Australia - Taxation of cross-border mergers and acquisitions
Taxation of cross-border mergers and acquisitions for Australia.
Taxation of cross-border mergers and acquisitions for Australia.
The Australian tax system is subject to ongoing legislative change and contains complex rules that, together with commercial and legal considerations, affect mergers and acquisitions (M&A) transactions in Australia. Several significant developments in tax law have occurred since the last edition of this publication.
This report provides an overview of some recent developments and key Australian tax issues that are relevant for buyers and sellers in M&A transactions in Australia. This report also discusses the Australian accounting and legal context of M&A transactions and highlights some key areas to address when considering the structure of a transaction.
Tax reform has proceeded apace in recent years in Australia. Many of the implemented and proposed changes affect the M&A environment. The key areas of focus include the following.
Recently implemented changes
Stapled Managed Investment Trust (MIT) structures:
The government has introduced reforms to address perceived exploitation of concessional 15 percent withholding tax (WHT) rates available to MITs.
The reforms accomplish this by applying the corporate tax rate of 30 percent to distributions of non-concessional MIT income that includes:
- cross-staple rental payments
- cross-staple payments under some financial arrangements
- distributions from trading trusts
- MIT agricultural income
- MIT residential housing income.
Importantly, the higher WHT will not apply to the pass-through of rent derived by an operating entity from third parties. Therefore, where the operating entity is itself deriving rental income from third parties that is passed on to an MIT, the structure should not be impacted by the new rules.
The rules apply to new structures from 1 July 2019, but for existing structures, a 7-year transition period applies provided certain requirements are satisfied. Given the long life of infrastructure assets, a 15-year transition period applies for certain existing economic infrastructure staples.
The Australian thin capitalization rules apply to deny a deduction for a portion of interest expenses where the level of debt in a group exceeds the level deemed supportable under the safe harbor or arm’s length debt tests.
Recent changes to the rules have removed double gearing structures. Double gearing structures involve the use of multiple layers of ‘flow-through’ entities (such as trusts and partnerships) to issue debt against the same underlying asset. The thin capitalization associate entity test has been lowered from 50 percent to 10 percent for interests in flow-through entities.
This measure is intended to ensure overall gearing of upstream entities (with a 10 percent or greater interest) takes into account the level of gearing of downstream entities.
The government has codified a more restrictive version of the existing exemption from Australian taxation for non-commercial investments by sovereign (government) investors.
Sovereign immunity is limited to investments of less than 10 percent where the investor has no influence over the entity’s key decision-making.
The sovereign immunity exemption will no longer be available for active income derived through a trust (including where active income has been converted to rental income through cross-staple lease payments).
The new rules apply from 1 July 2019. Guidance from the Australian Taxation Office (ATO) on certain aspects of the rules was issued in law companion ruling 2020/3 on 16 December 2020.
Pension fund WHT on interest and dividends:
Foreign pension funds have historically been eligible for an exemption from interest and dividend WHT often used to fund their real estate and other investments.
This exemption will now be limited to interest and dividend income derived from entities in which the foreign pension fund has an ownership interest of less than 10 percent and no influence over the entity’s key decision-making. The new rules apply to investments acquired after 27 March 2018.
For investments acquired on or before 27 March 2018, the existing rules will continue to apply in respect of income derived until 30 June 2026.
Foreign Investment Review Board (FIRB) tax conditions:
FIRB has started consulting with the ATO in relation to FIRB applications. Through FIRB, the ATO now typically imposes tax conditions and, where the ATO considers tax risk is high, can impose onerous obligations on foreign investors.
Changes to company income tax rates:
The Australian company tax rate currently differs based on the aggregated turnover and sources of income of a company. Companies below the threshold (currently A$50 million) and that derive 80 percent or less of their income from passive sources (e.g. interest, dividends, etc.) pay income tax at a rate of 26 percent (reducing to 25 percent for the 2021–2022 tax year) and those above the threshold or that derive over 80 percent of their income from passive sources pay income tax at a rate of 30 percent.
Significant Global Entities (SGEs):
At the time of the previous edition of this publication, the SGE legislation imposes additional compliance obligations on stand-alone Australian companies with income over A$1 billion or Australian entities that are part of a consolidated group where the income displayed in the accounts of the global parent entity exceeds A$1 billion.
The government has introduced changes to the existing SGE legislation to incorporate additional entities, primarily those that, under the existing rules, are not SGEs by virtue of not being consolidated for accounting purposes (e.g. investment entities that hold investments at fair value).
Where an entity is an SGE, that entity may be subject to the Multinational Anti-Avoidance Law (MAAL), country-by-country reporting requirements, as well as Diverted Profits Tax (DPT) rules. Furthermore, enhanced penalties for compliance failures (e.g. late filing of corporate tax returns) are imposed on SGEs.
The federal government announced in the 2020 budget that amendments are to be made to the corporate residency tests. Previous amendments legislated that companies with their central management and control in Australia would be an Australian tax resident, regardless of whether trading operations were carried out in Australia. Under the new rules, a company that is incorporated outside Australia will be treated as an Australian tax resident if it has a ‘significant economic connection to Australia’. This test will be satisfied where both:
- the company’s core commercial activities are undertaken in Australia, and
- its central management and control are in Australia.
The amendments will take effect from the first income year after the date of royal assent of the relevant enabling legislation. However, taxpayers will have the option of applying the measures with effect from 15 March 2017.
Asset purchase or share purchase
A foreign entity that is considering acquiring an existing Australian business needs to decide whether to acquire shares in an Australian company or its assets. Many small and medium-sized businesses in Australia are not operated by companies. Trusts are common and, in some cases, the only choice usually available is the acquisition of business assets. For larger businesses, a company is by far the most common structure. The commentary in this report focuses mostly on companies, although much of it applies equally to other business structures.
Within Australian corporate groups, the distinction between share and asset transactions is diminished for income tax purposes due to the operation of the tax consolidation rules, with the exception of a number of industry-specific rules (e.g. natural resources, life insurance). Generally, these rules treat a sale of shares as if it were a sale of assets. The buyer is then effectively able to push the purchase price of the target down to the underlying assets. The asset purchase or share purchase distinction is more important when dealing with other taxes, such as stamp duty and goods and services tax (GST).
Accordingly, the decision to acquire assets or shares is normally a commercial one, taking into account the ease of executing the transaction and the history of the target. In addition, transfer taxes may be greater in an asset purchase.
Purchase of assets
Purchase price allocation
The total consideration must be apportioned between the assets acquired for tax purposes. It is common practice for the sale and purchase agreement to include an allocation in a schedule, which should be respected for tax purposes provided it is commercially justifiable. There may be a tension in this allocation between assets providing a useful cost base for income tax purposes and the stamp duty payable on the acquisition.
Although there are no specific income tax rules for allocating the purchase price among the various assets purchased, the market value consideration provisions in the capital gains tax (CGT) rules in effect arguably permit the ATO to determine an arm’s length transfer price different from that allocated to the asset by the parties.
Note that the full value of the assets may not be attributable to assets for tax purposes where future tax deductions are available for certain liabilities.
Tax losses and franking (imputation) credits are not transferred as a result of an asset acquisition. The cost of depreciable assets is generally allocated as discussed earlier. However, a number of other matters must be considered.
- Trading stock: The disposal of the total trading stock is not a sale in the ordinary course of the seller’s trading. Thus, the seller is required to bring into account the market value of that stock as income on the date of disposal. The buyer is deemed to have purchased the trading stock at that value. In practice, the ATO generally accepts the price paid as the market value of the stock where the seller and buyer are dealing at arm’s length or the transaction occurs as part of a corporate group reorganization.
- Debt: Debts should not normally be acquired when the assets of a business are acquired. A deduction for bad debts is not generally available to the buyer since the amount claimed has never been brought to account as assessable income of the claimant/acquirer.
- Prepayments: When a business is acquired, it is preferable that any prepayments remain with the seller, as they may not be deductible by the buyer.
- Employee leave provisions: Australian income tax law denies the deduction of employee leave provisions (e.g. holiday pay, long service leave). In most cases, a deduction becomes available only on payment to the employee, although there are limited exceptions relating to certain employment awards where the transfer of the provision may be deductible/assessable.
