Tax Sharing Agreements 1

Transcription

1 Tax Sharing Agreements 1 Grant Cathro Partner, Allens Arthur Robinson 1. Introduction Consolidation manifests a very significant change in the way in which corporate groups are treated for income tax purposes. The central tenet of the consolidation regime is that wholly owned corporate groups are to be treated as a single taxpayer for income tax purposes, with the head company being treated for income tax purposes as the entity which earns all of the income and incurs all of the expenses of the consolidated group. In a consolidation environment, there is only one taxpayer and therefore prime facie one entity, the head entity, which is liable to pay the tax on the group s income. This is obviously an unacceptable outcome for the Revenue as it reduces the Commissioner s likelihood of recovering tax owning in the event of an insolvency. In a pre-consolidation environment, each entity was liable to pay tax on its own income. The ATO could recover that tax as a creditor of the relevant entity: a position which is far more advantageous, than one in which the Commissioner has to look solely to the head entity for the payment of tax. In an insolvency situation, all that the head entity, as a shareholder in a subsidiary entity is entitled to, is anything which is left after the subsidiary has paid all of its creditors. This is likely to be far less than the gross value of the assets of the subsidiary. Were the Commissioner only able to recover from the head entity he would in effect rank after both the secured and unsecured creditors of subsidiaries for the payment of tax on their income, 1 This paper was first presented at a Taxation Institute of Australia (Victorian Division) Consolidated Seminar in November wgcm M v Page 1

2 whereas at the present he ranks equally with all other unsecured creditors. This was clearly an outcome which would not have been acceptable to the government. 2. Joint and several liability The consolidation provisions make each subsidiary member of the consolidated group jointly and severally liable for the group income tax liability. As we will see, an exemption can be obtained from joint and several liability where either: an entity is prohibited according to Australian Law from entering into any arrangement under which the entity becomes subject to joint and several liability (section (2)); or a valid Tax Sharing Agreement has been entered into. 2.1 To what liabilities does joint and several liability apply? Joint and several liability applies to a group liability which is defined in section A group liability includes: a liability to pay instalments of tax; a liability to pay the annual income tax; and various liabilities for franking deficit tax, deficit deferral tax and general interest charge. The consolidation provisions do not effect an entity s liability to pay taxes, other than income tax, nor do they effect an entity s liability to pay taxes in respect of the entity s income for any period prior to the point at which the entity became part of a consolidated group. Any amendment which is received by an entity in respect of the pre-consolidation period, remains the responsibility of that entity. wgcm M v Page 2

3 2.2 Who is jointly and severally liable? The head company and each subsidiary member of the group which was a member of the group for at least part of a period to which the group liability relates, will be jointly and severally liable for the group liability. A subsidiary entity can thus remain jointly and severally liable in respect of a group liability even although it left the group before the time at which the group liability became due and payable. For example an entity could remain liable in respect of the final tax assessment for a year even although the entity was sold three months into the relevant tax year. Likewise an entity which has left the group will remain liable in respect of an amended assessment received which relates to a period during which the entity was part of the group. Liability for taxes under amended assessments relates back to the point in time that the original assessment was due and payable (see section 204). 2.3 When does joint and several liability arise? Joint and several liability does not arise in respect of a group liability unless the head company fails to pay or otherwise discharge the relevant group liability in full by the time it becomes due and payable (the Head Company s Due Time) (section (1)(a)). Joint and several liability will then arise immediately after the Head Company s Due Time (section (4)), although each subsidiary is not required to make payment and the liability does not become due and payable until a date 14 days after the Commissioner gives the member written notice under sub-section (5) of the liability. 3. Tax Sharing Agreements A group which has a valid Tax Sharing Agreement in place can avoid a situation in which all of the members of the group become jointly and severally liable for each group liability. wgcm M v Page 3

