Edited version of private advice

Authorisation Number: 1012640821552

Ruling

Subject: Earnout rights

Issue 1

Non-look through treatment

Question 1

Under the "non-look through treatment" of earnout rights set out in Draft Taxation Ruling TR 2007/D10 (TR 2007/D10):

(a) does CGT event C2 in section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) happen in respect of the 2013 Earnout on 30 June 2013, or on another date?

(b) does forex realisation event 2 (FRE 2) in section 775-45 of the ITAA 1997 happen on the day the 2013 Earnout is received by the Sellers, or on another date?

(c) for the purposes of section 775-85 of the ITAA 1997 is the forex cost base of the right to receive foreign currency for the 2013 Earnout worked out on 30 June 2013, or on another date?

(d) can the Sellers use the method set out in Forex Calculation Examples to determine the forex realisation gain or loss from forex realisation event 2 happening in relation to the 2013 Earnout. If not, how is the forex realisation gain or loss to be calculated?

(e) in terms of section 775-70 of the ITAA 1997 does CGT event K10 happen or in terms of section 775-75 of the ITAA 1997 does CGT event K11 happen in respect of the 2013 Earnout?

Answers

(a) CGT event C2 in respect of the 2013 Earnout does not happen on 30 June 2013; it happens on the date determined under the Sale Agreement when the earnout calculation for the 2013 Earnout is final and binding on the parties.

(b) Forex realisation event 2 happens on the day the 2013 Earnout is received by the Sellers.

(c) The forex cost base of the right to receive foreign currency is not worked out on 30 June 2013; it is worked out on the date determined under the Sale Agreement when the earnout calculation for the 2013 Earnout is final and binding on the parties.

(d) No. See the reasons for decision.

(e) Yes. A CGT event K10 or CGT event K11 happens in respect of the 2013 Earnout.

Question 2

Under the "non-look through treatment" of earnout rights set out in TR 2007/D10:

(a) does CGT event C2 in section 104-25 of the ITAA 1997 happen in respect of the 2014 Earnout on 30 June 2014, or on another date?

(b) does forex realisation event 2 (FRE 2) in section 775-45 of the ITAA 1997 happen on the day the 2014 Earnout is received by the Sellers, or on another date?

(c) for the purposes of section 775-85 of the ITAA 1997 is the forex cost base of the right to receive foreign currency for the 2014 Earnout worked out on 30 June 2014, or on another date?

(d) can the Sellers use the method set out in Forex Calculation Examples to determine the forex realisation gain or loss from forex realisation event 2 happening in relation to the 2014 Earnout. If not, how is the forex realisation gain or loss to be calculated?

(e) in terms of section 775-70 of the ITAA 1997 does CGT event K10 happen or in terms of section 775-75 of the ITAA 1997 does CGT event K11 happen in respect of the 2014 Earnout?

Answers

(a) CGT event C2 in respect of the 2014 Earnout does not happen on 30 June 2014, it happens on the date determined under the Sale Agreement when the earnout calculation for the 2014 Earnout is final and binding on the parties.

(b) Forex realisation event 2 happens on the day the 2014 Earnout is received by the Sellers.

(c) The forex cost base of the right to receive foreign currency is not worked out on 30 June 2014, it is worked out on the date determined under the Sale Agreement when the earnout calculation for the 2014 Earnout is final and binding on the parties.

(d) No. See the reasons for decision.

(e) Yes. A CGT event K10 or CGT event K11 will happen in respect of the 2014 Earnout.

Question 3

Are any anti-overlap provisions applicable to affect the tax consequences of CGT event C2 and also forex realisation event 2 (FRE 2) happening to both the 2013 Earnout and the 2014 Earnout, such as under section 118-20, and/or subsection 775-15(4) of the ITAA 1997?

Answer

No. There are no anti-overlap provisions which are applicable.

Issue 2

Look Through treatment

Question 1

Under the "look through treatment" of earnout rights set out on the ATO Website:

(a) does an Earnout Event happen in respect of the 2013 Earnout on 30 June 2013, or on another date?

(b) does forex realisation event 2 (FRE 2) in section 775-45 of the ITAA 1997 happen on the day the 2013 Earnout is received by the Sellers, or on another date?

(c) for the purposes of section 775-85 of the ITAA 1997 is the forex cost base of the right to receive foreign currency for the 2013 Earnout worked out on 30 June 2013, or on another date?

(d) can the Sellers use the method set out in Forex Calculation Example to determine the forex realisation gain or loss from forex realisation event 2 happening in relation to the 2013 Earnout? If not, how is the forex realisation gain or loss to be calculated?

(e) does CGT event K10 or CGT event K11 happen in respect of the 2013 Earnout?

Advice

We are unable to provide a private ruling on the above questions. Division 359 of the Taxation Administration Act 1953 (TAA) contains provisions relating to private rulings. Section 359-5 of the TAA provides as follows:

The Commissioner may on application, make a ruling on the way in which the Commissioner considers a relevant provision applies or would apply to you in relation to a specified *scheme. Such a ruling is called a private ruling.

Note: Section 357-55 specifies the relevant provision.

In this case there is no "relevant provision" upon which we can give a private ruling. This is because no legislation has yet been enacted in respect of the look through treatment of the capital gain realised from an earnout arrangement.