- Work-in-progress: The profit arising from the sale of work-in-progress is assessable income to the seller. The buyer is fully assessable on the subsequent realization of that work-in-progress but obtains a tax deduction for the cost of acquiring the work-in-progress.
GST, the Australian equivalent of value-added tax (VAT), applies to ‘taxable supplies’ (both goods and services), currently at a rate of 10 percent.
The GST treatment of transactions involving assets is dependent on the nature of the assets being transferred.
In some instances, where the entirety of a particular enterprise is being transferred by the seller to the buyer, the transaction may constitute a GST-free (i.e. zero-rated) supply of a going concern, on which no GST is payable. However, if the sale of assets does not fall within the GST-free going concern exemption, the GST implications arising on the disposal of each asset need to be determined separately. For example:
- A sale of assets is likely to be taxable, depending on the nature of the assets. The disposal of trading stock, goodwill and intellectual property generally constitute taxable supplies.
- A transfer of debtors or income streams generally constitutes input taxed (i.e. exempt) supplies.
- The GST treatment on the transfer of real property depends on the nature of the property. Supplies of commercial property are generally taxable for GST purposes (but may be GST-free subject to meeting certain criteria), while the GST treatment of residential property depends on whether it is ‘new’ (taxable) or second-hand (input taxed). Farmland is generally taxable but may be GST-free, subject to satisfying certain criteria.
A buyer’s entitlement to recover input tax credits (ITCs) (GST credits) in respect of GST incurred on a taxable supply of assets depends on how the buyer intends or actually uses those assets. Generally, full ITCs are available where the buyer intends to use the assets to make taxable or GST-free supplies. However, such credits may not be available where the assets are to be used to make input taxed supplies (e.g. financial supplies or residential leasing supplies). For completeness, to the extent that there is a change in the intended or actual use of the acquired assets subsequent to the buyer’s acquisition of those assets, this may impact the buyer’s historical entitlement to ITCs previously claimed.
The stamp duty implications of a transfer of assets depend on the nature and location (by Australian state and territory) of the assets transferred. Stamp duty is imposed by each state and territory of Australia on the transfer of certain assets. Each jurisdiction has its own revenue authority and stamp duty legislation. Exemptions, concessions and stamp duty rates differ substantially among the Australian states and territories.
The assets to which stamp duty may apply in a typical acquisition of an Australian business include land and buildings (including leasehold land and improvements), chattels or goods, debts, statutory licenses, goodwill and intellectual property. The specific types of assets subject to duty differ between the jurisdictions.
All states and territories, except Queensland, Western Australia and the Northern Territory, have abolished stamp duty on the transfer of non-real business assets, such as goodwill and intellectual property.
Depending on the state or territory, the maximum rates of duty range from 4.5 to 5.95 percent on the greater of the GST-inclusive consideration and the gross market value of the dutiable property. Additional foreign buyer surcharge duty applies for acquisitions of residential land in some jurisdictions. The buyer generally is liable to pay this duty.
Stamp duty can make reorganizations expensive. For this reason, it is often important to establish the optimum structuring of asset ownership at the outset to avoid further payments of duty on subsequent transfers.
However, most jurisdictions provide relief from duty for certain reconstructions within at least 90 percent-owned corporate groups. The grant of relief is subject to a number of conditions that vary among the jurisdictions, including certain pre-transaction and post-transaction association requirements for group members.
The exemption is not automatic. A formal application is required to be lodged with the relevant revenue authorities.
In Victoria, a concession for certain reconstructions is available and duty charged on applicable reconstructions will be 10 percent of the applicable duty rate. A lodgment must be made to the relevant revenue authority to obtain this concession.
Purchase of shares
Purchase price allocation
Where an entity is acquired and joins an existing tax consolidated group, the tax value of certain assets of the joining entity are reset by reference to the consideration paid to purchase the shares in the entity and the relative market values of the underlying assets held by the entity. This process essentially ‘pushes down’ the purchase price of the shares into the individual assets of the acquired entity. The ‘push down’ of purchase price is not available unless the buyer acquires 100 percent of the membership interests in the target.
Where the target company is a stand-alone company or the head company of an Australian tax consolidated group, carried forward tax losses may transfer along with the company, subject to transfer and utilization rules.
Where an Australian target company has carried forward tax losses, these generally continue to be available for recoupment only if there is greater than 50 percent continuity (with respect to dividends, capital and voting rights) in the beneficial ownership of the company. If this primary test is failed, as is usually the case in a takeover, the pre-acquisition losses are available for recoupment only if the Australian company, at all times during the year of recoupment, carries on the same business as it did immediately before the change in beneficial ownership of its shares. For losses incurred after 1 July 2015, the same business test is relaxed to allow businesses to access past year losses where it has been conducting a ‘similar’ business at the relevant test times.
Provided the transfer tests are satisfied, same or similar business losses may be refreshed as ownership losses on acquisition by an income tax consolidated group. Given the potential uncertainty in this area, often a ruling is obtained from the tax authorities and/or detailed written tax advice is sought to confirm that the same or similar business test has historically been satisfied.
Similarly, no deduction for bad debts is available to the Australian company after its acquisition by the foreign entity unless there is either:
- more than 50 percent continuity of ownership in relation to the year the deduction is claimed and the year the debt was incurred; or
- continuity of the same or similar business at relevant times.
Subject to transfer tests, when the target company becomes a member of the buyer’s income tax consolidated group as a result of the transaction, the tax attributes of the company transfer to the head company of the income tax consolidated group (i.e. tax losses, net capital losses, franking credits, foreign tax credits and R&D tax offsets).
Limitation of loss rules restrict the rate at which losses can be deducted against the taxable income of the tax consolidated group, based on the market value of the loss-making company as a proportion of the market value of the tax consolidated group as a whole. This is often a complex area.
By contrast, where the target company is a subsidiary member of a tax consolidated group, the tax attributes of the company leaving the group are retained by the head company of the group and do not pass to the buyer of the entity transferred.
Any franking credits generated with respect to taxable profits attributable to the target company will remain with the seller’s tax consolidated group post-disposal of the target company.
Statute of limitations
Under the self-assessment tax regime, the ATO generally is subject to a limited review period of 4 years (7 years for transfer pricing and 4–5 years for employment taxes) following the lodgment of the income tax return or business activity statement (except in the case of tax evasion or fraud).
It is not possible to obtain a clearance from the ATO giving assurances that a potential target company has no arrears of tax or advising as to whether or not it is involved in a tax dispute.
Where the target company is a member of an existing income tax consolidated group or GST group, the buyer should ensure the target company is no longer liable for any outstanding tax liabilities of the existing group (e.g. if the head company or representative member of that group defaults). The buyer should ensure that the target company is party to a valid tax-sharing agreement and indirect tax-sharing agreement with the head company/representative member and other members of the existing group, which reasonably limits the target company’s exposure to its own stand-alone tax liabilities and facilitates exit from the existing group clear of group liabilities by attaining evidence that the target company made an exit payment to the head company/representative member of the group prior to exit.
The ATO has a detailed law administration practice statement that sets out its approach to recovering outstanding group tax liabilities from an exiting company. The buyer should bear this in mind when assessing the tax position of the target company.
Tax indemnities and warranties
In the case of negotiated acquisitions, it is usual practice in Australia for the buyer to request and the seller to provide indemnities or warranties as to any undisclosed taxation liabilities of the company to be acquired. The extent of the indemnities or warranties is a matter for negotiation. Warranties and indemnities insurance has impacted market practices with respect to tax indemnities and warranties.
GST (VAT) does not apply to the sale of shares. The supply of shares constitutes a ‘financial supply’ for Australian GST purposes. Where a supply (and corresponding acquisition) of shares is undertaken between two Australian counterparties, the supply of those shares will be input taxed. Conversely, if the shares are sold to, or bought from, a non-resident that is not in Australia, the sale may constitute a GST-free supply (i.e. zero-rated).
While GST should not apply to either input taxed or GST-free supplies of shares, the distinction between an input taxed supply and a GST-free supply is important from an ITC-recovery perspective. Generally, full credits are not available for GST incurred on costs associated with making input taxed supplies, but full credits should be available for costs associated with making GST-free supplies. Where full ITCs are not available, reduced ITCs (equivalent to 75 or 55 percent) may be available subject to certain criteria.
