A merger or takeover arrangement must meet a number of requirements to qualify for capital gains tax rollover relief. These include:
- that all holders of voting interests in the target entity are able to participate in the arrangement, and
- that this participation must be on substantially the same terms.
Ideally, the (non cash) scrip component for a bid or offer should not be immediately taxable to the vendor shareholders – that is, tax on this scrip component of the gain should be deferred. Commercially this can be important because the vendor shareholders will otherwise need to fund the tax on this component of consideration out of their own funds, which makes the offer less attractive.
Earlier this year the Rudd Government announced that it would change the CGT rollover rules for all CGT events involving shares or units (scrip) that happen on or after 6 January 2010. Essentially, the proposed amendments broaden the circumstances in which CGT rollover relief would be available in relation to a takeover bid or scheme of arrangement (the proposed new rules are summarised below). While the proposed amendments were generally welcomed by the market, the reforms are in limbo. The amendments to the scrip for scrip rules were introduced as part of Tax Laws Amendment (2010 Measures No. 4) Bill 2010 on 23 June 2010, but this Bill lapsed when the election was announced and the Parliament prorogued. Not surprisingly this has created substantial uncertainty, including whether the proposed reforms will be reintroduced by the new government in the same form and, if they are reintroduced, whether they will apply retrospectively to CGT events occurring after 6 January 2010.
To provide some relief for investors who may have already relied on the proposed amendments, the ATO announced that tax returns can be lodged but assessments will not be reviewed until the outcome of the proposed amendments is known. At that time, taxpayers will need to review their position. Taxpayers who:
- did not choose rollover relief can seek amendments and if a reduction in liability results, interest on overpayment will be paid, and
- chose to anticipate the rollover relief, but find that this does not accord with the changes will need to seek amendments.
The ATO’s administrative concessions provide shareholders with the benefit of deferred assessment. However, the ultimate tax treatment of a scrip bid that relies on the reforms announced on 6 January 2010 remains uncertain and in limbo (because it will not qualify under the current law). In those circumstances none of the bidder, the target directors or the target shareholders will be able to know for certain whether scrip for scrip rollover relief will eventually be available.
This state of uncertainty creates tax limbo for a number of M&A deals, raises disclosure issues for directors and creates uncertainty for shareholders if asked to accept bids prepared in anticipation of the proposed changes. Accordingly, in the interests of certainty and in the interim, it will be preferable to ensure any takeover bid or scheme meets the existing CGT rollover requirements.
If reintroduced and passed, the CGT rollover rules will more closely align the tax requirements with the requirements of the Corporations Act as described below. Although the proposed new arrangements arguably do not significantly alter the position for takeover deals, they do significantly improve arrangements undertaken by way of a court approved scheme.
Summary of the proposed new rules
Under the proposed new rules, a single arrangement that results in the bidder increasing its interests to at least 80% is ‘exempt’ from the requirement that the arrangement must be one in which all of the target company’s shareholders can participate on substantially the same terms. It fulfils these rules if it is undertaken as either:
- a takeover bid (that is not carried out in contravention of the provisions mentioned in section 612 of the Corporations Act), or
- a compromise or arrangement entered into under Part 5.1 of the Corporations Act, approved by a court under paragraph 411(4)(b) of the Corporations Act (an approved scheme of arrangement).
A similar carve-out is included for arrangements involving trusts. However as a trust cannot currently undertake a scheme of arrangement, this carve-out only applies in relation to takeover bids (that do not contravene key provisions in Chapter 6 of the Corporations Act)1.
How does this help?
Commercially there are many good reasons for ‘locking in’ a significant stakeholder as part of any bid (including to deter rival bids). There has been some uncertainty as to whether this would disqualify a bid from being made under a single arrangement and whether the offer is on substantially the same terms. This potential area of uncertainty is significantly improved under the proposed amendments. Example 5.2 from the Explanatory Memorandum is helpful in this regard:
Green Ltd (Green) and Yellow Ltd (Yellow) jointly announce a proposal to merge where Yellow’s voting shares are transferred to Green. Yellow’s shareholders will participate in the merger on the following basis:
- Green acquires shares owned by a cornerstone shareholder (Blue Ltd) for cash by way of a sale agreement.
- Owners of the remaining voting shares in Yellow receive one share in Green for each share they hold in Yellow. This acquisition is by way of a scheme of arrangement under Part 5.1 of the Corporations Act.
- The merger is conditional upon Green successfully completing both acquisitions.
Obtaining court approval under paragraph 411(4)(b) of the Corporations Act will satisfy the requirements of paragraph 124-780(2A)(b).
There are also many sound commercial reasons why offers need to be made on different terms. The good news is that these offers may be eligible for rollover where they are undertaken by way of a court approved scheme – once the bill is passed!
This article is from our August 2010 edition
of Mergers & Aquisitions newsletter.