The information on the ATO website to which you refer appears under the heading of "new legislation". It is stated there that the Assistant Treasurer announced on 14 December 2013 that the measures regarding the look through treatment of an earnout arrangement, which were announced as part of the 2010-11 Budget, will be proceeding.

In your application you asked that where the Commissioner is unable to issue a private binding ruling on any question raised in your application, "administratively binding advice" be provided in respect of those questions.

We are unable to provide such administratively binding advice for the same reason that a private ruling cannot be given namely that there is no relevant provision.

Accordingly, your attention is drawn to the abovementioned entry on the ATO website and the statement therein regarding our administrative treatment. That statement sets out the transitional arrangements with respect to the choices available to the taxpayer including the protection from the application of any tax shortfall penalties and the remission of interest. No further advice is available.

Question 2

Under the "look through treatment" of earnout rights set out on the ATO Website:

(a) does an Earnout Event happen in respect of the 2014 Earnout on 30 June 2014, or on another date?

(b) does forex realisation event 2 (FRE 2) in section 775-45 of the ITAA 1997 happen on the day the 2014 Earnout is received by the Sellers, or on another date?

(c) for the purposes of section 775-85 of the ITAA 1997 is the forex cost base of the right to receive foreign currency for the 2014 Earnout worked out on 30 June 2014, or on another date?

(d) can the Sellers use the method set out in Forex Calculation Example to determine the forex realisation gain or loss from forex realisation event 2 (FRE 2) happening in relation to the 2014 Earnout? If not, how is the forex realisation gain or loss to be calculated?

(e) in terms of section 775-70 of the ITAA 1997 does CGT event K10 happen or in terms of section 775-75 of the ITAA 1997 does CGT event K11 happen in respect of the 2014 Earnout?

Advice

See the advice given for question 1 above.

Question 3

Are any anti-overlap provisions applicable to affect the tax consequences of CGT event C2 and also forex realisation event 2 (FRE 2) happening to both the 2013 Earnout and the 2014 Earnout, such as under section 118-20, and/or subsection 775-15(4) of the ITAA 1997?

Advice

See the advice given for question 1 above.

This ruling applies for the following periods:

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

1 July 2014 to 30 June 2015

The scheme commenced on

The scheme has commenced.

Relevant facts and circumstances

1. Company A as the trustee of Trust A conducted a business of selling, marketing and distributing its products (and services associated with such products) to wholesale and retail customers in Australia (Business).

2. Company B as the trustee of Trust B owned the intellectual property of the Business and carried on an enterprise of licensing the use of that intellectual property to Trust A.

3. XYZ Group acts as manager for Trust B in respect of the Business.

4. Pursuant to a Sale Agreement entered into in the 20XX calendar year (Sale Agreement), Trust A and Trust B (together, the Sellers) agreed to sell the assets of the Business including its goodwill to Company C and Company D (together the Buyers).

5. On completion of the Sale Agreement the Buyers paid a sum (the initial purchase price) to the Sellers.

6. In addition the Buyers must pay earnout amounts to the Sellers. Pursuant to the Sale Agreement the Sellers are entitled to receive earnout payments:

(a) for the 2013 income year, if operating income reaches specified levels for the period 1 July 2012 to 30 June 2013 (2013 Earnout); and

(b) for the 2014 income year, if operating income reaches specified levels for the period 1 July 2013 to 30 June 2014 (2014 Earnout).

7. The Sale Agreement sets out the method for determining the 2013 Earnout and the 2014 Earnout payable to the Sellers.

8. All payments to the Sellers are in a foreign currency.

9. The table below details key events relating to the Sale Agreement:

10. Another relevant date in respect of both the 2013 Earnout and the 2014 Earnout is a date determined in accordance with particular clauses of the Sale Agreement. For the 2013 Earnout that unspecified date is the date upon which the earnout calculation for the 2013 Earnout became final and binding on the parties. For the 2014 Earnout that date will be the date upon which the earnout calculation for the 2014 Earnout will become final and binding on the parties. Alternatively, if the Buyer does not comply with those particular clauses of the Sale Agreement then the 2014 Earnout will be determined in accordance with another clause of the Sale Agreement.

11. The Forex Calculation Examples which appear in your private ruling application set out the methods which the Sellers consider they should be entitled to use for calculating the forex realisation gain or loss from forex realisation event 2 in relation to the 2013 Earnout and the 2014 Earnout.

Sale Agreement

12. The Sale Agreement contains the relevant clauses in relation to the earnout rights and earnout payments. It also sets out the timetable and procedures for calculation and payment of the earnout amount for each year.

13. There is also provision for resolving disputes about the calculation which involves the engagement of an independent accountant to determine the earnout calculation.

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 102-25

Section 104-25 CGT event C2

Paragraph 104-25(2)(b)

Paragraph 104-35(5)(a)

Section 104-260 CGT event K10

Section 104-265 CGT event K11

Section 108-5

Subsection 110-25(2)

Subsections 112-30(1), 112-30(3), 112-30(4)

Section 115-25

Paragraph 116-20(1)(a)

Section 118-20

Section 188-20

Section 775-15

Subsection 775-15(1)

Subsection 775-15(4)

Subsection 775-30(1)

Section 775-45

Paragraph 775-(1)(a)

Subparagraph 775-45(1)(b)(iv)

Paragraph 775-45(1)(c)

Subsection 775-45(2)

Subsection 775-45(3)

Subsection 775-45(4)

Subsection775-45(5)

Subsection 775-45(7)

Section 775-70

Section 775-75

Section 775-80

Section 775-85

Subsection 775-105(1)

Subdivision 960-C

Subdivision 960-S

Section 977-5

Section 977-20

Section 977-55

Subsection 995-1(1)

Reasons for decision

Issue 1

All references to legislative provisions are to provisions of the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1(a)

Summary

CGT event C2 does not happen in respect of the 2013 Earnout on 30 June 2013.

