Senate

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

CHANGE OF TITLE - TAX LAW IMPROVEMENT BILL (No. 1) 1998 - SENATE - Explanatory Memorandum.

Chapter 2.23 - Share value shifting

Overview

This segment covers the rules in Division 140 that deal with attempts to obtain a capital gains tax advantage through schemes that shift value between different shares.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

A. Summary of the new law

Subdivision 140-A: When there is share value shifting

What the Subdivision does

Subdivision 140-A identifies what are share value shifts. The purpose of Division 140 is to prevent entities from obtaining a capital gains tax advantage from share value shifting which transfers value from one lot of shares to another lot.

CGT event G2 - a shift in share values

A shift in share values occurs if there is a material decrease in the market value of a share, or a right or option to acquire a share as a result of a scheme involving the company and its controller. [sections 104-140, 140-10 and 140-30]

How a share value shift occurs

A share value shift occurs if:

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the company, a controller of the company or an associate does something under a scheme involving one or more shares in the company;

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there results a decrease in the market value of one or more of the shares held by a complicit entity;

•

the shares were acquired after 19September1985 (post-CGT);

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new shares in the company are issued at a discount to the entity or an associate, or shares held by the entity or associate increase in value; and

•

the changes in value are reasonably attributable to the events of the scheme.

[section 140-15]

When an entity is a controller of a company

An entity is a controller if:

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it has an associate-inclusive control interest of at least 50%; or

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it has an associate-inclusive control interest of at least 40% and no other entities control the company; or

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alone or with an associate, it controls the company.

[section 140-20]

An associate-inclusive control interest

An entity has an associate-inclusive control interest in a company if the requirements in Subdivision A of Division 3 of PartX of the 1936 Act are met.

Material decrease in the market value of a share

There are rules for determining whether a shares market value has materially decreased as a result of a share value shift. [section 140-25]

Exceptions - off-market buy-backs

A share value shift is disregarded if it is attributable to certain off-market buy-backs of shares. [subsection 140-15(8)]

Subdivision 140-B: Consequences of share value shifting

What the Subdivision does

Subdivision 140-B determines the capital gain and the required adjustments to the cost bases and reduced cost bases of shares following a share value shift. [sections 140-55, 140-60 and 140-65]

The rules vary when value is shifted into shares that were acquired before 20 September 1985 (pre-CGT). [sections 140-90 and 140-95]

There are exceptions if the decreases and increases in value cancel for every shareholder. [sections 140-50]

When a controller of a company or an associate of a controller makes a capital gain

The controller, or their associate, will make a capital gain if:

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their shares materially decrease in market value; and

•

the shift proceeds are greater than a specific part of the cost base of those shares.

•

The capital gain is the excess. [subsection 140-55(2)]

Cost base adjustment - shares decreasing in value

There is a statutory formula for adjusting the cost base and reduced cost base of shares that decrease in value as a result of the value shift. [section 140-60]

Cost base adjustment - post-CGT shares increasing in value

There are formulas for increasing the cost base and reduced cost base of post-CGT shares that materially gain value as a result of the value shift, if they are held by:

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a controller;

•

an associate of a controller; or

•

in some cases, an associate of such an associate.

The formula to be used depends on whether the gain in value is as a result of the decrease in value of shares owned by the owner of the shares that decreased in value or by another entity. [sections 140-65, 140-70 and 140-75]

Material increase in the market value of a share

There are rules for determining whether a shares market value has materially increased as a result of a share value shift. [subsections 140-65(3) to (5)]

Value shifted into shares acquired pre-CGT

When a controller makes a capital gain

When the value is shifted to shares acquired by the controller or their associate pre-CGT, a capital gain will be made if:

•

their post-CGT shares materially decrease in market value; and

•

the shift proceeds exceed a specific part of the cost base of those shares.

•

The capital gain is the excess. [section 140-90]

Cost base adjustment - post-CGT shares decreasing in value

There is a statutory formula for adjusting the cost base and reduced cost base of post-CGT shares that decrease in value as a result of the value shift. [section 140-95]

B. Discussion of changes

Subdivision 140-B Consequences of share value shifting

Change

Examples have been used extensively to illustrate the operation of the formulas.

Explanation

The rewritten provisions make extensive use of numerical examples to illustrate the application of formulas. This is because the formulas, which reflect existing policy, are complex and difficult to understand.

Section 140-50 What if the share value shift is neutral for each shareholder

This section applies if, for each shareholder whose shares are affected by a share value shift, the sum of the gains in market value of shares that increased in value is equal to the sum of the losses in market value of shares that decreased in value. The effect of the section is to apply the Division to each shareholder as though the share value shift consisted only of a shift in value among that shareholders shares.

Change

This is a new provision.

Explanation

In circumstances such as an issue of new shares at other than market value to existing shareholders, in proportion to their respective existing shareholdings, provided value is not shifted into shares acquired pre-CGT, no shareholder will be taken to have made a capital gain. There will be adjustments to the cost base (and reduced cost base) of the shares only.

The provision will simplify the application of the law.

Sections 140-55 and 140-90 Making a capital gain

These sections explain how to calculate a capital gain that results from CGT event G2.

Change

Clarify that the capital gain is calculated by reference to all relevant increased value shares.

Explanation

Under the existing law, it is unclear whether the capital gain that results from a share value shift is calculated on a share by share basis. The rewritten provisions clarify that the capital gain is calculated by reference to all relevant shares that increase in value. This is a practical outcome that is consistent with the underlying policy and administrative practice.

Section 140-60 Cost base adjustment for shares decreasing in value

Section 140-95 Adjustments to cost base and reduced cost base

These sections will adjust cost bases and reduced cost bases of shares that have been reduced in value by a share value shift.

1. Change

Specify that cost base reduction of any share cannot exceed the reduction in its market value.

Explanation

Without this restriction, the formulas would operate to eliminate some or all losses in value that had accrued but were unrealised at the time of the share value shift.

2. Change

Specify that cost base adjustments become effective at the time of the share value shift.

Explanation

Under the existing law, if there are successive share value shifts without intervening disposals of affected shares, the cost base adjustments made as a result of earlier share value shifts are not effective for the purpose of later share value shifts. Consequently, capital gains and cost base adjustments in later share value shifts may be determined by reference to cost bases of shares without regard for the earlier value shifts. The rewritten provision corrects this unintended result.

Section 140-65 Cost base adjustment for shares increasing in value

This section will adjust cost bases and reduced cost bases of shares that have increased in value because of a share value shift.

1. Change

Specify that cost base adjustments become effective at the time of the share value shift.

Explanation

The explanation for this change is the same as that for the second change under sections 140-60 and 140-95.

2. Change

Standardise the formulas for increasing the cost bases of shares that materially increase in value in a share value shift.

Explanation

In all of the formulas, the rewritten law makes the increase in the cost bases dependent upon the increase in market value being reflected in the state or nature of the shares on their subsequent disposal.