House of Representatives

Tax and Superannuation Laws Amendment (2015 Measures No. 4) Bill 2015

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Chapter 1 - Improving the integrity of the scrip for scrip roll-over

Outline of chapter

1.1 Schedule 1 to this Bill makes amendments to improve the integrity of the scrip for scrip roll-over in Subdivision 124-M of the Income Tax Assessment Act 1997.

1.2 All legislative references in this Chapter are to the Income Tax Assessment Act 1997 unless otherwise indicated.

Context of amendments

1.3 The purpose of the scrip for scrip roll-over is to ensure that tax considerations are not an impediment to takeovers or mergers involving companies or trusts.

1.4 If shares or trust interests, or options or similar rights over shares or trust interests (scrip) are exchanged for similar interests in another entity in a takeover or merger, the scrip for scrip roll-over defers taxing a capital gain on the disposal of the scrip until the disposal of the replacement scrip. This reduces the cost of takeovers, as the acquiring entity need not compensate the holders of scrip for the tax they would otherwise have paid on the exchange.

Stakeholder rules

1.5 Integrity provisions (the stakeholder provisions in sections 124-782 and 124-784) are intended to ensure that potentially indefinite capital gains tax (CGT) deferral opportunities do not arise when the same person or group has influence over both the acquired entity and the acquiring entity. Inappropriate deferral could otherwise occur where an acquiring company receives shares in the original company in exchange for shares in itself and on-sells the original company. A cost base uplift would otherwise apply to the shares now held by the acquiring company while the original company's shareholders benefit from reinvesting capital gains without triggering a CGT liability.

1.6 To prevent inappropriate deferral, special cost base rules apply so that the cost bases for the acquiring entity of the interests in the acquired entity reflects the cost bases of the original interest holder rather than the market value of the interests. Broadly, these rules apply in respect of takeovers and mergers involving companies or trusts where neither the acquired entity nor the acquiring entity is widely-held (that is, they each have less than 300 members or beneficiaries).

1.7 The threshold levels of influence are called a significant stake or common stake, and are defined by section 124-783:

·
A shareholder of a company has a significant stake if the shareholder and the shareholder's associates own shares with 30 per cent or more of the voting rights or entitlements to dividends or entitlements to capital distributions.
·
One or more shareholders in a company have a common stake if they and their associates own shares with 80 per cent or more of the voting rights or entitlements to dividends or entitlements to capital distributions.

1.8 Section 124-783 also defines a significant stake and common stake in relation to trusts using equivalent tests that assess beneficiaries' entitlements to receive distributions from the trust.

Restructure rules

1.9 Further integrity provisions (the restructure provisions in sections 124-784A to 124-784C) apply to scrip for scrip roll-overs that are treated as corporate restructures because there is substantial continuity of ownership. Under a restructure, the cost bases for the acquiring entity of the affected interests in the entity acquired under the restructure reflect the cost bases of the acquired entity's underlying net assets rather than the market value of the interests.

1.10 The restructure rules apply to restructures involving companies, including widely-held companies, but do not apply to trusts.

The AXA case

1.11 The arrangement considered by the Full Federal Court in AXA Asia Pacific Holdings Ltd v Commissioner of Taxation [2009] FCA 1427 (AXA) highlighted a number of limitations in the existing integrity rules. The case itself concerned the arm's length test in subsection 124-780(4) and the application of Part IVA of the Income Tax Assessment Act 1936. The amendments in Schedule 1 do not address either of those provisions but rather the issues highlighted by the arrangement considered in AXA.

1.12 Subdivision 124-M treated the AXA arrangement as a genuine takeover involving a substantial change in ownership rather than as a corporate restructure. As a result, AXA was able to obtain the benefit of a CGT cost base uplift when eventually disposing of one of its subsidiaries.

