Edited version of private advice

Authorisation Number: 1051759555448

Date of advice: 18 November 2020

Ruling

Subject: Capital gains tax - rollovers - scrip for scrip rollover - subdivision 124-M

Question

Can Trust B choose roll-over relief under Subdivision 124-M of the Income Tax Assessment Act 1997 (ITAA 1997) for exchanging its ordinary shares in Company B for ordinary shares in Company D?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Relevant background

Company A

1.    Company A operates a business in Australia.

2.    The shareholders of Company A are as follows:

(i)     Company B which owns 60% of the shares; and

(ii)    Company C which owns 40% of the shares.

3.    Individual B and Individual C are the directors of Company A.

Company B

4.    Company B was incorporated in Australia. The company has ordinary shares on issue that are owned (i.e. 100%) by the trustee for Trust B. These shares were acquired after 20 September 1985.

5.    In addition to the shares which Company B owns in Company A it also owns plant and equipment which is used by Company A in its business operations.

Company C

6.    Company C is 100% owned by the trustee for Trust C.

7.    In addition to the shares which Company C owns in Company A it also owns plant and equipment which is used by Company A in its business operations.

Business E

8.    The Trustee for Trust E operates Business E and owns assets used in the business and hires assets owned by Company E to use in the business.

9.    The shareholders of Company E and Trust E are not associates of Company A, B or C or Trust B or Trust C having regard to section 318 of the Income Tax Assessment Act 1936 (ITAA 1936).

Background to the proposed transaction

10.  Company D was incorporated in Australia. Company D is an unlisted public company.

11.  Company D was established to raise capital for the acquisition of the operations of Company A and Business E. The intention is to explore growth opportunities and potentially further expand the group with an IPO in the future.

12.  The directors of Company D are:

(i)             Individual D (who Individuals B and C know through their mutual involvement in the industry);

(ii)            An external accountant for Company D; and

(iii)           Individual C.

13.  The current shareholders of Company D (who each hold equal amounts of ordinary fully paid shares) are as follows:

(i)             Individual D as trustee;

(ii)            Trust B;

(iii)           Trust C;

(iv)           Trust F;

(v)            Trust E.

14.  Each of the individuals associated with the current shareholders of Company D know each other through their mutual involvement in the industry.

15.  Company D owns 100% of the shares in New Subsidiary Company.

The proposed transactions

Purchase of shares in Company B and Company C

16.  Company D will acquire 100% of the shareholding in:

(i)             Company B from Trust B; and

(ii)            Company C from Trust C,

under the terms of the Agreement for Sale of Shares (ASS).

17.  The total price to be received by Trust B and Trust C under the ASS will be $X(as adjusted) and comprise cash and shares in Company D:

(i)             Trust B will receive 60% of the proceeds:

(ii)            Trust C will receive 40% of the proceeds.

18.  The following warranties will be provided under the ASS

(i)             Trust B will provide warranties in relation to Trust B, Company B and Company A; and

(ii)            Trust C will provide warranties in relation to Trust C, Company C and Company A.

19.  Completion of the ASS is conditional upon the following agreements completing on the same date as the completion of the ASS:

Sale of the business of Business E under the Sale of Business Agreement

20.  New Subsidiary Company will acquire Business E (including the business assets) from Trust E and Company E. The purchase price will be cash and shares in Company D (Purchase Agreement).

Capital raising under the terms of the Subscription Deeds

21.  It is anticipated that the following additional capital will be raised by Company D under Subscription Deeds for the purposes of completing the acquisitions of Company B, Company C and Business E and to continue to develop Company D's businesses:

(i)             Trust associated with Individual D;

(ii)            Trust associated with Individual F;

(iii)           A private equity fund.

Shareholdings in Company D on completion

22.  Following completion of the ASS, Purchase Agreement and the Subscription Deeds (the Transaction Documents), the shareholding of Company D (all fully paid ordinary shares which carry one vote per share and equal rights to receive distributions of dividends and on winding up) will be as follows:

*The Shareholders that are trusts are referred to in this Ruling as Shareholder trusts.

