Edited version of your written advice

Authorisation Number: 1051199012011

Date of advice: 3 March 2017

Ruling

Subject: Income Tax implications of proposed sale of business

Question 1

Will the consideration payable to the Taxpayer for disposal of all their shares in the company carrying on the medical practice business (“Medical Co”) be a capital receipt from disposal of a capital asset?

Answer

No, the amounts payable to the Taxpayer will be assessable income under section 6-5 of the ITAA 1997.

Question 2

Can the Taxpayer apply the roll-over under section 124-780 of ITAA 1997 in respect of the shares which the Taxpayer receives in exchange for their shares in Medical Co?

Answer

Yes, the Taxpayer can apply scrip for scrip rollover under Subdivision 124-M of the ITAA 1997 in relation to any capital gain that arises from the sale of the Taxpayer's shares in Medical Co to the extent that the capital proceeds were received for that sale are shares in the other company (“New Co”) Acquisition Co.

Question 3

Can the Taxpayer acquire additional shares in New Co during the replacement asset period as replacement assets for the purposes of s104-97 of the ITAA 1997?

Answer

Yes, if the Taxpayer meets the requirements of section 152-10 of the ITAA 1997, the Taxpayer can acquire additional shares in New Co during the replacement asset period. However, the replacement asset period starts one year before the sale of the Medical Co shares and ends two years after that. The replacement asset period will not be extended under subparagraph 104-190(1A)(b)(ii) of the ITAA 1997.

This ruling applies for the following periods:

● year ended 30 June 2017;

● year ended 30 June 2018.

The scheme commences on:

1 June 2016

Relevant facts and circumstances

● The Taxpayer is a specialist medical practitioner. The Taxpayer sees patients in a number of hospitals and leased premises outside of the hospitals

● The Taxpayer has established a 24 hour roster at a number of hospitals and has engaged the services of other practitioners, who service the hospital patients and outpatients at the practice, paying a 'facility fee' for the use of the practice's services. In addition to the payment to the Taxpayer for maintaining the service, each doctor is paid fees by the patients directly according to the service provided by them. An on-call fee paid to the Taxpayer on a yearly basis.

● The Taxpayer is also employed by a public hospital. Their time is split approximately equally between his engagement at the hospital and their business activities at the other hospitals and business premises.

● The Taxpayer has been operating their business under the current trading name for less than five years.

● The practice currently employs a number of staff.

● The Taxpayer operated their private practice through a proprietary limited company (Medical Co) of which they were the sole director, shareholder and secretary.

The proposed new Structure

● The Taxpayer has been approached by a third party (New Co) to acquire 100% of the shares in the company.

● It is proposed that, the Taxpayer would be a shareholder in New Co.

● It is proposed that the Taxpayer will receive a percentage of shares and an amount of money.

● Some of the key aspects of the arrangement are:

● An upfront payment and ongoing payments which are conditional upon certain events occurring;

● An option is granted to the Taxpayer to acquire a number of shares the entity and an option is granted in favour of purchaser to require the Taxpayer to acquire additional shares in the entity; and

● A non-competition clause restricting the ability of the Taxpayer to operate or be involved in a similar business in a certain geographical location for a period of time after the completion date or whilst the Taxpayer holds shares in the entity.

● The Taxpayer is required to become an employee of Medical Co. It is anticipated the Taxpayer would be remunerated for their personal services they provide by way of salary and wages.

● Net profit remaining after expenses, interest and taxes (if any) will be available for distribution to shareholders of New Co as dividends. Dividends would be payable subject to working capital requirements, debt repayments as well as current and future operations.

Financial Information

Financial statements for the 2016 income year for Medical Co, list minimal assets and no intangible assets.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5.

Income Tax Assessment Act 1997 Division 124-M.

Income Tax Assessment Act 1997 section 104-97.

Reasons for decision

Question 1

Summary

We cannot rule on this question because it does not specify a provision on which the Commissioner is being asked to rule as required by subsection 359-20(2) of Schedule 1 to the Taxation Administration Act 1953.

Detailed reasoning

The question of whether consideration is a capital receipt is a question of fact and does not require the Commissioner to consider the application of a provision of the taxation law to the Taxpayer's circumstances.

However, we consider that we can answer a related question in order to provide guidance on this issue, being:

Will the amounts payable to the Taxpayer be assessable income under section 6-5 of the ITAA 1997?

Answer:

Yes, the amounts payable to the Taxpayer will be assessable income under section 6-5 of the ITAA 1997.

Explanation:

The fundamental premise upon which the arrangement proposed in the ruling request is based is that the Taxpayer can transfer or has transferred their personal goodwill to Medical Co and Medical Co can then transfer that same goodwill to New Co as an asset of the business upon the sale of the shares.

The vast majority of the goodwill associated with the medical business is personal to the Taxpayer and cannot be transferred. We accept that Medical Co would have a small amount of its own goodwill which would have generated since its incorporation and that the Taxpayer could transfer or has transferred a small amount of goodwill that might have built up in the medical practice trading name since the Taxpayer started using it. However, a valuation of either of these components has not been provided.

The comprehensive list of the assets of the business and their value has not been provided. A Balance Sheet has been provided for the practice, prior to the incorporation of Medical Co, however the assets do not reflect the consideration payable by New Co.

