Scrip for Scrip Rollover: Key Considerations for Corporate Restructures

In the dynamic landscape of corporate restructures, a scrip for scrip rollover is a valuable mechanism that allows shareholders to exchange their shares in a target company for shares in the acquiring company without triggering an immediate capital gains tax (CGT) liability. This rollover can also apply to units in a trust under similar conditions. This article aims to highlight the intricacies of scrip for scrip rollovers, provide practical examples, and offer tips and traps to navigate this complex area.

Eligibility Criteria for Scrip for Scrip Rollover

To qualify for a scrip for scrip rollover, several conditions outlined in Subdivision 124-M of the Income Tax Assessment Act 1997 must be satisfied:

1. Exchange of Like for Like: The original interest must be exchanged for a similar interest, such as shares for shares or units for units. An exchange of shares for units or vice versa does not qualify.
2. Single Arrangement: The exchange must occur as part of a single arrangement, such as a takeover or scheme of arrangement, where at least 80% of the voting shares in the target company are acquired by the acquiring company.
3. Participation Terms: All shareholders with voting interests in the target entity must be able to participate in the arrangement on substantially the same terms.
4. Post-CGT Assets: The shares or units exchanged must be post-CGT assets, meaning they were acquired after 20 September 1985.
5. Capital Gain: The shareholders would have made a capital gain on the realisation of the original interests if the rollover was not utilised.
6. Significant or Common Stakeholders: Special rules apply if there are significant (30% or more) or common (80% or more) stakeholders involved.

Practical Examples

Example 1: Partial Scrip for Scrip Rollover

Scenario: James owns 100 shares in Titan Ltd, each with a cost base of $9. He accepts a takeover offer from Omega Ltd, which provides for James to receive one Omega share plus $10 cash for each share in Titan. James receives 100 shares in Omega and $1,000 cash. Just after James is issued shares in Omega, each share is worth $20.

Calculation:

• Cash Received: $10 per share x 100 shares = $1,000
• Total Proceeds: ($20 x 100) + $1,000 = $3,000
• Proportion of Cost Base Attributable to Cash:

1,000/3,000 × (100×9) = 1/3 × 900 = 300

• Capital Gain: 

1,000−300 = 700

• Cost Base of Omega Shares: 

900-300/100 = 600/100 = 6

In this scenario, James’s capital gain from the cash received is $700, and the cost base of each of his Omega shares is $6.

Example 2: Full Scrip for Scrip Rollover

Scenario: Emily owns ordinary shares in Coral Ltd. On 28 February 2021, she accepted a takeover offer from Pearl Ltd, under which she received one ordinary share and one preference share for each Coral share. The market value of the Pearl shares just after Emily acquired them was $20 for each ordinary share and $10 for each preference share. The cost base of each Coral share just before Emily ceased to own them was $15.

Calculation:

• Capital Gain Without Rollover: 

(20+10) −15 = 30−15 = 15

• Cost Base of Pearl Shares: 

20/30×15=10 (ordinary share)

10/30 x 15 = 5 (preference share)

In this case, the scrip for scrip rollover allows Emily to disregard the $15 capital gain. The cost base of the ordinary shares in Pearl Ltd is $10, and the cost base of the preference shares is $5.

General Tips and Traps

Tips:

1. Document Retention: Keep detailed records of the cost base of the original shares and any additional expenses related to the acquisition to ensure accurate CGT calculations.
2. Check Eligibility: Confirm all eligibility criteria, especially the 80% ownership requirement and the participation terms for shareholders.
3. Timing: Be aware of the timing of the exchange. The 12-month holding period for the CGT discount includes the time the original shares were held.

Traps:

1. Partial Rollovers: Be cautious with partial rollovers involving cash. The cash component will trigger a CGT event, and you must apportion the cost base correctly.
2. Significant Stakeholders: If there are significant or common stakeholders, ensure compliance with additional requirements, including joint election for the rollover.
3. Market Value Assessment: Accurately assess the market value of the replacement interests to avoid discrepancies in cost base calculations.

Specific Tips and Traps for Using Subdivision 124-M Rollover

Tips:

1. Participation on Substantially the Same Terms: Ensure that all shareholders of a particular class in the target company are given the opportunity to participate on substantially the same terms.
2. Earnouts: Consider structuring earnouts through special share classes that may later convert into ordinary shares to recognise the earnout value.
3. Interaction with Other Rollovers: Be aware that Subdivision 124-M does not apply when other rollovers, such as those in Subdivision 122-A or Division 615, are available.

