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CGT and earnouts

Finally, after more than 22 years (the original ruling was issued in 1993), the saga regarding the CGT consequences of earnout arrangements has come to an end, well mostly to an end. The new CGT and earnout rules in Tax and Superannuation Laws Amendment (2015 Measures No. 6) Bill 2015 have been passed by both houses of parliament and received Royal Assent. The new rules mostly apply to earnout arrangements entered into after 23 April 2015 although taxpayers who applied the look through approach to an arrangement entered into before 24 April 2015, in anticipation of the new rules coming into force, will be protected. A brief summary of the new rules follows.

Under a standard earnout arrangement the buyer agrees to pay the seller additional amounts if certain performance thresholds are met within a particular time. Under a reverse earnout arrangement the seller agrees to repay amounts to the buyer if certain performance thresholds are not met within a particular time.

As anticipated, a look through approach will apply. Under a standard earnout arrangement any additional amounts received by the seller will be treated as part of the consideration received for the disposal of the underlying assets and thus in determining the amount of capital gain or loss made. As well the additional amounts will be included in determining the cost base or reduced cost base of the asset acquired by the buyer. For example, a seller sells its business goodwill to a buyer for $3 million to be paid at settlement plus a further $500,000 to be paid 2 years later if net profit of the business exceeds certain amounts in the those two years. The targets are met and so the buyer pays the seller the additional $500,000 two years after settlement of the original sale. For CGT purposes the goodwill is treated as being sold for $3.5 million.

Under a reverse earnout arrangement any amounts repaid by the seller to the buyer will reduce its cost base and the seller will reduce its capital proceeds (and thus capital gain). The effect of the look through approach is that taxpayers will need to amend their tax returns for the year the CGT event happened to take into account the change in consideration. The new rules allow for these amendments to be undertaken after the normal two or four year amendment periods (and also allow the ATO to make amendments).

One significant advantage of the look through approach is that if the seller can satisfy the conditions to obtain the small business CGT concessions then the concessions will also apply to the earnout amounts received. The view in the ATO ruling was that the concessions did not apply to such amounts.

The new rules apply to a ‘look through earnout right’. In order to be a look through earnout right a right must satisfy all the following conditions:

  • The right is a right to future financial benefits that are not reasonably ascertainable at the time the right is created;
  • The right is created under an arrangement that involves the disposal of a CGT asset;
  • The disposal cause CGT event A1 to happen;
  • Just before the CGT event the CGT asset was an ‘active asset’ (as defined in the small business CGT concessions, but an alternative test can apply for shares) of the seller/disposer;
  • All the earnout payments must be paid within five years after the end of the income year in which the CGT event happens;
  • Those payments are contingent on the economic performance of the CGT asset sold or a business in which the CGT asset will be used;
  • The payments reasonably relate to that economic performance; and
  • The buyer and seller deal with each other at arm’s length in relation to the earnout arrangement.

As always, the devil is in the detail and the tip is to ensure the detail is understood so that taxpayers are not caught out.

By |March 11th, 2016|News|0 Comments

Patrick Cussen joins the team

PatrickWe are delighted to announce the merger of Cussen Legal into Bernie O’Sullivan Lawyers. Patrick Cussen has almost 30 years’ experience advising accountants, businesses and individuals on tax related matters. He is highly regarded by accountants and their clients for his astute advice on structuring of business and investment activities and business succession. We look forward to introducing Patrick to you in 2016.

This caps off a very exciting year for us which has also seen leading tax lawyer Rob Warnock and Accredited Wills & Estates Specialist Stephen Hardy join us.

Our reputation continues to grow as the go-to law firm for high net worth individuals, their accountants and advisers in the fields of estate planning, tax & duties, superannuation, trusts and related litigation.

We thank you for your continued support and wish you and your family a wonderful festive season and a safe and prosperous 2016.

By |December 14th, 2015|News|0 Comments

Dividend access shares and small business CGT concessions

The Full Federal Court, in its 30 November 2015 decision in FCT v Devuba, has shed some light on the vexed issue of dividend access shares (DAS) and the significant individual test in the small business CGT concessions.

Background

A company will need to demonstrate it has a significant individual at the appropriate time or times when:

  • it wishes to obtain the 15 year exemption;
  • it wishes to obtain the retirement exemption; or
  • the shareholders sell their shares and wish to obtain the concessions.

An individual is a significant individual in a company if the individual has a small business participation percentage in the company of at least 20%. A shareholder in a company has a direct small business participation percentage equal to the percentage of voting power, dividend entitlements and capital distribution entitlements of the shares they hold. If the voting, dividend or capital distribution entitlements are different percentages then the shareholder’s percentage is the smallest of the three.

Where a company issues a DAS (the share has rights to dividends only) to a shareholder and ordinary shares to other shareholders then, arguably, the company does not have a significant individual. This is because no one individual has the right to receive at least 20% of any dividends paid by the company. It is possible for the company to pay dividends only to the holders of the ordinary shares or only to the holder of the DAS. Given that it is possible for both lots of shareholders to not receive any dividends when the company actually pays dividends then each individual shareholder has a small business participation percentage of 0%. This is the ATO view – refer TD 2006/7, in particular example 3.

