* The concepts discussed in this blog are complex and require careful consideration to ensure compliance with Australian and US tax laws. Unless otherwise stated, all monetary references are to US dollar amounts, and all legislative references are to the Australian Income Tax Assessment Act (ITAA) 1997 and to the United States’ Internal Revenue Code (IRC).
Clients often consult us about changing the jurisdiction of the holding companies in their corporate groups.
For example, consider the following scenario where US Inc., a US registered “C Corporation” with both US and Australian resident shareholders, holds 100% of the voting shares in AU Pty Ltd. AU Pty Ltd is an Australian resident company, being incorporated in Australia and having its central management and control in Australia. The business (and value) of the group is held in AU Pty Ltd.
It is proposed that a new Australian holding company (AU HoldCo) hold the equity interests in US Inc., with the stockholders of US Inc. exchanging their interests in US Inc. for equivalent interests in AU HoldCo, as follows:
What are the US and Australian tax implications of such an exchange?
The Australian tax implications
The exchange would trigger capital gains tax (CGT) Event A1 for the Australian resident shareholders of US Inc. and they would be taxable on the difference between the market value of the shares and their cost base in those shares.
Subdivision 124-M roll-over relief is generally available for a “scrip for scrip” exchange, provided that the legislative requirements are satisfied, specifically:
1. an exchange of an “original interest” in a company for a “replacement interest” in another company (section 124-780(1))
a) an entity (the original interest holder) exchanges:
(i) a *share (the entity’s original interest) in a company (the original entity) for a share (the holder’s replacement interest) in another company; or
(ii) an option, right or similar interest (also the holder’s original interest) issued by the original entity that gives the holder an entitlement to acquire a share in the original entity for a similar interest (also the holder’s replacement interest) in another company; and
This requirement should be satisfied if the US Inc. shareholders acquired interests in AU HoldCo that were similar to their existing US Inc. interests.
2. “Single arrangement” requirement: this requirement would be satisfied if AU HoldCo acquires 80% or more of the voting shares in US Inc. and provided that the exchange is an arrangement in which all shareholders in US Inc. could participate, and in which participation is available on substantially the same terms for all interest holders in US Inc. (section 124-780(2)(a)(i), (b), and (c)). Careful consideration of the exchange agreement is required in order to ensure that these conditions are satisfied for all interest holders;
3. the required choice and cost base notifications are made to apply the roll-over: this could be done by the shareholders electing to apply the roll-over in the way they prepare their Australian tax returns for the relevant year in which the CGT event occurs (section 103-25);
4. the arm’s length / non-arm’s length rules are satisfied if the Exchange is not undertaken at arm’s length and if US Inc. has less than 300 shareholders, the market value of the shares in AU HoldCo must be substantially the same as that in US Inc. and the AU Hold Co shares must carry the same rights and obligations as those attached to the shareholder’s original interest. (see ATO ID 2004/498 and sections 124-780(4) and (5));
5. the arrangement is not excluded from roll-over relief: Subdivision 124-M roll-over relief is not available for foreign residents unless the replacement interest is taxable Australian property (TAP) (section 124-795(1))).
However, the disposal by the foreign residents of their shares in US Inc. (a foreign corporation) in exchange for shares in AU HoldCo would not trigger CGT for them as foreign residents of Australia are only subject to Australian CGT on TAP (section 855-10).
TAP consists of taxable Australian real property, an indirect interest in Australian real property, a business asset of a permanent establishment in Australia, on option or right to acquire such an asset, or a CGT asset that is deemed to be TAP where a taxpayer makes an election to treat it as such, on ceasing to be an Australian resident (section 855-15). The US Inc. shares would not be TAP as there is no underlying interest in Australian real property.
The exclusion of the foreign resident shareholders from roll-over relief should not preclude the Australian resident shareholders from accessing the roll-over. There is nothing in Subdivision 124-M requiring all shareholders to access the roll-over being a precondition to its application. In any event, no CGT consequences are triggered for foreign residents if the CGT asset is not TAP (section 855-10).
Further, the Explanatory Memorandum to the New Business Tax System (Miscellaneous) Bill (No.2) 2000 (Act No.89 of 2000) (EM) indicated that the roll-over was originally limited only where both the original company and the acquiring company were non-residents and requiring additional conditions to be satisfied in that event. Paragraph 11.68 of the EM envisages that a non-resident may acquire a replacement interest in an Australian company in a scrip for scrip exchange, stating:
11.68 The note in subsection 124-795(1) of the ITAA 1997 indicates that if a non-resident’s replacement interest is an interest in an Australian resident company or trust, it is treated as having the ‘necessary connection with Australia’. This ensures that the replacement asset is a taxable asset when the non-resident later disposes of it.
In next week’s blog, we will consider how the US corporate reorganization rules could operate to this restructure.
For more information on US-Australia cross-border M&A, please contact:
Head, US-Australia Tax Desk