House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 4 - CGT business restructures - Part 3: Roll-overs for change of incorporation

Outline of chapter

4.1 Part 3 of Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to expand the existing capital gains tax (CGT) roll-over for the change of a body to an incorporated company. The expanded roll-over applies to entities that change incorporation to become a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation. The expanded roll-over also covers a taxpayer's rights associated with a body, as well as their ownership interests, and situations where a body is wound up and replaced by a new company incorporated under a different law.

4.2 Part 3 also amends the ITAA 1997 to allow for tax neutral consequences for CGT, depreciating, revenue and trading stock assets of a body that is wound up and replaced by a new company incorporated under a different law, and these assets are transferred to the new company.

4.3 All legislative references in this chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

4.4 Subdivision 124-I currently provides a replacement asset roll-over for a member of a body that is established under a law (other than the Corporations Act 2001 (Corporations Act) or a similar foreign law relating to companies) and, as a result of the body being converted to a company incorporated under the Corporations Act (or a similar foreign law), the member receives shares in the company in exchange for their interests in the body. However, the existing roll-over is subject to limitations that reduce its effectiveness.

4.5 The existing law does not provide roll-over for an Indigenous body which is converted to a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation - it is limited to bodies converting their incorporation to the Corporations Act or a similar foreign law relating to companies. This results in the members of the body realising a potential CGT liability on the conversion of the body to a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation.

4.6 Further, the existing roll-over is not available to Indigenous companies that transfer incorporation from the Corporations Act to the Corporations (Aboriginal and Torres Strait Islander) Act 2006 , which restricts their flexibility to change their incorporation to suit their particular circumstances.

4.7 The existing roll-over requires an incorporated body to be 'converted' to a Corporations Act (or similar foreign law) company. As such the existing roll-over does not cater for situations where a body is wound up and then replaced by a new company incorporated under a different corporations law.

4.8 Also, the existing roll-over does not accommodate situations where the members of a body being converted wish to be compensated with additional shares in the new company for the value of rights (separate to their ownership interests) they held in the incorporated body.

4.9 This is because the existing roll-over only allows the new company to issue the member shares in substitution for the member's ownership interests in the body. This restricts taxpayers from receiving shares that reflect the value of their formerly held rights. They must either sacrifice the rights they previously had in the body or be ineligible for the roll-over and incur a CGT liability.

4.10 Finally, if a body is wound up and replaced by a newly incorporated company, this process may trigger the realisation of CGT assets, revenue assets, depreciating assets and trading stock, and loss of an asset's pre-CGT status, causing the body to incur a tax liability or suffer a disadvantage, which will be to the detriment of its members.

Summary of new law

4.11 These amendments allow Indigenous bodies to incorporate as Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporations without immediate CGT consequences for the body's members. Also, these amendments allow Indigenous companies incorporated under the Corporations Act to change their incorporation to the Corporations (Aboriginal and Torres Strait Islander) Act 2006 without immediate CGT consequences.

4.12 In addition, these amendments extend the existing roll-over by allowing the value of rights associated with a body to be reflected in the shares issued by the company, when the body changes its incorporation.

4.13 These amendments also allow members to access the roll-over where the body winds up and is replaced by a new company incorporated under a different law (the 'reincorporation roll-over').

4.14 Finally, these amendments provide a tax neutral outcome for the CGT, depreciating, revenue and trading stock assets of a body that winds up and is replaced by a company incorporated under a different law.

Comparison of key features of new law and current law

Detailed explanation of new law

4.15 Part 3 of this Schedule repeals the existing provisions of Subdivision 124-I, which provides a roll-over for conversion of a body to an incorporated company, and replaces them with provisions allowing for a more flexible CGT roll-over where a body that is incorporated under one law is converted to, or replaced with, a company incorporated under a different law. [Schedule 2, item 15, section 124-510]

4.16 The provisions aim to ensure that the CGT consequences of a body changing incorporation do not deter its members from changing the body's incorporation to either the Corporations Act (or a similar foreign law) or the Corporations (Aboriginal and Torres Strait Islander) Act 2006 . [Schedule 2, item 15, section 124-515]

4.17 The roll-over provisions have separate sections for changes of incorporation that do not involve the creation of a new legal entity and for those that involve the original body being wound up and a new company being formed. Subdivision 124-A provides the consequences for replacement-asset roll-overs generally. However, these amendments insert specific provisions modifying the operation of Subdivision 124-A where:

•

shares in a company replace a mix of pre-CGT and post-CGT interests and rights in a body; and

•

rights as a member of a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation replace a mix of pre-CGT and post-CGT interests and rights in a body.

