Edited version of your written advice

Authorisation Number: 1012994449315

Date of advice: 21 April 2016

Ruling

Subject: Deed of Company Arrangement for section 104-145 of the Income Tax Assessment Act 1997 (ITAA 1997)

Question

Will a written declaration - made by the Administrator of a Deed of Company Arrangement entered into with a company (Company A) - that shares owned by the trustee company of a trust (the Trustee Company) in, and loans it has provided to, Company A have no or negligible value satisfy the requirements of section 104-145 of the ITAA 1997 and result in capital gains tax (CGT) event G3 happening (if the Trustee Company chooses to realise its associated capital losses)?

Answer

Yes.

Period to which your private ruling applies

1 July 2015 to 30 June 2016

Date in which the scheme commences

1 July 2015

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Trustee Company's investment in shares in Company A

The Trustee Company has subscribed and paid for shares in Company A.

The Trustee Company's loans to Company A

The Trustee Company has lent a significant amount of money to Company A.

An Administrator of Company A was later appointed.

The Trustee Company subsequently lodged a formal proof of debt (Proof of Debt) in which the Trustee Company claimed Company A was indebted to it to the extent of the amount of subscription for the shares and the principal plus unpaid interest of the loans.

The Administrator of Company A has admitted the Proof of Debt in full.

Deed of Company Arrangement and related matters

Company A has entered into a Deed of Company Agreement (DOCA).

Clause 2 of the DOCA provides:

Immediately upon its execution of this Deed, the Company [Company A] shall deliver to the Administrator the following documents which will have been executed by [Company A], [the Trustee Company]…to the extent that each of those entities and persons are named as a party in any such documents:

a. Deed of Contribution, and

b. Deed of Debt Deferral.

The Trustee Company (as well as other identified entities) is identified as a 'Deferred Creditor' in Company A's DOCA. There is a related definition of 'Deferred Claim' in Company A's DOCA.

A 'Deferred Claim' means any debt owed by a company (Company A) to any of the Deferred Creditors.

Clause 6 of Company A's DOCA provides inter alia that the Fund must be applied by the Administrator as if Company A is being wound up and the winding up commenced on the Commencement Date as defined in the DOCA.

Clause 1 of the Deed of Debt Deferral provides:

The Deferred Creditors agree that they do not require the Administrator as administrator of the Deed of Company Arrangement to pay any debt or claim whatsoever (sic) any of them has against the Company [Company A] (including any employee entitlements).

Clause 3 of the Deed of Debt Deferral provides:

The Company [Company A] agrees that any debt or claim referred to in clause 1 will be due and payable in full to the Deferred Creditors on demand after the Deed of Company Arrangement has terminated.

Proposed written declaration

Following the conduct of a diligent review of the books and records of Company A, the Administrator of Company A's DOCA has reached the following conclusions:

a. There is no likelihood that the Trustee Company as a shareholder of Company A will receive any further distribution for its shares in Company A.

b. The loan made by the Trustee Company to Company A has only negligible value.

The Administrator of Company A's DOCA proposes to make - and has drafted - a written declaration in respect of these conclusions.

Relevant legislative provisions

Income Tax Assessment Act 1997

• Section 103-25

• Section 104-145

Corporations Act 2001

• Section 435C

• Section 437A

• Section 437C

• Section 437D

• Section 442A

• Section 448B

Reasons for decision

Summary

A written declaration - by the Administrator of the DOCA entered into with Company A - that shares owned by the Trustee Company in, and loans it has provided to, Company A have no or negligible value will satisfy the requirements of section 104-145 of the ITAA 1997 and result in CGT event G3 happening (if the Trustee Company chooses to realise its associated capital losses).

Detailed reasoning

CGT Event G3

Section 104-145 of the ITAA 1997 provides the following:

104-145(1)  

CGT event G3 happens if you own shares in a company, or financial instruments issued by or created by or in relation to a company, and a liquidator or administrator of the company declares in writing that the liquidator or administrator has reasonable grounds to believe (as at the time of the declaration) that:

(a) for shares - there is no likelihood that shareholders in the company, or shareholders of the relevant class of shares, will receive any further distribution for their shares; or

(b) for financial instruments - the instruments, or a class of instruments that includes instruments of that kind, have no value or have only negligible value.

104-145(2)  

The time of the event is when the declaration was made.