23.  The above Shareholders will be required to enter into a Shareholder's Agreement which will govern their relationship as Shareholders incorporating the funding, activities and management of the Company and the Business. The Shareholders Agreement is subject to completion of the Transaction Documents and commences on such completion.

Relationships

24.  Individual B, Individual C, Trust B, Trust C, Company B, Company C and Company A are using the same legal and accounting advisers in relation to the proposed transactions (which are not the same advisers that the other parties are using).

25.  The Related Principals identified in the Shareholders Agreement and their respective family members are not relatives as defined in subsection 995-1(1) of the ITAA 1997 of any of the other Related Principals and none of them benefit under the other Related Principals' respective Shareholder trusts.

Other information taken into account in this ruling

26.  Trust B would make a capital gain from the disposal of the shares in Company B if it did not qualify for the scrip for scrip roll-over.

27.  Trust B and Company D will jointly choose to obtain the scrip for scrip roll-over and Trust B will inform Company D in writing of the cost base of its original interest (the shares in Company B) worked out just before the CGT Event happened in relation to it.

28.  For the purpose of paragraph 124-795(2)(a) of the ITAA 1997, any capital gain Trust B might make from its replacement interest (shares in Company D) would not be disregarded.

29.  For the purpose of section 124-795(3) of the ITAA 1997, rollover was not applicable under Division 122 or Division 615 for the sale.

30.  This scheme description incorporates, and should be read with the Constitution for Company D and the following documents provided with the private ruling application (Annexures B to F are drafts and subject to further negotiation between the parties):

(i)     Annexure B - Information Memorandum;

(ii)    Annexure C - draft ASS;

(iii)   Annexure D - draft Shareholders Agreement;

(iv)   Annexure E - draft Purchase Agreement;

(v)    Annexure F - draft Subscription Deed;

(vi)   Annexure G - Company searches.

REASONS FOR DECISION.

Unless stated otherwise, all references to legislation in these Reasons are references to the Income Tax Assessment Act 1997 (ITAA 1997).

Summary

Trust B can choose roll-over relief under Subdivision 124-M of the Income Tax Assessment Act 1997 for exchanging its ordinary shares in Company B for ordinary shares in Company D.

Detailed reasoning

CGT event triggered on exchange of shares

1.    Section 104-10 provides that CGT event A1 happens if a taxpayer disposes of a CGT asset.

2.    This will occur for Trust B when it disposes of its shares in Company B to Company D in exchange for ordinary shares in Company D as there will be a change of both legal and beneficial ownership in the shares.

Subdivision 124-M - Scrip for scrip roll-over

3.    Subdivision 124-M provides that a taxpayer may choose to roll-over a capital gain where post-CGT shares the taxpayer owns are replaced with other shares, subject to certain requirements.

4.    Section 124-780 relevantly provides (and subject to some exceptions):

There is a roll-over if:

(a) an entity (the original interest holder) exchanges:

(i) a *share (the entity's original interest) in a company (the original entity) for a share (the holder's replacement interest) in another company; or

...

(c) the conditions in subsection (3) are satisfied; and

(d) if subsection (4) applies, the conditions in subsection (5) are satisfied.

5.    The original interest holder can obtain only a partial roll-over if the capital proceeds for its original interest include something other than its replacement interest: section 124-790.

6.    Paragraph 124-780(1)(a) will be satisfied in so far as Trust B (the original interest holder) will exchange a share in Company B (the original interest) for a share in Company D (the replacement interest) pursuant to the ASS.

The exchange is in consequence of a single arrangement that satisfies subsection 124-780(2)

7.    Paragraph 124-780(1)(b) requires that the exchange is in consequence of a single arrangement that satisfies subsection 124-780(2) or (2A).

8.    Subsection 124-780(2) relevantly states:

The *arrangement must:

(a) result in:

(i) a company (the acquiring entity) that is not a member of a *wholly-owned group becoming the owner of 80% or more of the *voting shares in the original entity; or

...; and

(b) be one in which at least all owners of *voting shares in the original entity (except a company referred to in paragraph (a)) could participate; and

(c) be one in which participation was available on substantially the same terms for all of the owners of interests of a particular type in the original entity.

