2015 Event Template - Paper
2016 AGRIBUSINESS – RISING TO THE CHALLENGE Tax structuring for agribusiness divestments
Written by: Glenn Russell Partner PwC
Presented by: Glenn Russell Partner PwC
Queensland Division 20 April 2016 Tattersall’s Club, Brisbane
© Glenn Russell 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 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.
Glenn Russell
Tax structuring for agribusiness divestments
CONTENTS 1
Overview ......................................................................................................................................... 4
2
Preferred agribusiness holding structures for investors .......................................................... 5
3
Corporate structure ....................................................................................................................... 6 3.1
Overview ................................................................................................................................... 6
3.2
Establishing a corporate structure ............................................................................................ 6
3.3
Asset acquisition ....................................................................................................................... 7
3.4
Share acquisition ...................................................................................................................... 8
3.4.1
Company tax losses and the choice to consolidate .......................................................... 8
3.4.2
Cost base recognition for asset deficiencies ................................................................... 10
3.4.3
Deferring capital gains on vendor retained interest ......................................................... 12
3.5 4
5
Mixed share and asset acquisition .......................................................................................... 12
Stapled structure .......................................................................................................................... 13 4.1
Overview ................................................................................................................................. 13
4.2
Establishing a stapled structure .............................................................................................. 14
4.3
Non-arm’s length income rule ................................................................................................. 14
4.4
Trading trust characterisation ................................................................................................. 14
4.5
Structuring for tax efficiency and flexible exits ........................................................................ 15
4.6
Catering for the acquisition of landholder companies ............................................................. 15
Other transaction issues ............................................................................................................. 17 5.1
Implementation agreements ................................................................................................... 17
5.2
Purchase price allocation ........................................................................................................ 17
5.3
Contingent consideration and earn-out arrangements ........................................................... 17
5.4
Sweat equity ........................................................................................................................... 19
5.5
Cattle transfer levy .................................................................................................................. 19
5.6
Land tax .................................................................................................................................. 19
5.7
Stamp duty .............................................................................................................................. 20
Appendix A........................................................................................................................................... 21
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1 Overview Traditionally agribusiness has received limited attention from Australian institutional investors due to the perception of high risk and poor returns. This has meant that agribusinesses remain largely family owned1 and their structures often reflect decades of organic growth which can typically result in multiple family members holding both direct and indirect interests in various underlying assets. The often complicated ownership structure of family-owned agribusinesses are often comprised of multiple partnerships, trusts, companies and sole proprietary interests, which can act as a significant deterrent to institutional investors who may wish to seek returns from this sector. More recently, institutional investors’ scepticism towards agribusiness has warmed to cautious optimism, as traditionally high-yielding investments continue to underperform (such as commodities or energy). In the face of these changed market conditions many institutional investors have explored alternative sectors and this has undoubtedly contributed to the recent increase in merger and acquisition activity in Australia.2 Investors in Australian agribusiness can typically be classified into the following groups (these groups are not exhaustive):
Widely held foreign investment funds
Private equity
Chinese corporates,
Australian corporates.
Each group has idiosyncrasies (such as their risk appetite, the nature of their ultimate investors – ie individuals or sovereign pension funds – or their corporate governance requirements) which will inform their respective preferences for an investment holding structure. The purpose of this paper is therefore to explore some of the taxation and duty consequences which may follow as a result of current agribusiness owners preparing their business for institutional investors. All legislative references are to the Income Tax Assessment Act 1997 or Income Tax Assessment Act 1936, unless otherwise stated.
Australian Agribusiness Group (2013), Top 25% Agri – Secure Performance. In 2015 agribusiness accounted for 15% of the deals advise on by law firm King and Wood Mallesons, up from just 4% in 2014. (Refer: http://www.abc.net.au/news/2016-03-29/kwm-foreign-investment-report/7280354). 1 2
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2 Preferred agribusiness holding structures for investors As mentioned above, each investor profile typically has unique characteristics which lead to a preferred investment structure for that investor (albeit there is no ‘rule of thumb’). In the author’s experience, the two most common structures pursued by investors are:
A company which directly holds the underlying business (Corporate structure), and
A trust which holds the assets and leases them across to a company which conducts the active business, where the units in the trust and the shares in the company are stapled together (Stapled structure).
Each individual investor’s preference will be guided by their particular facts and circumstances, however an investor’s preferences tend to typically fall into the following categories: Corporate structure
Stapled structure
Asian investors
Foreign investment funds
Australian corporates
Private equity
Of course, there are other potential structures which can be used and any particular investor may well have an appetite (or at least express some interest) in one or both of the above structures. For example, in recent times the author has seen Asian investors warm to stapled structures involving managed investment trusts (MITs)). This paper will briefly outline characteristics and issues relating to each structure, followed by a brief commentary on some general contemporary tax and duty issues faced by agribusinesses.
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3 Corporate structure 3.1 Overview Typically, a corporate structure involves a holding company which holds shares in separate subsidiaries which separate the land and active business assets (for asset protection). Generally the structure is consolidated for tax purposes. This is illustrated as follows. Figure 1 Existing family group
Investor
Holding Company
Rent
Operating Company
Landholding Company
Lease Trading Stock
Plant
Other
Land
Australian tax consolidated group
3.2 Establishing a corporate structure As previously discussed It is common for family-owned Agribusinesses to be structured as a collection of partnerships, trusts and trading companies with interests held in varying proportions by family members. The appeal of this no doubt lies in the flow-through taxation of partnerships and trusts and the ability for families to access the CGT discount. Accordingly, it is fair to say that family-owned agribusinesses are generally not set up in a manner immediately suitable to institutional investors. Where an investor wishes to establish a corporate structure, this may involve:
the investors establishing a new corporate structure which simply acquires the assets of the vendor business (asset acquisition)
Vendor partnership, trust and assets being ‘rolled’ into companies with those companies acquired by the investor, potentially with scrip-for-scrip or other rollover relief (share acquisition), or
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the investor acquiring an interest in an existing vendor company, with that company acquiring all other assets (combination of share sale and asset sale).
The choice between these potential options will likely be influenced by a numbers of commercial factors, including:
whether or not existing owners wish to retain an interest in the business
potential stamp duty cost of transferring partnership, trust and individual assets to companies under pre-sale restructuring
the existence of tax losses and franking credits in vendor companies.
Each method of establishment gives rise to its own issues and the following sections give a brief explanation of these issues both in the case of an asset acquisition and a share acquisition, followed by a comparison of both.
3.3 Asset acquisition An asset acquisition may be appropriate where:
There are no companies in the vendor group
There are no company tax losses and/or franking credits in the vendor group
Vendor companies do not own valuable CGT assets
Vendors do not wish to retain an equity interest in the business, or
Liability issues exist with vendor entities.
In the author’s experience, vendors generally prefer to sell shares rather than assets, where possible. This is due to the ability of vendor’s to access the CGT discount at the individual shareholder level. The mechanics of this are demonstrated by Example 1 contained within Appendix A. At a high level, the vendor’s tax cost under an asset sale would be expected to be greater than under a share sale, quite simply because the company is not entitled to the CGT discount, compared with an individual shareholder which should be entitled to this discount. The scenario becomes even more complicated when one considers that many agribusinesses have been established over multiple decades and are often rich in pre-CGT assets (usually land). Example 2 of Appendix A compares the outcome of a share sale with that of an asset sale where the company holds some pre-CGT land. As can be seen in this example, an asset sale is the only scenario in which a cash tax liability results for the ultimate owner of the pre-CGT land. If one considers the outcome at the level of the company at first instance the outcomes would appear identical as no tax is payable at the company level due to the pre-CGT status of the land. However there remains the necessary step of returning cash out of the company to investors, other than by way of an unfranked dividend (which would give rise to cash tax liability). One option (which is explored in Example 2 of Appendix A) is to return share capital, but the company’s ability to return capital is limited to the extent of the company’s share capital at the time the return is paid. Another option is to formally liquidate the company © Glenn Russell 2016
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whereby distributions sourced from pre-CGT profits will essentially be treated as returns of capital, without the need for sufficient share capital at the time of the return. Absent this, the company could resort to declaring an unfranked dividend or lending money by way of a Division 7A loan, however both of these options produce less desirous outcomes. Of course, there is always the option of repurposing the company as an investment vehicle moving forward (such that the profits are never returned to investors but instead used in the ongoing operation of the investment business), but this would rely on this result aligning with the family’s particular circumstances and desired outcome. The above complications which can be involved in an asset sale, more often than not, lead vendors to prefer a disposal of shares rather than a disposal of assets. However, as can be seen from the liquidation example, where there are pre-CGT profits, other options do exist which can result in equivalent outcomes. Accordingly, detailed analysis of a company’s circumstances should be considered before any transaction proceeds.
3.4 Share acquisition A combination of an asset and share sale may be appropriate where:
Vendor companies hold valuable CGT assets
There are valuable tax losses and/or franking credits in vendor companies
Vendor wishes to retain an equity interest in the business, and
Acquiring shares results in a lower stamp duty cost.
There are of course a number of key tax issues to consider in the case of a share acquisition. Some of the more interesting ones are considered briefly below.
3.4.1 Company tax losses and the choice to consolidate Often a primary production business can generate significant tax losses over time and these tax losses may be of some value to an investor in certain circumstances. From a purchaser’s perspective, one key benefit of a share acquisition over an asset acquisition is the potential of acquiring valuable tax losses. Of course, in a transaction context, tax losses are often a delicate issue and investors often ask the following two questions:
to what extent can the tax losses be utilised; and
what future considerations might impact the future use of the tax losses?
The above two questions demonstrate the difficulty with which tax losses are valued in the context of a transaction, based on the uncertainty around whether or not (and if, to what extent) a purchaser may be able to claim the losses in the future. Consequently, it often falls to the vendor to determine the expected usefulness (and, therefore, value) of tax losses to a purchaser in an effort to drive bid value. Broadly, the value of tax losses to a potential purchaser will be driven by the following:
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the ability of the purchaser to continue to carry forward the accumulated loss balance (in other words, whether the loss integrity rules preclude a purchaser from claiming the balance of the targe entity’s carry forward tax loss balance against taxable income in future years), and
where a target is brought within a purchaser’s consolidated group the rate at which those losses will be able to be claimed by a potential purchaser (in other words, the available fraction which is likely to attach to the acquired losses once the entity is acquired).
