2010 CGT ROADSHOW WORKBOOK

Transcription

1 i. XX Division National Division 28 July 2010 The Grace Hotel, Sydney WORKBOOK Written & presented by: Brian Richards Tax Consulting Partner BDO (QLD) Brisbane Taxation Institute of Australia 2010 Disclaimer: The material and opinions in this paper are those of the author and not those of the Taxation Institute of Australia. The Taxation Institute of Australia did not review the contents of this paper 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.

2 CONTENTS 1. INTRODUCTION OVERVIEW OF PAPER CGT ASSETS CGT ROLLOVERS DIVISION 122 DISPOSAL OF ASSETS TO A COMPANY DIVISION 124 REPLACEMENT ASSET ROLLOVERS SUBDIVISION 124-B ASSET COMPULSORILY ACQUIRED, LOST OR DESTROYED SUBDIVISION 124-C STATUTORY LICENSES SUBDIVISION 124-D STRATA TITLE CONVERSION SUBDIVISION 124-E EXCHANGE OF SHARES OR UNITS SUBDIVISION 124-F EXCHANGE of RIGHTS OR OPTIONS SUBDIVISION 124-G EXCHANGE OF SHARES IN A COMPANY FOR SHARES IN ANOTHER SUBDIVISION 124-H EXCHANGE OF UNITS TRUST FOR SHARES IN A COMPANY SUBDIVISION 124-I CONVERSION OF A BODY TO AN INCORPORATED COMPANY SUBDIVISION 124-J CROWN LEASES SUBDIVISION 124-K DEPRECIATING ASSETS SUBDIVISION 124-L PROSPECTING AND MINING ENTITLEMENTS SUBDIVISION 124-M SCRIP FOR SCRIP ROLL-OVER SUBDIVISION 124-N DISPOSAL OF ASSETS BY A TRUST TO A COMPANY SUBDIVISION 124-Q EXCHANGE OF STAPLED OWNERSHIP INTERESTS FOR OWNERSHIP INTERESTS IN A UNIT TRUST DIVISION 126 SAME ASSET ROLLOVER SUBDIVISION 126-A TRANSFERS AS A CONSEQUENCE OF MARRIAGE BREAKDOWNS SUBDIVISION 126-B ASSET ROLLOVERS WITHIN GROUP ENTITIES (PRIOR TO 1 JULY 2003) SUBDIVISION 126-C CHANGES TO TRUST DEEDS SUBDIVISION 126-D (SMALL SUPERANNUATION FUNDS) AND SUBDIVISION 126-E (ENTITLEMENT TO SHARES AFTER DEMUTUALISATION AND SCRIP FOR SCRIP ROLLOVER) SUBDIVISION 126-F TRANSFER OF ASSETS OF SUPERANNUATION FUNDS TO MEET LICENSING REQUIREMENTS Taxation Institute of Australia

3 2.4 RETENTION OF CGT STATUS CGT STATUS ACQUISITION DATE ROLLOVER REVERSALS CGT EVENT J SUBDIVISION 152-E REVERSALS (REPLACEMENT ASSET) CGT EVENT J USE OF THE TAX CONSOLIDATION REGIME SMALL BUSINESS CGT CONCESSION (DIVISION 152) FOUR CONCESSIONS BASIC CONDITIONS SMALL BUSINESS ENTITY NET ASSET THRESHOLD TEST CONNECTED ENTITY AFFILIATE CGT CONCESSION STAKEHOLDER SIGNIFICANT INDIVIDUAL SMALL BUSINESS PARTICIPATION PERCENTAGE APPLICATION OF THE INTERPOSED ENTITY TEST SOME OTHER DIVISION 152 FACTORS THAT IMPACT SME RESTRUCTURES EXTRACTING WEALTH OUT OF SME S SELLING THE BUSINESS ASSETS GOODWILL CLAW BACK CLAUSES AND EARN OUT CLAUSES DIVISION 152 ACTIVE ASSETS SHARE BUYBACKS CGT ON LIQUIDATIONS AND WINDING UP WINDING-UP COMPANIES OUTSIDE CONSOLIDATED GROUPS DIVISION Taxation Institute of Australia

4 3.6 INTERIM DISTRIBUTIONS BY LIQUIDATOR SMALL BUSINESS CONCESSIONS DIVISION 7A WINDING UP TRUSTS DISCRETIONARY TRUSTS UNIT TRUSTS DEMERGERS DEMERGER DIVIDEND CGT IMPLICATIONS FOR TRUSTS & PARTNERSHIPS PARTNERSHIPS DISPOSAL BY A PARTNER OF AN INTEREST IN THE PARTNERSHIP ASSETS DISPOSAL OF PARTNERSHIP ASSETS CGT EVENTS RELATING TO TRUSTS CGT EVENT E1 CREATING A TRUST OVER A CGT ASSET CGT EVENT E2 TRANSFERRING A CGT ASSET TO A TRUST CGT EVENT E3 CONVERTING A TRUST TO A UNIT TRUST CGT EVENT E4 CAPITAL PAYMENT FOR TRUST INTEREST CGT EVENT E5 BENEFICIARY BECOMING ENTITLED TO A TRUST ASSET CGT EVENT E6 DISPOSAL TO BENEFICIARY TO END INCOME RIGHT CGT EVENT e7 DISPOSAL TO BENEFICIARY TO END CAPITAL RIGHT CGT EVENT E8 disposal to beneficiary of capital CGT EVENT E9 CREATING A TRUST OVER FUTURE PROPERTY CGT DISCOUNTS FLOWING THROUGH TRUSTS TESTAMENTARY TRUSTS TRUST CLONING INTERNATIONAL ISSUES DIVISION 768 PROVIDES A CGT CONCESSION IN RESPECT OF SHARES IN ACTIVE FOREIGN COMPANIES NON-RESIDENTS Taxation Institute of Australia