Traps:

1. Buyer Veto: The buyer can veto the application of the rollover if they notify the seller before the exchange of shares. Ensure the Share Sale Agreement specifically states that the buyer will not veto the rollover application.
2. Non-Arm’s Length Conditions: Avoid separate negotiations with different shareholders as the buyer must make the offer on substantially the same terms to all shareholders of a particular class.
3. Cost Base Transfer: Be aware of the risk of double taxation when there is a cost base transfer due to significant or common stakeholders. This can lead to an unwanted double tax outcome.

Common Stakeholders and Significant Stakeholders

Significant Stakeholders

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, dividend 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.

Common Stakeholders

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, dividend 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.

Further Roll-Over Conditions in Certain Cases

Additional conditions must be satisfied if the original interest holder and an acquiring entity did not deal with each other at arm’s length and:

1. Neither the original entity nor the replacement entity had at least 300 members just before the arrangement started; or
2. The original interest holder, the original entity, and the acquiring entity were all members of the same linked group just before that time.

Impact of Rollover on Shareholders and Acquirers

Impact on Shareholders

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, such as some scrip and some cash provided to the original interest holder, the cash component will attract CGT.

Impact on Acquirers

If an original interest holder is a significant 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 the market value of the shares transferred at the time of exchange.

Exceptions

A taxpayer cannot obtain the rollover under Subdivision 124-M of the ITAA 1997 if:

1. Just before the taxpayer stops owning their original interest, they are a foreign resident, unless just after the taxpayer acquires their replacement interest, that replacement interest is taxable Australian property.
2. Any capital gain the taxpayer might make from their replacement interest would be disregarded, except because of a rollover.
3. The taxpayer and the acquiring entity are members of the same wholly-owned group just before the taxpayer stops owning their original interest and the acquiring entity is a foreign resident.
4. The taxpayer can choose a rollover under Division 122 of the ITAA 1997 or Division 615 of the ITAA 1997 for the CGT event.
5. The replacement entity makes a choice that you cannot obtain the rollover, and that entity or the original entity notifies you in writing of the choice before the exchange.

Wholly-owned Group

Section 975-500 of the ITAA 1997 provides that two companies are members of the same wholly-owned group if:

1. One of the companies is a 100% subsidiary of the other company; or
2. Each of the companies is a 100% subsidiary of the same third company.

Section 975-505 of the ITAA 1997 provides that a company (the subsidiary company) is a 100% subsidiary of another company (the holding company) if all the shares in the subsidiary are beneficially owned by:

1. The holding company; or
2. One or more 100% subsidiaries of the holding company; or
3. The holding company and one or more 100% subsidiaries of the holding company.

A company (other than the subsidiary company) is a 100% subsidiary of the holding company only if:

1. It is a 100% subsidiary of the holding company; or
2. It is a 100% subsidiary of a 100% subsidiary of the holding company.

The subsidiary company is not a 100% subsidiary of the holding company if a person is, or will be at some future time, in a position to affect rights, in relation to the subsidiary company, of:

1. The holding company; or
2. A 100% subsidiary of the holding company.

A person is taken to be in a position to affect rights if that person has a right, power, or option to acquire those rights or to do an act that would prevent the holder of the rights from exercising them for its own benefit.

A company is the ultimate holding company of a wholly-owned group if it is not a 100% subsidiary of another company in the group.

Linked Group

Companies that are linked to one another are in a linked group. Linked group has the meaning given to it by subsection 170-260(2) of the ITAA 1997, which provides:

Two companies are linked to each other if:

1. One of them has a controlling stake in the other; or
2. The same entity has a controlling stake in each of them.

An entity has a controlling stake in a company if, at a particular time, the entity or the entity and its associates between them:

1. Are able at that time to exercise, or control the exercise of, more than 50% of the voting power in the company (either directly, or indirectly through one or more interposed entities); or
2. Have at that time the right to receive for their own benefit (either directly, or indirectly through one or more interposed entities) more than 50% of any dividends that the company may pay; or
3. Have at that time the right to receive for their own benefit (either directly, or indirectly through one or more interposed entities) more than 50% of any distribution of capital of the company.

Conclusion

A scrip for scrip rollover can be a highly effective tool for deferring CGT liabilities during corporate restructures. However, navigating the eligibility criteria, calculating the correct cost bases, and understanding the implications of partial rollovers require meticulous attention to detail. By following the guidelines and being aware of the common pitfalls, shareholders can optimise their tax outcomes in a corporate restructure.

For further assistance and tailored advice, consult with tax professionals who can guide you through the complexities of scrip for scrip rollovers and other tax matters.