Turning to each of these considerations briefly:
Where a vendor company is acquired but does not enter a tax consolidated group, the vendor company’s ability to utilise its tax losses post-acquisition will depend on it satisfying the ‘same business test’ (SBT) in respect of the losses. This is on the basis that the vendor company should fail the ‘continuity of ownership test’ (COT) when the purchaser acquires its majority stake. The SBT can be considered by most to be a very hard test to satisfy, and almost subject in nature despite being an objective test. Accordingly, it is often hard to persuade investors to assign value to SBT losses.
On the other hand, where a vendor company is acquired and joins a tax consolidated group, prejoining time losses may be transferred to the head company of the tax consolidated group (transferred losses) and be refreshed to COT losses provided the vendor company satisfies modified SBT. In this respect, where SBT is failed because of the transaction, modified SBT should be much easier to satisfy. Whilst this initially seems like a good outcome, there are additional loss integrity rules arising in a tax consolidated environment; specifically, the ‘available fraction (discussed below).
Where tax losses are transferred to the head company of a tax consolidated group (i.e. because the joining company satisfied modified SBT), the transferred losses are assigned an ‘available fraction’, broadly calculated as the market value of the joining company (based on certain assumptions) divided by the adjusted market value of the joined group. The purpose of the available fraction is to limit the rate at which transferred losses can be utilised by the head company to the hypothetical rate those losses would have been used by the joining company had it not joined the group. Accordingly, where the value of the joining company is significantly less than the value of the joined group, the available fraction can be very low and possibly nil. In such circumstances, despite transferred losses refreshing to COT losses, the rate at which they can be used will be significantly diminished and possibly prevented all together. Accordingly, where a company with significant tax losses has a low or nil market value, it may be appropriate not to consolidate the group for tax purposes; that is, if an investor wishes to potentially claim those losses.
Often a purchaser’s decision of whether or not to consolidate a target entity into the purchaser’s tax consolidated group will be motivated by the relative value of any carried forward losses compared with any increase in positive tax attributes (for example, Division 40 cost of depreciating assets) as a result of the tax cost setting process on consolidation. Additionally, purchasers have the option of cancelling losses of an acquired subsidiary entity when it enters a tax consolidated group. This would lead to an increased allocable cost amount (ACA) which can be allocated to assets (some of which giving rise to positive tax attributes) as part of the tax cost setting process. A prudent purchaser will often compare
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the expected value of continuing to carry forward acquired losses subject to an available fraction against any anticipated step up in ACA as a result of cancelling the losses. 3 On the other hand, the choice of whether to consolidate must be considered in light of more than just tax losses. For example, tax consolidation will generally result in the tax cost of a joining company’s assets being reset generally to market value. Accordingly, there may be value in this where the existing tax base of assets is below their market value. Moreover, tax consolidation allows the members of the group as a ‘single entity’ for tax. A key benefit of this is that losses generated by one company can be offset against income of another (thus avoiding unnecessary tax leakage).
3.4.2 Cost base recognition for asset deficiencies As stated earlier, a primary production business may generate significant tax losses overtime. In the author’s experience, it is not uncommon for these losses to be the result of external debt guaranteed by shareholders by providing security over land owned outside the company. This can often result in the company running into a net asset deficiency during its lifecycle (with the deficiency equal to the market value of the company’s assets less its liabilities). In a transaction context, where multiple assets and entities are being sold, this raises an interesting question – how much value should be allocated to the company? This is illustrated in Example 3 of Appendix A, which illustrates that there is a significant difference in outcomes for the vendor depending on whether the market value substitution rule for capital proceeds in section 116-30 applies. Generally speaking, a vendor will be exposed to greater cash tax liability where the market value substitution rule applies, in circumstances where property sold outside of the deficient company at values taking into account the company deficiency. There are at least two potential options which a vendor has to mitigate these outcomes, absent arguments that the market value substitution rule does not apply, namely:
the vendor makes a non-scrip capital contribution (akin to a gift) to the company with funds received from disposal of the land, or
the vendor makes a guarantee payment to external lender and subsequently forgives the debt from the company.
These potential options are briefly explained below (a more detailed discussion, involving hypothetical amounts, can be found towards the end of Example 3 in Appendix A). Non-scrip capital contribution In the case of a non-scrip capital contribution, the following steps are envisaged:
The vendor disposes of the primary production land for its market value, realising a capital gain.
3
Generally, where the available fraction is relatively low (ie where the target entity represents a low percentage of the overall market value of the tax consolidated group) it may be more beneficial to cancel losses, depending on the asset to which the increased ACA is likely to be spread.
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With cash received from the gain, the vendor makes a non-scrip capital contribution to the company sufficient enough to reduce the net asset deficiency to nil.
The vendor subsequently disposes of the company for $1, being its market value, and realises a capital loss equal to the original cost of the shares plus the amount of the non-scrip capital contribution, less $1.
The capital loss is applied against the capital gain realised on disposal of the primary production land, resulting in a reduced net capital gain (before CGT discount).
The above outcome relies on the vendor receiving 4th element cost base recognition for the non-scrip capital contribution under subsection 110-25(5). In this regard, if it can be established that the reason for the contribution was to preserve or increase the value of the vendor’s shares, then the requirements for 4th element cost base should be met. Relevantly, there are a number of private rulings which considers similar circumstances and indicate the ATO may accept this argument.4 Provided the non-scrip capital contribution results in 4th element cost base, appropriate tax outcomes should result (consistent with Example 3 in Appendix A above where the market value substitution rule does not apply). Amongst other things to consider where a non-scrip capital contribution is being evaluated is whether the contribution could be treated as ordinary income of the recipient company (which in the author’s view is unlikely) or whether the contribution could trigger a stamp duty liability (this would be particularly relevant where there are multiple shareholders in the company). Shareholder guarantee payment In the case of a shareholder guarantee payment, the following steps are envisaged:
The vendor disposes of the primary production land for its market value, realising a capital gain.
With cash received from the above gain, the vendor makes a payment to the company’s lender under the guarantee arrangement. This gives rise to a right to recover the amount of the payment from the company. This right has a cost base equal to the payment made under the guarantee.
The vendor then forgives the amount owing from the company and realises a capital loss.
The vendor subsequently disposes of the company for $1, being its market value, and realises a capital loss.
Each capital loss above applied against the capital gain on the primary production land, resulting in a reduced net capital gain (before CGT discount).
Under this scenario, the vendor should have a right of indemnity against to company to be repaid the guarantee payment. This right would be a CGT asset with a cost base equal to the guarantee payment. Accordingly, when the shareholder subsequently forgives the debt to make good the company’s net asset deficiency, CGT event C2 would occur and the shareholder would realise a capital loss equal to the guarantee payment (however, it would be relevant to consider how the
4
See Private Binding Ruling Authorisation No. 91191; 1012653484192; and 1012313049488.
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commercial debt forgiveness rules would apply in this circumstances and whether it is of any practical relevance). Provided the vendor receives cost base recognition for the guarantee payment, appropriate tax outcomes should result (consistent with the example above where the market value substitution rules does not apply). The outcomes discussed above are in accordance with the ATO’s view set out in Taxation Ruling TR 96/23.
3.4.3 Deferring capital gains on vendor retained interest It may be the case that a vendor wishes to retain an interest in their business; a common question which often arises is whether unrealised gains on the vendor’s retained interest can be deferred. That is, can the existing owners avoid having to sell 100% of their interest and buy back in? If the vendor’s business consists of one or more companies, it may be the case that the existing owners can avoid having to sell 100% of their interest and subsequently buy back in. A new holding company could be used with a combination of scrip and cash offered to the vendor, with rollover relief chosen for the scrip component (for example under Subdivision 124-M: scrip-for-scrip). However, if the vendor’s business is comprised of a collection of partnerships, trusts and individually held assets, the answer may potentially still be yes, it is however technically harder to reach. In this case, while there may be rollover reliefs available to defer gains on the transfer of assets (for example under subdivisions 122-A, 122-B or subdivision 124-N), stamp duty could be a limiting factor, absent any corporate reconstruction relief. Accordingly, a detailed analysis of the potential stamp duty costs will be the precursor to any transaction involving the transfer of assets, regardless of the vendor’s holding structure.
3.5 Mixed share and asset acquisition A mixed share and asset sale will involve a combination of the issues discussed under the preceding sections. The added complexity of needing to consider the technical positions which apply in both circumstances mean that transactions of this kind require detailed consideration and planning (from both an income tax and duty perspective) prior to implementation. Advisors should seek to actively engage with clients whose structures may lend to this type of acquisition early to ensure adequate lead time over the introduction of any institutional investors.
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4 Stapled structure 4.1 Overview A stapled structure consists of a ‘flow through’ trust and a company, stapled together, with the trust holding land and the company holding all other business assets (ie trading stock, plant & equipment, agistments, etc.). The trust, which is typically established as managed investment trust (MIT), rents the land to the company such that returns to the stapled security holders take the form of:
trust distributions funded by rental income, and
dividends funded by business income.
This is illustrated as follows. Figure 2
Existing family group Investor
Stapled Security
MIT
Rent
Holding Company
Operating Company
Sub Trust
Property Trust
Land
Stock
Other
Australian tax consolidated group
This type of structure is generally sought after by foreign investment funds and infrastructure investors which are able to benefit from a withholding tax of 15% on MIT fund payments to exchange of information (EOI) countries (compared to 30% withholding tax which otherwise would apply). MIT status therefore can significantly increase post tax returns to investors, resident of EOI countries.
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4.2 Establishing a stapled structure Broadly, the considerations which are relevant to the establishment of a corporate structure will also warrant consideration in the establishment of a stapled structure (as they are mainly driven by the vendor’s existing structure, which is unaffected by the resultant structure). However, some additional complications arise by virtue of adopting a stapled structure which are not apparent in a pure corporate structure. These mainly relate to the ongoing operation of and exit from the agribusiness. We have briefly discussed some of the key considerations under the following headings.
