House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 2 - CGT and business restructures - Part 1: Share or interest sale facilities for foreign interest holders in a restructure

Outline of chapter

2.1 Part 1 of Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to ensure entities in a restructure can use a share or interest sale facility to deal with foreign held interests without Australian tax residents automatically failing a key requirement of certain capital gains tax (CGT) roll-overs.

2.2 For the purposes of this chapter, an interest holder is considered to be foreign where the issuing of an interest to that interest holder would be subject to a foreign law. This means that a foreign interest holder could also be an Australian resident for tax purposes or could own taxable Australian property.

2.3 All legislative references in this chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

2.4 Australian entities may have interest holders who are located in Australia or abroad. The issuing or transferring of interests when one of these entities restructures may be subject to a foreign law.

2.5 A share or interest sale facility (referred to as a 'share sale facility') is used by entities when they restructure as it:

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can be unreasonably onerous or impractical for those entities to comply with the requirements in each relevant foreign jurisdiction relating to the issuing or transferring of interests; and

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avoids inadvertent breaches of these requirements where entities, despite their best intentions, have not ascertained nor fully understood all the foreign law requirements.

2.6 Under a share sale facility, interests issued or transferred under an entity restructure in relation to the foreign interest holder's interest will be allocated to the share sale facility instead of to the foreign interest holder. The share sale facility owns these interests, but ultimately sells them and gives the capital proceeds (less expenses) to the former foreign interest holders.

2.7 However, the use of a share sale facility in an entity restructure may mean that certain requirements of any CGT roll-over relating to that restructure may not be able to be satisfied. A CGT roll-over allows a taxpayer to defer any capital gain or capital loss arising when a CGT event happens in the particular circumstances of the roll-over.

2.8 In particular, some CGT roll-overs for entity restructures require that all of the interest holders must exchange their interests in the original entity for interests in the new entity and that each interest holder owns the same, or in some instances substantially the same, percentage of interests in the new entity as they owned in the original entity (the 'same ownership requirements'). The entity restructure roll-overs that include these requirements are contained in the following provisions:

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Subdivisions 124-G, 124-H, 124-I, 124-N, 124-Q and 126-G; and

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Division 125.

2.9 The same ownership requirements generally cannot be satisfied where a share sale facility is used to deal with the interests of a foreign interest holder. This is because the interests are now owned by the share sale facility and not the foreign interest holder. Therefore, an entity with foreign interest holders may be reluctant to restructure because the interest holders that are Australian residents for tax purposes or that are foreign residents with taxable Australian property would not qualify for certain CGT roll-overs. If such a restructure occurs, these interest holders would face immediate CGT consequences from the realisation of their interests in the original entity.

2.10 Subdivisions 124-G and 124-Q and Division 125 already allow the same ownership requirements to be satisfied where a share sale facility is used to deal with certain foreign holders. However, Subdivisions 124-G and 124-Q simply disregard interests held by foreign holders rather than modifying the provisions so that the same ownership requirements can still apply to the interests held by the remaining holders. Subdivision 124-G also restricts this treatment to entities that are authorised deposit-taking institutions (ADIs).

2.11 For Division 125, the note to subsection 125-70(1) allows taxpayers access to the demerger roll-over where a share sale facility is used only if it entails a 'two step' process, involving a notional allocation of the interests to the interest holders followed by an actual allocation to a nominee.

2.12 These amendments facilitate the use of share sale facilities in a greater range of CGT entity restructure roll-overs and standardise the approach so that the interests of foreign interest holders are subject to the same ownership requirements of the relevant roll-overs as Australian interest holders.

Summary of new law

2.13 Part 1 of this Schedule treats a foreign interest holder as owning the relevant interest in an entity at a time the share sale facility owns the interest in that entity for the purposes of the relevant CGT entity restructure roll-over provisions.

2.14 For the relevant CGT roll-overs, this treatment ensures that entities can use a share sale facility in a restructure to deal with the interests of foreign interest holders without interest holders that are Australian residents for tax purposes (or foreign residents with taxable Australian property) automatically failing the same ownership requirements. The treatment also ensures that ownership requirements are appropriately maintained.