5 3.24 MAIN RESIDENCE OTHER UPDATES Taxation Institute of Australia

6 1. INTRODUCTION 1.1 OVERVIEW OF PAPER I first delivered this paper some three years ago. In preparing for this seminar series I have noted some significant changes to the CGT provisions. The purpose of this paper and the seminar is to discuss practical matters that involve the CGT provisions and in particular to re-emphasise the manner in which the various CGT rollovers and other concessions practically apply to SMEs. This Workbook outlines some of the more practical taxation issues that are relevant to those aspects of Australia s CGT regime that are applicable to small and medium enterprises (SMEs), particularly in relation to transactions that involve the restructuring of asset ownership for commercial and family reasons. These transactions are often experienced when a SME is seeking the following types of outcomes: Asset protection Entity restructuring Equity introduction Estate planning Asset distribution In recent times with the controversy concerning the use of discretionary trusts for typical closely held businesses has also raised the issue whether it would be preferable to restructure the discretionary trust. When SME taxpayers are seeking to restructure asset ownership as part of an internal arrangement, typically the objective of the transaction is to undertake the transaction without any taxation implication and in particular the need to maintain the acquisition date and CGT status of the asset is important. In this regard the various CGT rollovers are particularly relevant to consider. The Rollover provisions are discussed at Chapter 2. Whilst these rollover opportunities may be particularly useful in deferring capital gains and are commonly used in circumstances where there is a restructure of an SME entity or the movement of an asset, the longer term implications of the rollover provisions need to be carefully considered. The various aspects of CGT rollovers, particularly the replacement asset rollovers and rollover reversals are discussed. The Consolidation regime is considered in the context of asset protection. In this Workbook, the important concessions provided by Division 152 are considered in summary given the number of detailed seminars on this specific topic over the last few years. Chapter 3 considers some of the ways of extracting wealth out of SMEs. These include the tax implications of selling the SME business or selling the structure housing the SME business. Additionally the use of share buyback provisions is factored into this discussion. The chapter also discusses the tax consequences of liquidating a company structure and distributing the funds in a tax efficient manner. The demerger provisions are noted and discussed in the context of the ATO s concerns with what are genuine demerger arrangements. Taxation Institute of Australia

7 The CGT implications of trusts and partnerships are also discussed at Chapter 4. In particular, the issue of streaming capital gains out of trusts as a consequence of the Commissioners proposed application of the High Court s Bamford decision, and the impact of CGT event E4. Chapter 5 provides a commentary on recent developments. I have also been requested to provide a brief overview of the principal place of residence CGT provisions. 1.2 CGT ASSETS It is relevant to reconsider one of the more basic issues concerning the application of the CGT provisions, that is, what is a CGT asset. Whilst this is a fundamental issue, the recent controversy concerning foreign private equity investments illustrates how important this issue is. A CGT asset is defined by section 108 ITAA 1997 in the following manner: Section 108-5(1) A CGT asset is: a. any kind of property; or b. a legal or equitable right that is not property. Section 108-5(2) To avoid doubt, these are CGT assets: a. part of, or an interest in, an asset referred to in subsection (1); b. goodwill or an interest in it; c. an interest in an asset of a partnership; d. an interest in a partnership that is not covered by paragraph (c). The above definition is much broader that the usual description of property in that it includes all types of rights. Notwithstanding this distinction the other important factor to note is that not all transactions involving CGT assets will ultimately be assessable pursuant to the CGT provisions. The anti-overlapping provisions in this regard are particularly important, the more common asset situations being: i. Amounts otherwise assessable pursuant to some other provision of the Act Section reduces the amount of any CGT gain where the amount is otherwise included as: (a) your assessable income or *exempt income; or (c) if you are a partner in a partnership, the assessable income or exempt income of the partnership. This situation is evidenced by the current controversy concerning foreign private equity investments and whether the gain is ordinary income or a capital gain that would otherwise be exempt by Division 855. The issue of TD 2009/D18 illustrates the point. The draft determination provides that: The profit from the disposal of such assets may be included in the assessable income of the private equity entity under subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997)1 where the profit is income according to ordinary concepts (ordinary income). When a profit will be ordinary Taxation Institute of Australia

