Australia has a complex system of taxation including a Federal income tax, capital gains tax and goods and services tax (GST) and eight separate State and Territory systems of duties and taxes. Tax planning is therefore important to maximise after-tax investor returns. The following guide sets out some high level issues to consider on a global M&A deal where the target is an Australian company or business or where downstream Australian subsidiaries are involved.
Minter Ellison has an experienced team to advise and assist you with any Australian tax issues that may arise on your deal including:
- Documenting and evidencing your deal, including managing key taxation risks;
- preparing and negotiating tax rulings where appropriate (income tax, GST and stamp duty);
- Advising on funding, equity and governance structures and arrangements;
- Advising on relevant withholding taxes and appropriate gross up clauses;
- Advising on Indirect taxes such as GST and stamp duty and assisting with rulings and registrations.
We trust this guide will provide some useful insights into the Australian tax issues for M&A transactions. Please contact Minter Ellison should you require any further assistance or information in relation to these matters.
Choice of Acquisition Vehicle
A foreign investor looking to acquire an Australian business may acquire either the assets directly (using a branch or special purpose vehicle) or the membership interests in the existing ownership vehicles (eg an interest in a trust or shares in a company) – including using a branch or special purpose vehicle.
An Australian company is often the preferred acquisition vehicle where:
- the target will be 100% acquired (Note – there may be a resetting of the target’s tax cost base of assets where an election is made to form a tax consolidated group. However, a tax reset may not be beneficial where the historical tax cost of assets is greater than the current market value of the assets);
- local finance and security is sought;
- an Australian initial public offering is anticipated for the new group;
- a foreign entity does not wish to register as a foreign company carrying on business in Australia (which triggers a requirement to lodge financial reports for the global group in Australia); or
- Australia will be a conduit to flow through foreign dividends and capital gains.
An Australian trust is usually the preferred acquisition vehicle where the assets are eligible for capital allowance deductions or capital works deductions (eg building allowances) so that tax preferred cash distributions can be made. A trust may also facilitate a pass through or flow through of classes of income which may have lower withholding rates – for example; interest, exempt capital gains, discount capital gains.
Other variations and structures may be appropriate depending on the particular deal circumstances. For example, most mining projects or mining tenements are held through an unincorporated joint venture which may raise further tax considerations.
What to acquire – Shares or Assets?
The choice between the acquisition of assets or shares is usually determined on a case by case basis. Although tax considerations will not be the only considerations, they will be material in the M&A strategy for the purchaser group, particularly in a share acquisition case where the tax risk is inherited with the entity acquired.
A tax consolidated group consists of an Australian head company and its wholly owned Australian entities. The consolidation rules also permit two (2) or more resident first-tier wholly owned subsidiaries of a foreign holding company to form a multiple entry consolidated (MEC) group.
The consolidation rules ensure minimal tax consequences arise where an existing consolidated group is converted to a MEC group or an existing MEC group is converted to a consolidated group.
The consolidation regime allows franking credits, and potentially revenue and capital losses, of a target company to be transferred to the Australian head company purchaser. These tax attributes can be of value to an acquiring entity. The tax consolidation regime provides certain cost base advantages (refer below) but can also have adverse consequences and due to its complexity should be subject to specific advice.
Company losses are generally only available to carry forward where either a continuity of ownership test or same business test has been satisfied. These rules are modified for entities joining a tax consolidated group. In addition, losses may only be used at a rate that is based on the relative market value of the loss entity to the tax consolidated group. From 1 July 2012, companies will be able to carry back losses of up to $1 million to obtain a refund of tax in the 2011/2012, income year. These measures have been repealed effective from 1 July 2013.
Tax Cost base
The tax cost of most assets (including buildings and certain intangible assets) used in a business can give rise to annual tax deductions and shelters. Therefore, the tax cost base that can be attributed to assets when acquired directly, or indirectly through an entity acquisition, is important for financial modelling and investor returns.