4.3 Non-arm’s length income rule If enacted, Tax Laws Amendment (Net Tax System for Managed Investment Trusts) Bill 2015 (proposed AMIT rules) will include a ‘non arm’s length income rule’ (NALIR), the purpose of which is to remove the incentive to shift profits from a related active business to a MIT through non-arm’s length activity. In the case of an infrastructure business or an agribusiness MIT, this rule would be relevant to the lease charges between the MIT and the trading company as well as any internal financing. Where the NALIR applies, income which exceeds the expected arm’s length amount will be taxed at the corporate tax rate of 30% (compared to the concessional withholding rate of 15% which would otherwise apply). In this respect, while it is not intended that a MIT must satisfy the transfer pricing requirements in Subdivision 815-B, if a MIT can demonstrate that a transfer pricing benefit does not arise under the transfer pricing provisions, the ATO has stated it will generally accept this sufficient to establish arm’s length dealings for the purpose of the NALIR. 5 It follows that it should be considered appropriate to apply the arm’s length principle, as outlined in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators, July 2010 when pricing the relevant leases. In this respect, given the potential variability in the income of an agribusiness – i.e. given exposure to variables such weather, livestock price, etc. – a mechanism providing for regular market reviews of rent should be considered to avoid generating disproportionate losses in the company while still generating significant income in the trust.
4.4 Trading trust characterisation One key requirement for a trust to be characterised as a MIT is that the trust is not a ‘trading trust’ under Division 6C. A ‘trading business’ is anything which is not an ‘eligible investment business’, which relevantly includes investing in land primarily for the purpose of deriving rent. 6 At common law the term ‘rent’ is generally taken to be ‘a payment for possession of realty under lease’ 7 such that, there must in fact be a ‘lease’. Under common law, a lease has been defined as a “right to exclusive
5
See paragraph 45 of Law Companion Guide LCD 2015/D15 Subsection 102MB(2) ITAA 1936. 7 Commissioner of Stamp Duties (NSW) 6
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possession of land … to be distinguished from a license, which does not give rise to exclusive possession”.8 It follows that income from arrangements such as agistments is unlikely to be characterised as ‘rent’ for the purposes of Division 6C. Accordingly, income of this kind should, to the extent possible, be derived by the company side of the staple to avoid blowing up the MIT. Another form of income growing in prevalence in Agribusiness are compensation payments made by coal seam gas producers for the installation of wells on farmland. These payments, again, would generally not be considered rent. Accordingly, given the potential quantum of such payments, and their inability to satisfy the MIT requirements in any given year, it is appropriate to ensure the compensation payments are structured appropriately prior to reaching any agreement. Further discussion on this issue can be found in Applying Infrastructure Tax Concepts to Different Industries, authored by Stuart Landsberg.9
4.5 Structuring for tax efficiency and flexible exits It is important for the staple structure to provide commercial flexibility for a future exit of investors. For example, this could involve the use of a sub-trust and property trust structure, whereby the MIT holds units in a sub-trust, and the sub-trust in one or more ‘property trusts’ holding the relevant land. For example, in the case of a future capital raising (e.g a listing event) this would provide the ability to list the MIT entity or the sub-trust. In this respect, the Australian tax consequences would be different to the extent the sub-trust is used as the Australian listing vehicle rather than the MIT. In particular, listing at the sub-trust level would mean any capital gain realised on the future listing would be flowed through the MIT to existing investors, rather than a capital gain being realised at the investor level. This in turn should limit the Australian tax on the capital gain to 15% rather than 30% (provided the investor is resident of an EOI country). In addition, there may be benefits in separating each discrete parcel of land into a separate property trust, provided there are commercial reasons for doing so. Structuring the investment in this way could help reduce the quantum of ongoing land tax costs (albeit this would need to be considered in light of the increased administration cost of establishing the multiple property trusts).
4.6 Catering for the acquisition of landholder companies While a staple structure might provide foreign investors with greater post tax returns, it could come at a cost to the vendor where, for example, valuable land is held by a company which is not able to access the CGT discount. Generally, it is uncommon for a MIT to hold land through interposed companies as any income derived by those companies would be taxed at the 30% corporate tax rate, rather than the concessional withholding rate of 15% afforded to a MIT. However, structured appropriately, it may be possible to facilitate a share acquisition of the relevant company, thus allowing the vendor to benefit from the CGT discount. For example, the MIT could
8 9
LexisNexis, Encyclopaedic Australian Legal Dictionary Page 10, Applying Infrastructure Tax Concepts to Different Industries, written by Stuart Landsberg FTI and Hayden Scott, FTI.
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acquire the company through a wholly-owned subsidiary capitalised with debt to the greatest extent possible (subject to thin capitalisation provisions where they apply). This is illustrated as follows. Figure 3 Existing family group Investor
Stapled Security
MIT
Interest
Debt
Property HoldCo Dividend Vendor Company
Rent
Trading Company
Land
Australian tax consolidated group
In this example, the Property HoldCo acquires Vendor Company and forms a tax consolidated group such that transactions (including dividends) between each company are ignored for tax. Accordingly, Property HoldCo will be taken to receive rent from Trading Company against which it can deduct (subject to thin capitalisation if applicable) interest paid to the MIT. The effect of this is to reduce the quantum of assessable rent in Property HoldCo such that lesser tax is paid at the company level. The MIT, being a flow through trust, would then distribute the interest to investors and, depending on the jurisdiction of those investors, the distributions would be subject to withholding tax of 15%. In this regard, provided that the company only derives rental income, being income from an ‘eligible investment business’, the MIT should not be characterised as a trading trust under Division 6C and therefore should continue to be a MIT, all other things being equal. Indeed, the biggest limitation to this potential structure is the potential application of the thin capitalisation rules which would likely limit the quantum of interest deductions at the Property HoldCo level. It would also be relevant to consider the NALIR, discussed above. However, at least to some extent, this potential option may reduce the amount of income subject to tax at 30% at the company level and therefore may be entertained by an investor.
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5 Other transaction issues 5.1 Implementation agreements Before any pre-structuring is undertaken by a vendor, it is important there is agreement between both the vendor and purchaser on the sequence of events and the specific steps involved. This is to avoid tax and duty costs being borne by the vendor without certainty on the deal and that it will in fact proceed. Moreover, a carefully constructed implementation deed can help manage unnecessary double duty which could arise if deal is not appropriately structured. Amongst other things, this would involve ensuring new entities are capitalised with equity funding before underlying land assets are acquired.
5.2 Purchase price allocation Often there are competing interests on purchase price allocation as between the vendor and purchaser. A purchaser will often want as much value as possible allocated to its CGT assets which, for example, can obtain the benefit of the CGT discount. This is compared to a purchaser whom would ordinarily want as much value allocated to depreciating assets for which depreciation deductions may be claimed over time. In the author’s experience there is generally at least some negotiation to be had around purchase price allocation.
5.3 Contingent consideration and earn-out arrangements Often in a deal the parties cannot agree on the value to be paid under the transaction. One common way of dealing with the circumstance is for the parties to enter into an earn-out arrangement. There are broadly two types of such arrangement:
Standard earn-out arrangement, whereby the vendor is granted a right to receive an additional payment that is contingent on the underlying performance of the business or assets, and
Reverse earn-out arrangement, whereby the vendor will undertake to repay the buyer an amount contingent on the underlying performance of the business or assets over a specific period of time.
Historically, the ATO has applied the principles in draft Taxation Ruling TR 2007/D10 in determining the tax outcomes under earn-out arrangements; broadly, those outcomes being as follows: Purchaser
Vendor Standard earn-out
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Market value of earn-out right treated as a separate CGT asset and included in vendor’s capital proceeds on disposal of the business
Market value of earn-out right included in purchaser’s CGT cost base for the acquisition of the business
Subsequent payment does not impact the cost base of the original business asset acquired (which is good if the earn-out
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CGT event C2 occurs when earn-out payments are received and there is an ending of the asset.
Proceeds reasonably attributable to grant of earn-out right allocated to earnout right and not sale of business
Proceeds reasonably attributable to grant of earn-out right are included in the cost base of the earn-out right.
CGT event D1 does not occur such that there is no gain for the vendor
CGT event C2 occurs when earn-out payments are received and there is an ending of the asset.
If earn-out payments are made there is no capital loss for the vendor
payment is less than the amount original expected)
As helpfully summarised by Greg Thompson in his article Earn-outs and other issues for vendors, there are a number of issues for vendors by the treatment adopted in TR 2007-D10, including:
Bringing forward taxation on amounts never actually received
Mismatch of capital losses and capital gains, and
Capital gains resulting in respect of the underlying disposal of pre-CGT assets.10
Relevantly, on 25 February 2016, legislation was enacted 11 to provide look-through treatment for qualifying earn-out arrangements. Broadly, under the look-through treatment:
any financial benefit provided (or received) by a purchaser increases (or decreases) part of the cost base or reduced cost base of the underlying asset; and
any financial benefit received (or provided) by the vendor increases (or decreases) the capital proceeds for the underlying asset.
This treatment ensures that the issues identified above which can occur under the approach prescribed by TR 2007/D10 no longer arise. However, it is important to emphasise that the new law only applies to qualifying ear-out arrangements giving rise to “look-through earn-out rights”, as defined in section 118-565. The relevant criteria can summarised broadly, as follows:
there is a right to future financial benefits that are not reasonably ascertainable when the right is created.
the right is created under an arrangement involving the disposal of an active CGT asset
the earn-out arrangement has a term of no longer than 5 years
the value of financial benefits must be contingent on, and reasonably relate to, the economic performance of the business, and
10 11
See page 6, Earn-outs and other issues for vendors, written by Mr Greg Thompson. Tax and Superannuation Laws Amendment (2015 Measures No. 6) Act 2015
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the parties must be dealing at arm’s length.
Accordingly, with the benefit of the new look-through earn-out rules, there may be more scope to structure deals with consideration contingent on the economic performance of the relevant business, without there being risk of inappropriate tax outcomes. Indeed, earn-out arrangements, structured properly, are also a good way in which a vendor can share in the upside of the business post-sale, particularly if the vendor is to continue on in management role.
5.4 Sweat equity Another way of allowing a vendor to share in the upside of a business post disposal, is the entering into of ‘sweat equity’ style arrangements, whereby the former owners are provided equity-like returns for their continued involvement in the relevant business. One potential way of structuring this ‘sweat equity’ without giving rise to upfront taxation for the vendors is to provide for the contingent equity-like returns under an employment contract with the vendor, rather than, say, issuing a new class of share. Structured in this way, a ‘sweat equity’ style arrangement may create an alignment of interests between the purchaser and vendor.