[Schedule 2, item 15, sections 124-520, 124-525, 124-530 and 124-535]

Change of incorporation without change in entity

Conditions for the roll-over to apply

Eligible changes of incorporation

4.18 These amendments provide a CGT roll-over for members of bodies that change their incorporation from one law to another without forming a new legal entity where:

•

a body incorporated under a law other than the Corporations Act (or a similar foreign law relating to companies) changes its incorporation to either the Corporations Act or a similar foreign law - this roll-over is a continuation of the roll-over currently available under Subdivision 124-I ; or

•

a body incorporated under a law other than the Corporations (Aboriginal and Torres Strait Islander) Act 2006 changes its incorporation to that Act.

[Schedule 2, item 15, paragraphs 124-520(1)(a) and (b)]

Example 4.2

Farming Co-op Ltd (Farming) is a cooperative incorporated under the Cooperatives Act 1992 (NSW) . Its members have decided to change its incorporation from a cooperative to a company incorporated under the Corporations Act.

As the Cooperatives Act 1992 (NSW) allows incorporation to be transferred to the Corporations Act, Farming can convert its incorporation to being a Corporations Act company without needing to form a new legal entity.

This allows its members to access the section 124-520 roll-over if the other conditions are met.

Ownership test

4.19 In order for the roll-over to apply, it must be reasonable to conclude that there is no significant difference between the ownership, or the mix of the ownership, of the body just before and just after the conversion. This takes account of both the ownership of the body (that is, the ownership of membership interests in the body) and the ownership of rights relating to the body that were held by owners of the body. This ensures that the economic ownership of the entities remains substantially the same just before and just after the conversion of the body. [Schedule 2, item 15, paragraph 124-520(1)(c)]

4.20 The first part of this ownership test requires that it is reasonable to conclude that there is no significant difference between the ownership of the body and rights relating to the body (held by the entities that owned the body) just before conversion occurs, and the ownership of the company just after conversion. This test focuses solely on who owns the body (including associated rights), not how much they own. [Schedule 2, item 15, subparagraph 124-520(1)(c)(i)]

4.21 The second part of this ownership test, which concerns the mix of ownership, requires the owners of the body to have no significant difference between their proportional ownership of the company just after the conversion and their proportional ownership of the body just before the conversion occurred. This takes into account how much of the body (including associated rights) and how much of the company each member owns at the relevant times to assess whether there is a consistent mix of ownership. [Schedule 2, item 15, subparagraph 124-520(1)(c)(ii)]

4.22 Taking membership interests and rights relating to the body into account allows for shares to be issued reflecting the value of those membership interests and rights. This means that an owner of the body that holds rights related to the body can have the value of those rights reflected in the shares that they receive as an owner of the company. This was not possible under the former Subdivision 124-I. [Schedule 2, item 15, paragraph 124-520(1)(c)]

4.23 Rights relating to the body encompass non-ownership interests in the body. For example, a member of an agricultural cooperative may have a right to a percentage of production of the cooperative because they are an active participant in running the business. This type of right would be of value to the taxpayer and, under these amendments, can be reflected in the ownership of the company with the issue of additional shares.

4.24 This part of the ownership test requires that it is reasonable to conclude that there is no significant difference between the mix of ownership before and after conversion. This allows for some very minor differences in mix of ownership before and after conversion which may be necessary to facilitate the conversion. However, any large discrepancy in mix of ownership before and after conversion would make the taxpayer ineligible for the roll-over.

4.25 This part of the ownership test requires a value to be ascribed to the ownership interests before and after the conversion. In some circumstances it may be easy to value ownership interests and compare those values before and after the conversion. In other circumstances it may be very difficult or costly to value ownership interests. If it is very difficult or costly to value ownership interests, it may be reasonable to conclude that there is no significant difference in the mix of ownership before and after the conversion where there is appropriate regulatory oversight of the conversion.

Example 4.3

Continuing from Example 4.1, Farming converts to a Corporations Act company, Growers Ltd, and Farming's members receive shares in Growers Ltd as a replacement for their ownership interests in Farming and rights associated with Farming.

Farming has three members, Renee, Angelo and Tomas. Each of them has an equal ownership interest worth $20,000 in Farming.

Renee and Tomas work full time for Farming, while Angelo only contributed initial capital to Farming and does not actively participate in running the business. Accordingly, Renee and Tomas have an equal participation right, which has a value of $10,000 to Renee and Tomas respectively, to the first 25 per cent of Farming's profits before the residual 75 per cent is evenly divided between Renee, Angelo and Tomas.

Upon conversion to a company, Growers Ltd issues 400 shares, which are divided between Renee, Angelo and Tomas.