Comparison of key features of new law and current law

Detailed explanation of new law

2.15 Part 1 of this Schedule replaces the existing share sale facility provisions in Subdivisions 124-G and 124-Q and inserts a broader share sale facility provision into the ITAA 1997 in three places. This is achieved by inserting a new Subdivision into Division 125 and inserting a new provision into Subdivisions 124-A and 126-G. Each of these new provisions uses the same general approach to allow the operation of the relevant CGT restructure roll-over provisions where a share sale facility is used to deal with the interests of foreign interest holders. [Schedule 2, items 1, 3, 8, 9 and 10, sections 124-20, 125-235 and 126-265]

2.16 As Subdivision 124-A contains the share sale facility provisions for the relevant replacement-asset roll-overs contained in Division 124, notes are inserted into each relevant Subdivision in Division 124 to alert taxpayers accessing a roll-over that a share sale facility for foreign interest holders can be used without failing the same ownership requirements. [Schedule 2, items 2 and 4 to 7, item 15, paragraphs 124-360(1)(c)(note), 124-370(1)(e)(note), 124-445(c)(note) and 124-455(1)(e)(note), subsection 124-860(6)(note), paragraph 124-1045(1)(d)(note) and subsections 124-520(1)(note) and 124-525(1)(note)]

2.17 These amendments do not replace the approach to accommodate certain share sale facilities in the note to subsection 125-70(1) of the demerger relief provisions, as the note covers a broader range of use of share sale facilities. Where a restructure involving the use of a share sale facility for foreign interest holders qualifies for Division 125 roll-over and the share sale facility could be accommodated under either the existing law or these amendments, taxpayers can choose the approach to use because it will result in the same outcome.

2.18 These amendments have no application where the management of an entity that is restructuring decides to comply with the foreign law of the relevant jurisdiction when issuing or transferring the interest. These amendments have potential application only where a share sale facility is used for foreign interest holders in conjunction with an entity restructure covered by certain CGT roll-overs.

Facilitating the use of share sale facilities for foreign interest holders for various CGT restructure roll-overs

2.19 These amendments facilitate the use of share sale facilities in the CGT entity restructure roll-overs in Subdivisions 124-G, 124-H, 124-I, 124-N, 124-Q and 126-G and Division 125. These amendments do this by treating a foreign interest holder as owning an interest in a relevant entity at a time where the share sale facility owns that interest, provided certain conditions are satisfied (paragraphs 2.25 to 2.28 discuss the relevant conditions). Where the foreign interest holder is treated as owning the interest, the share sale facility will not be treated as owning the interest. [Schedule 2, items 1, 9 and 10, sections 124-20, 125-235 and 126-265]

2.20 Under these amendments, using a share sale facility ensures that Australian residents for tax purposes (or foreign residents with taxable Australian property) can satisfy the same ownership requirements in each of the relevant roll-overs. This is because the original interest and the replacement interest are treated as being owned by the same foreign interest holder at the relevant test times for each of the relevant roll-overs.

The foreign interest holder is an Australian resident for tax purposes (or owns taxable Australian property)

2.21 Where the foreign interest holder is an Australian resident for tax purposes (or a foreign resident with taxable Australian property), these amendments also ensure that these interest holders can access the relevant CGT entity restructure roll-overs where the share sale facility becomes the owner of the interest. Where a roll-over is applied, this will defer any CGT consequences for the foreign interest holder until a later dealing with the asset, typically when the share sale facility disposes of the interest. [Schedule 2, items 1, 9 and 10, sections 124-20, 125-235 and 126-265]

2.22 To ensure these particular entities can access the relevant CGT roll-overs in Division 124, where the conditions in paragraphs 2.25 to 2.28 are satisfied, the provisions also treat the foreign interest holder as owning the interest the share sale facility owns for the purposes of sections 124-10 and 124-15. This ensures that the requirements in these sections that the same entity own an original CGT asset or assets and a replacement CGT asset or assets, will be satisfied. [Schedule 2, item 1, subparagraph 124-20(3)(b)(ii)]

2.23 The provisions also treat the foreign interest holder as owning the interest the share sale facility owns for the purposes of subsection 115-30(1). This ensures the duration that the foreign interest holder owned the interest is taken into account when determining access to the CGT discount. [Schedule 2, items 1 and 9, subparagraph 124-20(3)(b)(i) and paragraph 125-235(3)(b)]

2.24 Australian residents for tax purposes (or foreign residents with taxable Australian property) that acquire a replacement interest will already satisfy the key requirement that the same owner own the original interest and the replacement interest. Therefore, the additional treatment for foreign interest holders contained in paragraphs 2.22 and 2.23 will not directly impact these interest holders.

Conditions for treating the foreign interest holder as owning the interest

2.25 The conditions that need to be satisfied for a foreign interest holder to be treated as owning an interest for the purposes of the relevant restructure roll-over provision are:

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the foreign interest holder owns an interest in a relevant entity (or for Subdivision 124-I cases, owns an interest in a body, with or without rights relating to the body);

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a transaction happens to the original interest;

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a foreign law impedes an entity's ability to issue or transfer an interest to the foreign interest holder, or alternatively, it would be impractical or unreasonably onerous to determine whether a foreign law impedes the entity's ability to issue or transfer the interest to the foreign interest holder;

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a share sale facility will acquire the interest instead of the foreign interest holder; and

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under the share sale facility, the foreign interest holder is entitled to receive the capital proceeds (less any expenses or taxes) when the share sale facility disposes of the interest.

