The Australian Taxation Office, in its most recent Compliance Focus, has flagged that it is on the lookout for value shifting.
If you own shares in a company or interest in a trust, you may be impacted by the value shifting rules. Failure to understand these rules can result in adverse tax consequences, especially for business owners seeking to admit other parties to their business.
The value shifting regime
The regime addresses arrangements that shift value out of assets, distorting the relationship between
their market values and their values for tax purposes. Without a value shifting regime, these
arrangements could encourage the creation of artificial losses and the deferring of gains.
The value shifting rules address arrangements that shift value out of assets and into other assets at less than market value. This practice may defer capital gains and/or create artificial losses. The value shifting regime has three components:
- Direct Value Shifts (DVS) involving equity or loan interests in companies and trusts;
- Direct value shifting creating rights in relation to non-depreciating assets;
- Indirect value shifting involving non-arm’s length dealings.
The DVS rules may come into play where shares or units are issued as a discount compared to what they are worth. This may be undertaken for any number of reasons, including:
- Succession planning – A parent may wish to ensure that their child carries on the family business;
- Admission of a new partner – A business owner may wish to admit a new partner to the business;
- Streaming of dividend income to minimise tax – You issue dividend access shares.
In all of these cases, the value of assets is shifted out of one entity (being the existing shares of the company) and into another (being the new shares in the company) at no charge or at a discounted rate.
For example, A and B each hold 1 share in the family business which is run through a company. The shares were originally issued at $1 each, having built up the business into a very profitable business. Their son, C, recently expressed an interest in working in the business and, nearing retirement, A and B consider him the perfect person to take over the family business. They subsequently issue another share in the business to C for free – There are now 3 equal shares in total.
In this situation, in the absence of the DVS rules, 1/3rd of the company’s value has been shifted to C, free of charge, with no tax consequences.
The DVS rules address the shifts by adjusting the costs base of shares or units in these companies/trusts, and in some cases, crystallise a capital gain.
The DVS rules may have application to the following entity types:
- Unit trusts;
- Fixed trusts; and
- Hybrid trusts.
The DVS rules do not apply where:
- The total value is less than $150,000 (the de-minimus exemption);
- The entities involved are in the same consolidated group;
- Interests are issued for more than their market value;
- Existing interests are sold at a discounted rate or are transferred free of charge.
Without the value shifting rules, capital gains may be deferred and artificial losses created. The DVS rules nullify this. In general terms, they may have the following effect:
- Entities with interests that decrease in value will be required to decrease the tax values of their interests and, in some cases, may make gains that are included in the assessable income in the year in which the value shift happens; and
- Entities with equity or loan interests that increase in value or that are issued at a discount, in relation to the same scheme, will be required to increase the tax values of their interests.
The rules apply to equity or loan interests in companies or trusts irrespective of their character for tax purposes. This means the rules will not be confined in their application to those interests held as capital assets (eg. shares), but will also extend to those held as trading stock or otherwise held as revenue assets.
For business owners, an awareness of the value shifting rules is essential, if you are contemplating succession planning, or meeting a new business partner. If you are not aware of the value shifting provisions, you will potentially incur a significant tax loss as a result of the value shift, without receiving any economic proceeds from the party to whom you have shifted value.
Contact us to find out more or to arrange a consultation with one of our experienced lawyer conveniently located in Sydney CBD.