8 income and therefore included in the assessable income will depend on all the circumstances of the particular case. If the profit is not ordinary income a capital gain or capital loss from the disposal of most CGT assets is disregarded for Australian income tax purposes if made by a non-resident of Australia. CGT assets that are not taxable Australian property are exempt assets: subsection (1). ii. The asset is a depreciating asset Section reduces the amount of any CGT gain in relation to a depreciating asset where the amount is also a *balancing adjustment event) that happens to a depreciating asset or a section 73BA depreciating asset (within the meaning of section 73BB of the Income Tax Assessment Act 1936) is disregarded if the asset was: a. an asset you held; or b. if you are a partner, an asset of the partnership; or c. if you are absolutely entitled to the asset as against the trustee of a trust (disregarding any legal disability), an asset of the trustee; where the decline in value of the asset was worked out under Division 40, or the deduction for the asset was calculated under Division 328, or would have been if the asset had been used. Whereas this often little practical concern with ordinary types of depreciable assets, there should be some concern with the broad inclusions within a depreciable asset, eg., certain types of intellectual property are treated as depreciating assets eg., copyright, patents and registered designs. iii. The asset is trading stock Section reduces the capital gain or loss made in relation to a CGT asset to the extent that it is trading stock. Taxation Institute of Australia

9 2. CGT ROLLOVERS If and when a SME taxpayer is contemplating the restructure of an entity or asset ownership as part of an internal arrangement, the methods that are available to achieve the optimal tax outcome invariably requires the taxpayer to consider in the first instance the use of the various CGT rollover concessions provided by Division 122, 124 and 126. Note however this may not always be the case. There are a number of CGT rollovers provided for in the tax law. These all have the aim of allowing the taxpayer to defer recognition of a gain. Rollovers generally operate by allowing the taxpayer to exchange one asset for another and deferring recognition of the capital gain by transferring the cost base of the original asset to the replacement asset. Importantly retention of the CGT status and acquisition date is a vital issue. The general implications of a Division 124 rollover are provided by subdivision 124-A. Note also the relevance of the special Division 115 acquisition rules provided by section items 1 and 2 are particularly important having regard to same asset rollovers (outlined in section ) and replacement asset rollovers (outlined in section ). The CGT discount provided by Division 115 is particularly relevant for individuals and trusts. Rollovers are designed for narrow circumstances and accordingly need to be carefully accounted for to ensure that the transaction its implementation are in accordance with the legislation, ie., the taxpayer will have to establish that each transaction fits within the legislative framework to qualify for rollover relief. Importantly, even though a transaction may qualify for rollover under the income tax law does not mean that it will also necessarily qualify for exemption under State based Duties Act. This will often mean in practice that transactions that make commercial sense are frustrated by State laws as these costs may be unacceptable. The rollover provisions may not always be the appropriate choice to implement a restructure or disposal of an asset. There may be occasions where rather than use the benefits of the rollover provisions discussed below, an alternative strategy may be to use the CGT concessions available by Division 115 and Division 152 to transfer assets. If by combination of these divisions the assets can be transferred without tax, update the CGT cost base for the transferee that might be a preferred outcome. The one situation where that strategy might not be appropriate is where the asset is a pre-cgt asset. Finally, when a business is being transferred, not all assets will be tax- advantaged by the CGT rollover provisions. Obviously the transfer of trading stock is not covered by the CGT rollover provisions and for depreciable assets, section ITAA 1997 needs to be considered. 2.1 DIVISION 122 DISPOSAL OF ASSETS TO A COMPANY Where the taxpayer currently holds CGT assets either as an individual, as a partner in a partnership or a trust, they can choose to transfer those assets to a company structure without CGT implications by choosing the application of the Division 122 rollover concessions. Taxation Institute of Australia

10 Notwithstanding the CGT disadvantages of using a company to hold assets, principally due to the exclusion of Division 115 for companies, there are many occasions where there are compensating economic factors that would favour the use of a company structure. This is particularly the present case where the taxpayer is using a trust with a corporate beneficiary structure. Why a use a company? Commercial acceptance; Risk protection; Introduction of new equity; Employee equity participation; Succession ease; Separation of business activities, eg., by the use of the consolidation provisions; Research & development activities; Demerger provisions; Access to Division 152 notwithstanding ownership of the company held by a trust; Taxation benefits, eg., present and future company tax rate and ability to retain profits; Imputation system TR 2010/3 Unpaid Present Entitlements The implications of this ruling as it applies to unpaid present entitlements to a company and the potential application of Division 7A to these amounts, will have significant implications for trusts. Once the full implications of this ruling are comprehended, the taxpayer has a number of alternative strategies to consider: (i) Treat the UPE as a Division 7A loan and wrap a loan agreement around the deemed loan; (ii) Treat the UPE as a sub-trust and deal with the 2 options provided in PS LA 3362 draft ie., income entitlements for the sub-trust to be calculated by reference to: a. A notional income based on the Division 7A benchmark interest rate b. A notional income based on a proportional share on the trust s income. (iii) Transfer the trust s business to a company to allow the retention of post tax profits. With regard to the latter point, the transfer of the business can either be transacted by: (i) A rollover using subdivision 122-A to defer any CGT immediate; or (ii) A sale arrangement and utilise the Division 152 CGT concessions available (if possible). There are three types of rollover allowed under Div 122 ( disposal cases): Taxation Institute of Australia

