SESSION 2B: TOPICAL M&A IN THE TROPICS

Transcription

1 SESSION 2B: TOPICAL M&A IN THE TROPICS Reid Zulpo, ATI Partner, Transaction Tax EY Natalie Chang Director, Transaction Tax EY

2 Overview There is a very broad range of taxation issues that need to be considered and managed in any M&A transaction. Taxation and duty imposts can be a significant cost to completing the transaction. This session provides an overview of certain technical and practical issues which may arise in M&A transactions in relation to ACA push-downs and asset/entity divestments. Importantly, changes to the consolidations rules in recent years may mean that tax outcomes do not necessarily align with expected commercial and accounting outcomes. In particular, we will examine: 1. Certain asset push-down and consolidation issues on acquisition arising from: changes to Rights to Future Income and Residual Assets 2. Consolidation and TOFA interaction Federal Budget Changes 4. Transfer of Tax Attributes (i.e. tax losses, franking credits and R&D offsets) 2. Ways of implementing an asset/entity spin-out and related issues; and 3. The requirements for exiting a tax consolidating group clear of group liabilities.

3 1. Acquisitions - ACA push down issues In response to the Rights to Future Income ( RTFI ) saga, a range of changes to the tax consolidations regime were made in 2012 (Taxation Laws Amendment (2012 Measures No.2) Act 2012). The 2012 amendments included pre (pre 12 May 2010), interim (post 12 May 2010 to 30 March 2011) and prospective law changes (which broadly apply to the period after 30 March 2011). The prospective amendments sought to do the following: 1. CGT Approach - restrict the operation of the tax cost setting rules to CGT assets, revenue assets, depreciating assets, trading stock and Division 230 financial arrangements; 2. Business Acquisition Approach - apply a business acquisition approach to the residual tax cost setting rule (i.e. to effectively treat the acquisition of an asset through consolidation as capital in nature); 3. Specific rules for WIP and consumables - ensure that the reset tax costs for rights to future income that are WIP amount assets and consumable stores are deductible; and 4. RTFIs - treat rights to future income, other than WIP amount assets, as retained cost base assets.

4 1. Acquisitions - ACA push down issues The changes were prompted by the 2010 RTFI amendments to the consolidation regime. The 2010 rules allowed consolidated groups to deduct the reset tax cost for a right to future income asset over, broadly, the lesser of the period of the relevant contract or 10 years. The amendments applied retrospectively from 1 July The 2010 RTFI measures had a far broader Government s consolidated revenue than was ever anticipated. Rationale for 2012 amendments: The 2012 amendments were intended to restore the pre-2010 position to increase certainty for taxpayers by making the tax outcomes for consolidated groups more consistent with the tax outcomes that arise when assets are acquired by entities outside the consolidation regime (Explanatory memorandum, para 3.89).

5 1. Acquisitions - ACA push down issues However, following the 2012 amendments it is no longer safe to assume that the tax cost bases of your assets under the consolidations regime will align with the intended economic (or accounting) outcomes of a transaction. The results are now not always intuitive. Those differences can arise due to: The breadth of the current definition of a RTFI (now a retained cost base asset); and The restriction of the types of assets which now can be reset under tax consolidation.

6 1.1 Rights to Future Income changes Asset Class Exam ples RTFI Customer contract with service fees. Long term construction contract. Offtake Agreement. Royalty Streams. Trailing. Commissions Work In Progress ( WIP ) amount asset Financial advice prepared, but not yet invoiced. Rights to unbilled income for supply of gas. Incom e Tax T reatm ent Entity Acquisition Tax Consolidation 2010 Am endm ents 2012 Am endm ents Defined to include unbilled income, other future income rights and WIP. Tax Cost Setting Amount ( TCSA ) deductible (some restrictions) over the lesser of the life of the contract or 10 years. RTFI rights deemed to be separate asset from underlying contractual rights for TCSA purposes. Not distinguished from RTFI. Treatment same as for RTFI above. RTFI other than WIP amount asset treated as retained cost asset. TCSA is limited to joining entities historic tax cost. ACA that would otherwise be applied to RTFI assets is allocated across other reset cost base assets held by the subsidiary. RTFI rights not deemed to be separate asset from underlying contractual rights for TCSA purposes Recognised as a separate asset for ACA allocation purposes. Specific deduction equal to the TCSA in the income year that recoverable debt arises. Asset Acquisition Purchase price allocated to underlying asset. Cost base likely to approximate market value. Purchase price allocated to underlying asset. Likely deduction equal to PPA/MV allocation in the income year that recoverable debt arises.

