Restructuring for UPEs, s 45B and Part IVA
The Federal Court recently considered a case that involved a substantial restructure of a unit trust to over come division 7A UPEs issues. The (pre-CGT) City Beach Unit Trust had two unitholders (pre-CGT) who ran a successful retail business. Being a trust, it was not able to accumulate income without paying tax at the highest marginal tax rate.
The accountant for the group decided to implement a restructure. The steps of the restructure are detailed below. The case is notable not just for its practical solution to a common problem, but also because the ATO attacked the taxpayer on 2 grounds. First, the ATO alleged there was a capital benefit under section 45B of the Income Tax Assessment Act 1936. Secondly, the ATO alleged a scheme under Part IVA. This was due to the trust and the units being pre-CGT. The ATO failed on both grounds. The ATO have appealed the matter and it is a case to be watched.
Notably the ATO submitted that an ‘alterative posutale’ to the restructure was the ‘bucket’ company simply paying a dividend. As the bucket company had never paid a dividend on that scale before, and that the bucket company did not have the money, and that such a dividend would severely impact the finance of the business, the Federal Court that this postulate was “just not reasonable”.
The case demonstrated that section 45B and Part IVA must be considered wholistically in light of the specific scenario of the taxpayer.
The structure that was implemented is detailed below:
The following was put forward as a mechanism to extinguish UPEs converted to a division 7A loan between a trust and a ‘bucket’ company.
Step 1 – a transfer of the units in CBT to a new company (Methuselah) in consideration for new shares in Methuselah (Methuselah was an interposed entity between the trustee company and the unitholders, so the structure was trustee co è holding co è unitholders);
Step 2 – the undertaking of a selective share buy-back to allow, in substance, a realisation of pre-CGT capital gains to the shareholders in Methuselah;
Step 3 – the assignment of the debt (loan) interests arising from the share buy-back to the Division 7A entities; and
Step 4 – an election by Methuselah to form a consolidated group with the CBT.
The purpose in relation to this restructure proposal were as follows. The proposed share buy-back would give rise to a liability in the new company (which became Methuselah), which would be payable to the existing unitholders of the unit trust (being discretionary trusts). As Methuselah “would not have the cash available to fund the ‘cancellation’, loan agreements were proposed to be put in place to recognise the debts due under the share buy-back, which could then be assigned as an asset of the shareholders thereby enabling the Division 7A loans to be repaid”.
The advisers considered that “this was the optimal result as it would result in both unitholders retaining a portion of the pre-CGT value and only realising the amount necessary to enable repayment of the balances of each of the Division 7A loans”.
On 20 May 2016:
Methuselah and Mr Ierna entered into a Unit Sale Agreement, under which Methuselah agreed to issue 14,000,000 shares to Mr Ierna in exchange for the 14 units held by him in the CBT;
Methuselah and Oxlade as trustee for the IFT entered into a Unit Sale Agreement, under which Methuselah agreed to issue 1,000,000 shares to the IFT in exchange for the 1 unit held by Oxlade as trustee of the IFT in the CBT; and
Methuselah and Corkdon, as trustee for the WHFT, entered into a Unit Sale Agreement, under which Methuselah agreed to issue 15,000,000 shares to the WHFT in exchange for the 15 units held by Corkdon as trustee of the WHFT in the CBT,
(collectively, the Unit Sale Agreements)
Under the Unit Sale Agreements, the units in the CBT were provided as consideration for the issue of shares in Methuselah. No further cash consideration was payable by the former unitholders for the issue of the shares.
At that same meeting, Messrs Ierna and Hicks, in their capacity as directors of Methuselah, resolved that Methuselah would issue additional ordinary shares at $2.50 per share to comply with its obligations under the Unit Sale Agreements.
The price of the shares in Methuselah was determined having regard to the value of the net assets of the CBT at 20 May 2016 determined on the basis of the valuations made by Hanrick Curran, as set out above.
On 20 May 2016, Methuselah issued 30,000,000 shares with a fully paid amount of $2.50 per share, in compliance with its obligations under the Unit Sale Agreements.
