CGT - roll-over relief

1 Will CGT event A1 in Subdivision 104-A occur when X enters exchanges its shares in A for shares in B as a result of the merger?

Yes. Question 2 Will A be able to choose the scrip for scrip roll-over relief under Subdivision 124-M? Answer Yes. Question 3 If A chooses the scrip for scrip roll-over relief under Subdivision 124-M, will the capital gain it makes on its disposal of its shares in A be disregarded under section 124-785? Answer Yes. Question 4 If A chooses the scrip for scrip roll-over relief under Subdivision 124-M, will section 124-785 apply when working out the cost base and reduced cost base of its B shares? Answer Yes. This ruling applies for the following periods : Year ended 30 June 20XX R elevant facts and circumstances On XX XX XXXX, A and B will merge by way of a Share Sale Agreement. The merger is subject to several conditions. Under the merger, the two equal shareholders in A will dispose of all of their shares in A to B in exchange for the shares in B. After the merger, each of the original shareholders in A will own less than thirty percent of the shares in B. The original shareholders in A are not associates of each other nor are they foreign residents.

Income Tax Assessment Act 1936 section 318 Income Tax Assessment Act 1997 subdivision 104A Income Tax Assessment Act 1997 section 108-5(1) Income Tax Assessment Act 1997 Division 122 Income Tax Assessment Act 1997 subdivision 124-M Income Tax Assessment Act 1997 section 124-780 Income Tax Assessment Act 1997 subsection 124-780(1) Income Tax Assessment Act 1997 subsection 124-780(2) Income Tax Assessment Act 1997 section 124-782 Income Tax Assessment Act 1997 subsection 124-783 Income Tax Assessment Act 1997 subsection 124-784 Income Tax Assessment Act 1997 subsection 124-785 Income Tax Assessment Act 1997 section 124-795 Income Tax Assessment Act 1997 Division 615 Income Tax Assessment Act 1997 section 975-500 Income Tax Assessment Act 1997 subsection 995-1 Does IVA apply to this private r

Question 1 Will CGT event A1 in Subdivision 104-A occur when X enters into a binding contract to exchange its shares in A for shares in B as a result of the merger? Summary Yes. CGT event A1 will happen. Detailed reasoning Division 104 sets out the CGT events for which you can make a capital gain or loss. Subsection 104-10(1) provides that CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(2) provides that you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. 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. Subsection 104-10(3) states the time of the event is: (a) when you enter into the contract for the disposal; or (b) if there is no contract--when the change of ownership occurs. Example: In June 1999 you enter into a contract to sell land. The contract is settled in October 1999. You make a capital gain of $50,000. The gain is made in the 1998 - 99 income year (the year you entered into the contract) and not the 1999 - 2000 income year (the year that settlement takes place).

A CGT asset is defined in section 108-5(1) as: (a)         any kind of property; or (b)         a legal or equitable right that is not property. ... Note 1: Examples of CGT assets are: •         land and buildings; •         shares in a company and units in a unit trust; •         options; •         debts owed to you; •         a right to enforce a contractual obligation; •         foreign currency. CGT event A1 will occur when X disposes of its shares in A for the shares in B. The timing of the CGT event The timing of the CGT event determines the income year in which you report your capital gain or loss. Generally, if you dispose of shares, the CGT event happens when you enter into the contract of sale. Where there is no contract, the timing is when the change of ownership occurs. The merger is subject to certain conditions as set out in the SSA. These conditions are drafted so that no contract of sale will be entered into for the purposes CGT event A1 (i.e. no contract for the disposal of shares in A) until the conditions in the SSA are satisfied. Question 2 Will X be able to choose the scrip for scrip roll-over relief under Subdivision 124-M? Summary

Yes. X is eligible to choose the roll-over relief. Detailed reasoning Subdivision 124-M allows a shareholder to choose roll-over relief where post-CGT shares are replaced with shares in another entity, subject to certain requirements. Section 124-780 contains a number of conditions for, and exceptions to, the eligibility of a shareholder to choose scrip for scrip roll-over relief. Subsection 124-780(1) provides (subject to certain exceptions in section 124-795) that 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 (ii) an option, right or similar interest (also the holder's original interest) issued by the original entity that gives the holder an entitlement to acquire a share in the original entity for a similar interest (also the holder's replacement interest) in another company; and (b) the exchange is in consequence of a single arrangement that satisfies subsection (2) or (2A); and (c) the conditions in subsection (3) are satisfied; and