The acquisition of assets is relatively straightforward from an income tax perspective. The price paid by the acquirer for each asset is usually agreed between the seller and buyer and this determines the tax cost of the assets for the purchaser, provided the parties are dealing at arms length.
Since the introduction of a tax consolidation regime in Australia in 2002, the purchase price for shares in 100% entity acquisitions can be ‘pushed down’ to the underlying assets of the entity acquired so that a tax cost base is set which ‘approximates’ the cost base that would arise for an asset acquisition.
A resetting of tax cost base may be disadvantageous where the ‘push down’ process results in a lower tax cost base for assets than the historic tax cost base of assets.
The tax cost base of assets may also be varied under earn-out arrangements, that is, arrangements that operate post completion of the purchase/sale, that require the purchaser to pay a further amount for the assets (standard earn-out) or entitle the purchaser to be repaid an amount in respect of the acquisition of assets (reverse earn-out). The tax consequences of such arrangements are currently uncertain (as they are subject to ongoing Treasury consultation) and specific advice should be sought where earn-out arrangements are contemplated.
Tax Treatment of Acquisition Costs
Acquisition costs (eg investment banking fees, professional advisor fees, etc) relating to the acquisition of shares (held on capital account) are generally considered to be capital, not deductible and form part of the cost base of the shares. However, in appropriate circumstances capital costs may be deducted over 5 years. Borrowing costs (eg loan establishment fees) are deductible over the period that is the shorter of:
- the term of the borrowing; or
- 5 years from the date of the borrowing.
The CGT rules are also varied for some straddle contracts, ie an entity enters a contract to sell an asset which completes after the entity leaves a consolidated group or after the entity joins another consolidated group.
It is market practice to provide that any claim made against a tax warranty is to be treated as an adjustment to the sale price (up to the limit of the consideration provided). As disclosure will typically exclude any warranty claim, it is important to ensure the warranties are drafted after considering all relevant disclosures. That is, after conducting appropriate tax due diligence, considering all relevant data room materials and any disclosures made as part of the other sale discussions and investigations. This is also critical where warranty and indemnity insurance is to be obtained.
Tax Indemnities & Statutory Clean exit
All members of a tax consolidated group can be jointly and severally liable for the unpaid liabilities of the group even after a member leaves the group. Therefore, if the target is an Australian entity that was a member of a tax consolidated group, care should be taken to limit as far as possible the purchaser’s exposure to the unpaid tax liabilities of the vendor’s tax consolidated group.
This can be done provided the group has entered a valid tax sharing agreement and by ensuring that the target company achieves a statutory clean exit (ie a clean exit prescribed under the Tax Act) which is backed up by specific tax warranties and/or indemnities. Specific advice should always be sought to ensure the purchaser is sufficiently protected when acquiring entities out of a tax consolidated group.
Taxes Payable by the Vendor Group on exit
The vendor group will reset the tax cost base of any equity interests in a subsidiary that leaves a consolidated group (eg by way of sale or issue of shares or units to entities outside the consolidated group).
The tax cost base of equity interests in a leaving subsidiary is broadly the excess of the tax cost base of the leaving entity’s assets over the leaving entity’s liabilities at the leaving time.
The resetting process may trigger a capital gain for the head company of the vendor group where the subsidiary’s accounting liabilities exceeds the tax cost base of assets.
Debt for equity swaps may trigger both an exit and a capital gain for the head company of the vendor group where the swap results in a member leaving the group and therefore the balance sheet of the leaving entity needs to be carefully considered.
Cash or Share Consideration
The choice between cash and share (ie ‘scrip’) consideration is a complex commercial decision. Scrip consideration may allow the vendor shareholders to ‘defer’ the immediate tax consequences of any gain on disposal – that is, where rollover relief is available.
Existing resident shareholders are generally taxed on any consideration received for the disposal of their shares. Non-resident shareholders are generally not taxed unless the Australian entity is land-rich for capital gains tax purposes. The scrip for scrip rollover concessions may defer tax to the extent the consideration is shares in either the acquiring entity or its ultimate parent entity. The scrip concessions are currently only available where:
- the purchaser acquires or increases its shareholding to 80% or more; and
- there is a like for like exchange – shares for shares, units for units but not shares for units.