11 The transfer of assets from an individual taxpayer to a wholly-owned company: The transfer of assets by a trustee to a wholly-owned company; and The transfer of partnership assets to a wholly-owned company. In each of these cases the transfer of assets will be allowed rollover relief where the consideration received by the transferors are ordinary shares in the wholly-owned company that receives the assets and the prescribed conditions complied with. Alternatively, where the transaction is a disposal of a CGT asset, or all the assets of a business, to the company - the consideration is shares in the company and the company undertaking to discharge one or more liabilities in respect of the asset or assets of the business (as appropriate). There is a trap that must be noted where the rollover consideration includes the assumption of liabilities. More particularly, the relevant section provides: Section (1) The consideration you receive for the trigger event happening must be only: (a) shares in the company; or (b) for a disposal of a CGT asset, or all the assets of a business, to the company (a disposal case) - shares in the company and the company undertaking to discharge one or more liabilities in respect of the asset or assets of the business (as appropriate). It is to be noted that it is necessary to relate the liabilities to the relevant assets, however there is a further stipulation in relation to liabilities, namely that as required by section (1), the liabilities assumed cannot exceed the cost base of the asset, if the asset was acquired on or after 20 th September 1985 or the market value of the asset if the asset was acquired before 20 th September The conditions include the following: The only consideration for the disposal must only be shares or shares and the assumption of related liabilities; The market value of the shares received must be substantially the same as the net assets transferred to the company; The shares received for the transfer are non redeemable; The company is subject to tax in the usual way; The transferor and transferee are residents; or The transferor is not a resident the asset transferred is a taxable Australian property and the company shares are taxable Australian property. You can no longer dispose of a precluded asset on its own to a rollover company. Where however you transfer the whole (or part) of the assets and liabilities of a business, and that transfer includes precluded assets, then the transfer may be effective (refer to section , ) However, in the case of depreciating assets, section permits the transfer of a depreciating asset to a company if the transferor is able to choose a roll-over under Subdivision 122-A or subdivision 122-B. Taxation Institute of Australia

12 Where a pre-cgt asset is transferred to a rollover company the asset will retain its pre-cgt nature in the hands of the company and the shares in respect of that asset will also retain their pre-cgt nature. For post-cgt assets, the assets will be transferred at their existing cost base and the shares received for these assets will assume that cost base in the hands of the shareholder. Where both pre-cgt and post-cgt assets of a business are being transferred, an apportionment is required. The rules for the transfer of partnership assets into a company are comparable to the rules discussed above with the additional requirement that each partner s pro-rata interest in the partnership should be reflected in its pro rata shareholding after the rollover. In addition to the disposal cases discussed above, Division 122-A can also apply to situations where an asset is created - creation cases: CGT event D1 - creating contractual or other rights in the company (sec ); CGT event D2 - granting an option to the company (sec ); CGT event D3 - granting the company a right to income from mining (sec ); and CGT event F1 - granting a lease to the company, or renewing or extending a lease (sec ). Practical matter: If the taxpayer is presently using a discretionary trust structure, there are many advisors that might presently be concerned with the ongoing use of a trust structure for the conduct of a business, particularly where the profits of the trust are being regenerated into funding the business growth. In this situation, the Division 122 rollover provisions allow a discretionary trust to transfer the business assets to a company without any immediate taxation consequences (albeit stamp duty issues in many States). As a result of a rollover in these circumstances, the revised structure would be: Taxation Institute of Australia

13 2.2 DIVISION 124 REPLACEMENT ASSET ROLLOVERS Division 124 deals with various types of replacement asset rollovers. There a broad range of rollover concessions that might be applicable to the different taxation situations. In all of the circumstances covered by Subdivision 124 the taxpayer must fit the defined and exact requirements. For example the compulsory acquisition concession provided by subdivision 124-B is particularly relevant in certain State jurisdictions at the moment. Generally, if a transaction fits within one of the delineated categories, the taxpayer will be accepted as replacing one asset with another, with the consequence that carries forward the tax value and other attributes of the original asset to the replacement asset. Where for example, the original asset is a pre-cgt asset, the replacement asset will be deemed to be pre-cgt. In many respects the circumstances covered by Division 124 could be regarded as involuntary disposals, however some of the rollover provisions can be used by taxpayers to restructure entities or asset ownership, eg. the scrip for scrip rollover provisions. It is important to consider the general implications of the application of the various rollover concessions provided by Division 124. These are provided by subdivision 124-A: Consequences of one asset ending; and Consequences for new asset Also note the implications of a Division 124 rollover for Division 115 purposes see section and section SUBDIVISION 124-B ASSET COMPULSORILY ACQUIRED, LOST OR DESTROYED Subdivision 124 B provides the taxpayer with a choice to access the rollover where: a. An asset or part thereof is disposed of as a consequence of a specified event; b. Cash or property is received as a result of the event; c. The transaction generates a capital gain; and d. A replacement asset is acquired or other capital expenditure incurred within a specified time with the cash or property. Circumstances where rollover available This subdivision deals with the case where inter alia the taxpayer s asset is disposed or impacted generating a capital gain as a consequence of the following situation where the asset is: compulsorily acquired by an Australian Government agency; Taxation Institute of Australia

