Edited version of private advice

Authorisation Number: 1052109677476

Date of advice: 9 May 2023

Ruling

Subject: Capital proceeds

Question

For the purpose of section 116-20 of the Income Tax Assessment Act 1997 (ITAA 1997), in working out the amount of capital proceeds, does it exclude the Debt Amounts of the company?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

30 June 20XX

Relevant facts and circumstances

1.            A Co was incorporated on XX/XX/20XX with X shares with two shareholders.

2.            On XX/XX/20XX, the shareholders of A Co received an offer from B Co for the sale and purchase of 100% of their shares in A Co. You are shareholders of A Co at the time of the offer.

3.            You accepted the offer and a Share Sale and Purchase Agreement (SSPA) was entered into.

4.            The offer for the purchase of A Co's shares was based on an enterprise value of $XXXX (the valuation or Purchase Price). The valuation assumes no cash and no debt or other long-term liabilities at the closing.

5.            Under the SSPA, you (collectively the Sellers) agree to sell all of your shares in A Co to B Co on a debt free basis for a Purchase Price that is made up of cash and scrip shares in C Co (a wholly owned subsidiary of B Co). The cash component is subject to adjustments for payment of various debts (Debt amounts) owed by A Co that were incurred as part of its business operation.

6.            The SSPA provides that at completion of the sale contract, the Seller must procure that A Co repays and discharges all of its debt by way of providing direction to B Co to repay such amount out of the Purchase Price. The Sellers will receive the Purchase Price after adjustments have been made for the payment of A Co's debt (the Completion Amount).

7.            The SSPA provides that at completion of the contract, the Buyer will pay the Completion Amount and direct C Co to issue scrip shares to the Sellers in C Co in their respective proportions.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 103-10(1)

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(4)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 108-5(2)

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-25

Reasons for decision

1.            Section 104-10 provides 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 to another entity. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

2.            The time of the event is when you enter into the contract for the disposal or when a change in ownership occurs if there is no contract.

3.            Section 108-5 defines a CGT asset as any kind of property, or a legal or equitable right that is not property. Specifically, shares fall within the definition of a CGT asset under subsection 108-5(2).

4.            Under Subsection 104-10(4), the taxpayer will make a capital gain if the capital proceeds from the disposal are more than the cost base of the CGT asset.

5.            Section 116-20 is about the general rules relating to capital proceeds which states that the capital proceeds from a CGT event are the total of:

(a)           The money you have received, or are entitled to receive, in respect of the event happening; and

(b)           The market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

6.            You entered into an SSPA to sell all of your shares in A Co on a debt free basis.

7.            The Purchase Price represented the total enterprise value of A Co. Enterprise value is the total value of a company, defined in terms of its financing. Generally, the enterprise value of a company is made up of its equity value plus net debt (or the cost to pay off net debt). As equity value is the total value of a business that is attributable to the shareholders, it represents the actual amount a buyer will pay to a seller for a business, having made certain adjustments for matters such as cash, debt and working capital.

8.            An offer to buy a business will usually be made in terms of the enterprise value and the equity value is what will ultimately be paid to the seller. Effectively, equity represents the value of the shares that the seller can expect to receive after accounting for the company's debts.

9.            The term 'debt-free basis' generally means that the buyer is only acquiring the equity of the business and not its debt. Debts (include debt like items) are liabilities incurred by the company as part of its business activity. Acquiring a business on a debt-free basis demands that the owner of the business settles any outstanding debts and at the same time that the sale and purchase transaction is completed. This usually means that any amount allocated out of the overall purchase price to pay off company's debts do not form part of the consideration received by the shareholders for their shares.

10.          The SSPA was executed under which B Co acquired all the shares in A Co for an agreed value on a debt free basis. The agreed value (Purchase Price) is based on the total enterprise value of A Co's business. The Purchase Price is adjusted for repayment of outstanding debt at the closing of the transaction and will be funded through a combination of debt capital, seller equity and additional investment from B Co.

11.          The SSPA provides for adjustments to the Purchase Price at completion of the transaction for the payment of A Co's debt through various clauses in the SSPA. Collectively, the clauses provide that at Completion, the Sellers must give direction to the Buyer, on behalf of A Co, to pay the Debt Amounts as part of the agreed adjustments to the Purchase Price.

12.          In reference to the relevant terms in the SSPA, ultimately the Sellers can only expect to receive the Purchase Price representing the equity value of A Co. The operation of agreed terms also meant the Sellers were only entitled to receive the Purchase Price, which included determining the Completion Amount (after adjustments for the Debt Amounts).

13.          Therefore, in accordance to the terms of the SSPA, the amount of capital proceeds you received on the disposal of your shares in A Co is $XXXX,worked out as follows:

(a)          under clause XX of the SSPA, a cash component of $XXXX, and

(b)          under clause XX of the SSPA, a Share component of $XXXX.

14.          Further consideration is given to whether you are taken, for the purpose of applying the CGT provisions, to have received money or other property in respect of the part of the Purchase Price subject to the direction you provide to the Buyer to pay the Debt Amount.

15.          Subsection 103-10(1) ensures that, in relation to a CGT event, if you direct money or property be applied in a particular way for your benefit, including the discharging of all or part of a debt owed by you, the CGT provisions apply as if you had actually received the money or property (see Hedges v FC of T 2022 ATC 20-842). In your case, no amount included in the Debt Amounts were your debts. These debts were incurred by A Co as part of its ordinary business operation. Therefore, the rule in subsection 103-10(1) does not apply to the sale of your shares.

16.          Section 116-25 provides a table of modification rules about capital proceeds in relation to a CGT event. None of the modification rules apply to your situation. Therefore, the capital proceeds received by you for the sale of your A Co shares are the amount of cash and value of scrip shares in C Co received.

17.          Accordingly, for the purpose of section 116-20, the capital proceeds you are taken to have received for the sale of your shares in A Co does not include the Debt Amounts of A Co.