Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 2 - Scrip for scrip roll-over
2.1 Schedule 2 to this Bill amends the ITAA 1997 to insert Subdivision 124-M. It allows CGT roll-over when original interests in one entity are exchanged for interests in another entity, typically because of a takeover.
2.2 This roll-over allows a capital gain made on the disposal of the original interests to be deferred until the disposal of the replacement interests.
2.3 The existing CGT provisions are an impediment to corporate acquisition activity in Australia. Acquiring an interest in an entity may crystallise a capital gain in the hands of the existing equity holder. Entities seeking to acquire interests often find it necessary to pay a premium to compensate the equity holder for the potential CGT liability. Also, the offer may have to include cash so that the equity holder has funds to pay its tax.
2.4 New Subdivision 124-M will enable an equity holder in a scrip for scrip exchange to choose to obtain a CGT roll-over to defer any CGT liability.
2.5 The roll-over will enhance the functioning of, and value creation by, the corporate sector in Australia.
2.6 Subdivision 124-M will provide for a CGT roll-over when certain interests in companies and trusts are exchanged for interests in another entity, typically as the result of a takeover.
2.7 Broadly, the effect of the roll-over is to defer the making of a capital gain. Roll-over is not available under this Subdivision if the exchange results in a capital loss.
2.8 Roll-over is available for shares in a company, interests that entitle the holder to fixed income and capital entitlements in fixed trusts and other interests (such as convertible notes) that confer an entitlement to acquire those interests in the future. Roll-over is only available for interests acquired on or after 20 September 1985.
2.9 Roll-over is available if:
- interests are exchanged for similar interests in another entity;
- the exchange is in consequence of an offer made by the other entity to all of the holders of interests in the original entity to acquire:
- voting shares in a company; or
- trust voting interests or, if none, units or fixed interests in the fixed trust; and
- the other entity becomes the owner, because of the offer, of at least 80% of the interests.
2.10 A capital gain or loss may arise if the proceeds received for the original interests include cash or something other than an interest in the acquiring entity. The cost base of the original interest is apportioned in such a case in working out the amount of the gain or loss.
2.11 Special capital proceeds rules apply in some cases where the original and acquiring entities:
- have fewer than 300 members; or
- are members of the same linked group.
An entity will be treated in the same way as an entity with fewer than 300members if interests in it are concentrated in the hands of 20 or fewer individuals.
2.12 The cost base of a replacement interest is determined by reference to the cost base of the original interest.
2.13 The cost base of an interest acquired in exchange for a pre-CGT interest is its market value just after it is acquired.
2.14 Roll-over is not available in certain circumstances, for example, where replacement interests are trading stock.
2.15 There is no current law in relation to CGT roll-over for scrip for scrip exchanges.
2.16 Scrip for scrip roll-over is available for the exchange of an original interest in an original entity for a replacement interest in an acquiring entity.
What interests does the roll-over apply to?
2.17 Roll-over is available for:
- a share in a company [subparagraph 124-780(1)(a)(i)] ;
- a unit or other interest in a fixed trust that entitles the holder to a fixed entitlement to income and capital of the trust [subparagraph 124-780(1)(a)(ii)] ; or
- other interests, such as a convertible note or option, that gives the holder a right to acquire any of those shares or trust interests [subsection 124-780(3)] .
2.18 There is no roll-over for an interest acquired before 20 September 1985 [paragraph 124-780(1)(a)] . Scrip for scrip roll-over is intended to alleviate cash flow problems associated with meeting a CGT liability arising from an equity exchange. No such liability arises where a pre-CGT interest is exchanged.
When is roll-over available?
2.19 Roll-over applies if an equity holder exchanges an original interest in one entity for a replacement interest in another entity. The exchange must be in consequence of an offer made by the acquiring entity to all the holders of interests in the original entity to acquire:
- voting shares in the original entity if it is a company; or
- 'trust voting interests', or if there are none, units or other fixed interests in the original entity if it is a fixed trust.
