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Ruling

Subject: Disposal of a Capital Gains Tax asset

Question 1

Do the first, second and third completion dates in respect of the share sale agreement on the sale of shares in Company A between you and the other shareholder and Company C and Company B constitute separate sales and therefore a separate capital gains event in years ended 30 June 2009 and 2010?

Answer

No.

Question 2

Should gains and losses the arise under CGT events (A1, K10 and K11) be included in your income tax returns for the years ended 30 June 2009 and 2010?

Answer

No.

Question 3

Does the share sale agreement on the sale of shares in Company A between you and the other shareholder and Company C and Company B constitute and "earnout" arrangement?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commences on:

Year ended 30 June 2008

Relevant facts and circumstances

You and your spouse emigrated to Australia as permanent residents.

You are an Australian resident for income tax purposes.

You held an interest in a Company A, a company registered and operated overseas.

Company B offered to purchase Company A from you and your fellow shareholder.

Company B is an unconnected party and the offer was made at arms length at a time close to the date you became an Australian resident.

The offer made by Company B valued your holding in Company A at $X

A share sale Agreement (the Agreement) in respect of Protocol between the following parties:

· The sellers

· you and

· the other shareholder and

· The Purchaser

· Company C, and

· The Guarantor

· Company B

was entered into and signed..

Relevant clauses extracted from the Agreement are detailed below:

The sale was structured in three tranches; the purchase price is defined at a clause of the agreement to mean the aggregate of the First Purchase Price, the Second Purchase Price and the Third Purchase price.

Another clause of the agreement states the purchase price shall not be more than X and shall not be less than X - your entitlement being a specified percentage of these amounts.

Other clauses of the agreement see the First Purchase Price, Second Purchase Price and Third Purchase Price determined in the following manner:

Clause X.1.a First purchase price = 0.Y x X.25 x Adjusted EBITA

Where adjusted EBITA shall mean the Company's audited earnings before interest, tax and amortisation, for the financial year ended 29 February 20XX, after excluding any extraordinary or exceptional items and making certain adjustments thereto agreed by the parties, and which First Purchase price the Parties agree shall be X.

Clause X.1.b Second purchase price = 0.X x X.25 x Adjusted EBITA

Where adjusted EBITA shall mean the Company's audited earnings before interest, tax and amortisation, after excluding any extraordinary or exceptional items for the 12 month period ending on 30 September 20XX determined in accordance with the provisions of another clause (Adjusted EBITA).

Clause X.1.c Third purchase price = 0.Z x X.25 Adjusted EBITA

Where adjusted EBITA shall mean the company's audited earnings before interest, tax and amortisation, for the 12 month period ending on 30 September.20XX excluding any extraordinary or exceptional items, determined in accordance with the provisions of another clause .

The first closing date occurred on a specified date. You sold Y shares for an amount of X.

The second closing date occurred on a specified date. You sold X shares for a sum of X.

The third closing date was scheduled for a specified date however the transaction occurred earlier. You sold X shares for a sum of X.

Relevant legislative provisions

Income Tax Assessment Act 1997 104-10,

Income Tax Assessment Act 1997 104-260,

Income Tax Assessment Act 1997 104-265,

Income Tax Assessment Act 1997 116-20,

Income Tax Assessment Act 1997 109-5,

Income Tax Assessment Act 1997 775-70,

Income Tax Assessment Act 1997 775-75 and

Income Tax Assessment Act 1997 775-80.

Reasons for decision

Question 1

The disposal of the tranches of shares in Company A triggered CGT event A1. Under Section 104-10 of the ITAA 1997 CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you or another entity.

The time of the disposal is when you enter into the contract for the disposal or if there is no contract - when the change of ownership takes place. The contract for the disposal of Company A in a number of tranches of shares was signed in the year ended 30 June 2009.

As you entered into and signed a contract in the year ended 30 June 2009 in which you agreed to sell Company A to the purchaser, the date for the disposal of the shares in Company is in the financial tear ended 30 June 2009. CGT event A1 therefore occurred for all the tranches of shares in the financial year ended 30 June 2009.

Question 2

Capital Gains Tax (CGT) event K10 happens if:

(a) you make a foreign exchange (forex) realisation gain as a result of forex realisation event 2; and

(b) item 1 of the table in subsection 775-70(1) applies.

