Edited version of private advice

Authorisation Number: 1052266544872

Date of advice: 28 June 2024

Ruling

Subject: Scrip for scrip roll-over

Question

Is Trust A able to access scrip for scrip roll-over relief under Subdivision 124-M of the Income Tax Assessment Act 1997 ('ITAA 1997'), to defer a capital gain that would otherwise be made on the exchange of its shares in the Original Entity for shares in the Replacement Entity?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

1. The Original Entity is a private company engaged in business in Australia.
2. The Replacement Entity is a private company.
3. Owing to similar majority shareholding in both the Replacement Entity and Original Entity, the parties will enter into an Agreement wherein the Replacement Entity will acquire all of the shares in the Original Entity and in exchange, the Original Entity shareholders will receive newly issued shares in the Replacement Entity ('the Transaction').
4. Under the Transaction, the Replacement Entity will become the sole shareholder of the Original Entity.
5. The Transaction will occur before 30 June 20XX.
6. An independent valuation was obtained to determine the market value of the shares in each of the Replacement Entity and Original Entity and provides a merger ratio based on these values.
7. All Original Entity shares are ordinary shares carrying voting rights and rights to receive dividends and distribution of capital of the company.
8. All Replacement Entity shares are ordinary shares carrying voting rights and fixed entitlements to its capital and income.
9. Under the Agreement, all Original Entity shareholders are subject to identical terms under the Transaction. There are no clauses within the Agreement offering different terms to different parties.
10. The shares in the Original Entity pre-transaction will carry the same kinds of rights and obligations as those attached to the new shares to be issued in the Replacement Entity, being:

•         voting rights are one per fully paid share

•         capital rights are proportionate to the shareholder's share of paid up capital

•         dividend rights are proportionate to the shareholder's share of paid up capital.

11. Trust A holds its shares in the Replacement Entity on capital account.
12. Apart from the roll-over in Subdivision 124-M of the ITAA 1997, Trust A would make a capital gain under CGT event A1 when it disposes of its shares in the Original Entity for shares in the Replacement Entity.
13. Trust A will notify the Replacement Entity of the cost base in its Original Entity shares before the share exchange.
14. The Replacement Entity will not make a choice to not utilise scrip for scrip roll-over relief under the Transaction.
15. Trust A and the Replacement Entity each have less than 300 members.
16. Trust A is not a foreign resident for tax purposes.
17. The Replacement Entity is not a foreign resident for tax purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 124-M

Income Tax Assessment Act 1997 section 124-780

Income Tax Assessment Act 1997 section 124-795

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

All provisions refer to the Income Tax Assessment Act 1997 unless stated otherwise.

Question

Is Trust A able to access scrip for scrip roll-over relief under Subdivision 124-M of the ITAA 1997, to defer a capital gain that would otherwise be made on the exchange of its shares in the Original Entity for shares in the Replacement Entity?

Detailed reasoning

CGT Event A1

CGT event A1 will occur when Trust A disposes of its shares in the Original Entity to the Replacement Entity, as there will be a change in ownership (section 104-10).

Trust A will make a capital gain from CGT event A1 happening if the capital proceeds from the disposal of the Original Entity shares exceed the cost base of the Original Entity shares (subsection 104-10(4)). The capital gain is the amount of the excess.

Trust A will make a capital loss from CGT event A1 happening if the capital proceeds are less than the reduced cost base of the Original Entity shares (subsection 104-10(4)). The capital loss is the amount of the difference.

The capital proceeds from a CGT event are the total of the money, and the market value of any property, received or entitled to be received (the market value is worked out as at the time the CGT event happens) (subsection 116-20(1)).

Prima facie, Trust A is expected to make a capital gain on the disposal of its shares in the Original Entity.

Availability of scrip for scrip roll-over if a capital gain is made

Subdivision 124-M allows a shareholder or a unit holder to choose scrip for scrip roll-over, which enables the shareholder or a unit holder to disregard a capital gain they make from the exchange of a share or a unit if the shareholder or unit holder receives a replacement share or replacement unit (subsection 124-785(1)).

A capital gain will be only partially disregarded if, in addition to shares or units, the capital proceeds include something (ineligible proceeds) other than replacement shares or units (subsection 124-790(1)).

Another consequence of the roll-over is that the cost base and reduced cost base of the replacement shares and units is based on the cost base and reduced cost base of the original shares and units at the time of the CGT event for which the roll-over is chosen (subsections 124-785(3) and 124-785(4)).

