In a recent decision of the Full Bench of the Federal Court, the Court had to consider whether or not the scrip for scrip roll over provisions applied in a takeover transaction in the context where the original entity and the replacement entity did not have at least 300 members and the shares in the replacement entity that were exchanged for shares in the original entity had different rights to the original shares.
The scrip for scrip roll over provisions provide that the following conditions must be satisfied if the parties do not deal with each other at arm’s length and neither the original entity nor the replacement entity had at least 300 members just before the arrangement started or the original interest holder, the original entity and the acquiring entity were all members of the same linked group:
- the market value of the original interest holder’s capital proceeds for the exchange of shares must be the same as the market value of the original interest holder’s original shares, and
- the replacement shares must carry the same rights and obligations as those attached to its original interest.
Therefore the question of whether or not the parties dealt with each other at arm’s length was vital to the question of whether or not the scrip for scrip roll over provisions were available.
In this case it was accepted that the relationship between the original interest holder and a party acting on behalf of the acquiring entity was an arm’s length one. The only issue was whether the original interest holder and the party acting on behalf of the acquiring entity dealt with each other “at arm’s length”.
The Commissioner submitted that original interest holder and the party acting on behalf of the acquiring entity did not deal “at arm’s length” because the latter’s role in structuring the transactions so as to minimise the tax payable by the original interest holder resulting from any capital gain arising from the disposal of the shares in the original entity meant that the acquiring entity did not deal with the original interest holder “at arm’s length”. The Commissioner also argued that the parties had “colluded” to achieve the purpose of minimising tax independently of, and in addition to, the commercial purposes they were pursuing.
The majority rejected these arguments.
The majority applied the general principles in the earlier case law as to whether or not parties are dealing with each other at arm’s length. They held that it does not follow that because an offeror structures an arrangement in order to attract the offeree’s acceptance of the offer by structuring the bid to take advantage of the scrip-for-scrip roll-over relief that the offeror was not acting in its own interests or that the parties were not acting severally and independently in forming their bargain or that there was collusion between the parties. The fact that a transaction is devised to obtain a revenue advantage to the original interest holder does not mean that the transaction is a nonarm’s length one.
The Court noted that if the Commissioner’s submission was taken to its logical conclusion, it would be difficult to conceive of any circumstances in which parties to an arrangement under which roll-over relief is provided could to be said to be an arm’s length transaction.
In relation to the application of Part IVA, interestingly in rejecting the alternate postulate proposed by the Commissioner because the transaction would not have been carried out in the way set out in the alternative postulate as the party acting on behalf of the acquiring entity would not have received under the alternate postulate the substantial underwriting fee that flowed from the manner in which the scheme was carried, the majority of the Court (with whom the dissenting judge agreed on this point) made some criticism of the use of the alternate postulate.
The Court noted that in litigation concerning Part IVA where the focus is on the “scheme” and the “alternative postulate” identified by the parties, there is a real risk of creating considerable artificiality often divorced from commercial reality. Perhaps there may be some movement in the future on the application of Part IVA where the result of the application is divorced from commercial reality.