7 1.1 Treatment of Other Assets Asset Class Exam ples Incom e Tax T reatm ent Entity Acquisition Tax Consolidation 2010 Am endm ents 2012 Am endm ents Asset Acquisition Non-tax assets Customer Lists. Unregistered trademarks. Information Databases. Trade Secrets. Accounting intangible assets that are not contractual rights. Reset cost base asset. ACA allocated in proportion to market value. Tax treatment subject to residual asset rule (see below) Effectively ignored - no ACA allocation. TCSA relating to these assets now effectively spread across other reset cost base assets. Purchase price allocated to underlying asset. Cost base likely to approximate market value. Consumables Fuel, oil (i.e. not trading stock). Certain spare parts. A deduction equal to the TCSA arguably available under section 8-1. However, deductibility was not clear cut. A deduction equal to the TCSA is available under section 8-1. No distinction for joining entities deducting consumables on a purchase or usage basis. Purchase price allocated to underlying asset and likely s8-1 deduction available.

8 1.1 Treatment of Other Assets Asset Class Exam ples Incom e Tax T reatm ent Entity Acquisition Tax Consolidation 2010 Am endm ents 2012 Am endm ents Asset Acquisition Residual Assets Revenue Assets (investments held on revenue a/c) Asset based approach Links TCSA to other provisions in the Act (not otherwise stipulated) to enable TCSA to be assessable, deductible, establish cost as appropriate Residual asset rule clarified to broaden cost to include cost, outgoings, expenditure, or amount of a similar kind and expressly deem the TCSA to be incurred by the joined group to acquire the asset. Business acquisition approach Arguably contentious and ATO indications suggest that business acquisition approach should result in most residual assets as being capital in character. Purchase price allocated to underlying asset. Cost base likely to approximate market value.

9 1.1 ACA Worked Example ABC Co, the Head Co of TCG acquires New Co from vendor Total ACA to allocate to New Co s assets is $100M Asset M arket Value Interim Rules Current Rules Land WIP RTFI * Div 40 Assets Customer Lists Goodwill TOTAL *RTFI assumed historical tax written down value in joining entity is nominal.

10 1.2 Consolidation-TOFA Interaction (Assets) Head Co s TOFA elections prevail Head Co is deemed to pay an amount to acquire the financial arrangement at the joining time Div 230 asset can be a retained cost base asset (if it meets ss705-25(5) definition) or reset cost base asset. TOFA M ethod Deem ed paym ent at joining tim e Other im plications FV, Financial Reports, FX retranslation Division 230 starting value Difference between Div 230 starting value & TCSA assessable/deductible over 4 years (701-61) Hedging, accruals, realisation Tax cost setting amount* N/A.

11 1.2 Consolidation-TOFA Interaction (Assets) TOFA Example Realisation Method Fair Value Joining Entity Head Company Gain to HC - 27 TCSA 33 Div 230 Gain Joining Entity Div 230 Gain Head Co TOTAL for instrum ent $0 $27 $ Joining Time Realisation *Joining entity and Head Co both use default methods

12 1.2 Consolidation-TOFA Interaction (Liabilities) Head Co s TOFA elections prevail Head Co is deemed to receive an amount to acquire the financial arrangement at the joining time (i.e. no TOFA loss for existing liabilities brought into the consolidated group) TOFA M ethod Deemed payment at joining time FV, Financial Reports, FX retranslation Hedging, accruals, realisation Division 230 starting value Joining entity s accounting value

13 1.2 Consolidation-TOFA Interaction (Liabilities) TOFA Example Realisation Method Fair Value (10) (20) (30) (40) (50) (60) Joining Entity Head Company Joining Time Realisation Joining Entity Accounting Value (32) Loss to HC - 22 Div 230 Loss Joining Entity Div 230 Loss Head Co TOTAL for instrum ent $0 $22 $22 *Joining entity and Head Co both use default methods

14 Federal Budget changes 2016 Federal Budget proposed changes to ACA Step 2: Changes to previously announced 2013 integrity measures for deductible liabilities (deemed assessable income) should be disregarded; Deductible liabilities proposed to be excluded from ACA calculations from 1 July 2016; and Deferred Tax Liabilities ( DTL ) DTL treatment under ACA calculations will be modified by removing adjustments relating to DTLs, commencing after the date of law introduction (new measure).