1.13 The AXA arrangement demonstrated that the stakeholder provisions can be circumvented by temporarily suppressing the ownership rights of a party in a scrip for scrip exchange through the use of instruments including convertible shares, options and rights. Later, when the stakeholder provisions no longer apply, these instruments can be executed to give the holder an increased level of rights that would have meant the stakeholder provisions would have applied if the relevant party had held that level of ownership rights at the earlier time.

Repayment of intra-group debts

1.14 Where the stakeholder or restructure provisions apply to a scrip for scrip exchange, any capital gain arising on the settlement of a debt owed by an acquiring entity to its parent company as part of the scrip for scrip acquisition is disregarded. This rule can be used to shelter part of the deferred capital gain from taxation.

1.15 In 'downstream acquisitions', the acquiring company is a member of a wholly owned group and original shareholders receive shares in the parent company in exchange for their shares in the original company. As consideration for the shares issued by the parent, the acquiring company may incur a debt to the parent company in addition to, or instead of, issuing equity. To accommodate downstream acquisitions, the provisions include the term 'replacement entity', which extends the concept of 'acquiring entity' to include the parent company (the ultimate holding company defined by subsection 124-780(7)).

Diagram 1.1 : Downstream acquisitions

1.16 When an acquiring company repays a loan to its parent company acquired under a takeover arrangement, the capital gain that would otherwise arise (that is, if the cost base allocated to the debt is less than its market value) is disregarded under subsection 124-784(3), or 124-784C(3) under the restructure provisions.

1.17 However, if the parent company sells the acquiring company (and therefore the original company) by selling all of the equity of the acquiring company, the capital gain that arises reflects only a portion of the capital gain that would otherwise arise if the acquiring entity had sold the original company. The use of debt between the acquiring company and the parent company provides a shelter for a portion of the capital gain that should be transferred with the cost base transfer to the parent company if it had sold the acquiring company. For example, even if the stakeholder provisions had applied to the AXA transaction, the use of debt between the acquiring entity and the parent entity in that transaction would have resulted in the recovery of only part of the inappropriately deferred CGT liability.

Intra-group cost base allocation rules

1.18 A separate issue with the cost base allocation rules for downstream acquisitions, which are set out in sections 124-784 and 124-784C, arises if the acquiring company issues equity or owes new debt to a company in the group other than the parent company. The rules assume that the equity is issued, or the debt is owed, directly by the acquiring company to the parent company.

1.19 This rule does not apply where a company in the group other than the parent company makes the acquisition and issues equity or owes a debt as a result of the acquisition to another company in the group other than the parent company. This means there will be no cost base transfer or no reduction to the cost base of the debt asset or equity issued by the acquiring company to the other group company as part of the scrip for scrip acquisition. If the other company then on-sells its equity in the acquiring company, the integrity provisions would not recapture any of the tax deferral.

Trusts

1.20 Further analysis of the underlying issues in the AXA arrangement revealed similar problems with the scrip for scrip roll-over provisions as they apply to trusts.

1.21 Broadly, the stakeholder provisions do not apply to scrip for scrip arrangements where either the original or the replacement entity has at least 300 members or beneficiaries (subsections 124-783(5) and (8)). In contrast, the restructure rules in section 124-784A apply to all scrip for scrip transactions involving companies, regardless of the number of members. The restructure rules do not apply in relation to trusts.

1.22 If an acquisition that qualifies for the scrip for scrip roll-over is taken to be a restructure and roll-over relief is chosen, the cost base for the original interests that the acquiring entity acquires reflects the cost bases of the underlying net assets of the original entity, rather than the market value of the original entity. The rationale behind the restructure integrity provisions is that a takeover by an entity of low value relative to the target entity is considered a restructure rather than a takeover.

1.23 Widely-held trusts may also engage in similar transactions that are more like restructures of an existing trust, with no substantial change in ownership, rather than a genuine takeover.