[Schedule 2, items 1, 9 and 10, subsections 124-20(1), (4) and (5), 125-235(1) and 126-265(1)]

An entity is facing an impediment in issuing or transferring an interest

2.26 These provisions will apply where a foreign law impedes the entity's ability to issue or transfer the interest to the foreign interest holder. This may happen where it is shown that a foreign law had obstructed or hindered the entity issuing or transferring the interest. This condition would be satisfied where, for example, the foreign law would not permit the entity to issue or transfer a particular interest to a foreign interest holder. [Schedule 2, items 1, 9 and 10, subparagraphs 124-20(1)(c)(i), 125-235(1)(c)(i) and 126-265(1)(c)(i)]

2.27 Alternatively, these provisions will also apply where it would be impractical or unreasonably onerous to determine whether a foreign law impedes the entity's ability to issue or transfer the interest. Even where an entity could ultimately issue or transfer an interest to a foreign interest holder, this condition would be satisfied where the entity would be required to incur substantial cost in issuing a prospectus that complies with the particular foreign law of that country for a relatively small number of shareholders (by number and value). [Schedule 2, items 1, 9 and 10, subparagraphs 124-20(1)(c)(ii), 125-235(1)(c)(ii) and 126-265(1)(c)(ii)]

The share sale facility disposes of interests on a pooled basis

2.28 In some circumstances, the share sale facility may dispose of some or all the interests on a pooled basis. That is, a share sale facility would dispose of the interests together with the interests that would ordinarily be allocated to the other foreign interest holders. In these circumstances, the share sale facility will be required to give the foreign interest holder an amount equal to their proportion of the capital proceeds (less expenses or taxes). [Schedule 2, items 1, 9 and 10, subparagraphs 124-20(1)(e)(ii), 125-235(1)(e)(ii) and 126-265(1)(e)(ii)]

The period when the foreign interest holder is treated as owning the interest

2.29 Each CGT restructure roll-over specifies when the ownership requirements are tested. These requirements are tested 'just before' and 'just after' a specific time or period, or are tested throughout a particular period. The concepts 'just before' and 'just after' take their ordinary meanings so that the testing begins immediately before and ends immediately after the relevant time.

2.30 Providing the share sale facility owns the interest in the same proportion as the foreign interest holder when the ownership requirements are tested, the ownership requirements will be satisfied in respect of the foreign interest holder. This is because the foreign interest holder is treated as owning the interest when the share sale facility owns that interest.

Example 2.1

Paint Ltd (Paint) has a foreign shareholder that is a foreign tax resident that owns 1 per cent of the shares in Paint. Australian tax resident shareholders own the remaining 99 per cent.

Paint proposes to interpose a non-operating holding company, Brush Ltd (Brush), between itself and its shareholders under an arrangement where its shareholders dispose of their shares in Paint for shares in Brush.

Due to the onerous cost of complying with the foreign laws relating to issuing a prospectus to a single shareholder that owns 1 per cent of the shares in Paint, a share sale facility is used.

For the Australian shareholders to be eligible for a CGT roll-over in Subdivision 124-G when they dispose of their shares in Paint, the Subdivision requires, amongst other things, all the shareholders in Paint to own shares in Brush just after the completion time and that each shareholder in Paint owns the same percentage (by number and value) of shares in Brush as they owned in Paint.

The new shares in Brush are issued so that each shareholder in Paint owns the same percentage (by number and value) of shares in Brush that they owned in Paint, with the exception that the 1 per cent of shares representing the foreign shareholder's shares are issued to the share sale facility.

For the purposes of Subdivision 124-G, the foreign shareholder is treated as owning the 1 per cent of shares in Brush for the time that the share sale facility owned those shares in Brush. This ensures the same ownership requirements are satisfied in the Subdivision.

Provided all the other conditions in Subdivision 124-G are satisfied, the Australian tax resident shareholders will be eligible for the CGT roll-over.

Application and transitional provisions

2.31 This measure applies to CGT events happening after 7.30 pm (by legal time in the Australian Capital Territory) on 11 May 2010. These amendments are retrospective to ensure that transactions that have occurred since these changes were announced are covered by these amendments. [Schedule 2, item 11]

2.32 These amendments are not expected to disadvantage taxpayers that could previously access the roll-overs in Subdivisions 124-G and 124-Q when using a share sale facility to deal with the original interests of foreign interest holders. This is because the level of regulatory oversight and reputational risk relevant to an ADI or stapled entity that restructures would typically mean the restructures could still satisfy the ownership requirements in Subdivisions 124-G and 124-Q that now need to be satisfied as a result of the amendments.

2.33 Other taxpayers that are involved in a relevant restructure that uses a share sale facility for foreign interest holders will benefit from these amendments.