SURGERY WITH ANAESTHETICS: M&A TAXATION

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1 18 December 2015 SURGERY WITH ANAESTHETICS: M&A TAXATION Ken Spence, Special Counsel Edward Consett, Senior Associate Greenwoods & Herbert Smith Freehills Pty Limited Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills 2015 Disclaimer: The material and opinions in this article are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this article and does not have any view as to its accuracy. The material and opinions in the article should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.

2 CONTENTS Introduction... 3 Scrip-for-scrip relief... 5 Transaction-related distributions Consolidations regime where the target company joins the acquiring company s tax consolidated group Demergers Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

3 Introduction Undertaking a corporate restructure prior to the late 1990s was much like attempting heart surgery without anaesthetics: there were no specific provisions designed to deaden the pain of significant tax exposures. In reality, the only shot of whisky and biting the bullet panacea that may have enabled taxpayers to survive a corporate restructure was either the pre-cgt status of their shareholdings or the extensive use of distributions from share capital accounts neither of which are still as readily accessible. The introduction of scrip-for-scrip relief (1999), the tax consolidation regime (2002) and demerger relief (2002) have been game changers and without doubt have facilitated numerous corporate restructures and takeovers that could not otherwise have been implemented. As such, they have played no small part in increasing the efficiency of the Australian economy. As these restructuring-related tax regimes have all been in operation for some years, their general eligibility criteria and scope are well known and this article does not seek to re-state them. Rather, this article focuses on some of the more important problem areas and anomalies that exist in the application of the scrip-for-scrip, demerger and consolidation provisions in the context of takeovers and corporate restructures. In addition, reference is also made to issues associated with distributions that may relate to a takeover or restructure. The following points are noted in relation to this article. For ease of reference, a summary table format has been used, divided into the following parts: scrip-for-scrip relief; transaction-related distributions; consolidation regime where the target company joins the acquiring company s tax consolidated group; demergers. These summary tables do not profess to deal with every issue that can arise in these contexts, but rather focus on those that are most important or sometimes misunderstood. A number of aspects discussed can be problematic both for taxpayers and the Australian Taxation Office (ATO) because the relevant legislative provisions are very widely drafted and seem to anticipate that they be applied within the context of broad but unstated policy objectives. Therefore, in addition to considering these broader policy objectives, in many cases it is essential to engage with the ATO which will commonly involve seeking to confirm outcomes by way of a binding private or class ruling. Some of the discussion in this article is based on ATO Class Rulings (CRs) and ATO Edited Private Rulings (EPRs). Although this material can provide some insight into the ATO s approach, they should be treated with caution. The ATO makes it clear that an EPR is not a publication approved in writing by the Commissioner and is not intended to provide you with advice, nor does it set out the ATO's general administrative practice. Similarly, a CR applies to Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

4 the entities or class of entities in relation to the scheme or class of schemes set out in the ruling only. Particularly in the context of CRs and EPRs that were issued some time ago, it is also possible that the ATO s views have altered. Similarly, in the context of ATO Interpretative Decisions (ATO IDs), they are not regarded by the ATO as binding on it but may mitigate penalty exposures. Therefore even in circumstances where ATO material such as CRs, EPRs or ATO IDs may appear to be specifically applicable to a pending transaction, it will often be appropriate to seek a specific and binding ruling from the ATO prior to implementing the restructure. This article was updated on 16 December 2015 and therefore encompasses the scrip-for-scrip 2015 legislative amendments and also has regard to the proposed earnout amendments that were introduced into the Parliament on 3 December 2015, but have yet to be debated or passed by the Parliament. This article primarily focuses on restructures involving corporate entities, and does not seek to address issues that can arise in relation to transactions involving trusts or trust structures. Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

5 Scrip-for-scrip relief Scrip-for-scrip roll-over relief can enable a vendor shareholder to disregard a capital gain they make from shares that are disposed of as part of a corporate restructure, if the shareholder receives replacement shares in exchange. While various divisions of the Income Tax Assessment Act 1997 (Cth) provide scrip-for-scrip relief, the most broadly applied provisions are contained in Subdiv 124-M and it is these provisions to which the majority of the comments in the table below relate. However, newly introduced Div 615 (previously Subdiv 124-G) can apply to certain top hatting scrip-for-scrip restructuring transactions and Div 122 can apply where the target company is wholly-owned by a single individual or a partnership. It is outside the scope of this article to list and discuss in detail all the specific eligibility criteria for obtaining Subdiv 124-M relief, but some of the key requirements are briefly summarised as follows. The vendor shareholder exchanges shares in the target company for shares in another company (s (1)). The exchange of shares occurs as a consequence of a single arrangement that results in the acquiring company becoming the owner of 80% or more of the voting interests in the target company (s (2)). Under that single arrangement at least all owners of voting shares in the target company must be able to participate, and except in certain circumstances it is necessary that this participation be available on substantially the same terms (ss (2) and (2A)). But for roll-over relief, the vendor shareholder would have made a capital gain as a result of the disposal (s (3)). The shares received in exchange must be in the acquiring company or, if applicable, the ultimate holding company of the wholly-owned group which includes the acquiring company (s (3)). Where the significant stakeholder or common stakeholder provisions apply (ss and ), the vendor shareholders and the acquiring company must jointly choose rollover and the vendor shareholders must provide information as to the cost base (ss (3)(d) and (e)). Additional requirements can apply if the vendor shareholders and the acquiring company do not deal with each other at arm s length and widely held entity exemptions do not apply (ss (4) and (5)). On 13 October 2015 the scrip-for-scrip roll-over rules were further amended, with effect from 8 May 2012, to deal with deficiencies that the government identified as a result of the case Commissioner of Taxation v AXA Asia Pacific Holdings Ltd (2010) FCAFC 134. Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