14 lost or destroyed ie with involuntary disposals; or disposed of to an entity, where the circumstances relating to the transaction satisfies a number of elements what would otherwise have resulted in a compulsory acquisition of the property; or the asset is land over which a mining lease was compulsorily granted (Section ) For example, the above requirements were illustrated by the Queensland Government s Traviston Dam project. As a consequence of this project properties were acquired by a Government entity for the purposes of the future construction of a dam. In certain instances the long led time for the project has resulted in the concessions otherwise provided by subdivision 124-B not being available with the consequential effect being the taxpayers were not correctly been compensated for the taxation costs. Subdivision 124-B is important where a taxpayer s assets have, for example, been destroyed in a bushfire, subject to some other disaster or a land resumption and sets out how to deal with proceeds where this happens. The Subdivision deals with cases where the taxpayer is provided with a replacement asset or insurance proceeds or is required to incur capital expenditure to repair or replace lost assets. Note that this rollover relief is not available if the asset is only damaged. Loss or destruction does not include damage. Rollover is however available if the damage done is so extensive that the asset, or a discrete part of it, can be considered to be lost or destroyed (see TD 2000/38). This rollover is only available if money or another asset (other than a revenue asset such as trading stock or a depreciating asset) is received as compensation for the CGT event or received under an insurance policy. Not only are amounts incurred in replacing an asset covered, but also sums incurred in repairing or restoring the original asset. Forced disposals due to financial difficulties are not covered (see TD 93/82). Requirements for rollover (section ) The taxpayer must: a. incur expenditure in acquiring another CGT asset (except a Division 40 asset; or b. if part of the original asset is lost or destroyed - incur expenditure of a capital nature in repairing or restoring it. At least some of the expenditure must be incurred: a. no earlier than one year before the event happens; or b. no later than one year, after the end of the income year in which the event happens. (Note the Commissioner can vary these timing requirements) Because of the above there is no requirement that the taxpayer incur the whole of the expenditure within that time. If the taxpayer acquires another asset, the replacement asset must satisfy the following requirements: Taxation Institute of Australia

15 If the original asset was used in the taxpayers business or installed ready for such use, then:- the replacement asset must be used in the business, or be installed ready for use in the business, for a reasonable time after you acquired it. Otherwise, the taxpayer must use the other asset (for a reasonable time after you acquired it) for the same purpose as, or for a similar purpose to, the purpose for which the taxpayer used the original asset just before the event happened. Where money is received, the rollover is only available where: Expenditure is incurred in acquiring another asset, or if part of the original asset is lost or destroyed, expenditure of a capital nature in repairing or restoring it; and Some of that expenditure is incurred within 1 year before or 1 year after the CGT event (see TD 2000/40). Note that where monetary compensation is received for the loss or destruction of a pre-cgt asset, and the owner wishes to use this rollover, the replacement asset, or the asset as repaired will also be regarded as a pre-cgt asset (see s124-85(3)). This will however not apply if the compensation received for the loss of the original asset exceeded the market value of the original asset by more than 20% (unless the original asset was destroyed by a natural disaster and it is reasonable to treat the replacement asset as substantially the same as the original asset). There appears to be little reason in principle to create a distinction between a loss due to a natural disaster and due to other causes eg why should the loss of a factory due to a bushfire be treated differently to the loss of a factory due to an unidentified fire bug? Nevertheless, whether it is reasonable to treat a replacement asset as substantially the same as the original asset is a matter of fact and degree (see TD 2000/45). The effect is to allow (say) a farmer who loses assets in a bushfire to replace a lost or destroyed asset with one that is somewhat better than the one destroyed without incurring a tax issue as long as the improvement is relatively modest. Where the original asset was a post-cgt asset and money is received as compensation: If the compensation amount was more than the expenditure incurred to acquire a replacement asset (or to repair/restore the original asset) If the gain is more than the excess: the gain is reduced to the amount by which the money exceeds that expenditure; and that expenditure is reduced by the amount by which the gain (before it is reduced) is more than the excess If the capital gain is not more than the excess, the capital gain is not reduced. If the compensation money received is less than the expenditure required to acquire another asset (or to repair/restore the original asset) then any capital gain is ignored and the expenditure for cost base purposes is reduced by the amount of the capital gain. Taxation Institute of Australia

16 Example provided by notes to section In 1999 Simon bought a small factory. In 2000 a fire destroys part of it. He receives $100,000 under an insurance policy. The capital gain is worked out under section Suppose the factory's cost base at the time of the fire is $75,000 and the market value of the part that is not destroyed is $150,000. The cost base of the part that is destroyed is: $75,000 $100,000 $100,000 + $150,000 = $30,000 The capital gain is: $100,000 - $30,000 = $70,000 Case 1 Suppose Simon spent $80,000 on repairing the factory. The money he received under the insurance policy exceeds the repair cost by $20,000. The gain exceeds that by $50,000. The result is that the gain is reduced to $20,000 and the $80,000 he spent on repairs is reduced to $30,000. Case 2 Suppose Simon spent $15,000 on repairs instead. The money he received under the policy exceeds that amount by $85,000. This is more than the gain he made. The gain is relevant to working out Simon's net capital gain or loss for the income year and the $15,000 he spent on repairs forms part of the factory's cost base. Case 3 Suppose Simon spent $120,000 on repairs instead. The gain is disregarded and the $120,000 is reduced to $50,000. Taxation Institute of Australia

