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Edited version of your written advice
Authorisation Number: 1013095515364
Date of advice: 25 October 2016
Ruling
Subject: CGT Scrip for scrip roll-over
Question 1
Does Company A and Company B's arrangement for the exchange of its shares in Company C for shares in Company D satisfy all the conditions in subsection 124-780(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer
No.
Question 2
Are Company A and Company B entitled to roll-over relief under Subdivision 124-M of the ITAA 1997 for the exchange of its shares in Company C for shares in Company D?
Answer
No.
This ruling applies for the following periods:
1 July 20XX to 30 June 20YY
The scheme commences on:
1 July 20XX
Relevant facts and circumstances
1. Company A acquired X ordinary shares in Company C. This constituted X% of the issued shares in Company C.
2. Company B acquired X ordinary shares in Company C. This constituted X% of the issued shares in Company C.
3. Company A and Company B entered into a Shareholders' Agreement in relation to the shares they owned in Company C.
4. Representatives of Company A and Company B approached representatives of Company D regarding the possible sale of Company C to Company D.
5. During negotiations Company A wanted to receive its X% share of the sale consideration in the form of shares in Company D, whereas Company B wanted to receive its X% share of the sale consideration in the form of a mixture of shares, cash and an earnout (to comprise of cash and/or scrip). Company D agreed to pay the different forms of consideration to the shareholders.
6. Company D also wanted Company B's director to remain on Company C's management team. A management services agreement between the director of Company B's related entity Company E and Company D was entered into to facilitate the ongoing management by Company B's director and their management team.
7. By Share Sale Agreement Company A and Company B agreed to sell all their shares in Company C to Company D on the terms and conditions set out in the Agreement.
8. Pursuant to the Share Sale Agreement, Company D acquired 100% of the shares in Company C from Company A and Company B. Company A exchanged its shares in Company C for Company D securities. Company B exchanged its shares in Company C for Company D securities plus cash consideration and an earnout. Company A and B were each issued their Company D securities.
9. Pursuant to the Share Sale Agreement, Company B may receive all or part of the earnout as Company D securities.
10. Company B negotiated separately with Company D in arriving at the consideration it received from Company D.
11. Company A only had a restriction placed on it in relation to selling Company D securities.
12. Company A wanted to exit the business because it was only an investor in the industry, whereas Company B wanted to continue in this business.
13. Company A was at all times an investor and thus was 'in the business' only as an investor. Company B's director devised the model used in the business and developed it, whilst Company A provided the necessary finance.
14. The director of Company B entered into a Management services contract with their related entity, Company E, to earn service income during the period that coincided with the earnout period. Company A or any of its related entities were not offered an earnout component and are not party to the management services agreement.
15. The Share Sale Agreement limits Company B and its director in future business ventures preventing it from competing with Company D. But there are no limits on Company A or its director.
16. The Management services contract with Company E will allow Company B's director to implement their business model in conjunction with Company D's business and to retain the right to continue to operate independently in the business. This is a valuable intangible right to Company B's director and their related entities that is not available to Company A.
Relevant legislative provisions
Income Tax Assessment Act 1997 Subdivision 124-M
Income Tax Assessment Act 1997 section 124-780
Income Tax Assessment Act 1997 subsection 124-780(2)
Income Tax Assessment Act 1997 paragraph 124-780(2)(c)
Reasons for decision
Question 1
Does Company A's and Company B's arrangement for the exchange of its shares in Company C for shares in Company D satisfy all the conditions in subsection 124-780(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Summary
No, Company A and Company B does not satisfy all the conditions of subsection 124-780(2) of the ITAA 1997 because participation in the arrangement was not available on substantially the same terms to both Company A and Company B pursuant to paragraph 124-780(2)(c) of the ITAA 1997.
Question 2
Are Company A and Company B entitled to roll-over relief under Subdivision 124-M of the ITAA 1997 for the exchange of its shares in Company C for shares in Company D?
Summary
No, Company A and Company B are not entitled to scrip for scrip roll-over relief because they do not satisfy all the conditions of subsection 124-780(2) of the ITAA 1997. Participation in the arrangement was not available on substantially the same terms to both Company A and Company B pursuant to paragraph 124-780(2)(c) of the ITAA 1997. Therefore Company A and Company B are not eligible for scrip for scrip roll-over relief under Subdivision 124-M of the ITAA 1997.