It happens on another date which is ascertained in accordance with the terms of the Sale Agreement.

Detailed reasoning

In terms of section 104-25 CGT event C2 relates to the cancellation, surrender and similar endings of the ownership of intangible CGT assets.

An earnout right is an intangible CGT asset and therefore CGT event C2 is relevant to the earnout right in this case.

At the date of the Sale Agreement the Sellers collectively acquired the earnout right in respect of each year ended 30 June 2013 and 30 June 2014 under the earnout arrangement. The earnout right is a chose in action.

In terms of paragraph 104-25(1)(b) CGT event C2 happened in respect of the 2013 Earnout on the date when the Sellers' ownership of the earnout right ended because that was when it was "released, discharged or satisfied".

For the 2013 Earnout it was "released, discharged or satisfied" when the amount to be paid in accordance with the terms of the Sale Agreement was determined. The Sale Agreement sets down a procedure and a timetable in respect of the earnout calculation being the calculation of the amount to be paid for the 2013 Earnout. There is also provision for resolving disputes about the calculation which involves the engagement of an Independent accountant to determine the earnout calculation.

In the situation where there is no dispute, the Sales Agreement further provides that when a specified period has elapsed following the provision of the earnout calculation to the Sellers and there has been no written objection by the Sellers to that calculation then such calculation shall be final and binding.

Similarly in the situation where there is a dispute, the Sale Agreement also provides for submissions to the independent accountant by all parties to the dispute about the earnout calculation. Within a specified period the independent accountant must provide a determination of the earnout calculation and such determination shall be final and binding.

CGT event C2 happened when the earnout right came to an end and a debt expressed in foreign currency was created.

The consideration received for the 2013 Earnout when CGT event C2 happened was a right to receive a quantified sum of foreign currency.

Note that it is necessary to convert that sum to Australian dollars because Subdivision 960-C contains a basic rule requiring an amount in foreign currency to be translated into Australian dollars. Accordingly Subdivision 960-C applies to the calculation of the proceeds received upon CGT event C2 occurring.

Question 1(b)

Summary

A forex realisation event 2 happened on each of the days on which a part payment was received by the Sellers in satisfaction of the right to receive foreign currency that was created when CGT event C2 occurred in respect to the 2013 Earnout.

Detailed reasoning

Section 775-45 contains provisions relating to forex realisation event 2 which occurs when an entity ceases to have a right, or a part of a right to receive foreign currency, provided that right falls within the terms specified in the section.

The right of the Sellers to receive foreign currency comes within subparagraph 775-45(1)(b)(iv) as it was acquired upon the occurrence of a CGT event.

The time of forex realisation event 2 is when you cease to have the right or part of the right. This is set out in subsection 775-45(2).

The Sale Agreement provides that the right to receive foreign currency came into existence and was acquired by the Sellers on the date provided for in the Sale Agreement.

A foreign exchange event 2 occurred on each of the days on which a part payment was received by the Sellers. This is because on each of those dates an amount of foreign currency was received and those receipts satisfied or extinguished the right to receive foreign currency which had been created when CGT event C2 occurred.

This is in terms of subsection 775- 45(1).

Paragraph 775-45(1)(a) states that a forex realisation event 2 happens if you cease to have a right, or part of a right, to receive foreign currency. This has happened.

While subparagraph 775-45(1)(b)(iv) applies where the right or part of the right is a right or part of a right, created or acquired in return for the occurrence of a *realisation event in relation to a* CGT asset you own and none of subparagraphs (i), (ii) and (iii) applies. This provision is met because a realisation event occurred when CGT event C2 happened with respect to the earnout right which was a CGT asset.

Further, the condition set down in paragraph 775-45(1)(c) is met. That condition is that you did not cease to have the right, or the part of the right, because you disposed of the right or part of the right (within the meaning of section 775-40 regarding forex realisation event 1). In other words the right to receive foreign currency that was received or exchanged for the earnout right was still held by you when the payments of foreign currency were made to you.

Question 1(c)

Summary

The forex cost base of the right to receive foreign currency is worked out on the date on which CGT event C2 occurs in respect to the 2013 Earnout. The CGT event C2 occurred in respect of the 2013 Earnout on the date determined in accordance with the terms of the Sale Agreement. That date was not 30 June 2013; it was another later date ascertained in accordance with the procedure and timetable set down in the Sale Agreement for arriving at the calculation of the 2013 Earnout and its acceptance by the relevant parties.

Detailed reasoning

Section 775-85 which relates to the forex cost base of a right to receive foreign currency states:

The forex cost base of a right to receive *foreign currency is the total of:

(a) the money you:

(i) paid; or

(ii) are required to pay; or

(iii) would be required to pay in the event of the exercise of an option;

in respect of acquiring the right or part of the right; and

(b) the *market value of any *non-cash benefit you

(i) provided; or

(ii) are required to provide; or

(iii) would be required to provide in the event of the exercise of an option;

in respect of acquiring the right or part of the right;

reduced by any amounts that are deductible under a provision of this Act other than this Division.

