Edited version of your written advice

Authorisation Number: 1013066054489

Ruling

Subject: Assignment of options

Questions

In relation to the CGT consequences of entering into the Assignment Deed, does:

(a) CGT event A1 in section 104-10 of the ITAA 1997 happen to the Sellers:

• upon exercise of a put option or a call option; and

• in respect of the Exercise Price, less the portion of the Exercise Price that is the subject of the Assigned Proportion of Earn-out and which will have already vested in the trustee of the Trust.

(b) CGT event A1 in section 104-10 of the ITAA 1997 happen to the Participant Trust:

• upon exercise of a put option or a call option; and

• in respect of the portion of the Exercise Price that is the subject of the Assigned Proportion of Earn-out, less the Transfer Consideration.

(c) CGT event D1 in section 104-35 of the ITAA 1997 happen to the applicants (Sellers):

• upon entering into the Assignment Deed; and

• in respect of the right to be paid the Transfer Consideration

Answers

(a) Yes, in respect of the whole of the exercise price.

(b) No, given that all of the exercise price will represent proceeds in answer to (a).

(c) No.

This ruling applies for the following periods:

Income year ending 30 June 2016

Income year ending 30 June 2017

Income year ending 30 June 2018

Income year ending 30 June 2019

Income year ending 30 June 2020

The scheme commences on:

1 July 2015

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

A Share Purchase Agreement (SPA) was entered into between, the rulees (Sellers) and the Buyer, Under the provisions of the SPA:

• the Sellers disposed of the Initial Shares to the Buyer. Completion of the disposal occurred on XX/XX/XXXX. A clause of the SPA contains the terms and conditions for Completion;

• the remaining X% of the Shares, ownership of which was retained after Completion by the Sellers (Option Shares), were made subject to the grant of:

• the First Put Option and the Second Put Option (collectively Put Options); and

• the First Call Put Option and the Second Call Option (collectively Call Options);

• no fee or consideration - other than the relevant parties entering into and performing their respective obligations under the SPA - was paid or remains payable on or after Completion, in consideration for the grant of any Option. In effect, the Put Options and the Call Options constitute an "earn out" arrangement that formed part of the original sale transaction as evidenced by the SPA; and

Column X of Schedule X sets out all of the Shares held by each Seller immediately prior to Completion.

Call Options

Under the provisions of the SPA, each Seller irrevocably granted to the Buyer certain rights to require that Seller to sell its respective Option Shares to the Buyer, in consideration for payment by the Buyer of the applicable Exercise Price: Clause X (Call Option).

First Call Option exercise date and First Call Option Lapse Date

The First Call Option:

• cannot be exercised prior to XX/XX/XX (clause X of SPA); and

• to exercise the First Call Option, the Buyer must deliver a First Call Option Notice to each of the Sellers on or before XX/XX/XX (clause X of SPA).

Once each Seller has received the First Call Option Notice from the Buyer, that notice to exercise will be irrevocable (clause X of SPA). If all the First Call Options are not duly exercised on or before XX/XX/XX, they will all thereupon lapse (clause X of SPA).

Second Call Option exercise date and Second Call Option Lapse Date

The Second Call Option:

• cannot be exercised prior to XX/XX/XX (clause X of SPA); and

• to exercise the Second Call Option, the Buyer must deliver a Second Call Option Notice to each of the Sellers on or before XX/XX/XX (clause X of SPA).

Once each Seller has received the Second Call Option Notice from the Buyer, that notice to exercise will be irrevocable (clause X of SPA). If all the Second Call Options are not duly exercised on or before XX/XX/XX, they will all thereupon lapse (clause X of SPA).

Put Options

Under the provisions of the SPA, the Buyer irrevocably granted to each Seller, certain rights to require the Buyer to buy that Seller's Option Shares for the applicable exercise price: Clause X (Put Option).

First Put Option exercise date and First Put Option Lapse Date

The First Put Option:

• cannot be exercised prior to XX/XX/XX (clause X of SPA); and

• to exercise the First Put Option, each of the Sellers must deliver to the Buyer a First Put Option Notice on or before XX/XX/XX (clause X of SPA).