6 2 SCRIP-FOR-SCRIP RELIEF 2.1 Eligibility aspects Aspect Nature of roll-over relief. Only CGT relief is provided in respect of a gain that would otherwise arise on disposal of the target shares (s (2), s (3)). In the context of the exchange of shares associated with the interposition of a new holding company (new Div 615, previously Subdiv 124-G) legislative amendments in December 2014 extended roll-over relief to encompass shareholders in the target company who hold their shares as trading stock or revenue assets. However, unfortunately this extension of relief still does not apply in the more common scrip-for-scrip Subdiv 124-M context, which still only provides CGT relief Aspect Participation available on substantially the same terms to all owners of interests of a particular type (s (2)). i. This can be an issue where consideration provided to holders of original interests may vary. ii. Takeover bids governed by Corporations Act or acquisition pursuant to scheme of arrangement are generally not subject to this condition (s (2A)). Notwithstanding that the acquiring company is prepared to deal with each of the vendor shareholders on substantially the same terms, if at the request of the vendor shareholders the consideration is allocated between them on a disproportionate basis, this will invalidate roll-over relief (FCT v Fabig 2013 ATC ). Takeover provisions of Corporations Act require that all shareholders be treated equally. A scheme allows for different consideration, provided it is disclosed. This may require separate meetings of security holders Aspect Whether replacement interests can be issued in a subsidiary of a wholly-owned group (s (3)). Where the acquiring company is a member of the whollyowned group then the ATO s view had been that the replacement interests must be shares in the company that is the ultimate holding company of that wholly-owned group (s (3)(ii)). This restrictive ATO view is anomalous in that more appropriate commercial outcomes would arise if in such circumstances the replacement interests could be issued in either the ultimate holding company or in the acquiring company itself, as this would further facilitate a range of incorporated joint ventures. This issue was relevant in Class Ruling CR 2007/113 (now withdrawn) which in its original version suggested that the ATO accepted that replacement interests could be issued in the acquiring company, notwithstanding that it was a member of a wholly-owned corporate group prior to the arrangement. In a note to the withdrawal of the ruling issued on Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

7 8 October 2008 the ATO indicated that the initial version of the Ruling was incorrect at law because a replacement interest must be issued in the ultimate holding company of the wholly-owned group. In the context of this issue, consideration could be given to the definitions of a wholly-owned group and 100% subsidiary (Subdiv 975-W) given that at the time of acquiring the shares in the target company and prior to the issuing of the acquiring company s shares as consideration the in a position to affect rights provision may apply (s ) such that prior to the final implementation of the transaction the acquiring company may have already ceased to be a member of the wholly-owned group (refer TR 2000/15). (Note: it is not apparent that the ATO accepts this proposition in the context of the application of Subdiv 124-M.) (d) However, more broadly in the context of scrip-for-scrip transactions, ATO ID 2002/239 indicates that the ATO s view is that this wholly-owned group aspect is tested immediately before the implementation date of the restructure and not at an earlier date (eg not at the date the offer is made to the vendor shareholders) Aspect Contractually interrelated arrangements. Contractually interrelated transaction steps for arrangements need to be carefully considered, as in some circumstances they can invalidate scrip-for-scrip relief. A key example in this regard is illustrated in Edited Private Ruling 78306, where the vendor shareholder, being a company, was considering entering into an arrangement whereby it would dispose of shares in the target company under a scrip-for-scrip arrangement and immediately following obtaining replacement shares in the acquiring company the taxpayer company intended to implement a demerger whereby these replacement shares would be distributed to its shareholders. Contractually, the scrip-for-scrip transfer and the subsequent demerger were interdependent and, in particular, the scrip-forscrip transfer could not be undertaken unless the demerger had been approved to be implemented (including obtaining confirmation that Div 125 demerger relief would be available). In the circumstances, the ATO determined that scrip-for-scrip relief was precluded by virtue of s (2) because any capital gain that the vendor shareholder may make in respect of the replacement shares it acquired under the scrip-for-scrip transaction would be disregarded by virtue of s on the immediately following demerger (and the demerger was not considered to be a roll-over for the purposes of s (2)) Aspect Other shares issued or new debt owed relating to the arrangement. As a result of a newly enacted provision (s (3)(f), it is possible that scrip-for-scrip relief may not be available if the acquiring entity is a member of a wholly-owned group (irrespective of whether or not it is a tax consolidated group) and in relation to the arrangement new shares are issued in addition to the shares issued to the vendor shareholders or new debts become owing by any member of the group to an external party. This new prohibition from obtaining script-forscript relief is only triggered if the new non-group equity or debt relates to the issuing of the replacement script-for-script shares i.e. it does not apply to the cash component of any consideration paid. A not dissimilar rule was contained in a July 2012 Treasury Proposals Paper. However, at that time it appeared that this rule would only apply if the arrangement was: subject to the significant stakeholder or common stakeholder provisions; the debt or additional shares were issued by a company other than the ultimately holding company of the group; and these shares or new debt was issued to an entity outside the group that was controlled but not wholly owned by the Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