Note that *market value has the meaning given by Subdivision 960-S and *non-cash benefit is defined in subsection 995-1(1).

The Sellers did not pay any money for the right to receive foreign currency. Thus subsection 775-85(a) does not apply.

However, it is necessary to consider whether the Sellers gave any non-cash benefit for the right to receive foreign currency. This is for the purposes of subsection 775-85(b).

Subsection 995-1(1) states that non-cash benefit is property or services in any form except money.

In draft Taxation Ruling TR 2007/D10 at paragraph 15 it is stated that "The earnout right is property, and a CGT asset, in the hands of the seller". This statement is repeated at paragraph 91 and a detailed analysis of the law in support of that view appears in paragraphs 91 to 100.

Therefore because an earnout right is property it is a non-cash benefit.

For the purposes of section 775-45 that is for the purposes of working out when forex realisation event 2 occurs subsection 775-45(7) contains a table which is to be used in working out the tax recognition time. The table has three columns. In the first column, the table lists six items each of which relates to a different type of right as described in the second column. Depending upon the nature of the right the tax recognition time is as set out in the third column.

In this case the tax recognition time is worked out in accordance with item 6.

This is because item 6 in the table in subsection 775-45(7) will apply "If the right or part of the right is … a right or part of a right created in return for the occurrence of a *realisation event in relation to a *CGT asset you own, and none of the above items apply" so that "the tax recognition time is … when the realisation event occurs."

Note that *realisation event has the meaning given by sections 977-5, 977-20 and 977-55 and *CGT asset is defined in section 108-5.

Note also that as discussed above it has been established that the CGT asset at issue is the earnout right for the year ended 30 June 2013 or the 2013 Earnout as it is termed in the Sale Agreement.

Further it has also been found above that you have a right to receive the earnout payment when the earnout amount is determined in accordance with the terms of the Sale Agreement. At that point a realisation event, the CGT event C2, occurs when the earnout right comes to an end and a debt in foreign currency is created. When the foreign currency debt is later discharged by payment a forex realisation event 2 happens.

Question 1(d)

Summary

The method set out in the Forex Calculation Examples does not correctly reflect the time at which CGT event C2 occurred in relation to the 2013 Earnout and therefore it cannot be used to determine the outcome of forex realisation event 2.

An explanation of the relevant law is provided below.

Detailed reasoning

The Forex Calculation Examples do not correctly reflect the time at which CGT event C2 occurred in relation to the 2013 Earnout and therefore cannot be used to determine the forex realisation gain or loss from forex realisation event 2.

Section 775-45 deals with forex realisation event 2 which occurs when you cease to have a right to receive foreign currency and hence for the purpose of computing a forex realisation gain or loss it is necessary to know both the value of that right and when such a right to receive foreign currency came into existence.

In terms of paragraph 104-25(1)(b) CGT event C2 happened in respect of the 2013 Earnout on the date when the Seller's ownership of the earnout right ended because that was when it was "released, discharged or satisfied".

Likewise in terms of the clauses to the Sale Agreement relating to review, dispute and payment procedures,the CGT event C2 occurred with respect to the 2013 Earnout when the amount to be paid in foreign currency became final and binding.

The consideration for the earnout right was a right to receive a quantified amount of foreign currency.

In calculating the capital gain or capital loss from CGT event C2 happening to the 2013 Earnout the capital proceeds received in terms of section 116-20 must be translated into Australian dollars at the date on which CGT event C2 happened as required by Subdivision 960-C.

When the Sellers subsequently receive a payment in foreign currency in full or in part satisfaction of the right to receive foreign currency that was acquired when CGT event C2 happened that right to receive foreign currency will cease to exist and forex realisation event 2 will occur. This is in terms of subparagraph 775-45(1)(b)(iv).

In terms of subsection 775-45(3) you make a forex realisation gain when the amount you receive in respect of the forex realisation event 2 exceeds the forex cost base of the right to receive foreign currency. The forex cost base of the right was determined at the tax recognition time.

Alternatively, in terms of subsection 775-45((4) you make a forex realisation loss when the amount you receive in respect of the forex realisation event 2 is less than the forex cost base of the right to receive foreign currency. The forex cost base of the right was determined at the tax recognition time.

Note that the tax recognition time is when the CGT event C2 occurred in accordance with item 6 of the table in subsection 775-45(7).

Question 1(e)

Summary

There are two possible outcomes from the forex realisation event 2 which will happen in this case and they are either a short term forex realisation gain or a short term forex realisation loss. If the result is a forex realisation gain then CGT event K10 happens whereas if the result is a forex realisation loss then CGT event K11 happens.

Detailed reasoning

The question posed here relates to two outcomes being either a forex realisation gain or a forex realisation loss that results from forex realisation event 2. Each outcome will be examined separately.

In this discussion it is understood that you have not made and will not make an election in writing under section 775-80 within the time prescribed. That is, you have not chosen that section 775-70 or section 775-75 will not apply to you. Therefore section 775-70 or section 775-75 will apply to you.