As a consequence of the share issue on 20 May 2016, the shares in Methuselah were held as follows:
14,000,014 shares (46.67%) were held by Mr Ierna;
1,000,001 shares (3.33%) were held by Oxlade, as trustee of the IFT; and
15,000,015 shares (50%) were held by Corkdon, as trustee of the WHFT.
Each of the shareholders in Methuselah chose to obtain a roll-over under Subdivision 615-A of the ITAA 1997 in respect of their disposal of their units in the CBT.
Messrs Ierna and Hicks met again in their capacity as directors of Methuselah at 12.40pm on 20 May 2016. The minutes of this meeting record that:
“to realise value from the shares held in the Company, it has been recommended to the Company that the Company implement a selective capital reduction”; and
Methuselah intended to cancel 10,400,000 ordinary shares held by each of Mr Ierna and Corkdon as trustee of the WHFT.
The selective capital reduction was undertaken in accordance with the requirements of s 256C of the Corporations Act 2001 (Cth) (Corporations Act).
On 14 June 2016:
Mr Ierna and Methuselah entered into a Loan Agreement by which the applicant agreed to loan $26,000,000 to Methuselah, by way of forbearance from requiring Methuselah to pay the cancellation amount on 29 June 2016; and
Corkdon as trustee of the WHFT and Methuselah entered into a Loan Agreement by which the trustee of the WHFT agreed to loan $26,000,000 to Methuselah, by way of forbearance from requiring Methuselah to pay the cancellation amount on 29 June 2016,
(collectively, the Loan Agreements).
No interest was payable under either of the Loan Agreements and no security was provided. The loans made under the Loan Agreements were repayable within 90 days of the lender providing written notice that repayment was required, although Methuselah was permitted to repay the loans earlier if it had the funds to do so.
On 29 June 2016, Mr Ierna entered into a deed of assignment with Methuselah, Ierna Beneficiary and Surfstone as trustee of the IPT (IB Deed of Assignment), under which:
Mr Ierna assigned to Ierna Beneficiary all of his right title and interest in $11,685,407.08 of the $26,000,000 owed to him by Methuselah, including the right to demand performance of or to sue for and enforce the payment of that amount; and
in consideration of the assignment, Ierna Beneficiary received the assignment of the debt of $11,685,407.08 as repayment of the IB-CI Loan and the IB-IPT Loan, which the parties agreed were in the amount of $10,588,236.13 and $1,097,170.95, respectively, at 29 June 2016.
Also on 29 June 2016, Mr Ierna entered into a deed of assignment with Methuselah, Mastergrove and Surfstone as trustee of the IPT (Mastergrove Deed of Assignment), under which:
Mr Ierna assigned to Mastergrove all of his right title and interest in $14,286,681.36 of the $26,000,000 owed to him by Methuselah, including the right to demand performance of or to sue for and enforce the payment of that amount; and
in consideration of the assignment, Mastergrove received the assignment of the debt of $14,286,681.36 as repayment of the Mastergrove-IPT Loan and the Mastergrove-CI Loan, which the parties agreed were in the amount of $10,131,875.56 and $4,154,805.80, respectively, at 29 June 2016.
The effect of the IB Deed of Assignment and the Mastergrove Deed of Assignment was that Mr Ierna assigned $25,972,088.44 of the $26,000,000 owed to him by Methuselah to companies within the City Beach group on 29 June 2016, as follows:
Assignee: Ierna Beneficiary
Amount assigned: $11,685,407.08
Assignee: Mastergrove
Amount assigned: $14,286,681.36
Total: $25,972,088.44
The IB Deed of Assignment and the Mastergrove Deed of Assignment effectively extinguished the Ierna Division 7A Loans.
The same was done for the other unitholder.
The assignments and repayments of the Division 7A loans were recorded in the accounts of the relevant entities by accounting entries.
In effect, the Division 7A loan assets were replaced by another loan asset of equal value.
There was no net change to the asset position of Mastergrove, Ierna Beneficiary or Hicks Beneficiary as a result of these accounting entries. In effect, the Division 7A loan assets were replaced by another loan asset of equal value. The recording of the repayment of the Division 7A loans in the accounts of Mastergrove (that is via the credit entry as described) did not, in accounting terms, record or reflect any payment to or for the entity repaying the Division 7A loans being made by those companies, because the companies received something of equal value in exchange for the reduction of the Division 7A loans.