104-145(3)  

Examples of financial instruments referred to in subsection (1) are:

(a) debentures, bonds or promissory notes issued by the company; and

(b) loans to the company; and

(c) futures contracts, forward contracts or currency swap contracts relating to the company; and

(d) rights or options to acquire an asset referred to in a preceding paragraph of this subsection; and

(e) rights or options to acquire shares in the company.

104-145(4)  

You can choose to make a capital loss equal to the reduced cost base of your shares or financial instruments (as at the time of the declaration).

104-145(5)  

If you make the choice, the cost base and reduced cost base of the shares or financial instruments are reduced to nil just after the declaration was made.

Note: This is for the purpose of working out, if you make a capital gain or loss from any later CGT event in relation to the shares or financial instruments.

Exceptions

104-145(6)  

You cannot choose to make a capital loss if:

(a) you acquired the shares or financial instruments before 20 September 1985; or

(b) the shares or financial instruments were revenue assets at the time when the declaration was made.

104-145(7)  

You cannot choose to make a capital loss for a share, or a right to acquire a beneficial interest in a share, if:

(a) you acquired the beneficial interest (the ESS interest) in the share or right under an employee share scheme; and

(b) subsequent to an amount being included in your assessable income under Division 83A (about employee share schemes) in relation to the ESS interest, section 83A-310 (about forfeiture) applies in relation to ESS interest.

Therefore, in order for CGT event G3 to happen, each of the following elements must be satisfied:

a. There must be a relevant asset. A taxpayer must own:

i. shares in the company; or

ii. a financial instrument issued by, or created by, or in relation to, the company.

b. There must be a relevant Liquidator or Administrator 'of the company'.

c. The Liquidator or Administrator must declare in writing that they have reasonable grounds to believe the relevant matter in paragraph 104-145(1)(a) or paragraph 104-145(1)(b) of the ITAA 1997 applies to the asset in question.

d. The taxpayer must choose to make a capital loss.

Section 104-145 of the ITAA 1997, in its present form, applies to declarations by Liquidators or Administrators made after 21 March 2005.

A declaration by an Administrator or Liquidator is irrevocable because, once the declaration is made, shareholders and instrument owners, are entitled to rely on it for the purpose of making a choice in relation to CGT event G3.

CGT event G3 is not automatic and will only happen if a taxpayer chooses to apply it.

For shareholders who own valueless shares - or owners of valueless financial instruments - in companies in liquidation or administration, the effect of choosing to apply CGT event G3 is that it enables those taxpayers to accelerate a capital loss to the time of the written declaration (by the Administrator 'of the company'), which may not otherwise arise until the loss is actually realised under another CGT event at some time in the future (such as the ultimate disposal by cancellation of the shares, or when the company is deregistered). However, the shares or financial instruments continue to be held with a zero cost base, so that if a distribution on the shares or payment under the financial instrument is subsequently received, a capital gain may be realised, but no further capital loss.

If a taxpayer does not choose to make a capital loss under CGT event G3, no capital loss will be made until the share or security is disposed of, which is usually when the company is dissolved.

There is no provision in section 104-145 of the ITAA 1997 concerning the method of making the choice or election. Therefore, the rule in section 103-25 of the ITAA 1997 applies, which provides that:

• the election must be made by the date on which the tax return is lodged, for the income year in which the CGT event occurs (subject to any extension), and

• the way in which the income tax return for the relevant income year is prepared is sufficient evidence of the election being made (ie. a taxpayer indicates their choice to realise a capital loss under CGT event G3 by the amounts shown in the CGT questions on the return for that income year).

In terms of whether the requirements of section 104-145 of the ITAA 1997 are met in the current circumstances, it is clear based on the facts provided that:

• The Trustee Company's shares in Company A are shares for the purposes of section 104-145 of the ITAA 1997, and

• The Trustee Company's loan to Company A is a financial instrument for the purposes of section 104-145 of the ITAA 1997.

However, it is necessary to determine whether the other requirement of section 104-145 of the ITAA 1997 - that is, a written declaration is provided by an Administrator 'of the company' on the worthlessness of shares/financial instruments in respect of that company - would also be satisfied in the current circumstances.