4 Where a group liability is covered by a tax sharing agreement : the head company remains primarily liable for the group liability; where the head company does not pay the group liability by the Head Company s Due Time (section (1)), each subsidiary member of the group which is a party to the TSA (TSA Contributing Member) becomes liable to pay to the Commonwealth an amount determined in accordance with the Tax Sharing Agreement (their contribution amount) (section (2)); the liability of each TSA Contributing Member arises just after the Head Company s Due Time (section (4)); and the liability does not become due and payable until a date 14 days after the Commissioner gives the relevant group member written notice under section of the liability. 3.1 When is a group liability covered by a Tax Sharing Agreement? The circumstances in which a group liability is to be taken to be covered by a Tax Sharing Agreement are set out in section A particular group liability will be covered by a Tax Sharing Agreement if: just before the Head Company s Due Time in respect of that group liability there is an agreement in place between the head company of the group and one or more of the entities which were subsidiary members of the group for all or part of the period to which the group liability relates (TSA Contributing Members); the agreement provides for the determination of a particular contribution for each TSA Contributing Member which is the amount for which that TSA Contributing Member is to be liable to the Commonwealth if the head company defaults and does not pay the group liability by the Head Company s Due Time; wgcm M v Page 4

5 the contribution amounts for each of the TSA Contributing Members in relation to the group liability, as determined under the agreement, represent a reasonable allocation of the total amount of the group liability among the head company and the TSA Contributing Members and the agreement complies with any requirement set out in the regulations. In addition: the agreement must not have been entered into as part of an arrangement, the purpose of which was to prejudice the recovery by the Commissioner of some or all of the amount of the group liability; and if, at some point in the future, the Commissioner gives the head company a notice requiring the head company to give the Commissioner a copy of the agreement, the head company must provide a copy of that agreement within 14 days, failing which the group liability will be taken never to have been covered by a Tax Sharing Agreement. There appears to have been an element of confusion in recent months as to what a tax sharing agreement is about. As far as the Income Tax Assessment Act is concerned, a Tax Sharing Agreement is simply an agreement which provides for the allocation of liability on default and sets up the amount which each entity will be liable to pay the Commissioner direct in the event of default. It is not an agreement which provides for the funding of the head company to make its regular tax payments. While there is no doubt that an agreement which deals with default could also have within it provisions which deal with contributions to the head company to enable the head company to make payment by its due date, there is nothing in the Act which requires there be any particular form of arrangement in place to help the head company fund its regular tax payments. Indeed, an agreement which merely provides for contributions to enable the head company to make wgcm M v Page 5

6 payment of tax on time, and does not independently determine an amount for the purposes of section will not be a Tax Sharing Agreement. It is clear that it would theoretically be possible to have a different Tax Sharing Agreement to deal with a head company s default in respect of different group liabilities. In practice, it seems likely that groups will seek to put in place an agreement with an enduring life, which covers particular categories of group liabilities, rather than individual group liabilities which might arise. It is however likely that it may be necessary for the Tax Sharing Agreement to have a different method of allocating different types of group liability. If an agreement is put in place which is to have an enduring life, it is clear that the agreement will need to be regularly monitored to ensure that the basis of allocation remains reasonable. 3.2 Reasonable allocation The question of what is a reasonable allocation is ultimately a question of law which will be capable of being challenged by subsidiary entities in a court. While it may be unlikely that such a challenge will occur where an entity remains within a corporate group, there is certainly a real possibility that challenges may arise where entities have been sold, or where entities have become insolvent and their affairs have been placed into the hands of the banks, an administrator or liquidator. While the ATO may issue some guidance about what it believes is a reasonable allocation, it must be recognised that if the ATO seeks to ameliorate difficulties in the law by taking a pragmatic approach in any guidance which it issues, there may be limits to the extent to which you can rely on that guidance. The one saving grace is that the ATO will hopefully abide by any guidance which it gives and that most subsidiaries will not want to argue that a Tax Sharing Agreement is unreasonable, for fear that they will then become jointly and severally liable for the entire group liability. wgcm M v Page 6

