ITAA 1936 contains the rules for non-public entities to determine if an asset is a pre-CGT asset. A public entity was defined under former subsection 160ZZRR(1) of the ITAA 1936 as a public company, mutual insurance organisation or publicly traded unit trust. A 'public company' was defined under former subsection 160ZZRR(1) of the ITAA 1936 as a listed public company or a company all the shares in which are beneficially owned by any one or more of listed public companies, mutual insurance organisations and/or publicly traded unit trusts. The Company was not a 'public entity' as defined in former subsection 160ZZRR(1) of the ITAA 1936 since it was a company that was not a public company. Former subsection 160ZZS(1) of the ITAA 1936 states:
For the purposes of the application of this Part in relation to a taxpayer, an asset acquired by the taxpayer on or before 19 September 1985 shall be deemed to have been acquired by the taxpayer after that date unless the Commissioner is satisfied, or considers it reasonable to assume, that, at all times after that date when the asset was held by the taxpayer, majority underlying interests in the asset were held by natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset. The effect of former subsection 160ZZS(1) of the ITAA 1936 was to deem an asset that was acquired on or before 19 September 1985 to be acquired after that date unless the Commissioner was satisfied, or found it reasonable to assume, that majority underlying interests in the asset were maintained, at all times after 19 September 1985, by persons who had majority underlying interests in the asset immediately before 20 September 1985.
Paragraph 149-10(b) represents a specific testing point, requiring the Commissioner to be satisfied that there has been a continuation of majority underlying interests in the asset at all times from 19 September 1985 to immediately before the start of the 1999 income year. Relevantly, former section 160ZZRU of the ITAA 1936 provided that, if, because of a person's death, a natural person acquired a percentage of the underlying interests in an asset, the natural person was taken to have held, at any time when the dead person held a percentage of the total underlying interests in the asset, a percentage of the total underlying interests in the asset equal to the lesser of the acquired percentage or the dead person's percentage at that time. Subdivision C of Division 20 of the former Part III of the ITAA 1936 contains rules for public entities and is therefore not applicable to the Company. Subdivision 149-B
Subdivision 149-B provides for when assets of a non-public entity stop being a pre-CGT asset. Entities that are regarded as a 'public entity' are listed in subsection 149-50(1) and includes a listed public company or a company all the shares in which are beneficially owned by any one or more of listed public companies, mutual insurance companies, mutual affiliate companies and/or publicly traded unit trusts. The Company does not fall within the definition of a 'public entity' for the purposes of Division 149. Subsection 149-30(1) is therefore applicable to the Company and provides: [An] asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. Subsection 149-30(1) applies subject to subsection 149-30(2) which states:
If the Commissioner is satisfied, or thinks it reasonable to assume, that at all times on and after 20 September 1985 and before a particular time majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day, subsections (1) and (1A) apply as if that were in fact the case. Therefore, although paragraphs 149-10(b) and (c) are separate requirements, the effect of both provisions is similar; an asset of a non-public entity that was acquired on or before 19 September 1985 is a pre-CGT asset at a particular time only if: • the Commissioner is satisfied, or thinks it is reasonable to assume, that majority underlying interests in the asset have been maintained at all times since 20 September 1985 to the beginning of the 19XX income year (as reflected by the requirements in paragraph 149-10(b)); and
• majority underlying interests in the asset have been maintained since 20 September 1985 or the Commissioner is satisfied, or thinks it is reasonable to assume, that majority underlying interests in the asset have been maintained at all times since 20 September 1985 and before a particular time (as reflected by the requirements in paragraph 149-10(c)). Relevantly, subsections 149-30(3) and (4) provide that, if an ultimate owner (new owner) has acquired an interest in an asset because it was transferred to the new owner upon the death of a person (former owner), the new owner is treated as having held the underlying interest of the former owner for the period the former owner held them. [1] Majority underlying interests in a CGT asset Subsection 149-15(1) provides that 'majority underlying interests' consist of: (a) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and (b) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.
