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Tax ramifications relating to capital

raising 13 April 2011

Tax structures• Sole trader

• Partnership/JV

• Company

• Conducive to investment

• Flexible structure - facilitate entry and exit of shareholders

• Note tax rules can be complex depending on transactions

• Unit trust

• Similar to company in terms of attractiveness

• Flow through entity - need to flush out distribution every year or else

subject to punitive tax

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Scenarios• Scenario 1: Vanilla equity raising

• Scenario 2: Convertible notes fund raising

• Scenario 3: Tax loss position

• Scenario 4: High net wealth individual investor(s)

• Scenario 5: Foreign investor(s)

• Scenario 6: Unit trust with SMSF investor(s)

Scenario 1: Vanilla equity raising

• ABC Pty Ltd (“ABC”) requires funding of $20m

• Ordinary shares issued to new investors in exchange

• Transaction costs (including legal and tax advisory)

of $550k incurred

• GST incurred on the transaction costs: $50k

ABC Pty Ltd

New

InvestorsYou

3

Scenario 1: Vanilla equity raising • Tax ramifications on issue of shares:

• No CGT implications for ABC and new investors on issue ofshares

• Capital raising costs not tax deductible upfront but can beamortised over 5 years

• Issue of shares is an input taxed supply; this means generally nocredit claims for associated capital raising costs

• No stamp duty should apply in Victoria for the new investors

• What if you issue the shares for below market value or noconsideration?

Scenario 2: Convertible notes fund raising

• Similar to scenario 1 except that convertible notes are issued insteadof ordinary shares

• Terms include (discretionary) interest payments and convertible notescan be converted into ordinary shares in future years

• Tax ramifications on issuing convertible notes:

• Debt/equity rules

• Convertible notes can be reclassified as equity for taxpurposes

• Interest will not be deductible for ABC

• Tip: Run your convertible note term sheet past your tax advisor toensure you can secure your interest deduction

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Scenario 3: Tax loss position

• Similar to scenario 1

• Strategic investor, being an ASX listed co., acquires 51% of ABC

• ABC has tax losses of $4.5m at the time it issues shares to ASXlisted co.

ABC Pty Ltd

ASX

listed co.You

Scenario 3: Tax loss position• Tax ramifications:

• Utilisation of the tax losses going forward

• Need to satisfy recoupment tests, being either continuity ofownership test (“COT”) or same business test (“SBT”):

• COT failed because of majority ownership has changed; and

• SBT is hard to satisfy (more so if you are a start-up andevolving)

• Resultantly, $4.5m in tax benefits may be wasted if capital raising isnot structured properly

• Tip: Ongoing monitoring of underlying shareholders required togetherwith nature of the business

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Scenario 4: HNWI investor(s)

• Tax (administrative) ramifications:

• HNWI subject to heightened scrutiny from the ATO

• Business venture affiliated to HNWI will, to a certain extent, formpart of the review

• Tax risks should be managed and mitigated at ABC level

ABC Pty Ltd

HNWI You

Scenario 5: Foreign investor(s)

ABC Pty Ltd

Foreign

investor

You

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Scenario 5: Foreign investor(s)

• Tax ramifications in relation to having foreign investor(s):

• Arm’s length dealings (transfer pricing rules)

• Interest deductibility (thin capitalisation rules)

• Withholding tax (royalties, dividend, interest)

• Foreign denominated transactions (TOFA rules). For instance:

• Bank a/c

• Loan

Scenario 6: Unit trust with SMSF investors

• Tax ramifications:

• Corporate tax treatment; no longer subject to flow throughtreatment

• Tax leakage of 30% will apply

• Timing of tax payments will need to be managed to be able tofrank distributions

ABC Unit Trust

SMSFs You

20% 80%

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Conclusion

• Tax rules are complex

• No two capital raising scenarios are the same from a tax

perspective; any slight change in your capital raising financial

instrument, investor profile or structure may yield a different

tax outcome

• Remember it is not a ‘set and forget’ approach from a tax

perspective. At some stage, you may want to raise further

capital, divest or exit completely out of the business

Machel Advisory ServicesLevel 10 530 Collins Street Melbourne VIC 3000

P: +613 8635 1987F: +613 8102 5487E:machel@macheladvisory.com.au

Liability limited by a scheme approved under Professional Standards Legislation

Disclaimer

• The contents herein are generic in nature and should not be

relied upon by readers as tax, legal or business advice.

• Machel Advisory Services is not responsible and, to the

extent permitted by law, should not be held responsible if

you have relied on the above contents.

Machel Advisory ServicesLevel 10 530 Collins Street Melbourne VIC 3000

P: +613 8635 1987F: +613 8102 5487E:machel@macheladvisory.com.au

Liability limited by a scheme approved under Professional Standards Legislation