9.    The various components of the requirement in paragraph 124-780(1)(b) are discussed in the following paragraphs.

'In consequence of'

10.  There is no legislative guidance as to when an exchange would occur 'in consequence of' an arrangement for the purposes of the scrip for scrip roll-over provisions.

11.  The Explanatory Memorandum to New Business Tax System (Capital Gains Tax) Bill 1999, being the Bill that introduced Subdivision 124-M, states at paragraph 2.9 that scrip for scrip roll-over is available if 'the exchange is in consequence of an offer'. At paragraph 2.23 of that Explanatory Memorandum, it further states that:

'an acquisition occurs in consequence of an offer if the acquisition occurs as a result of, or effect of, the offer. This means that the offer needs to occur before the acquisition and have a causal connection or other connection with it.' [emphasis added]

12.  The amendments to Subdivision 124-M in the New Business Tax System (Miscellaneous) Bill (No 2) 2000 had the effect that the acquiring entity no longer needed to make 'an offer'. Paragraph 1.19 of the Explanatory Memorandum to the New Business Tax System (Miscellaneous) Bill (No 2) 2000 states that:

'An acquiring entity will no longer be required to make an offer. It will now be sufficient that the exchange be in consequence of an arrangement that results in an entity (an acquiring entity) becoming the owner of 80% or more of the specified interests in the original entity. In the context of a wholly-owned group of companies, the arrangement must result in a company in the group (an acquiring entity) increasing the percentage of voting shares that it owns in the original entity and the members of the group becoming the owners of 80% or more of those interests.'

13.  The exchange of the ordinary shares in Company B for the shares in Company D will be in consequence of an arrangement.

Single arrangement

14.  The term 'arrangement' is defined very broadly in section 995-1 as follows:

'arrangement means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.'

15.  There is no legislative guidance as to what would constitute a 'single arrangement' for the purposes of the scrip for scrip roll-over provisions. The Explanatory Memorandum to the New Business Tax System (Miscellaneous) Bill (No. 2) 2000, at paragraph 11.23, states:

'What constitutes a single arrangement is a question of fact. Relevant factors in determining whether what takes place is part of a single arrangement would include, but not be limited to, whether there is more than one offer or transaction, whether aspects of an overall transaction occur contemporaneously, and the intention of the parties in all the circumstances as evidenced by the objective facts.'

16.  The Explanatory Memorandum to Tax Laws Amendment (2010 Measures No. 4) Bill 2010, at paragraph 5.14, states:

'It is a question of fact as to what forms a single arrangement. If there is a close nexus between particular elements of a broader transaction, then those elements would form part of the same arrangement. A scheme of arrangement may include a number of elements where only some of those elements form the single arrangement.'

17.  In TR 2005/19 a detailed scheme is set out by way of illustration at paragraph 12. Relevantly, the scheme involves the following elements (in the interests of brevity, the steps have been significantly simplified and summarised below):

•  Company A contemplating a disposal of 100% of its shares in Company B;

•  Company C incorporates two special purpose companies, Company D and Company E; and

•  Company C making a bid for Company B which results in Company A disposing of its shares in Company B in exchange for shares in Company D, the company nominated by Company C to acquire the Company B shares.

18.  At paragraph 34 of TR 2005/19 it notes that 'under the single arrangement', 100% of the shares held by Company A are, at a point in time and pursuant to a series of transaction documents, exchanged for a certain number of shares in Company D in satisfaction of the requirement in paragraph 124-780(1)(b). This indicates that notwithstanding that there may a series of related steps involved in a broader commercial restructure, in determining whether a single arrangement exists, it is necessary to focus on the particular step under which the subject shares are actually exchanged. That is, the existence of other related steps should not detract from the potential existence of a single arrangement that is the focus of roll-over relief under Subdivision 124-M.

19.  In the Full Federal Court decision in Commissioner of Taxation v Fabig [2013] FCAFC 99; 215 FCR 122; 95 ATR 660 (Fabig), amongst other things, the Court considered the identification of the relevant 'arrangement' for the purposes of Subdivision 124-M. Relevantly, in Fabig, the acquiring entity had made a number of pre-contractual offers and various iterations of the draft Share Purchase Agreement were negotiated between the parties. These were held to not form part of the relevant arrangement. Rather the arrangement relevant to Subdivision 124-M was held to be the contractual relationship entered into by the parties for the share exchange.