On the basis of the facts provided, it is the Administrator of Company A's DOCA who proposes to make - and has drafted - a written declaration of the following conclusions based on a review of the books and records of Company A:

a. that there is no likelihood that the Trustee Company as a shareholder of Company A will receive any further distribution for its shares in Company A; and

b. that the loan made by the Trustee Company to Company A has only negligible value.

Therefore, satisfaction of this condition of section 104-145 of the ITAA 1997 is dependent upon whether the Administrator of Company A's DOCA is considered an Administrator 'of the company' for the purposes of section 104-145 of the ITAA 1997. Consideration of this condition is discussed in the section below.

Neither of the exceptions provided under subsections 104-145(6) and 104-145(7) apply in the present circumstances.

Is an Administrator of a DOCA an Administrator 'of the company' for the purposes of section 104-145 of the ITAA 1997?

Appointment and duties of an Administrator

The administration of a financially-troubled company begins with the appointment of a person to act as Administrator, who is charged with the obligation to:

• take control of the affairs and business of the company, and

• investigate the financial situation and affairs of the company with a view to recommending to the company's creditors at the end of that period whether it is in the interests of creditors for the company to execute a DOCA, under which it is expected the company's financial difficulties can be overcome.

The term 'administration' describes the procedure contained in Part 5.3A of the Corporations Act 2001, being 'Administration of a Company's Affairs with a View to Executing a Deed of Company Arrangement'.

During the administration period, the company has the benefit of a moratorium period during which creditors, subject to a few limited exceptions, are prohibited from taking any action against the company to recover debts, enforce charges or have the company wound up without the consent of the Administrator or the court. Owners of property that is being used by the company and lessors of property to the company are also prohibited from seizing or reclaiming property without consent.

When a company enters voluntary administration, shareholders became subject to restrictions, including a restriction on their ability to transfer their shares.

A DOCA - executed under Part 5.3A of the Corporations Act 2001 - is a binding arrangement between a company and its creditors governing how the company's affairs will be dealt with, including the scheduling of payment and the release, if any, of the debts of the company during the life of the deed. Such an arrangement may be agreed to as a result of the company entering voluntary administration. The intent of a DOCA is to maximise the chances of a company - or, as much as possible, of its business - continuing, or to provide a better return for creditors than an immediate winding up of the company, or both. The DOCA is administered by an Administrator.

The Corporations Act 2001 recognises a distinction in office and function between the following:

a. An Administrator 'of the' (or 'of a') company; and

b. An Administrator 'of the' (or 'of a') DOCA.

Section 9 of the Corporations Act 2001 defines an 'Administrator' in relation to a body corporate (but not in relation to a DOCA) as 'an administrator of the body or entity appointed under Part 5.3A'. An 'Administrator' in relation to a DOCA is defined in the Corporations Act 2001 as 'an administrator of the deed appointed under Part 5.3A'.

Section 435C of the Corporations Act 2001 provides that the administration of a company begins when an Administrator of the company is appointed and ends when inter alia a DOCA is executed by both the company and the deed's Administrator.

The two offices are vested with different powers. An Administrator of a company effectively has general powers in relation to a company's affairs, while the powers of an Administrator of a DOCA are confined in essence to administering the terms of the deed.

According to section 437A of the Corporations Act 2001, while a company is under administration, an Administrator of a company:

…has control of the company's business, property and affairs; and may carry on that business and manage that property and those affairs; and may perform any function, and exercise any power that the company or any of its officers could perform or exercise if the company were not under administration.

Further, an Administrator of a company has power to 'execute a document, bring or defend proceedings, or do anything else, in the company's name and on its behalf' and the powers of other officers of the company are suspended. Transactions or dealings affecting property are also void unless entered into by the Administrator of the company or with his/her consent or under a court order.

The Administrator of a DOCA has the power conferred by the instrument (the DOCA) and given force by statute. The deed's Administrator is not at large in relation to the company, nor is the Administrator of a DOCA the company's agent generally.

Object of 2005 amendments to section 104-145 of the ITAA 1997

As originally enacted, former section 104-145 of the ITAA 1997 applied only in respect of declarations made by a Liquidator. As commercial factors may cause a company to appoint an Administrator (rather than a Liquidator) to conduct external administration proceedings, it was considered necessary to extend the scope of CGT event G3 to cover a declaration by an Administrator, particularly as the Administrator is in a similar position to a Liquidator and able to make a judgement that shares or financial instruments in a company are worthless.