Renee and Tomas each receive 150 shares on account of their ownership interest in Farming and their ownership of the participation right relating to the body - 100 shares for the ownership interest and 50 shares for the participation right. Angelo receives 100 shares for his ownership interest in Farming.

Considering the shares received by Renee, Angelo and Tomas, it is reasonable to conclude that there is no significant difference between ownership before and after conversion. This is because the division of the shares between Farming's members just after the conversion replicates the total ownership of Farming and the ownership of the participation rights just before conversion. This means that the conditions for the roll-over to apply have been met.

Conditions for the taxpayer to choose the roll-over

4.26 If the conditions for the roll-over to apply are met, the taxpayer may choose the roll-over where certain other conditions are satisfied. First, the taxpayer must receive only shares in the new company. Therefore, any rights relating to the body that were held by the taxpayer prior to the conversion, must be reflected in new shares that replicate their value to the taxpayer. This means that the taxpayer cannot have a previously held right relating to the company, continue in existence or have a new right in the company granted to them in exchange for their interests in the original body. Similarly, the taxpayer's membership interests in the body should no longer exist when shares in the company are issued to them. [Schedule 2, item 15, paragraph 124-520(2)(a)]

4.27 Second, the taxpayer must be an Australian resident at the time the body is converted to a company or, if the taxpayer is a foreign resident, the interests in the body and any rights related to the body that they held must have been taxable Australian property just before the conversion time, and the shares in the company they receive must be taxable Australian property when they are issued. [Schedule 2, item 15, paragraph 124-520(2)(b)]

4.28 If these other conditions are met, the taxpayer may choose to obtain the roll-over, with the standard roll-over consequences set out in Subdivision 124-A applying. Generally, this means a taxpayer that satisfies the conditions for the roll-over disregards any capital gains or capital losses arising from the ending of their membership interests in the body or rights relating to the body.

4.29 However, these amendments make specific modifications to the standard roll-over consequences for this roll-over where the taxpayer has a mix of pre-CGT and post-CGT interests and rights. These modifications are set out in paragraphs 4.49 to 4.55.

The Corporations (Aboriginal and Torres Strait Islander) Act 2006 and the rights as a member of a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation

4.30 Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporations do not issue shares to their members but issue 'rights as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation'. The term 'rights as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation' describes the bundle of rights that members of a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation have in relation to the corporation. These rights may include allowing a member to:

•

attend, speak and vote at general meetings;

•

be made a director;

•

put forward resolutions at general meetings;

•

ask the directors to call a general meeting; and

•

inspect the records of the corporation.

4.31 While the conditions for taxpayers to choose the roll-over refer to shares, the roll-over applies to conversions of bodies to Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporations, even though they do not issue shares to members. Instead, when a body is converted to a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation, the roll-over conditions are modified to apply in relation to 'rights as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation' in the same way they apply to shares of a non- Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation. [Schedule 2, item 15, subsection 124-520(3)]

4.32 The taxpayer's previously held ownership interests and any rights relating to the original body should be replaced by rights as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation. [Schedule 2, item 15, subsections 124-520(2) and (3)]

Example 4.4

River Shop Inc (River Shop) is an indigenous store that is currently incorporated under the Associations Act 2003 (NT) . The members of River Shop have decided to transfer its incorporation to the Corporations (Aboriginal and Torres Strait Islander) Act 2006 . They are able to transfer the body's incorporation without needing to form a new legal entity.

River Shop's incorporation is transferred to the Corporations (Aboriginal and Torres Strait Islander) Act 2006 and, accordingly, River Shop's members have their membership interests in the association replaced by 'rights as a member of a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation' (and their membership interests cease to exist). These rights are guaranteed by the Corporations (Aboriginal and Torres Strait Islander) Act 2006 and allow members to attend, speak and vote at general meetings, be a director, put forward resolutions at general meetings, ask the directors to call a general meeting and inspect the records of the corporation.

River Shop's members would be eligible to choose the conversion of incorporation CGT roll-over if the conversion satisfies the ownership test (see paragraphs 4.19 to 4.25).