All states and territories impose landholder duty on ‘relevant acquisitions’ of interests in companies or unit trusts that are ‘landholders’. The tests for whether an entity is a landholder differ among the jurisdictions. In some jurisdictions, landholder duty is also imposed on certain takeovers of listed landholders.
Landholder duty is imposed at rates of up to 5.95 percent of the value of the land (land and goods in some states) held by the landholder. For these purposes, land has an expanded definition in most jurisdictions and includes, for example, assets fixed to land (or fixed to land subject to a lease) regardless of whether the fixed asset is a fixture.
A concessional rate of duty applies to takeovers of listed landholders in some states (the concessional rate is 10 percent of the duty otherwise payable). Additional foreign buyer surcharge duty applies on acquisitions of interests in companies or unit trusts that directly or indirectly hold residential land.
The acquirer generally is liable to pay stamp duty, but in some jurisdictions the landholder and acquirer are jointly and severally liable for stamp duty.
To prevent pre-sale dividends from being distributed to reduce capital gains arising on sale of shares, the ATO has ruled that a pre-sale dividend paid by a target company to the seller shareholder is part of the seller shareholder’s capital proceeds for the share disposal (thereby increasing capital gain or reducing capital loss arising on the share sale), if the seller shareholder has bargained for the dividend in return for selling the shares. This follows the High Court of Australia decision in Dick Smith.
In this case, the share acquisition agreement stipulated that a dividend would be declared on shares prior to transfer and the buyer was to fund the dividend (with the purchase price calculated by deducting the dividend amount). The court found the value of the dividend formed part of the consideration for the dutiable transaction for stamp duty purposes. Complex integrity and anti-avoidance provisions also apply in this area. Sellers should take care to consider the tax implications of pre-transaction dividends.
Relevant to both asset and share purchase
Most tangible assets may be depreciated for tax purposes, provided they are used, or installed ready for use, to produce assessable income. Rates of depreciation vary depending on the effective life of the asset concerned.
Capital expenditure incurred in the construction, extension or alteration of a building that is to be used to produce income may be depreciated for tax purposes using the straight-line method, normally at the rate of 2.5 percent per year. Entitlement to this capital allowance deduction usually accrues to the building’s current owner or, in certain cases, a lessee or quasi-ownership right holder, even though they may not be the taxpayer that incurred the construction costs. The entitled party continues to write off the unexpired balance of the construction cost.
An important consideration in any acquisition of Australian assets or shares in an Australian company that joins a tax consolidated group is that, as part of the push down of the purchase price, depreciable assets can have their tax cost base reset to a maximum of their market value (noting that method of depreciation can only be changed in an asset deal). In this scenario, any buildings acquired do not have their amortizable cost base increased, even though the tax cost base of the asset may be reset to a higher value. Capital allowances for expenditure on these assets are generally capped at 2.5 percent per year of the original construction cost, regardless of the market value of the asset. The reset tax cost base of these assets is only relevant on a future disposal of the asset.
On the disposal of depreciable plant and equipment, the excess of the market value over the tax written-down value for each item is included in the seller’s assessable income. Conversely, where the purchase price is less than the tax written-down value, the difference is an allowable deduction to the seller.
Relatively few payments giving rise to intangible assets may be amortized or deducted for tax purposes. Currently, the main types of intangible assets that may be deducted or amortized are:
- software, including software used internally in the business
- cost of developing or purchasing patents, copyrights or designs, which are amortized over their effective life.
Capital expenditure can be deducted over a 5-year period provided the expenditure is not otherwise taken into account (by being deducted under another provision of the tax law or capitalized into the tax cost base of an asset), the deduction is not denied under another provision and the business is carried on for a taxable purpose. It is therefore important that the tax implications of transaction costs are considered carefully.
In this context, a ‘taxable purpose’ broadly means for the purpose of producing assessable income in Australia. For example, expenditure incurred in setting up a new foreign subsidiary that will produce dividend income that is exempt from Australian tax would not be considered as related to carrying on a business for a taxable purpose.
Goodwill of a business cannot be deducted or amortized.
Therefore, the buyer may wish to have the purchase and sale agreement allocate more purchase price to the tangible assets acquired, thus reducing purchase price assigned to goodwill.
The impact on stamp duty liabilities should also be considered.
Foreign resident capital gains WHT
A buyer that acquires certain Australian assets from a seller that is a relevant foreign resident may be liable to pay up to 12.5 percent of the purchase price to the Commissioner of Taxation. The buyer must withhold this amount from the purchase price paid to the seller. This is a non-final WHT and is available as a refundable tax offset to the seller.
The obligation applies to the acquisition of an asset that is:
- a direct interest in taxable Australian real property (TARP);
- an indirect Australian real property interest (i.e. shares or units); or
- an option or right to acquire such property or such an interest.
Certain transactions are exempt from the withholding obligations, including transactions involving TARP (and certain indirect Australian real property interests) valued at less than A$750,000 and transactions conducted through an approved stock exchange.
Further, no obligation is imposed where the seller obtains a clearance certificate from the Commissioner of Taxation or for indirect interests only where the seller has made a declaration about their residency status or the nature of the interest in their asset. The amount withheld may be varied, including to nil, where the seller makes an appropriate application to the Commissioner.
Foreign resident capital gains WHT applies in relation to acquisitions on or after 1 July 2016.
Choice of acquisition vehicle
After the choice between the purchase of shares or assets has been made, the second decision concerns the vehicle to be used to make the acquisition and, as a consequence, the position of the Australian operations in the overall group structure. The following vehicles may be used to acquire the shares or assets of the target:
- foreign company;
- Australian branch of the foreign company;
- special-purpose foreign subsidiary;
- Australian holding company;
- joint venture; or
- other special purpose vehicle (e.g. partnership, trust or unit trust).
The structural issues in selecting the acquisition vehicle can usually be divided into two categories:
- The choice between a branch or a subsidiary structure for the acquired Australian operations.
- Whether there would be advantages to interposing an intermediary company as the head office for the branch or the holding company for the subsidiary.
Local holding company
It is common to interpose an Australian holding company between a foreign company (or third-country subsidiary) and an Australian subsidiary. The Australian holding company may act as a dividend pool because it can receive dividends free of further Australian tax and reinvest these funds in other group-wide operations. It is common to have an Australian holding company act as the head entity of an income tax consolidated group.
Foreign parent company
Where the foreign country of the parent does not tax capital gains, the foreign parent may wish to make the investment directly. Non-residents are not subject to capital gains tax (CGT) on the disposal of shares in Australian companies unless the company is considered to have predominantly invested in real property. However, while Australian WHT on interest is generally 10 percent for treaty and non-treaty countries, the WHT on dividends is commonly limited to 15 percent on profits that have not been previously taxed (referred to as ‘unfranked’ or ‘partly franked’ dividends; see ‘Dividend imputation rules’ below), but only when remitted to treaty countries. (Australia’s more recent treaties may reduce this rate further if certain conditions are satisfied.)
The dividend WHT rate is 30 percent for unfranked dividends paid to non-treaty countries. The tax on royalties paid from Australia is commonly limited to 10 percent for treaty countries (30 percent for non-treaty countries). Therefore, an intermediate holding company in a treaty jurisdiction with lower WHT rates may be preferred, particularly if the foreign parent is unable to fully use the WHT as a foreign tax credit in its home jurisdiction (subject to limitation on benefit clauses in tax treaties and the application of the Australian General Anti-Avoidance Rules [GAAR]).
Non-resident intermediate holding company
If the foreign country imposes tax on capital gains, locating the subsidiary in a third country may be preferable. The third-country subsidiary may also sometimes achieve WHT benefits if the foreign country does not have a tax treaty with Australia.
However, some treaties contain anti-treaty shopping rules. As noted, the ATO has ruled in a taxation determination that the Australian domestic GAAR would apply to inward investment private equity structures designed with the dominant purpose of accessing treaty benefits. The taxation determination demonstrates the ATO’s enhanced focus on whether investment structures (e.g. the interposition of holding companies in particular countries) have true commercial substance and were not designed primarily for tax benefits.
