TOPICAL M&A IN THE TROPICS - s3. · PDF fileIn response to the Rights to Future Income (‘RTFI’) saga, a range of changes to the tax consolidations regime were made in 2012 (Taxation

SESSION 2B:

TOPICAL M&A IN THE

TROPICS

Reid Zulpo, ATI

Partner, Transaction Tax

EY

Natalie Chang

Director, Transaction Tax

EY

There is a very broad range of taxation issues that need to be considered and managed

in any M&A transaction. Taxation and duty imposts can be a significant cost to

completing the transaction.

This session provides an overview of certain technical and practical issues which may

arise in M&A transactions in relation to ACA push-downs and asset/entity divestments.

Importantly, changes to the consolidations rules in recent years may mean that tax

outcomes do not necessarily align with expected commercial and accounting outcomes.

In particular, we will examine:

1. Certain asset push-down and consolidation issues on acquisition arising from:

1. 2012 changes to Rights to Future Income and Residual Assets

2. Consolidation and TOFA interaction

3. 2016 Federal Budget Changes

4. Transfer of Tax Attributes (i.e. tax losses, franking credits and R&D offsets)

2. Ways of implementing an asset/entity spin-out and related issues; and

3. The requirements for exiting a tax consolidating group clear of group liabilities.

Overview

In response to the Rights to Future Income (‘RTFI’) saga, a range of changes to the tax

consolidations regime were made in 2012 (Taxation Laws Amendment (2012 Measures

No.2) Act 2012).

The 2012 amendments included pre (pre 12 May 2010), interim (post 12 May 2010 to

30 March 2011) and prospective law changes (which broadly apply to the period after

30 March 2011).

The prospective amendments sought to do the following:

1. CGT Approach - restrict the operation of the tax cost setting rules to CGT assets, revenue

assets, depreciating assets, trading stock and Division 230 financial arrangements;

2. Business Acquisition Approach - apply a business acquisition approach to the residual tax

cost setting rule (i.e. to effectively treat the acquisition of an asset through consolidation as

capital in nature);

3. Specific rules for WIP and consumables - ensure that the reset tax costs for rights to

future income that are WIP amount assets and consumable stores are deductible; and

4. RTFIs - treat rights to future income, other than WIP amount assets, as retained cost base

assets.

1. Acquisitions - ACA push down issues

The changes were prompted by the 2010 RTFI amendments to the consolidation

regime. The 2010 rules allowed consolidated groups to deduct the reset tax cost for a

right to future income asset over, broadly, the lesser of the period of the relevant

contract or 10 years. The amendments applied retrospectively from 1 July 2002.

The 2010 RTFI measures had a far broader Government’s consolidated revenue than

was ever anticipated.

Rationale for 2012 amendments:

The 2012 amendments were intended to restore the pre-2010 position “to increase

certainty for taxpayers by making the tax outcomes for consolidated groups more

consistent with the tax outcomes that arise when assets are acquired by entities outside

the consolidation regime” (Explanatory memorandum, para 3.89).


However, following the 2012 amendments it is no longer safe to assume that the tax

cost bases of your assets under the consolidations regime will align with the intended

economic (or accounting) outcomes of a transaction. The results are now not always

intuitive.

Those differences can arise due to:

The breadth of the current definition of a RTFI (now a retained cost base asset);

and

The restriction of the types of assets which now can be reset under tax

consolidation.


Asset

ClassExamples

Income Tax Treatment – Entity Acquisition Tax ConsolidationAsset Acquisition

2010 Amendments 2012 Amendments

RTFI • Customer

contract with

service fees.

• Long term

construction

contract.

• Offtake

Agreement.

• Royalty

Streams.

• Trailing.

Commissions

• Defined to include unbilled income,

other future income rights and WIP.

• Tax Cost Setting Amount (‘TCSA’)

deductible (some restrictions) over

the lesser of the life of the contract

or 10 years.

• RTFI rights deemed to be separate

asset from underlying contractual

rights for TCSA purposes.

• RTFI other than WIP amount asset

treated as retained cost asset.

• TCSA is limited to joining entities

historic tax cost.

• ACA that would otherwise be

applied to RTFI assets is allocated

across other reset cost base

assets held by the subsidiary.

• RTFI rights not deemed to be

separate asset from underlying

contractual rights for TCSA

purposes

• Purchase price

allocated to

underlying asset.

• Cost base likely to

approximate market

value.

Work In

Progress

(‘WIP’)

amount

asset

• Financial advice

prepared, but

not yet invoiced.