FCT v Devuba

In this case there were three shareholders, two held ordinary shares and the third held a DAS. At first instance the AAT took the view that the significant individual test was satisfied despite the presence of the DAS. The AAT’s reasoning is not entirely clear. Whilst the Full Federal Court also found in favour of the taxpayer it did so for a slightly different reason. In 2008 a resolution was passed varying the rights attached to the DAS. They were varied so that they had no right to payment of a dividend until the directors first resolve the holders of a DAS have a right to payment of a dividend. The Full Federal Court held that as the directors had not passed such a resolution the company could not declare and pay a dividend on the DAS shares even if it wanted to. The DAS holder had no rights to dividends until the directors first resolved they had such rights. Therefore, if the company declared a dividend it could only be paid to the holders of the ordinary shares. Thus the ordinary shareholders were the only shareholders that had rights to dividends.

What this means in practice

Great care needs to be undertaken when issuing a DAS so as not to cause a problem with being entitled to the small business CGT concessions. It seems without the 2008 variation of rights to the DAS the Full Federal Court would have found in favour of the Commissioner. So the issue of a DAS is still likely to cause problems with taxpayers satisfying the significant individual test unless the DAS has a restriction of the type that was imposed by the 2008 variation in Devuba. There are other possible solutions, such as to make the DAS redeemable as redeemable shares are ignored when determining an individual’s direct small business participation percentage.

Contact

Rob Warnock
Patrick Cussen

By |December 14th, 2015|News, Uncategorised|0 Comments

A new era for estate disputes

2015 changes to Victoria legislation

On 17 September 2014 Parliament passed amendments (the Amendments) to the Administration and Probate Act 1958 (Vic) (the Act), effectively restricting the type of claims that can be brought by a prospective claimant against a deceased’s estate. The Amendments took effect on 1 January 2015; this means they apply to estates where the willmaker dies on or after that date.

Why were the changes made?

In 1997 the Act was amended to broaden the class of persons entitled to claim against an estate to persons for whom the deceased “would have a moral duty to make proper and adequate provision”.  As a result, the number of claims against deceased estates increased dramatically, including by persons such as carers and distant relatives. Such claims were assisted by the reluctance/inability of courts to award costs against parties bringing unsubstantiated claims.

The Amendments significantly prevent unmeritorious legal proceedings brought by a person claiming to provide some minor form of care or assistance to the Deceased prior to death (i.e – mowing the Deceased’s lawns or taking the Deceased grocery shopping once a fortnight). The Amendments also give the Court power to make orders as to costs it thinks necessary in cases where claims are frivolous, vexatious or issued with no reasonable prospect of success.

The new rules

The Amendments clearly state who is entitled to bring a claim against an estate under the heading “Eligible Person”.  An Eligible Person is defined as the following:

  • Spouse or Domestic Partner of the deceased as at the date of the deceased’s death;
  • A child, including adopted child, who at the date of the deceased’s death;
  • Was under 18 years of age; or
  • Is a full time student between 18 and 25 years of age; or
  • Has a disability.
  • A step child of a domestic partner as at the date of the Deceased’s death, subject to the criteria in points 2)(a) – 2)(c) above; or
  • A person treated as a natural child of the deceased for a substantial period subject to the criteria in points 2)(a) – 2)(c) above; or

A former spouse or domestic partner who would have been able to commence divorce and / or spousal maintenance proceedings at the time of the deceased’s death.
An “Eligible Person” is also defined as:

  1. A person treated as a natural child of the deceased for a substantial period; or
  2. A registered caring partner of the deceased; or
  3. Spouse or domestic partner of a child of the deceased only where that child dies within one year of the deceased’s death; or
  4. A member of the deceased’s household.

A child, or children born under a surrogacy arrangement will now be recognised as the child, or children of the commissioning parents under amendments to the Status of Children Act and therefore classified as an “Eligible Person” under the new legislation.

The new amendments also incorporate the present legislative provisions the court has long been required to take into account when considering the merits of a claim under section 91(4) of the Administration and Probate Act 1958.

Who will be affected?

Clients should note that adult children, not falling into the above categories, are still eligible to bring a claim.  However, where this is the case, the Court must have regard to the degree to which that child is not capable of providing adequately for their own maintenance and support.  This approach is consistent with the Court’s requirement for the claimant to demonstrate they have a true “financial need” for provision from the estate of the deceased and are not merely “prospecting”.

People falling outside of the definition of “Eligible Person” will find it difficult to make a successful claim.  Aside from affecting rights of independent adult children, the new provision will make it more difficult for relatives outside of the immediate family group (e.g. nieces, nephews) and ‘friendly neighbours’ or carers (other than registered caring partners) to bring a successful claim.

It will be interesting to see if there is a rise in the number of ‘registered carers’, and also how courts will interpret the meaning of the phrase ‘a member of the deceased’s household’ – case law from other States, such as New South Wales, where this phrase has been in play for some time, will be relevant. It may also see a greater reliance on other avenues for claims, such as constructive trust-type claims.

Generally it is expected that the number of estate disputes will decrease (at least compared to what would have been the case) and certainly we along with most in the legal profession will welcome the reduction in frivolous claims.

Our lawyers have significant experience dealing with estate disputes. If you are seeking advice or are contemplating bringing proceedings against a deceased’s estate please contact our offices.

Contact:

Bernie O’Sullivan
Stephen Hardy

© Bernie O’Sullivan Lawyers

By |December 2nd, 2015|News, Uncategorised|0 Comments