A long, long time ago in a Tax Office far, far away…
After waiting 6 and a half years the Treasury has finally drafted some legislation to fix up how capital gains tax concessions apply to earnouts.
But just a quick reminder on the history of this issue…
In October 2007 the then Commissioner of Taxation released a draft ruling (Draft Taxation Ruling TR 2007/D10) that stated the small business CGT concessions could NOT apply to payments under earnout arrangements. As this outcome was ridiculous, the Commissioner never finalised the draft ruling waiting for the Treasury to fix the legislation. And the clock started ticking…
In 2010 the then Assistant Treasurer announced they would make a legislative changes to overcome some some consequences of the Commissioner’s position in the draft ruling (3 years to get a press release).
In 2013 the then Assistant Treasurer confirmed they would continue with this proposed legislative change (another 3 year to get another press release saying they will do what the first press release said).
During this time the Treasury was working hard to come up with the obvious solution that everyone knew. They released a discussion paper saying what we all thought, and had consultation in 2010 and 2011 where we told them we agree with what they want to do. It was so obvious what was going to happen that the Commissioner has allowed taxpayers to apply the law in expectation of what it will be under these changes all the way back to 2007 …
And now on to what the Treasury has done in the last 6 and a half years…
The draft law does four things:
- Capital gains and losses in respect of a look-through earnout right are disregarded;
- Financial benefits under or in respect of a ‘look-through’ earnout right are included when determining the capital proceeds or cost base of the underlying business asset to which the arrangement relates;
- A taxpayer’s assessment for a tax related liability that can be affected by financial benefits provided or received under a ‘look-through’ earnout right may be amended for up to four years after the earnout arrangement expires.
- Capital losses arising from a CGT event related to an earnout right may not be taken into account in determining tax liabilities until such time as they cannot be reduced by future financial benefits received under a relevant look-through earnout right.
So the draft law means that where there is an earnout, the only CGT event is the sale of the business and any future payments under the arrangement is just a change in consideration for that sale. Therefore, the small business CGT concession can apply to all the consideration for the sale of the business. Exactly what we always thought.
Just a few quick notes:
- This only applies to active assets;
- This only applies to real earnouts, and not to just deferred payment plans – the financial benefits provided must also be not able to be reasonably ascertained at the time the right is created;
- All the payments under the earnest have to be paid within four years;
- All look-through earnout rights must be created as part of arrangements entered into on an arm’s-length basis.
An 18 page bill, a 33 page EM and a two page issue register in 78 months since the issue arose, and remember there was a pretty obvious answer in October 2007 – so obvious we just kept lodging returns as if the law was as this draft law is.
But at least the Commissioner has learnt a lesson. Releasing a draft Ruling with a ridiculous outcome (but correct at law) is not an effective way to encourage the Treasury to quickly fix the law…