By Shelley-ann Brinkley – 29 January 2014

Here is just one example, of many, how tax legislation can make life difficult for businesses.

Throughout the year we are often approached by clients looking to either restructure or sell part of their business.

Part of this discussion often involves tax considerations, particularly around shareholder continuity and the impact on losses and imputation credits.

A recent client predicament highlights yet another issue which could be easily overlooked.  That issue being “associated person capital gains” derived by a company.

This particular situation involved a company that operated a successful business.  The owners were preparing the business for sale.  Normally, a transaction of this nature would be undertaken by selling the underlying business rather than shares.  This was not however possible in our client’s situation due to the key contractual relationships that were already in place with the company that they did not want to have to renegotiate and, as it transpired, it was necessary to sell the business by way of a share sale rather than a business sale .

The company also owns the commercial property in which the business is currently operating out of.  The buyer is not interested in purchasing the commercial property.  The owners of the company have therefore decided to continue to hold the property for long term rental purposes.

In order to sell the shares, it is therefore necessary to sell the commercial property to another entity.

The tax legislation states that where a company derives a capital gain from the sale of an asset to an associated person, that capital gain will be deemed to be an “associated person capital gain” (APCG).  Whilst not taxable in the first instance to the company, at any point that gain is distributed to shareholders, (whether or not that is in the course of liquidation), that gain will become taxable to the shareholders.  Clearly this is not a great result.

If the client proceeded with what they intended to do, a APCG would arise which will ultimately impact on the price the purchaser is willing to pay, given a future tax liability will arise to the new shareholders at some time when the gain is distributed from the company.

Anyone that has looked at the “associated persons” definitions knows that it is now nigh on impossible in most cases to break association.

The above situation is not unusual by any means.  Unfortunately given these rules, significant compliance costs are being incurred by taxpayers in seeking appropriate tax advice.  In many instances taxpayers are otherwise being caught unaware of this ticking time bomb.

This outcome is as a result of the application of the dividend and associated person definitions contained in the Income Tax Act 2007.  There is however no monkey business or avoidance going on here.  The company is merely trying to sell an asset in order that a third party purchaser will agree to acquire its shares.

It seems these rules are well overdue for an overhaul as clearly the rules in their present form are tripping up many business owners as a result of their innocent and necessary business transactions.

If you would like to discuss this further, please feel free to contact Phil Barlow or Shelley-ann Brinkley.

Phil Barlow
Tax Director
T +64 9 414 5444
F +64 9 414 5001

Shelley-ann BrinkleySenior Manager – Tax Consulting
T +64 9 414 5444