A key consideration in this regard is to ensure the payee beneficially owns the dividends or royalties. Beneficial entitlement is a requirement in most of Australia’s treaties.
Australia has signed the multilateral instrument (MLI) and will adopt the principal purpose test (PPT) within its tax treaties where the treaty partner jurisdiction has also elected to adopt the PPT.
Forming a branch may not seem to be an option where shares rather than assets are acquired. This is because, in effect, the foreign entity has acquired a subsidiary. However, if the branch structure is desired but the direct acquisition of assets is not possible, the assets of the newly acquired company may be transferred to the foreign company post-acquisition, effectively creating a branch. Great care needs to be taken when creating a branch from a subsidiary in this way, including consideration of the availability of CGT rollover relief, potential stamp duties and the presence of tax losses.
However, a branch is not usually the preferred structure for the Australian operations. Many of the usual advantages of a branch do not exist in Australia.
- There are no capital taxes on introducing new capital either to a branch or to a subsidiary.
- No WHT applies on taxed branch profits remitted to the head office or on dividends paid out of taxed profits (i.e. ‘franked dividends’; see ‘Dividend imputation rules’ below) from an Australian subsidiary.
- The profits of an Australian branch of a non-resident company are taxed on a normal assessment basis at the same rate as the profits of a resident company.
The branch structure has one main potential advantage. Where the Australian operations are likely to incur losses, in some countries, these may be offset against domestic profits. However, the foreign acquirer should consider that deductions for royalties and interest paid from branches to the foreign head office, and for foreign exchange gains and losses on transactions between the branch and head office, are much more doubtful than the equivalents for subsidiaries, except where it can be shown that the payments are effectively being made to third parties.
The only provisions that might restrict the deduction for a subsidiary are the arm’s length pricing rules applicable to international transactions and the thin capitalization provisions, anti-hybrid rules and the GAAR.
Reorganizations and expansions in Australia are usually simpler where an Australian subsidiary is already present.
An Australian subsidiary would probably have a much better local image and profile and gain better access to local finance than a branch. The repatriation of profits may be more flexible for a subsidiary, as it may be achieved either by dividends or by eventual capital gain on sale or liquidation. This can be especially useful where the foreign country tax rate is greater than 30 percent; in such cases, the Australian subsidiary may be able to act as a dividend trap. Finally, although Australian CGT on the sale of the subsidiary’s shares might be avoided, this is not possible on the sale of assets by a branch, which is, by definition, a permanent establishment (PE).
Two other frequently mentioned advantages of subsidiaries are limited liability (i.e. inaccessibility of the foreign company’s funds to the Australian subsidiary’s creditors) and possible requirements for less disclosure of foreign operations than in the branch structure. However, both of these advantages can also be achieved in Australia through the use of a branch, by interposing a special-purpose subsidiary in the foreign country as the head office of the branch.
Where the acquisition is to be made together with another party, the parties must determine the most appropriate vehicle for this joint venture. In most cases, a limited liability company is preferred, as it offers the advantages of incorporation (separate legal identity from that of its members) and limited liability (lack of recourse by creditors of the Australian operations to the other resources of the foreign company and the other party). Where the foreign company has, or proposes to have, other Australian operations, its shareholding in the joint venture company is usually held by a separate wholly owned Australian subsidiary, which can be consolidated with the other operations.
It is common for large Australian development projects to be operated as joint ventures, especially in the mining industry. Where the foreign company proposes to make an acquisition in this area, it usually must decide whether to acquire an interest in the joint venture (assets) or one of the shares of the joint ventures (usually, a special-purpose subsidiary).
This decision and decisions relating to the structuring of the acquisition can usually be made in accordance with the preceding analysis.
Trusts, particularly Australian unit trusts, are popular investment structures in Australia. Under a trust arrangement, the legal owner (the trustee) holds the property ‘in trust’ for the benefit of the beneficial owners (the unit holders). In essence, the trust separates the legal and beneficial ownership of the property.
Depending on the objectives for entering into the arrangement, trusts can be established in a number of different forms, including discretionary trusts and unit trusts.
In a discretionary trust (or family trust), the beneficiaries do not have a fixed entitlement or interest in the trust funds. The trustee has the discretion to determine which of the beneficiaries are to receive the capital and income of the trust and how much each beneficiary is to receive. The trustee does not have complete discretion. The trustee can only distribute to beneficiaries within a nominated class as set out in the terms of the trust deed.
A unit trust is a trust in which the trust property is divided into a number of defined shares, or ‘units’. The beneficiaries subscribe for the units in much the same way as shareholders in a company subscribe for shares. Some benefits on the use of a unit trust over a discretionary trust and company include:
- clearly defined interest in the asset and income of the trust
- less regulation than a company
- trust deed can be tailored to the needs of the beneficiaries
- no legal issues on the redemption of units by the unit holders
- easier to wind-up than a company.
To the extent an Australian trust’s income is sourced in Australia, corresponding distributions to non-resident unit holders are generally subject to WHT. The rate of tax and method of payment depend on whether the income represents:
- Interest: The trust is generally required to withhold tax at 10 percent, which is a final tax.
- Distributions: On distributions made by a flow-through unit trust, the trust is generally required to withhold tax at 30 percent depending on the recipient entity type.
- MIT distributions: The MIT regime is a concessional WHT regime that is used primarily in Australian real estate investment.
The regime’s key benefit is that the rate of WHT on distributions of net rental income and capital gains made by the MIT may be as low as 15 percent (or 10 percent for a ‘clean’ building) when distributed to residents of ‘exchange of information countries’ per the Australian tax regulations. An MIT is a unit trust that satisfies certain requirements.
- The trust must satisfy a widely held ownership requirement and must not be closely held under the applicable tests.
- A ‘substantial proportion’ of the ‘investment management activities’ must be carried out in Australia.
- The trust must not be carrying on a ‘trading business’ or control another entity that is carrying on a ‘trading business’.
Certain managed investment trusts are able to elect into the attribution MITs (AMIT) regime. The AMIT regime:
- Allows AMITs to use a simplified attribution method of tax in relation to distribution of income.
- Allows AMITs to carry forward under- and over-estimates of tax amounts into the discovery income year, generally without adverse tax consequences.
- Allows unit holders in AMITs to make both upward and downward adjustments to the cost base of their unit holdings in certain circumstances to eliminate double taxation that may otherwise arise.
- Deems AMITs that meet eligibility requirements to be fixed trusts, which can have benefits for tax-loss testing and CGT treatment does not give a trust access to the concessional WHT regime but does not preclude access either, that is, a trust can simultaneously be both an AMIT and a withholding MIT.
The AMIT rules have effect from 1 July 2016, with the option of early adoption from 1 July 2015. Recent reforms discussed earlier limit the ability to access the concessional 15 percent MIT WHT rate.
Choice of acquisition funding
Where a buyer uses an Australian holding company in an acquisition, the form of this investment must be considered. Funding may be by way of debt or equity. A buyer should be aware that Australia has a codified regime for determining the debt or equity classification of an instrument for tax purposes. This is, broadly, determined on a statutory substance over form basis.
In the context of equity funding, it will also need to be considered whether the issue of shares or units in a landholder may trigger landholder duty (see ‘Stamp duty’ above).
Generally, interest is deductible for income tax purposes (subject to commentary below), but dividends are not. Additionally, the non-interest costs incurred in borrowing money for business purposes, such as the costs of underwriting, brokering, legal fees and procurement fees, may be generally written off and deducted over the lesser of 5 years or the term of the borrowing.
Deductibility of interest
Interest payable on debt financing is generally deductible in Australia, provided the borrowed funds are used in the assessable income-producing activities of the borrower or to fund the capitalization of foreign subsidiaries. No distinction is made between funds used as working capital and funds used to purchase capital assets.
The major exceptions to this general rule are as follows.
- Where the thin capitalization rules are breached, a portion of the interest is not deductible.
- In addition to the quantum of the loan being arm’s length under the thin capitalization rules (or within the safe harbor limits), the terms and interest rate on loans must be arm’s length in accordance with transfer pricing principles.
- Where a hybrid mismatch arises on a debt instrument, the portion of interest attributable to the mismatch may not be deductible.
- Interest expenses incurred in the production of certain tax-exempt income are not deductible.