Exception for certain demutualisations

4.33 The provisions do not apply to demutualisation of entities if Division 326 of Schedule 2H to the Income Tax Assessment Act 1936 applies to the demutualisation in question. Division 326 applies to mutual entities other than insurance companies and health insurers, and sets out the CGT consequences for demutualisation. [Schedule 2, item 15, subsection 124-520(4)]

The old corporation is wound up

Conditions for a roll-over to apply

Eligible reincorporations

4.34 These amendments provide a CGT roll-over for members of bodies that change their incorporation from one law to another where the old incorporated body is wound up and is replaced by another corporation. [Schedule 2, item 15, section 124-525]

4.35 This CGT roll-over applies to the same set of changes in incorporation as the CGT roll-over for conversions (see paragraph 4.18). [Schedule 2, item 15, paragraphs 124-525(1)(a) and (b)]

4.36 This CGT roll-over requires the original body to cease to exist and the company which is replacing it to continue to exist after the time the members of the original body have received shares in the new company, or, if it is a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation, received rights as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation. [Schedule 2, item 15, paragraph 124-525(1)(c)]

4.37 The time when the members receive the shares in the company or their rights in the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation, is known as the 'switch time'. The switch time is indicative of when the new company has effectively taken over from the original incorporated body, even though the latter may still exist. [Schedule 2, item 15, paragraph 124-525(1)(c)]

Example 4.5

Town Store Inc (Town Store) was incorporated under a state association Act, and in order to become a Corporations Act company must wind up and form a new legal entity. The members of Town Store want to wind up Town Store and incorporate a new company under the Corporations Act.

On 15 October 2010, in preparation for winding up Town Store, its members incorporated a new company, Big Store Ltd, under the Corporations Act. Big Store Ltd issued shares to the members of Town Store on the same day.

The time when the members received the shares is known as the 'switch time', and is indicative of when Big Store Ltd had effectively taken over from Town Store, even though Town Store still existed.

4.38 The switch time allows for the new company to be in existence before the original body is wound up, which reflects the commercial reality that a company can be created in anticipation of the original body ending. This allows for the use of 'shelf company' arrangements in winding up the original body and replacing it with a company.

4.39 The shares received must be issued to the members of the original body for their ownership interests and any other rights relating to the original body that they possessed. That is, the interests in the original body are exchanged for shares in the new company or rights received as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation. [Schedule 2, item 15, subparagraphs 124-525(1)(c)(i) and (ii)]

4.40 Similar to the CGT roll-over for conversions of incorporation described above, the members of the original body must receive only shares in the new converted company, or, rights as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation. The shares or rights as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation must be received in exchange for the member's interests and rights ending, and not for any other reasons. [Schedule 2, item 15, paragraph 124-525(1)(d)]

Ownership test

4.41 For this CGT roll-over to apply, it must be reasonable to conclude that there is no significant difference between the ownership, or the mix of the ownership, of the body just before the switch time and the ownership, or the mix of the ownership, of the company just after the switch time. [Schedule 2, item 15, paragraph 124-525(1)(e)]

4.42 Similar to the CGT roll-over for conversions of incorporation, this provision seeks to ensure that there is consistency in the ownership of the entities subject to the roll-over. Also, this provision takes both the ownership of the body, that is, membership interests in the body, and rights relating to the body that were held by owners of the body, into account when assessing the continuity of ownership. The discussion in paragraphs 4.19 to 4.25 about the practical aspects of applying the ownership test to conversions of incorporation is relevant to applying the ownership test to reincorporations.

Asset disposal requirement

4.43 For the roll-over to apply the original body must dispose of all of its CGT assets to the new company. This ensures that the new company is the entity that continues to carry on the business. The assets must be disposed of by the switch time, that is, when the members of the body have received shares in the new company, or, if it is a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation, received rights as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation. [Schedule 2, item 15, paragraph 124-525(1)(f)]

4.44 There is a limited exception to this requirement. This exception recognises that in the process of winding up the original body, the body may be required to meet existing or expected liabilities. The exception allows it to retain some assets in order to meet those liabilities. At the time of the final winding up of the original body, it is expected that any assets not used to meet liabilities would have been disposed of to the new company. This may result in the body being required to transfer its assets in more than one tranche where the assets retained for expected liabilities are not needed to meet liabilities. [Schedule 2, item 15, paragraph 124-525(1)(f)]

Conditions for the taxpayer to choose the roll-over

4.45 If the conditions for the roll-over to apply are met, the taxpayer may choose the roll-over for their interest in the original body and any associated rights where certain other conditions apply. The other conditions are that:

•

the taxpayer must have been a member of the original body just before the switch time;

•

the taxpayer's ownership interest in the original body must end after the switch time (known as the 'end time');

•

at the end time, the taxpayer must have the shares in the new company that they received at the switch time; and

•

the taxpayer must be an Australian resident, or if they are a foreign resident, the interests (or any rights) in the original body held just before the end time must be taxable Australian property and the shares in the new company received at the switch time must be taxable Australian property at the end time.

[Schedule 2, item 15, subsection 124-525(2)]

Example 4.6

Continuing from Example 4.4, after Big Store Ltd issued shares to the members of Town Store, Town Store was wound up on 20 December 2010. This is known as the 'end time' for the purposes of the roll-over. At this time, the membership interests and any rights relating to Town Store ceased to exist.