An 'underlying interest' in a CGT asset is defined in subsection 149-15(2) as "a beneficial interest that an ultimate owner has (whether directly or indirectly) in the asset or in any ordinary income that may be derived from the asset". An 'ultimate owner' is defined in subsection 149-15(3) to include an individual or a company whose constitution prevents it from making any distribution, whether in money, property or otherwise, to its members. Subsection 149-15(4) states: An ultimate owner indirectly has a beneficial interest in a CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of the capital of the other entity if: (a) the other entity were to distribute any of its capital; and (b) the capital were then successively distributed by each entity interposed between the other entity and the ultimate owner. Subsection 149-15(5) states: An ultimate owner indirectly has a beneficial interest in ordinary income that may be derived from a CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of a dividend or income if:
(a) the other entity were to pay that dividend, or otherwise distribute that income; and (b) the dividend or income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner. In Taxation Ruling IT 2340 Income tax: capital gains: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date the Commissioner adopts a pragmatic approach of looking through interposed entities to determine whether natural persons hold the beneficial interests for the purposes of former section 160ZZS of the ITAA 1936, which preceded Division 149. Paragraph 2 of IT 2340 states:
... underlying interests in relation to the assets concerned mean beneficial interests held by natural persons whether directly or through one or more interposed companies, partnerships or trusts. The clear policy of the law thus permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be "looked through" in order to determine whether there has been a change in the effective interests of natural persons in the assets. Section 357-85 of Schedule 1 to the Taxation Administration Act 1953 provides that if the Commissioner has made a ruling about a relevant provision and that provision is re-enacted or remade, the ruling is taken to be about the re-enacted or remade provision, insofar as the new law expresses the same ideas as the old law. As former section 160ZZS of the ITAA 1936 expresses the same ideas as Division 149, IT 2340 equally applies to Division 149. Application to discretionary trusts
The expression 'beneficial interest' as used in the definition of 'majority underlying interests' (as well as the definition of 'underlying interest') is not defined. Under ordinary legal concepts, where there is a discretionary trust deed, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. As the beneficiary of a discretionary trust does not hold an interest in any asset of a trust or in the ordinary income derived from the asset until the trustee's discretion is exercised, it would not be possible for a discretionary trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1). However, IT 2340 sets out the Commissioner's view on the application of the 'underlying interest' and 'majority underlying interest' requirement when assets are held by the trustees of family trusts where the trustees are vested with discretionary powers as to distributions from the trusts. Paragraphs 5 to 8 of IT 2340 state as follows:
5. In relation to what are generally referred to as discretionary trusts, i.e., family trusts, the trustees of which have discretionary powers as to the distribution of trust income or property to beneficiaries, in considering the question of whether majority underlying interests have been maintained in the assets of the trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised. 6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of their discretion.
7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. That is consistent with the role of the section to close potential avenues for avoidance of tax in cases where there is a substantial change in underlying ownership of assets and the legislative guidance contained in Subdivision G of Division 3 of Part III of the Act. On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act. 8. On the other hand where, by the exercise of a trustee's discretionary powers to appoint beneficiaries or by amendment of the trust deed, there is in practical effect a change of 50% or more in the underlying interests in the trust assets - such as where the members of a new family are substituted as recipients of distributions from the trust in place of persons who were formerly the object of such distributions - the section would have its intended application as described.
Therefore, where the trustee of a family trust continues to administer a trust for the benefit of members of a particular family, it would be reasonable for the Commissioner to assume that majority underlying interests in the trust assets have not changed. ATO Interpretative Decision 2003/778 Income Tax: CGT: majority underlying ownership and deceased estate - discretionary trust - beneficiary a 'new owner' explains that: Taxation Ruling IT 2340 correctly reflects the position that section 160ZZS of the ITAA 1936, by its terms, necessarily supplants normal legal concepts of interests in assets. For the purposes of section 160ZZS, a beneficiary of a discretionary trust is treated as having a beneficial interest in the trust's assets. Likewise, a shareholder is treated for the purposes of section 160ZZS of the ITAA 1936 as having a beneficial interest in the company's assets.
ATO ID 2003/778 further explains that the discretionary powers of the trustee of a discretionary (family) trust and those of the trustee of a discretionary testamentary trust are not materially different and it is reasonable to adopt the same approach to both when considering the question of majority underlying interests for purposes of Division 149. The beneficiary of a discretionary testamentary trust can therefore be said to have a beneficial interest in the assets of the trust and, where appropriate, be a 'new owner' for purposes of subsections 149-30(3) and (4). Application to the company's circumstances The company last acquired the Asset before 20 September 1985 - paragraph 149-10(a) The Company acquired the Asset in the 1970s, so paragraph 149-10(a) is satisfied. The company was not, immediately before the start of the 1999 income year, taken under former subsection 160ZZS(1) of the ITAA 1936 to have acquired the Asset on or after 20 September 1985 - paragraph 149-10(b) The Asset has not stopped being a pre-CGT asset of the company because of Division 149 - paragraph 149-10(c)
As mentioned, although paragraphs 149-10(b) and (c) are separate requirements to be met, both provisions are similar and the effect of both provisions is that an asset of a non-public entity that was acquired on or before 19 September 1985 is a pre-CGT asset at any particular time only if: • majority underlying interests in the asset were maintained at all times after 19 September 1985 by persons who immediately before 20 September 1985 held majority underlying interests in the asset; or • the Commissioner is satisfied or thinks it is reasonable to assume that this is the case. Immediately before 20 September 1985 The Company held the Asset immediately prior to 20 September 1985. While the Company receives ordinary income derived from the Asset, the Company's constitution does not prevent it from making distributions to its members, such that it is not an 'ultimate owner' who can have an underlying interest in the asset. Establishing underlying interest requires the adoption of a 'look through' approach to trace the beneficial interest in an asset to an ultimate owner which is usually a natural person.
