Asset purchase vs share purchase
A threshold issue for a Purchaser is whether to acquire the equity in the Target (Share Purchase) or the underlying assets of the Target (Asset Purchase). Usually this is a commercial decision, driven by the characteristics of the Target and the preference of the parties.
The type of asset can also sometimes impact this decision. For example, it is usual for an asset purchase in real estate transactions, but shares sales are more common where there is an operating business.
While a Purchaser will have to consider certain issues irrespective of whether an Asset Purchase or a Share Purchase is being undertaken (eg. choice of any acquisition vehicle, capital structure of acquisition vehicle), the tax consequences of an Asset Purchase and a Share Purchase are different.
The Target's tax liabilities remain with the Seller.
The Target's tax liabilities are acquired with the Target. However, where the Target leaves a tax consolidated group (see below), the Target can be liable for the tax liabilities of that group while it was a member (unless clear exit is achieved – see Transaction Documentation).
The purchase price allocation is important as it determines the tax basis for each asset and the extent of any duty or GST (see below) payable.
Where parties are dealing with each other at arm's length, Australian tax authorities will generally accept an agreed purchase price allocation for tax basis, stamp duty and GST purposes.
For buildings, it is a requirement for certain tax information to be provided to the purchaser.
No purchase price allocation needs to be agreed between the Buyer and the Seller. However, the purchase price may be allocated to the underlying assets in accordance with the tax consolidation rules – see Tax Cost Setting below.
Usually a higher stamp duty cost arises for an Asset Purchase – duty can apply not only to real property assets but also other assets, including goodwill, IP, debts, etc. –see Stamp duty below.
No stamp duty arises on the acquisition of shares. However, landholder duty will arise where the Target holds real property interests (including leases) above a particular threshold – see Stamp duty below.
An Asset Purchase is generally subject to GST unless the assets are acquired as the acquisition of a "going concern" – see GST below.
While a GST credit to recover GST included in the purchase price may potentially be available to the Purchaser, any stamp duty liability would usually be payable on the GST-inclusive amount.
The acquisition of shares is not subject to GST. However, a Purchaser may be unable to claim GST credits in respect of transaction costs relating to an acquisition of shares – see GST below.
Tax attributes of the Target (eg. tax losses, franking credits, etc.) are not generally transferred to the Purchaser and remain with the Seller.
Tax attributes can be transferred with the Target and can be utilised in the future (subject to satisfying any loss integrity tests). However, where the Target leaves a tax consolidated group, such tax attributes will remain with the Seller tax consolidated group.
From a non-tax perspective, an Asset Purchase can be complex and may require new contracts (eg. leases, supply contracts, employment contracts, etc.) to be entered into.
A Share Purchase is likely to be less complex, although change of control issues will need to be considered.
An offshore Purchaser may either acquire the Australian Target directly, or establish an acquisition vehicle to acquire the Target or the Target's assets. The choice of acquisition vehicle will depend on the characteristics of both the Purchaser and the Target. The typical acquisition structure for an inbound investment is the use of Australian companies ("Holdco / Bidco"). In specific circumstances, other investment structures may be utilised, including an Australian trust (a Managed Investment Trust being a form of unit trust).
Each of these is discussed in turn below.
The incorporation of one or more Australian proprietary limited companies is a common acquisition structure for both an Asset Purchase or a Share Purchase. (see Asset Purchase vs Share Purchase above).
For a share purchase, the Purchaser(s) will typically establish an Australian company as a holding entity ("HoldCo") and have that company incorporate a wholly-owned Australian subsidiary ("BidCo") to undertake the acquisition.
Under Australia's tax consolidation regime, HoldCo / BidCo can form a tax consolidated group before acquiring the Target company (a Tax Consolidated Group is treated as a single entity from a tax perspective such that the tax implications of intra-group transactions are ignored). This enables the following:
- Where BidCo draws down debt to finance the acquisition of the Target, the interest deductions incurred by BidCo can be used to reduce the assessable income of the Target, subject to satisfying certain rules (see Capital Structure Issues below).
