29 June, 2019
This Bulletin outlines the key Australian income tax developments in the last month affecting your business, including the release of an ATO draft tax determination in relation to demergers.
Top 5 developments in tax this month you need to know
| RELEVANT AREA | AT A GLANCE |
|---|---|
| The business continuity test – carrying on a similar business | The ATO has released Law Companion Ruling LCR 2019/1 which provides guidance on what "carrying on a similar business" means for the purposes of the similar business test. Under this test, companies are able to use tax losses made from carrying on a business against income derived from carrying on a similar business following a majority change in ownership or control.
The Ruling says that in the context of the similar business test, "similar" does not mean similar "kind" or "type" of business. The focus remains on the identity of a business, as well as continuity of business activities and use of assets to generate assessable income. Accordingly, it will be more difficult to satisfy the similar business test if substantial new business activities and transactions do not evolve from, and complement, the business carried on before the test time. In contrast, where a company develops a new product or function from the business activities already carried on, and this development opens up a new business opportunity or allows the company to fill an existing gap in the market, the business as a whole is likely to satisfy the similar business test. |
| Whether penalty interest is deductible |
The ATO has released Tax Ruling TR 2019/2 which explains when "penalty interest" is deductible as a general deduction or under certain other provisions in the income tax law. Penalty interest is the amount a borrower pays a lender for agreeing to an early repayment of a loan. According to the Ruling, penalty interest is generally deductible as a general deduction where:
However, penalty interest is not deductible to the extent that it is a loss or outgoing of capital, or of a capital, private or domestic nature. |
| The definition of "financial intermediary business" in the CFC rules | The ATO has released Taxation Determination TD 2019/8 which clarifies what is meant by the term "a business whose income is principally derived from the lending of money" in the definition of "financial intermediary business" which is relevant in applying the active income test in the controlled foreign company (CFC) rules.
According to the determination, the concept of "a business whose income is principally derived from the lending of money" is concerned with the character of the business that is being conducted and it contemplates a commercial or profit-making operation that involves scale, repetition and continuity of money-lending. |
| ATO approved forms for certain stapled structures |
Following the commencement of the stapled structures legislation through Parliament (Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019), the ATO has released approved forms on its website for:
|
| Synthesised text of Australia and Singapore tax treaty under MLI | The ATO has released the synthesised text of the Australia/Singapore double tax agreement (DTA) as modified by the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). The MLI had entered into force for both countries as at 1 April 2019. |
- The ATO has released a draft taxation determination (TD) in relation to demergers
- The TD sets out the ATO's views on what constitutes a "restructuring" for the purposes of the demerger provisions
- Based on the views expressed in the TD, all but "vanilla" demergers may fail to qualify for demerger relief
- The ATO is expected to release the final TD in September 2019
Draft Tax Determination TD 2009/D1
The ATO has released a draft tax determination (TD) on what is a "restructuring" for the purposes of the demerger rules. In broad terms, a demerger occurs when the head company of a "demerger group" distributes at least 80% of its ownership interests in a "demerged entity" to its shareholders. The demerger rules provide tax relief to both the head company and its shareholders in respect of the distribution.
Background
In order to qualify as a "demerger" there must be a "restructuring" of a demerger group. The scope of the "restructuring" is critical in determining whether the conditions to qualify for demerger relief are satisfied, including that:
- under the restructuring, the shareholders acquire a new interest in the demerged entity and nothing else (the nothing else requirement); and
- the shareholders:
- acquire under the demerger the same proportion of new interests in the demerged entity as they owned in the head company; and
- have just after the demerger the same proportionate market value of ownership interests in the head company and demerged entity
(the proportionality requirements).
In 2018, the ATO did not agree to demerger relief in two well-publicised transactions that each involved a demerger followed by an acquisition of the head entity by a third party. The first transaction was Westfield's demerger of OneMarket Limited, which was conditional on Unibail-Rodamco's subsequent acquisition of Westfield for a combination of cash and shares. The ATO ruled that the nothing else requirement was not satisfied because the consideration provided by Unibail-Rodamco meant that Westfield's owners received something other than OneMarket shares under the restructuring.
The second transaction was AMA's proposed demerger of one of its two businesses and an acquisition of the remaining business by Blackstone. The ATO's reasons were not publicly released but it was likely due to the nothing else requirement not being satisfied.