• Rights to

unbilled income

for supply of

gas.

• Not distinguished from RTFI.

• Treatment same as for RTFI above.

• Recognised as a separate asset

for ACA allocation purposes.

• Specific deduction equal to the

TCSA in the income year that

recoverable debt arises.

• Purchase price

allocated to

underlying asset.

• Likely deduction

equal to PPA/MV

allocation in the

income year that

recoverable debt

arises.

1.1 Rights to Future Income changes

Asset

ClassExamples



Non-tax

assets

• Customer Lists.

• Unregistered

trademarks.

• Information

Databases.

• Trade Secrets.

• Accounting

intangible

assets that are

not contractual

rights.

• Reset cost base asset.

• ACA allocated in proportion to

market value.

• Tax treatment subject to residual

asset rule (see below)

• Effectively ignored - no ACA

allocation.

• TCSA relating to these assets

now effectively spread across

other reset cost base assets.

• Purchase price

allocated to

underlying asset.


approximate market

value.

Consuma-

bles

• Fuel, oil (i.e. not

trading stock).

• Certain spare

parts.

• A deduction equal to the TCSA

arguably available under section 8-1.

However, deductibility was not clear

cut.

• A deduction equal to the TCSA is

available under section 8-1.

• No distinction for joining entities

deducting consumables on a

purchase or usage basis.

• Purchase price

allocated to

underlying asset and

likely s8-1 deduction

available.

1.1 Treatment of Other Assets

Asset

ClassExamples



Residual

Assets

• Revenue Assets

(investments

held on revenue

a/c)

• Asset based approach

• Links TCSA to other provisions in

the Act (not otherwise stipulated) to

enable TCSA to be assessable,

deductible, establish “cost” as

appropriate

• Residual asset rule clarified to

broaden “cost” to include cost,

outgoings, expenditure, or amount of

a similar kind and expressly deem

the TCSA to be incurred by the

joined group to acquire the asset.

• Business acquisition approach

• Arguably contentious and ATO

indications suggest that business

acquisition approach should

result in most residual assets as

being capital in character.

• Purchase price

allocated to

underlying asset.


approximate market

value.

1.1 Treatment of Other Assets

1.1 ACA Worked Example

ABC Co, the Head Co of TCG acquires New Co from vendor

Total ACA to allocate to New Co’s assets is $100M

Asset M arket Value Interim Rules Current Rules

Land 30 30 42.5

WIP 15 15 15

RTFI 10 10 0*

Div 40

Assets

25 25 25

Customer

Lists

10 10 0

Goodwill 10 10 17.5

TOTAL 100 100 100

*RTFI – assumed historical tax written down value in joining entity is nominal.

Head Co’s TOFA elections prevail

Head Co is deemed to pay an amount to acquire the financial arrangement at

the joining time

Div 230 asset can be a retained cost base asset (if it meets ss705-25(5)

definition) or reset cost base asset.

1.2 Consolidation-TOFA Interaction (Assets)

TOFA M ethod Deemed payment at joining time Other implications

FV, Financial Reports, FX

retranslation

Division 230 starting value Difference between Div 230 starting

value & TCSA assessable/deductible

over 4 years (701-61)

Hedging, accruals, realisation Tax cost setting amount* N/A

.

20

10

40

30

60

50

Joining Time

Joining Entity Head Company

TCSA 33

Realisation

Gain to HC - 27

0

Fair Value

TOFA Example – Realisation Method

*Joining entity and Head Co both use default methods

Div 230 Gain

Joining Entity

$0

Div 230 Gain

Head Co

$27

TOTAL for

instrument

$27

1.2 Consolidation-TOFA Interaction (Assets)

Head Co’s TOFA elections prevail

Head Co is deemed to receive an amount to acquire the financial

arrangement at the joining time (i.e. no TOFA loss for existing liabilities

brought into the consolidated group)

1.2 Consolidation-TOFA Interaction (Liabilities)

TOFA M ethod Deemed payment at joining time

FV, Financial Reports, FX retranslation Division 230 starting value

Hedging, accruals, realisation Joining entity’s accounting value

1.2 Consolidation-TOFA Interaction (Liabilities)

TOFA Example – Realisation Method

*Joining entity and Head Co both use default methods

(50)

(60)

(30)

(40)

(10)

(20)

Joining Time

Joining Entity Head Company

Joining Entity Accounting Value (32)

Realisation

Loss to HC - 22

0

Fair Value

20

10

Div 230 Loss

Joining Entity

$0

Div 230 Loss

Head Co

$22

TOTAL for

instrument

$22

1.3 2016 Federal Budget changes

2016 Federal Budget proposed changes to ACA Step 2:

Changes to previously announced 2013 integrity measures for

deductible liabilities (deemed assessable income) should be

disregarded;

Deductible liabilities proposed to be excluded from ACA

calculations from 1 July 2016; and

Deferred Tax Liabilities (‘DTL’) – DTL treatment under ACA

calculations will be modified by removing adjustments relating to

DTLs, commencing after the date of law introduction (new

measure).