- Under the tax consolidation rules, the tax basis of the assets held by the Target can be reset to market value, potentially resulting in tax cost basis uplift in these assets (see Tax Cost Setting below). This can be important where assets are to be sold post-acquisition, or where the Target owns tax depreciable assets.
- Where the Target is itself a tax consolidated group, the acquisition of the Target group by a tax consolidated group precludes a "deconsolidation" of the Target tax consolidated group (which should reduce administrative compliance and also reduce potential taxable gains that may otherwise arise).
An Australian unit trust may be utilised to undertake an acquisition. From a tax perspective, a unit trust is generally structured as a transparent entity which is not itself subject to Australian tax. Rather, the members (unitholders) of the trust are subject to Australian tax on their share of the income of the trust to which they are entitled. This enables a trust to pass through pre-tax income to its members.
Trusts are often used to acquire real property assets and infrastructure assets. This is because of the concessional tax regime which applies to Managed Investment Trusts (MIT) (see below) and a trust can also facilitate the distribution of tax deferred distributions.
It is important that a widely-held trust holds passive investments (rather than controlling an active business), otherwise the trust can be treated as a company for tax purposes.
Where a trust is sufficiently widely-held, has the appropriate licensing arrangements in place and does not control an active business, the trust may qualify as a MIT. An MIT allows for the following:
- distributions to be taxed at the reduced 15% rate; and
- gains not related to land-based assets potentially not being subject to tax.
There are certain anti-avoidance rules which must be considered when using MITs as well as rules around certain income that would not be eligible for the reduced 15% withholding tax rate.
For various reasons, a Purchaser may choose to acquire the Australian investment directly from the Purchaser's jurisdiction by either acquiring the shares in the Australian Target or the assets of the Australian Target (see Asset Purchase vs Share Purchase above).
Purchase of shares
In this case, a new Australian entity will not be used to undertake the acquisition. This has a number of implications including:
- The Purchaser will generally not be able to introduce new acquisition debt into Australia.
- Importantly, a direct acquisition will mean that there will be no potential to uplift the tax basis of the assets in Target to market value. However, it can prevent a reduction ("step-down") in the tax basis of Target assets where the historical tax basis is greater than the purchase consideration.
- The Purchaser should consider the appropriate offshore holding jurisdiction for undertaking the acquisition (see Offshore Holding Structure below).
Purchase of assets
Where the acquisition is structured as an Asset Purchase (see Asset Purchase vs Share Purchase above), a Purchaser may consider forming an Australian branch to acquire the relevant assets (noting however, that an Australian branch does not have material advantages over an Australian subsidiary when considering the appropriate vehicle for the relevant Australian operations).
On a future disposal of the branch assets, Australian capital gains tax will apply as the relevant assets will have been used in carrying on a business through a permanent establishment in Australia (see Exit Issues).
Offshore holding structure
For an offshore purchaser of an Australian asset, the jurisdiction in which the Purchaser chooses to hold the Australian assets (whether or not through an Australian acquisition vehicle(s)), will have an impact on the Purchaser's tax position.
One of the most important factors in this regard is whether the Purchaser is resident in a country which has entered into a Double Taxation Agreement with Australia.
Double Taxation Agreements
Double Taxation Agreements (DTAs) are bilateral agreements which are entered into for the purposes of allocating taxing rights between countries to prevent double taxation.
Australia has a wide network of DTAs, with these agreements having been entered into with over 40 different jurisdictions.
It is important to note that Australia has also adopted the Multilateral Instrument (MLI) which is a multilateral agreement that facilitates the modification of treaties to address multinational tax avoidance. As a result, certain DTAs which Australia has entered into will have been modified by the MLI.
Why are DTAs important?