Requirements to qualify for scrip for scrip roll-over in respect of the Original Entity shares

Subdivision 124-M contains a number of conditions for, and exceptions to, the eligibility of a shareholder to choose scrip for scrip roll-over. The main conditions and exceptions that are relevant to the scheme that is the subject of this Private Ruling are:

1. Shares in the original company are exchanged for shares in another replacement company (subparagraph 124-780(1)(a)(i)).
2. The exchange occurs as part of a single arrangement ((paragraph 124-780(1)(b)).
3. The single arrangement satisfies the conditions in subsection 124-780(2) (paragraph 124-780(1)(b)).
4. Conditions for roll-over in subsection 124-780(3) are satisfied (paragraph 124-780(1)(c))
5. Further conditions are satisfied where the transaction is non-arm's length (subsection 124-780(4) and subsection 124-780(5)).
6. Exceptions to obtaining scrip for scrip roll-over are not applicable (section 124-795).

These requirements are considered below.

1. Shares in the original company are exchanged for shares in another replacement company

Paragraph 124-780(1)(a) requires an entity (the original interest holder) to exchange a share (the entity's original interest) in a company (the original entity) for a share (the holder's replacement interest) in another company.

This requirement is satisfied as Trust A will exchange their shares in the Original Entity for shares in the Replacement Entity.

2. The exchange occurs as part of a single arrangement (paragraph 124-780(1)(b))

Paragraph 124-780(1)(b) requires that the exchange (of shares) is in consequence of a single arrangement.

The definition of 'arrangement' in subsection 995-1(1) is:

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

Taxation Ruling TR 2005/19 Income tax: scrip for scrip roll-over arrangements - application of Subdivision 124-M of the Income Tax Assessment Act 1997 - Part IVA of the Income Tax Assessment Act 1936 ('TR 2005/19') states at paragraph 32:

While the term 'arrangement' is defined very broadly, there is no definition of the term 'single arrangement'. Paragraph 11.23 of the Explanatory Memorandum to the New Business Tax System (Miscellaneous) Bill (No. 2) 2000 details a number of factors that may assist in determining what constitutes a single arrangement:

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 objective facts.

Under the Transaction, the Replacement Entity will acquire the shares in the Original Entity pursuant to the Agreement, which is the only arrangement being undertaken in relation to the Original Entity shares.

The Commissioner accepts that the Transaction constitutes a 'single arrangement'.

3. The single arrangement satisfies the conditions in subsection 124-780(2) (paragraph 124-780(1)(b)).

Paragraph 124-780(1)(b) requires that the exchange (of shares) is in consequence of a single arrangement that satisfies subsection 124-780(2) or subsection 124-780(2A). The requirements in subsection 124-780(2) are set out below:

a)    The acquiring entity becomes the owner of 80% or more of the original entity.

b)    Subparagraph 124-780(2)(a)(i) requires that the arrangement must result in the acquiring entity that is not a member of a wholly-owned group, becoming the owner of 80% or more of the voting shares of the original entity.

The Original Entity has one class of shares on issue which are ordinary shares carrying voting rights.

This condition will be satisfied as The Replacement Entity (the acquiring entity) is not a member of a wholly-owned group and would acquire 100% of these voting shares in the Original Entity (the original entity).

It is not necessary to consider subparagraph 124-780(2)(a)(ii) as the Replacement Entity (the acquiring entity) is not a member of a wholly-owned group.

c)    All owners of voting shares can participate

d)    Paragraph 124-780(2)(b) requires that the arrangement must be one in which at least all owners of voting shares in the original entity (except the acquiring entity or members of the acquiring entity's wholly-owned group) could participate.

This requirement is satisfied because the proposed share exchange has been offered, by way of the Agreement, to all the Original Entity shareholders.

e)    Participation is on substantially the same terms for all owners of interests of a particular type in the original entity

Paragraph 124-780(2)(c) requires that the arrangement must 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.

All shareholders of the Original Entity will participate in the Transaction on substantially the same terms. That is, they are eligible to dispose of their shares in the Original Entity for consideration, being only ordinary shares in the Replacement Entity to the market value of their respective shares in the Original Entity as at the date of the Transaction.

There are no terms of the arrangement available for one shareholder that are not available to others. This condition is therefore satisfied.

As the above requirements have been met, subsection 124-780(2) is satisfied and subsection 124-780(2A) does not need to be considered.

4. Conditions for roll-over in subsection 124-780(3) are satisfied (paragraph 124-780(1)(c))

Paragraph 124-780(1)(c) requires that the conditions in subsection 124-780(3) are satisfied. These conditions must be satisfied in relation to each of the Original Entity shares for which a shareholder wishes to choose scrip for scrip roll-over. These conditions are:

a)    The original interest holder acquired its original interest on or after 20 September 1985 (paragraph 124-780(3)(a))

b)    Paragraph 124-780(3)(a) requires that the original interest holder acquired its original interest on or after 20 September 1985. The Original Entity was established after 1985, and so all original interests were acquired on or after 20 September 1985. Therefore, this condition is satisfied.

c)    Shareholder would otherwise make a capital gain from a CGT event happening in relation to its original interest (paragraph 124-780(3)(b))

d)    Paragraph 124-780(3)(b) requires that, apart from the roll-over, the original interest holder would make a capital gain from a CGT event happening in relation to its original interest.

