Edited version of private advice

Authorisation Number: 1052127421665

Date of advice: 10 July 2023

Ruling

Subject: Division 230 financial arrangement treatment

Question 1

Does the PF Earnout Consideration payable by the Purchaser to the Vendor(s) under the Share Sale Agreement (SSA) qualify as a look-through earnout under section 118-565 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes (as per the assumption).

Question 2(a)

Does the PF Earnout Consideration payable by the Purchaser qualify as a *financial arrangement for Division 230 ITAA 1997 purposes?

Answer

Yes.

Question 2(b)

If the answer to Question 2(a) is yes, will the 'Proceeds from certain business sales' exception in subsection 230-460(13) of the ITAA 1997 apply to the PF Earnout Consideration to exclude it from being a *Division 230 financial arrangement?

Answer 2

No.

Question 3

If the answer to Question 1 is yes but answer to Question 2(b) is no, will the *Division 230 financial arrangement treatment of the PF Earnout Consideration override the CGT look-through treatment?

Answer 3

Yes.

Relevant facts and circumstances

Introduction

The Purchaser is the head company of a tax consolidated group and is subject to Division 230.

The shares in the Purchaser are stapled to the units in a Unit Trust to form a single stapled security listed and traded on the Australian Securities Exchange.

In the second month of the year ended 30 June 202X year the Purchaser entered into a Share Sale Agreement (SSA) to acquire all the shares in the Target Entity (Target Group). Completion of the SSA occurred on XX of the third month of the year ended 30 June 202X with the purchase price for all the shares consisting of:

(i) Initial Purchase Price of $XX,XXX,XXX paid on completion and subject to the Adjustment Amount (paid just after completion).

(ii) Business Earnout Consideration (of up to a maximum of $XX million) payable (in accordance with SSA clause 8) on the Business Earnout Payment Date.

(iii) PF Earnout Consideration payable (in accordance with clause 6) on each PF Earnout Payment Date. The provisional fair value of the PF Earnout Consideration in the financial statements of the stapled entity was $Y.Y million.

The Business Earn-Out Consideration is not the subject of this ruling request.

The PF Earnout Consideration is contingent on the receipt, by the Target Group, of the Performance Fees from each of the property unit trusts in existence and being managed by the Target Group (the identified property unit trusts) at the completion date. The PF Earnout Consideration is equal to the after-tax amount of all the Performance Fees received by the Target Group (from the identified property unit trusts) and is payable by the Purchaser to the Vendor on each PF Earnout Payable Date or within ten (10) business days of receipt of each Performance Fee by the group. Whilst all the Performance Fees potentially payable to the Target Group by the identified property unit trusts are expected to be paid to (received by) the group (and all after-tax amounts of same paid by the Purchaser to the Vendors) no later than five (5) years after the year ended 30 June 202X), the SSA classifies the PF Earnout Consideration into the First PF Earnout Consideration for Performance Fees paid within this no later than five (5) years period and the Second PF Earn-Out Consideration for Performance Fees (if any) paid after this time.

The Target Group

Target Entity is the head company of a tax consolidated group (Target Group) with thirty (30) wholly owned subsidiary members. The Target Group is described as one of Australia's leading private asset funds management businesses with a thirty-year track record of generating strong returns for high net worth and institutional investors.

In addition to being a provider (and arranger) of private debt financing the Target Group originates property unit trusts (unregistered managed investment schemes) in respect of which it then provides the following services and generates the following fees;

•         Trustee fees / Custodian fees

•         Acquisition (and disposal) of property fees

•         Debt arrangement fees

•         Leasing fees

•         Other - accounting fees etc

•         Investment management fees (paid as a percentage of the gross asset value of the trust for the term of the trust pa)

•         Performance Fees (see below).

Each unit trust is formed by the Target Group for the purpose of acquiring (raising equity (issued units) and debt capital needed to acquire) a particular identified property which is then held (and in some cases developed) by the unit trust (under the Target Group's management) for a number of years (generally no more than five (5)) before being sold. Once sold the unit trust is wound up and all proceeds (less fees, disbursements and other costs) returned to the unitholders. Pursuant to the SSA there were twenty-eight (28) property unit trusts in existence and being managed by the Target Group as at the completion time.