(d) if subsection (4) applies, the conditions in subsection (5) are satisfied. Shares are exchanged for shares in another company Subparagraph 124-780(1)(a)(i) requires an entity to exchange a share in a company for a share in another company. This requirement is satisfied as the X will dispose of its shares in A in exchange for shares in B. In consequence of a single arrangement that satisfies subsection (2) or (2A) Paragraph 124-780(1)(b) requires that the shares are exchanged "in consequence of a single arrangement" that satisfies subsection (2) or (2A). Subsection (2) provides: 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 (ii) a company (also an acquiring entity) that is a member of such a group increasing the percentage of voting shares that it owns in the original entity, and that company or members of the group becoming the owner of 80% or more of those shares; 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. Single arrangement 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. 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 5.14 and 11.23 explains what constitutes a single arrangement is a question of fact. In 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) a detailed scheme is set out by way of illustration at paragraph 12. 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 be 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. The exchange of the ordinary shares in A for the shares in B will be in consequence of a single arrangement. Conditions for arrangement are satisfied The single arrangement must satisfy the conditions in subsection 124-780(2) as detailed below: 80% or more ownership Paragraph 124-780(2)(a) requires that the arrangement must result in:

(ii)   a company (also an acquiring entity) that is a member of such a group increasing the percentage of voting shares that it owns in the original entity, and that company or members of the group becoming the owner of 80% or more of those shares; Acquiring entity becoming the owner of 80% or more of the voting rights in the original entity Section 975-500 provides that two companies are members of the same wholly owned group if one of the companies is a 100% subsidiary of the other company. So both the holding company and subsidiary are members of the same wholly owned group. Taxation Determination TD 2000/51 Income tax: capital gains: scrip for scrip roll-over: can a company 'increase' the percentage of voting shares that it owns in another company (an original entity), in terms of subparagraph 124-780(2)(a)(ii) of the ITAA 1997, as a result of an arrangement if it owned no shares in that company before the arrangement (TD 2000/51) states:

Subparagraph 124-780(2)(a)(i) requires that the arrangement result in the company which is the acquiring entity increasing the percentage of voting shares that it owns in the original entity. The subparagraph therefore requires a comparison between the ownership of voting shares before the arrangement and after it starts. If the acquiring entity owns no voting shares in the original entity before the arrangement but as a result of the arrangement owns voting shares in the original entity, the acquiring entity will have increased the percentage of voting shares it owns in the original entity. In terms of subparagraph 124-780(2)(a)(ii), the arrangement will result in the acquiring entity increasing its percentage ownership of voting shares in the original entity. B is the head company of a tax consolidated group with wholly owned subsidiaries. All of the shares in A will be owned by B after the proposed merger. The condition in subparagraph 124-780(2)(a)(ii) is satisfied as B will have increased its percentage of voting shares in A to more than 80% under the merger (was nil prior to the merger).

All of the owners of voting shares in the original entity are eligible to participate in the arrangement Paragraph 124-780(2)(b) requires that the arrangement is one in which at least all of the owners of voting shares in the original entity could participate. This condition is satisfied as all the A shareholders are entitled to participate in the arrangement. Participation available on substantially the same terms Paragraph 124-780(2)(c) requires that the arrangement is one in which participation is available on substantially the same terms for all the owners of interests of a particular type in the original entity. This condition is satisfied as the offer to acquire the A shares was made by B to all the shareholders in proportion to their shareholdings of each class of the shares in A and all the shareholders of each class are able to participate on the same terms. Conditions for roll-over As specified in paragraph 124-780(1)(c), the arrangement must also satisfy the following conditions in subsection 124-780(3). Original interest is acquired on or after 20 September 1985

Subsection 124-780(3)(a) requires that the original interest holder acquired its interest on or after 20 September 1985. A was first registered as a company after 20 September 1985 and all of the A shares are post-CGT shares. Consequently, X acquired its original interest (in the A shares) on or after 20 September 1985. Shareholder would otherwise make a gain Subsection 124-780(3)(a) 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 shares). This condition is satisfied as apart from the roll-over in Subdivision 124-M, X would realise a capital gain as a result of disposing of its A shares. Replacement interests in the acquiring entity Paragraph 124-780(3)(c) requires that the replacement interest is in an acquiring entity that is: (i) the company referred to in subparagraph 124-780(2)(a)(i); or (ii) in any other case - the ultimate holding company of the wholly owned group which includes the acquiring entity. The A shareholders will receive the replacement shares in B and this condition is satisfied. Replacement interests in the acquiring entity

Paragraph 124-780(3)(d) requires that the original interest holder chooses to obtain the roll-over, or, if section 124-782 applies, the original interest holder and the replacement entity jointly choose to obtain the roll-over. Section 124-782 applies if an original interest holder is a significant stakeholder or a common stakeholder for the arrangement. X will choose to obtain the roll-over and the requirements in paragraph 124-780(3)(d) is satisfied. Section 124-782 will not apply because there are no significant or common shareholders. Significant or common stakeholders notify cost base Section 124-782 will not apply as there are no significant or common shareholders. Issue of equity or new debt by member of a wholly owned group Paragraph 124-780(3)(f) provides that 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: (i) to an entity that is not a member of the group; and (ii) in relation to the issuing of the replacement interest.