[Subsection 995(1), paragraphs 124-780(1)(b) and (c)]
2.20 If either the original entity or acquiring entity is a trust, the beneficiaries of the entities must have 'fixed entitlements' to all the income and capital of the trust. [Subsection 124-795(3)]
2.21 A beneficiary of a trust has a fixed entitlement to a share of the income or capital of the trust in the circumstances as set out in section 272-5 of Schedule 2F of ITAA 1936 [F13] . [Subsection 995-1(1)]
2.22 The entity that made the offer must, as a consequence of the offer, own at least 80% of the relevant interests in the original entity. [Paragraph 124-780(1)(d)]
2.23 An acquisition occurs in consequence of an offer if the acquisition occurs as a result of, or effect of, the offer. This means that the offer needs to occur before the acquisition and have a causal or other connection with it. The requirement will be satisfied if, for example, after a takeover offer expires, an entity acquires interests under powers of compulsory acquisition contained in the Corporations Law.
Example 2.1 Tall Ships Ltd makes a scrip for scrip takeover offer for 100% of the shares in Pacific Cruises Ltd. Tall Ships receives 92% acceptances and consequently acquires the remaining 8% of shares in Pacific Cruises under the compulsory acquisition rules in the Corporations Law.The shareholders in Pacific Cruises whose shares are compulsorily acquired are eligible for scrip for scrip roll-over.
Example 2.2 Green Bottles Ltd makes a scrip for scrip offer for Tincans Ltd. Green Bottles acquires 62% of the shares in Tincans through acceptances of the offer. Roll-over is not available to the shareholders in Tincans as Green Bottles did not acquire 80% of the shares.Green Bottles continues to acquire Tincans shares on the market increasing its shareholding to 70%. Green Bottles makes a new scrip for scrip offer to Tincans shareholders and as a consequence increases its shareholding to 85%. The shareholders in Tincans who accepted this second offer are eligible for scrip for scrip roll-over.
When is a full roll-over available?
2.24 A full roll-over is available for an equity holder who, in exchange for an interest that otherwise qualifies for roll-over, receives only a similar interest in the entity making the offer. [Subsection 124-780(2)]
2.25 This requirement will be satisfied if:
- a share in a company is exchanged for a share in another company; or
- a unit or other interest in a fixed trust is exchanged for a unit or other interest in another fixed trust,
even if the rights attaching to the share, unit or other trust interest are different.
2.26 Similarly, roll-over will be available for an exchange of an option, a right or similar interest issued by the original entity that enables an equity holder to acquire a share, unit or trust interest in that entity. The equity holder must receive from the acquiring entity options, rights and similar interests of the same kind as those owned in the original entity [subsection 124-780(3)] . It is not a requirement for this extension of the roll-over that the equity holder own a share, unit or other trust interest in the original entity.
Example 2.3 Julie owns 1,000 shares in Holiday Ltd. She also owns 200 options to acquire preference shares in Holiday. Travel Ltd makes an unconditional takeover offer for Holiday offering 2 Travel shares for each Holiday share and one Travel share for each Holiday option. Julie accepts the offer and receives 2,200 Travel shares.Julie can choose roll-over in respect of the 1,000 Holiday shares she exchanged. Roll-over is not available in respect of the Holiday options as she received shares in exchange for options. If Julie had received options in Travel in exchange for her options in Holiday, roll-over would also have been available.
2.27 Roll-over will not be available if a share is exchanged for a unit or other interest in a fixed trust or a unit or other interest in a fixed trust is exchanged for a share. Other situations in which roll-over will not be available include the exchange of a convertible note for a share, a share for a convertible note, an option for a share and a share for an option.
2.28 An equity holder can determine on a reasonable basis what capital proceeds it has received for particular interests.