Summary of new law

1.24 Schedule 1 to this Bill makes a number of changes to the scrip for scrip roll-over:

·
Options, variations, rights and other things that affect membership interests and other rights are taken into account for the purposes of the significant and common stakeholder tests.
·
A capital gain arising on the settlement of a debt owed, as part of a scrip for scrip acquisition, by an acquiring company to its parent company will no longer be disregarded.
·
The cost base allocation rules for debt owed and equity issued by an acquiring entity will apply regardless of whether it is to the group's parent company or to another member of the group.
·
In downstream acquisitions, roll-over relief will not be available where new debt is owed or equity (other than a replacement interest) has been issued to an entity outside the wholly-owned group in relation to the issue of replacement interests and as part of the arrangement.
·
The restructure provisions that apply to companies will be amended so that they apply correctly to trusts.

Comparison of key features of new law and current law

New law Current law
The significant and common stakeholder tests will also take into account any entitlements that interest holders have to acquire additional distribution or voting rights. The significant and common stakeholder tests are based on the distribution and voting rights of interest holders.
The capital gains are not disregarded. Certain capital gains, made by an ultimate holding company when settling debt issued by a subsidiary acquiring entity under a scrip for scrip arrangement, are disregarded.
The cost base allocation rules will apply to new debt owed and equity issued by an acquiring entity to any member of their corporate group. The cost base allocation rules apply to debt and equity issued by an acquiring entity to the ultimate holding company of their group.
Roll-over relief will not be available where an acquiring entity issues debt or equity (other than a replacement interest) to an entity that is not a member of the wholly-owned group. No equivalent.
The restructure provisions apply to both companies and trusts that enter into restructures. The restructure provisions apply to company restructures but not trust restructures.

Detailed explanation of new law

Stakeholder rules and entitlements to acquire rights

1.25 Amendments are made to ensure that instruments that affect an entity's ownership rights are taken into account in determining whether a significant or common stake exists. This is achieved by treating any entitlement to acquire relevant interests to have been realised. [Schedule 1, item 8, subsections 124-783A(1) and (2)]

1.26 The relevant interests assessed under the stakeholder tests (for example voting rights in a company) are known as 'stake interests'. An entitlement to acquire stake interests arises under things such as an option, a share with varied rights, a contractual right or other instrument (a 'stake option'). [Schedule 1, item 8, subsections 124-783A(3) and (4)]

1.27 Where a stake option of an entity may be exercised, converted or varied, that entity is treated as having acquired the maximum number of stake interests possible. That assessment is made without reference to any other stake option holder's maximum number of stake interests. In some circumstances, it may not be possible to ascertain the maximum amount with certainty and a reasonable estimation will be required.

1.28 The rule does not apply in situations where an interest holder has an entitlement to exercise an option that diminishes its holding, such as a put option.

1.29 This rule does not apply to stake options or interests that cannot be realised within five years of the scrip for scrip arrangement being completed. The integrity rule is targeted towards short-term entitlements that distort the application of the stakeholder rules without having an ongoing impact on the commercial positions of the relevant entities. [Schedule 1, item 8, subsection 124-783A(3)]

Example 1.1 : Entitlements to acquire stake interests An original interest holder owns all of the ordinary shares and voting rights in a company (the target company). The original interest holder enters into a scrip for scrip arrangement with an acquiring entity. Under the arrangement, the acquiring entity acquires all of the shares in the target company. In return, the acquiring entity issues convertible preference shares in itself to the original interest holder.The replacement shares currently carry 15 per cent of the voting rights in the acquiring entity. The shares are capable of converting after 12 months. Following the conversion of the shares, the shares will carry 40 per cent of the voting rights in the acquiring entity.Under the current law, the original interest holder does not have a significant stake (30 per cent) in the acquiring entity after the arrangement. Under the amendments, the original interest holder is treated as having converted its shares and it will have a significant stake.

Example 1.2 : Multiple options including option to acquire stake interest Further to Example 1.1, the original interest holder could choose, instead of having all of the shares converted, to receive some other financial benefit.If the original interest holder elected to receive the other financial benefit, the conversion would result in the shares carrying 25 per cent of the voting rights in the acquiring entity.The original interest holder still has a stake option to acquire up to 40 per cent of the voting rights in the company. The original interest holder will still have a significant stake as in Example 1.1.