In late 2018 the ATO announced that it was developing guidance on how to establish the scope of a restructuring for the purposes of demerger relief.
What does the TD say?
The TD says that what constitutes a restructuring is essentially a question of fact, but "all the steps which occur under a single plan of reorganisation will usually constitute the restructuring."
What constitutes a single plan of reorganisation is itself a question of fact. On the one hand, the TD says:
"Transactions which are to occur under a plan for the reorganisation of the demerger group may constitute parts of the restructuring of the demerger group even though those transactions are legally independent of each other, contingent on different events, or may not all occur."
But on the other hand, it says:
"Conversely, a transaction is not necessarily part of the restructuring of the group merely because it is necessary for the restructuring of the group to occur, or was the occasion for the restructuring, or because it is enabled by the restructuring of the group or is a consequence of the restructuring of the group."
This may leave taxpayers and their advisers wondering how to determine whether a transaction is part of the restructuring.
Do the examples in the TD assist?
The examples in the TD discuss the following factual scenarios involving listed companies:
- demerger followed by capital raising (example 1 and 2);
- sale of head company after demerger of subsidiary (example 3 and 4); and
- post-demerger sale facility (example 5).
Examples 1 and 2 are intended to demonstrate that a demerger will not satisfy the nothing else and proportionality requirements if a post-separation capital raising by the demerged entity is part of the restructuring. In example 1, the demerged entity has sufficient cash flows to fund its operations and undertakes a "minor" capital raising following listing on the ASX to pursue specific acquisitions and expansion plans. The capital raising in this example does not form part of the restructuring because:
"even without the capital raising the in specie distribution and ASX listing would still have proceeded, which suggests the capital raising is not part of a connected plan with the in specie distribution and ASX listing. The intention to raise capital is legally and commercially independent of the in specie distribution and ASX listing."
In example 2, the demerged company distributes 50% of its net assets by way of a capital return or dividend prior to separation. This causes the demerged company to have insufficient profits and cash flows to fund its operations and prior to the separation the head company negotiates with a third party to acquire shares in the demerged company under a capital raising. In this example, it is "significant" that negotiations took place between the head company and the third party investor prior to the separation and on that basis it is "reasonable to infer" that the capital raising forms part of the restructuring.
Example 3 involves a supermarket and specialty food business proposing schemes of arrangement to demerge the specialty food business and then sell the supermarket business to a competitor. Consistently with the ATO position in the Westfield and AMA transactions, this example shows that a prearranged plan involving a demerger followed by a sale of the head company will not qualify for relief.
The facts in example 4 are similar to example 3 except that the subsequent sale in example 4 occurs by way of takeover bid and was not planned or intended when the demerger was implemented. This aspect of the sale means that it is not part of the restructuring and the demerger qualifies for relief.
Example 5 involves a listed company demerging a subsidiary to be listed on the ASX and offering a sale facility to its non-executive shareholders to sell their shares in the demerged company at a 5% premium to the market price (funded by the demerged company). In this example, the shareholders who sell their shares under the sale facility cause the nothing else and proportionality requirements to be failed. Although not stated, the ATO's concern with the sale facility in this example may be the 5% premium paid to selling shareholders. This will hopefully be clarified in the final TD.
Hopefully, the final TD will also provide more precise guidelines to determine whether a particular step is part of the restructuring. As currently drafted, it is difficult to know where the ATO will draw the line.
The proportionality requirements
The TD does not discuss the proportionality requirements in much detail. Examples 2, 3 and 5 say that the "proportionality requirements" are not satisfied, without saying whether it is one or both proportionality requirements and without providing reasons.
The proportionality requirements raise a number of important issues in practice. For example, in the first proportionality requirement (see above) what is meant by "new interests in the demerged entity".
And one more thing…
The interaction between demergers and the tax consolidation regime may produce harsh tax outcomes. For example, where a demerged group elects to consolidate, the tax values of assets held by the subsidiary members of the group will be reset.
This can result in reduced tax values for assets such as trading stock and depreciating assets and increased tax values for assets such as land and goodwill.
In 2010, the Government announced legislative amendments to remove the need to reset tax values if the demerged group immediately consolidated. However, in an effort to clear the then legislative backlog, the subsequent Government decided not to proceed with the amendments. With the legislative backlog now reduced, the Government should consider reviving these amendments.
For further information, please contact:
Vivian Chang, Partner, Ashurst
vivian.chang@ashurst.com