Norman has 200 shares in Wanted Ltd; 100 were acquired pre-CGT and 100 were acquired post-CGT. Acquirer Ltd makes an offer to acquire those shares. The offer provides these alternatives:
2.29 Roll-over will not be available in some cases where the equity holder is not dealing at arm's length with the acquiring entity. Roll-over will not be available in these cases if:
- the original entity and the acquiring entity have fewer than 300members or beneficiaries; or
- the equity holder, the original entity and the acquiring entity are members of a linked group [F14] ,
unless the proceeds received for the original interest is substantially the same as its market value and the replacement interest received carries the same rights and obligations attached to the original interest. [Subsections 124-780(4) and (5)]
2.30 Where interests in an entity are concentrated in the hands of 20 or fewer individuals, an entity is treated in the same way as an entity having fewer than 300 members or beneficiaries. [Subsection 124-810(1) to (4)]
2.31 The concentrated ownership test also considers whether there is any potential for rights attaching to the shares or interests in the trust to be varied or abrogated. It does not matter whether or not the rights attaching to any of the shares or interests are actually varied or abrogated. [Subsections 125-810(1), (2) and (5)]
2.32 For the purposes of the concentrated ownership test, one individual together with associates, and any nominees of the individual or their associates will be counted as one individual. [Subsection 125-810(6)]
What roll-over is provided?
2.33 If an equity holder chooses to obtain a roll-over, the CGT consequences are as follows.
2.34 A capital gain made from an original interest is disregarded [subsection 124-785(1)] . There is no roll-over if the exchange results in a capital loss [paragraph 124-780(1)(e)] .
2.35 The first element of the cost base of a replacement interest is the cost base or a portion of the cost base of the original interest, exchanged for the replacement interest [subsection 124-785(2)] . The cost base of the original interest is apportioned if an original interest is not exchanged for a single replacement interest, for example, one share is exchanged for 2shares.
2.36 The cost base of an original interest is the cost base just before the interest is exchanged, reduced by the amount of the cost base that is attributable to an ineligible part. For example, the cost base is reduced if an original interest is exchanged for a replacement interest and cash. [Subsection 124-785(3)]
2.37 The first element of the reduced cost base of a replacement interest is worked out similarly. [Subsection 124-785(4)]
Lila owns ordinary shares in Reef Ltd. She accepts a takeover offer from Heron Ltd under which she receives one ordinary share and one preference share for each Reef share. The market value of Heron shares just after Lila acquires them is $20 for each ordinary share and $10 for each preference share.The cost base of each Reef share just before Lila ceased to own them was $15. This cost base is apportioned to each of Lila's Heron shares as follows:Ordinary share
When is there a partial roll-over?
2.38 Roll-over does not apply to the extent that an equity holder accepts an offer that provides for the payment of ineligible proceeds. Ineligible proceeds are something other than a replacement interest in the acquiring entity, for example, cash. To work out the amount of any capital gain or loss made on disposing of the ineligible part of the original interest, a proportion of the cost base of the original interest reduces the ineligible proceeds. The apportionment is done on a reasonable basis. [Section 124-790]
Patrick owns 100 shares in Windsor Ltd each with a cost base of $9. He accepts a takeover offer from Regal Ltd which provides for Patrick to receive one Regal share plus $10 cash for each share in Windsor. Patrick receives 100 shares in Regal and $1,000 cash. Just after Patrick is issued shares in Regal each is worth $20.Patrick has received $10 cash for each of his 100 Windsor shares and so has ineligible proceeds of $1,000.In this case it is reasonable to allocate a portion of the cost base of the original shares having regard to the proportion that the ineligible proceeds bears to the total proceeds ($3,000). That is:
($1,000 * $900)/$3,000 = $300
less Cost base
($900 - $300)/100 = $6
Adventure Rail Ltd makes an offer to acquire shares in Thomas Ltd. The offer provides these alternatives:
- Offer 1 in respect of 50 post-CGT shares with a cost base of $2 each; and
- Offer 2 in respect of 50 post-CGT shares with a cost base of $6 each.