Example 1.3 : Stake options include temporarily suppressed rights An original interest holder owns all of the ordinary shares and voting rights in a company (the target company). The original interest holder enters into a scrip for scrip arrangement with an acquiring entity. Under the arrangement, the acquiring entity acquires all of the shares in the target company, in exchange for shares in itself that it provides to the original interest holder.As part of the arrangement, an agreement was entered into to suppress voting rights attached to replacement shares for a period of 12 months.As a result of this agreement, the replacement shares do not carry voting rights in the acquiring entity. Following the expiry of the 12 months, the shares will carry 40 per cent of the voting rights in the acquiring entity.Under the current law, the original interest holder does not have a significant stake (30 per cent) in the acquiring entity after the arrangement. Under the amendments, the temporarily suppressed rights are included in the summation of ownership rights such that the interest holder is treated as having a significant stake.

Repayment of debt within corporate groups

1.30 Subsections 124-784(3) and 124-784C(3) provide that, if a loan is repaid by the acquiring entity to its ultimate holding company, any capital gain made on the debt from that repayment is disregarded.

1.31 Those provisions are repealed as part of a broader rewrite of sections 124-783 and 124-784C. [Schedule 1, items 8 and 11, sections 124-784 and 124-784C]

1.32 This amendment ensures that the full value of a capital gain deferred under the scrip for scrip roll-over is recovered through the operation of the stakeholder rules. Replacement entities that are controlled by original interest holders who are significant or common stakeholders will not be able to shelter the capital gain with the use of intra-group debt.

Cost base allocation rules

1.33 Sections 124-784 and 124-784C contain cost base allocation rules for debt owed and equity issued as part of a downstream acquisition. The cost base of the parent company's debt or equity received is determined by reference to the acquisition cost of the membership interests in the original company that the acquiring entity acquires.

1.34 Currently, the rules only apply to debt owed and equity issued by an acquiring entity to the parent company of the group. An amendment is made to apply these rules where the acquiring entity owes debt or issues equity to another member of the group. [Schedule 1, items 8 and 11, sections 124-784 and 124-784C]

Example 1.4 : Cost base allocation rules

Example of cost base allocation rules

As part of a scrip for scrip arrangement, the acquiring entity acquires all the shares in the original entity. The original entity's shareholders, who are significant stakeholders, receive shares of the replacement entity in exchange.The acquiring entity owes new debt to the interposed subsidiary, and the interposed subsidiary issues equity to the replacement entity for the issue of its shares.Under the existing law, the cost base of the significant stakeholders in the original entity's shares is transferred to the acquiring entity, but is not allocated to the interposed subsidiary or the replacement entity.Under the amendments, the acquiring entity's cost base is allocated to the interposed subsidiary for the debt owed by the acquiring entity, and to the replacement entity for the equity issued by the interposed subsidiary.

1.35 To prevent structuring that circumvents these expanded rules, a new condition is placed on the availability of scrip for scrip roll-over relief. That is, roll-over relief will not be available where, under the arrangement, the acquiring entity owes new debt or issues equity to an entity outside the wholly-owned group in relation to the issue of replacement interests. [Schedule 1, item 4, paragraph 124-780(3)(f)]

1.36 The debt or equity will be 'in relation to the issue of replacement interests' where it is new debt owed or equity issued, directly or indirectly, to compensate the issuer of the replacement interests for that issue. This rule will prevent scenarios where the acquiring entity issues debt or equity to another member of the group through an interposed entity that is not part of the wholly-owned group.

Example 1.5 : New roll-over condition for interposed entities

New roll-over condition for interposed entities

Consider the same facts as in Example 1.4, except the interposed subsidiary is not a member of the wholly-owned group.The original interest holders will not be entitled to roll-over relief under the arrangement.