8 group. These important limitations are not reflected in the new provisions, albeit that they will have retrospective effect back to 8 May In the case of a partial cash/share takeover by a corporate group, to the extent that the group funds the cash component of the consideration by either an external borrowing or an external share placement, prima facie this will not invalidate roll-over relief being claimed on the share component of the consideration but particular care will have to be taken to ensure that exemption requirement is satisfied. [EM para 1.36 and 1.37] 2.2 Commonality of shareholders (ie the significant stakeholder and common stakeholder provisions) Aspect The percentage of the vendor shareholders interests in the target company and their pre- or post-implementation interest in the acquiring company can have significant implications. The potential importance of these percentage interest tests applicable to the vendor shareholders cannot be overstated, in that they can not only impact on the eligibility to obtain rollover relief but also they can dramatically impact on the cost base that the acquiring company obtains in respect of the shares it acquires in the target company. The cost base that the acquiring company obtains in the shares it acquires in the target company (or the cost base it obtains in the assets of the target company by way of the tax consolidation regime) can be impacted by a range of scenarios where specific cost base determination provisions apply: Div 615: the acquiring company acquires all the shares in the target company, and after the transaction the vendor shareholders own all the shares in the acquiring company in the same proportional numbers and values as they held in the target company; Div 122: the vendor shareholder is a single individual or a partnership, and the acquiring company is whollyowned by them; significant stakeholders s : a vendor shareholder holds a 30% or greater interest in the target company and ultimately holds a 30% or greater interest in the acquiring company; common stakeholders s or s A: if shareholders with a combined interest of 80% or more in the target company ultimately have an 80% or more interest in the acquiring company; under the newly enacted s A both the significant stakeholders and common stakeholders tests are expanded to also take into account options and other entitlements to acquire membership interests or other rights that can be exercised within five years. Importantly, these stake options are only taken into account in respect of options held by the vendor shareholder that is the focus of the particular significant or common stakeholder test. As such, option interests held by other shareholders do not increase the denominator in the relevant percentage threshold calculations. It is proposed that these measures have effect back to 8 May As a point of caution, it is possible that this measure could have significant and possibly unintended outcomes in the context of a scripfor-scrip takeover where the number of shares to be issued in consideration is subject to an uncapped earnout Aspect Anomalous extension of the common stakeholder classification and related impacts. i. Prima facie, if the acquiring company holds any shares at all in the target company prior to implementing the arrangement, all other shareholders in the target company (irrespective of the application of an associate test) will be deemed to be common stakeholders under the arrangement, even if, after the arrangement, the vendor shareholders do not hold 80% or more of interests in the acquiring company or the ultimate holding Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

