Tax and Superannuation Laws Amendment (2015 Measures No. 6) Act 2016 (10 of 2016)

Schedule 1   CGT treatment of earnout rights

Part 1   Main amendments

Income Tax Assessment Act 1997

4   At the end of Division 118

Add:

Subdivision 118-I - Look-through earnout rights

Table of sections

118-560 Object

118-565 Look-through earnout rights

118-570 Extra ways a CGT asset can be an active asset

118-575 Creating and ending look-through earnout rights

118-580 Temporarily disregard capital losses affected by look-through earnout rights

118-560 Object

(1) This Subdivision and its related provisions set out special rules for *look-through earnout rights. The object of these rules is to avoid unnecessary compliance costs and disadvantageous tax outcomes when entities involved in the sale of a business:

(a) cannot agree on the current value of some or all of the business' assets due to uncertainty about the future economic performance of the business; and

(b) resolve this uncertainty by agreeing to potentially provide future additional consideration linked to this performance.

(2) These rules achieve this object by:

(a) disregarding any *capital gain or *capital loss relating to the creation of a *look-through earnout right; and

(b) for the acquirer of the business - treating any *financial benefits provided (or received) under the right as forming part of (or reducing) the cost base or reduced cost base of the business assets; and

(c) for the seller of the business - treating any financial benefits received (or provided) under the right as increasing (or reducing) the capital proceeds for the business assets.

Note: Sections 112-36 and 116-120 are 2 of the more important related provisions that set out these rules.

118-565 Look-through earnout rights

Look-through earnout rights - main case

(1) A look-through earnout right is a right for which the following conditions are met:

(a) the right is a right to future *financial benefits that are not reasonably ascertainable at the time the right is created;

(b) the right is created under an *arrangement that involves the *disposal of a *CGT asset;

(c) the disposal causes *CGT event A1 to happen;

(d) just before the CGT event, the CGT asset was an *active asset of the entity who disposed of the asset;

Note: For extra ways to be an active asset, see section 118-570.

(e) all of the financial benefits that can be provided under the right are to be provided over a period ending no later than 5 years after the end of the income year in which the CGT event happens;

(f) those financial benefits are contingent on the economic performance of:

(i) the CGT asset; or

(ii) a business for which it is reasonably expected that the CGT asset will be an active asset for the period to which those financial benefits relate;

(g) the value of those financial benefits reasonably relates to that economic performance;

(h) the parties to the arrangement deal with each other at *arm's length in making the arrangement.

Matters affecting the 5-year maximum period

(2) The condition in paragraph (1)(e) is not met, and is treated as never having been met, for the right if:

(a) the *arrangement includes an option to extend or renew the arrangement; or

(b) the parties to the arrangement vary the arrangement; or

(c) those parties enter into another arrangement over the *CGT asset or a business for which it is reasonably expected that the CGT asset will be an *active asset;

so that a party could, or does, provide *financial benefits under the right (or one or more equivalent rights) over a total period ending later than 5 years after the end of the income year in which the *CGT event happens.

(3) For the purposes of paragraph (1)(e) or subsection (2), in working out the period over which *financial benefits under a right can be provided, disregard any part of an *arrangement that allows for an entity to defer providing such a financial benefit if:

(a) the deferral is contingent on an event happening that is beyond the control of the parties to the arrangement; and

(b) the deferral cannot change the amount of any financial benefit provided, or to be provided, under the right; and

(c) when the arrangement is entered into, the contingent event is not reasonably expected to happen.

Look-through earnout rights - rights for ending other rights

(4) A look-through earnout right is a right to receive one or more future *financial benefits that:

(a) are for ending a right to which subsection (1) applies; and

(b) are certain.

Note: This subsection will not apply if the old right ends as described in subsection (2), as subsection (2) causes the old right to be treated as if it had never been a right to which subsection (1) applies.

118-570 Extra ways a CGT asset can be an active asset

(1) For the purposes of this Subdivision, treat a *CGT asset as if it were an active asset of an entity at a particular time, if:

(a) the entity owns it at that time; and

(b) it is either a *share in a company, or an interest in a trust; and

(c) at that time, the entity:

(i) is a *CGT concession stakeholder of the company or trust; or

(ii) if the entity is not an individual - has a *small business participation percentage in the company or trust of at least 20%; and

(d) at that time, the company or trust:

(i) is carrying on a *business, and has been carrying on a business since the start of the most recent income year ending before that time; and

(ii) is not a *subsidiary member of a *consolidated group; and

(e) the assessable income of the company or trust for that most recent income year was greater than nil, and at least 80% of that assessable income was:

(i) from the carrying on of one or more businesses; but

(ii) not *derived (directly or indirectly) from an asset of a kind to which paragraph 152-40(4)(d) or (e) applies.

Note: Paragraphs 152-40(4)(d) and (e) refer to financial instruments and assets used to derive interest, annuities, rent, royalties or foreign exchange gains.

(2) For the purposes of this Subdivision, treat a *CGT asset as if it were an active asset of an entity at a particular time, if subsection 152-40(3) would have been satisfied for the asset at that time had paragraph 152-40(3)(a) only required the asset to be:

(a) a *share in a company; or

(b) an interest in a trust.

Note: This enables shares and interests in foreign entities to be active assets for the purposes of this Subdivision.

(3) Subsections (1) and (2) do not limit section 152-40 (about active assets).

118-575 Creating and ending look-through earnout rights

Disregard a *capital gain or *capital loss you make because:

(a) *CGT event C2 happens in relation to a *look-through earnout right you receive; or

(b) CGT event D1 happens when you create a look-through earnout right in another entity.

118-580 Temporarily disregard capital losses affected by look-through earnout rights

(1) Temporarily disregard a portion of a *capital loss you make from *disposing of a *CGT asset if the capital loss could be reduced by you receiving one or more *financial benefits under a *look-through earnout right relating to the CGT asset and the disposal.

(2) The portion of the *capital loss that is temporarily disregarded is:

(a) if those *financial benefits can never exceed a maximum amount that is certain - so much of the capital loss as is equal to that maximum amount; or

(b) otherwise - all of the capital loss.

Note: When you receive a financial benefit under the look-through earnout right:

(a) you cease to disregard under this section a portion of your loss related to the amount of that financial benefit; and

(b) your capital proceeds for the disposal increase (see paragraph 116-120(1)(b)), causing a reduction in the amount of your loss.