- Interest expenses incurred in relation to the holding of a capital asset are not deductible where the only prospective assessable income in Australia is the capital gain potentially available on sale (the interest expenses may be included in the cost base for CGT purposes).
The thin capitalization rules apply to inbound investing entities with respect to all debt that gives rise to tax deductions. These rules deny interest deductions where the average amount of debt of a company exceeds the safe harbor debt amount, the alternative arm’s length debt amount and, in certain circumstances, the worldwide debt amount of the company.
The safe harbor debt amount is essentially 60 percent of the value of the net Australian assets of the Australian company, which is a debt-to-equity ratio of 1.5:1. For financial institutions, this ratio is increased to 16:1. The arm’s length debt amount is the amount of debt that the Australian company could reasonably be expected to have borrowed from a commercial lending institution dealing at arm’s length.
The thin capitalization rules, subject to additional safe harbors, apply to Australian groups operating overseas (outbound investing entities) in addition to Australian entities that are foreign-controlled and Australian operations of foreign multinationals.
As the thin capitalization rules apply regarding all debt that gives rise to tax deductions, no distinction is made between connected and third-party financing or between local and foreign financing.
WHT on debt
Australia generally imposes WHT at 10 percent on all payments of interest, including amounts in the nature of interest (e.g. deemed interest under hire purchase agreements or discounts on bills of exchange). The 10 percent rate applies to countries whether or not Australia has concluded a tax treaty with the country in question. However, the applicable interest WHT rate may be reduced to 0 percent on certain interest payments to financial institutions by some of Australia’s more recent tax treaties (including those with the US, the UK, France, Germany and Japan) and in relation to certain publicly offered debt.
Few techniques to eliminate WHT on interest are available.
Interest paid on widely held debentures issued outside Australia for the purpose of raising a loan outside Australia is exempt from WHT where the interest is paid outside Australia. As Australian WHT cannot usually be avoided, the acquisition should be planned to ensure that credit is available in the country of receipt.
Australia does not impose WHT on franked dividends. Australia imposes WHT on the unfranked part of a dividend at a rate that varies from 15 percent, the usual rate in Australia’s treaties, to 30 percent for all non-treaty countries. In the case of the New Zealand, US and UK treaties, the rate of dividend withholding may be as low as 0 percent.
Australia is renegotiating its tax agreements with its preferred trading partners with a view to extending the 0 percent concessional WHT rate.
Hybrid mismatch rules
Legislation has been introduced targeted at ‘hybrid mismatches’, which include:
- hybrid financial instruments treated as debt in one jurisdiction and equity in another
- hybrid entities that are treated as taxable in one jurisdiction but as flow-through entities in another jurisdiction.
Such structures can give rise to double deductions (where deductions arise in more than one jurisdiction for the same payment) or deduction/non-inclusion outcomes (where payments are deductible in one jurisdiction but not assessable in the other).
Where a hybrid mismatch arises, the rules either deny a deduction for an otherwise deductible payment or tax a receipt that would be otherwise non-taxable. The response depends on the tax treatment in the other jurisdiction, which could change over time as more countries introduce hybrid mismatch rules.
The rules also cover ‘imported’ mismatches where a mismatch arises in respect of two non-Australian entities outside Australia and is subsequently imported.
There are no grandfathering exclusions or de minimis thresholds under the hybrid mismatch rules.
In addition, Australia has introduced a targeted integrity rule that can apply where low-taxed offshore finance companies provide related party debt.
Checklist for debt funding
- Interest WHT at 10 percent ordinarily applies to cross-border interest, except to banks in the UK, Japan, France, Germany and the US, unless the interest is paid in relation to a publicly offered debenture.
- Third-party and related-party debt are treated in the same manner for Australian thin capitalization purposes.
- Interest expense in a financing vehicle can be offset against income of the underlying Australian business when it is part of an Australian tax consolidated group.
Equity is another alternative for funding an acquisition. This may take the form of a scrip-for-scrip exchange whereby the seller may be able to defer any gain, although detailed conditions must be satisfied.
The main conditions for rollover relief include the following.
- All selling shareholders can participate in the scrip-for-scrip exchange on substantially the same terms.
- Under the arrangement, the acquiring entity must become the owner of 80 percent or more of the voting shares in the target company.
- The selling shareholders hold their shares in the target company on capital account (i.e. the shares are not trading stock).
- The selling shareholders acquired their original shares in the target company on or after 20 September 1985.
- Apart from the rollover, the selling shareholders would have a capital gain on the disposal of their shares in the target company as a result of the exchange.
Additional conditions apply where both the target company and the buyer are not widely held companies or where the selling shareholder, target company and buyer are commonly controlled.
Where the selling shareholders receive only shares from the acquiring company (the replacement shares) in exchange for the shares in the target company (the original shares) and elect for scrip-for-scrip rollover relief, they are not assessed on any capital gain on the disposal of their original shares at the time of the acquisition. Any capital gain on the shares is taxed when they dispose of their replacement shares in the acquiring company. Where the sellers receive both shares and other consideration (e.g. cash), only partial CGT rollover is available. The cost base of the original shares is apportioned on a reasonable basis between the replacement shares and the other consideration, and the selling shareholders are subject to CGT at the time of the share exchange to the extent that the value of the other consideration received exceeds the allocated portion of the original cost base of the original shares.
Where the selling shareholders acquired their original shares prior to 20 September 1985 (pre-CGT shareholders), subject to transitional provisions, the selling shareholders are not subject to CGT on the disposal of the original shares, so they do not require rollover relief. However, such shareholders lose their pre-CGT status, so they are subject to CGT on any increase in the value of the replacement shares between the acquisition and subsequent disposal of the replacement shares. The cost base of the replacement shares that a pre-CGT shareholder receives is the market value of those shares at the time of issue.
Provided the target company or buyer is a widely held company, the cost base of the shares in the target company that are acquired by the buyer is the market value of the target company at the date of acquisition. The CGT cost base of the target shares acquired by the buyer is limited to the selling shareholders’ cost base in the target company (i.e. no step-up to market value is available) if:
- the shares are acquired from a substantial shareholder who holds a 30 percent or more interest (together with associates) in the target company and the buyer company following the transaction;
- the shares are acquired from common shareholders in the target company and the buyer company, who, together with associates, hold an 80 percent or more interest in the target company prior to the acquisition and an 80 percent or more interest in the buyer after the acquisition; or
- the shares are acquired as part of a ‘restructure’ under the scrip-for-scrip arrangement rather than a genuine takeover.
Generally, a company is widely held if it has at least 300 members. Special rules prevent a company from being treated as widely held if interests are concentrated in the hands of 20 or fewer individuals.
Demerger relief rules are also available to companies and trusts where the underlying ownership (at least 80 percent) of the divested membership interests in a company is maintained on a totally proportionate basis. These rules are not available to membership interests held on revenue account. In an M&A context, safeguards in the anti-avoidance provisions prevent demergers from occurring where transactions have been pre-arranged to effect change in control. The ATO issued guidance in 2018 that provides additional clarity on whether a demerger is undertaken for commercial reasons. Further guidance was issued in 2020 with respect to what situations would qualify as a restructure for the purpose of the demerger rules and should be considered carefully in the M&A context.
The demerger relief available is as follows.
- CGT relief at the shareholder level providing for cost base adjustments between the original and new membership interests.
- CGT relief at the corporate level providing for a broad CGT exemption for the transfer or cancellation of membership interests in the demerged entity.
- Deeming the divestment of shares to shareholders not to be a taxable dividend, subject to anti-avoidance rules.
Dividend imputation rules
Australia operates an imputation system of company taxation through which shareholders of a company gain relief against their own tax liability for taxes paid by the company.
Resident companies must maintain a record of the amount of their franking credits and franking debits to enable them to ascertain the franking account balance at any point in time, particularly when paying dividends. This franking account is a notional account maintained for tax purposes and reflects the amount of company profits that may be distributed as franked dividends.
Detailed rules determine the extent to which a dividend should be regarded as franked. A dividend may be partly franked and partly unfranked. Generally, a dividend can be franked where the distributing company has sufficient taxed profits from which to make the dividend payment and the dividend is not sourced from the company’s share capital.
