Tax Risks associated with nomination clauses in Share Purchase Agreements

This article highlights potential tax and stamp duty risks associated with the use of nomination clauses in the context of acquiring shares in Australian companies. This potential income tax risk is currently being considered by the Federal Court in the Mylan Australia Holding Pty Ltd vs Commissioner of Taxation (Mylan) case.

In Brief

The key takeaways

• The use of a nomination clause in a share purchase agreement (SPA) provides flexibility for a purchaser in its structuring, particularly for M&A between global groups.
• However, the ATO is currently asserting that in a transaction involving a non-Australian parent buying various target subsidiaries, nominating an Australian buyer to buy the Australian target entity in conjunction with intra group debt may result in the application of the general anti-avoidance provisions.
• Stamp duty can be triggered in WA and Queensland when nominee clauses are invoked.
• Advice on both income tax and stamp duty implications should be taken when agreeing, and using, nomination clauses.

Income Tax Considerations

Background

It is common in SPAs for the buyer to have the right to nominate a subsidiary or other related entity to be the purchaser of the shares, rather than the buyer itself. This allows the buyer group flexibility in structuring its acquisition, especially where global groups are being acquired.

However, in the Mylan case, the Commissioner has alleged that the exercise of such a nomination right formed part of a "scheme" to which Australia's general anti-avoidance rule in Part IVA of the Income Tax Assessment Act 1936 could apply.

In 2007, Mylan Inc, a US tax resident, entered into a SPA with Dutch tax resident company Merck Generics Group B.V. to acquire five Merck group companies, one of which was an Australian company. The SPA permitted Mylan to substitute an ‘Affiliate’ to acquire the shares in the target entities. Following the receipt of tax advice the SPA was amended to facilitate the acquisition of the Australian Merck target by a newly incorporated Australian Mylan subsidiary. The Australian Mylan entity then used a mixture of equity and related party debt – within the thin capitalisation ‘safe harbour’ which applied at the time – to fund the acquisition.

The Commissioner of Taxation has sought to deny the interest deductions contending that the "scheme" included the following steps:

1. The incorporation of new Australian entities within the Mylan group;
2. Amending the SPA to nominate the Australian Mylan entity as the purchaser of shares in the Australian Merck target company; and
3. The Australian Mylan entity funding its purchase of the shares in part by issuing interest bearing promissory notes to a related party.

The Commissioner has argued that this scheme was entered into for the dominant purpose of the Australian Mylan entities obtaining a "tax benefit" in the form of deductions for interest paid on the promissory notes.

In determining the tax benefit the Commissioner has submitted that instead of the scheme outlined above it might reasonably have been expected that:

• The Australian Mylan entities would not have been incorporated;
• The SPA would not have been amended to facilitate the nomination of the Australian Mylan entities; and
• The promissory notes would not have been issued.

The Commissioner also contends (in the alternative) that less related party debt would have been used, or the terms of the debt (including interest rates applied) would have been different – though the ATO is no longer seeking to apply Australia’s transfer pricing rules to contend the terms were not arm’s length.

While the Mylan case is yet to be decided, the Commissioner’s approach gives rise to a broader concern that exercising a standard nomination right in a SPA could potentially form part of a “scheme” for Part IVA purposes.

Risks and mitigations

The mere fact that a nomination clause is included in a SPA, or that a buyer exercises its right to nominate a subsidiary as purchaser, should not of itself attract the operation of Part IVA.

However, the Commissioner’s position in Mylan suggests that where the nominated purchaser funds the acquisition in a way that generates Australian tax deductions (e.g. by borrowing funds from a related party), there is a risk the Commissioner may scrutinise the arrangement under Part IVA.

This risk is heightened where:

• The nominated purchaser is a newly incorporated Australian entity with no or limited business activities of its own;
• The acquisition is funded by intra-group or related party borrowings;
• There is a more “direct” way for the buyer group to acquire the shares which would not have resulted in Australian tax deductions being claimed.

To mitigate the Part IVA risk, consideration should be given to:

• Where possible, ensuring the ultimate buyer is incorporated and is a party to the SPA from the time it is signed to remove the need for nomination. Alternatively the entity nominated as purchaser should be an existing operating subsidiary with real business activities (not a newly incorporated "shell" company);
• If intra-group/related party debt is used to fund the acquisition, the loan should be on arm's length terms (including principal, interest rate, security and repayment terms); and
• There should be clear commercial reasons for nominating a particular subsidiary as the purchaser (beyond obtaining a tax benefit).

Stamp Duty Considerations

An acquisition of shares in a company can give rise to duty issues in an Australian State or Territory, if the target company is a landholder for the purposes of the applicable duties legislation. Broadly, landholder duty is chargeable when a person acquires an interest of 50% or more in a landholder company (or 90% or more for a listed company).

Complex rules apply to determine whether a company is a landholder (including tracing rules), and whether the 50% dutiable threshold is met (including aggregation rules). The details of the landholder duty regimes in the 8 States and Territories are beyond the scope of this note, but the below illustrates some complexities which can arise where the target is a landholder for duties purposes. It is important to consider duty issues in detail ahead of documenting a transaction to ensure there are no unexpected duty outcomes.

Generally a liability to landholder duty arises on completion of a share sale agreement. Accordingly, nominating a share transferee under a share sale agreement should not give rise to additional duty issues in the usual case (and subject to the below key exception) as the share sale agreement is not of itself a dutiable transaction. Rather the transfer of shares to the nominee will give rise to a liability to landholder duty, if the nominee acquires a 50% or more interest in the landholder company.

The key exception to the above position is where the target company is a landholder for Queensland or Western Australian duties purposes. In those States, a liability to duty can arise on a share sale agreement, and it will be necessary to consider specific drafting of relevant agreements, timing issues and other factual circumstances, to manage potential double duty issues on a nomination. For example:

• Typically, a global share sale agreement relating to multiple share acquisitions in multiple targets would expressly contemplate a local purchaser entering into a subsequent local shale sale agreement and taking a transfer of shares. Critically, where the global agreement provides for a mechanism for nominating / identifying the local purchaser entity and expressly provides that that entity is not the “purchaser” entity that is party to the global agreement, the global agreement should not be characterised as a dutiable agreement to acquire shares. In such a case, the liability for landholder duty should arise when the applicable local purchaser enters into the local share sale agreement. No additional issues arise on nominating the local purchaser to enter into the local share sale agreement, with a duty liability arising once in the usual way.
• In contrast, where a purchaser enters into an agreement to acquire shares in a landholder, and the agreement provides that the purchaser may nominate an alternate transferee, a nomination can give rise to landholder duty complexities:
  • The contracting share purchaser may be liable to landholder duty on entering into the share sale agreement;
  • Depending on drafting, a nomination may give rise to a novation of the sale agreement at law (this can turn on, amongst other things, the drafting of the agreement); and
  • The nominee/transferee will also be liable to landholder duty, and it is therefore important to consider any double duty implications (including the availability of a refund of any duty paid on the sale agreement).