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Submission No. 54 Back to full list of submissions
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13 April 1999

 

Dr Alan Preston
Secretary
Review of Business Taxation
Department of the Treasury
Parkes Place
CANBERRA ACT 2600

Dear Dr Preston

The Securities Institute of Australia commends Mr John Ralph AO, and his Secretariat for their comprehensive review of business taxation in Australia. We believe it offers a unique opportunity to redress some of the inequities of the current regime and to remove impediments to Australia’s economic growth and global competitiveness.

The Institute wishes to comment on some aspects of the taxation of capital gains, specifically the option of extending rollover relief to scrip-for-scrip transactions in mergers and company demergers.

Rollover relief would encourage savings and investment

The Institute considers that the potential application of capital gains tax to scrip-for-scrip mergers and takeovers distorts the market for corporate control and hinders economic efficiency.

Under the current regime shareholders who accept the offer of shares in a scrip-for-scrip transaction are deemed to have realised a capital gain, notwithstanding that they receive no cash and their investments continue through a swapped shareholding. This often results in their decision being influenced more by the potential crystallisation of a tax liability than the merits of the proposal. This was a significant problem in St George/Advance Bank, Westpac/Bank of Melbourne and AMP/GIO, and is known to have prevented many other proposals from proceeding.

In the absence of rollover relief, those relying on share income, especially self-funded retirees, face a reduction in their future income stream by virtue of paying the capital gains tax.

Taxation of unrealised capital gains is also a concern for shareholders who have decided not to accept the offer, but whose shares are compulsorily acquired in a minority mop up.

We believe rollover relief should be extended to any unrealised gains in mergers and acquisitions, whether they are pure scrip-for-scrip transactions or transactions involving part cash and part scrip. In the latter case, rollover relief would apply to the scrip component of the transaction and the capital gains tax cost base could be divided appropriately between the two components.

Rollover relief would be more equitable for all shareholders

The Institute believes the current regime is inequitable in its treatment of some shareholders.

Where there is a scrip-for-scrip merger or takeover, the shareholders in one of the companies (usually the target company) are disadvantaged by being deemed to have realised a capital gain for tax purposes. However, the shareholders in the other company (usually the acquiring company) are not regarded as having disposed of their shares and therefore incur no liability.

The Institute believes it is illogical to treat one group of shareholders more favourably than the other simply because their company has been selected as the remaining company.

Rollover relief would boost Australia’s economic growth

The Institute believes the lack of rollover relief for scrip-for-scrip mergers and takeovers discourages the efficient allocation of assets.

In a comparison of the treatment of capital gains in a number of major overseas jurisdictions, the Review of Business Taxation second information paper `An International Perspective’ found it to be an area where `other countries provide more generous treatment than does Australia’. In particular, the paper found rollover relief for scrip-for-scrip transactions to be a standard approach in the United Kingdom, the United States, Canada, Ireland, Japan and Sweden, and stated that `this mechanism tends to encourage corporate reorganisation, as well as mergers and takeovers’.

This is supported in the study by Professor Philip Brown and Dr Raymond da Silva Rosa, of the University of Western Australia, of data gathered from 1986 to 1996, which shows that in Australia the value of takeovers relative to ASX market capitalisation and average takeover premiums fell sharply during the recession and has not recovered. A recent study by Ernst and Young showed that although the total figures for 1997 would suggest that merger and takeover activity was booming in Australia, these figures were distorted by several one-off privatisations and that the underlying trend was one of more modest growth. The following statistics show that merger and takeover activity in Australia lags markedly behind the United Kingdom and the United States.