The Performance Fees

The Target Group (or member of the group as manager of the unit trust) will only be paid a Performance Fee by the identified property unit trust if, on the sale of the property and wind up of the trust, the return made by all the unitholders over the life of the trust exceeds a specified percentage.

Assumption

It is assumed that all the Performance Fees potentially payable to the Target Group by the identified property unit trusts will be paid to (received by) the group no later than five (5) years after the year ended 30 June 202X and that the PF Earnout Consideration payable by the Purchaser in respect of these fees, meets the requirements of subsection 118-565(1) of the Income Tax Assessment Act 1997 for CGT look-through treatment. This assumption has been made to ensure the issue at Question 3 arises and to (thereby) allow the Commissioner to rule on this Question 3 issue.

Relevant legislative provisions

Income Tax Assessment Act 1997 paragraph 110-25(2)(b))

Income Tax Assessment Act 1997 subsection 112-36(1)

Income Tax Assessment Act 1997 section 118-565

Income Tax Assessment Act 1997 subsection 118-565(1)

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 subsection 230-15(1).

Income Tax Assessment Act 1997 subsection 230-15(2)

Income Tax Assessment Act 1997 section 230-20

Income Tax Assessment Act 1997 section 230-25

Income Tax Assessment Act 1997 paragraph 230-45(1)(b)

Income Tax Assessment Act 1997 Subsection 230-460(13)

Income Tax Assessment Act 1997 Section 230-505

Reasons for decision

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

Question 1

Does the PF Earn-Out Consideration payable by the Purchaser to the Vendor under the Share Sale Agreement (SSA) qualify as a look-through earnout under section 118-565 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes - as per the assumption.

Reasons

For a right (or obligation) to qualify for CGT look-through treatment under Subdivision 118-I the requirements of subsection 118-565(1) (paragraphs (a) to (e)) must be met, these being as follows:

(a)  The right is a right to future financial benefits that are not reasonable ascertainable at the time the right is created

(b)  The right is created under an arrangement that involves the disposal of a CGT asset.

(c)   The disposal causes CGT event A1 to happen.

(d)  Just before the CGT event the CGT asset was an active asset of the entity who disposed of the asset.

(e)  All of the financial benefits that can be provided under the right are to be provided over a period ending no later than 5 years after the end of the income year in which the CGT event happens.

(f)    Those financial benefits are contingent on the economic performance of:

(i)            the CGT asset; or

(ii)           a business for which it is reasonably expected that the CGT asset will be an active asset for the period to which those financial benefits relate.

(g)  The value of those financial benefits reasonably relates to that economic performance.

(h)  The parties to the arrangement deal with each other at arm's length in making the arrangement.

The assumption that the PF Earnout Consideration meets the requirements of subsection 118-565(1) of the Income Tax Assessment Act 1997 for CGT look-through treatment has been made to ensure the issue at Question 3 arises and to (thereby) allow the Commissioner to rule on this Question 3 issue.

Question 2(a)

Does the PF Earnout Consideration payable by the Purchaser qualify as a *financial arrangement for Division 230 ITAA 1997 purposes?

Answer

Yes.

Reasons

A *financial arrangement is defined in section 230-45 as (broadly) a cash settleable legal or equitable right to receive a *financial benefit (paragraph 230-45(1)(a)) or a cash settleable legal or equitable obligation to provide a *financial benefit (paragraph 230-45(1)(b)) A financial benefit is defined in section 974-160 to mean anything of economic value and includes property and services.

The PF Earnout Consideration is a cash settleable legal obligation to provide a financial benefit and as such qualifies (pursuant to paragraph 230-45(1)(b)) as a *Division 230 financial arrangement of the Purchaser.

Question 2(b)

If the answer to Question 2(a) is yes - will the 'business sale exception' in subsection 230-460(13) of the ITAA 1997 apply to the PF Earn-Out Consideration to exclude it from being a *Division 230 financial arrangement?

Answer

No.

Reasons

Subsection 230-460(13) Proceeds from certain business sales states as follows;

A right to receive, or an obligation to provide, *financial benefits arising from the sale of:

(a)  a business; or

(b)  shares in a company that operates a business; or

(c)   interests in a trust that operates a business;

is the subject of an exception if the amounts, or the values, of those benefits are only *contingent on aspects of the economic performance of the business after the sale.