9 company of the acquiring company (ie the replacement entity) (s (4)). ii. However, if either the target company or the replacement entity are widely held before the arrangement commences (ie have at least 300 members and also satisfy the more than 20 people / 75% test ), then the common stakeholder provisions do not apply (s (5)). If in any circumstances the common stakeholder or significant stakeholder provisions apply, then the following additional eligibility requirements apply: the vendor shareholder and the replacement entity must jointly choose roll-over relief (s (3)(d)); and the vendor shareholder must inform the replacement entity in writing of the previous cost base of their shares in the target company (s (3)(e)). Therefore in such cases the compliance issues associated with obtaining roll-over relief are significantly more administratively burdensome. Aspects associated with the resulting cost base implications for the acquiring group are noted below at Aspect Cost base limitations imposed on the acquiring company (s ). Where Subdiv 124-M roll-over relief applies to either significant stakeholders or common stakeholders, the fact that the acquiring company will inherit the cost base that the vendor shareholders had in their shares in the target company (rather than obtaining a market value cost base) can have significant adverse implications. (Note: a vendor shareholder cannot claim roll-over relief in respect of a share if the market value of the share is below its cost base (s (3)).) Where the acquiring company inherits the vendor shareholder s cost base in shares in the target company, impacts can be most adverse and direct where the target company joins the acquiring company s tax consolidated group. In these circumstances, this suppressed cost base of shares similarly suppresses the step 1 amount of allocable cost amount (ACA) that is used to reset the tax value of the assets of the target company. Given the interaction with the resulting allocation of the ACA based on the relative market value of reset cost base assets of the target company, this can commonly result in a significant reduction in the tax values of the target company s revenue assets (eg trading stock), capital allowance assets and foreign currency trade receivables, such that on the subsequent disposal of such assets a significantly higher taxable gain may be triggered than would otherwise have been the case. Recommendation 7.2 of the Board of Taxation s (BoT) April 2013 report entitled Post-implementation Review of Certain Aspects of the Consolidation Tax Cost Setting Process proposed that this problem be addressed, albeit in the limited circumstance where a new holding company is interposed over an existing tax consolidated group under a restructure and the provisions of Div 615 would not otherwise apply (refer (d) below). The Government has yet to announce its response to this Recommendation. If the restructure simply involves the imposition of a new interposed holding company above the target company in circumstances where the provisions of Div 615 apply, and the target company was previously the head company of a tax consolidated group, then that consolidated group is deemed to continue to exist with the interposed company becoming its substituted head company (s to s ). As such, the assets of the target company retain their Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

10 existing tax values. (d) Otherwise, where Div 615 applies (rather than Subdiv 124-M) the cost base to the acquiring company of shares in the target company are reset based on the tax value of assets of the target company less its liabilities (s ). Where the common stakeholder provisions do not apply solely because the target company or the replacement entity are widely held, and certain market value ratios are met (s A), then the tax cost of shares in the target company are reset based on the tax value of assets of the target company less its liabilities (s B); or, where the tax consolidation provisions apply, in some circumstances it is possible to elect that the underlying assets of the target company retain their existing tax values (s /920). 2.3 Downstream acquisitions Aspect Downstream acquisitions debt or equity funding the acquiring company to undertake the acquisition of shares in the target company. i. Particularly in unconsolidated groups, the significant stakeholder and common stakeholder cost base limitation mechanisms outlined at above could previously be easily circumvented by a subsequent sale of the ultimate holding company s shareholding or debt interests in the acquiring company, as compared to the acquiring company subsequently disposing of its suppressed cost base shares in the target company. ii. By way of amended s these downstream cost base adjustment provisions have been significantly broadened with retrospective effect back to 8 May iii. In addition, as noted at above, by way of the new provisions roll-over relief may not be available in the context of downstream acquisitions where equity (other than the replacement shares) or debt is issued outside a wholly-owned group as part of the takeover arrangement. The provisions of s had limited application as they only applied to new equity issued in or new debt owed by the acquiring company directly to the ultimate holding company under the arrangement, and in respect of such debt funding these provisions had no impact if the acquiring company subsequently repaid the debt to the ultimate holding company. The amended s introduces a far broader and onerous regime that will apply with retrospective effect back to 8 May In particular, the exemption that applied when an impacted intra-group loan was repaid (s (3)) has been removed; and where the acquiring company in a wholly-owned group issues as part of the arrangement equity or debt to another company in the group (including the ultimate holding company), an appropriately suppressed cost base will be allocated to such debt or equity. These new s cost base adjustments should not be necessary where the acquiring company and the ultimate holding company are members of the same tax consolidated group. (d) These new measures also apply to widely-held group top-hatting scrip-for-scrip related restructures to which s A applies. Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

11 Transaction-related distributions Transaction-related distributions can be used to provide value to vendor shareholders. Distributions may be made by the: target company, which will usually take the form of a dividend or return of capital prior to the acquisition; or in a scrip acquisition, by the acquirer which may take the form of a dividend, return of capital or a contingent value right issued as part of the acquisition. It is outside the scope of this article to list and discuss in detail all possible types of distributions and likely income tax outcomes. Instead, this article focusses on some of the critical issues concerning: pre-acquisition dividends paid by the target company; and contingent value rights issued by the acquirer as part of the acquisition. 3 TRANSACTION-RELATED DISTRIBUTIONS 3.1 Pre-acquisition dividends Aspect In certain circumstances, a pre-acquisition dividend paid by the target company may be included as part of the consideration received by vendor shareholders for sale of interests in the target company. Where a vendor shareholder makes a taxable capital gain from the disposal of interests in the target company and does not have carry-forward or current year capital losses, the inclusion (or otherwise) of the dividend in the consideration received from the disposal should not affect the tax outcome for the vendor shareholder. This is due to the anti-overlap provision in s However, where a vendor shareholder makes a capital loss from the disposal of interests in the target company the dividend will be assessable while also reducing the capital loss if it is considered part of the disposal consideration. If scrip-for-scrip relief is obtained for the disposal, the inclusion of the dividend as part of the capital proceeds will result in a permanent loss of cost base in the shares issued by the acquiring company to the vendor shareholder. This is because part of the cost base of the vendor shareholder s shares in the target company will need to be apportioned to the capital proceeds comprising the dividend (s (2)). The ATO (in TR 2010/4) considers that a dividend will be part of the capital proceeds received by a vendor shareholder for the disposal of shares (CGT event A1) if: the vendor shareholder: is entitled under the contract to refuse to complete the transfer if the dividend is not declared by the target Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