Where the Purchaser is resident in a DTA jurisdiction, it can benefit in these ways:
- A DTA will reduce withholding taxes that may otherwise apply on the repatriation of profits or other amounts from the Australian Target (see Hold period issues – distributions); and
- A DTA can protect a Purchaser from being taxed on Australian sourced income (as opposed to capital gains) provided that the Purchaser does not have a permanent establishment (broadly, a fixed place of business, eg. a branch) in Australia.
Can a Purchaser be subject to Australian Tax even where a DTA applies?
Where the Australian assets are either Australian real property assets, or shares or units in an entity the value of which is principally attributable to Australian real property, the existence of a DTA between Australia and the Purchaser's jurisdiction will not prevent an Australian tax liability from arising. This is because Australia, like other countries, retains taxing rights in respect of such assets irrespective of whether a DTA exists.
In addition, where the Purchaser carries on business in Australia through a permanent establishment (broadly, a fixed place of business, eg. a branch), again, the existence of a DTA between Australia and the Purchaser's jurisdiction will not prevent an Australian tax liability from arising for the Purchaser. A Purchaser will always be subject to Australian tax on profits attributed to a business carried on through an Australian permanent establishment, whether or not a DTA exists.
Tax cost setting
Understanding cost base setting is an important component of asset and share acquisitions from an Australian tax perspective (for example, it impacts any capital gain or loss on any disposal of a capital asset; the depreciation available for "depreciating assets" and the “dutiable value” of “dutiable assets” for Australian stamp duty purposes).
Generally speaking in an arm's length transaction, the cost base of relevant assets (such as capital assets and depreciating assets) for Australian income tax purposes is the consideration paid for the assets. However, market value substitution rules can be applicable in certain scenarios such as certain related party transactions.
It should also be noted that certain rules can adjust cost base in assets post acquisition (for example, value shifting and debt forgiveness rules)
Share acquisitions – cost setting for Tax Consolidated Groups (TCG)
There are special cost base setting rules for TCGs. The typical transaction would involve a member of a TCG acquiring 100% of the membership interests in a target entity (in the case of a company, a solely Australian tax resident company). Under the "single entity rule", assets that are brought into a TCG by members become assets of the head company (see Transaction documentation) and, in an arm's length transaction, would be expected to have their tax basis set at a value approximating market value (subject to certain adjustments). This means you must determine what assets are brought into a TCG and their associated value / cost base. This may require valuations to be undertaken for both tax and accounting purposes.
Share acquisitions – foreign acquirer
Cost base may or may not be relevant to a foreign acquirer of shares in an Australian company. If the shares are not "indirect Australian real property interests" (broadly, a 10% or greater interest in a company which has 50% or more of the value of its assets being interests in Australian land), and the shares are held on capital account, cost base should not be relevant. In other situations, cost base will be relevant and there can be complexities associated with calculating this. See also Deal Structuring – Seller.
Capital structure issues
The capital structure of an Australian vehicle may comprise both equity and debt. It is possible for Australian tax purposes to structure debt interests which are legal form equity. For example, certain redeemable preference shares. However, the use of hybrids is constrained by the integrity rules explained further below.
Debt / equity characterisation of the instrument
The Australian debt / equity rules outline what constitutes a debt interest or an equity interest for Australian income tax purposes.
The rules look to a number of factors and tests to take a "substance over form" approach in determining whether an instrument should be characterised as a debt interest or an equity interest. This means that the legal form of an instrument will not necessarily be determinative of the Australian income tax characterisation of the instrument.
The distinction between a debt interest and an equity interest for Australian income tax purposes is significant in a number of ways.
Where the financing instrument is considered a debt interest, the returns payable by the borrower under the instrument should generally be deductible (subject to satisfying the general tests for deductibility and subject to any thin capitalisation limits). Alternatively, where the financing instrument is considered an equity interest, the returns payable by the issuer are not deductible but should be frankable. This means that the dividend carries a credit for the tax paid by the company. This imputation credit results in lower income taxes for resident holders, or a reduction in withholding tax for non-resident holders.
