Duty and Taxes – the two real certainties
ABOUT THIS SERIES
- This is the third edition of McCullough Robertson’s six part Commercial Law Masterclass series.
ABOUT THIS ARTICLE
- Duty and taxes are often a certainty in business and asset acquisitions but they are rarely straight forward, often becoming complex and costly if not approached in the right away. In this article we discuss some traps to be mindful of during the initial stages of planning an acquisition.
- We’ll wrap up the series with a Masterclass in Brisbane in early 2019 where you can ask our expert panel any questions.
COMING UP NEXT
- Our next article in this series will focus on reducing the exposure of sellers in M&A transactions through warranty & indemnity insurance.
COMMERCIAL MASTERCLASS: THIRD EDITION
‘In this world nothing can be said to be certain, except death and taxes’. While there is no solid evidence confirming who first uttered this famous quote, there is no denying that their observation is correct. Taxes continue to be a fact of life, and while duty and taxes are not necessarily the core drivers when negotiating a deal, they can be costly in the long term if you get them wrong.
At its simplest, the concept of paying duty and tax can appear relatively straightforward (“isn’t it just 5% duty on acquisition and 30% tax on disposal?”). However the calculations become complicated quickly, especially when operating across multiple jurisdictions. Australian’s income taxation law is arguably one of the most complex in the world. Combine this with the possibility of triggering the state and territory based duties, and then throw GST into the mix, and a business or asset acquisition can quickly descend into an expensive taxable nightmare.
This edition of the Commercial Masterclass will discuss some of the tips and traps to be mindful of during the initial stages of planning an acquisition.
This article is designed to be a general overview of some of the issues to be considered. You must seek specialist advice as the relevance of these issues will vary depending on the specific facts and circumstances affecting your transaction.
Duty tips and traps
Despite the constant promises that it will be abolished, stamp duty still exists in all Australian States and Territories (although its impact, particularly for non-land assets, has been gradually reduced in some jurisdictions). In almost all jurisdictions duty continues to be an issue across a wide range of transactions, from general commercial transactions relating to shares and business assets to personal structuring arrangements including trust and partnership dealings.
Transfer duty in Queensland is currently calculated on a sliding scale up to 5.75%. It is payable where there is a dutiable transaction, the most common of which will be a transfer or agreement for the transfer of dutiable property.
The most well known example of dutiable property in Queensland is land and interests in land. However in Queensland, dutiable property still includes other items of property on which duty has been gradually abolished in some other jurisdictions. This includes, for example, goodwill, intellectual property, debtors of a Queensland business, work in progress, business names and licences, supply rights and general business assets.
Additionally, although shares are no longer dutiable property in their own right, an acquisition of shares may still give rise to a duty liability under the (separate) landholder duty regime.
At a basic level, landholder duty in Queensland will apply where:
- a person makes a relevant acquisition (i.e. 50% or more in a private company or 90% or more in a public company when aggregated with interests held or acquired or held by the person or related persons);
- in a landholder (an entity which holds ‘land’ in Queensland); and
- that landholder has landholdings in Queensland with an unencumbered value of $2 million or more ( this landholder value threshold varies between jurisdictions, between nil and $2 million).
An interest in a landholder will be acquired if an entity’s interest increases, regardless of how the interest is obtained or increased. This means that an entity does not need to be issued with shares or take a transfer of shares in order for landholder duty to apply to a transaction. An interest may also be acquired by:
- the purchase, gift or issue of a share;
- the cancellation, redemption or surrender of a share;
- the abrogation or alteration of rights attaching to shares;
- the payment of an amount owing for a share; or
- a change in the capacity in which the share is held (for example, starting to hold shares as a trustee).
There are also other aspects of landholder duty which indicate that the scope of landholder duty continues to expand, for example:
- in some jurisdictions the calculation of landholder duty is on the value of not just land owned by the landholding entity, but land and goods;
- the inclusion of items fixed to the land in the definition of landholdings, even if the landholding entity does not have any interest in those items (for example, leasehold improvements); and
- the extension of the traditional understanding of ‘land’ or ‘interest in land’ for the purposes of determining whether landholder duty applies.
The effect of this expansion means that the scope of landholder duty now goes well beyond concepts of what is ordinarily considered to be ‘land’. This can have significant impacts on the triggers for landholder duty and the quantum of landholder duty payable on a transaction.
What is ‘land’?
It has historically been accepted that the value of fixtures (which at law are deemed to form part of the land) are to be included in an entity’s landholdings for duty purposes. However, the legislation in most jurisdictions now uses the much broader term ‘fixed’ to land, rather than a reference to ‘fixtures’ – presumably to do away with any difficulty associated with determining whether or not an item affixed to land amounts to a fixture at law.
However, this legislative change potentially gives rise to its own difficulties. Although the ordinary meaning of the word ‘fixed’ objectively requires some connection to the land, the question still remains as to what degree of affixation is required for an item to be ‘fixed to the land’ to form part of an entity’s landholdings for duty purposes. It is also counter intuitive for duty to be calculated on the value of assets that the landholding company has no interest in.
An example of where we have seen this issue give rise to a significant (unexpected) landholder duty issue occurred during the acquisition of the shares in a company that owned a caravan park. Here, the Office of State Revenue sought to include the value of items ‘fixed’ to the land for the purposes of calculating a landholder duty assessment on the acquisition of the shares, even though the company had no interest in those items. Specifically, the land and buildings owned by the company were valued just above the $2 million landholder duty threshold, however there were numerous mobile dwellings (transportable homes) located on the land, which were owned by the residents who leased the site, not the company.