Amendments to section 104-145 of the ITAA 1997 were consequentially made in 2005 which substantially broadened the scope of this provision.

In particular, CGT event G3 was extended to relevant declarations made by 'Administrators' after 21 March 2005. This means shareholders of a company that is under voluntary administration may be able to claim a capital loss without having to wait until a Liquidator makes a declaration or the company is dissolved. The amendments also expressly extended to financial instruments.

The regulation impact statement in the Explanatory Memorandum to Tax Laws Amendment (2004 Measures No.6) Bill 2004 (Explanatory Memorandum) explained the policy objective of the amendments in paragraphs 8.29 and 8.30, as follows:

8.29 …to allow taxpayers to more easily claim a capital loss on their worthless shares or financial instruments.

8.30 …to allow a wider range of insolvency practitioners to be able to make the relevant declaration in relation to shares or financial instruments.

Such a policy objective is further supported by paragraph 8.5 of the Explanatory Memorandum:

8.5 …the amendments will allow administrators to make a declaration that causes CGT event G3 to happen and allow the declaration to cover both shares and financial instruments. This will reduce compliance costs for affected taxpayers and allow them to more easily claim a capital loss in respect of their shares or financial instruments.

The Explanatory Memorandum also includes the following relevant paragraph as further explanation of the object of the amendments to section 104-145 of the ITAA 1997, which specifically provides that an Administrator of a DOCA is in a position to reasonably make a declaration for the purposes of CGT event G3 (emphasis added):

8.11 An administrator is appointed under Part 5.3A of the Corporations Act 2001 to conduct external administration proceedings. An administrator of a company would require a comprehensive grasp of all of the company's affairs in order to have reasonable grounds to make a declaration for the purposes of CGT event G3. Generally, only an administrator appointed in relation to a deed of company arrangement will be in a position to reasonably make this assessment.

Therefore, despite the differences in the offices of an Administrator 'of a company' and an Administrator 'of a DOCA' under the Corporations Act 2001, the object of section 104-145 of the ITAA 1997 is to allow specified persons with the requisite knowledge of the company's affairs to declare the worthlessness of assets. It is an ameliorating provision, designed to ensure a real but unrealisable capital loss can crystallise.

This is further supported by the language in the media release announcing the 2005 amendments to section 104-145 of the ITAA 1997, where it is stated that the intent of the improvements to the CGT regime (including to section 104-145 of the ITAA 1997) was to 'allow any insolvency practitioner to declare shares and other securities in a company to be worthless for CGT purposes'.

Scope of the term 'of the company' for the purposes of section 104-145 of the ITAA 1997

Part 5.3A of the Corporations Act 2001 was drafted on the basis that a DOCA may follow an administration (though they are separate). It is a form of administration governed by a deed, and agreed to by the creditors. The required qualifications of an Administrator are identical between those appointed in relation to a company or a deed and both offices are within the ambit of Chapter 5 of the Corporations Act 2001 dealing with external administration.

Further, an entity which enters into a DOCA must have been in voluntary administration previously and such entities can only have been insolvent at that time. Therefore, the shares by definition are worthless. Given that the powers of the directors are suspended with the appointment of the Administrator of a DOCA and are presumably not revived as a term of the DOCA, then only the Administrator of a DOCA has standing to make a declaration in any event for the purposes of CGT event G3 under section 104-145 of the ITAA 1997.

The Explanatory Memorandum does not distinguish between an Administrator 'of a company' and an Administrator 'of a DOCA'. In fact, paragraph 8.11 of the Explanatory Memorandum emphasises that only an Administrator of a DOCA will generally be in a position to make a declaration for the purposes of section 104-145 of the ITAA 1997.

Based on the object of the amendments to section 104-145 of the ITAA 1997 (as stipulated in the relevant paragraphs of the Explanatory Memorandum above), it is considered that the intention of the legislature in amending section 104-145 of the ITAA 1997 in 2005 was to capture and include in the scope of this provision - specifically the term 'of the company' - an Administrator of a DOCA.

Conclusion

Therefore, in the present circumstances, a written declaration by the Administrator of Company A's DOCA that shares owned by the Trustee Company in, and loans it has provided to, Company A have no or negligible value will satisfy the requirements of section 104-145 of the ITAA 1997 and result in CGT event G3 happening (if the Trustee Company chooses to realise its associated capital losses).

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