5.5 Cattle transfer levy Pursuant to the Primary Industries (Excise) Levies Act 1999 (Cth), the Federal Government imposes a levy on the direct transfer of ownership of cattle on a per head basis (generally $5 per head). Where there is an indirect transfer of the ownership of cattle (e.g. where an interest in a trust or company is acquired), no levy is applied. There are also various exemptions to the levy. For example, where ownership is transferred between related bodies corporate (as defined under the Corporations Act 2001 (Cth)) and the purchaser is not a processor, or where a transfer of ownership occurs as a result of the dissolution of a partnership (in circumstances where subsection 70-100(1) of the Income Tax Assessment Act 1997 applies). Accordingly, where it is not possible to indirectly transfer the cattle, consideration should be given to the availability of any exemptions. Where livestock other than cattle is involved, it may be necessary to consider whether the livestock transaction levy (which operates similarly to the levy on cattle) or other levies may apply. Useful information regarding the cattle transaction levy and other livestock levies can be found at: http://www.agriculture.gov.au/ag-farm-food/levies/categories/livestock/cattle-livestock-transactionlevy-annual/information_sheet
5.6 Land tax Land tax is paid in all Australian jurisdictions, except the Northern Territory. It is generally imposed on freehold land, but can also apply to other land interests such as Crown leases. In some cases the relevant land ownership may not involve freehold land and may comprise of pastoral leases. In those circumstances, land tax may not be payable depending on the jurisdiction (e.g. in Queensland).
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Each of the jurisdictions has land tax exemptions for primary production land and the eligibility requirements differ between the various jurisdictions. For example, in Queensland, the exemption may apply where the land is owned by natural persons that are not absentees or relevant proprietary companies (as specifically defined). Where a restructure or an acquisition occurs there is a risk of losing the exemption where it results in an absentee, public company or foreign company directly or indirectly owning the relevant land. Each State Revenue Office currently has an audit and compliance program that monitors the eligibility of granted exemptions, and they have been particularly active in Queensland, New South Wales and Western Australia.
5.7 Stamp duty Stamp duty continues to be imposed in all Australian jurisdictions on direct and indirect dealings in interests in land and associated plant and equipment. In most jurisdictions, livestock is not considered dutiable property, however Queensland is an exception. In Queensland, on a direct transfer of land and cattle, both will be subject to duty. Aggregation rules may also apply to treat several transactions as one for stamp duty purposes, in certain circumstances. For example, where the land of the business is acquired from one entity, and the plant and equipment is acquired from another, stamp duty may apply to treat both transactions as if they were one, rather than treating them separately and only imposing duty on the land. The stamp duty regime also extends to the indirect transfer of assets, through dealings in either companies or trusts. Generally, stamp duty will apply to acquisitions of interests of 50% or more in private companies that are considered to be landholders. Depending on the jurisdiction concerned, the acquisition of an interest as little as 20% in a trust (e.g. in Victoria) or any percentage change in the interest of a trust can be subject to duty (e.g. under the Queensland trust look through provisions). Most jurisdictions have corporate reconstruction provisions that can apply to exempt certain transactions between related entities (e.g. unit trusts and companies). However, these provisions generally do not extend to discretionary trusts and in some jurisdictions, such as Queensland, mainly apply to transactions between companies. There are also stamp duty concessions for intergenerational transfers of farming businesses and family partnership acquisitions. Depending on the group structure and parties involved, this may be relevant and require further consideration.
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Appendix A Example 1 Assume the following:
A company is capitalised with $1,000,000 by Shareholder 1
The company uses the $1,000,000 to acquire a large parcel of land
Over a number of years the value of the land increases to $2,000,000
An investor wishes to acquire the land and is considering either a direct asset acquisition or a share acquisition.
A comparison of outcomes is as follows. Asset sale
Share sale
Capital proceeds
$2,000,000
$2,000,000
Cost base of land / shares
$1,000,000
$1,000,000
Gross capital gain
$1,000,000
$1,000,000
n/a
($500,000)
Net capital gain
$1,000,000
$500,000
Tax at 49%
$490,000*
$245,000
(Less) CGT discount
*Assume the company pays 30% tax on the capital gain and distributes a fully franked dividend to its shareholder who in turn pay’s top-up tax of 19%.
Example 2 Another, slightly more complicated example, but one quite conceivably arising for a generational family-owned agribusiness, is as follows.
Company is capitalised with $1,000,000 by Shareholder 1 before 20 September 1985
Company uses the $1,000,000 to acquire a large parcel of land before 20 September 1985
Over a number of years the value of the land increases to $2,000,000
Shareholder 1 dies in 20X6 and Shareholder 2 inherits Shareholder 1’s shares
An investor wishes to acquire the land and is considering either a direct asset acquisition or a share acquisition.
Under this example it is assumed that the transaction could be approached in one of three ways:
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Asset acquisition without a liquidation of the vendor company
Asset acquisition with the vendor company liquidated under a member’s voluntary liquidation, or
Share acquisition.
A comparison of outcomes under this scenario is as follows.
Asset sale Capital proceeds
Asset sale (liquidation)
Share sale
Note
$2,000,000
$2,000,000
$2,000,000
Cost base of land / shares
Pre-CGT
Pre-CGT
$2,000,000
Gross capital gain / (loss)
n/a
n/a
$0
(Less) CGT discount
n/a
n/a
n/a
Net capital gain
n/a
n/a
$0
Unfranked dividend
$1,000,000
n/a
n/a
3
Return of capital
$1,000,000
n/a
n/a
3
Liquidator’s distribution – assessable component
n/a
$0
n/a
3
Liquidators distribution – nonassessable component
n/a
n/a
3
Taxable income - Shareholder 2 Tax at 49%* Capital loss on cancellation of shares
$2,000,000 3
$1,000,000
$0
$0
$490,000
$0
$0
$1,000,000
$0
n/a
1,2
4
Notes: 1. The company’s land will continue to be pre-CGT after shareholder 2 inherits the shares, despite there in fact being a majority change in ownership. This is on the basis that, Division 149 will not treat there as being a majority change in ownership for the purposes of the Division, because Shareholder 2 acquired its shares because of the death of Shareholder 1. This is pursuant to subsection 149-30(4).
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2. On the basis that Shareholder 1 acquired its shares before 20 September 1985, Shareholder 2’s cost base for the shares when inherited from Shareholder 1, will be their market value at the date of death of Shareholder 1, which in the above example, is assumed to be $2,000,000. This is pursuant to the cost base modification in item 4 of the table included at subsection 128-15(4). 3. Under an asset sale where there is a member’s voluntary liquidation, after disposing of the asset, the liquidator with distribute free cash by way of a liquidator’s distribution. The assessable components of the liquidator’s distribution will be worked out under section 47 of the Income Tax Assessment Act 1936. In this respect, profits referable to the disposal of preCGT assets will not be assessable, nor will the distribution of original share capital. These amounts will instead reduce the cost base of Shareholder 2’s shares under CGT event G1. 4. Under an asset sale without a formal liquidation, it is assumed that, after disposing of the land, the company pays an unfranked dividend of $1,000,000; returns capital of $1,000,000, being the capital reflected in the company’s financial statements; and, is subsequently deregistered. The unfranked dividend would be included in Shareholder 2’s assessable income and would be taxed at 49%, whereas the return of capital would reduce the CGT cost base of Shareholder 2’s shares under CGT event G1: capital payment for shares. Consequently, Shareholder 2 would realise a capital loss of $1,000,000 when the shares are cancelled under CGT event C2 occurs. Example 3 Assume the following:
A company has a net asset deficiency of $50 (assets with a market value of $100 and external debt of $150).
External debt has been guaranteed by shareholder 1 and secured over primary production land owned by shareholder 1.
The primary production land is worth $200 and has a cost base of $50. There is no associated debt.
Shareholder 1 has a cost base in its shares of $10.
An investor wishes to acquire the company and the primary production land for a total purchase price of $150.
One potential option is for the investor to acquire the company for $1 and the land for $149. The investor could subsequently subscribe for further equity in the company to retire the external debt, if that is desired. However, this outcome relies on there being no ‘market value substitution’ in respect of capital proceeds received for the primary production land. This is relevant because the land, which is owned by shareholder 1 in its own right, has a market value of $200, but is disposed of for $150 to take into account the net asset deficiency in the company. Accordingly, there may be a risk that the market value substitution rule in section 116-30 could apply. However, this would require a conclusion that the purchaser and vendor were not “dealing at arm’s length” in respect of the disposal of the land. Indeed, the fact that the vendor and
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purchaser are in fact “at arm’s length” might go some way to arguing that section 116-30 should not apply; however, this might not be enough in every circumstance. That is, notwithstanding two parties are in fact at arm’s length (i.e. because they are not related in any way), this is not always to say they are “dealing at arm’s length”. Relevant case law would need to be considered in this regard. A comparison of outcomes where the market value substitution rule for capital proceeds, is as follows. i)
Market value substitution rule in section 116-30 does not apply Shares
Land
Total
Capital proceeds
$1
$149
$150
Cost base of land / shares
$10
$50
$60
Gross capital gain / (loss)
($9)
$99
$90
(Less) CGT discount
($45)
Net capital gain
$45
Tax at 49%
$22.05
ii)
Note
Market value substitution rule in section 116-30 applies Shares
Land
Total
Capital proceeds
$1
$149
$200
Cost base of land / shares
$10
$50
$60
Gross capital gain / (loss)
($9)
$99
$140
(Less) CGT discount
($70)
Net capital gain
$70
Tax at 49%
$34.3
Note
Potential options to mitigate the above include: Non-scrip capital contribution In the case of a non-scrip capital contribution, the following might occur:
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Shareholder 1 disposes of the primary production land for its market value of $200, realising a capital gain of $150.
With cash received from the above, shareholder 1 makes a non-scrip capital contribution of $50 to the company so as to reduce the net asset deficiency to nil.
Shareholder 1 subsequently disposed of the company for $1, being its market value, and realises a capital loss of $60.
The capital loss is applied against the capital gain of $150 on the primary production land, resulting in a net capital gain (before CGT discount) of $90.
Shareholder guarantee payment In the case of a shareholder guarantee payment, the following might occur:
Shareholder 1 disposes of the primary production land for its market value of $200, realising a capital gain of $150.
With cash received from the above, shareholder 1 makes a payment to the company’s lender under the guarantee arrangement and has a right to recover the amount from the company with a cost base equal to the payment.
Shareholder 1 forgives the amount owing from the company and realises a capital loss of $50.
Shareholder 1 subsequently disposed of the company for $1, being its market value, and realises a capital loss of $10.