 

Value of Transactions Market Cap Transactions/Mkt Cap

yr end

US

UK

Aust

US

UK

Aust

US

UK

Aust

Dec

US$b

US$b

A$b

US$b

US$b

A$b

(Dom. coys)

(Dom. coys)

(Dom. coys)

1997

597.0

67.7

8.4

10,617.6

2,068.2

453.9

8.4%

4.9%

1.9%

1998

1,222.0

87.1

12.5

12,796.0

2,298.0

453.9

14.3%

5.7%

2.7%

Sources:

  • Transaction Values: Corporate Adviser Securities Data (criteria of transactions covered: total value of public acquisitions announced during the particular calendar year)

  • Market Capitalisations (based on domestic companies only):

    • ASX

    • FIBV (for overseas stock exchanges) ie. London and NYSE/Nasdaq

Many factors contribute to Australia’s comparatively low level of activity, including litigation risk and the competition policy. However, we believe the lack of rollover relief has a significant effect on transaction costs and is usually pivotal in determining whether or not to proceed with a bid. By comparison, other jurisdictions look more attractive to potential bidders.

Rollover relief would attract capital

As a capital importing economy Australia competes with other jurisdictions for investment capital to enable business growth to provide the jobs necessary for our economic well being. The lack of rollover relief inhibits potential mergers and acquisitions, especially by overseas bidders, as the cost of the transaction is made greater by the immediate crystallisation of capital gains tax liability for shareholders in the target company. This makes the deal less attractive, and as a result, Australia often misses out on potential investments.

The application of a capital gains tax to unrealised gains in mergers and acquisitions is particularly damaging to high-growth sectors of the economy on which Australia’s long-term future growth depends. High growth technology companies go through a number of phases during their development and it is often useful for these companies to achieve economies of scale by merging. However, under the current regime this may not be a viable option because of the lack of rollover relief. The inability to take this `next step up’ may lead to these companies stagnating or moving offshore to a more favourable tax environment.

For reasons of neutrality and equity, it is important for rollover relief to be available in a takeover situation, regardless of whether the bidder is a domestic entity or a foreign entity. Otherwise bids by foreign entities will be severely discouraged, damaging our capital markets. Appropriate mechanisms could ensure capital gains tax is recovered by the revenue upon disposal of the shares involved.

Rollover relief would encourage capital reorganisation

The Institute believes the current regime inhibits business diversification through spin-offs, divestitures and equity carve-outs. In the absence of rollover relief, the potential crystallisation of capital gains tax results in the continuation of an organisational structure which is no longer suited to the efficient operation of the business.

There have been no significant company demergers in Australia in recent history. By way of contrast, this activity is prevalent in the United States and the United Kingdom, where more favourable tax regimes encourage structural reorganisation to enable each business to concentrate on its core competencies (Hewlett-Packard and RJR Nabisco in the United States have recently announced spin-offs). Spin-off businesses have been shown to outperform the average share market performance.

Reorganisations would require some allocation of the cost base and we believe that a pro rata allocation could be determined by the company involved on a reasonable basis, subject to judicial review.

Revenue impact of rollover relief

Following our preliminary submission to the Treasurer in February 1998, the Institute commissioned Access Economics to construct two models to assess the potential impact on Commonwealth Government taxation revenue of extending the existing capital gains tax rollover relief provisions to scrip-for-scrip mergers and company demergers.

Based on reasonable assumptions and an introduction date of 1 July 2000, the report found that rollover relief would result in a small cost to the revenue in the first few years, but a net gain to the revenue over time as the relief leads to increased merger and demerger activity.

We enclose a copy of that report.

Transitional Issues

In order to avoid problems in the financial markets, we believe the recommended changes should take effect from the date they are announced, rather than delayed to coincide with other changes to Australia’s tax regime. If this does not occur, many transactions may be put on hold until the implementation date, affecting government revenues and causing a severe downturn in corporate finance activities. This would damage economic activity generally.

Conclusion

The Institute recommends the extension of capital gains tax rollover relief to scrip-for-scrip mergers and company demergers in the belief that this will lead to greater economic growth and global competitiveness.

For practicality, the models prepared by Access Economics are confined to Australian publicly listed companies. However, we believe there is nothing to prevent rollover relief being extended to takeovers, mergers and demergers of listed trusts and widely-held trusts, as well as to foreign companies bidding for or merging with Australian entities, provided a mechanism is put in place to ensure Australia receives the appropriate capital gains tax upon ultimate disposal of the shares. There is no reason in principle why rollover relief should not ultimately also be extended to private companies and trusts.

Yours sincerely

 

Alison Lansley FSIA
Chairman, Markets Policy Group

 

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