Short term forex realisation gain

Section 775-70 deals with the tax consequences of certain short-term forex realisation gains. Subject to the conditions in item 1 of the table in subsection 775-70(1) being met the result will be that the forex realisation gain you make from forex realisation event 2 is not included in your assessable income under section 775-15 but CGT event K10 in section 104-260 of the ITAA 1997 happens.

The conditions to be met in order for CGT event K10 to happen are set out at item 1 in column 2 of the table in subsection 775-70(1). Those conditions are:

(a) the right to receive *foreign currency was created in return for the occurrence of a *realisation event in relation to a *CGT asset you own; and

(b) item 6 of the table in subsection 775-45(7) applies; and

(c) the foreign currency became due for payment within 12 months after the occurrence of the realisation event.

Each of these conditions is met. The right to receive foreign currency was created in return for the earnout right being "released, discharged or satisfied" and at that time CGT event C2 happened upon the earnout right coming to an end.

The tax recognition time in accordance with item 6 of the table in 775-45(7) is when the realisation event occurs.

Only a number of days elapsed between the realisation event and the due date for payment.

Based on the calculation procedures and the timetable set down in the Sale Agreement for ascertaining the 2013 Earnout and the actual dates of payment for the 2013 Earnout, the payments for the 2013 Earnout were made less than 12 months after the realisation event.

Therefore as all of the conditions set out at item 1 in column 2 of the table in subsection 775-70(1) are met regarding a short term forex realisation gain the result is that the forex realisation gain is not included in your assessable income under section 775-15 and CGT event K10 happens.

Short term forex realisation loss

Section 775-75 deals with the tax consequences of certain short term forex realisation losses. Subject to the conditions in item 1 of the table in subsection 775-75(1) being met the result will be that the forex realisation loss you make from forex realisation event 2 is not allowed as a deduction from your assessable income under section 775-30 but CGT event K11 in section 104-265 of the ITAA 1997 happens.

The conditions to be met in order for CGT event K11 to happen are set out at item 1 in column 2 of the table in subsection 775-75(1). Those conditions are:

(a) the right to receive *foreign currency was created in return for the occurrence of a *realisation event in relation to a *CGT asset you own; and

(b) item 6 of the table in subsection 775-45(7) applies; and

(c) the foreign currency became due for payment within 12 months after the occurrence of the realisation event.

Each of these conditions is met. The right to receive foreign currency was created in return for the earnout right being "released, discharged or satisfied" and at that time CGT event C2 happened upon the earnout right coming to an end.

The tax recognition time in accordance with item 6 of the table in 775-45(7) is when the realisation event occurs.

Only a number of days elapsed between the realisation event and the due date for payment.

Based on the calculation procedures and the timetable set down in the Sale Agreement for ascertaining the 2013 Earnout and the actual dates of payment for the 2013 Earnout, the payments for the 2013 Earnout were made less than 12 months after the realisation event.

Therefore as all of the conditions set out at item 1 in column 2 of the table in subsection 775-75(1) are met regarding a short term forex realisation loss the result is that the forex realisation loss is not allowed as a deduction from your assessable income under section 775-30 and CGT event K11 happens.

Other matters

In addition to either CGT event K10 or CGT event K11 applying, CGT event C2 could also happen upon the satisfaction or discharge of the debt by payment of the foreign currency. However, the effect of the ordering rules in section 102-25 is that the CGT event that is "most specific" to your situation is used. This is in terms of subsection 102-25(1). In this case the most specific event will be either CGT event K10 (if there is a forex realisation gain) or CGT event K11 (if there is a forex realisation loss).

Question 2(a)

Summary

CGT event C2 does not happen in respect of the 2014 Earnout on 30 June 2014. It happens on another date which is ascertained in accordance with the Sale Agreement.

Detailed reasoning

In terms of section 104-25 CGT event C2 relates to the cancellation, surrender and similar endings of the ownership of intangible CGT assets.

An earnout right is an intangible CGT asset and therefore CGT event C2 is relevant to the earnout right in this case.

At the date of the Sale Agreement the Sellers collectively acquired the earnout right in respect of each year ended 30 June 2013 and 30 June 2014 under the earnout arrangement. The earnout right is a chose in action.

In terms of paragraph 104-25(1)(b) CGT event C2 will happen in respect of the 2014 Earnout on the date when the Seller's ownership of the earnout right ends as a result of it being "released, discharged or satisfied".

For the 2014 Earnout it will be "released, discharged or satisfied" when the amount to be paid in accordance with the terms of the Sale Agreement is determined. The Sale Agreement sets down a procedure and timetable in respect of the earnout calculation being the calculation of the amount to be paid for the 2014 Earnout. There is also provision for resolving disputes about the calculation which involves the engagement of an independent accountant to determine the earnout calculation. In addition if the procedure breaks down at the outset there is provision to address such a breakdown.

In the situation where there is no dispute, the Sale Agreement provides that when a specified period has elapsed following the provision of the earnout calculation to the Sellers and there has been no written objection by the Sellers to that calculation then such calculation shall be final and binding.

Therefore CGT event C2 will happen on the date when the specified period expires. This is because on that date the amount to be paid for the earnout right is quantified as a specific amount of foreign currency. The earnout right is "released, discharged or surrendered" in terms of paragraph 104-25(1)(b) on that date.

At that date the amount to be paid for the earnout right is a debt expressed in foreign currency.

