Focus: Mergers & Acquisitions – May-June 2002
In this issue: We look at issues relating to demergers and the latest developments in consolidation.
Tax relief for demergers
In brief: AAR Partner Martin Fry (view CV) reports on the recently announced tax relief provisions for demerged entities, beginning at the start of the new financial year.
The Federal Government has announced that tax relief will apply to company demergers, or 'spin-offs', from 1 July 2002.
Importantly, relief will only be provided where the demerger results in continuity of the underlying ownership of the demerged entity. That is, it is not proposed that demerger relief will extend to allow a group to 'split', with some shareholders receiving interests in one group and other shareholders receiving interests in the other group.
The distribution will have to be made pro rata to existing shareholders, but that should not preclude a demerger from being done in conjunction with a sell-down facility or further capital raising by an additional offering of shares.
A demerger occurs when a group splits itself into two or more groups by distributing to its shareholders a direct interest in one or more parts of the group. Often referred to as a 'spin-off', examples include the Amcor-PaperlinX demerger, the BHP-OneSteel demerger and the BHP Billiton-BHP Steel demerger.
Demerger relief will be available to both companies and trusts (except discretionary trusts). However, as with scrip for scrip rollover relief, the demerger relief will only be available for a company demerging another company or a trust demerging another trust. It will be available for widely held and non-widely held entities (with additional integrity rules applying to non-widely held entities) and will apply to the demerger of a single entity or multiple entity demergers.
Status
Tax relief will apply from 1 July 2002, however, transitional rules will apply to transactions that have already commenced. There has been extensive consultation with business and professional groups regarding the design of the measures. The consultation process is ongoing, but the Government plans to introduce the legislation in the winter 2002 Parliamentary sittings (probably late in June 2002).
Requirements
The key criteria for tax relief on demergers are:
- underlying ownership of the demerged entity must be maintained. This will be tested by reference to both proportionate ownership interests in the demerged entity and the market value of those ownership interests. A de minimis exception is to be provided for shares acquired under an employee share scheme, however, the de minimis threshold is not yet settled; and
- the demerging entity must divest at least 80% of its ownership interests in the demerged entity. If the demerging entity subsequently disposes of its remaining ownership interests, demerger relief will not be available for this later disposal.
Specific provisions will be provided to allow dual listed companies to access the demerger relief.
As with the scrip for scrip relief, demerger relief will be available to both residents and nonresidents, provided the demerger does not result in an asset moving outside of the Australian tax net.
Consequences
The capital gains and income tax relief for demergers will apply at both the shareholder and entity levels.
From the shareholder's perspective, demerger relief will result in the following:
- an exemption from the provisions that would otherwise treat the shareholder as having received a taxable dividend from the transaction, subject to specific anti-avoidance rules. The anti-avoidance rules will be directed at demerger transactions which return value to shareholders that may otherwise have been taxed as dividends (ie similar to existing section 45B, the rules will target demerger transactions which contain a disguised dividend component). This will be determined by reference to factors including the treatment of shareholder funds in the demerging entity, the pattern of dividend distributions and the existence of a prearranged onsale by shareholders of their shares in the demerged entity;
- relief from capital gains tax (CGT) that would otherwise be payable as a result of the demerger transaction;
- the cost base in the original interest will be spread between the original interest and the interest in the demerged entity (based on the relative split in market values); and
- any pre-CGT interests will retain their pre-CGT status.
At the corporate level, demerger relief will result in:
- relief from CGT that would otherwise be payable on the disposal by the demerging entity of the demerged entity (which is significant in that it is a permanent relief at the corporate level, not just a deferral); and
- relief from a recapture of CGT roll-over relief that has been applied to certain transfers of assets that have occurred prior to and as part of the overall demerger transaction. At this stage there is no guidance on how broad this measure will be.
Limitations
The demerger relief will not apply to:
- tax on gains derived by shareholders who hold their shares as revenue assets (eg share traders); or
- tax on gains derived by shareholders from the disposal of shares acquired under employee share schemes where the shareholder has elected for deferred taxation under the special taxing rules which apply to such shares (ie Division 13A).
Stamp duty
Importantly, the demerger relief does not address the stamp duty costs of a demerger in any way. In this context it will be critical to consider both:
- whether there is stamp duty payable on the demerger transaction; and
- whether the demerger transaction triggers a recapture of reconstruction relief previously obtained within the demerged group.
Next steps
The enactment of tax relief for demerger transactions could lead to a significant increase in spin-off transactions undertaken by Australian corporate groups.
Many such transactions are likely to have been inhibited by the amount of tax likely to be incurred by the parent company on its disposal of profitable subsidiaries and the inability of the parent company to debit the entire amount of the distribution to its share capital account, which under present law is necessary to avoid creating a taxable dividend for shareholders.
It is anticipated that shareholders receiving shares in spin-off transactions are relatively more likely to sell either those shares or their shares in the parent company.
The taxation of gains from those subsequent share sales would offset (to some unquantifiable extent) the loss of revenue from the demerger relief itself. If all of that occurs, the enactment of tax relief for demergers will facilitate the creation of more efficient business structures and a more efficient allocation of capital among Australian business organisations.
Latest developments in consolidation
In brief: The Government remains committed to introduce the tax consolidation rules from 1 July 2002. Two key developments have arisen in recent weeks.
Extension of Grouping Benefits
Wholly owned groups may still elect to consolidate for tax purposes from 1 July 2002.
However, the recent Federal Budget announced that groups electing not to consolidate will continue to have the benefit of the existing tax grouping concessions until:
- 30 June 2003, for groups with a 30 June year end;
- as late as 30 December 2003, for groups with substituted accounting periods.
The existing tax grouping concessions include grouping of losses, asset rollovers, thin capitalisation grouping and rebates for intragroup unfranked dividends.
The retention of these grouping concessions until 30 June 2003 (or later) means that wholly owned groups have added flexibility in deciding whether and when to enter the tax consolidation regime (and less risk in delaying the decision).
Joint and several liability for tax
The latest version of the draft consolidation legislation contains rules which make wholly owned group companies jointly and severally liable for the tax liabilities of the entire consolidated group if the group defaults in paying its tax liabilities.
As a concession, the joint and several liability for tax will not apply if the wholly owned group companies enter into a 'Tax Sharing Agreement' which allocates the tax liability of the entire consolidated group among its members on a reasonable basis.
The joint and several liability for tax will clearly be a fundamental issue in the acquisition and disposal of wholly owned companies, and in providing finance to companies which are in a consolidated group. As the Tax Sharing Agreement is a means of avoiding joint and several liability, it will be critical for acquirers and lenders to ensure that the Agreements are in place and effective.