Each capital loss above applied against the capital gain of $150 on the primary production land, resulting in a net capital gain (before CGT discount) of $90.
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Written by: Glenn Russell Partner PwC
Presented by: Glenn Russell Partner PwC
Queensland Division 20 April 2016 Tattersall’s Club, Brisbane
© Glenn Russell 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 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.
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CONTENTS 1
Overview ......................................................................................................................................... 4
2
Preferred agribusiness holding structures for investors .......................................................... 5
3
Corporate structure ....................................................................................................................... 6 3.1
Overview ................................................................................................................................... 6
3.2
Establishing a corporate structure ............................................................................................ 6
3.3
Asset acquisition ....................................................................................................................... 7
3.4
Share acquisition ...................................................................................................................... 8
3.4.1
Company tax losses and the choice to consolidate .......................................................... 8
3.4.2
Cost base recognition for asset deficiencies ................................................................... 10
3.4.3
Deferring capital gains on vendor retained interest ......................................................... 12
3.5 4
5
Mixed share and asset acquisition .......................................................................................... 12
Stapled structure .......................................................................................................................... 13 4.1
Overview ................................................................................................................................. 13
4.2
Establishing a stapled structure .............................................................................................. 14
4.3
Non-arm’s length income rule ................................................................................................. 14
4.4
Trading trust characterisation ................................................................................................. 14
4.5
Structuring for tax efficiency and flexible exits ........................................................................ 15
4.6
Catering for the acquisition of landholder companies ............................................................. 15
Other transaction issues ............................................................................................................. 17 5.1
Implementation agreements ................................................................................................... 17
5.2
Purchase price allocation ........................................................................................................ 17
5.3
Contingent consideration and earn-out arrangements ........................................................... 17
5.4
Sweat equity ........................................................................................................................... 19
5.5
Cattle transfer levy .................................................................................................................. 19
5.6
Land tax .................................................................................................................................. 19
5.7
Stamp duty .............................................................................................................................. 20
Appendix A........................................................................................................................................... 21
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1 Overview Traditionally agribusiness has received limited attention from Australian institutional investors due to the perception of high risk and poor returns. This has meant that agribusinesses remain largely family owned1 and their structures often reflect decades of organic growth which can typically result in multiple family members holding both direct and indirect interests in various underlying assets. The often complicated ownership structure of family-owned agribusinesses are often comprised of multiple partnerships, trusts, companies and sole proprietary interests, which can act as a significant deterrent to institutional investors who may wish to seek returns from this sector. More recently, institutional investors’ scepticism towards agribusiness has warmed to cautious optimism, as traditionally high-yielding investments continue to underperform (such as commodities or energy). In the face of these changed market conditions many institutional investors have explored alternative sectors and this has undoubtedly contributed to the recent increase in merger and acquisition activity in Australia.2 Investors in Australian agribusiness can typically be classified into the following groups (these groups are not exhaustive):
Widely held foreign investment funds
Private equity
Chinese corporates,
Australian corporates.
Each group has idiosyncrasies (such as their risk appetite, the nature of their ultimate investors – ie individuals or sovereign pension funds – or their corporate governance requirements) which will inform their respective preferences for an investment holding structure. The purpose of this paper is therefore to explore some of the taxation and duty consequences which may follow as a result of current agribusiness owners preparing their business for institutional investors. All legislative references are to the Income Tax Assessment Act 1997 or Income Tax Assessment Act 1936, unless otherwise stated.
Australian Agribusiness Group (2013), Top 25% Agri – Secure Performance. In 2015 agribusiness accounted for 15% of the deals advise on by law firm King and Wood Mallesons, up from just 4% in 2014. (Refer: http://www.abc.net.au/news/2016-03-29/kwm-foreign-investment-report/7280354). 1 2
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2 Preferred agribusiness holding structures for investors As mentioned above, each investor profile typically has unique characteristics which lead to a preferred investment structure for that investor (albeit there is no ‘rule of thumb’). In the author’s experience, the two most common structures pursued by investors are:
A company which directly holds the underlying business (Corporate structure), and
A trust which holds the assets and leases them across to a company which conducts the active business, where the units in the trust and the shares in the company are stapled together (Stapled structure).
Each individual investor’s preference will be guided by their particular facts and circumstances, however an investor’s preferences tend to typically fall into the following categories: Corporate structure
Stapled structure
Asian investors
Foreign investment funds
Australian corporates
Private equity
Of course, there are other potential structures which can be used and any particular investor may well have an appetite (or at least express some interest) in one or both of the above structures. For example, in recent times the author has seen Asian investors warm to stapled structures involving managed investment trusts (MITs)). This paper will briefly outline characteristics and issues relating to each structure, followed by a brief commentary on some general contemporary tax and duty issues faced by agribusinesses.
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3 Corporate structure 3.1 Overview Typically, a corporate structure involves a holding company which holds shares in separate subsidiaries which separate the land and active business assets (for asset protection). Generally the structure is consolidated for tax purposes. This is illustrated as follows. Figure 1 Existing family group
Investor
Holding Company
Rent
Operating Company
Landholding Company
Lease Trading Stock
Plant
Other
Land
Australian tax consolidated group
3.2 Establishing a corporate structure As previously discussed It is common for family-owned Agribusinesses to be structured as a collection of partnerships, trusts and trading companies with interests held in varying proportions by family members. The appeal of this no doubt lies in the flow-through taxation of partnerships and trusts and the ability for families to access the CGT discount. Accordingly, it is fair to say that family-owned agribusinesses are generally not set up in a manner immediately suitable to institutional investors. Where an investor wishes to establish a corporate structure, this may involve:
the investors establishing a new corporate structure which simply acquires the assets of the vendor business (asset acquisition)
Vendor partnership, trust and assets being ‘rolled’ into companies with those companies acquired by the investor, potentially with scrip-for-scrip or other rollover relief (share acquisition), or
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the investor acquiring an interest in an existing vendor company, with that company acquiring all other assets (combination of share sale and asset sale).
The choice between these potential options will likely be influenced by a numbers of commercial factors, including:
whether or not existing owners wish to retain an interest in the business
potential stamp duty cost of transferring partnership, trust and individual assets to companies under pre-sale restructuring
the existence of tax losses and franking credits in vendor companies.
Each method of establishment gives rise to its own issues and the following sections give a brief explanation of these issues both in the case of an asset acquisition and a share acquisition, followed by a comparison of both.
3.3 Asset acquisition An asset acquisition may be appropriate where:
There are no companies in the vendor group
There are no company tax losses and/or franking credits in the vendor group
Vendor companies do not own valuable CGT assets
Vendors do not wish to retain an equity interest in the business, or
Liability issues exist with vendor entities.
In the author’s experience, vendors generally prefer to sell shares rather than assets, where possible. This is due to the ability of vendor’s to access the CGT discount at the individual shareholder level. The mechanics of this are demonstrated by Example 1 contained within Appendix A. At a high level, the vendor’s tax cost under an asset sale would be expected to be greater than under a share sale, quite simply because the company is not entitled to the CGT discount, compared with an individual shareholder which should be entitled to this discount. The scenario becomes even more complicated when one considers that many agribusinesses have been established over multiple decades and are often rich in pre-CGT assets (usually land). Example 2 of Appendix A compares the outcome of a share sale with that of an asset sale where the company holds some pre-CGT land. As can be seen in this example, an asset sale is the only scenario in which a cash tax liability results for the ultimate owner of the pre-CGT land. If one considers the outcome at the level of the company at first instance the outcomes would appear identical as no tax is payable at the company level due to the pre-CGT status of the land. However there remains the necessary step of returning cash out of the company to investors, other than by way of an unfranked dividend (which would give rise to cash tax liability). One option (which is explored in Example 2 of Appendix A) is to return share capital, but the company’s ability to return capital is limited to the extent of the company’s share capital at the time the return is paid. Another option is to formally liquidate the company © Glenn Russell 2016
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whereby distributions sourced from pre-CGT profits will essentially be treated as returns of capital, without the need for sufficient share capital at the time of the return. Absent this, the company could resort to declaring an unfranked dividend or lending money by way of a Division 7A loan, however both of these options produce less desirous outcomes. Of course, there is always the option of repurposing the company as an investment vehicle moving forward (such that the profits are never returned to investors but instead used in the ongoing operation of the investment business), but this would rely on this result aligning with the family’s particular circumstances and desired outcome. The above complications which can be involved in an asset sale, more often than not, lead vendors to prefer a disposal of shares rather than a disposal of assets. However, as can be seen from the liquidation example, where there are pre-CGT profits, other options do exist which can result in equivalent outcomes. Accordingly, detailed analysis of a company’s circumstances should be considered before any transaction proceeds.
3.4 Share acquisition A combination of an asset and share sale may be appropriate where:
Vendor companies hold valuable CGT assets
There are valuable tax losses and/or franking credits in vendor companies
Vendor wishes to retain an equity interest in the business, and
Acquiring shares results in a lower stamp duty cost.
There are of course a number of key tax issues to consider in the case of a share acquisition. Some of the more interesting ones are considered briefly below.
3.4.1 Company tax losses and the choice to consolidate Often a primary production business can generate significant tax losses over time and these tax losses may be of some value to an investor in certain circumstances. From a purchaser’s perspective, one key benefit of a share acquisition over an asset acquisition is the potential of acquiring valuable tax losses. Of course, in a transaction context, tax losses are often a delicate issue and investors often ask the following two questions:
to what extent can the tax losses be utilised; and
what future considerations might impact the future use of the tax losses?
The above two questions demonstrate the difficulty with which tax losses are valued in the context of a transaction, based on the uncertainty around whether or not (and if, to what extent) a purchaser may be able to claim the losses in the future. Consequently, it often falls to the vendor to determine the expected usefulness (and, therefore, value) of tax losses to a purchaser in an effort to drive bid value. Broadly, the value of tax losses to a potential purchaser will be driven by the following:
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the ability of the purchaser to continue to carry forward the accumulated loss balance (in other words, whether the loss integrity rules preclude a purchaser from claiming the balance of the targe entity’s carry forward tax loss balance against taxable income in future years), and
where a target is brought within a purchaser’s consolidated group the rate at which those losses will be able to be claimed by a potential purchaser (in other words, the available fraction which is likely to attach to the acquired losses once the entity is acquired).
