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Ruling

Subject: Disposal of a Capital Gains Tax asset

Question 1

Did the capital gains Tax (CGT) event triggered by the disposal of your shares happen in year ended 30 June 2012?

Answer

Yes.

Question 2

Is the capital gain assessed in the one year?

Answer

Yes.

Question 3

Can you amend future returns if no further payments are made?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on:

On or after 1 April 2012

Relevant facts and circumstances

You were a minor shareholder in a private company that provides administration matters for one client.

An agreement was entered into for the sale of 100% of the shares.

Payments are conditional on certain events occurring and are spread over a several financial year period, provided the fund is continually administered by the purchaser.

The total purchase price to all shareholders is not to exceed a set amount subject to completion of a number of events and circumstances, mainly proposed Government policies.

A payment was received in year ending 30 June 2012.

A further payment would be payable if the client extended the contract under the same conditions. The client has inserted a 'get out clause' into the contract as they are concerned that a proposed federal government changes may force them to merge with a bigger entity. As a result, under the terms of sale agreement, deferred payments will be made provided that the client remains an entity in it's own right and the purchaser remains as the administrator.

A working capital adjustment was received in year ending 30 June 2012.

Potential deferred payments in the agreement you have supplied include payments in

· Year ending 30 June 2014,

· Year ending 30 June 2015 and

· Year ending 30 June 2016.

There is an additional payment scheduled to be made, which is conditional upon the proposed government auto-consolidation of superannuation accounts. The client consists primarily of small account balances and will be severely affected by the proposed auto consolidation.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 104-25(2)

Income Tax Assessment Act 1997 Section 112-30

Income Tax Assessment Act 1997 Section 116-20

Reasons for decision

Issue 1

Question 1

Summary

The capital gains tax event triggered by the disposal of your shares happened in the year ended 30 June 2012.

Detailed reasoning

The disposal of your shares triggered CGT event A1. Under Section 104-10 of the Income Tax Assessment Act 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 your shares was entered into in or after 1 April 2012.

As you entered into an agreement in year ending 30 June 2012 in which you agreed to sell your shares to the purchaser, the date for the disposal of the shares is in year ending 30 June 2012. CGT event A1 therefore occurred in the financial year ended 30 June 2012.

Question 2

Summary

The capital gain on the disposal of your shares is assessed in one year.

Detailed reasoning

The amount of the capital proceeds from a CGT event is generally the sum of the money received or receivable and the market value of any other property received or receivable as a result of the CGT event. The capital proceeds from a CGT event are defined by reference to money and property that a taxpayer has received or is entitled to receive but a capital gain or loss arises in the income year in which the event happens.

Earnout Arrangement

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. 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, the earnout right is not an entitlement to money for the purposes of calculating the seller's capital proceeds from 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 from 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 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 purpose 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, at the time the contract was signed, the final sale price had not been finalised as it was dependant upon a number of events and circumstances around proposed Government policies regarding superannuation. Therefore, the remainder of the sale price will be determined by the performance of the company.

Ending of an earnout right

Generally, the seller's ownership of an earnout right will come to an end when satisfied by the payment of an amount or amounts by the buyer, or by expiring without any amounts becoming payable. In each of these situations, CGT event C2 (about cancellation, surrender and similar endings) happens.

The contract for the sale of the original asset for an earnout right is not a 'contract that results in the asset ending' under paragraph 104-25(2)(a). Accordingly, under paragraph 104-25(2)(b), the time of the CGT event is when the right ends and not before.

In your case, the sale is deemed to be an earnout right and the capital proceeds from the sale are the money received and the market value of the rights created under the contract.

Issue 1

Question 3

Summary

You cannot amend future returns if no further payments are made.

Detailed reasoning

An amendment cannot be made to your future returns if no further payments are made.

As discussed previously, additional CGT events (event C2) will occur as the rights end. Generally, the seller's ownership of the right will come to an end when satisfied by the payment of an amount or amounts by the buyer, or by expiring without any amounts becoming payable. In each of these situations, CGT event C2 happens.

The contract for the sale of the original asset for an earnout right is not a 'contract that results in the asset ending' under paragraph 104-25(2)(a). Accordingly, under paragraph 104-25(2)(b), the time of the CGT event is when the rights ends and not before.

Where an earnout is discharged progressively in instalments, the CGT treatment will differ depending on the circumstances of the payments. In some circumstances, it will be appropriate to regard each right to an instalment as a separate CGT asset. In others, it may be more appropriately characterised as part of a single CGT asset comprising the totality of rights under a contract covering both the sale of the original asset and of the earnout arrangement.

The totality of rights under a contract is generally regarded as a single for CGT purposes. However, this is ultimately a question of fact to be determined on a case by case basis.

Where the rights to progressive payments are part of a single CGT asset comprising the totality of the rights under a single contract, CGT event C2 happens to part of it at the time specified for each payment (other than the final payment). The seller's cost base for the part of the right to which the event happens is apportioned according to the formula in sub-section 112-30(3). Under subsection 112-30(4), the remainder of the cost base after each payment is made is attributed to the part of the asset that remains.

Where each right to progressive payments under the earnout arrangement is a separate CGT asset, the seller is required to determine the cost base of each separate right as it is acquired. Under subsection 112-30(1), the first element of the cost base of each right is part of the expenditure that relates to its acquisition.

In your case as discussed above additional CGT events (CGT event C2) occur as the rights to compensation end. This could allow capital losses to be made and claimed against future capital gains.