17 2.2.2 SUBDIVISION 124-C STATUTORY LICENSES This subdivision deals with situations where a taxpayer is required to hold a statutory or other license to carry on his business and that licence is subject to a C2 Event ie., asset is expiring or is being redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited (section (1). A statutory licence, is defined in section (3), an authority, licence, permit or quota granted by an Australian government agency under an Australian law, or by a foreign government agency under a foreign law. Leases, mining entitlements and prospecting entitlements are, however, specifically excluded from the definition. The purpose of Subdivision 124-C is to allow the taxpayer to roll the original license (and any cost base attaching to it) into the replacement license eg a license to fish commercially. There are three requirements to be met: a. a statutory licence ends resulting in CGT event C2 happening. b. one or more new statutory licences are issued in respect of the original licence or licences. and c. the new licence or licences authorise activity that is substantially similar to that authorised by the original licence. Note that this rollover relief is automatic and not the subject of a taxpayer s choice. Consequence of rollover As a consequence of the rollover where a new licence results from the ending of an original post CGT licence, section (2) and (3) apply so that the cost base or reduced cost base of that original licence forms the first element of the cost base or reduced cost base of the new licence. For the purposes of the CGT discount (s ), the new licence will be taken to have been acquired on the date the original licence was acquired SUBDIVISION 124-D STRATA TITLE CONVERSION This Subdivision deals with the reclassification of a right to occupy premises into a strata title. Where this happens the old right to occupy is extinguished and replaced by a strata title with the same CGT cost base as the extinguished right. Taxation Institute of Australia

18 2.2.4 SUBDIVISION 124-E EXCHANGE OF SHARES OR UNITS This rollover provides a taxpayer a choice to disregard a capital gain where there has been an exchange of shares in a company or units in a unit trust. The roll-over in respect of shares in a company (or units in a unit trust) when the following circumstances apply (section shares & units): a. the taxpayer owns shares or units of a certain class b. the company redeems or cancels all shares, or the trustee redeems or cancels all units, of that class c. the company issues new shares or the trustee issues new units in substitution for the original shares or units, and the taxpayer receives nothing else d. the market value of the new shares or units is at least equal to the market value of the original shares or units e. the taxpayer is an Australian resident at the time of the redemption or cancellation or the taxpayer is not a resident but the original shares or units were "taxable Australian property" just before that time and the new shares are taxable Australian property when they are issued, and f. in relation to shares in a company - the paid-up share capital of the company just after the new shares were issued is the same as just before the original shares were redeemed or cancelled. The above rollover will be relevant where a company or unit trust is reconstructed and certain shares or units are cancelled and replaced by other shares or units in the same entity in substitution, and the market value of the shares or units given up is the same as those received in replacement then this rollover may apply. This will be relevant where a company or unit trust undergoes a capital reconstruction. For example, the company or unit trust may have been formed with a number of classes of shares or units and it is decided to replace these classes with a single ordinary class of shares or units to allow the entity to comply with the ASX listing rules. Taxation Institute of Australia

19 2.2.5 SUBDIVISION 124-F EXCHANGE OF RIGHTS OR OPTIONS This rollover is similar to the Subdivision 124-E rollover but instead relates to rights or options. It deals with cases where a company or unit trust decides to either consolidate the number of shares on issue, or decides on a share or unit split, and the taxpayer has rights or options to acquire shares or units. To undertake the transaction the company or trust must cancel the existing rights or options and issue replacement rights or options to the taxpayer. In either case, the important thing is that the market value of the replacement interests received are the same as those being cancelled. In essence this rollover is the same as Subdiv 124-E, except that it deals with rights or options, where the original rights or options will have to be adjusted to reflect the change in the volume of shares on issue. It is quite common for rights or options issued to include clauses that require the number of rights or options to be recalculated to reflect share spits or consolidations to allow parity of treatment between shareholders and holders of parcels of rights or options in a company SUBDIVISION 124-G EXCHANGE OF SHARES IN A COMPANY FOR SHARES IN ANOTHER Subdivision 124-G is a very useful rollover in practice where a restructure is required eg., inserting a new holding company. Importantly whilst it is similar to subdivision 124-M (scrip for scrip) there are some important differences, in particular this subdivision requires there to be at least 2 shareholders all of which dispose of their shares as a consequence of a scheme of reorganisation of the company. It allows for the reorganisation of a corporate group to put in place a new holding company into the structure. This can be done either by: The shareholder (plus another shareholder) disposing of shares in the company to another (interposed) company and the interposed company issuing new (replacement) shares to the shareholder; or The shareholder s shares in the company being cancelled or redeemed and another (interposed) company issues replacement shares in return. The provision is useful to create a group structure and achieve asset protection through the process of interposing a new holding company. Disposal Case The conditions (section ) for the rollover under a disposal case include the following: There are at least 2 members owning all the shares in the original company; The exchanging members dispose of all of their shares in the original company in exchange for shares in the interposed company (and nothing else); Taxation Institute of Australia

