RESOURCES

The Tax and Superannuation Laws Amendment (2015 Measures No 6) Bill 2015 received Royal Assent on 29 February 2016, becoming Act No 10 of 2016.

The Bill, amongst other measures, amends the ITAA 1997 to change the CGT treatment of the sale and purchase of businesses involving certain earn out rights – rights to future payments linked to the performance of assets after sale.

The changes will apply from 24 April 2015.

An earn out is an arrangement, usually entered into on the sale of an asset or a business, where part of the sale price is contingent on something that happens after settlement.  It may be that a later payment is made contingent on profits, on customers being retained, or other targets being met.

The ATO last published its views on earn outs in 2007 as TR 2007/D10 which created necessary complication and imposed additional costs on parties to an earn out arrangement. Treasury subsequently released its own Discussion Paper in 2010, resulting in significant uncertainty about how they are treated for tax purposes.

The new law is broadly in line with what Treasury proposed in 2010, and under the new law a ‘look-through earn out right’:

• will not need to be valued at the time of selling the underlying asset;
• will not result in tax being payable until an amount is received under an earn out arrangement;
• will result in that tax being payable by amending the assessment for the year of sale to include the amount received under the earn out as part of the original sale proceeds; and
• will not result in any interest being charged by the ATO so long as an amendment is requested within a specified time period.

The fact that the amount received under the earn out will be included as capital proceeds for the original sale will mean that any concessions available on the original gain will effectively be available on the amount received under the earn out arrangement – so if the original asset sale resulted in the gain being disregarded because the asset was pre-CGT, or the general discount or the small business concessions being accessed, then the same treatment will apply to the amount received under the earn out.

For a purchaser any amounts paid under an earn out will simply be included in cost base.

The new rules also accommodate ‘reverse’ earn out arrangements where any amount repaid by a seller reduces the capital proceeds received and is treated as a recoupment of the purchaser’s cost base.

The most difficult part of the new rules will be whether the eligibility conditions that need to be met for an earn out to be a ‘look-through earn out right’ are satisfied.  The two main conditions are that an earn out cannot last for more than 5 years, and the asset being disposed of must be an ‘active asset’.

The new law also tweaks some aspects of the small business CGT concessions so that they work better with the new treatment of earn outs.

The new Law now provides ‘clarity’ on what was the uncertain and debatable treatment of earn outs previously, and provide a welcome simplification to the way earn outs might be taxed.