Dividends paid to Australian resident shareholders carry an imputation rebate that may reduce the taxes payable on other income received by the shareholder. Additionally, shareholders who are Australian resident individuals and complying superannuation funds can obtain a refund of excess franking credits.
For non-resident shareholders, however, franked dividends do not result in a rebate or credit but instead are free of dividend WHT (to the extent to which the dividend is franked). The franking credits of companies that have been 95 percent or more foreign owned previously become exempting credits that can exempt WHT but do not give rise to a tax credit for resident shareholders.
No dividend WHT is levied on dividends paid by a resident company to its resident shareholders. Income tax assessed to an Australian resident company generally results in a credit to that company’s franking account equivalent to the amount of taxable income less tax paid thereon.
The franking account balance is not affected by changes in the ownership of the Australian company. As non-resident companies do not obtain franking credits for tax paid, an Australian branch has no franking account or capacity to frank amounts remitted to a head office.
Mixed debt/equity funding and hybrid instruments
Due to Australia’s thin capitalization regime, a buyer usually finances through a mix of debt and equity and may consider certain hybrid instruments. Australia does not impose stamp duty on the issue of new shares in any state, and there is no capital duty. However, it should be considered whether landholder duty may be triggered on the issue of shares in a landholder.
As noted earlier in this report, the characterization of hybrids (e.g. convertible instruments, preferred equity instruments and other structured securities) as either debt or equity is governed by detailed legislative provisions that have the overriding purpose of aligning tax outcomes to the economic substance of the arrangement.
These provisions contain complex, interrelated tests that, in practice, enable these instruments to be structured such that subtle differences in terms can decisively alter the tax characterization in some cases. Examples of terms that can affect the categorization of an instrument include the term of the instrument, the net present value of the future obligations under the instrument and the degree of contingency/certainty surrounding those obligations.
Additionally, the debt/equity characterization of hybrid instruments under the Australian taxation law and that under foreign taxation regimes have been subject to enhanced scrutiny by the ATO and foreign revenue authorities. In this context, consideration should be given to the application of the recently enacted hybrid mismatch tax regime and integrity provision.
The careful structuring of hybrid instruments is a common focus in Australian business finance. In some cases, this focus extends to cross-border hybrids, which are characterized differently in different jurisdictions. The hybrid mismatch rules discussed above remove certain previous benefits from the differences in classifications between jurisdictions.
Historically, a complex specific statutory regime has applied that, broadly, seeks to tax discounted securities on an accruals basis. This treatment is essentially preserved under the Taxation of Financial Arrangements (TOFA) provisions, which aim to align the tax and accounting treatment of financial arrangements. Note that interest WHT at 10 percent may apply when such a security is transferred for more than its issue price.
Where settlement is deferred on an interest-free basis, any CGT liability accruing to the seller continues to be calculated from the original disposal date and on the entire sale proceeds. Furthermore, where interest is payable under the settlement arrangement, it does not form part of the cost base. Rather, it is assessable to the seller and deductible to the buyer to the extent that the assets or shares are capable of producing assessable income, other than the prospective capital gain on resale. However, taxation of some earnout arrangements can be deferred.
Concerns of the seller
Non-residents generally are exempt from CGT on the disposal of Australian assets held on capital account, including a disposal of shares in a company or interests in a trust. The key exception is where a non-resident has a direct or indirect interest in real property, which is defined broadly to include leasehold interests, fixtures on land and mining rights. The provisions that seek to apply CGT in these circumstances are extremely broad and carry an extraterritorial application in that non-residents disposing of interests in upstream entities that are not residents of Australia may also be subject to CGT. Similarly, stamp duty is potentially payable by a buyer in these circumstances.
The CGT exemption for non-residents does not apply to assets used by a non-resident in carrying on a trade or business wholly or partly at or through a PE in Australia.
The ATO has also historically argued that disposals by overseas private equity funds may have an Australian source and be taxable on revenue account and therefore not benefit from the exemption for non-residents on capital gains on Australian shares. In such cases, the source of the gain will be critical in determining Australian taxing rights and recent tax law indicates a liberal interpretation of Australian source has been adopted by the courts.
Where a purchase of assets is contemplated, the seller’s main concern is likely to be the CGT liability arising on assets acquired after 19 September 1985. Where the sale is of a whole business or a business segment that was commenced on or before 19 September 1985, the seller normally seeks to allocate as much of the price as possible to goodwill. Payment for goodwill in these circumstances is generally free from Australian income tax, unless there has been a majority change in underlying ownership of the assets.
The CGT liability may also be minimized by favorably spreading the overall sale price of the assets in such a way that above-market prices are obtained for pre-CGT assets and below-market prices obtained for post-CGT assets. Such an allocation may be acceptable to the buyer because it may not substantially alter the CGT on sales.
However, the prices for all assets should be justifiable; otherwise, the ATO may attack the allocation as tax avoidance or non-arm’s length. The buyer would also be keen to review the allocation, with particular reference to those assets that have the best prospects for future capital gains.
The seller is concerned about the ability to assess the amount of depreciation recouped where depreciable assets (other than buildings) are sold for more than their tax written-down value.
The excess of consideration over the tax written-down value is included in assessable income in the year of sale as a balancing adjustment and taxed according to the normal income tax rules. Where a depreciable building is sold, no such balancing adjustment is generally made. Where a depreciable asset (other than a building) is sold for less than its tax written-down value, the loss is deductible as a balancing deduction in the year of sale. This balancing deduction is not treated as a capital loss.
Strictly speaking, the seller is also required to include as assessable income the market value of any trading stock sold, even though a different sale price may be specified in the sale agreement. As noted earlier, the ATO’s usual practice is to accept the price paid as the market value.
Stamp duty is payable by the buyer but inevitably affects the price received by the seller.
GST considerations are also relevant to the seller. As noted above, the sale of assets may be a taxable supply unless the sale qualifies as a GST-free supply of a going concern. Where the going concern exemption is not available, the types of assets being transferred need to be considered individually to determine the applicable GST treatment. Consequently, the GST treatment of an asset transaction may impact the purchase price commercially agreed to by the parties where the GST may not be recoverable to the buyer (in part or in full) or if stamp duty applies to the transaction (as stamp duty is generally payable by the buyer based on the GST inclusive price). While the sale and purchase of shares do not attract GST, full ITCs may not be available for GST incurred on transaction costs associated with the sale or purchase.
However, a reduced ITC may be available for certain prescribed transaction costs.
Where the seller company has carried forward losses, the sale of business assets does not ordinarily jeopardize its entitlement to recoup those losses. However, the seller company may be relying on satisfaction of the same or similar business test (see ‘Tax losses’ above) to recoup the losses (e.g. due to changes in the ownership of the seller since the year(s) of loss). Care is then required, as the sale of substantial business assets could jeopardize satisfaction of this test and lead to forfeiture of the losses.
Where a purchase of shares is contemplated, the seller may have several concerns, depending on the seller’s situation. Potential concerns include the following.
- Current or carried forward losses remain with the company, so they are unavailable to the seller where the shares in the company are sold. If the seller currently has an entitlement to such losses without recourse to the same or similar business test, this entitlement is not forfeited when the business assets are sold and the seller may be able to inject new, profitable business to recoup these losses. Similarly in a share sale scenario, where the target company is included within the seller’s tax consolidated group prior to sale, the seller retains the tax losses.
- Where the seller acquired all or part of its shareholding after 19 September 1985, the sale of shares has CGT consequences and a capital gain or loss may accrue. Where the acquisition is achieved by way of a share swap, CGT rollover relief may be available. Where the target company forms part of the seller’s tax consolidated group, the seller is treated as if it had disposed of the assets of the target company; any gain is calculated as the excess of the sale proceeds over the tax cost base of the assets (less liabilities) of the target company. Where the liabilities of the target company exceed the tax cost base of the target’s assets, a deemed capital gain arises for the seller. The buyer may request indemnities or warranties (usually subject to negotiation).
- Any gain on the sale of pre-CGT shares may also be assessable where the seller is dealing in shares or where the seller purchased the shares either with the intention of sale at a profit or as part of a profit-making endeavor.
