- Significant stakeholders
- Common stakeholders
- Impact of rollover on shareholders (original interest holders).
- Impact of rollover on acquirer
The scrip for scrip rollover is designed to enable the exchange of shares in a company or units in a trust for other shares or units without capital gains tax being triggered.
The exchange of units and shares between entities is a regular occurrence when a business is restructuring or during the course of a takeover or merger.
As a basic illustration, take ABC Pty Ltd which acquires the shares of DEF Pty Ltd from DEF Pty Ltd shareholders. As consideration for the acquired shares, ABC Pty Ltd provides the DEF Pty Ltd shareholders with shares (instead of a cash payment) in ABC Pty Ltd. The cost base of the issued shares is the cost base of the shares exchanged and any capital gain at this point in time is disregarded.
The rules concerning the scrip for scrip rollover are contained in Subdivision 124-M of the Income Tax Assessment Act 1997. The rollover provides tax relief to resident shareholders who may otherwise end up with a capital gains tax liability without having received a cash payment to cover the tax liability. Note that a non resident shareholder is generally only subject to capital gains tax on taxable Australian property. The share of a foreign shareholder will only be taxable Australian property where the company holds a majority of its asset value in Australian real property.
Note this article does not address how the restructure applies to wholly owned groups.
To be eligible for the scrip for scrip rollover, all of the following requirements set out in section 124-780 of the Act must be satisfied in respect of the shares (there are similar requirements for the exchange of units set out in section 124-781 of the Act):
- The shares in the original entity must generally be exchanged for replacement shares in the acquiring entity.
- The exchange must occur as part of a single arrangement. This could include:
- having shares exchanged
- a scheme of arrangement involving cancellation of shares
- a scheme of arrangement involving the redemption of shares
- a hybrid of the above.
- The acquiring entity becomes the owner of at least 80% of the voting shares in the original entity.
- The shareholders with voting shares in the original entity must all be invited to participate in the arrangement.
- Participation must be offered on substantially the same terms to all voting shareholders of a similar class in the original entity. This does not mean that each shareholder in the original entity must participate on the same terms – only that each of these shareholders is given a genuine opportunity to participate in the arrangement on the same terms. Note that requirement 5 and 4 (above) does not apply if the arrangement is a takeover bid or a scheme of arrangement carried out in compliance with the Corporations Act.
- The shareholders holdings in the original entity must be post CGT assets. That is, the shareholders must not have acquired their shares in the original entity prior to 20 September 1985. However, note there are special rules that that deal with pre CGT holdings and enable the rollover to continue to be available (in certain circumstances).
- The shareholders would have made a capital gain on the realisation of shares in the original entity if this rollover was not utilised.
- The type / kind of replacement interest must match the type / kind of the original interest. For example, a share can only be exchanged for a share, or a unit with a unit, an option with an option etc.
- Where the arrangement does not occur under arm’s length conditions (and we are not referring to widely held entities), the replacement interest will need to confer the same rights and obligations as available to shareholders under their original interests. The market value of the issued replacement interests must also substantially match the market value of the original interests acquired by the takeover entity.
- The original entity shareholders must elect that the rollover applies. Note that a joint election from original interest holders and the shareholders of the acquiring entity may be required where there are common or significant stakeholders involved.
- The rollover is not available where the restructure rollover in Division 122 or Division 615 of the Act are available to be applied in respect of the transaction.
Note that the replacement interest issued to a shareholder will restart the clock for the purposes of satisfying the 12 month rule relevant to the 50% CGT discount. Therefore, if a replacement interest is disposed within 12 months the discount will not be available.
A significant stakeholder is defined as an original interest holder that had both:
- A significant stake in the original entity just prior to the arrangement.
- A significant stake in the replacement entity just following the completion of the arrangement.
A significant stake is essentially where that shareholder (inclusive of associates) has at least 30% of the rights to either: voting entitlements, dividends entitlements, or entitlements to capital distributions. The rules around significant stakeholders will not apply where the relevant entity has more than 300 members provided there is no concentrated ownership within that entity.
A common stakeholder is defined as an original interest holder that had:
- A common stake in the original entity just prior to the arrangement.
- A common stake in the replacement entity just following the completion of the arrangement.
A common stake is essentially where a shareholder (inclusive of associates) has at least 80% of the rights to either: voting entitlements, dividends entitlements, or entitlements to capital distributions. The rules around common stakeholders will not apply where the relevant entity has more than 300 members provided there is no concentrated ownership.
Impact of rollover on shareholders (original interest holders).
If the rollover is available, there is no capital gain for the original interest holders. The original interest holder’s replacement shares will have a tax base equal to the original interest cost base.
If there is a partial rollover e.g. some scrip and some cash provided to the original interest holder, the cash (or other non scrip consideration) component will attract CGT.
Impact of rollover on acquirer
If an original interest holder is a significant stakeholder or common stakeholder, the acquiring entity’s cost base for acquiring the shares in the original entity is equal to the cost base of the shares held by the shareholders in the original entity. Note that if a shareholder is a significant stakeholder or a common stakeholder, they must inform the replacement entity of the cost base of their original shares.
However, where an unrelated third party is involved in the takeover of the original entity, the acquiring entity’s cost base for shares acquired in the original entity is equal to market value of the shares transferred at the time of exchange.
Therefore, you can see that the cost base the acquiring entity has over shares acquired in the original entity is determined by whether or not there is a significant stakeholder / common stakeholder involved.
It is worth noting that there is a risk of double taxation on the same economic gain where there is a cost base transfer (instead of a market value cost base) due to there being a significant stakeholder / common stakeholder.
The first tax is imposed on the original interest holder who will eventually be assessed on the gain made from the time of acquisition of the shares in the original entity to the time of disposal of the replacement interest (once the replacement shares are sold). There is no cost base uplift available for the shareholder between the time the original interest is acquired and the time the replacement interest is issued. The second tax is imposed on the acquiring entity which will also be taxed on any capital gain made on disposal of the shares. However, again, there is no cost base uplift available for the acquiring entity. The double tax outcome is therefore seen in that the gain made between the time the shares were acquired by the original interest holder and the time of restructure is counted twice (firstly, to the original interest holder and secondly to the acquiring entity).
By way of illustration, Take DEF Pty Ltd which acquires the shares in ABC Pty Ltd and elects for the scrip for scrip rollover to apply. The shareholders of ABC Pty Ltd had a cost base of $1,000,000 but the market value of the shares is now $2,000,000. There are significant stakeholders involved and therefore a cost base transfer occurs. That is, upon rollover, the shareholders of the original entity retain their $1,000,000 cost base (instead of a $2,000,000 cost base which reflects the value of the shares at the time of the arrangement) and DEF Pty Ltd acquires the shares in ABC Pty Ltd with a cost base of $1,000,000 (instead of a $2,000,000 cost base which reflects the value of the shares at the time of the arrangement). Here, the shareholders of ABC Pty Ltd and DEF Pty Ltd will both be subject to capital gain tax (when a CGT event happens) on the $1,000,000 unrealised gain between the time the original interests were acquired and the time of the restructure occurred.
In this way, it may be preferrable not to utilise the scrip for scrip rollover where there is a cost base transfer (instead of a cost base based on market value at the time of the arrangement) to prevent an unwanted double tax outcome.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.