In the situation where there is a dispute about the earnout calculation the Sale Agreement provides that if the parties fail to resolve the dispute within a specified period then the matters must be submitted to an independent accountant. The Sale Agreement provides a method and a timeframe for the selection of an independent accountant who will be appointed.

The independent accountant will receive submissions from the parties about the disputed issues; have access to work papers and other documents and information relating to the disputed issues; and is entitled to decide upon the interpretation of the Sale Agreement.

The independent accountant must provide a determination of the earnout calculation by notice in writing within a specified period of receipt of each party's submissions.

The determination of the independent accountant will be final and binding on the parties.

Therefore CGT event C2 will happen on the date when the independent accountant provides the written notice of the determination of the earnout calculation. This is because on that date the amount to be paid for the earnout right is quantified as a specific amount of foreign currency. The earnout right is "released, discharged or surrendered" in terms of paragraph 104-25(1)(b) on that date.

In the situation where the Buyer fails to comply, that is, fails to deliver a final calculation of income for the 2014 financial year by the date specified in the Sale Agreement, an alternative clause applies.

It is considered that the alternative clause is open to a number of interpretations. Those interpretations relate to the remedy available to the Seller and when it can be taken.

However, it is not proposed to attempt to interpret that clause to identify all of the possible outcomes. Instead the advice provided applies to all outcomes irrespective of the choices made by the Seller. The advice is in the same terms as given above in respect to the relevant clauses concerning review and dispute.

Where the Buyer fails to deliver a final calculation of income for the 2014 financial year by the date specified in the Sale Agreement, then depending upon the action taken by the Seller to obtain payment for the earnout right, CGT event C2 will happen on the date when the amount to be paid for the earnout right is quantified as a specific amount of foreign currency. The earnout right is "released, discharged or surrendered" in terms of paragraph 104-25(1)(b) on that date.

At that date the amount to be paid for the earnout right is a debt expressed in a foreign currency.

Note that it is necessary to convert the amount to Australian dollars because Subdivision 960-C contains a basic rule requiring an amount in foreign currency to be translated into Australian dollars. Accordingly Subdivision 960-C applies to the calculation of the proceeds received upon CGT event C2 occurring.

Question 2(b)

Summary

A forex realisation event 2 will happen when you cease to have a right, or part of a right, to receive foreign currency where that right was acquired in return for the occurrence of a realisation event. The realisation event in this case is CGT event C2 in respect of the 2014 Earnout.

Detailed reasoning

Section 775-45 contains provisions relating to forex realisation event 2 which occurs when an entity ceases to have a right, or a part of a right to receive foreign currency, provided that right falls within the terms specified in the section.

The right of the Sellers to receive foreign currency comes within subparagraph 775-45(1)(a)(iv) as it was acquired upon the occurrence of a CGT event.

The time of forex realisation event 2 will be when you cease to have the right or part of the right. This is set out in subsection 775-45(2).

Pursuant to the terms of the Sale Agreement the right to receive foreign currency will come into existence and be acquired by the Sellers on the date provided for in the Sale Agreement.

A foreign exchange event 2 will occur on the date an amount of foreign currency is received and the receipt satisfies or extinguishes in part or in full the right to receive foreign currency which had been created when CGT event C2 occurred in respect of the 2014 Earnout. This is in terms of subsection 775- 45(1).

Question 2(c)

Summary

The forex cost base of the right to receive foreign currency is not worked out on 30 June 2014. It is worked out on the date on which CGT event C2 occurs in respect of the 2014 Earnout being the date determined in accordance with the terms of the Sale Agreement. That date will not be 30 June 2014, it will be a later date determined in accordance with the Sale Agreement which sets down a procedure and a timetable for arriving at the calculation of the amount of the 2014 Earnout and its acceptance by the relevant parties.

Detailed reasoning

Section 775-85 which relates to the forex cost base of a right to receive foreign currency states:

The forex cost base of a right to receive *foreign currency is the total of:

(a) the money you:

(i) paid; or

(ii) are required to pay; or

(iii) would be required to pay in the event of the exercise of an option;

in respect of acquiring the right or part of the right; and

(b) the *market value of any *non-cash benefit you

(i) provided; or

(ii) are required to provide; or

(iii) would be required to provide in the event of the exercise of an option;

in respect of acquiring the right or part of the right;

reduced by any amounts that are deductible under a provision of this Act other than this Division.

Note that *market value has the meaning given by Subdivision 960-S and *non-cash benefit is defined in subsection 995-1(1).

The Sellers did not pay any money for the right to receive foreign currency. Thus subsection 775-85(a) does not apply.

However, it is necessary to consider whether the Sellers gave any non-cash benefit for the right to receive foreign currency. This is for the purposes of subsection 775-85(b).

Subsection 995-1(1) states that non-cash benefit is property or services in any form except money.

In draft Taxation Ruling TR 2007/D10 at paragraph 15 it is stated that "The earnout right is property, and a CGT asset, in the hands of the seller". This statement is repeated at paragraph 91 and a detailed analysis of the law in support of that view appears in paragraphs 91 to 100.

Therefore because an earnout right is property it is a non-cash benefit.

For the purposes of section 775-45, that is, for the purposes of working out when forex realisation event 2 occurs subsection 775-45(7) contains a table which is to be used in working out the tax recognition time. The table has three columns. In the first column the table lists six items each of which relates to a different type of right as described in the second column. Depending upon the nature of the right the tax recognition time is as set out in the third column.