A capital gain will be made from CGT event A1 happening on the disposal of an Original Entity share under the Agreement if the capital proceeds from the disposal are more than the cost base of that Original Entity share.

In accordance with section 116-20, the capital proceeds received by Trust A under this CGT event will be the market value of the shares it receives in the Replacement Entity. As this amount will be greater than Trust A's cost base in the original shares in the Original Entity, Trust A will make a capital gain when the CGT event occurs.

e)    shareholders receive replacement interests in the acquiring entity or the ultimate holding company (paragraph 124-780(3)(c))

f)     Paragraph 124-780(3)(c) requires that the replacement interest is in the company that is the acquiring entity or the ultimate holding company of the wholly-owned group of which the acquiring entity is a member.

As Trust A will receive replacement shares in the Replacement Entity (which is the acquiring entity and is not a member of a wholly-owned group), this condition is satisfied.

Note it is not necessary to consider subparagraph 124-780(3)(c)(ii) as the Replacement Entity (the acquiring entity) is not a member of a wholly-owned group.

g)    The original interest holder chooses to obtain roll-over, OR the original interest holder and replacement entity choose to jointly obtain roll-over (paragraph 124-780(3)(d))

h)    Paragraph 124-780(3)(d) requires that the original interest holder chooses to obtain the roll-over, or, if section 124-782 applies to it for the arrangement, the original interest holder and the replacement entity jointly choose to obtain the roll-over.

i)      Section 124-782 applies if an original interest holder obtains a roll-over and is a 'significant stakeholder' or a 'common stakeholder' for the arrangement.

j)      Subsections 124-783(1) and (2) provide that an original interest holder will be a significant stakeholder for an arrangement if it had a significant stake:

•         in the original entity before the arrangement started, and

•         in the replacement entity just after the arrangement was completed (subsection (1)) or is an associate of the replacement entity just after the arrangement was completed.

Subsection 124-783(6) provides that an entity has a significant stake in a company if between it and its associates, the entity holds shares carrying 30% or more of the voting, dividend or capital rights of the company.

Further, subsection 124-783(3) provides that an original interest holder will be a common stakeholder for an arrangement if it had a common stake in the original entity just before the arrangement started and a common stake in the replacement entity just after the arrangement was completed.

Subsection 124-783(9) provides that an entity, or 2 or more entities, have a common stake in the original entity just before the arrangement started and in the replacement entity just after the arrangement was completed if the entity or entities, and their associates, between them held 80% or more of the voting, dividend or capital rights before and after the arrangement.

Trust A is a significant or common stakeholder for the purpose of section 124-782.

As section 124-782 applies to the arrangement, to satisfy paragraph 124-780(3)(d), Trust A and the Replacement Entity would jointly choose for Trust A to obtain the roll-over. Trust A has advised that this is the intention of each party meaning this condition will be satisfied.

k)    Significant or common stakeholders notify the replacement entity of its cost base in the original interest

Paragraph 124-780(3)(e) provides that if section 124-782 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.

Trust A is considered a significant or common stakeholder and will notify the Replacement Entity in writing of the cost base of its shares in the Original Entity. Therefore, this condition is satisfied.

l)      If an acquiring entity is a member of a wholly-owned group, no member of the group issues equity (other than a replacement interest), or owes new debt, under the arrangement

Paragraph 124-780(3)(f) does not need to be considered as the Replacement Entity is not a member of a wholly-owned group.

5. Further conditions are satisfied where the transaction is non-arm's length (subsection 124-780(4) and subsection 124-780(5)).

Subsection 124-780(4) states that the conditions specified in subsection 124-780(5) must be satisfied if the original interest holder and the 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 (paragraph 124-780(4)(a)); or

b)       the original interest holder, the original entity and the acquiring entity were all members of the same linked group (as defined in section 170-260) just before that time (paragraph 124-780(4)(b)).

As both the Original Entity and the Replacement Entity had less than 300 members just before the arrangement, whether or not the original interest holder and the acquiring entity were dealing with each other at arm's length (and if so, the conditions in subsection 124-780(5)) must be considered.