The Australian Government relaxed the scrip for scrip rollover requirements for takeovers and mergers under the Corporations Act 2001 with effect from 6 January 2010. Takeovers and schemes of arrangement after this time will not need to involve an offer to all voting shareholders and will not need to be on substantially identical terms for all shareholders. The other requirements for the rollover relief will continue to apply including the requirement to acquire at least 80% of the target.
Non-resident shareholders that are not taxable on a share sale are not eligible for rollover relief.
To the extent cash (or any other ineligible property) is received for a disposal of shares, scrip for scrip rollover relief will not be available to the seller.
Funding Issues & Profit Repatriation
Australian profits may be repatriated by an Australian resident company to an offshore parent in a variety of ways including:
- interest on related party loans;
- dividends (only companies);
- royalties on the use of technology and intellectual property;
- management fees;
- secondment fees; or
- other charges
With the exception of dividends and subject to transfer pricing considerations, each of the abovementioned methods of profit repatriation is generally tax deductible to an Australian entity or branch in calculating its taxable income.
Withholding Taxes - Interest, Dividends and Royalties
When interest, unfranked dividends (ie dividends paid out of company profits which have not been subject to full Australian tax), or royalties are paid by an Australian resident to a non-resident, withholding tax potentially applies.
The withholding tax rates are as follows:
- Interest at 10%;
- unfranked dividends at 30%; and
- royalties at 30%.
These rates are generally reduced under an applicable double tax treaty. Generally the treaty rates are as follows:
- Interest at 10%;
- unfranked dividends at 15%; and
- royalties at 15%.
An exemption for dividend withholding tax can also apply to unfranked dividends that are declared to be conduit foreign income. Broadly, conduit foreign income comprises certain foreign income amounts including:
- foreign source dividends and branch profits,
- capital gains from the disposal of foreign companies undertaking active businesses, and
- certain foreign income sheltered by foreign tax credits in Australia.
The Government is proposing a new tax collection mechanism from 1 July 2016 which (if enacted) will require a purchaser of Australian assets to withhold 10 % of the purchase/sale proceeds where they are acquired from a foreign resident vendor. This proposal will have a significant impact on Australian M&A deals – including tax due diligence, tax warranties, tax indemnities and completion timetables.
Interest – Other Issues
The tax deductibility of interest on borrowings and related debt deductions is also subject to thin capitalisation limits. The thin capitalisation rules generally limit debt deductions to a maximum level based on ‘safe harbour’ debt to equity ratios of 1.5:1 (previously 3.1) (15:1 for certain deposit taking entities) or arms length debt financing principles. The general safe harbour debt limits effectively provide a safe harbour limit on debt deductions equal to 60% of the accounting value of assets (previously 75% of total assets).
External unrelated debt, related party non-interest bearing debt, loans, bills of exchange or promissory notes can all be counted towards the thin capitalisation limits.
Debt or equity
Australia applies an ‘in-substance’ rule for determining for some tax purposes (including withholding tax and thin capitalisation) whether a return on a financing instrument is to be treated as interest (ie a deductible return on debt) or as a dividend (ie a non-deductible distribution on equity which may be franked).
Under these rules it is possible, for example, to treat a share as a debt interest or a loan as an equity interest. Specific advice should always be sought as to the correct tax classification of any financing instrument. This is a current audit interest area for the Australian Taxation Office – especially for stapled groups.
Importantly, it should be noted that the debt or equity classification of interests in a company do not affect tax consolidation membership rules or eligibility for scrip for scrip rollover. For example a convertible loan note which is debt in form but equity for tax purposes, does not qualify as a membership interest for tax consolidation purposes. Furthermore, scrip for scrip rollover is potentially available for the exchange of a redeemable preference share (equity in form) even though it may be classified as a non-equity share for tax purposes.