|Ineligible proceeds||(50 * $1)||$50|
|less Cost base||(($1/$5)*$100)||$20|
(($100-$20)/50) = $1.60
|Capital proceeds||(50 * $5)||$250|
|less Reduced cost base||(50 * $6)||$300|
|Capital loss||$ 50|
2.39 In certain situations roll-over is not available.
Residency status of equity holder
2.40 Roll-over is not available if a non-resident acquires a replacement interest in a company that is not a resident of Australia or a fixed trust that is a not a resident trust for CGT purposes. [Subsection 124-795(1)]
2.41 If a non-resident acquires a replacement interest in an Australian resident entity in place of an interest that had the 'necessary connection with Australia', the effect of the roll-over is that the replacement interest is treated as having the 'necessary connection with Australia'. This ensures that the non-resident can make a capital gain or loss when a CGT event happens to the replacement interest. [Items 5 and 6, section 136-25]
2.42 A non-resident would not need to seek roll-over for an original interest that did not have the 'necessary connection with Australia' as no capital gain or loss would arise if a CGT event happened to that interest.
2.43 Roll-over is not available if, should a CGT event happen to the replacement interest, any capital gain or capital loss would be disregarded. An exception to this rule applies if roll-over is the reason for the capital gain or loss being disregarded [paragraph 124-795(2)(a)] . Roll-over will not be available if a replacement interest is trading stock.
2.44 Roll-over is not available under Subdivision 124-M if the equity holder is a member of the same wholly-owned group as the entity in which it holds a replacement interest. Roll-over may be available under Subdivision 126-B. This Subdivision allows a company to obtain roll-over if it transfers a CGT asset to another company that is a member of the same wholly-owned group. [Paragraph 124-795(2)(b)]
Interests acquired in exchange for pre-CGT interests
2.45 An interest acquired in exchange for a pre-CGT interest is acquired when issued. The cost base of such an interest is its market value just after acquisition. If the interest is listed on a stock exchange in Australia, the last sale price on the day of issue is an acceptable market value. If the interest is not listed, another method that gives a current reflection of the market value of the interest must be used. [Section 124-800]
Cost base issues
2.46 The scrip for scrip roll-over applies to ensure that a shareholder or unitholder who exchanges their equity for new equity as part of a takeover or merger defers any capital gain on that transaction. This roll-over is achieved by ensuring that any capital gain is disregarded at the time of the exchange, and by ensuring that the new equity takes on the cost base of the original equity.
2.47 The scrip for scrip roll-over focuses on the exchanging shareholders and unitholders, and provides for cost base changes for the new equity. These measures do not apply to any other part of the takeover or merger process.
2.48 A common feature of a takeover or merger is the interposition of the acquiring entity, the takeover or merger target, or another entity as part of the process of acquiring at least 80% of the equity in the target. Existing roll-over relief under Subdivisions 124-G and 124-H ensures that the full effect of the interposition is recognised and dealt with appropriately for wholly internal reconstructions with 100% beneficial ownership of the interposed entity. The provisions do not apply to mergers or takeovers of the type contemplated by the scrip for scrip proposals.
2.49 The Government is examining options for dealing with the cost base of assets acquired by an interposed entity as part of a takeover or merger process where the scrip for scrip roll-over applies to the exchanging shareholders or unitholders, and will be consulting on this issue.
2.50 The changes made by Schedule 2 apply to CGT events that happen on or after the date of Royal Assent of this Bill. [Item 7]
2.51 There are no transitional provisions in relation to scrip for scrip roll-over.
2.52 Amendments are made to the ITAA 1997 to reflect the availability of scrip for scrip roll-over. Scrip for scrip roll-over is added to the table in section 112-115 which list the replacement asset roll-overs that may modify a CGT asset's cost base [item 1] . Subdivision 124-M is included in the references to replacement asset roll-overs in the guide material to Division 124 [items 2 and 3] .