These mobile dwellings were far more valuable than the land, and were held in place by a hooked chain that was anchored to a concrete block dug into the ground. On that basis the Office of State Revenue initially decided that they were ‘fixed’ to the land, and included their value in the landholder duty assessment, even though the company had no interest in them. While the Office of State Revenue eventually accepted that in the circumstances most parts of the mobile dwellings were not ‘fixed’ for landholder duty purposes, it was an unexpected fight for our client.
Leasehold interests in land
As another example that highlights how these concepts can effect whether landholder duty is triggered at all, leasehold interests are increasingly becoming problematic.
There is clear authority that a lease (being a right to occupy land) constitutes an interest in land and leasehold interests fall within the definition of land for the purposes of landholder duty. However, in circumstances where the lease is on arm’s length terms and requires the lessee to pay market value rent for the term of the lease, the leasehold interest in the land itself should have no material value.
However, a tenant’s interest in any fixtures attached to land (which amounts to a right of the tenant to remove those fixtures at the end of the lease term) also constitutes an interest in land.
Therefore, even where an entity may not own any ‘land’ per se, if that entity holds a lease over land and has an interest in the fixtures attached to the land, the entity may be a ‘landholder’ for duty purposes. If the fixtures ‘owned’ by the lessee of leased premises have a value in excess of the relevant threshold for landholder duty in a particular jurisdiction, landholder duty may apply on the acquisition of shares in that entity – including by an indirect acquisition of shares (for example, by acquiring 100% of the shares in the entity’s ultimate holding company).
We have seen this exact scenario in the context of expensive medical scanning equipment that was bolted to the floor of leased premises (that is, $2 million is a relatively low threshold amount in the context of equipment and machinery used in some industries).
Another issue which may be of particular relevance in business transactions is to note that in a number of jurisdictions the landholdings of an entity will be deemed to include (depending on the jurisdiction):
- land that the entity has contracted to purchase; and/or
- land that the entity has a right acquire under a put and call option; and
- land that the entity has contracted to sell.
This can be relevant where, for example, an entity has signed a contract to acquire land and prior to settlement there is a dealing in the shares that results in a shareholder acquiring a significant interest in the entity.
Although the entity may not yet own the land in question at the time the shares are acquired, it will potentially be a landholder. The result is that the dealing in shares will trigger landholder duty (in addition to the transfer duty payable on the contract to acquire the land).
Capital gains tax
At a very basic level if you are selling business assets or shares in a company you will likely make a capital gain or capital loss when you sell (unless a relevant exemption applies).
If you make a capital gain you (or the entity disposing of the assets) will be liable for capital gains tax subject to any discount or other available exemptions. If the sale results in a capital loss, the losses can be carried forward and offset against future capital gains.
Conversely, if you are acquiring business assets or shares in a company then capital gains tax may not be at the forefront of your mind (given any liability will not arise until the assets are disposed of in the future). However, thinking about capital gains tax now may influence the structure that you choose to make the initial acquisition.
For example, some of the tax issues to consider include:
- What will be the tax rate of entities that are initially and ultimately taxed? Companies have the benefit of being tax at a flat rate of either 27.5% or 30%, and have the ability to retain profit, or distribute it to shareholders. Further, shareholders will obtain a credit (franking credit) for any tax paid by the company and attached to dividends distributed to shareholders. If you acquire assets in your individual capacity you will pay tax on any net profit at your marginal tax rate. Compare this with the ability to stream income to a number of entities if the assets are acquired by a discretionary trust (although noting the requirement to make distributions each year or risk the trustee being required to pay tax at the top marginal tax rate);
- Will the capital gains tax discount apply on an eventual disposal? The discount of 50% for individuals and trusts and 33.3% for superannuation funds will apply where the assets are held for 12 months or longer. Companies are not eligible for any discount; and
- Can losses be distributed? – losses incurred by a partnership can be applied by the partners to reduce their taxable income. In contrast, losses derived by a company or trust must be retained in the entity and applied against future income derived by the company or trust in question. Only in some cases can those losses be used by other associated entities.
GST and the going concern exemption
In the context of business sales and acquisitions we are often asked whether the GST going concern exemption will apply. As a general rule, for a business sale to be a supply of a going concern (and therefore eligible for the exemption), the following conditions must be satisfied:
- the sale must be for consideration;
- the purchaser must be registered, or required to be registered, for GST;
- the purchaser and the seller must have agreed in writing that the sale is of a going concern;
- the sale must include everything that is necessary for the continued operation of the business; and
- the business must be carried on by the seller up until the day of sale.
Where all of these basic conditions are not satisfied, the going concern exemption cannot apply to the sale.
The main traps we see are circumstances where the purchaser is acquiring all the assets of a business but it is not acquiring the premises, or a lease for the premises, from which the business is conducted. In most cases premises will be required for the operation of the enterprise, meaning that where the premises are not supplied (via transfer or lease) to the purchaser, the exemption will not be available.
Similarly, the business in question must be carried on by the seller up until the date of sale. Where the business ceases to be carried on prior to the date of sale, the going concern exemption will not be available (even if the parties agree that it would apply).
Where to from here…
In the case of business and share transactions commercial drivers may often take priority over tax and duty considerations. However, while tax and duty may not be the core driver at the beginning of a new acquisition, in our experience it either quickly becomes an important factor or, raises issues down the track when clients look to undertake internal restructures in order to adopt a more tax effective ownership structure. The need to restructure can be costly and, frankly, is often wholly avoidable with a degree of forward planning.
Early engagement and planning will assist you when navigating the tax and duty systems in order to manage your tax liabilities. This can be as simple as seeking tax and structuring advice prior to signing a contract as part of the broader due diligence process.
The Australian tax and duty systems are often difficult and overly complex. We have a team of people who work exclusively in this space, every day. Before you kick your own goal, kick it to us.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.