12 company or if the dividend is not paid by the target company; or is entitled to refuse to complete the transfer if a purchaser or third party does not finance or facilitate payment of the dividend; or has bargained for any other obligation on the part of the purchaser to bring about the result that the dividend shall be received by the vendor shareholder; or the disposal of shares occurs under a scheme of arrangement and the vendor shareholders acceptance of the scheme is conditional on one or more of the following: the dividend being declared by the target company; or the purchaser or a third party financing or facilitating payment of the dividend; or the purchaser or a third party being obliged to bring about the result that the dividend will be received by the vendor shareholders Aspect Negotiation or adjustment to the purchase price made by reference to a pre-acquisition dividend to be paid by the target company may be a related payment for determining the vendor shareholders entitlement to franking credits. Reference in this section is made to certain former sections of the Income Tax Assessment Act 1936 (Cth) (ITAA36) which ceased to have application from 1 July 2002 and have not been re-enacted in the ITAA97. In TD 2007/11 the ATO stated its view that taxpayers must still have regard to these former provisions when determining a shareholder s entitlement to franking credits. Normally, vendor shareholders will be entitled to franking credits if they have held their shares in the target company at risk for at least 45 days during the period (former s 160APHD): i. beginning the day after acquiring the shares; and ii. ending on the 45 th day after the shares go ex-dividend. However, if there is a related payment (former s 160APHN), the vendor shareholders will only be entitled to franking credits if they have also held their shares in the target company at risk for at least 45 days during the period (former s 160APHD): i. beginning 45 days before the shares go ex-dividend; and ii. ending on the 45 th day after the shares go ex-dividend. For income tax purposes, shares go ex-dividend on the day after the last day on which the acquisition by a person of the share will entitle the person to receive the dividend (former s 160APHE). In a takeover scenario, the shares may cease to be held : when a contract to sell is entered into, which may be (see, for example, CR 2012/122): when a takeover offer is accepted by a shareholder and the offer is declared unconditional; or when shares are compulsorily acquired pursuant to the Corporations Act 2001; on the scheme record date (see, for example, CR 2012/53). Depending on the nature of the arrangements between the shareholder and the acquirer, including the terms of the takeover bid, consideration may need to be given to the deemed disposal rules in former s 160APHH. In practice (and subject to former s 160APHH considerations), this can mean that if there is a related payment the dividend record date should be: in the case of sale by contract: before the date of acceptance; Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