Same Business Test (‘SBT’) testing times (tax consolidation vs non-

consolidation)

Example:

ABC Co incurs a tax loss in the 2012 income year;

ABC Co is acquired by XYZ Co on 1 May 2016;

ABC Co does not breach COT prior to 1 May 2016;

ABC Co had a change in business on 30 September 2013; and

The loss is to be utilised in the 30 June 2017 income year.

1.4 Transfer of Tax Attributes on Consolidation (Losses)

Standard SBT (ABC does not join XYZ tax consolidated group)

Modified SBT (ABC joins XYZ tax consolidated group)

1.4 Transfer of Tax Attributes on Consolidation (Losses)

30/6/2012 30/6/2013 30/6/2014 30/6/2015 30/6/2016 30/6/201730/6/2011

1/5/2015 1/5/2016

Joining TimeSBT Testing Times

Loss Year

Business Change

30/6/2012 30/6/2013 30/6/2014 30/6/2015 30/6/2016 30/6/201730/6/2011

1/5/2016SBT Testing Times

Loss Year

Business Change

Income Year

Income Year

Franking surplus in joining entity’s franking account is transferred to

the head company (subject to s177EB ITAA97) – Subsection 709-

60(2))

Franking deficit in joining entity’s franking account gives rise to a

franking deficits tax liability to the joining entity (as if its income year

ended just before the joining time) – Subsection 709-60(3))

Head company maintains franking account

Joining entity’s franking account becomes inoperative

1.4 Transfer of Tax Attributes on Consolidation

(Franking Credits)

Section 65-40 ITAA97 treats R&D offsets as if they were a tax

loss (arising in the claim year) for the purposes of testing

whether they can be carried forward and applied.

No specific R&D Tax Offset consolidation interaction provisions

(in contrast to tax losses, franking credits etc).

Possible risk R&D Tax Offsets cannot be transferred to TCG in

acquisition scenario.

ATO aware of issue – developing a Practical Compliance Guide

(PCG).

1.4 Transfer of Tax Attributes on Consolidation

(R&D Offsets)

Depending upon the nature of the transaction and the parties involved, there

are various ways in which a target group may be ‘split’ between the acquirers,

each having different tax considerations.

Some of the possible ways in which an entity ‘spin out’ may occur are as

follows:

Acquisition of 100% of the membership interests by Bid Co, followed by

the transfer of entities and/or assets (Alternative 1);

Transfer of assets or entities in the target group prior to consolidation

occurring (Alternative 2); and

Demerger of business prior to acquisition under separate Schemes of

Arrangement (Alternative 3).

Subject to commercial drivers, the transfer of assets under the first two

alternatives above may be to another consolidated tax group/s or possibly a

unit trust (with the same or different economic owners).

2. Entity/Asset Spin Outs

Alternative 1 (push down and spin out)

Buyer X

Target Co

Sub BSub A

Buyer Z

$200m $100m

$300m

Funding

$100mBuyer X

Target Co

Sub BSub A

Buyer Z

$200m $100m

$300m

Funding

$100m

Sale of Sub B

$100m

$100m

Repayment

Tax Consolidated Group Tax Consolidated Group

Considerations:

The tax cost bases of the assets being divested may not necessarily

align with the parties commercial view of value (despite ACA push

down) e.g. due to RTFIs, non-CGT assets in Sub B, leading to capital

gains on sale of Sub B shares.

Any tax attributes will remain with Buyer X as head company

(including transferred tax losses, franking credits, R&D offsets etc).

Any existing tax losses in Target Co may be refreshed as COT losses

subject to Available Fraction. Sale of Sub B does not impact upon

modified SBT as it occurs post consolidation.


Considerations (Cont’d):

Need to consider CGT event L5 on consolidation (unless Subdivision

705-C applies which requires acquisition of Target Group by another

tax consolidated group) and also exit of Sub B.

