Transaction documentation issues
Below is a summary of some of the key Australian income tax issues associated with negotiating a share purchase agreement.
In broad terms, a tax consolidated group (TCG) is a group of wholly owned Australian tax resident entities with a common Australian tax resident holding company. The TCG operates as a single entity for Australian income tax purposes. The head company of a TCG is prima facie liable for the income tax obligations of the group. However, each member of a TCG is jointly and severally liable for the income tax liabilities of the TCG (unless a valid "Tax Sharing Agreement" is in place).
Further, for certain Australian groups of entities which share a common ultimate foreign owner, the entities can form a Multiple Entry Consolidated group (MEC group) if the relevant criteria are satisfied (we refer to a TCG and a MEC group, in each case, as a Consolidated Group). One significant advantage of income tax consolidation is that transactions between group members are generally disregarded for Australian income tax purposes (but not for example stamp duty purposes or GST purposes (unless a GST Group is in place)). This assists in restructuring before or after a sale and generally when transferring assets between group entities.
If a group of entities form a Consolidated Group it impacts significantly on the documentation and, the Australian Taxation Office (ATO) must be notified within the relevant time frame.
Tax Sharing Agreement (TSA)
As noted above each member of a Consolidated Group is jointly and severally liable for the income tax liabilities of the Consolidated Group (unless a valid TSA is in place). One of the requirements of a valid TSA is that there is a reasonable allocation of the group tax liability amongst group members (which is often calculated on a "standalone" basis).
If a valid TSA is in place, the Commissioner can generally only recover an amount reasonably allocated to a group member.
Generally speaking, a TSA can be important when the shares in a member of a Consolidated Group are proposed to be sold, as it may give a potential purchaser certain comfort regarding the target entities exposure to the income tax liabilities of the TCG / MEC group during the period in which it is a member (which can be relevant when negotiating tax warranties / tax indemnity).
Tax Funding Agreement (TFA)
In some cases, a Consolidated Group will also have a TFA.
Broadly, a TFA is an internal agreement between group members to pay an amount to the head company in regards to their agreed portion of the group tax liability. It ensures the head company has sufficient funds to satisfy its tax liability and also compensates loss-making subsidiaries for the value of tax losses utilised by other members of the Consolidated Group.
Sometimes for efficiency and ease, a TSA will be combined with a TFA and there will be a "Tax Sharing and Funding Agreement" in place to deal with both tax agreements.
Clear exit from Consolidated Group
When a member of a Consolidated Group is acquired by an entity outside the group, the buyers will ordinarily seek to ensure a "clear exit" of the group member from its income tax liabilities of the Consolidated Group. This is so that the acquired entity will not be generally liable for any unexpected income tax liabilities after it has exited the group which have not yet fallen due but which relate to a period while it was a member of the vendor Consolidated Group (Pre-Closing Period). If the clear exit process is properly managed, this should also protect the subsidiary for claims from the Commissioner for amended assessments issued after the closing of a transaction but which relate to an original assessment issued before closing.
Clear exit payments, properly calculated (including a reasonable estimate thereof) represent the relevant target subsidiary's share of the overall Consolidated Group's tax liabilities for the Pre-Closing Period. The payment of these amounts prior to closing of the relevant transaction essentially shields the Purchaser from the ATO seeking to recover tax for the Pre-Closing Period from the target subsidiaries. Clear exit payments require that a TSA be in place for the Pre-Closing Period.
A share sale agreement will often include a clause dealing with a “clear exit” as appropriate. A buyer should always ensure a valid TSA is able to facilitate a clear exit and that a clear exit has occurred in respect of the target entity if it is part of a Consolidated Group. It is good practice for the buyer to keep a record of the relevant “clear exit” calculations.
For other exit issues, please see Exit Issues – Share Sale and Exit Issues – Asset Sale.
If a group of entities forms a Consolidated Group it will impact significantly on the documentation.
Foreign Resident Capital Gains Tax Withholding (FRCGTW)
In very broad terms, the FRCGTW can require a purchaser to withhold 12.5% (or a relevant lower varied %) from the purchase price and remit to the ATO in certain transactions involving the direct acquisition of Australian real property (including certain mining tenements etc.) (Direct Acquisitions) and the indirect acquisition of Australian real property (ie. through shares in a company or units in a trust) (Indirect Acquisitions).
Importantly the FRCGTW can impose obligations on parties in a relevant transaction irrespective of whether they are foreign residents.
However, a purchaser generally does not have any withholding obligations under the FRCGTW regime if for a:
- Direct Acquisition, the vendor provides the purchaser with a valid “clearance certificate” issued by the ATO (which in broad terms states that the vendor is an Australian tax resident); or
- Indirect Acquisition, the vendor provides the purchaser with a valid declaration (which states that the vendor is an Australian tax resident or the shares / units being disposed of are not of a type which are subject to the FRCGTW regime).
Transaction documentation needs to accommodate this regime, provide for any relevant declarations and provide a mechanism for payment of FRCGTW in the event that the purchaser is required to pay FRCGT.
Other transaction documentation issues
Transaction documents will sometimes be subject to conditions precedent which may include approvals from the Foreign Investment Review Board (FIRB) (which can contain certain tax conditions) or relevant tax rulings from the ATO. See FIRB for more information on when a transaction is a notifiable action and Tax Rulings on the role of rulings in M&A transactions.
In addition, in an Australian transaction, it is customary to include provisions dealing with tax warranties and indemnities with the typical period for making claims being in the range of 5 to 7 years (depending on the circumstances). Warranty and indemnity insurance may also affect the way in which these provisions are drafted (see Tax Insurance).
Provisions governing the preparation of tax returns, tax audits and reviews, and the conduct of tax related claims which may give rise to indemnification under the agreement are also customarily included in the document.
The payment of stamp duty and GST is also typically covered by specific provisions in a customary sale agreement.