Turning to each of these considerations briefly:
Where a vendor company is acquired but does not enter a tax consolidated group, the vendor company’s ability to utilise its tax losses post-acquisition will depend on it satisfying the ‘same business test’ (SBT) in respect of the losses. This is on the basis that the vendor company should fail the ‘continuity of ownership test’ (COT) when the purchaser acquires its majority stake. The SBT can be considered by most to be a very hard test to satisfy, and almost subject in nature despite being an objective test. Accordingly, it is often hard to persuade investors to assign value to SBT losses.
On the other hand, where a vendor company is acquired and joins a tax consolidated group, prejoining time losses may be transferred to the head company of the tax consolidated group (transferred losses) and be refreshed to COT losses provided the vendor company satisfies modified SBT. In this respect, where SBT is failed because of the transaction, modified SBT should be much easier to satisfy. Whilst this initially seems like a good outcome, there are additional loss integrity rules arising in a tax consolidated environment; specifically, the ‘available fraction (discussed below).
Where tax losses are transferred to the head company of a tax consolidated group (i.e. because the joining company satisfied modified SBT), the transferred losses are assigned an ‘available fraction’, broadly calculated as the market value of the joining company (based on certain assumptions) divided by the adjusted market value of the joined group. The purpose of the available fraction is to limit the rate at which transferred losses can be utilised by the head company to the hypothetical rate those losses would have been used by the joining company had it not joined the group. Accordingly, where the value of the joining company is significantly less than the value of the joined group, the available fraction can be very low and possibly nil. In such circumstances, despite transferred losses refreshing to COT losses, the rate at which they can be used will be significantly diminished and possibly prevented all together. Accordingly, where a company with significant tax losses has a low or nil market value, it may be appropriate not to consolidate the group for tax purposes; that is, if an investor wishes to potentially claim those losses.
Often a purchaser’s decision of whether or not to consolidate a target entity into the purchaser’s tax consolidated group will be motivated by the relative value of any carried forward losses compared with any increase in positive tax attributes (for example, Division 40 cost of depreciating assets) as a result of the tax cost setting process on consolidation. Additionally, purchasers have the option of cancelling losses of an acquired subsidiary entity when it enters a tax consolidated group. This would lead to an increased allocable cost amount (ACA) which can be allocated to assets (some of which giving rise to positive tax attributes) as part of the tax cost setting process. A prudent purchaser will often compare
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the expected value of continuing to carry forward acquired losses subject to an available fraction against any anticipated step up in ACA as a result of cancelling the losses. 3 On the other hand, the choice of whether to consolidate must be considered in light of more than just tax losses. For example, tax consolidation will generally result in the tax cost of a joining company’s assets being reset generally to market value. Accordingly, there may be value in this where the existing tax base of assets is below their market value. Moreover, tax consolidation allows the members of the group as a ‘single entity’ for tax. A key benefit of this is that losses generated by one company can be offset against income of another (thus avoiding unnecessary tax leakage).
3.4.2 Cost base recognition for asset deficiencies As stated earlier, a primary production business may generate significant tax losses overtime. In the author’s experience, it is not uncommon for these losses to be the result of external debt guaranteed by shareholders by providing security over land owned outside the company. This can often result in the company running into a net asset deficiency during its lifecycle (with the deficiency equal to the market value of the company’s assets less its liabilities). In a transaction context, where multiple assets and entities are being sold, this raises an interesting question – how much value should be allocated to the company? This is illustrated in Example 3 of Appendix A, which illustrates that there is a significant difference in outcomes for the vendor depending on whether the market value substitution rule for capital proceeds in section 116-30 applies. Generally speaking, a vendor will be exposed to greater cash tax liability where the market value substitution rule applies, in circumstances where property sold outside of the deficient company at values taking into account the company deficiency. There are at least two potential options which a vendor has to mitigate these outcomes, absent arguments that the market value substitution rule does not apply, namely:
the vendor makes a non-scrip capital contribution (akin to a gift) to the company with funds received from disposal of the land, or
the vendor makes a guarantee payment to external lender and subsequently forgives the debt from the company.
These potential options are briefly explained below (a more detailed discussion, involving hypothetical amounts, can be found towards the end of Example 3 in Appendix A). Non-scrip capital contribution In the case of a non-scrip capital contribution, the following steps are envisaged:
The vendor disposes of the primary production land for its market value, realising a capital gain.
3
Generally, where the available fraction is relatively low (ie where the target entity represents a low percentage of the overall market value of the tax consolidated group) it may be more beneficial to cancel losses, depending on the asset to which the increased ACA is likely to be spread.
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With cash received from the gain, the vendor makes a non-scrip capital contribution to the company sufficient enough to reduce the net asset deficiency to nil.
The vendor subsequently disposes of the company for $1, being its market value, and realises a capital loss equal to the original cost of the shares plus the amount of the non-scrip capital contribution, less $1.
The capital loss is applied against the capital gain realised on disposal of the primary production land, resulting in a reduced net capital gain (before CGT discount).
The above outcome relies on the vendor receiving 4th element cost base recognition for the non-scrip capital contribution under subsection 110-25(5). In this regard, if it can be established that the reason for the contribution was to preserve or increase the value of the vendor’s shares, then the requirements for 4th element cost base should be met. Relevantly, there are a number of private rulings which considers similar circumstances and indicate the ATO may accept this argument.4 Provided the non-scrip capital contribution results in 4th element cost base, appropriate tax outcomes should result (consistent with Example 3 in Appendix A above where the market value substitution rule does not apply). Amongst other things to consider where a non-scrip capital contribution is being evaluated is whether the contribution could be treated as ordinary income of the recipient company (which in the author’s view is unlikely) or whether the contribution could trigger a stamp duty liability (this would be particularly relevant where there are multiple shareholders in the company). Shareholder guarantee payment In the case of a shareholder guarantee payment, the following steps are envisaged:
The vendor disposes of the primary production land for its market value, realising a capital gain.
With cash received from the above gain, the vendor makes a payment to the company’s lender under the guarantee arrangement. This gives rise to a right to recover the amount of the payment from the company. This right has a cost base equal to the payment made under the guarantee.
The vendor then forgives the amount owing from the company and realises a capital loss.
The vendor subsequently disposes of the company for $1, being its market value, and realises a capital loss.
Each capital loss above applied against the capital gain on the primary production land, resulting in a reduced net capital gain (before CGT discount).
Under this scenario, the vendor should have a right of indemnity against to company to be repaid the guarantee payment. This right would be a CGT asset with a cost base equal to the guarantee payment. Accordingly, when the shareholder subsequently forgives the debt to make good the company’s net asset deficiency, CGT event C2 would occur and the shareholder would realise a capital loss equal to the guarantee payment (however, it would be relevant to consider how the
4
See Private Binding Ruling Authorisation No. 91191; 1012653484192; and 1012313049488.
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commercial debt forgiveness rules would apply in this circumstances and whether it is of any practical relevance). Provided the vendor receives cost base recognition for the guarantee payment, appropriate tax outcomes should result (consistent with the example above where the market value substitution rules does not apply). The outcomes discussed above are in accordance with the ATO’s view set out in Taxation Ruling TR 96/23.
3.4.3 Deferring capital gains on vendor retained interest It may be the case that a vendor wishes to retain an interest in their business; a common question which often arises is whether unrealised gains on the vendor’s retained interest can be deferred. That is, can the existing owners avoid having to sell 100% of their interest and buy back in? If the vendor’s business consists of one or more companies, it may be the case that the existing owners can avoid having to sell 100% of their interest and subsequently buy back in. A new holding company could be used with a combination of scrip and cash offered to the vendor, with rollover relief chosen for the scrip component (for example under Subdivision 124-M: scrip-for-scrip). However, if the vendor’s business is comprised of a collection of partnerships, trusts and individually held assets, the answer may potentially still be yes, it is however technically harder to reach. In this case, while there may be rollover reliefs available to defer gains on the transfer of assets (for example under subdivisions 122-A, 122-B or subdivision 124-N), stamp duty could be a limiting factor, absent any corporate reconstruction relief. Accordingly, a detailed analysis of the potential stamp duty costs will be the precursor to any transaction involving the transfer of assets, regardless of the vendor’s holding structure.
3.5 Mixed share and asset acquisition A mixed share and asset sale will involve a combination of the issues discussed under the preceding sections. The added complexity of needing to consider the technical positions which apply in both circumstances mean that transactions of this kind require detailed consideration and planning (from both an income tax and duty perspective) prior to implementation. Advisors should seek to actively engage with clients whose structures may lend to this type of acquisition early to ensure adequate lead time over the introduction of any institutional investors.
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4 Stapled structure 4.1 Overview A stapled structure consists of a ‘flow through’ trust and a company, stapled together, with the trust holding land and the company holding all other business assets (ie trading stock, plant & equipment, agistments, etc.). The trust, which is typically established as managed investment trust (MIT), rents the land to the company such that returns to the stapled security holders take the form of:
trust distributions funded by rental income, and
dividends funded by business income.
This is illustrated as follows. Figure 2
Existing family group Investor
Stapled Security
MIT
Rent
Holding Company
Operating Company
Sub Trust
Property Trust
Land
Stock
Other
Australian tax consolidated group
This type of structure is generally sought after by foreign investment funds and infrastructure investors which are able to benefit from a withholding tax of 15% on MIT fund payments to exchange of information (EOI) countries (compared to 30% withholding tax which otherwise would apply). MIT status therefore can significantly increase post tax returns to investors, resident of EOI countries.
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4.2 Establishing a stapled structure Broadly, the considerations which are relevant to the establishment of a corporate structure will also warrant consideration in the establishment of a stapled structure (as they are mainly driven by the vendor’s existing structure, which is unaffected by the resultant structure). However, some additional complications arise by virtue of adopting a stapled structure which are not apparent in a pure corporate structure. These mainly relate to the ongoing operation of and exit from the agribusiness. We have briefly discussed some of the key considerations under the following headings.