13 in the case of sale by scheme: before the scheme record date. Therefore, it is relevant to recognise that the ATO considers there to be a related payment if the pre-acquisition dividend is an integral part of the arrangement (CR 2012/122). This turns on whether: most importantly, the dividend reduces the consideration payable by the acquiring company for the takeover; and the payment of the dividend is conditional upon the target company gaining approval from the vendor shareholders to enter into a scheme of arrangement. (d) (e) However, given that a related payment is an arrangement whereby the taxpayer passes on the benefit of a dividend or distribution to another party, it may be worth questioning whether the reduction in purchase price payable as a result of a pre-acquisition dividend really is a benefit being passed on to the acquirer. In reality, the value of the target company has reduced because, as a result of paying the dividend, the target company has fewer assets. This could suggest that no net benefit is being passed onto the acquirer. Finally, the negotiation of a pre-acquisition dividend could also cause non-tax complications such as occurred in Saputo Dairy Australia Pty Ltd s bid for Warrnambool Cheese and Butter Factory Company Holdings Limited (Australian Government Takeovers Panel, Warrnambool Cheese and Butter Factory Company Holdings Limited Panel Decision (Media Release, TP13/69, 17 December 2013)) Aspect A takeover may cause a company to become an exempting entity (s ). This will occur if and when the company is effectively controlled by prescribed persons, such as foreign entities (s /45). If the target company pays a franked dividend to Australian resident vendor shareholders after it has become an exempting entity the distribution will generally be treated as an unfranked dividend in the hands of the Australian resident vendor shareholder (s ). (d) In broad terms, an entity is effectively owned by prescribed persons (eg foreign entities) if 95% or more of accountable membership interests or accountable partial interests (broadly direct and indirect ownership interests) are held by or on behalf of prescribed persons (s 208-5). The target company will become an exempting entity where at least 95% of the interests in the target company are held by or for the benefit of a foreign acquirer, or it is reasonable to conclude that the risks and opportunities from holding interests in target company substantially accrue to the foreign acquirer (ss to ). Generally speaking, it appears the ATO has been or may be prepared to issue a class ruling on the status of a target company as not being an exempting entity based on the share register prior to the shareholder meeting that approves the dividend and takeover, and taking into account any circumstances described in the class ruling application (see, for example, CR 2011/38 and CR 2011/45). Sometimes, however, the ATO will look at the share register as at the date the dividend is paid (CR 2012/52). The ATO has a general power to cancel an imputation benefit or impose a franking debit (s 177EA) where there is a scheme that has a more than a merely incidental purpose of conferring an imputation benefit. The payment of a preacquisition dividend prior to a takeover by foreign entities could, in certain circumstances, constitute such a scheme. In determining whether to exercise this power, the ATO may look at whether: the target company has a history of paying franked dividends to its vendor shareholders; the dividend is paid to vendor shareholders in proportion to their shareholding on the record date; the dividend is paid to vendor shareholders irrespective of their ability to utilise the relevant franking credits; and non-resident vendor shareholders are compensated for the inability to use franking credits. (e) The ATO could also be asked to confirm that the dividend is not part of a dividend stripping operation (ss to ). Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

14 3.2 Contingent value rights Aspect Contingent value rights (CVRs) may be issued to vendor shareholders as part of a takeover. The CVRs issued to the vendor shareholders may take the form of a right to cash or additional scrip in the acquiring company in the following circumstances: The timing of any taxable gain to a vendor shareholder in respect of a CVR will depend upon the nature of the CVR. i. Performance Driven CVRs: value of acquiring company s scrip falls below an agreed level at a certain time (hedging instrument); the target company or part of its business performs at or above an agreed level (earnout instrument). ii. Event Driven CVRs: a certain event occurs, such as resolution of litigation or receipt of regulatory approval for a product. CVR cash As the law currently stands (see CR 2011/89), a CVR that is a right to a distribution of cash at some point in time in the future may well have the following consequences: market value of the CVR will be included in the capital proceeds from disposal of interests in the target company (s (1)); the CVR will be a separate CGT asset with a cost base equal to its market value as at the date it is issued (s (2), s (1)); each time a payment is received in respect of the CVR, CGT event C2 will occur (s (1)): the holder s cost base for the part of the CVR to which CGT event C2 happens is apportioned (s (3)); the remainder of the cost base after each payment is attributed to the part of the CVR that remains (s (4)); (d) if the holder makes a capital gain when CGT event C2 happens to their CVR they may be eligible to treat the gain as a discount capital gain (provided that the requirements of Div 115 are satisfied). Tax and Superannuation Laws Amendment (2015 Measures No. 6) Bill 2015 (Cth), introduced into Parliament in December 2015, proposes look through CGT treatment for certain earnouts ( look-through earnout rights ). Look-through earnout rights are cash CVRs that (s (1)): (d) (e) are a right to future financial benefits that are not reasonably ascertaining at the time the right is created; are created as part of the disposal of an active business or its assets, including certain qualifying interests in a company or trust whose active assets constitute at least 80% of the market value of all its assets; do not require financial benefits to be provided more than 5 years after the end of the income year in which the relevant CGT event happens; and provide for financial benefits which are contingent on, and the value of which reasonably relates to, the future economic performance of the asset or the business; are created as part of an arrangement entered into on an arm s length basis. Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