- For shares in a private company or interest in a private trust acquired before 20 September 1985, where the value of the underlying assets of a company or trust acquired after 19 September 1985 represents 75 percent or more of the net worth of the company or trust, CGT may be payable.
Company law and accounting
Corporations Act 2001 and IFRS
- The Australian Corporations Act 2001 (Corporations Act) governs the types of company that can be formed, ongoing financial reporting and external audit requirements, and the repatriation of earnings (either as dividends or returns of capital).
- Australian accounting standards issued by the Australian Accounting Standards Board (AASB) are effectively the equivalent of International Financial Reporting Standards (IFRS). The acquisition of a business, regardless of whether it is structured as a share acquisition or asset acquisition, is accounted for using purchase under business combination accounting in accordance with AASB 3 Business Combinations (AASB 3).
- Under purchase business combination accounting, all identifiable assets and liabilities are recognized at their respective fair values on the date that control of the business is obtained. Identifiable assets may include intangible assets that are not recognized on the target’s balance sheet. These intangible assets may have limited lives and require amortization.
- In a business combination, liabilities assumed include contingent liabilities, which are also recognized on the balance sheet at their estimated fair value.
- The difference between consideration paid (plus the balance of non-controlling interest at acquisition date and the acquisition date fair value of the acquirer’s previous interest in the asset) and the ownership interest in the fair value of acquired net assets represents goodwill. Goodwill is not amortized but is tested for impairment annually. Any negative goodwill impairment is recognized immediately in the income statement.
- Transaction costs associated with business combinations occurring in fiscal years commencing on or after 1 July 2009 are expensed as incurred. Acquisition-related costs are generally expensed as incurred with the exception of costs relating to the issuing of debt or equity securities.
- The reorganization of businesses under the control of the same parent entity is outside the scope of AASB 3 accounting standards. Typically, these such restructurings occur at book values, with no change in the carrying value of reported assets and liabilities and no new goodwill. Again, transaction costs associated with these common control transactions are generally expensed as incurred.
Generally, all substantial Australian companies have an obligation to file audited financial statements with the Australian Securities and Investments Commission (ASIC). ASIC monitors compliance with the Corporations Act. These financial statements are publicly available. SGEs also now have an obligation to prepare General Purpose Financial Statements.
Filing relief may be available for certain registered foreign companies and Australian entities by taking advantage of class order relief granted by ASIC.
Payment of dividends
The payment of dividends by companies to their shareholders is governed by the Corporations Act, general law and the relevant company’s constitution in conjunction with the accounting standards and taxation law.
Under the Corporations Act, a company currently cannot pay a dividend to its shareholders unless its assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend. The dividend payment must also be fair and reasonable to shareholders as a whole and must not materially prejudice the company’s ability to pay its creditors.
The above requirements replaced the former statutory profits-based test, which provided that a company could only pay a dividend out of profits. However, it seems that the general law principle remains that dividends may only be paid out of profits. Furthermore, if the company’s constitution provides that dividends may only be paid out of profits, then that profits-based test must be complied with for the dividend to be valid and not potentially constituting an unlawful reduction of capital. Based on this, it is likely that a dividend declared other than out of profits (e.g. by relying on the net assets test only) would constitute an unlawful reduction of capital (as the Corporations Act prescribes a procedure that must be followed to effect a capital reduction). As a result, companies need to ensure all legal requirements are met and avoid dividend traps (i.e. the inability to stream profits to the ultimate shareholder due to insufficient profits and assets within a chain of companies). Note that for income tax purposes, the ATO’s view is that a dividend needs to be paid out of profits in order for a shareholder to obtain a credit for the tax paid by the company.
The assessment of whether the applicable requirements have been met (including in relation to available profits) for the declaration of a dividend is determined on a stand-alone, legal-entity-by-legal-entity basis, not the consolidated position of the corporate group. This entity-by-entity assessment requires planning to avoid dividend traps. Appropriate pre-acquisition structuring helps minimize this risk. Australian law does not have a concept of par value for shares. As mentioned above, the Corporations Act prescribes how share capital can be reduced, including restrictions on the redemption of redeemable preference shares.
Where the buyer owns other Australian companies and has elected to form an Australian income tax consolidated group, the target company becomes a subsidiary member on acquisition. Only wholly owned subsidiaries can join an Australian tax consolidated group.
Issues that arise as a result of the tax-consolidation regime for share acquisitions are as follows.
- A principle underlying the income tax consolidation regime is the alignment of the tax value of shares in a company with its assets. On acquisition, it may be possible to obtain a step-up in the tax value of assets of the newly acquired subsidiary when it joins a consolidated group by pushing down the purchase price of the shares to the underlying assets. The acquiring company is effectively treated as purchasing the assets of the target company, including any goodwill reflected as a premium in the share price above the value of the net assets of the company.
- Because the tax basis of a target’s CGT assets is reset, the acquiring company can dispose of unwanted CGT assets acquired as part of the acquisition with no tax cost.
- Each corporate member of a tax consolidated group or GST group is jointly and severally liable for the tax and GST liabilities of the whole group. As noted above, this liability can be limited where the companies within the group enter into a tax-sharing agreement (or indirect tax-sharing agreement for GST purposes). When acquiring a company that is or has previously been a member of an income tax or GST consolidated group, it is important to determine the extent of its exposure for the tax liabilities of its previous group and mechanisms to reduce this exposure.
- Where an Australian entity is acquired directly by a foreign entity and the foreign entity has other Australian subsidiaries that have formed a tax consolidated group, there is a decision to be made as to whether or not to include the newly acquired Australian entity in the tax consolidated group by restructuring the group so that the newly acquired entity is held by a member of the existing tax group, and therefore automatically becomes a member of the tax consolidated group. In order to achieve any step up in the value of underlying assets of the newly acquired entity under the purchase price allocation rules, the restructuring must take place within 12 months of acquisition by the foreign entity.
- Alternatively, where the Australian entity is acquired by an existing Australian entity that forms part of an income tax consolidated group, the newly acquired Australian entity is automatically included in the existing group. However, a newly acquired Australian entity is not automatically included in an existing GST group.
- The historical tax expense and cash flow of the target company is no longer a valid indicator for projecting future cash tax payments. The resetting of the tax base in the assets of the company makes tax modeling for the cash outflows more important.
Australia has a complex regime for the taxation of international related-party transactions. These provisions specify significant contemporaneous documentation and record-keeping requirements.
The transfer pricing rules focus on determining an arm’s length profit allocation and provide the Commissioner of Taxation with broad powers of reconstruction in respect of international related-party dealings.
In terms of key developments that are relevant for M&A, these are outlined below.
Chevron case: The decision in the Chevron case is significant from an Australian tax perspective. The case involved the transfer price applied to an A$3.7 billion intercompany loan agreement used to fund development of gas reserves. The decision resulted in an A$340 million tax bill for Chevron.
In the decision, among other things, the Full Federal Court relied on evidence regarding the financing and treasury policies of the ultimate parent in determining how the shareholder loan should be priced, and considered that Chevron was unable to discharge its onus of proof that the loan as structured would be entered into by third parties. Further, the Chevron case confirmed that the Chevron subsidiary’s membership in the global group should be considered when pricing the loan, i.e. implicit parent support applied. The decision is important as it has led to the release of PCG 2017/4, which is the ATO’s risk assessment framework for intragroup loans (with a higher risk rating typically applying if the shareholder loan interest rate deviates materially from a relevant third party debt or global cost of debt of the group).
Glencore case: The ATO recently lost a transfer pricing case to Glencore in the Federal Court. In this case, the ATO sought to reconstruct terms of the tested transaction in question (and cited the Chevron case to support their argument). However, the Court determined that Glencore was able to discharge its onus of proof and support, through contemporaneous commercial evidence and relevant market and pricing data, that the terms of its tested transaction were commercially rational, and subsequently that the pricing was arm’s length. The ATO has appealed the case to the Full Federal Court.
General anti-avoidance rule
The GAAR (Part IVA) can apply where:
- a taxpayer enters into a scheme
- the taxpayer obtains a tax benefit from the scheme
- the circumstances indicate that the obtaining of that tax benefit was a dominant purpose of one of the parties
- if the GAAR applies to a scheme, the Commissioner may cancel the tax benefit, make compensating adjustments and impose substantial penalties.