In this case the tax recognition time is worked out in accordance with item 6.

This is because item 6 in the table in subsection 775-45(7) will apply "If the right or part of the right is … a right or part of a right created in return for the occurrence of a *realisation event in relation to a *CGT asset you own, and none of the above items apply" so that "the tax recognition time is … when the realisation event occurs."

Note that *realisation event has the meaning given by sections 977-5, 977-20 and 977-55 and *CGT asset is defined in section 108-5.

Note also that as discussed above it has been established that the CGT asset at issue is the earnout right for the year ended 30 June 2014 or the 2014 Earnout as it is termed in the Sale Agreement.

Further it has also been found above that you have a right to receive the earnout payment when the earnout amount is determined in accordance with the terms of the Sale Agreement. At that point a realisation event, the CGT event C2, occurs when the earnout right comes to an end and a debt in foreign currency is created.

In other words the amount of that debt as expressed in foreign currency is the cost base of the right to receive foreign currency.

When the foreign currency debt is later discharged by payment a forex realisation event 2 will happen.

Question 2(d)

Summary

The method set out in the Forex Calculation Examples does not correctly reflect the time at which the CGT event C2 occurred and therefore it cannot be used to determine the outcome of forex realisation event 2.

Detailed reasoning

The Forex Calculation Examples do not correctly reflect the time at which CGT event C2 will occur in relation to the 2014 Earnout and therefore cannot be used to determine the forex realisation gain or loss from forex realisation event 2.

Section 775-45 deals with forex realisation event 2 which occurs when you cease to have a right to receive foreign currency and hence for the purpose of computing a forex realisation gain or a forex realisation loss it is necessary to know both the value of that right to receive foreign currency and when such a right came into existence.

In terms of paragraph 104-25(1)(b) CGT event C2 will happen in respect of the 2014 Earnout on the date when the Seller's ownership of the earnout right ends because that is when it will be "released, discharged or satisfied".

Likewise the terms of the Sale Agreement determine when CGT event C2 will occur with respect to the 2014 Earnout. It will be when the amount to be paid in foreign currency becomes final and binding.

The consideration for the earnout right will be a right to receive a quantified amount of foreign currency.

In calculating the capital gain or capital loss from CGT event C2 happening to the 2014 Earnout the capital proceeds received in terms of section 116-20 must be translated into Australian dollars at the date on which CGT event C2 happens as required by Subdivision 960-C.

When the Sellers subsequently receive a payment in foreign currency in full or in part satisfaction of the right to receive foreign currency that they acquired when CGT event C2 happened, that right to receive foreign currency will cease to exist and forex realisation event 2 will occur. This is in terms of subparagraph 775-45(1)(b)(iv).

In terms of subsection 775-45(3) you make a forex realisation gain when the amount you receive in respect of the forex realisation event 2 exceeds the forex cost base of the right to receive foreign currency. The forex cost base of the right was determined at the tax recognition time.

Alternatively, in terms of subsection 775-45(4) you make a forex realisation loss when the amount you receive in respect of the forex realisation event 2 is less than the forex cost base of the right to receive foreign currency. The forex cost base of the right was determined at the tax recognition time.

Note that in accordance with item 6 of the table in subsection 775-45(7) the tax recognition time is when the CGT event C2 occurred.

Question 2(e)

Summary

There are a number of possible outcomes from the forex realisation event 2 which will happen in this case. First, there can be a short term forex realisation gain. Where the result is a short term forex realisation gain and subject to the conditions in column 2 of item 1 of the table in subsection 775-70(1) being met the forex realisation gain is not assessable in terms of section 775-15 and CGT event K10 happens. Secondly, there can be a short term forex realisation loss. Where the result is a short term forex realisation loss and subject to the conditions in column 2 of item 1 of the table in subsection 775-75(1) being met the forex realisation loss is not an allowable deduction in terms of section 775-30 and CGT event K11 happens.

Alternatively, where the conditions in subsection 775-70(1) are not met the forex realisation gain is assessable income in terms of section 775-15, or where the conditions in subsection 775-75(1) are not met the forex realisation loss is an allowable deduction in terms of section 775-30.

Detailed reasoning

The question posed here relates to two outcomes being either a forex realisation gain or a forex realisation loss that results from forex realisation event 2. Each outcome will be examined separately.

In this discussion it is understood that you have not made and will not make an election in writing under section 775-80 within the time prescribed. That is, you have not chosen that section 775-70 or section 775-75 will not apply to you. Therefore section 775-70 or section 775-75 will apply to you.

Short term forex realisation gain

Section 775-70 deals with the tax consequences of certain short-term forex realisation gains. Subject to the conditions in item 1 of the table in subsection 775-70(1) being met the result will be that the forex realisation gain you make from forex realisation event 2 is not included in your assessable income under section 775-15 and CGT event K10 will happen.

The relevant conditions in item 1 at column 2 are:

(a) the right to receive *foreign currency was created in return for the occurrence of a *realisation event in relation to a *CGT asset you own; and

(b) item 6 of the table in subsection 775-45(7) applies; and

(c) the foreign currency became due for payment within 12 months after the occurrence of the realisation event.