7 4. Does joint and several liability matter? It is perhaps worth asking whether or not joint and several liability is really a major issue for most corporate groups. Many groups are already parties to an ASIC cross-guarantee which makes each of the entities which are party to that guarantee jointly and severally liable for each other s debts. There is however an important difference between the ASIC cross-guarantee and joint and several liability under the consolidation provisions. Not all group entities need be a party to the ASIC cross-guarantee. A group can choose which entities are in and which are out. In addition, the ASIC cross-guarantee provides that where an entity is sold in an arm s length transaction at market value, all liability under that cross-guarantee is brought to an end. By contrast, joint and several liability, if it applies, will apply to all members of a consolidated group and any entity which is sold will remain jointly and severally liable for tax liabilities in respect of the period during which it was a member of the consolidated group and for the period during which it exited it. Directors of subsidiary companies may also be somewhat unhappy with the concept that if the head company is a day late in making payment of its taxes, their company is then technically liable to pay the entire income tax bill of the group. I think it likely that most companies within consolidated groups will prefer to have a Tax Sharing Agreement in place in an attempt to avoid joint and several liability. It is however clear that the parties who would be most concerned to see the Tax Sharing Agreement in place are those who are external to the group and who may be affected by the presence of joint and several liability. Joint and several liability is a particular concern for: financiers, who are lending to a particular entity within the group on an unsecured basis; and anyone who subsequently purchases a subsidiary out of the group and who clearly does not want to purchase an entity which is exposed to joint and several liability for the group wgcm M v Page 7

8 taxes for the period up to and including the end of the year in which the entity ceases to be part of the consolidated group. 5. Entities departing the group As we have already discussed, where there is no Tax Sharing Agreement, a subsidiary entity will be jointly and severally liable for taxes payable by the consolidated group in respect of the period during which it was a member of the consolidated group. Where the entity leaves part way through a period, it will be liable for the taxes in respect of that period, even if they fall due for payment after the day on which the entity leaves the group. Liability for taxes under amended assessments relates back to the point in time that the original assessment was due and payable, so that amended assessments received in the future may create liabilities for which entities are liable, even after they leave the group. The Act makes specific provision to allow a company which exits the group to limits its liability for taxes in respect of the period of exit if the relevant group liability is covered by a Tax Sharing Agreement and the exiting entity was a party to that Tax Sharing Agreement. Section provides for a TSA Contributing Member to leave the group free and clear of a group liability (being a group liability in respect of the period in which exit occurs), if: (a) (b) (c) (i) the tax sharing agreement contributing member ceased to be a member of the group at a time (the leaving time) before the head company s due time; and the cessation of membership was not part of an arrangement, a purpose of which was to prejudice the recovery by the Commissioner of some or all of the amount of the group liability or liabilities of that kind; and before the leaving time, the tax sharing agreement contributing member had paid to the head company: if the contribution amount for that member in relation to the group liability could be determined before the leaving time an amount equal and attributable to that amount; or wgcm M v Page 8

9 (ii) otherwise an amount that is a reasonable estimate of, and attributable to, that amount. It is important note that section only applies to a liability which has not yet fallen due for payment. It does not apply to liabilities where the subsidiary entities cease to be a member of the group after the Head Company s Due Time. Section therefore does not provide a clean exit in respect of liabilities for prior periods and, in particular, liabilities which may arise because either: the head company has already defaulted in payment of a group liability; or an amended assessment is received, relating to an earlier period. Where the subsidiary entity leaving the group was a party to a Tax Sharing Agreement, its responsibility to the Commissioner in respect of these amounts will be dependent upon the terms of the Tax Sharing Agreement. When the Tax Sharing Agreement regime was first introduced, many of us might have thought that it would not be unreasonable for a Tax Sharing Agreement to provide an allocation of liability, which was such that any entity which had left the group no longer remained responsible for the group s income taxes. This is not however a position which is likely to be accepted by the ATO, which does not want to see the revenue placed in a worse position vis a vis recovery under a consolidation regime, than is the case in the pre-consolidation environment. 6. The need for certainty While theoretically the concept of a Tax Sharing Agreement makes sense, I suspect that in practice banks and purchasers of companies will have significant difficulty in obtaining certainty that a Tax Sharing Agreement is valid. The two principal areas of concern are: (a) obtaining certainty that any Tax Sharing Agreement provides a reasonable allocation of the relevant group liability; and wgcm M v Page 9