Subsection 230-460(13) utilises the *contingent on aspects of the economic performance term defined in section 974-85 Right or return contingent on aspects of economic performance of SD 974-C Equity interests in companies.

The section 974-85 definition of a Right or return contingent on aspects of economic performance states, at subsection 974-85(1), as follows;

A right or the amount of a return is contingent on aspects of the economic performance of an entity, or a part of the entity's activities, if the right or return is contingent on the economic performance of that entity or that part of those activities, but not solely because of one of the following:

(a)         the ability of willingness of an entity to meet the obligation to satisfy the right to the return;

(b)         the receipts or turnover of the entity or the turnover generated by those activities.

As both the right to and amount of the PF Earnout Consideration is contingent on the Performance Fees being paid to (received by) the Target Group, it is a right or return contingent on the receipts of the entity and is therefore excluded, by paragraph 974-85(1)(b), from meeting the section 974-85 definition.

As the PF Earnout Consideration does not meet the section 974-85 definition of a right or amount *contingent on aspects of the economic performance, the exception in subsection 230-460(13) does not apply.

Question 3

If the answer to Question 1 is yes but the answer to Question 2(b) is no - will the *Division 230 financial arrangement treatment of the PF Earn-Out Consideration override the CGT look-through treatment?

Answer

Yes.

Reasons

The anti-overlap rules in sections 230-20 and 230-25 of Subdivision 230-A together with the section 230-505 valuation rule in Subdivision 230-I mean the *Division 230 financial arrangement (obligation) treatment of the PF Earnout Consideration has priority and will over-ride the section 118-565 and subsection 112-36(1) of Part 3-1 CGT look-through treatment.

Section 230-20 Gain or loss to be taken in account only once under this Act and section 230-25 Associated financial benefits to be taken into account only once under this Act ensure an assessable gain or deductible loss from a Division 230 financial arrangement and any associated financial benefits making up the calculation of that assessable gain or deductible loss is recognised only once under Division 230 ITAA 97 for tax purposes and is not recognised under any other provision of the Income Tax Assessment Act 1936 or Income Tax Assessment Act 1997.

Section 230-505 Financial arrangement as consideration for provision or acquisition of a thing applies if an entity starts to have a *Division 230 financial arrangement as consideration for the provision (sale) or acquisition of an asset or thing. The objective of section 230-505 is to provide appropriate proceeds and cost base interaction rules and ensure symmetry between the provisions of Division 230 and the other provisions of the ITAA (such as the capital gains tax (CGT) regime).

On acquiring the CGT asset (shares Target Entity) section 230-505 applies to treat the Purchaser as starting to have a *Division 230 financial arrangement (liability) (of having received financial benefits) equal to the market value of the PF Earnout Consideration obligation as at the completion date, with this same market value amount included in the first element (subsection 110-25(2) cost base of the CGT asset acquired.

If the market value of the (future contingent) PF Earnout Consideration payment obligation at the completion date is $Y.Y million, the Purchaser is treated as starting to have a *Division 230 financial arrangement (liability) of $Y.Y million and $Y.Y million is included in the subsection 110-25(2) first element cost base of the CGT asset (shares in Target Entity) acquired. If, in satisfying the PF Earnout Consideration payment obligation (over the next five (5) years), the total financial benefits provided (total payments made) by the Purchaser to the Vendor are more than $Y.Y million, the Purchaser will claim a loss, under subsection 230-15(2), for the difference (excess). Alternatively, if the total financial benefits provided (total payments made) by the Purchaser (over the next five (5) years) in satisfying the PF Earnout Consideration obligation are less than $Y.Y million, the Purchaser will recognise an assessable amount, under subsection 230-15(1), for the difference (shortage).

The section 230-20 and 230-25 anti-overlap rules that apply in respect of *Division 230 financial arrangement (liability) treatment of the PF Earnout Consideration override the section 118-565 and subsection 112-36(1) CGT look-through treatment and prevent the Purchaser from including the actual payments made in satisfying the PF Earnout Consideration obligation (over the next five (5) years) in the subsection 110-25(1) first element (or any other element) of the cost base of the CGT asset acquired.