20.  The proposed acquisition by Company D of the shares in Company B under the terms of the ASS forms a single arrangement for the purposes of 124-780(1)(b). Whilst there are other steps in the lead up to the exchange, and that will occur contemporaneously with and are conditional upon the exchange, the disposal of the shares under the ASS will itself constitute a single arrangement. As a direct consequence of this single arrangement, the shares in Company B will be exchanged by Trust B for ordinary shares in Company D.

The arrangement must result in the acquiring entity becoming the owner of 80% or more of the voting shares in the original entity - paragraph 124-780(2)(a)

21.  Prior to the arrangement under which the shares in Company B are transferred, Company D does not hold any shares in Company B.

22.  Under the terms of the ASS, Company D will acquire all of the voting shares in Company B.

23.  Accordingly, the requirements in paragraph 124-780(2)(a) would be satisfied.

The arrangement must enable at least all owners of voting shares in the original entity (apart from the acquiring entity or members of the acquiring entity's wholly owned group) to be able to participate - paragraph 124-780(2)(b)

24.  Prior to the arrangement, the only shareholder in Company B is Trust B who will dispose of all of their shares in Company B to Company D under the terms of the ASS.

25.  Therefore, the arrangement is one in which all the owners of the voting shares in Company B could participate.

26.  Accordingly, the requirements in paragraph 124-780(2)(b) will be satisfied.

The arrangement must enable participation on substantially the same terms for all of the owners of interests of a particular type in the original entity - paragraph 124-780(2)(c)

27.  As the only shareholder in Company B is Trust B and all its shares will be disposed of under the terms of the ASS the requirements in paragraph 124-780(2)(c) will be satisfied.

The conditions for rollover in subsection 124-780(3)

28.  The relevant conditions for the roll-over under subsection 124-780(3) of the ITAA 1997 are as follows:

(a) the original interest holder *acquired its original interest on or after 20 September 1985; and

(b) apart from the roll-over, it would make a *capital gain from a *CGT event happening in relation to its original interest; and

(c) its replacement interest is in a company (the replacement entity) that is:

(i) the company referred to in subparagraph (2)(a)(i); or

...; and

(e) if that section applies, the original interest holder informs the replacement entity in writing of the *cost base of its original interest worked out just before a CGT event happened in relation to it; and

...

29.  Trust B acquired its shares in Company B after 20 September 1985 so the condition in paragraph 124-780(3)(a) is satisfied.

30.  Apart from the roll-over, Trust B would make a capital gain from the disposal of the shares in Company B, so the condition in paragraph 124-780(3)(b) is satisfied.

31.  The replacement interest is shares in Company D which is the company that became the 100% owner of Company B under the arrangement (i.e. the acquiring company referred to in subparagraph 124-780(2)(a)(i)). Therefore, paragraph 124-780(3)(c) is satisfied.

The original interest holder chooses to obtain the roll-over, or if the holder is a significant stakeholder or a common stakeholder, both the holder and the replacement entity jointly choose to obtain the roll-over - paragraph 124-780(3)(d) and (e)

32.  Trust B will choose to obtain the roll-over.

33.  If section 124-782 applies to Trust B for the arrangement, it and Company D will need to jointly choose to obtain the roll-over.

34.  Section 124-782 provides that if the original interest holder is a *significant stakeholder or a *common stakeholder for the arrangement, the cost base of an original interest acquired by an acquiring entity under the arrangement from an original interest holder becomes the first element of the cost base and *reduced cost base of the acquiring entity for the interest.

35.  Further, if section 124-782 applies, Trust B will need to inform Company D of the cost base of its original interest (shares in Company B) worked out just before the CGT event happened: paragraph 124-780(3)(e).

36.  Therefore, if Trust B is either a 'significant stakeholder' or a 'common stakeholder', as those terms are defined in section 124-783, Trust B (the original interest holder) and Company D (the replacement entity) must jointly choose to obtain the roll-over under paragraph 124-780(3)(d) and Trust B must comply with paragraph 124-780(3)(e).