As the new shareholders of Big Store Ltd were members of Town Store just before the switch time (see Example 4.4) and the following has occurred:

•

their ownership interests in Town Store have ended;

•

they received shares in Big Store Ltd; and

•

they were Australian residents when their ownership interest in Town Store ended,

they are able to choose the roll-over if the conditions for the reincorporation roll-over (see paragraphs 4.34 to 4.44) are met.

Corporations (Aboriginal and Torres Strait Islander) Act 2006 and rights as a member of a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation

4.46 As explained for the roll-over for conversions of incorporation (paragraphs 4.30 to 4.32), the roll-over for wind ups and reincorporations also applies to Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporations in relation to 'rights as a member of the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation' in the same way it applies to shares of a non- Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation. [Schedule 2, item 15, subsection 124-525(3)]

Consequences of the roll-overs

4.47 If a taxpayer is entitled to choose the conversion of incorporation or the reincorporation roll-over, the standard roll-over consequences set out in Subdivision 124-A apply. Generally, this means the taxpayer disregards any capital gains or capital losses arising from the ending of their membership interests in the body or rights relating to the body.

4.48 However, these amendments make specific modifications to the standard roll-over consequences where the taxpayer has a mix of pre-CGT and post-CGT interests and rights. These modifications are set out in paragraphs 4.49 to 4.55. [Schedule 2, item 15, subsections 124-530(5) and 124-535(3)]

A pre-CGT and a post-CGT mix of original assets of a non-Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation

4.49 Assets acquired before 20 September 1985 are known as pre-CGT assets. Capital gains and losses realised on these assets are generally disregarded. Assets acquired on or after 20 September 1985 are typically known as post-CGT assets.

4.50 If a taxpayer has chosen the conversion of incorporation or reincorporation roll-over and their interests in the original body or rights relating to the original body - the original assets - that they held were a mix of pre-CGT and post-CGT assets, there are special consequences for the shares that replaced the original assets. [Schedule 2, item 15, subsection 124-530(1)]

4.51 If some of the original assets that were replaced by shares in the company were pre-CGT assets and some were post-CGT assets, some of the shares in the new company are taken to be pre-CGT assets as is reasonable having regard to the number and market value of the:

•

original assets; and

•

shares in the new company.

[Schedule 2, item 15, subsection 124-530(2)]

4.52 For the shares which are not pre-CGT assets, the taxpayer calculates the first element of the cost base of each post-CGT share as is reasonable having regard to the:

•

total cost bases of the original post-CGT assets; and

•

number and market value of the replacement post-CGT shares.

[Schedule 2, item 15, subsection 124-530(3)]

4.53 The reduced cost base of the post-CGT shares is worked out similarly. [Schedule 2, item 15, subsection 124-530(4)]

Example 4.7

Li is a part owner of a cooperative. Li acquired her ownership interest in the cooperative in 1982. Its current market value is $80,000. There is one other owner of the cooperative who has a similar ownership interest valued at $80,000.

In 1990, Li acquired a right to 25 per cent of the cooperative's production, on the basis of making a payment of $20,000 to the business. The cost base of this right is therefore $20,000 and its current market value is estimated to be $40,000.

In 2011, the cooperative converts its incorporation to the Corporations Act. Upon doing so, the new company issues Li and her business partner with shares in the company. In total 1,000 shares are issued.

Li receives 600 shares to replace her ownership interest and right relating to the cooperative. The shares have a market value of $200 each.

As Li's original assets were a mix of pre-CGT and post-CGT assets, some of her shares should be regarded as pre-CGT assets. It would be reasonable for Li to regard 400 of her shares as pre-CGT assets having regard to the number and market value of the original assets and shares. This is because two-thirds of Li's ownership value in the business resides in her ownership interest ($80,000 of the total $120,000 value) which was a pre-CGT asset and consequently she can treat two-thirds of her shares as pre-CGT assets.

This means Li's 200 remaining shares are to be post-CGT assets. These shares should take their cost base from the cost base of Li's post-CGT right. Accordingly, the first element of the cost base of each of these shares is taken to be $100 (the $20,000 cost base of the right apportioned equally across the 200 shares).

A pre-CGT and a post-CGT mix of original assets of a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation

4.54 If the taxpayer has chosen the conversion of incorporation or reincorporation roll-over and, under the conversion or reincorporation, they receive rights as a member of a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation there is a special rule where the original assets are a mix of pre-CGT and post-CGT assets. This special rule reduces compliance costs and reflects the difficulties in valuing pre-CGT and post-CGT rights in an Indigenous body. [Schedule 2, item 15, subsection 124-535(1)]

4.55 Under the special rule, if the taxpayer has acquired any of the original assets before 20 September 1985, they are taken to have acquired all of their replacement assets before that day. This means that the rights they receive in the Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation are pre-CGT assets. [Schedule 2, item 15, subsection 124-535(2)]

Example 4.8

Andrew is a member of IndigStore Inc (IndigStore), an incorporated association which runs an Indigenous store. Andrew acquired his membership interest in IndigStore in 1984. Also in 2000, Andrew acquired a right to half the profits from the association if it is wound up and a profit remains for distribution to members.