Detailed reasoning
Subdivision 124-M of the ITAA 1997 provides roll-over relief for certain post-CGT interests in companies and trusts that are exchanged for interests in another entity. Roll-over relief is available for the replacement of shares where all the conditions in section 124-780 of the ITAA 1997 have been satisfied. From the information provided, Company A and Company B satisfy all the conditions of section 124-780 of the ITAA 1997 with the exception of paragraph 124-780(2)(c) of the ITAA 1997.
Paragraph 124-780(2)(c) of the ITAA 1997 requires that the offer be on substantially the same terms to each offeree.
It is your view that paragraph 124-780(2)(c) of the ITAA 1997 is satisfied because participation in the arrangement was available to both taxpayers on substantially the same terms. This is despite the fact that although both taxpayers could each have sold their shares to Company D on substantially the same terms, they chose to sell their shares to Company D on slightly different terms.
It is difficult to envisage circumstances where an offer could differ and yet be on substantially the same terms. For example, in ATO ID 2003/17 the Commissioner said that where a particular shareholder had additional rights to other shareholders under a Shareholder's Agreement this condition is not satisfied. This approach was confirmed in FCT v Fabig [2013] FCAFC 99; 2013 ATC 20-413 (Fabig).
The Fabig case concerned whether partial scrip-for-scrip rollover relief was available to the taxpayers in relation to their exchange of shares in one company for those in another, where the consideration received by them was disproportionate to their shareholding. The Full Federal Court held that the offer made was not on substantially the same terms. This was because under a separate contractual arrangement between the shareholders, the consideration for the shares was split unevenly between them even though the offer made to each shareholder was on the same terms. The Full Federal Court found that the private arrangement between the shareholders to split the consideration unevenly meant that it was not open to the shareholders to accept the offer on the same terms.
Similarly in this case, a Share Sale Agreement was entered into and Company D proposed to pay consideration in different forms to Company A and Company B which will result in different consideration being paid to each entity. Moreover, the Share Sale Agreement imposed different conditions and warranties on each entity based on each entity's requirements.
The Commissioner does not agree with the view all that occurred was Company A and Company B agreed to receive its consideration in a different form. It is the Commissioner's view that participation in the arrangement entered into between Company A and Company B with Company D was not on substantially the same terms and will refer to the following in support of this view:
● Company A exchanged its shares in Company C for Company D securities. Company B exchanged its shares in Company C for Company D securities plus cash consideration and an earnout.
● Pursuant to the Share Sale Agreement, Company B may receive all or part of the earnout as Company D securities.
● Company B negotiated separately with Company D in arriving at the consideration it received from Company D.
● Company A only had a restriction placed on it in relation to selling Company D securities.
● Company A wanted to exit the business because it was only an investor in the industry, whereas Company B wanted to continue in this business.
● Company A was at all times an investor and thus was 'in the business' only as an investor. Company B's director devised the model used in the business and developed it, whilst Company A provided the necessary finance.
● The director of Company B entered into a Management services contract with their related entity, Company E, to earn service income during the period that coincided with the earnout period. Company A or any of its related entities were not offered an earnout component and are not party to the management services agreement.
● The Share Sale Agreement limits Company B and its director in future business ventures preventing it from competing with Company D. But there are no limits on Company A or its director.
● The Management services contract with Company E will allow Company B's director to implement their business model in conjunction with Company D's business and to retain the right to continue to operate independently in the business. This is a valuable intangible right to Company B's director and their related entities that is not available to Company A.
● Company D wanted Company B's director and Company B's management team to continue to be involved in the business after Company D purchased Company C.
● The director of Company B entered into a Management services contract with their related entity, Company E, to earn service income during the period that coincided with the earnout period. Company A or any of its related entities were not offered an earnout component and are not party to the management services agreement.
● The Share Sale Agreement limits Company B and its director in future business ventures preventing it from competing with Company D. But there are no limits on Company A or its director.
● The Management services contract with Company E will allow Company B's director to implement their business model in conjunction with Company D's business and to retain the right to continue to operate independently in the business. This is a valuable intangible right to Company B's director and their related entities that is not available to Company A.
As was the case with Fabig, the consideration Company A and Company B received was disproportionate to their X% shareholding subject to the Share Sale Agreement and Management services agreement. Company A was not offered cash, an earnout or service income. As Justice Davies concluded in Fabig (at [27]):
They were contractually obliged to sell their shares for different consideration and in consequence, participation in the share sales was not available to them on substantially the same terms.
Therefore, the condition in paragraph 124-780(2)(c) of the ITAA 1997 has not been satisfied, which means that Company A and Company B are not entitled to scrip for scrip roll-over relief.
Case law
Commissioner of Taxation v. Fabig and Dickinson [2013] FCAFC 99; 2013 ATC 20-413
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