Once the Buyer has received a First Call Option Notice from each Seller on or before XX/XX/XX, that notice to exercise will be irrevocable (clause X of SPA). If all the First Put Options are not duly exercised on or before XX/XX/XX, they will all lapse thereupon (clause X of SPA).

Second Put Option exercise date and Second Put Option Lapse Date

The Second Put Option:

• cannot be exercised prior to XX/XX/XX (clause X of SPA); and

• to exercise the Second Put Option, each of the Sellers must deliver to the Buyer a Second Put Option Notice on or before XX/XX/XX (clause X of SPA).

Once the Buyer has received a Second Call Option Notice from each Seller on or before XX/XX/XX, that notice to exercise will be irrevocable (clause X of SPA). If all the Second Put Options are not duly exercised on or before XX/XX/XX, they will thereupon all lapse (clause X of SPA).

Exercise Price for Options

For the purposes of the SPA, the Exercise Price (as outlined in Schedule X) shall not exceed:

• $X in relation to the First Put Option;

• $X in relation to the First Call Option;

• $X in relation to the Second Put Option; and

• $X in relation to the Second Call Option,

(each, as more particularly set out in Schedule X, Paragraph X of SPA, and in respect of each such Option, a Maximum Option Consideration).

Schedule X of the SPA also sets out the specific calculations of the components of each Exercise Price for each Option, which are:

• an Option Upfront Payment; and

• an Option Earn Out Amount.

Proposed assignment

It is proposed that each of the Sellers enters into a deed that will assign a proportion of their respective contractual rights that comprise each of their respective Options (each an Assignment Deed). It is intended that that the assignee of those contractual rights will acquire and hold the right to receive the Exercise Price payable by the Buyer in respect of those assigned contractual rights (each an Assigned Proportion of Earn-Out) if and when any such Option has been exercised in accordance with the provisions of the SPA.

The proposed assignment by each Seller will be made to the same Trustee of the same special purpose trust (Trust). In consideration for and at the time of making each of those assignments - which will each occur at the same time - the Trustee will pay to each of the Sellers the Assignment Consideration as stated in the applicable Assignment Deed.

Relevant legislative provisions

Section 104-10 of the Income Tax Assessment Act 1997

Section 116-35 of the Income Tax Assessment Act 1997

Section 116-20 of the Income Tax Assessment Act 1997

Section 116-40 of the Income Tax Assessment Act 1997

Reasons for decision

CGT event A1 occurs for a seller of a share when an option under the SPA is exercised. The date of the CGT event is when notice of the exercise of option is given. Subsection 116-40(5) applies to disregard any capital gain or loss made from the grant of the options by the sellers.

Under section 116-20, the capital proceeds from a CGT event include the money you have received or are entitled to receive in respect of the event happening. On the exercise of an option under the SPA for transfer of share, the proceeds include the exercise price for each option over the share.

The SPA options do not involve an 'earnout' arrangement as described in Taxation Ruling TR 2007/D10. At paragraph 2 of that ruling a standard earnout arrangement is defined as "any transaction in which an income-earning asset (often a business asset) is sold for consideration that includes the creation of an 'earnout right' in the seller of the asset."

However, in this case the proceeds from CGT event A1 in respect of disposal of a share via an option process include only monetary proceeds from the possible future exercise of an option over shares, and not any form of 'earnout right'. Accordingly the standard CGT rules concerning treatment of option with respect to shares apply.

Does the assignment involve an A1 event?

An option is a CGT asset as defined in section 108-5 of the ITAA. An option, and an interest in an option, is property that is capable of assignment (FCT v Miranda 76 ATC 4180).

Whether a particular option is capable of assignment depends upon the context in which it is a part. In the context of the SPA, the intent of creating call and put options is to give sellers and the buyer the right or obligation to obtain specific shares on particular terms over the timeline of the agreement. In this context the options would constitute property capable of assignment.