In 2011, the members of IndigStore decide to convert it to a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation. Accordingly, Andrew's interest and right relating to IndigStore are replaced by rights as a member of a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation.

As Andrew's membership interest in IndigStore was a pre-CGT asset, and even though his right was a post-CGT asset, Andrew's rights as a member of a Corporations (Aboriginal and Torres Strait Islander) Act 2006 corporation are taken to be pre-CGT assets.

A roll-over for assets of an entity winding up

4.56 These amendments insert a new Part into the Act that provides a roll-over that applies broadly across the Act to defer taxation consequences where the original body which is wound up as part of the process of changing incorporation transfers its assets to a new company. The asset roll-over automatically applies if the reincorporation roll-over applies to the original body and the company. [Schedule 2, Part 3-80, item 16, sections 620-5 and 620-10]

4.57 The asset roll-over ensures that there are tax neutral consequences where the original body which is wound up disposes of its assets to a new company and the ownership of the two entities is not significantly different. This ensures that there is a tax neutral outcome for the CGT, depreciating, revenue and trading stock assets of the body in situations where the original body winds up in order to change its form of incorporation. [Schedule 2, Part 3-80, item 16, section 620-15]

Consequences for CGT assets

4.58 Where an original body disposes of a CGT asset to the company replacing it because the body ceases to exist, the capital gain or loss the body makes on the transfer of that CGT asset is disregarded. [Schedule 2, Part 3-80, item 16, paragraph 620-20(1)(a) and subsection 620-20(2)]

4.59 Also, if any other CGT event happens to a CGT asset of the body because the body ceases to exist, the capital gain or loss the body makes on that CGT asset is also disregarded. This caters for circumstances where the body does not dispose of the asset to the new company, but instead, an asset is no longer held by the original body in connection with its winding up. An example of this type of asset is a lease. [Schedule 2, Part 3-80, item 16, paragraph 620-20(1)(b) and subsection 620-20(2)]

4.60 Where an original body disposes of a CGT asset to the new company and the body ceases to exist, the first element of the CGT asset's cost base for the new company is the asset's cost base when it was disposed of by the original body. [Schedule 2, Part 3-80, item 16, subsections 620-25(1) and (2)]

4.61 The first element of the reduced cost base for the CGT asset for the new company is worked out similarly. [Schedule 2, Part 3-80, item 16, subsection 620-25(3)]

4.62 If the original body acquired the asset before 20 September 1985, it will retain its pre-CGT status for the new company. [Schedule 2, Part 3-80, item 16, subsection 620-25(4)]

Example 4.9

Yellow Inc (Yellow) is an association, and its members have chosen to wind it up and incorporate a new company Orange Ltd under the Corporations Act. The members choose to use the section 124-525 roll-over to disregard capital gains and losses on their ownership interests in Yellow. Yellow was wound up and its assets transferred to Orange Ltd.

Just before ceasing to exist, Yellow held business premises purchased in 1994 for $250,000 with a market value of $380,000 and a parcel of shares in Silver Pty Ltd purchased in 1983.

Yellow disposes of the business premises and the shares to Orange Ltd just before it ceases to exist.

As Yellow was the 'original body' in the reincorporation roll-over, the capital gain of $130,000 arising on the disposal of the business premises to Orange Ltd is disregarded.

The first element of the business premises' cost base for Orange Ltd is $250,000.

The shares in Silver Pty Ltd now held by Orange Ltd retain their pre-CGT status in the hands of Orange Ltd.

Consequences for depreciating assets

4.63 The disposal of a depreciating asset to a new company will cause a 'balancing adjustment event' (as defined by section 40-295) to occur. A balancing adjustment event may require the original body disposing of the depreciating asset to adjust its taxable income.

4.64 Where there is a difference between the asset's termination value (that is, the final sale price) and its adjustable value (that is, the original cost less the decline in value while it was held by the taxpayer) a balancing adjustment may be assessable or deductible under section 40-285. However, section 40-285 will not apply if the roll-over provided by section 40-340 applies.