Immediately prior to 20 September 1985, the shareholding of the Company was: • X ordinary shares (spread across classes A, B, C and D) held by Person A and Person B (in different proportions); and • X Z class redeemable preference shares held by trustee for the Family Trust. As individual shareholders, Person A and Person B were ultimate owners who had a direct beneficial interest in the assets of the Company, and in the ordinary income that may be derived from the assets of the Company. The Family Trust is a discretionary trust. As mentioned, the beneficiaries of a discretionary trust that are natural persons are treated, for the purposes of former subsection 160ZZS(1) of the ITAA 1936 and Division 149, as having beneficial interest in the trust's assets.
The Family Trust was established for the benefit of Person A, Person B and the descendants of Person A (including X and Y, each of their children and grandchildren); all members of the G family (a 'particular family' that is referred to in paragraph 6 of IT 2340). The natural persons and ultimate owners who indirectly held beneficial interests in the assets of the Company, and in the ordinary income that may be derived from the assets of the Company, were members of the G family. On this basis, immediately before 20 September 1985, the majority underlying interests in the Asset were held by Person A and Person B, as well as by other members of the G family as beneficiaries of the Family Trust. After 19 September 1985 It is reasonable for the Commissioner to assume that members of the family have been the ultimate owners of the Asset and have maintained majority underlying interests in the Asset since 19 September 1985, having regard to the following factors: • The Asset has continuously been held by the Company and the shares in the Company have also been continuously held by members of the family.
• The trustee of the Family Trust and each of the Estate Trusts has administered the trust for the benefit of members of the family, as evidenced by the available history of distributions by these trusts. • Variations in the trust deed of the Family Trust have not introduced any new persons as beneficiaries of the trust that are not members of the family. Under these circumstances, pursuant to former subsection 160ZZS(1) of the ITAA 1936 and subsection 149-30(2) (and consistent with IT 2340), the Commissioner thinks it reasonable to assume that at all times on and after 20 September 1985 and until the date of this ruling 2 , majority underlying interests in the Asset have been held by ultimate owners (the members of the G family) who had such interests immediately before 20 September 1985. The Asset is therefore not taken to have stopped being a pre-CGT asset of the Company pursuant to former subsection 160ZZS(1) of the ITAA 1936 or subsection 149-30(1). For completeness, the following is noted in relation to each change to the Company's shareholding since 19 September 1985: i. 198N Share Changes
Where, by reason of the death of Person A, Person B acquired Person A's XX ordinary shares (spread across classes A, C and D) in the Company and, by extension, a percentage of the underlying interests in the Company's Asset, pursuant to former section 160ZZRU of the ITAA 1936 Person B was taken to have held that percentage of the total underlying interests in the Asset at any time when Person A held it (i.e. since before 20 September 1985). Accordingly, the 198N Share Changes did not trigger the application of former subsection 160ZZS(1) of the ITAA 1936 to deem the Asset to have been acquired by the Company at that time. ii. 199M Share Changes The respective transfers of the 100 C class ordinary shares by Person B to X and the 100 D class ordinary shares by Person B to Y did not result in the acquisition of a beneficial interest in the Company's Asset, or in any ordinary income that may be derived from the Asset, by any ultimate owner who had no such beneficial interest immediately before 20 September 1985. Immediately after the 199M Share Changes, all the majority underlying interests in the Asset continued to be held by members of the family.
Accordingly, the 199M Share Changes did not trigger the application of subsection 149-30(1) to stop the asset from being a pre-CGT asset. iii. 202P Share Changes Where, by reason of the death of Person B (former owner), the Estate Trusts acquired Person B's A and B class ordinary shares in the Company and, by extension, where X, Y and their respective families, as beneficiaries of the Estate Trusts and ultimate owners (new owners), acquired an interest in the Asset, pursuant to subsections 149-30(3) and (4) those new owners were treated as having held the underlying interest of Person B for the period Person B held them, including the period Person B is deemed to have held a portion of that interest pursuant to subsection 149-30(4) (i.e. since before 20 September 1985). Accordingly, the 202P Share Changes did not trigger the application of subsection 149-30(1) to stop the asset from being a pre-CGT asset. Question 2
To the extent any part of the interests owned by the Company in other properties is not treated as a separate asset pursuant to the operation of Subdivision 108-D, those interests are pre-CGT assets on the basis that they meet the requirements under section 149-10 for the same reasons specific in relation to question 1. > [1] Subsection 149-30(1) applies as if the beneficiary had beneficial interests in the assets of the estate from the date of the deceased person's death until the time the estate has been fully administered. 2 It is assumed for the purposes of this ruling that this outcome will not change prior to the sale of the Asset.