10 (b) the requirement that the head company provide a copy of the Tax Sharing Agreement to the ATO within 14 days of written request. The difficulties which arise in determining what is a reasonable allocation are compounded by the fact that the Tax Sharing Agreement is a document which, at least as far as Division 721 is concerned, deals with the liability to make a payment to the Commonwealth on default and not the liability to contribute to regular tax payments. It may be far easier to determine that an allocation method is reasonable where we are looking to see whether or not the method provides a reasonable basis for contributions to the ongoing tax payments by the head company, than will be the case when we are looking at the default scenario. It is uncertain whether what is reasonable on default should be influenced by circumstances surrounding that default and in particular the extent to which particular entities may already have provided moneys to the head company to assist in payment of the tax liability. There is clearly a risk that subsidiaries who have already contributed moneys to the head company to help pay a tax liability, may nonetheless be liable to make payment to the Commonwealth in respect of the same group liability on default. In effect, exposing subsidiary entities to an element of double jeopardy. There would also seem to be a real risk that attempts to allocate group liability in what from a purist s perspective may be a fair way, taking account of losses and notional subvention payments within the group, may well have the result that the Tax Sharing Agreement does not provide a reasonable allocation on default. What section requires is that there be a reasonable allocation of the total amount of the group liability. There must be a provision within the document which deals specifically with this. Any provision within the document which seeks to allocate an amount which is both the sum of the group liability and the sum of previous subvention payments may not represent a reasonable allocation of the total amount of the group liability, as it attempts to do more than that which is required by the Act. wgcm M v Page 10

11 There are also risks which arise from the need to ensure that the Tax Sharing Agreement provides a reasonable allocation of the total amount of the group liability, given the membership of the group and possible changes in circumstances over time. It is important to note that where a group liability is covered by a Tax Sharing Agreement, the provision which makes all subsidiary entities jointly and severally liable does not appear to operate at all (section (3)). Thus, while section does not require that all subsidiary members be a party to the Tax Sharing Agreement, absence of certain entities may be relevant in determining whether or not a Tax Sharing Agreement can be seen to represent a reasonable allocation of the total amount of the group liability among the head entity and those subsidiaries which are a party to it. The existence of a Tax Sharing Agreement appears to remove joint and several liability for all subsidiaries, not just those which are party to the Tax Sharing Agreement. It is debatable whether or not one simply looks at the entities which are a party to the document and asks whether the allocation amongst those who chose to execute it is reasonable, or whether, given the impact of the document, the absence of some significant group members might mean that there could not be a reasonable allocation. There is a real risk that a failure to ensure that all subsidiaries which have substantial assets, or substantial income, are parties to the Tax Sharing Agreement, may mean that the allocation made by that agreement is not a reasonable allocation. It appears from the drafting of section (3) that it is intended that there can only be one Tax Sharing Agreement in respect of a particular group liability. Yet if the allocation within that agreement is not entirely reasonable, the agreement will not be valid. This raises the prospect that an unreasonable allocation to one entity could invalidate the Tax Sharing Agreement, notwithstanding the fact that the allocation to many other entities might be reasonable. 7. Conclusion While the concept of a Tax Sharing Agreement may seem a good one, there are a number of features of the regime which are going to make it difficult for taxpayers and their advisers to be certain that a Tax Sharing Agreement complies with the requirements of the law. Many of those wgcm M v Page 11

12 difficulties arise from the manner in which the legislation has been structured. It would clearly be desirable for the legislation to permit a head company to have a separate Tax Sharing Agreement with each subsidiary member. It would also seem that a far greater degree of certainty would be obtained in relation to the reasonableness of an allocation if the Tax Sharing Agreement was required to focus on the actual funding of the payment of group liability, rather than the circumstances on default. If each subsidiary entity had a liability to contribute to tax payments as they fell due, they would then have a liability which they could discharge before default by simply making payment to the Commissioner, avoiding the risk of double jeopardy. Grant Cathro 20 November Postscript Since writing this paper, the ATO has published Chapter 35 of its Receivables Policy. It is now clear that: The group liability allocated on default is the entire gross liability prior to the offset of any credits ie in the case of an amended assessment, the entire gross liability on the assessment as amended and not just the increased liability generated by the amendment. A TSA should not seek to deal with notional subvention payments. Great care has to be taken when choosing an allocation methodology for a TSA, to ensure that it is one which will work in circumstances in which the head company is in financial difficulties. The first group liability for a consolidated group may not be the final tax liability under section 204 for the first year in which the consolidated group files a return. Rather, instalments which the head company is due to pay on account of that liability during the first year of consolidation may also be a group liability. (In the first year a special instalment regime applies so that individual companies still pay their own instalments. those instalments are then credited to the liability of the head company. Instalments liabilities of subsidiary entities are not group liabilities.) Grant Cathro August wgcm M v Page 12