4.65 These amendments provide roll-over relief for a balancing adjustment event arising where the original body disposes of a depreciating asset to the new company because the body ceases to exist and the disposal involves a CGT event. [Schedule 2, Part 3-80, item 16, subsections 620-30(1) and (2)]

4.66 The ITAA 1997 applies as if there was roll-over relief under subsection 40-340(1) and the original body was the transferor and the new company was the transferee mentioned in that subsection and subsection 328-243(1A). This formulation means there is automatic roll-over relief under subsection 40-340(1) for a body that is not a small business entity for any assessable balancing adjustment arising from the transfer of a depreciating asset to the new company. Although the provisions treat the body and the company as the transferor and transferee mentioned in subsection 328-243(1A), this is irrelevant for an entity that is not a small business entity because its deductions for its assets are not calculated under Division 328. If the body is a small business entity, the roll-over relief under subsection 40-340(1) is contingent on the conditions in subsection 328-243(1A) being met apart from paragraph 328-243(1A)(c). Satisfaction of paragraph 328-243(1A)(c) by the entity is excluded because the CGT roll-over for assets of an entity being wound up in a reincorporation is not listed in the table in subsection 40-340(1). [Schedule 2, Part 3-80, item 16, subsections 620-30(2) and (3)]

4.67 The effects of the ITAA 1997 applying as if there were roll-over relief under subsection 40-340(1) include that:

•

the balancing adjustment event does not affect the original body's assessable income or deductions (subsection 40-345(1));

•

the new company can claim depreciation deductions for the depreciating asset's decline in value on the same basis that the original body did (subsection 40-345(2)); and

•

the new company is treated as if it had carried out any acts that the original body had carried out in relation to the asset and the application of Division 45, which concerns the disposal of leases and leased plant (subsection 40-350(1)).

[Schedule 2, Part 3-80, item 16, subsection 620-30(2) and (note)]

Example 4.10

Continuing on from Example 4.8, Yellow owns a generator purchased on 1 July 2008 for $40,000 which is used in the business. It is a depreciating asset which the business is depreciating using the 'prime cost method'. The generator's effective life is 10 years.

In anticipation of winding up, Yellow disposes of the generator to its new company Orange Ltd on 1 July 2010. The generator's termination value (that is, the final sale price) is $35,000 and its adjustable value (that is, the original cost less the decline in value while it was held by Yellow) is $32,000. This will cause a balancing adjustment to occur when the generator is disposed of to Orange Ltd requiring Yellow to adjust its assessable income upwards by $3,000.

As Yellow's members chose to use the section 124-525 roll-over to disregard capital gains and losses on their ownership interests in Yellow upon reincorporation, the depreciating asset roll-over is available to Yellow. Under the depreciating asset roll-over, the balancing adjustment is disregarded and Yellow does not need to adjust its assessable income.

Orange Ltd will be able to continue to claim depreciation deductions from the generator using the prime cost method over the next eight years.

Consequences for trading stock

4.68 The disposal of an item of 'trading stock' (as defined by section 70-10) from the original body to the new company can result in an amount of assessable income being attributed to the original body upon disposal of the item.

4.69 For each item of trading stock that the original body disposes of to the new company because the original body ceases to exist, the original body is taken to have sold the item, and the company is taken to have bought the item (dealing with each other at arm's length) for:

•

the cost of the item for the original body; or

•

if it was trading stock at the start of the income year, the value of the item at that time.

[Schedule 2, Part 3-80, item 16, subsections 620-40(1) and (2)]

4.70 The disposal of the trading stock by the original body and the acquisition of it by the new company are taken to have occurred in the ordinary course of business for the entities. This avoids any doubt as to the application of the trading stock provisions, especially section 70-90, which specifies that if an item of trading stock is disposed of outside the ordinary course of business then the entity that disposed of it will include the market value of the item in its assessable income. [Schedule 2, Part 3-80, item 16, subsection 620-40(2)]

4.71 The company is taken to have held the item as trading stock from the date it bought the item from the original body. [Schedule 2, Part 3-80, item 16, subsection 620-40(3)]

4.72 This has the effect of giving the original body a nil profit and a nil loss for the income year it ceased to hold the item of trading stock, giving it a tax neutral outcome for disposing of the item to the company.

4.73 For the company, this treatment means that it is taken to have acquired the trading stock held by the original body for the same value that the original body was taken to have received for the trading stock. This provides the company with the same tax outcome for the trading stock (assessable income or deduction depending on the closing value of the trading stock) as would have applied if the original body had continued to exist for the relevant income year.

Example 4.11

Continuing on from Example 4.8, Yellow holds widgets that are trading stock in its business. Yellow holds 25 widgets just before it is wound up, and of these widgets:

•

ten widgets were held as trading stock at the beginning of the current income year, with the value of $100 each; and

•

fifteen widgets were purchased during the current income year for $90 each.