4.3 Non-arm’s length income rule If enacted, Tax Laws Amendment (Net Tax System for Managed Investment Trusts) Bill 2015 (proposed AMIT rules) will include a ‘non arm’s length income rule’ (NALIR), the purpose of which is to remove the incentive to shift profits from a related active business to a MIT through non-arm’s length activity. In the case of an infrastructure business or an agribusiness MIT, this rule would be relevant to the lease charges between the MIT and the trading company as well as any internal financing. Where the NALIR applies, income which exceeds the expected arm’s length amount will be taxed at the corporate tax rate of 30% (compared to the concessional withholding rate of 15% which would otherwise apply). In this respect, while it is not intended that a MIT must satisfy the transfer pricing requirements in Subdivision 815-B, if a MIT can demonstrate that a transfer pricing benefit does not arise under the transfer pricing provisions, the ATO has stated it will generally accept this sufficient to establish arm’s length dealings for the purpose of the NALIR. 5 It follows that it should be considered appropriate to apply the arm’s length principle, as outlined in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators, July 2010 when pricing the relevant leases. In this respect, given the potential variability in the income of an agribusiness – i.e. given exposure to variables such weather, livestock price, etc. – a mechanism providing for regular market reviews of rent should be considered to avoid generating disproportionate losses in the company while still generating significant income in the trust.
4.4 Trading trust characterisation One key requirement for a trust to be characterised as a MIT is that the trust is not a ‘trading trust’ under Division 6C. A ‘trading business’ is anything which is not an ‘eligible investment business’, which relevantly includes investing in land primarily for the purpose of deriving rent. 6 At common law the term ‘rent’ is generally taken to be ‘a payment for possession of realty under lease’ 7 such that, there must in fact be a ‘lease’. Under common law, a lease has been defined as a “right to exclusive
5
See paragraph 45 of Law Companion Guide LCD 2015/D15 Subsection 102MB(2) ITAA 1936. 7 Commissioner of Stamp Duties (NSW) 6
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possession of land … to be distinguished from a license, which does not give rise to exclusive possession”.8 It follows that income from arrangements such as agistments is unlikely to be characterised as ‘rent’ for the purposes of Division 6C. Accordingly, income of this kind should, to the extent possible, be derived by the company side of the staple to avoid blowing up the MIT. Another form of income growing in prevalence in Agribusiness are compensation payments made by coal seam gas producers for the installation of wells on farmland. These payments, again, would generally not be considered rent. Accordingly, given the potential quantum of such payments, and their inability to satisfy the MIT requirements in any given year, it is appropriate to ensure the compensation payments are structured appropriately prior to reaching any agreement. Further discussion on this issue can be found in Applying Infrastructure Tax Concepts to Different Industries, authored by Stuart Landsberg.9
4.5 Structuring for tax efficiency and flexible exits It is important for the staple structure to provide commercial flexibility for a future exit of investors. For example, this could involve the use of a sub-trust and property trust structure, whereby the MIT holds units in a sub-trust, and the sub-trust in one or more ‘property trusts’ holding the relevant land. For example, in the case of a future capital raising (e.g a listing event) this would provide the ability to list the MIT entity or the sub-trust. In this respect, the Australian tax consequences would be different to the extent the sub-trust is used as the Australian listing vehicle rather than the MIT. In particular, listing at the sub-trust level would mean any capital gain realised on the future listing would be flowed through the MIT to existing investors, rather than a capital gain being realised at the investor level. This in turn should limit the Australian tax on the capital gain to 15% rather than 30% (provided the investor is resident of an EOI country). In addition, there may be benefits in separating each discrete parcel of land into a separate property trust, provided there are commercial reasons for doing so. Structuring the investment in this way could help reduce the quantum of ongoing land tax costs (albeit this would need to be considered in light of the increased administration cost of establishing the multiple property trusts).
4.6 Catering for the acquisition of landholder companies While a staple structure might provide foreign investors with greater post tax returns, it could come at a cost to the vendor where, for example, valuable land is held by a company which is not able to access the CGT discount. Generally, it is uncommon for a MIT to hold land through interposed companies as any income derived by those companies would be taxed at the 30% corporate tax rate, rather than the concessional withholding rate of 15% afforded to a MIT. However, structured appropriately, it may be possible to facilitate a share acquisition of the relevant company, thus allowing the vendor to benefit from the CGT discount. For example, the MIT could
8 9
LexisNexis, Encyclopaedic Australian Legal Dictionary Page 10, Applying Infrastructure Tax Concepts to Different Industries, written by Stuart Landsberg FTI and Hayden Scott, FTI.
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acquire the company through a wholly-owned subsidiary capitalised with debt to the greatest extent possible (subject to thin capitalisation provisions where they apply). This is illustrated as follows. Figure 3 Existing family group Investor
Stapled Security
MIT
Interest
Debt
Property HoldCo Dividend Vendor Company
Rent
Trading Company
Land
Australian tax consolidated group
In this example, the Property HoldCo acquires Vendor Company and forms a tax consolidated group such that transactions (including dividends) between each company are ignored for tax. Accordingly, Property HoldCo will be taken to receive rent from Trading Company against which it can deduct (subject to thin capitalisation if applicable) interest paid to the MIT. The effect of this is to reduce the quantum of assessable rent in Property HoldCo such that lesser tax is paid at the company level. The MIT, being a flow through trust, would then distribute the interest to investors and, depending on the jurisdiction of those investors, the distributions would be subject to withholding tax of 15%. In this regard, provided that the company only derives rental income, being income from an ‘eligible investment business’, the MIT should not be characterised as a trading trust under Division 6C and therefore should continue to be a MIT, all other things being equal. Indeed, the biggest limitation to this potential structure is the potential application of the thin capitalisation rules which would likely limit the quantum of interest deductions at the Property HoldCo level. It would also be relevant to consider the NALIR, discussed above. However, at least to some extent, this potential option may reduce the amount of income subject to tax at 30% at the company level and therefore may be entertained by an investor.
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5 Other transaction issues 5.1 Implementation agreements Before any pre-structuring is undertaken by a vendor, it is important there is agreement between both the vendor and purchaser on the sequence of events and the specific steps involved. This is to avoid tax and duty costs being borne by the vendor without certainty on the deal and that it will in fact proceed. Moreover, a carefully constructed implementation deed can help manage unnecessary double duty which could arise if deal is not appropriately structured. Amongst other things, this would involve ensuring new entities are capitalised with equity funding before underlying land assets are acquired.
5.2 Purchase price allocation Often there are competing interests on purchase price allocation as between the vendor and purchaser. A purchaser will often want as much value as possible allocated to its CGT assets which, for example, can obtain the benefit of the CGT discount. This is compared to a purchaser whom would ordinarily want as much value allocated to depreciating assets for which depreciation deductions may be claimed over time. In the author’s experience there is generally at least some negotiation to be had around purchase price allocation.
5.3 Contingent consideration and earn-out arrangements Often in a deal the parties cannot agree on the value to be paid under the transaction. One common way of dealing with the circumstance is for the parties to enter into an earn-out arrangement. There are broadly two types of such arrangement:
Standard earn-out arrangement, whereby the vendor is granted a right to receive an additional payment that is contingent on the underlying performance of the business or assets, and
Reverse earn-out arrangement, whereby the vendor will undertake to repay the buyer an amount contingent on the underlying performance of the business or assets over a specific period of time.
Historically, the ATO has applied the principles in draft Taxation Ruling TR 2007/D10 in determining the tax outcomes under earn-out arrangements; broadly, those outcomes being as follows: Purchaser
Vendor Standard earn-out
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Market value of earn-out right treated as a separate CGT asset and included in vendor’s capital proceeds on disposal of the business
Market value of earn-out right included in purchaser’s CGT cost base for the acquisition of the business
Subsequent payment does not impact the cost base of the original business asset acquired (which is good if the earn-out
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CGT event C2 occurs when earn-out payments are received and there is an ending of the asset.
Proceeds reasonably attributable to grant of earn-out right allocated to earnout right and not sale of business
Proceeds reasonably attributable to grant of earn-out right are included in the cost base of the earn-out right.
CGT event D1 does not occur such that there is no gain for the vendor
CGT event C2 occurs when earn-out payments are received and there is an ending of the asset.
If earn-out payments are made there is no capital loss for the vendor
payment is less than the amount original expected)
As helpfully summarised by Greg Thompson in his article Earn-outs and other issues for vendors, there are a number of issues for vendors by the treatment adopted in TR 2007-D10, including:
Bringing forward taxation on amounts never actually received
Mismatch of capital losses and capital gains, and
Capital gains resulting in respect of the underlying disposal of pre-CGT assets.10
Relevantly, on 25 February 2016, legislation was enacted 11 to provide look-through treatment for qualifying earn-out arrangements. Broadly, under the look-through treatment:
any financial benefit provided (or received) by a purchaser increases (or decreases) part of the cost base or reduced cost base of the underlying asset; and
any financial benefit received (or provided) by the vendor increases (or decreases) the capital proceeds for the underlying asset.
This treatment ensures that the issues identified above which can occur under the approach prescribed by TR 2007/D10 no longer arise. However, it is important to emphasise that the new law only applies to qualifying ear-out arrangements giving rise to “look-through earn-out rights”, as defined in section 118-565. The relevant criteria can summarised broadly, as follows:
there is a right to future financial benefits that are not reasonably ascertainable when the right is created.
the right is created under an arrangement involving the disposal of an active CGT asset
the earn-out arrangement has a term of no longer than 5 years
the value of financial benefits must be contingent on, and reasonably relate to, the economic performance of the business, and
10 11
See page 6, Earn-outs and other issues for vendors, written by Mr Greg Thompson. Tax and Superannuation Laws Amendment (2015 Measures No. 6) Act 2015
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the parties must be dealing at arm’s length.
Accordingly, with the benefit of the new look-through earn-out rules, there may be more scope to structure deals with consideration contingent on the economic performance of the relevant business, without there being risk of inappropriate tax outcomes. Indeed, earn-out arrangements, structured properly, are also a good way in which a vendor can share in the upside of the business post-sale, particularly if the vendor is to continue on in management role.
5.4 Sweat equity Another way of allowing a vendor to share in the upside of a business post disposal, is the entering into of ‘sweat equity’ style arrangements, whereby the former owners are provided equity-like returns for their continued involvement in the relevant business. One potential way of structuring this ‘sweat equity’ without giving rise to upfront taxation for the vendors is to provide for the contingent equity-like returns under an employment contract with the vendor, rather than, say, issuing a new class of share. Structured in this way, a ‘sweat equity’ style arrangement may create an alignment of interests between the purchaser and vendor.
