Australia: Bill Modifies Scrip For Scrip Tax Implications Of Corporate Restructures

Last Updated: 18 December 2008
Article by Allan Blaikie

On 3 December 2008, the Federal Government introduced the Tax Laws Amendment (2008 Measures No 6) Bill 2008 proposing new integrity rules targeted at scrip based corporate restructures that are not genuine takeovers. The rules will be most detrimental to scrip takeovers where the target entity is acquired at a premium to the existing tax cost of its net assets, such that the acquirer obtains a step-up in the value of those assets. A review of all scrip takeovers, however, will be required to determine whether the new rules apply.

Broadly, under the proposed amendments, where an arrangement that qualifies for capital gains tax (CGT) scrip for scrip roll-over is taken to be a "restructure", the cost base of the shares acquired will reflect the existing tax value of the net underlying assets of the target entity, rather than the market value of that entity.

The amendments follow on from the proposals made by the previous Government in 2007 to modify the tax consolidation regime to ensure the tax cost setting rules did not apply to uplift the tax costs of the target entity's assets following a scrip takeover.These proposals however were poorly targeted and effectively stopped scrip for scrip arrangements, causing disruptions in the market.

The current Government announced an amended proposal as part of the 2008/9 Federal Budget on 13 May 2008. The new rules will apply to takeover bids, schemes of arrangement and other arrangements entered into after 13 May 2008.

Why are these changes needed?

A CGT scrip for scrip roll-over is available for shareholders when shares held in the target company are exchanged for shares in the acquiring company, typically as a result of a takeover offer or merger.

Currently, subject to certain integrity rules, the cost base of the shares acquired will be set at the market value of the shares given in exchange. Where the target entity joins the acquiring entity's consolidated group, the consolidation tax cost setting rules apply to push down the market value cost base into the underlying assets of the target entity. This may result in increased capital allowance deductions and reduced capital gains arising on the future disposal of those assets.

The new rules aim to ensure that when a transaction is in effect a restructuring of an existing group (for example, the insertion of a "top hat" company), a cost base step up will not be available.

When will the new rules apply?

The rules will apply where an arrangement that qualifies for scrip for scrip roll-over is taken to be a "restructure". Broadly, this will arise where the acquirer knows, or could reasonably be expected to know:

  • that a scrip for scrip roll-over will be obtained in relation to the arrangement;
  • there is a common stakeholder for the arrangement (that is, 80 percent or more of the voting, dividend and capital rights are held commonly in both the acquiring entity and the target entity before and after the arrangement), ignoring the pre-existing exclusion for widely held entities (that is, transactions involving entities with more than 300 members may now fall within the new integrity rules); and
  • just after the arrangement was completed, the market value of the issued shares in the acquiring entity (or its ultimate holding company) in exchange for shares in the target entity is more than 80 percent of the market value of all the shares (including options, rights and other interests) issued by the acquiring entity (or its ultimate holding company).

As an illustration of how this will work in practice:

  • Just before the arrangement, Acquirer Co has a market value of $2 million and Target Co has a market value of $20 million.
  • Under the arrangement, the shareholders of Target Co receive $2 million cash and shares with a value of $18 million in Acquirer Co in exchange for their Target Co shares.
  • After the arrangement, the market value of all the shares issued by Acquirer Co is $20 million.
  • The ratio of the market values arising from the arrangement would be 90 percent (that is, $18 million divided by $20 million).
  • As the result is greater than 80 percent, the arrangement is taken to be a restructure and the new rules will apply.

Where the acquirer is a listed entity, it may elect to apply modified rules to simplify the determination of its market value for the purposes of applying the restructure test.

To reduce compliance costs, the acquirer can now elect to prevent shareholders in the target company from being able to obtain the CGT scrip for scrip rollover, whether or not the arrangement is taken to be a restructure. The acquirer will be required to notify the shareholders of the choice before the exchange of shares.

How will the new rules work?

Where an arrangement is taken to be a restructure, the cost base of the acquired shares in the target entity will reflect the cost base of the underlying net assets of the target. However, these proposed new rules will only apply where the existing "common stakeholder" rules do not apply to the arrangement.

Modified rules apply to determine the relevant cost base where the shares are acquired under an arrangement partly with a payment of cash and partly with an exchange of scrip.

Arrangements involving tax consolidated groups will also have a special set of rules operating to calculate the relevant cost base.

Effective date of changes

If an arrangement involves a takeover bid (within the meaning of the Corporations Act 2001), the amendments will apply in relation to the arrangement if:

  • for an off-market bid - the bidder lodged with the Australian Securities and Investments Commission a notice stating that the bidder's statement and offer document has been sent to the target after 7.30 pm (Australian Capital Territory time) on 13 May 2008; or
  • for a market bid - the bidder announced the bid to the relevant financial market after 7.30 pm on 13 May 2008.

If an arrangement involves a scheme of arrangement (within the meaning of the Corporations Act), the amendments will apply if a court orders a meeting of the company's members about the arrangement and the application for the order was made after 7.30 pm on 13 May 2008.

If an arrangement does not involve a takeover bid or a scheme of arrangement, the amendments will apply in relation to the arrangement if a decision to enter the arrangement was not made before 7.30 pm on 13 May 2008.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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