20 The interposed company must own all the shares in the original company after the completion time; Each exchanging member must own a whole number of shares in the interposed company and in the same proportion to their percentage interest in the original company; The market value of each exchanging member s interest in the original company is the same as the market value of the of each exchanging member s shares in the interposed company; The taxpayer is an Australian resident or if the taxpayer is a non-resident the shares in the original and replaced entity are taxable Australian property; The shares in the interposed company must not be redeemable shares. Redeemable shares are defined in section 995 to mean: a. shares that are liable to be redeemed; or b. shares that, at the option of the company that issued them, are liable to be redeemed. Just after the completion time, the exchanging members must own all the shares in the interposed company; The original company and the interposed companies must be Australian residents. Redemption Case The conditions (section ) for the rollover under a redemption or cancellation case are generally the same as for the disposal case. Under the redemption or cancellation case; The interposed company must acquire no more than 5 shares in the original company; There are at least 2 exchanging members of the original company; The original company redeems or cancels those remaining shares; Each exchanging member receives shares (and nothing else) in the interposed company in return for their shares in the original company being redeemed or cancelled; The interposed company must own all the shares in the original company after the completion time; Each exchanging member must own a whole number of shares in the interposed company and in the same proportion to their percentage interest in the original company; The market value of each exchanging member s interest in the original company is the same as the market value of the of each exchanging member s shares in the interposed company; The taxpayer is an Australian resident or the shares are taxable Australian property; The shares in the interposed company must not be redeemable shares; Just after the completion time, the exchanging members must own all the shares in the interposed company; Taxation Institute of Australia

21 The original company and the interposed companies must be Australian residents. The number of shares issued by the new entity need not be the same number as the original company as long as the market value is the same before and after. Consequences for interposed company, unless consolidated group continues This is an important feature of the subdivision where the structure is a tax consolidated group. The subdivision provides that where the original company is the head company of a consolidated group, the interposed company can make a choice whether or not the consolidated group will continue with the interposed company being the new head company. Any such choice must be made within 28 days after the completion time or within such further time as the Commissioner allows. Other instances For all other cases, section applies, i.e., where some or all of the assets of the original company are pre-cgt assets, a whole number of shares in the original company held by the interposed company just after the completion time will be treated as pre-cgt assets in the hands of the interposed company. The proportion is calculated as the net value of the original company s pre-cgt assets divided by the net value of all of the original company s assets. Where a liability relates to more than one asset, it will be apportioned according to market value. The cost base of the interposed company s shares in the original company that are not pre-cgt will be equal to the total of the cost bases of the original company s assets less liabilities in respect of those assets. Taxation Institute of Australia

22 2.2.7 SUBDIVISION 124-H EXCHANGE OF UNITS TRUST FOR SHARES IN A COMPANY This rollover is designed for the exchange of units in a unit trust for shares in a company. It can work in one of two ways: the first is where units in a unit trust are disposed to a company and the company issues the unitholder with shares; and the second is where the units in a unit trust are redeemed or cancelled and the company issues shares to the unitholder. In either case the original unit trust will continue to exist. For this reason the preferred route is now to regard the Subdivision 124-H rollovers as superseded by the Subdivision 124-N rollover where the (generally superfluous) unit trust can be eliminated completely. Where Subdivision 124-H is used, there will be no CGT liability on the disposal of the post-cgt units in the trust in exchange for post-cgt shares, the replacement shares having the same cost base as the units that were disposed of. Essentially, the conditions and consequences are similar to the Subdivision 124-G rollover. Where unit holders dispose of pre-cgt units, the replacement shares will also be treated as pre-cgt shares. Where there is a mix of pre-cgt and post-cgt units swapped for shares there will be a corresponding mixture of pre-cgt and post-cgt shares received, with the post-cgt shares having the same cost base as the units disposed of SUBDIVISION 124-I CONVERSION OF A BODY TO AN INCORPORATED COMPANY There will be occasions where a body is formed under a law other than the Corporations Act 2001 and due to a change in circumstances now wishes to migrate to the Corporations Act For example a body may be initially formed under (say) the Co-operatives Schemes Act or the Associations Incorporation Act and now has grown to a size where it makes sense to become a company instead. Taxation Institute of Australia

23 In these cases, as long as the ownership proportions of the body are the same before and after the migration and the company issues shares to members in substitution for their pre-existing interests, a rollover will be allowed under Subdivision 124-I SUBDIVISION 124-J CROWN LEASES This is a rollover of very narrow application. It deals with situations where the holder of a crown lease over land obtains a replacement asset when the lease is renewed, extended or converted to an estate in fee simple SUBDIVISION 124-K DEPRECIATING ASSETS This is used in very narrow circumstances and covers the case where the taxpayer holds a depreciating asset that is attached to land held by the taxpayer under a quasi ownership right granted by a government agency and for some reason a rollover is not available under either Subdivision 124-J (eg. due to an easement) or Subdivision 124-L (relating to mining and prospecting rights). The rollover only applies where the quasi-ownership rights are granted to the original holder and will not apply if granted to an associate of the taxpayer. Again, this is rarely encountered in practice SUBDIVISION 124-L PROSPECTING AND MINING ENTITLEMENTS This deals with cases where there is a rollover of a mining or prospecting right where an entitlement expires or is surrendered and is replaced by a new one. Note that it is accepted that from time to time the boundaries covered by a mining or prospecting right will be altered by the issuing body (eg to correct earlier surveying errors). As long as the overall difference is not significant, the rollover will continue to apply notwithstanding such changes, as long as the market value of the right is not significantly affected SUBDIVISION 124-M SCRIP FOR SCRIP ROLL-OVER The scrip for scrip rollover in Subdivision 124-M is one of the more useful and commonly used of the replacement asset rollovers. Under this rollover a shareholder can elect to exchange its shares in an original company for scrip in another company without triggering a capital gain. Subdivision 124-M is used regularly for takeovers of one company by another and can be used for a unit trust to take over another unit trust. Subdivision 124-M cannot be used where a company takes over a unit trust or vice versa. Taxation Institute of Australia