15 If a cash CVR is a look-through earnout right, then under these new provisions: the CGT consequences described above will not arise; instead, the value of the cash CVR is disregarded for CGT purposes; and the value of any financial benefits subsequently made or received under the cash CVR is included in: the capital proceeds arising from the disposal for the seller (which may have the effect of preserving the CGT discount in relation to the cash CVR proceeds if the original disposal benefited from the CGT discount) (s ); and the cost base of the acquisition for the buyer (s ). In addition, a capital loss made by a taxpayer on disposal of an asset must be temporarily disregarded if the capital loss could be reduced by the taxpayer receiving one or more financial benefits under a look-through earnout (s ). The portion of the capital loss disregarded is equal to the maximum financial benefits that may be received under the look-through earnout or, if there is no maximum, the total amount of the capital loss. The new law will apply to look-through earnout rights created on or after 24 April Although the amendments will not apply to arrangements entered into prior to 23 April 2015, taxpayers who have reasonably and in good faith anticipated these changes to the tax law as a result of the previous Government announcement (on 11 May 2010) may have their current tax income treatment preserved. Where potentially relevant, it will be important to monitor the development of this legislative proposal. CVR scrip The crucial difference between using cash and scrip is that issuing scrip CVRs may attract roll-over relief, allowing the vendor shareholders to defer the taxing point until the ultimate consideration, which may be cash, is received. In order to be eligible for roll-over relief, the CVR must be a share. The ATO has accepted (see CR 2012/123) that a CVR is a share where it carries a right to receive notice of and to attend any general meeting and to receive a copy of any reports or accounts to be considered by the meeting, but does not carry any rights to: receive dividends; subscribe for, or participate in any bonus issue of, new shares; or vote at any meeting. On the other hand, a mere right to receive a share (for example) will not be a share that can attract roll-over relief. However, additional roll-over eligibility conditions are imposed if the acquiring entity and the vendor shareholders do not deal with each other at arm s length and either: both the target and the acquiring group had less than 300 members before the arrangement started; or the vendor shareholder, the target and an acquiring entity were all members of the same linked group just before that time. In such circumstances, the market value of the shares received by the vendor shareholders must be substantially the same as the market value of the shares disposed, and the shares issued by the acquiring group must carry the same kind of rights and obligations as the shares the vendor shareholder held in the target (i.e. the analysis in CR 2012/123 may not apply). Provided all roll-over requirements are satisfied and the vendor shareholder chooses to apply the roll-over: the capital gain they would have otherwise made in respect of the disposal of the shares and receipt of the CVR is disregarded (s /785(1)); the cost base of the CVR will be a reasonable apportionment of the cost base of shares disposed of in the target for the purpose of applying the CGT discount (s ). In the event the CVR is later cash settled (eg through acquisition by the acquiring group), the holder may make a capital gain or capital loss under CGT event A1 at that time (s ). Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

16 If the CVR is able to be settled by the issue of ordinary shares in the acquirer group to the holder of the CVR: CGT event C2 will happen (s ); the transaction may be treated as a conversion of a convertible interest (Item 2 of the table in s (1)), meaning that: any capital gain or capital loss the holder makes from CGT event C2 is disregarded (s (3)); the cost base of the new ordinary shares will include the cost base of the CVRs as at the date of conversion (s (1)); the holder of the new ordinary shares will be taken to have acquired them on the date of the conversion (s (2)). Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

17 Consolidations regime where the target company joins the acquiring company s tax consolidated group The tax consolidation regime has broad application to corporate acquisition and disposal transactions and primarily has relevance where the target company either becomes whollyowned by an existing tax consolidated group or is disposed of by an existing tax consolidated group. In the context of an acquisition, where the target company becomes 100% owned by an existing tax consolidated group it will in effect lose its separate tax identity and the tax value of its assets will be reset. Where a company ceases to be wholly-owned by a tax consolidated group, the tax cost base of the group s shareholding in the leaving entity will be reset based on the tax values of the assets of the leaving entity less the quantum of its liabilities. It is obviously outside the scope of this general article to note all significant tax consolidation corporate acquisition and disposal issues (including issues relating to multiple entry consolidated (MEC) groups). Rather, those noted below are commonly overlooked or misunderstood. 4 CONSOLIDATIONS REGIME WHERE THE TARGET COMPANY JOINS THE ACQUIRING COMPANY S TAX CONSOLIDATED GROUP 4.1 CGT events that straddle a consolidation joining or leaving event Aspect Where a contract for a sale of an asset by the target company is entered into before it joins the acquiring company s tax consolidated group (the joining time) but settlement of the contract is not until after that time, a range of CGT/consolidation regime interaction issues arise. Similar issues can arise in the context of an entity leaving a tax consolidated group where a contract to dispose of an asset is entered into by the leaving company prior to the leaving time but not settled until after the leaving time. The timing of the contract date for the sale of an asset as compared with the joining time or leaving time can potentially impact on the quantum of the related CGT gain/loss and also to which taxpayer this CGT gain/loss will arise. Additional issues can arise where a pre-joining time contract is entered into by the joining entity in respect of a post-joining time disposal of trading stock or depreciating assets. In relation to CGT outcomes, where a contract for the disposal of an asset is entered into before the joining time but the settlement does not occur until after the joining time (ie an entry-sell scenario ), issues arise as to whether the asset to which the contract relates has its tax value reset at the joining time. In addition, importantly, the issue also arises as to whether the CGT gain/loss on the disposal of this asset triggers to the joining entity before the joining time (particularly relevant if the joining entity was acquired from another consolidated group) or to the acquiring group after the joining time. Generally, for CGT purposes the timing of the CGT event in the context of a consolidation/straddle transaction is deferred until the subsequent settlement of the disposal contract (s ), and as such the tax value of the contracted asset is reset and the resulting CGT gain/loss triggers to the acquiring group. However, the ATO is of the view that these provisions currently do not apply in the context of the intra-consolidated group disposal of an asset or, more importantly, as per the example below, the disposal of an intra-consolidated group shareholding within the target company s tax consolidated group. Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

