bright-line test and the sale of shares, money changing hands for sharesDoes the bright-line test apply to the sale of shares in a company? We take a look at a case study that explains this scenario.

In April 2018, Rhys acquired 65% of the shares in QRS Ltd and at that time the company acquires an apartment block and the land it is built on. Those assets comprise more than 50% of the assets of the company. The property was acquired by the company as a residential rental investment. Now Rhys and the other shareholders wish to sell the company, which means that the shares will be transferred to a new owner. Will the sale of shares be caught by the bright-line test?

Because the apartment property was acquired in April 2018, this falls within the 5-year bright-line test period. The rules state that the sale of Rhys’ shares can trigger a taxing event under the bright-line test if:

  • QRS Ltd owns residential land – in this case the apartment block; and
  • The market value of that residential land makes up 50% or more of QRS Ltd’s assets; and
  • The sale of shares occurs within 2, 5 or 10 years of the date of registration of QRS Ltd’s title to the land – in this case within 5 years.

On the basis that the shares in the company were held as an investment by the shareholders, any actual gain on the sale of the shares will not be taxable. However, given that the apartment block and land do account for more than 50% of QRS Ltd’s assets, the sale of shares by Rhys and his other shareholders will trigger taxing events under the bright-line test. Upon the sale of their shares, each shareholder will be deemed to buy their portion of the apartment property at cost from the company and then they are deemed to resell their portion of the apartment property back to the company at market value. Any gain on disposal from those deemed transactions will be taxable income of the shareholder.

Please contact us if you have concerns or questions regarding the bright-line test.