The tax characterisation of the financing instrument can also determine whether payments to non-residents under a financing arrangement are subject to either Australian interest withholding tax (in the case of a debt interest) (see below) or Australian dividend withholding tax (in the case of an equity interest).
Very broadly, in order for an instrument to constitute a debt interest, the issuer of the financing instrument must have an "effectively non contingent obligation" to pay a return to the holder which is at least equal to the holder’s original investment in relation to that instrument.
Australian interest withholding tax (IWT)
Broadly, a liability to IWT arises when interest is paid by an Australian resident (ie. an Australian payer) to a non-resident lender who does not derive the interest income in carrying on business at or through a permanent establishment of the non-resident in Australia.
Despite IWT being the liability of the non-resident lender, the Australian payer has the obligation to withhold and remit the IWT to the Australian Taxation Office (ATO).
The current rate of IWT is 10%, unless an exemption applies.
One such exemption from IWT is the public offer test exemption contained in section 128F of the Income Tax Assessment Act 1936. This is commonly used to exempt interest paid on note issuances and under syndicated loans from withholding tax. There are certain tests which must be satisfied so that the notes or syndicated loans are regarded as publicly offered.
This exemption from IWT is only available for debt capital raisings involving third party debt and is not available in respect of shareholder loans or loans from offshore associates of the Australian borrower.
An exemption may also be available where the interest is derived by a lender in a country where the tax treaty with Australia has a financial institutions exemption. These treaty provisions typically require the lender to be an unrelated entity which derives its profits by carrying on the business of raising and providing finance.
Australian thin capitalisation provisions
The thin capitalisation rules may apply to limit the debt (interest) deductions of an Australian entity with foreign controllers, or an entity that is an Australian controller of a foreign entity.
Where the thin capitalisation rules apply, the rules will disallow debt deductions that an entity can claim to the extent that its debt levels exceed the following prescribed limits:
- the safe harbour debt amount – debt deductions are denied to the extent the amount of debt exceeds 60% of adjusted assets (note that a higher percentage is allowed for certain entities such as financial entities and authorised deposit taking institutions); or
- the arm's length debt amount – debt deductions are denied to the extent that the amount of debt exceeds the amount that the entity would have been in the position to borrow from an external third party to fund its Australian operations, assuming that it could not rely on any parent or related-party guarantees. This is a more complex test and is subject to greater scrutiny from the Australian Taxation Office.
For some entities, another test, the worldwide gearing debt amount, may also be available.
It should be noted that the thin capitalisation rules only apply where the debt deductions of an entity and its associates in a particular income year are greater than AUD$2,000,000.
Hybrid mismatch rules
The hybrid mismatch rules are anti-avoidance rules which may apply to "hybrid mismatches" in the payments under a debt or equity instrument. The rules are directed to multinational corporate groups which seek to arbitrage differences in the tax treatment of instruments or entities across multiple jurisdictions. There are no de minimus exclusions and no purpose requirements.
The rules apply to payments between related parties and members of a control group. It also applies to parties under a structured arrangement, which occurs where the hybrid mismatch is priced into the terms of the scheme, or is a design feature of the scheme.
The rules are extremely complex and require an understanding of the nature and foreign law tax treatment of offshore group transactions.
The types of hybrid mismatches which may arise include the following:
- deduction or non-inclusion mismatches where a payment is deductible in one jurisdiction and non-assessable in the other jurisdiction. An example might be a redeemable preference share which is treated as debt in the issuer jurisdiction but which gives rise to a non-taxable dividend to the holder;
- deduction or deduction mismatches where the one payment qualifies for a tax deduction in two jurisdictions. This could occur as a consequence of a deductible payment made by an Australian entity which is disregarded for tax purposes in a foreign jurisdiction, resulting in another company being entitled to the deduction in the foreign jurisdiction; and
- imported hybrid mismatches, where receipts are sheltered from tax directly or indirectly by hybrid outcomes in a group of entities or a chain of transactions. This allows the rules to apply to a wholly offshore hybrid mismatch, which can be traced to an Australian company eg. because the Australian company makes a deductible payment to one of the offshore participants.