For these purposes:

A "forex realisation gain" that occurs under forex realisation event 2 arises where a right to receive foreign currency ceases and a gain arises by virtue of a currency exchange rate fluctuation; and

Item 1 of the table in s 775-70(1) applies where the gain is considered "short term" (that is, the foreign currency becomes due for payment within 12 months after the occurrence of the realisation event).

The time of the event is when the forex realisation event happens.

You make a gain equal to the forex realisation gain.

CGT event K11 happens if:

(a) you make a forex realisation loss as a result of forex realisation event 2 and

(b) item 1 of the table in subsection 775-75(1) applies.

The time of the event is when the forex realisation event happens

You make a capital loss equal to the forex realisation loss.

Generally, short term foreign currency realisation gains are taxed under Division 775 of the Income Tax Assessment Act 1997 (ITAA1997) as revenue gains. However CGT events K10 and K11 will apply to capture as a capital gain or loss certain short term foreign currency realisation gains where the capital gain or loss is linked sufficiently to the disposal of a capital asset.

Where a taxpayer makes a "forex realisation gain" on ceasing to have a right to receive foreign currency the gain will be excluded from being assessed as income under Division 775 of the ITAA 1997. This is provided that the right to receive foreign currency was created in relation to a CGT asset owned by the taxpayer and the foreign currency became due for payment within 12 months after the disposal of the CGT asset.

In your case, the right to receive foreign currency came about as a result of the disposal of shares in Company A (CGT assets) in a number of tranches on in the year ended 30 June 2009.

As the date of CGT event A1 occurring is in the year ended 30 June 2009 some of the foreign exchange gains and losses will trigger CGT events K10 and K11. As discussed previously under the legislative provisions applicable to these arrangements in order for CGT events K10 and K11 to be applicable, the foreign currency must become due for payment within twelve months after the occurrence of the realisation event. As CGT event A1 took place on a particular date, those forex realisations and gains that took place prior to and including the particular date will trigger CGT events K10 and K11.

Under the CGT provisions, the taxpayer must make an election under Section 775-80 of the ITAA 1997 to apply section 775-70 and 775-75 for the gain or loss to be considered as assessable income or a deductible loss. You did not elect to make this choice, as a result CGT events K10 and K11 are applied to those foreign exchange gains and losses that occurred.

Those remaining forex realisations that occurred will not trigger CGT event K10 and K11 and will be considered to be assessable income or a deductible loss.

The disposal of the shares in Company A triggered CGT event A1. Under Section 104-10 of the ITAA 1997CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you or another entity. The time of the event is when you enter into the contract for the disposal. As you entered into the contract for the disposal in year ended 30 June 2009 , CGT event A1 occurred in year ended 30 June 2009.

Question 3

A standard earnout arrangement is any transaction in which an income earning asset is sold for consideration that includes the creation of an earnout right in the seller of the asset.

An earnout right is a right to an amount calculated by reference to the earnings generated by the asset for a defined period following the sale (generally a period of between one and five years). It is to be distinguished from a right to a sum in respect of that sale which is certain as to amount and as to receipt, as this '…money you… are entitled to receive…' in terms of paragraph 116-20(1)(a) of the ITAA 1997 regarding capital proceeds.

Under Section 116-20 of the ITAA 1997 , the earnout right is not an entitlement to money for the purposes of calculating the seller's capital proceeds form CGT event A1. An earnout right is considered 'other property.received' by the seller in respect of the disposal of the original asset. Accordingly the seller's capital proceeds form that event includes the market value of that right. It is not possible for the seller to 'look through' the earnout right and treat any payments made in relation to it as capital proceeds in respect of the disposal of the original asset.

The earnout right is property, and a CGT asset, in the hands of the seller. It commences to be owned and is acquired for the purposes of section 109-5 of the ITAA 1997 at the time the contract for the sale of the original asset is made.

In your case, the final price on the sale of the asset is not a fixed amount, but is dependant on the future performance based on Adjusted EBITA of the company over three time periods.

At the time the contract was signed, only agreement on the amount for the first disposal had been established.

As a result the disposal meets the definition of being an earnout arrangement and the CGT consequences of earnout arrangements should be considered in relation to the disposal.