18 (d) If s (3) does not apply, then based on TD 2008/29 (and its predecessor draft, TD 2005/D27) it is the ATO s position that: the CGT event in relation to the sale of shares in Target Sub happens to Target Co at the contract date; and for the purposes of calculating the resulting CGT gain/loss, the cost base of these shares is their historic cost base (refer Example 2 in paras of TD 2005/D27). However, the ATO material does not seek to address the additional technical complications that arise where the relevant asset was in effect disregarded by the single entity rule at the initial contract date, as in the case of intra-group shareholdings. 4.2 Asset tax cost resetting ACA aspects Aspect Deferred tax liabilities. Deferred tax liabilities have traditionally been a significant element in ACA entry and exit calculations, but whether they will continue to be included in these ACA calculations is currently uncertain. By way of announcements by successive governments on 14 May 2013 and 6 November 2013, it appeared that Recommendation 3.1 of the BoT s April 2013 Report could be implemented with effect from 14 May 2013, to the effect that deferred tax liabilities would no longer be included in both step 2 of the entry ACA calculation and step 4 of the exit ACA calculation, even where these relate to amounts other than Australian income tax, ie foreign taxes. An associated recommendation by the BoT was that s (1A) should be repealed so that it would no longer be necessary to make iterative adjustments where the quantum of a liability is altered by the consolidation joining event. Importantly, these measures were not ultimately included in the package of other proposed consolidation amendments flagged for consultation in the 28 April 2015 ED. This suggests that the Government may have deferred acting on these BoT recommendations, at least with retrospective effect back to 14 May However, given the significance of these deferred tax liability amounts in ACA calculations, ongoing developments in this regard should be closely monitored Aspect Deductible liabilities significant retrospective legislative amendments pending. By way of pending legislative amendments with retrospective effect back to 14 May 2013, where a target company that joins a consolidated group has future deductible liabilities in its balance sheet (eg employee leave provisions or warranty provisions), the acquiring consolidated group may be assessed on a corresponding amount progressively over a 12 month or 48 month period. Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills

19 As detailed in the BoT s April 2013 Report, the motivation for these proposed changes is the perception that deductible liabilities of a target company can result in dual benefits for the acquiring group, being, firstly, an increase in the entry ACA, and secondly, deductions when the liability is subsequently incurred. On 28 April 2015 proposed ED provisions were released by Government for comment. Under these proposed provisions, deductible liabilities would first have to be dissected into an acquired component and an owned component (only relevant where the acquiring consolidated group already held shares in the target company prior to the takeover). In respect of the acquired component, it is proposed that an amount equivalent to the current liability element would be included in the assessable income of the acquiring group progressively over 12 months, with the non-current liability element being included in assessable income progressively over 48 months. The ED proposes that this measure will not apply to: certain policy liabilities of life insurance companies; certain liabilities and reserves of general insurance companies; accounting liabilities that are Div 230 TOFA financial arrangements; certain arrangements relating to retirement villages; and certain foreign currency liabilities (although other provisions will apply in these circumstances). (d) (e) In respect of the owned component of a deductible liability, it is proposed that an assessable amount would not be triggered to the acquiring group. Rather, these liability amounts would be excluded from the ACA. These measures are currently only outlined in an ED, and hence their ultimate scope and nature will not be finally determined until the relevant provisions have been enacted. Therefore it is important to closely monitor developments in this regard. When ultimately enacted, it is proposed that these measures have retrospective effect back to 14 May Aspect Tax loss/aca interactions. Where the target company has unutilised current year or carry forward revenue or capital losses, in many situations this can reduce the ACA amount. Step 5 reduces the entry ACA by 100% in respect of any owned tax losses of the target company (s ). Importantly, an owned loss will still reduce the ACA even if it does not transfer to the acquiring consolidated group because it does not satisfy the Subdiv 707-A specific eligibility criteria for transferring to the group, or it is elected to be cancelled under s In comparison, acquired losses only reduce the entry ACA by 30% and regard is had only to those losses that actually transfer to the acquiring consolidated group and/or are not otherwise cancelled under s Aspect A consolidated group acquiring a consolidated group. i. It is necessary to satisfy quite specific eligibility rules in order to utilise the somewhat concessional ACA and asset tax value resetting provisions of Subdiv 705-C. ii. Where a consolidated group is acquired by another consolidated group, an appropriate mechanism applies for calculating the available fraction that is to apply to any losses of the acquired group (s ); otherwise, very adverse available fraction outcomes can arise. Ken Spence and Edward Consett, Greenwoods & Herbert Smith Freehills