For the purposes of paragraph (a) it is necessary to identify the elements of that provision that will exist in the facts of your case. The CGT asset you own is the earnout right for the year ended 30 June 2014. The realisation event for that CGT asset is CGT event C2 in terms of section 104-25 which will happen when the earnout right comes to an end because it is "released, discharged or satisfied" pursuant to paragraph 104-25(1)(b).

The Sale Agreement provides that the amount to be paid for the earnout right is expressed in a foreign currency. Thus the amount to be paid for the earnout right when CGT event C2 occurs is a foreign currency debt which is your right to receive foreign currency. Accordingly, all of the necessary elements will be present in your case and thus the condition in paragraph (a) will be met.

For the purposes of the application of paragraph (b) to your situation you will have a right to receive foreign currency that will come into existence when the earnout right ends. In turn the right to receive foreign currency will cease to exist when payment of the foreign currency takes place. The time at which the right to receive foreign currency is created, as recognised in the legislation, is determined in accordance with item 6 of the table in subsection 775-45(7). It is termed the "tax recognition time" and it happens when a realisation event in relation to a CGT asset occurs. Given the facts of your case the tax recognition time will be when CGT event C2 happens. Although the table in subsection 775-45(7) lists 5 other items no other item applies to the facts of your case; only item 6 applies. Accordingly, the condition in paragraph (b) will be met.

For the purposes of paragraph (c) it will be necessary for a period of less than 12 months to elapse between the occurrence of the realisation of the CGT asset, that is, the date on which CGT event C2 occurs in respect of the earnout right, and the date on which the foreign currency becomes due for payment. Subject to this timeframe being satisfied the condition in paragraph (c) will be met.

Therefore where all the relevant conditions in column 2 of item 1 of the table in subsection 775-70(1) as described above are met the result will be that the forex realisation gain is not included in your assessable income and CGT event K10 happens.

Alternatively, where the conditions in column 2 of item 1 of the table in subsection 775-70(1) are not met, the forex realisation gain is assessable income in terms of section 775-15.

Short term forex realisation loss

Section 775-75 deals with the tax consequences of certain short-term forex realisation losses. Subject to the conditions in item 1 of the table in subsection 775-75(1) being met the result will be that the forex realisation loss you make from forex realisation event 2 is not deductible under section 775-30 and CGT event K11 will happen.

The relevant conditions are:

(a) the right to receive *foreign currency was created in return for the occurrence of a *realisation event in relation to a *CGT asset you own; and

(b) item 6 of the table in subsection 775-45(7) applies; and

(c) the foreign currency became due for payment within 12 months after the occurrence of the realisation event.

For the purposes of paragraph (a) it is necessary to identify the elements of that provision that will exist in the facts of your case. The CGT asset you own is the earnout right for the year ended 30 June 2014. The realisation event for that CGT asset is CGT event C2 in terms of section 104-25 which will happen when the earnout right comes to an end because it is "released, discharged or satisfied" pursuant to paragraph 104-25(1)(b).

The Sale Agreement provides that the amount to be paid for the earnout right is expressed in a foreign currency. Thus the amount to be paid for the earnout right when CGT event C2 occurs is a foreign currency debt which is your right to receive foreign currency. Accordingly, all of the necessary elements will be present in your case and thus the condition in paragraph (a) will be met.

For the purposes of the application of paragraph (b) to your situation you will have a right to receive foreign currency that will come into existence when the earnout right ends. In turn the right to receive foreign currency will cease to exist when payment of the foreign currency takes place. The time at which the right to receive foreign currency is created, as recognised in the legislation, is determined in accordance with item 6 of the table in subsection 775-45(7). It is termed the "tax recognition time" and it happens when a realisation event in relation to a CGT asset occurs. Given the facts of your case the tax recognition time will be when CGT event C2 happens. Although the table in subsection 775-45(7) lists 5 other items no other item applies to the facts of your case; only item 6 applies. Accordingly, the condition in paragraph (b) will be met.

For the purposes of paragraph (c) it will be necessary for a period of less than 12 months to elapse between the occurrence of the realisation of the CGT asset, that is, the date on which CGT event C2 occurs in respect of the earnout right, and the date on which the foreign currency becomes due for payment. Subject to this timeframe being satisfied the condition in paragraph (c) will be met.

Therefore, where all the relevant conditions in column 2 of item 1 of the table in subsection 775-75(1), as described above, are met the result will be that the forex realisation loss is not deductible and CGT event K11 happens.

Alternatively, where the conditions in column 2 of item 1 of the table in subsection 775-75(1) are not met, the forex realisation loss is deductible in terms of section 775-30.

Other matters

In addition to either CGT event K10 or CGT event K11 applying, CGT event C2 could also happen upon the satisfaction or discharge of the debt by payment of the foreign currency. However, the effect of the ordering rules in section 102-25 is that the CGT event that is "most specific" to your situation is used. This is in terms of subsection 102-25(1). In this case the most specific event will be either CGT event K10 (if there is a forex realisation gain) or CGT event K11 (if there is a forex realisation loss).

Question 3

Summary

No anti-overlap provisions apply.

Detailed reasoning

In answer to the various parts of question 1 and to question 2 above it has been found that the relevant CGT events are limited to CGT event C2, CGT event K10 and CGT event K11.

No other provisions apply to include an amount as assessable income or to allow a deduction against your assessable income.

Accordingly no anti-overlap provisions apply.