Transactions between Australian and non-Australian related parties must be conducted at arm’s length prices. These transactions include the various ways of repatriating profits outlined above. The Commissioner of Taxation has the power to increase the profit attributable to an Australian resident entity where the Commissioner believes that its profits reflect dealings between related parties that are not on arms length terms. For example, an Australian entity paying excessive prices for products sourced from its non-resident parent could be subject to an adjustment.
Australia's transfer pricing rules were amended in 2012 with retrospective effect to 1 July 2004. The amendments affect transactions between related parties in countries which have a double tax agreement with Australia. These new rules allow the transfer pricing article iAustralia's tax treaties to be applied independently of the domestic transfer pricing rules and effectively permit a transfer pricing adjustment where the profits returned in Australia do not reflect arm's length conditions. The Government maintains that Australia's treaties have always provided a separate and independent basis for making transfer pricing adjustments.
The amendments also address the interaction between thin capitalisation and transfer pricing provisions and require that the arm's length rate of interest is determined having regard to the level of debt that is likely to exist where the parties are independent of each other.
Accordingly, even where the debt funding level is within the thin capitalisation limits, a transfer pricing adjustment may nevertheless arise where the rate of interest is excessive, having regard to arm's length principles.
Further substantial amendments were made with effect from 1 July 2013. These amendments apply to both treaty and non-treaty countries. The amendments can replace the actual conditions entered into between related parties with arm's length conditions in certain circumstances.
Australian Taxation Office Compliance Program
As part of the 2012-13 Compliance Program the Australian Taxation Office has noted that it will closely examine corporate restructures including M&A transactions where the arrangements are unnecessarily complex and the tax and economic outcomes are not aligned
Accordingly the need to seek specific tax advice has now become even more critical.
In 2013–14 the ATO will focus their compliance activities on companies that engage in practices designed to shift profits offshore or avoid tax obligations.
Goods & Services Tax (GST)
GST is payable (at a rate of 10%) on taxable supplies of goods and services made by enterprises registered or required to be registered for GST in Australia. Certain exemptions apply to supplies made to non residents. The issue or acquisition of shares is generally an input taxed financial supply which means that no GST is payable on the issue or acquisition of the shares.
Stamp duty in Australia may be relevant to asset, as well as share and unit acquisitions.
Transfer duty is generally substantially higher on the transfer of business assets as opposed to shares and units. Transfers of certain assets may be subject to duty at rates of up to 7%, but are generally approximately 5.5%. A transfer of shares in a private company, and a transfer of units in a private unit trust scheme, are subject to duty of 0.6% in New South Wales (abolition scheduled to be effective from 1 July 2016) and South Australia (abolition deferred indefinitely), however no transfer duty is payable on listed shares or units in any jurisdiction.
The transfer of shares or units in a land-rich or land-holding company or unit trust scheme can also attract the higher rates of duty in all jurisdictions which would have been payable on a direct transfer of the land assets (and in some cases certain goods) themselves. These higher rates of duty can be payable on a share/unit acquisition when the relevant entity or group holds land exceeding a minimum land value. The minimum land values vary amongst the jurisdictions and range from no minimum value (ACT) to $2,000,000 (New South Wales, Queensland and Western Australia). A dealing of units in a unit trust scheme that holds any dutiable property in Queensland or South Australia may also be subject to duty at transfer duty rates on the same general basis.
It is intended that the imposition of some stamp duties will be phased out in various jurisdictions over the next few years. Accordingly, from 1 July 2016, no stamp duty should be payable on acquisitions of business assets in New South Wales (together with Victoria, ACT, and Tasmania, which have already abolished this duty). No stamp duty is payable on mortgages or charges (it has been abolished by all jurisdictions), except for New South Wales, which is scheduled to abolish stamp duty on mortgages on 1 July 2016 (currently, loans/advances which are secured by property located in New South Wales can be liable for mortgage duty at a rate of 0.4%).
However, stamp duty will remain payable on the direct and indirect acquisitions of land assets/interests in land.