Today’s budget announcement will be good news for corporates undertaking M&A transactions because it now provides the market with greater certainty in relation to the scrip-for-scrip rules and could encourage more scrip to scrip M&A activity, according to Mark Goldsmith, Deloitte Tax Partner.

“Since late last year, the M&A market has been in a state of turmoil after the former Government’s announcement of its proposed changes to the scrip-for-scrip rules,” Mr Goldsmith says.

“Since that time, the Federal Government has moved to calm the markets by indicating earlier this year that the proposed changes would be a more targeted integrity measure than had been previously announced by the Howard Government.”

“Until tonight, the market has been left in doubt as to how these changes will apply and, whilst there is considerable detail to follow, at least we now have a basic understanding of how the changes will operate.”

“In essence, the changes are intended to prevent a cost base step-up for the assets of a target entity (which arises as a consequence of the combined application of the scrip-for-scrip and tax consolidation rules) in a transaction that is more in the nature of a ‘restructure’ than a genuine takeover.”

This meant that the Government needed to distinguish between what it considered to be a restructure and what it considered to be a takeover. The Government tonight announced that “[an] arrangement will be taken to be a restructure if, under the arrangement, the market value of the net assets of the acquiring entity immediately before the arrangement is less than 20% of the market value of its net assets immediately after the completion of the arrangement.”

“Obviously anything not falling within this category will be regarded as a takeover and therefore eligible for the benefits of scrip-for-scrip rollover and cost base step-up,” Mr Goldsmith said.

“Where the arrangement is taken to be a restructure, the cost base of the shares in the target entity will be worked out having regard to the total of the cost base of the target entity’s assets less its liabilities, rather than the market value of its shares.”

“In the case of a partial rollover (ie. where the consideration for the acquisition of the target entity’s shares is partly cash), the Government will allow a market value cost base for the shares to the extent of the cash consideration.”

Acquiring entities will have the choice of whether to access the cost base step-up rather than providing the target entity’s shareholders with scrip-for-scrip rollover. This might prove attractive for a company that is acquiring a target company with a shareholder base that cannot readily take advantage of the benefits of scrip-for-scrip rollover such as those with a large non-resident shareholder base. As a simplification measure, the Government has indicated that the acquiring entity will be able to make this election without having to first determine whether the transaction satisfies the criteria to be classified as a “restructure”.

Mr Goldsmith observes that there are some issues that are left to be ironed out, including:

• the means by which the market value of a company will be determined.  “In this respect, it is pleasing to see the Government adopting a pragmatic approach to this issue by indicating that they would consider accepting proxies for market value, such as the quoted price of shares on a stock exchange,” Mr Goldsmith says
• whether the Government will allow an acquiring entity the flexibility to adopt the “stick method” (ie. the retention of the target entity’s tax cost for its assets) rather than being required to conduct a full blown tax consolidation calculation.  “The use of the ‘stick method’ could provide taxpayers with benefits beyond a reduction in compliance costs.  For many taxpayers, an acquisition will result in a need to recognise goodwill that may result in part of the deemed purchase price for the target shares being allocated to goodwill and away from assets that may have been previously subject to some form of tax relief,” Mr Goldsmith noted.

A welcome change in stance is the fact that the Government has announced that these measures will now only apply to arrangements either announced to the Australian Stock Exchange, in the case of a listed company, or to shareholders, in the case of an unlisted company, after 7:30pm Eastern Standard Time on 13 May 2008 rather than the date of the original announcement late last year.