No member of the wholly owned group issues equity (other than a replacement interest), or owes new debt, to an entity that is not a member of the wholly owned group in relation to the issuing of the replacement interest. Therefore, this condition is satisfied. Further roll-over conditions Subsection 124-780(4) provides that additional conditions specified in subsection 124-780(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 (paragraph 124-780(4)(a)); 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 (paragraph 124-780(4)(b)). "Arm's length" is defined at subsection 995-1(1) as "in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstances."

When determining whether the shareholder dealt with the acquiring entity at arm's length, it is the collective bargaining power of the group of the shareholders against the acquiring entity which must be considered (Elmslie and Others v Commissioner of Taxation (1993) 46 FCR 576; 26 ATR 611; (1993); 93 ATC 4964 ). There is no variation of shareholder rights under the entity's constitution or any other contract or agreement, power, option etc. Under the proposed merger all of the shareholders propose to sell the shares in accordance with the SSA. Based on the SSA, the B and the A shareholders will be taken to have dealt with at arm's length. Therefore, the additional conditions specified in subsection 124-780(5) does not need to be satisfied. Exceptions to obtaining scrip for scrip roll-over are not applicable Section 124-795 sets out the circumstances where the roll-over under subdivision 124-M is not available. Subsection 124-795(1) provides that the original interest holder cannot obtain a roll-over if it is a foreign resident just before it stops owning the original interest unless the replacement interest is a taxable Australian asset.

The A shareholders are not foreign residents just before the share exchange, therefore this exception does not apply. Subsection 124-795(2) states that you cannot obtain the roll-over if: a)    any capital gain you might make from your replacement interest would be disregarded (except because of a roll-over); or b)    you and the acquiring entity are members of the same wholly owned group just before you stop owning your original interest and the acquiring entity is a foreign resident. Example: An example of a capital gain or loss being disregarded as mentioned in paragraph (2)(a) is because the asset is trading stock. The exceptions in paragraphs 124-795(2)(a) and 124-795(2)(b) will not apply as the shareholders will hold the shares on capital account and therefore any capital gain they might make will not be disregarded except because of a roll-over. Further, B is not a foreign resident entity and the A shareholders are not members of a wholly owned group as none of the A shareholders directly own or indirectly own 100% of the shares in B. B does not directly, or indirectly, own 100% of the shares in A.

The exceptions under subsection 124-795(3) does not apply as the exchanging members cannot choose a roll-over under Divisions 122 or 615 as they will not be the sole shareholders of B after the arrangement and therefore will not hold the same number of shares in B immediately after the merger. Subsection 124-795(4) states that you cannot obtain the roll-over for the CGT event happening in relation to the exchange of your qualifying interest if: (a) the replacement entity (ParagonCare) makes a choice to that effect under this subsection; and (b) that entity (ParagonCare) or the original entity (CH2) notifies you in writing of the choice before the exchange. The exception under subsection 124-795(4) does not apply as neither entity propose to make a choice that Subdivision 124-M will not apply. In conclusion, X is eligible to choose to obtain the CGT roll-over relief under Subdivision 124-M with respect to the disposal of its shares in A in exchange for shares in B under the proposed merger. Where the roll-over is chosen any capital gain on the disposal of its A shares is disregarded pursuant to subsection 124-785(1). Question 3

If X chooses the scrip for scrip roll-over relief under Subdivision 124-M, will the capital gain it makes on its disposal of the shares in A be disregarded under section 124-785? Summary Yes. Where X chooses the roll-over, any capital gain it makes on disposing of its A shares in exchange for shares in B is disregarded. Detailed Reasoning X is eligible to choose to obtain the CGT roll-over relief under Subdivision 124-M under the proposed merger as explained in our response to question 2. Subsection 124-785(1) provides that under the roll-over, any capital gain made from the original interest is disregarded. Under the SSA, X will receive (only) shares in B as consideration for its shares in A. Any capital gain it makes on the disposal of its A shares would be disregarded under subsection 124-785(1). Question 4 If X chooses the scrip for scrip roll-over relief under Subdivision 124-M, will section 124-785 apply when working out the cost base and reduced cost base of the B shares it will have received in exchange for its A shares? Summary

Yes. Section 124-785 will apply so that the cost base and reduced cost base of the B shares acquired by X as part of the merger will be worked out by reference to the cost base of the A shares it exchanged for those B shares. Detailed reasoning Under subsection 124-785(2), the first element of the cost base for the B shares is worked out by reasonably attributing the cost base of the A shares that X exchanged for the B shares. The cost base of each of the B shares received by X under the proposed merger is worked out by reasonably attributing the cost base of the A shares to the B shares it will receive in exchange for those shares. For CGT purposes, X will be taken to have acquired its shares in B at the time it acquired the shares in A.