Although we consider that the arrangement is ineffective to transfer the Taxpayer's goodwill, the Taxpayer could still transfer their shares in Medical Co to New Co but the consideration the Taxpayer receives for that transfer should be a reflection of the value of the assets of the business and the small amount of goodwill it would have.

On the basis that the amounts paid by New Co to the Taxpayer for their shares in Medical Co are grossly in excess of the value of those shares based on the value of the business assets, we need to consider the correct characterisation of those amounts.

Payment for the Taxpayer using their personal goodwill to benefit Medical Co

We consider that the amounts paid to the Taxpayer are correctly characterised as being for the ability of New Co to benefit from the Taxpayer and their personal goodwill's continued association with the business, which will enable additional goodwill to be built up in New Co and the other doctors and therefore increase the amount of the business's income that is eventually generated from Medical Co's business structure as opposed to the personal services of the Taxpayer. This arrangement reflects the commercial reality of the transaction being undertaken as well as the genuine value that the Taxpayer and their personal goodwill are able to contribute to the long term growth of Medical Co's business.

Those amounts would therefore be ordinary income pursuant to section 6-5 of the ITAA 1997 as they are payments made to the Taxpayer generated by their ability to use their own personal goodwill for financial gain.

Inducement payment

In the alternative, the amounts could be an inducement paid to the Taxpayer to continue to work in the business of Medical Co and/or to enter into the arrangement as a whole. As discussed above the Taxpayer has significant, valuable personal goodwill and their continued association with and provision of medical services as an employee of Medical Co, will provide immediate and long term benefits to Medical Co and therefore the amounts can be considered to be an inducement and assessable under section 6-5 of the ITAA 1997.

Isolated transaction

As a further alternative, the amounts could be assessable as a profit or gain from an isolated transaction. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides guidance in determining the appropriate tax treatment of isolated transactions. It states:

6. Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, a profit from an isolated transaction is generally income when both of the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

7. The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

8. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

An objective assessment of the Taxpayer's intention upon entering into this transaction indicates that they had an intention to make a profit or gain. The transaction results in the sale of their medical practice business the success of which is as result of his efforts and they would intend to profit from selling 60% of that business to a third party.

The transaction was also entered into, and the profit was made, in the course of carrying on business or in the course of carrying out a business operation or commercial operation. Although a medical practitioner may not enter into many arrangements to sell a significant portion of their medical practice business, the medical practice the subject of the transaction is the Taxpayer's business of which they remains a percentage owner and this transaction is designed to give the medical practice access to the services of New Co who intend to increase the profitability of the business through their involvement.

As such, the amounts could also be assessable under section 6-5 of the ITAA 1997 as a profit or gain made from an isolated transaction.

Question 2

Summary

Yes, the Taxpayer can apply scrip for scrip rollover under Subdivision 124-M of the ITAA 1997 in relation to any capital gain that arises from the sale of his shares in Medical Co to the extent that the capital proceeds he received for that sale are shares in New Co.

Detailed reasoning

The Taxpayer can apply scrip for scrip rollover under Subdivision 124-M of the ITAA 1997 in relation to any capital gain that arises from the sale of their shares in Medical Co to the extent that the capital proceeds that they receive for that sale are shares in New Co.

As a result of a single arrangement, the Taxpayer (the only shareholder in Medical Co) will sell 100 per cent of his Medical Co shares to New Co. As the Taxpayer acquired their shares in Medical Co after X date, and assuming that a capital gain arises on their sale, the Taxpayer will satisfy the requirements of section 124-780 of the ITAA 1997. The rollover will apply to disregard the capital gain to the extent that the Taxpayer receives replacement shares in New Co. It will also apply to transfer the cost base of his Medical Co shares to his replacement New Co shares.

Where the capital proceeds received consist of anything other than replacement shares (for example, cash), section 124-790 of the ITAA 1997 provides that only a partial rollover can apply. The rollover will not apply to any capital gain that arises in respect of such ineligible capital proceeds. However, as discussed above (Question 1), the amounts paid to the Taxpayer will have been or will be included in the Taxpayer's assessable income in the year it is paid. To that extent, they are not capital proceeds for the sale of the Taxpayer's Medical Co shares and section 124-790 of the ITAA 1997 will not apply.

Question 3

Summary

Yes, if the Taxpayer meets the requirements of section 152-10 of the ITAA 1997, the Taxpayer can acquire additional shares in New Co during the replacement asset period. However, the replacement asset period starts one year before the sale of the Medical Co shares and ends two years after that. The replacement asset period will not be extended under subparagraph 104-190(1A)(b)(ii) of the ITAA 1997.

Detailed reasoning

As discussed above in Question 2, the “Earn Out Amount” is assessable as income pursuant to section 6-5 of the ITAA 1997 and therefore is not considered to be capital proceeds from the sale of the Taxpayer's shares in Medical Co.

Even if the amounts were not assessable as income the “Earn Out Amount” does not meet all of the conditions for a look through Earn Out right in subsection 118-565(1) of the ITAA 1997. In order for the amounts to meet those conditions, the arrangement would need to be changed so fundamentally that it would either not be financially viable or be so different from what is currently proposed that a new ruling would need to be requested.