15 1.4 Transfer of Tax Attributes on Consolidation (Losses) Same Business Test ( SBT ) testing times (tax consolidation vs nonconsolidation) Example: ABC Co incurs a tax loss in the 2012 income year; ABC Co is acquired by XYZ Co on 1 May 2016; ABC Co does not breach COT prior to 1 May 2016; ABC Co had a change in business on 30 September 2013; and The loss is to be utilised in the 30 June 2017 income year.

16 1.4 Transfer of Tax Attributes on Consolidation (Losses) Standard SBT (ABC does not join XYZ tax consolidated group) 30/6/ /6/ /6/ /6/ /6/ /6/ /6/2017 Loss Year Income Year SBT Testing Times Business Change 1/5/2016 Modified SBT (ABC joins XYZ tax consolidated group) 30/6/ /6/ /6/ /6/ /6/ /6/ /6/2017 Loss Year Income Year SBT Testing Times Business Change 1/5/2015 1/5/2016 Joining Time

17 1.4 Transfer of Tax Attributes on Consolidation (Franking Credits) Franking surplus in joining entity s franking account is transferred to the head company (subject to s177eb ITAA97) Subsection (2)) Franking deficit in joining entity s franking account gives rise to a franking deficits tax liability to the joining entity (as if its income year ended just before the joining time) Subsection (3)) Head company maintains franking account Joining entity s franking account becomes inoperative

18 1.4 Transfer of Tax Attributes on Consolidation (R&D Offsets) Section ITAA97 treats R&D offsets as if they were a tax loss (arising in the claim year) for the purposes of testing whether they can be carried forward and applied. No specific R&D Tax Offset consolidation interaction provisions (in contrast to tax losses, franking credits etc). Possible risk R&D Tax Offsets cannot be transferred to TCG in acquisition scenario. ATO aware of issue developing a Practical Compliance Guide (PCG).

19 2. Entity/Asset Spin Outs Depending upon the nature of the transaction and the parties involved, there are various ways in which a target group may be split between the acquirers, each having different tax considerations. Some of the possible ways in which an entity spin out may occur are as follows: Acquisition of 100% of the membership interests by Bid Co, followed by the transfer of entities and/or assets (Alternative 1); Transfer of assets or entities in the target group prior to consolidation occurring (Alternative 2); and Demerger of business prior to acquisition under separate Schemes of Arrangement (Alternative 3). Subject to commercial drivers, the transfer of assets under the first two alternatives above may be to another consolidated tax group/s or possibly a unit trust (with the same or different economic owners).

20 Alternative 1 (push down and spin out) Buyer X Funding $100m Buyer Z Buyer X Funding $100m Buyer Z $300m $300m $100m Repayment Target Co Target Co Sale of Sub B $100m Sub A Sub B Sub A Sub B $200m $100m Tax Consolidated Group $200m $100m Tax Consolidated Group

21 Alternative 1 (push down and spin out) Considerations: The tax cost bases of the assets being divested may not necessarily align with the parties commercial view of value (despite ACA push down) e.g. due to RTFIs, non-cgt assets in Sub B, leading to capital gains on sale of Sub B shares. Any tax attributes will remain with Buyer X as head company (including transferred tax losses, franking credits, R&D offsets etc). Any existing tax losses in Target Co may be refreshed as COT losses subject to Available Fraction. Sale of Sub B does not impact upon modified SBT as it occurs post consolidation.

22 Alternative 1 (push down and spin out) Considerations (Cont d): Need to consider CGT event L5 on consolidation (unless Subdivision 705-C applies which requires acquisition of Target Group by another tax consolidated group) and also exit of Sub B. Sub B must obtain clear exit from both Target Co Group and Buyer X Groups (even under a 705-C acquisition). Return of capital (from sale of Sub B) can occur within tax consolidated group and repayment of loan to Buyer X.