24 For a takeover to allow the original shareholders to use subdivision 124-M, the acquirer must become entitled to at least 80% of the voting shares in the target company. Note that this may include shares to which the acquirer company was already entitled before the takeover offer was made. (This is one of the fundamental differences with subdivision 124-G) Earlier this year, Mr Sherry announced changes that would make it easier for takeovers and mergers regulated by the Corporations Act 2001 to qualify for the capital gains tax scrip for scrip roll-over. Mr Sherry said the government will carve out takeovers and mergers from having to satisfy the requirement that members in the target entity must be able to participate in the merger or takeover on substantially the same terms for the rollover, when the arrangement has been approved under the Corporations Act, including via a scheme of arrangement. The issues that is of concern is that as the law currently stands, scrip for scrip roll-over in Subdivision 124-M of ITAA 1997 may not be available to shareholders even though the takeover or merger has been approved under the Corporations Act The proposed changes are intended to better align the CGT scrip for scrip roll-over requirements with the Corporations Act 2001, to make it easier for takeovers and mergers regulated by the Corporations Act 2001 to qualify for the roll-over. Additional information provided by the Government In order for a takeover or merger arrangement to presently qualify for scrip for scrip roll-over it must satisfy the requirements in s (2) and s (2). One of the requirements, which concerns member participation, is that all holders of similar voting interests in the target entity must be able to participate in the arrangement on substantially the same terms. Under the proposed changes, if the original entity in an arrangement is subject to Ch 6 of the Corporations Act 2001, then that arrangement will not have to satisfy s (2)(b) and (c) or s (2)(b) and (c) of ITAA 1997 to qualify for the roll-over. However, the arrangement will still need to satisfy any other relevant conditions for the roll-over. Chapter 6 of the Corporations Act 2001 regulates takeovers. Generally, this Chapter applies to listed companies and managed investment schemes as well as companies and managed investment schemes with more than 50 members. Alternatively, if the arrangement is a scheme of arrangement within the meaning of s 411 of the Corporations Act 2001 that receives court approval, then that arrangement will not have to satisfy s (2)(b) and (c) of ITAA 1997 to qualify for the roll-over. The arrangement will still need to satisfy any other relevant conditions for the roll-over. All other arrangements will continue to be subject to the existing requirements in the scrip for scrip roll-over. One difficulty, particularly where a hostile takeover is undertaken, is that an acquirer may not be able to give certainty to shareholders of the target company that they will be entitled to the benefit of the rollover until the outcome of the bid is known (ie whether or not they have sufficient acceptances to meet the 80% requirement). Upon electing rollover by a shareholder who swaps existing shares in the target for shares in the acquirer, the cost base of the original shares is transferred to the new shares in the acquirer. Where a takeover offer for shares in a target is expressed as a cash offer, a scrip offer or a combination of cash and scrip and a shareholder in the target elects for part cash and part scrip in acquirer, there may be a partial rollover to the extent to which the shareholder elects to take scrip rather than cash. Taxation Institute of Australia

25 Utilizing the scrip for scrip rollover, SMEs operating as companies or trusts can merge their operations without triggering a CGT event. SMEs also have the opportunity of selling their business to larger listed public companies where their non-listed shares are able to be swapped for listed shares and hence be able to be sold down to their desired holding level or to suit their own cash circumstances. Conditions to Access Scrip for Scrip Rollover Scrip for scrip rollover relief applies to both companies and trusts with broadly similar conditions: i. an entity (the original interest holder) exchanges its original interest (share, option, right, unit or other similar interest) in a company or a trust (the original entity) for a replacement interest in another company or trust (the acquiring entity); ii. iii. iv. the replacement interest is the same kind of interest as the original interest; the exchange occurs as part of a single arrangement; the arrangement results in the acquiring entity, or a wholly-owned group of which the acquiring entity is a member of, owning at least 80% of the voting interests in the original entity; v. participation in the arrangement is available to all original interest holders on substantially the same terms; vi. vii. viii. ix. the original interest is post-cgt; a capital gain would have arisen from the disposal but for the rollover; if the acquiring entity and the original interest owners are not dealing with each other at arm s length, and the entities are linked (i.e. controls one another or subject to common control) or the interests are not widely held, then the market value and rights must be substantially the same; and the original interest holder is an Australian resident or the replacement entity is an Australian resident company or trust; x. you can not choose a rollover under another Div 122 or subdivision 124-G. With regard to the 80% requirement, a company or wholly-owned group of companies can become the owner of 80% or more of the voting shares in another company even if the company or group owned 80% or more of those shares before the arrangement, provided that they owned a greater percentage after the arrangement (Taxation Determination TD 2000/50). Similarly, a company can increase the percentage of voting shares that it owns in an original entity, for purposes of s (2)(a)(ii), even if it started out owning no voting shares (Taxation Determination TD 2000/51). The roll-over is not available if, just before the exchange, the taxpayer is a foreign resident, unless, just after the exchange, the replacement interest is "taxable Australian property" (s (1)). "Taxable Australian property" is defined in s Taxation Institute of Australia