TR 2005/19 provides, at paragraph 59:

The question whether the parties are dealing with each other at arm's length is not decided by asking whether the parties were at arm's length to each other. Subsection 995-1(1) of the ITAA 1997 provides:

arm's length: in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

ATO Interpretive Decision ATOID 2004/498 Income Tax Capital gains tax: scrip or scrip rollover - whether original shareholders and acquitting company are dealing at arm's length ('ATOID 2004/498') states that in this context:

The Commissioner is therefore required to consider not only the relationship or connection between the shareholder and the acquiring entity but also the nature and circumstances of the dealing.

When determining whether the shareholder dealt with the acquiring entity at arm's length it is the collective bargaining power of the group of shareholders against the acquiring entity which must be considered...

As the restructure occurred in accordance with terms and conditions agreed between the shareholders it is considered that the newly incorporated acquiring company did not bargain as a party dealing at arm's length with these shareholders.

The Commissioner has determined that the parties were not dealing with each other at arm's length.

Further conditions to be satisfied per subsection 124-780(5)

As the parties were not dealing at arm's length the requirements in subsection 124-780(5) must also be satisfied.

Paragraph 124-780(5)(a) requires the market value of the original interest holder's capital proceeds for the exchange to be at least substantially the same as the market value of its original interest.

The number of Replacement Entity shares to be received by Trust A under the share exchange will directly reflect the market value of their original shares in the Original Entity. This has been calculated pursuant to an independent valuation. Accordingly, the market value of the capital proceeds (i.e. shares in the Replacement Entity) received by Trust A will substantially be the same as the market value of its original interests in the Original Entity.

Paragraph 124-780(5)(b) requires the replacement interest to carry the same kind of rights and obligations as those attached to its original interest. The replacement ordinary shares will carry the same voting, capital and dividend rights.

The requirements in subsection 124-780(5) are therefore satisfied.

6. Exceptions to obtaining scrip for scrip roll-over are not applicable (section 124-795).

Section 124-795 sets out the circumstances where roll-over under Subdivision 124-M is not available.

Foreign resident shareholder

Subsection 124-795(1) provides that roll-over is not available if, just before the disposal, the original interest holder is a foreign resident unless, just after the acquisition of the replacement interest, the replacement interest is taxable Australian property.

Subsection 124-795(1) is not relevant, as Trust A is an Australian resident.

A capital gain cannot (apart from the roll-over) be otherwise disregarded

Paragraph 124-795(2)(a) provides that the roll-over is not available if any capital gain the original interest holder might make from their replacement interest would be disregarded (except because of a roll-over), for example, if the shares are trading stock.

This exception does not apply as Trust A holds the Original Entity shares on capital account and any capital gain made will not be disregarded, except because of a roll-over.

Acquiring entity is not a foreign resident

Paragraph 124-795(2)(b) provides that the roll-over is not available if the original interest holder and the acquiring entity are members of the same wholly-owned group just before the original interest holder stops owning their original interest and the acquiring entity is a foreign resident.

Paragraph 124-795(2)(b) is not relevant, as the Replacement Entity is an Australian resident.

No roll-over is available under Divisions 122 or 615 of the ITAA 1997

Subsection 124-795(3) provides that the roll-over cannot be obtained if the taxpayer can otherwise choose a roll-over under Division 122 or Division 615 in respect of the CGT event.

Division 122 deals with the disposal of assets to a wholly-owned company which is not relevant to the Transaction.

Broadly, roll-over under Division 615 is available for business restructures where a company is wholly-owned by two or more entities that exchange their shares in the original entity for shares in an interposed company. However, one of the requirements to access a Division 615 roll-over is that immediately after completion the exchanging members must own all the shares in the interposed company, or entities other than those members must own no more than five shares in the interposed company, and the proportional market value of those shares must make it reasonable to treat the exchanging member as owning all the shares.

Post-transaction, entities other than the exchanging members will continue to hold significantly more than five shares.

Neither the Division 122 nor Division 615 roll-over can be utilised for this transaction, and the exception in subsection 124-795(3) does not apply.

Election for no roll-over

Subsection 124-795(4) provides that roll-over is not available if the acquiring entity elects for Subdivision 124-M to not apply for the original interest holders and the original interest holders must be advised of this election before the exchange of shares.

The Replacement Entity will not make such a choice, and therefore the exception under subsection 124-795(4) does not apply.

Partial roll-over

Subsection 124-790(1) provides that the original interest holder can only obtain 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. 'Ineligible proceeds' refers to something that is made with the exchange offer other than a replacement interest in the acquiring entity. The most common form of ineligible proceeds is a cash component.

Under the Transaction, the Original Entity shareholders will only receive the replacement shares in the Replacement Entity. Therefore, full roll-over is available.

Conclusion

As the requirements of Subdivision 124-M have been met, and none of the exceptions apply, Trust A may choose to obtain scrip for scrip roll-over, under Subdivision 124-M, for that part of a capital gain that is attributable to the receipt of shares in the Replacement Entity.