Just before Yellow ceases to exist, it disposes of the widgets to Orange Ltd.

As Yellow's members chose to use the section 124-525 roll-over to disregard capital gains and losses on their ownership interests in Yellow upon reincorporation, the trading stock roll-over automatically applies to its trading stock.

This means that Yellow is taken to have sold the 10 widgets it held as trading stock at the beginning of the current income year at $100 each to Orange Ltd and to have sold the 15 widgets it acquired during the current income year at $90 each. This results in Yellow having nil profit and nil loss on its trading stock.

Orange Ltd is taken to have acquired 10 widgets at $100 each and 15 widgets at $90 each. This effectively passes the tax attributes of the trading stock held by Yellow to the trading stock now held by Orange Ltd.

Consequences for revenue assets

4.74 A revenue asset is defined in section 977-50 as an asset for which a profit or loss on disposal, on ceasing to own the asset, or other realisation is taken into account in calculating assessable income other than as a capital gain or loss and is neither trading stock nor a depreciating asset. Disposals of revenue assets from the original body to the new company could result in the body realising a profit or loss.

4.75 The roll-over for revenue assets applies if a CGT asset that the original body disposes of to the new company, because the original body ceases to exist, is a revenue asset just before the time of the disposal. [Schedule 2, Part 3-80, item 16, subsection 620-50(1)]

4.76 The original body is taken to have disposed of the revenue asset to the new company for an amount that would result in the original body not making a profit or loss because of the disposal. This means that there is no effect on the original body's taxable income. [Schedule 2, Part 3-80, item 16, subsection 620-50(2)]

4.77 The new company is taken to have paid the original body the amount to acquire the asset that resulted in that body not making a profit or loss because of the disposal of the revenue asset. This amount is used by the new company to calculate future profits and losses, allowing it to be in same tax position as the original body in regards to the revenue asset at the time of the disposal. [Schedule 2, Part 3-80, item 16, subsection 620-50(3)]

Example 4.12

Continuing on from Example 4.8, Yellow currently has a revenue asset. The market value of the revenue asset is $45,000 and its cost was $50,000. This means there is a $5,000 unrealised loss on the asset.

When Yellow disposes of the asset to Orange Ltd in anticipation of it ceasing to exist, it is taken to have sold the asset to Orange Ltd for $50,000, resulting in Yellow not making a profit or loss because of the disposal.

Orange Ltd is taken to have acquired the asset for $50,000, which rolls over the unrealised loss on the asset to Orange Ltd, putting it in the same position as Yellow just before the disposal.

4.78 The roll-over for revenue assets also applies to realisations of revenue assets that involve ceasing to own the asset or realising it in another way besides a disposal. For the purpose of the revenue asset roll-over, such realisations are treated as disposals and accordingly benefit from the same treatment as described in paragraphs 4.74 to 4.77. [Schedule 2, Part 3-80, item 16, subsections 620-50(4) and (5)]

Application and transitional provisions

4.79 The CGT roll-over for interests in a body that change incorporation applies to CGT events happening after 7.30 pm (by legal time in the Australian Capital Territory) on 11 May 2010. [Schedule 2, item 24, section 124-510 of the Income Tax (Transitional Provisions) Act 1997]

4.80 The roll-over for the CGT, depreciating, revenue and trading stock assets of a body that must wind up and form a new company in order to change its incorporation applies in relation to the cessation of existence of bodies corporate occurring after 7.30 pm (by legal time in the Australian Capital Territory) on 11 May 2010. [Schedule 2, Part 3-80, item 25, section 620-10 of the Income Tax (Transitional Provisions) Act 1997]

4.81 The dates of effect of these roll-overs are retrospective so that that any transactions occurring since the time of announcement are covered by the amendments so that taxpayers can benefit from the measure. The amendments are beneficial to taxpayers.

Consequential amendments

4.82 A new note is inserted at the end of subsection 40-340(1) to indicate the existence of the depreciating asset roll-over for an original body that is being wound up and replaced by a new company incorporated under a different law. [Schedule 2, items 17 and 18]

4.83 Also, a note is inserted after subsection 70-80(1) to indicate that an incorporated body is treated as disposing of an item of its trading stock in the ordinary course of business where the body ceases to exist and disposes of the asset to its new company. [Schedule 2, item 19]

4.84 There are also amendments to the finding tables in Subdivision 112-B, which indicate the location of certain cost base modifications made outside of Parts 3-1 and 3-3. [Schedule 2, items 20 to 23, sections 112-53AB, 112-97 (at the end of the table), 112-115 (the cell at item 11 in the table, the column headed 'For the rules about this roll-over' and 112-150 (at the end of the table)]