An ATO view on the effectiveness of assignments is set out in Taxation Ruling TR 2007/!0:

94. Following the Hepples decision, in Federal Commissioner of Taxation v. Orica Limited (formerly ICI Australia Limited ) (1998) 194 CLR 500; 39 ATR 66; 98 ATC 4494, five members6 of the High Court endorsed the view of Kitto J in National Executors & Agency Co of Australasia v. Federal Commissioner of Taxation (1954) 91 CLR 540, at 583 that assignability is a sufficient, but not a necessary, attribute of property. Kitto J stated in that case that:

It may be said categorically that alienability is not an indispensable attribute of a right of property according to the general sense which the word 'property' bears in the law. Rights may be incapable of assignment, either because assignment is considered incompatible with their nature, as was the case originally with debts (subject to an exception in favour of the King) or because a statute so provides or considerations of public policy so require, as is the case with some salaries and pensions; yet they are all within the conception of 'property' as the word is normally understood ...

95. A right to the payment of money under an existing contract, the repudiation of which means an action can be brought for anticipatory breach, is a present chose in action: Norman v. Federal Commissioner of Taxation ( Norman )(1963) 109 CLR 9 at 26; [1964] ALR 131 at 146. A present chose in action is capable of immediate assignment and is property according to the test in Hepples . A right is capable of being a present chose in action even if the extent of the right is dependent on a future contingency.

96. By contrast, a 'future chose in action' or expectancy is the mere prospect or possibility of possessing a future proprietary right: Norman (1963) 109 CLR 9 at 26; [1964] ALR 131 at 146; see also Starke, JG, Assignments of Choses in Action in Australia (1972) at page 6. An example of a future chose in action is a mere possibility that a debt will mature in one's favour. A future chose in action is not assignable at law or in equity. A purported assignment of future property may, in appropriate circumstances, be construed as a binding agreement to assign which effects an automatic transfer in equity of the subject property when it comes into existence: Booth v. Federal Commissioner of Taxation 87 ATC 5100; 19 ATR 514 [see also Starke above, at pages 6-7].

The application of the ATO view to the current facts is that the fact that at the time of assignment, the options may or not be exercised indicates that the proposed assignment of option proceeds is best described as a 'future chose in action' or expectancy. More recently it was also noted in Howard v FCT (2014 HCA 21), that a transfer of proceeds without the underlying right would not be effective to displace the CGT proceeds from the party entitled to the proceeds:

40. The appellant argued in the alternative that by the litigation agreement he assigned his right to the amount of the equitable compensation ultimately received in 2005 and not the sum itself. As a matter of construction of the agreement, that argument, which was made for the first time in the Full Court, should not be accepted. Under the terms of the agreement the appellant, Donovan and Quinert assigned "any award of damages (whether on revenue or capital account), costs or interest made in their favour as a consequence of their participation in the joint venture or arising out of the proceedings and the ultimate outcome thereof". The agreement did not assign the appellant's interest in the joint venture nor in the cause of action arising out of the breach of fiduciary duties by Edmonds and Cahill and asserted in the main proceeding in the Supreme Court. It did not involve an assignment of a chose in action.

41. This Court in Federal Commissioner of Taxation v Everett^[53] distinguished between an equitable assignment of present property for value, carrying with it a right to future income, and a like assignment of mere future income, dissociated from the proprietary interest with which it is ordinarily associated. The latter takes effect "when the entitlement to that income crystallizes or when it is received, and not before."^[54] Mason CJ observed in Booth v Federal Commissioner of Taxation^[55]:

"[I]n some cases it may be impossible to identify a present right to future income divorced from the proprietary right which generates that future income. In such cases an attempted assignment deals with future property or an expectancy and operates to vest the future income in the assignee as and when that future income accrues due, but not before it accrues due. Accordingly, the assignment would not be effective to prevent the income being derived or being deemed to be derived by the assignor."

In this case it is noted that::

• The assignment does not describe a percentage interest in the assignment of any property, only a formula amount as a component of total proceeds under possible future exercise of the option

• The intent of the SPA is to transfer the whole interest in the shares to the purchasers contingent on future actions of either the vendor or purchasers.

It is considered that CGT event A1 does not arise for the sellers from the entering into of the assignment deed and that consequently all of the exercise price amount would be CGT proceeds in relation to CGT event A1 for the seller.

As the assignment is not effective it follows that event A1 does not happen for the participant trust and that event D1 does not arise.

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