Significant stakeholder

37.  Relevantly, subsection 124-783(1) provides:

An original interest holder is a significant stakeholder for an *arrangement if it had:

(a) a *significant stake in the original entity just before the arrangement started; and

(b) a significant stake in the replacement entity just after the arrangement was completed.

38.  Significant stake is defined in subsection 124-783(6) as follows:

An entity has a significant stake in a company at a time if the entity, or the entity and the entity ' s *associates between them:

(a) have at that time *shares carrying 30% or more of the voting rights in the company; or

Example:

There are 4 shareholders in YZT Company: Sonja has 60%, Mario has 20%, Peter has 10% and Dave has 10%.

Sonja, Mario and Peter are associates. They each have a significant stake in YZT because, on an associate inclusive basis, they each have a 90% stake in YZT. Dave does not have a significant stake because his total stake, on an associate inclusive basis, is 10%.

39.  Trust B has a significant stake in Company B just before the arrangement started because it holds 100% of the voting shares.

40.  Trust B will have a significant stake in Company D just after the arrangement is completed because it will hold more than 30% of the voting shares.

41.  Therefore, Trust B and Company D will jointly need to choose to obtain the roll over. Further Trust B must inform Company D in writing of the cost base of its shares in Company B worked out just before the CGT event happened in relation to it (paragraph 124-780(3)(e)).

42.  This requirement will be satisfied.

Further roll-over conditions if subsection 124-780(4) applies

43.  Subsection 124-780(4) provides for further roll-over conditions in certain circumstances, as follows:

The conditions specified in subsection (5) must be satisfied if the original interest holder and an acquiring entity did not deal with each other at *arm's length and:

(a) neither the original entity nor the replacement entity had at least 300 *members just before the *arrangement started; or

(b) the original interest holder, the original entity and an acquiring entity were all members of the same *linked group just before that time.

44.  Subsection 124-780(5) provides that the conditions are:

(b) its replacement interest carries the same kind of rights and obligations as those attached to its original interest.

45.  It is accepted that Trust B and Company D are dealing at arm's length in relation to the ASS. Therefore, we do not need to consider the further conditions.

Only partial roll-over available in certain circumstances - subsection 124-790(1)

46.  Subsection 124-790(1) provides:

The original interest holder can obtain only a partial roll-over if its capital proceeds for its original interest include something (the ineligible proceeds) other than its replacement interest. There is no roll-over for that part (the ineligible part) of its original interest for which it received ineligible proceeds.

47.  The cost base of the ineligible part is that part of the cost base of the original interest (the shares in Company B) as is reasonably attributable to it: subsection 124-790(2).

48.  The consideration received by Trust B in consequence of the exchange consists of shares in Company D and cash. Therefore, Trust B can only obtain a partial roll-over under section 124-790. There is no roll-over for that part of the original interest for which the cash is received.

Exceptions

49.  In some circumstances rollover relief under Subdivision 124-M is not available. The exceptions are outlined in section 124-795. None of the exceptions are applicable.

Conclusion

50.  Trust B may obtain partial scrip for scrip rollover of the capital gain they would make in disposing of their shares in Company B for replacement shares in Company D under Subdivision 124-M.

Consequences of roll-over relief under Subdivision 124-M of the ITAA 197 being available

51.  The consequences of partial roll-over relief applying (pursuant to section 124-785) would be as follows:

•                    the capital gain Trust B would otherwise make from CGT event A1 in respect of the exchange of its shares in Company B for shares in Company D will be partially disregarded;

•                    Trust B will make a capital gain in relation to the ineligible part of its original interest for which it received ineligible proceeds: 124-790(1);

•                    the first element of the cost base of the shares in Company D acquired by Trust B will be determined by 'reasonably attributing to it' the cost base of the shares in Company B exchanged under the arrangement (subsection 124-785(2)); and

•                    in determining the cost base of the shares in Company D, Trust B will reduce the cost base of their original interest i.e. shares in Company B (just before they stop owning it) by so much of the cost base as is attributable to the ineligible part.