1.37 The new roll-over condition does not apply to:

·
the issue of replacement interests themselves;
·
new debt owed or equity issued to an external financier or investor to fund the purchase of original interests under the arrangement; or
·
new debt owed or equity (including equity other than replacement interests) issued to the original interest holders as consideration for their original interests.

Example 1.6 : The roll-over condition and external finance An acquiring group enters into a partial scrip for scrip arrangement to acquire a target company (market value $10 million). The arrangement is a downstream acquisition (see Diagram 1.1) where a subsidiary acquiring company will acquire all of the original interests.In return:

·
the parent company of the group issues replacement shares (market value $5 million) to the original interest holders; and
·
the acquiring company pays $5 million to the original interest holders.

The acquiring company issues new shares to its parent company as compensation for the issue of replacement shares. This is subject to the cost base allocation rules if the original interest holder is a significant or common stakeholder for the arrangement (see paragraph 1.33).The acquiring company raises the $5 million in cash borrowing from an external financier. This new debt owed to the financier does not breach the new roll-over condition in paragraph 124-780(3)(f).The arrangement is entitled to a partial roll-over for the scrip for scrip portion of the arrangement (see section 124-790).

Trusts

1.38 A number of amendments are made to the scrip for scrip roll-over in order to align the treatment of trusts with that of companies.

1.39 The primary amendment is to allow the restructure provisions to apply to trusts. [Schedule 1, item 9, subparagraph 124-784(1)(a)(i)]

1.40 Currently, the method statement in section 124-784A relies on calculating the market value of shares and associated rights and options. An amendment is made to expand the scope of the method statement to include units in trusts and options and rights to acquire units. [Schedule 1, item 10, step 3 of the method statement in subsection 124-784A(2)]

1.41 Further amendments are made to the trust roll-over provision (section 124-781) and the common stakeholder provisions (subsections 124-783(9) and (10)). The amendments include trusts in the defined term 'replacement entity' and apply this term in a standardised way so that it applies correctly to both companies and trusts. [Schedule 1, items 5 and 7, subparagraphs 124-781(1)(a)(i) and (ii), and subsections 124-783(9) and (10)]

Minor and consequential amendments

1.42 A consequential amendment is made to remove a note that refers to repealed subsection 124-784(3). [Schedule 1, item 1, note 4 to subsection 104-25(5)]

1.43 Two consequential amendments are made in relation to the expanded operation of the cost base allocation rules. [Schedule 1, items 2 and 6, table item 2 in section 112-53 and note 2 to subsection 124-782(1)]

1.44 Consequential amendments are made to the definitions of 'common stake' and 'significant stake'. [Schedule 1, items 12 and 13, subsection 995-1(1)]

1.45 The definitions 'stake interest' and 'stake option' are inserted into the Act's dictionary. [Schedule 1, item 14, subsection 995-1(1)]

1.46 A minor amendment is made to insert an omitted asterisk denoting the term 'arrangement' as a defined term. [Schedule 1, item 3, paragraph 124-780(3)(d)]

Application and transitional provisions

1.47 The amendments apply in relation to CGT events that occur after 7:30pm (Australian Eastern Standard Time) on 8 May 2012 - the date of the original Budget announcement. [Schedule 1, item 15]

1.48 The retrospective application of these amendments is appropriate. The Federal Court's decision in AXA revealed significant risks to the integrity provisions of the scrip for scrip roll-over. Addressing these integrity concerns will ensure that the roll-over operates as intended.

1.49 In developing the legislation, the Government has undertaken extensive consultation with interested parties since the publication of the proposals paper in July 2012. This was followed by public consultation on draft legislation in May 2015. Adverse impacts on taxpayers are therefore minimal.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 Improving the integrity of the scrip for scrip roll-over

1.50 Schedule 1 to this Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

1.51 Schedule 1 to this Bill makes amendments to improve the integrity of the scrip for scrip roll-over in Subdivision 124-M of the Income Tax Assessment Act 1997.

Human rights implications

1.52 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

1.53 This Schedule is compatible with human rights as it does not raise any human rights issues.


Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).