5.5 Cattle transfer levy Pursuant to the Primary Industries (Excise) Levies Act 1999 (Cth), the Federal Government imposes a levy on the direct transfer of ownership of cattle on a per head basis (generally $5 per head). Where there is an indirect transfer of the ownership of cattle (e.g. where an interest in a trust or company is acquired), no levy is applied. There are also various exemptions to the levy. For example, where ownership is transferred between related bodies corporate (as defined under the Corporations Act 2001 (Cth)) and the purchaser is not a processor, or where a transfer of ownership occurs as a result of the dissolution of a partnership (in circumstances where subsection 70-100(1) of the Income Tax Assessment Act 1997 applies). Accordingly, where it is not possible to indirectly transfer the cattle, consideration should be given to the availability of any exemptions. Where livestock other than cattle is involved, it may be necessary to consider whether the livestock transaction levy (which operates similarly to the levy on cattle) or other levies may apply. Useful information regarding the cattle transaction levy and other livestock levies can be found at: http://www.agriculture.gov.au/ag-farm-food/levies/categories/livestock/cattle-livestock-transactionlevy-annual/information_sheet
5.6 Land tax Land tax is paid in all Australian jurisdictions, except the Northern Territory. It is generally imposed on freehold land, but can also apply to other land interests such as Crown leases. In some cases the relevant land ownership may not involve freehold land and may comprise of pastoral leases. In those circumstances, land tax may not be payable depending on the jurisdiction (e.g. in Queensland).
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Each of the jurisdictions has land tax exemptions for primary production land and the eligibility requirements differ between the various jurisdictions. For example, in Queensland, the exemption may apply where the land is owned by natural persons that are not absentees or relevant proprietary companies (as specifically defined). Where a restructure or an acquisition occurs there is a risk of losing the exemption where it results in an absentee, public company or foreign company directly or indirectly owning the relevant land. Each State Revenue Office currently has an audit and compliance program that monitors the eligibility of granted exemptions, and they have been particularly active in Queensland, New South Wales and Western Australia.
5.7 Stamp duty Stamp duty continues to be imposed in all Australian jurisdictions on direct and indirect dealings in interests in land and associated plant and equipment. In most jurisdictions, livestock is not considered dutiable property, however Queensland is an exception. In Queensland, on a direct transfer of land and cattle, both will be subject to duty. Aggregation rules may also apply to treat several transactions as one for stamp duty purposes, in certain circumstances. For example, where the land of the business is acquired from one entity, and the plant and equipment is acquired from another, stamp duty may apply to treat both transactions as if they were one, rather than treating them separately and only imposing duty on the land. The stamp duty regime also extends to the indirect transfer of assets, through dealings in either companies or trusts. Generally, stamp duty will apply to acquisitions of interests of 50% or more in private companies that are considered to be landholders. Depending on the jurisdiction concerned, the acquisition of an interest as little as 20% in a trust (e.g. in Victoria) or any percentage change in the interest of a trust can be subject to duty (e.g. under the Queensland trust look through provisions). Most jurisdictions have corporate reconstruction provisions that can apply to exempt certain transactions between related entities (e.g. unit trusts and companies). However, these provisions generally do not extend to discretionary trusts and in some jurisdictions, such as Queensland, mainly apply to transactions between companies. There are also stamp duty concessions for intergenerational transfers of farming businesses and family partnership acquisitions. Depending on the group structure and parties involved, this may be relevant and require further consideration.
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Appendix A Example 1 Assume the following:
A company is capitalised with $1,000,000 by Shareholder 1
The company uses the $1,000,000 to acquire a large parcel of land
Over a number of years the value of the land increases to $2,000,000
An investor wishes to acquire the land and is considering either a direct asset acquisition or a share acquisition.
A comparison of outcomes is as follows. Asset sale
Share sale
Capital proceeds
$2,000,000
$2,000,000
Cost base of land / shares
$1,000,000
$1,000,000
Gross capital gain
$1,000,000
$1,000,000
n/a
($500,000)
Net capital gain
$1,000,000
$500,000
Tax at 49%
$490,000*
$245,000
(Less) CGT discount
*Assume the company pays 30% tax on the capital gain and distributes a fully franked dividend to its shareholder who in turn pay’s top-up tax of 19%.
Example 2 Another, slightly more complicated example, but one quite conceivably arising for a generational family-owned agribusiness, is as follows.
Company is capitalised with $1,000,000 by Shareholder 1 before 20 September 1985
Company uses the $1,000,000 to acquire a large parcel of land before 20 September 1985
Over a number of years the value of the land increases to $2,000,000
Shareholder 1 dies in 20X6 and Shareholder 2 inherits Shareholder 1’s shares
An investor wishes to acquire the land and is considering either a direct asset acquisition or a share acquisition.
Under this example it is assumed that the transaction could be approached in one of three ways:
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Asset acquisition without a liquidation of the vendor company
Asset acquisition with the vendor company liquidated under a member’s voluntary liquidation, or
Share acquisition.
A comparison of outcomes under this scenario is as follows.
Asset sale Capital proceeds
Asset sale (liquidation)
Share sale
Note
$2,000,000
$2,000,000
$2,000,000
Cost base of land / shares
Pre-CGT
Pre-CGT
$2,000,000
Gross capital gain / (loss)
n/a
n/a
$0
(Less) CGT discount
n/a
n/a
n/a
Net capital gain
n/a
n/a
$0
Unfranked dividend
$1,000,000
n/a
n/a
3
Return of capital
$1,000,000
n/a
n/a
3
Liquidator’s distribution – assessable component
n/a
$0
n/a
3
Liquidators distribution – nonassessable component
n/a
n/a
3
Taxable income - Shareholder 2 Tax at 49%* Capital loss on cancellation of shares
$2,000,000 3
$1,000,000
$0
$0
$490,000
$0
$0
$1,000,000
$0
n/a
1,2
4
Notes: 1. The company’s land will continue to be pre-CGT after shareholder 2 inherits the shares, despite there in fact being a majority change in ownership. This is on the basis that, Division 149 will not treat there as being a majority change in ownership for the purposes of the Division, because Shareholder 2 acquired its shares because of the death of Shareholder 1. This is pursuant to subsection 149-30(4).
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2. On the basis that Shareholder 1 acquired its shares before 20 September 1985, Shareholder 2’s cost base for the shares when inherited from Shareholder 1, will be their market value at the date of death of Shareholder 1, which in the above example, is assumed to be $2,000,000. This is pursuant to the cost base modification in item 4 of the table included at subsection 128-15(4). 3. Under an asset sale where there is a member’s voluntary liquidation, after disposing of the asset, the liquidator with distribute free cash by way of a liquidator’s distribution. The assessable components of the liquidator’s distribution will be worked out under section 47 of the Income Tax Assessment Act 1936. In this respect, profits referable to the disposal of preCGT assets will not be assessable, nor will the distribution of original share capital. These amounts will instead reduce the cost base of Shareholder 2’s shares under CGT event G1. 4. Under an asset sale without a formal liquidation, it is assumed that, after disposing of the land, the company pays an unfranked dividend of $1,000,000; returns capital of $1,000,000, being the capital reflected in the company’s financial statements; and, is subsequently deregistered. The unfranked dividend would be included in Shareholder 2’s assessable income and would be taxed at 49%, whereas the return of capital would reduce the CGT cost base of Shareholder 2’s shares under CGT event G1: capital payment for shares. Consequently, Shareholder 2 would realise a capital loss of $1,000,000 when the shares are cancelled under CGT event C2 occurs. Example 3 Assume the following:
A company has a net asset deficiency of $50 (assets with a market value of $100 and external debt of $150).
External debt has been guaranteed by shareholder 1 and secured over primary production land owned by shareholder 1.
The primary production land is worth $200 and has a cost base of $50. There is no associated debt.
Shareholder 1 has a cost base in its shares of $10.
An investor wishes to acquire the company and the primary production land for a total purchase price of $150.
One potential option is for the investor to acquire the company for $1 and the land for $149. The investor could subsequently subscribe for further equity in the company to retire the external debt, if that is desired. However, this outcome relies on there being no ‘market value substitution’ in respect of capital proceeds received for the primary production land. This is relevant because the land, which is owned by shareholder 1 in its own right, has a market value of $200, but is disposed of for $150 to take into account the net asset deficiency in the company. Accordingly, there may be a risk that the market value substitution rule in section 116-30 could apply. However, this would require a conclusion that the purchaser and vendor were not “dealing at arm’s length” in respect of the disposal of the land. Indeed, the fact that the vendor and
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purchaser are in fact “at arm’s length” might go some way to arguing that section 116-30 should not apply; however, this might not be enough in every circumstance. That is, notwithstanding two parties are in fact at arm’s length (i.e. because they are not related in any way), this is not always to say they are “dealing at arm’s length”. Relevant case law would need to be considered in this regard. A comparison of outcomes where the market value substitution rule for capital proceeds, is as follows. i)
Market value substitution rule in section 116-30 does not apply Shares
Land
Total
Capital proceeds
$1
$149
$150
Cost base of land / shares
$10
$50
$60
Gross capital gain / (loss)
($9)
$99
$90
(Less) CGT discount
($45)
Net capital gain
$45
Tax at 49%
$22.05
ii)
Note
Market value substitution rule in section 116-30 applies Shares
Land
Total
Capital proceeds
$1
$149
$200
Cost base of land / shares
$10
$50
$60
Gross capital gain / (loss)
($9)
$99
$140
(Less) CGT discount
($70)
Net capital gain
$70
Tax at 49%
$34.3
Note
Potential options to mitigate the above include: Non-scrip capital contribution In the case of a non-scrip capital contribution, the following might occur:
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Shareholder 1 disposes of the primary production land for its market value of $200, realising a capital gain of $150.
With cash received from the above, shareholder 1 makes a non-scrip capital contribution of $50 to the company so as to reduce the net asset deficiency to nil.
Shareholder 1 subsequently disposed of the company for $1, being its market value, and realises a capital loss of $60.
The capital loss is applied against the capital gain of $150 on the primary production land, resulting in a net capital gain (before CGT discount) of $90.
Shareholder guarantee payment In the case of a shareholder guarantee payment, the following might occur:
Shareholder 1 disposes of the primary production land for its market value of $200, realising a capital gain of $150.
With cash received from the above, shareholder 1 makes a payment to the company’s lender under the guarantee arrangement and has a right to recover the amount from the company with a cost base equal to the payment.
Shareholder 1 forgives the amount owing from the company and realises a capital loss of $50.
Shareholder 1 subsequently disposed of the company for $1, being its market value, and realises a capital loss of $10.
Each capital loss above applied against the capital gain of $150 on the primary production land, resulting in a net capital gain (before CGT discount) of $90.
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