Sub B must obtain clear exit from both Target Co Group and Buyer X

Groups (even under a 705-C acquisition).

Return of capital (from sale of Sub B) can occur within tax

consolidated group and repayment of loan to Buyer X.


Alternative 2 (transfer prior to consolidation)

Seller

Target Co

Sub BSub A

$200m $100m

Sale of Sub B

$100m

1

Buyer X

Sale of Target Co

$200m

2

Buyer X

Target Co

Sub A

Buyer Z

$200m

$100m

Sub B

Pre Acquisition

Buyer Z

Tax Consolidated Group

Post Acquisition

Tax Consolidated GroupTax Consolidated Group

1 2

May give rise to better stamp duty outcome as Sub B has been transferred

pre-acquisition.

As the assets will not have been reset under tax consolidation, the tax

position of the target group will need to be carefully considered.

Need to know existing tax cost bases of assets within the leaving entity and/or

test availability of any tax losses in group (if offsetting capital gains on sale of

Sub B), including the potential application of Subdivisions 165-B and 165-CB

(part year loss rules).

Subdivision 165-CD as modified by Subdivision 715-B (loss duplication rules)

may be relevant where Sub B leaves the group with unrealised losses.

Modified SBT may be impacted due to Sub B leaving prior to consolidation.

Alternative 2 (transfer prior to consolidation)

Alternative 3 (demerger)

Seller

Sale Co

Sub BSub A

$200m $100m

Demerger of Sub B

$100m

1

Buyer X

Sale of Sale Co

$200m

2

There are three ways to demerge that can be used alone or in

combination:

1. Ownership interests (for example, shares or units) in the demerged

entity are disposed of, to owners of the head entity.

2. Ownership interests in the demerged entity are cancelled and new

interests in that entity are issued to owners of the head entity.

3. The demerged entity issues enough new interests in itself to owners of

the head entity to bring about an effective transfer (swamping).


Forms of Relief:

For shareholders or unit-holders of a group that demerges:

CGT and dividend (‘demerger dividend’) tax relief may be available for

the demerger;

they will need to adjust the cost base of their remaining interests and

new interests.

For members of the demerger group:

certain capital gains and capital losses are ignored;

reduced cost base and capital loss adjustments may be required.


Parties will typically seek confirmation of demerger relief from the ATO

Critical to obtaining a favourable ruling will be that:

the entity or entities are being demerged for sound business reasons

(such as growth strategy, access to capital and investment profiles for

investors); and

the “nothing else” requirement is satisfied - the demerger cannot be

dependent upon the acquisition of the remaining business (excluding

the demerged entities) being acquired. However, the acquisition can be

dependent upon the demerger occurring. This requirement is typically

managed by having separate schemes of arrangement.


Members of a tax consolidated group are jointly and severally liable

for group liabilities that arise during a period that they were members

of the tax consolidated group.

The exception is where the group liability was covered by a valid Tax

Sharing Agreement (‘TSA’) that allocates the liability between the

members of the group on a reasonable basis.

3. Obtaining a Clear Exit

Under section 721-35, a contributing member can leave a group clear

of a specific group liability if:

it ceases to be a member of the group before the due date of the group

liability before the leaving time; and

it pays to the head company an amount equal to the contribution

amount or, if that amount cannot be determined at that time, a

reasonable estimate of that amount; and

the member's exit from the group is not part of an arrangement, a

purpose of which was to prejudice the recovery of all or part of the group

liability by the Tax Office.


Some key issues in practice:

1. Is the TSA valid?

2. Did the leaving entity accede to the TSA at the joining time?

3. Have all members acceded to the TSA? If not, does this impact upon the

reasonableness of the allocation for the leaving entity?

4. Is the contribution amount ‘reasonable’ if an amended assessment arises

after the leaving time? What level of due diligence on TCG is required to

determine the contribution amount for the leaving entity?

5. Does the TSA contractually require a future contribution by the leaving entity

in the event of an amended assessment?

6. Has the leaving entity been a member of a TCG which has been previously

acquired? (if so a clear exit from the previous TCG is also required)


© Reid Zulpo, ATI, Natalie Chang, Jason Sham, EY 2016

Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax

Institute did not review the contents of this presentation and does not have any view as to its accuracy. The material and

opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries

in making any decisions concerning their own interests.

Documents

TOPICAL M&A IN THE TROPICS - s3. · PDF fileIn response to the Rights to Future Income (‘RTFI’) saga, a range of changes to the tax consolidations regime were made in 2012 (Taxation