Diverted profits tax
As of 1 July 2017, the diverted profits tax (DPT) gives the ATO more powers to deal with global groups that have ‘diverted’ profits from Australia to offshore associates in jurisdictions with a tax rate of less than 24 percent, using arrangements that have a ‘principal purpose’ of avoiding Australian income or WHT. The DPT can apply to both Australian inbound and outbound groups, where an entity in the group is an SGE.
If the DPT applies, income tax is payable on the amount of the ‘diverted profit’ at a rate of 40 percent. There is a risk that the mutual agreement procedure in Australia’s tax treaties would be unavailable where DPT applies — in which case unalleviated double taxation can result.
Australia has introduced MAAL as an anti-avoidance rule targeting multinationals and in particular targets schemes that limit a taxable presence in Australia. The MAAL applies to certain schemes on or after 1 January 2016 irrespective of when the scheme commenced.
In order for the MAAL to apply to a proposed transaction or scheme, all the following conditions would need to be satisfied:
- a foreign entity (that is an SGE) makes a supply (of goods or services excluding debt or equity) to Australian customers;
- activities are undertaken in Australia directly in connection with those supplies by an Australian entity who is associated or commercially dependent on the foreign entity;
- the foreign entity derives income from those supplies, some or all of which is not attributable to a PE in Australia of the foreign entity; and
- there is a principal purpose of obtaining an Australian tax benefit or to obtain both an Australian and a foreign tax benefit.
Where the MAAL applies, the Commissioner can cancel any tax benefits an SGE and its related parties obtain from certain schemes meeting the above characteristics.
Dual residency is unlikely to give rise to any material Australian tax benefits and could significantly increase the complexity of any transaction.
Foreign investments of a local target company
Where an Australian target company holds foreign investments, the question arises as to whether those investments should continue to be held by the Australian target company or whether it would be advantageous for a sister or subsidiary company of the foreign acquirer to hold the foreign investments.
Australia has a comprehensive international tax regime that applies to income derived by controlled foreign companies (CFCs). The objective of the regime is to place residents who undertake certain passive or related-party income earning activities offshore on the same tax footing as residents who invest domestically.
Under the current CFC regime, an Australian resident is taxed on certain categories of income derived by a CFC if the taxpayer has an interest in the CFC of 10 percent or more. A CFC is broadly defined as a foreign company that is controlled by a group of not more than five Australian residents whose aggregate controlling interest in the CFC is not less than 50 percent. However, a company may also be a CFC in certain circumstances where this strict control test is not met but the foreign company effectively is controlled by five or fewer Australian residents.
Taxpayers subject to the current CFC regime must calculate their income by reference to their interest in the CFC. The income is then attributed to the residents holding the interest in the CFC in proportion to their interests in the company — that is, the Australian resident shareholders are subject to tax in Australia on their share of the attributable earnings of the CFC.
Any income of a CFC that has been subjected to foreign or Australian tax can offset that amount with a credit against Australian tax payable. Excess credits may be carried forward for up to 5 income years. The income of a CFC generally is not attributed where the company is predominantly involved in actively earning income.
Given the comprehensive nature of the CFC regime and the few exemptions available, the Australian target company may not be the most tax-efficient vehicle for holding international investments. However, due to conduit relief, Australia may in some cases be a favorable intermediary holding jurisdiction. In particular, Australia has broad participation exemption rules that enable dividend income sourced from offshore subsidiaries and capital profits on realization of those subsidiaries to be paid to non-resident shareholders free from domestic income tax or non-resident WHT.
Foreign investment into Australia
Australia has a foreign investment review framework that requires certain proposals by foreign persons to be lodged with the FIRB and approved by the Treasurer before they are implemented. The package of legislative reforms that commenced on 1 January 2020 represents the most significant changes to Australia’s foreign investment regime since it was introduced over 45 years ago. The primary objectives of the reforms are to provide for:
- certain transactions involving ‘national security businesses’ and ‘national security land’ to be notified regardless of the size of the transaction and for approval to be granted by the Treasurer if satisfied that the transaction is not contrary to ‘national security’;
- the Treasurer to have the power to call-in certain investments (of any value and that have not previously been notified to FIRB) for a national security review and for the Treasurer to be able to impose conditions on the acquirer or give directions or make orders to stop the transaction (if it has not occurred) or to require the acquirer to divest if the transaction raises national security concerns;
- the Treasurer to have a ‘last resort power’ under which an approved transaction may be the subject of further review if national security risk arises in respect of the approved transaction and since the original approval the business, structure or organization of the person has changed, or the person’s activities have changed, or the circumstances or market have changed, or the Treasurer becomes aware of a relevant material omission or misstatement by the foreign person. In order to minimize or eliminate the national security risk, the Treasurer may impose conditions, or vary or revoke existing conditions that apply to the original approval and may make orders prohibiting an action or requiring the undoing of a part or whole of an action (including, as a last resort, requiring divestment);
- stronger enforcement, monitoring and investigative tools to promote and enforce compliance with the legislation and conditions imposed on approvals given by the Treasurer;
- substantially increased penalties for breach of criminal and civil penalty provisions to act as an effective deterrent to non-compliance; and
- a new regime for the calculation and imposition of fees on foreign investment applications.
Previous amendments to the foreign investment regime increased the involvement of the ATO in ensuring compliance and enforcement of critical aspects of the regime (particularly in relation to residential property). The ATO also plays a key role in the assessment of applications since taxation compliance is an aspect of the national interest test that the Treasurer will consider in determining an application. The Treasurer may, on the recommendation of the ATO in the FIRB application process, impose tax conditions on FIRB approvals to ensure ongoing compliance with Australian tax law.
Determining whether an application for approval is required to be made to FIRB depends on a range of factors that must be carefully assessed case-by-case. These factors include the type of investor, the type of investment, the industry sector in which the investment will be made and the value of the investment.
To avoid delays, it is crucial for foreign investors to consider at an early stage of any transaction whether approval under Australia’s foreign investment regime will be required.
Comparison of asset and share purchases
Advantages of asset purchases
- Step-up in the tax value of all assets (minor exceptions only).
- A deduction is available for trading stock purchased.
- Possible to acquire only part of a business.
- Not subject to takeover legislation (but may be subject to stock exchange listing rules).
- May qualify as a GST-free supply of a going concern.
- May minimize GST leakage on transaction costs.
Disadvantages of asset purchases
- Complexity of renegotiating/transferring supply, employment, technology and other agreements.
- Higher rates of transfer (stamp) duties.
- Benefit of any tax attributes of the target company remains with the seller.
- Need to consider whether the GST going concern exemption is available.
- Requirement to consider GST treatment of individual assets where GST-free going concern exemption is not available.
- Potential impact of transfer taxes (GST and stamp duty) on negotiated purchase price.
Advantages of share purchases
- Lower capital outlay (purchase net assets only).
- Potential to step-up the tax value of certain assets in a 100 percent acquisition.
- Less complex contractually and likely more attractive to seller.
- May benefit from tax attributes of the target company (unless the target company was a member of a tax consolidated group).
- Lower or no stamp duties payable (if not predominantly land).
- Acquisition of shares should be either input taxed (exempt) or GST-free (zero rated).
Disadvantages of share purchases
- Liable for any historic claims or liabilities of the entity, including joint and several liability for tax debts of seller’s consolidated group where no valid tax-sharing agreement exists.
- Target company losses remain with the seller where the target company exits the seller’s tax consolidated group.
- GST leakage may arise on transaction costs if full ITCs are not available.
Regional Leader M&A Tax
Tower 3, 300 Barangaroo Avenue
Sydney NSW 2000 Australia
T: +61 2 9335 8288
National Lead, Deals Advisory — Tax
Tower 3, 300 Barangaroo Avenue
Sydney NSW 2000 Australia
T: +61 2 9335 7888
Tower 2, Collins Square
727 Collins Street
Melbourne VIC 3008
T: +61 3 9288 5618
This country document does not include COVID-19 tax measures and government reliefs announced by the Australian government. Please refer below to the KPMG link for referring jurisdictional tax measures and government reliefs in response to COVID-19.
Click here — COVID-19 tax measures and government reliefs
This country document is updated as of 31 January 2021.