23 Alternative 2 (transfer prior to consolidation) Pre Acquisition Post Acquisition 1 2 Buyer X Seller Buyer Z Buyer Z Buyer X 2 1 Sale of Target Co $200m Target Co Sale of Sub B $100m Sub B Target Co $100m Sub A Sub B Sub A $200m $100m Tax Consolidated Group Tax Consolidated Group $200m Tax Consolidated Group

24 Alternative 2 (transfer prior to consolidation) May give rise to better stamp duty outcome as Sub B has been transferred pre-acquisition. As the assets will not have been reset under tax consolidation, the tax position of the target group will need to be carefully considered. Need to know existing tax cost bases of assets within the leaving entity and/or test availability of any tax losses in group (if offsetting capital gains on sale of Sub B), including the potential application of Subdivisions 165-B and 165-CB (part year loss rules). Subdivision 165-CD as modified by Subdivision 715-B (loss duplication rules) may be relevant where Sub B leaves the group with unrealised losses. Modified SBT may be impacted due to Sub B leaving prior to consolidation.

25 Alternative 3 (demerger) Buyer X 2 Sale of Sale Co $200m Seller Sale Co 1 Demerger of Sub B $100m Sub A Sub B $200m $100m

26 Alternative 3 (demerger) There are three ways to demerge that can be used alone or in combination: 1. Ownership interests (for example, shares or units) in the demerged entity are disposed of, to owners of the head entity. 2. Ownership interests in the demerged entity are cancelled and new interests in that entity are issued to owners of the head entity. 3. The demerged entity issues enough new interests in itself to owners of the head entity to bring about an effective transfer (swamping).

27 Alternative 3 (demerger) Forms of Relief: For shareholders or unit-holders of a group that demerges: CGT and dividend ( demerger dividend ) tax relief may be available for the demerger; they will need to adjust the cost base of their remaining interests and new interests. For members of the demerger group: certain capital gains and capital losses are ignored; reduced cost base and capital loss adjustments may be required.

28 Alternative 3 (demerger) Parties will typically seek confirmation of demerger relief from the ATO Critical to obtaining a favourable ruling will be that: the entity or entities are being demerged for sound business reasons (such as growth strategy, access to capital and investment profiles for investors); and the nothing else requirement is satisfied - the demerger cannot be dependent upon the acquisition of the remaining business (excluding the demerged entities) being acquired. However, the acquisition can be dependent upon the demerger occurring. This requirement is typically managed by having separate schemes of arrangement.

29 3. Obtaining a Clear Exit Members of a tax consolidated group are jointly and severally liable for group liabilities that arise during a period that they were members of the tax consolidated group. The exception is where the group liability was covered by a valid Tax Sharing Agreement ( TSA ) that allocates the liability between the members of the group on a reasonable basis.

30 3. Obtaining a Clear Exit Under section , a contributing member can leave a group clear of a specific group liability if: it ceases to be a member of the group before the due date of the group liability before the leaving time; and it pays to the head company an amount equal to the contribution amount or, if that amount cannot be determined at that time, a reasonable estimate of that amount; and the member's exit from the group is not part of an arrangement, a purpose of which was to prejudice the recovery of all or part of the group liability by the Tax Office.

31 3. Obtaining a Clear Exit Some key issues in practice: 1. Is the TSA valid? 2. Did the leaving entity accede to the TSA at the joining time? 3. Have all members acceded to the TSA? If not, does this impact upon the reasonableness of the allocation for the leaving entity? 4. Is the contribution amount reasonable if an amended assessment arises after the leaving time? What level of due diligence on TCG is required to determine the contribution amount for the leaving entity? 5. Does the TSA contractually require a future contribution by the leaving entity in the event of an amended assessment? 6. Has the leaving entity been a member of a TCG which has been previously acquired? (if so a clear exit from the previous TCG is also required)

32 Reid Zulpo, ATI, Natalie Chang, Jason Sham, EY 2016 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this presentation and does not have any view as to its accuracy. The material and opinions in the paper 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.