The rules also include a targeted financing integrity measure, which can apply where a foreign lender is taxed at the rate of 10% or less.
Where the hybrid mismatch rules apply, there is either the cancelling of a deduction, or the inclusion of income in an entity’s assessable income.
Foreign Investment Review Board
Mergers and acquisitions over a particular threshold, which involve a foreign investor, require approval from Australia's Foreign Investment Review Board (FIRB).
An investor's application to FIRB must include information about the investor, the investor's associated entities and the target. In addition, the application must outline details of the transaction, including the entities involved, the nature and extent of acquisition funding and details of the proposed capital structure of the target.
ATO – upfront involvement
When considering an application, FIRB is required to consult with various stakeholders, one of which is the Australian Taxation Office (ATO). The ATO will often ask a series of questions (through FIRB) of the applicant. The questions will typically cover the tax aspects of the transaction (transfer pricing, thin capitalisation, withholding tax on distributions, etc.) but a key focus of the ATO will be understanding how the acquisition is intended to be funded.
Financing, and particularly related-party financing, has been a particular focus of the ATO in recent years. As part of the FIRB process, the ATO will typically ask the applicant to outline the key terms of all proposed debt and equity arrangements and then require the applicant to rank each of these arrangements based on Schedule 1 of the Practical Compliance Guideline 2017/4 (PCG 2017/4).
PCG 2017/4 is the ATO's published guidelines on related-party financing. Schedule 1 allocates points to certain terms of the debt. For instance, where the transaction involves an inbound loan from a parent entity which is priced more than 150 basis points over the relevant traceable third party debt (but less than 200 basis points over such third party debt), Schedule 1 of PCF 2017/4 will allocate 10 points to that inbound loan. The higher the number of points allocated, the riskier the ATO perceives the loan to be. Where a debt arrangement attracts 15 points on the pricing indicator, the debt will automatically be in the "red" zone, which means that the ATO will review the applicant as a matter of priority.
As such, the FIRB process facilitates the ATO having an upfront insight into the taxation implications of an acquisition (and the ongoing tax implications of a target) before the transaction even occurs. This enables the ATO to be proactive about monitoring tax compliance, rather than having to wait for the investor to lodge its first tax return in Australia.
Where the ATO perceives a risk, it will require FIRB to impose conditions on the applicant in conjunction with FIRB providing approval (known as a "no objection" notification) to the applicant.
The "standard" tax conditions require the applicant to agree to comply with Australian tax laws, cooperate with the ATO, pay outstanding debts and report annually on compliance with the conditions. It is usually the case that the ATO will seek to at least impose the "standard" tax conditions, particularly on larger or more complex transactions. Where only the "standard" tax conditions are imposed, it would be unusual for there to be any direct interaction between the applicant and ATO/FIRB – these conditions are usually agreed by the applicant as part of the routine FIRB process.
Where the ATO perceives additional tax risk, the ATO may require FIRB to impose "additional" tax conditions. These may require the applicant to supply information within a particular timeframe or take particular action to resolve an issue that the ATO has identified. FIRB has recently updated the example list of "additional" tax conditions and they now formally reflect the questions (eg. in relation to related party financing) that the ATO would typically ask earlier in the FIRB process. Where "additional" tax conditions are imposed, an applicant should consider arranging a meeting with the ATO (and/or FIRB) to discuss the issues.
The tax conditions imposed by FIRB will continue to apply until the investor ceases to hold the asset acquired. In the event that an applicant breaches the tax conditions, the investor may be subject to prosecution or an application for a civil penalty order. In an extraordinary case, the investor may be required to dispose of the asset acquired.