The taxation implications of company law reform
A discussion document
Chapter 3: Amalgamations
This chapter considers the tax implications of the amalgamation provisions of the new Companies Act.
3.2 The Amalgamation Provisions of the New Companies Act
Under the amalgamation provisions of the new Companies Act, the procedures governing the amalgamation of two or more companies into one company have been simplified in comparison with those applicable under existing company law. Under the new Companies Act, the amalgamation of two or more companies generally requires the following:
- approval from the board of directors;
- a resolution of the board of directors that the amalgamation will be in the best interests of the company;
- a resolution of the board of directors that the amalgamated company will satisfy the solvency test immediately after the amalgamation;
- advice to all secured creditors of the amalgamation proposal;
- shareholders' approval by special resolution; and
- registration of the proposal with the Registrar of Companies.
The amalgamation takes effect on the date specified in the amalgamation certificate issued by the Registrar of Companies.
Under the new amalgamation procedures court involvement is no longer required unless sought. In addition, an even simpler amalgamation process is provided for the amalgamation of wholly-owned companies. A "short-form" amalgamation procedure is provided under section 222 of the new Companies Act for a wholly-owned subsidiary amalgamating with a parent, or for two wholly-owned subsidiaries that amalgamate. Under the short-form procedure, an amalgamation may be approved solely by the boards of each amalgamating company agreeing to the amalgamation, provided the solvency test is still met.
Under the new Companies Act, the amalgamating companies continue as one company, which may be a continuation of one of the amalgamating companies or a new company. All assets and liabilities of the amalgamating companies are vested in the amalgamated company. Amalgamating companies can agree to the terms of their amalgamation. Thus, if the terms of the amalgamation so provide, some shareholders in the amalgamating companies may be issued shares in the amalgamated company, while other shareholders in the amalgamating companies may be bought out for cash and debentures. Where one amalgamating company holds shares in another amalgamating company, those shares must be cancelled for no payment when the amalgamation becomes effective.
3.3 Tax Treatment of Revenue Account Shareholders in an Amalgamation
3.3.1 Current Treatment
Under current tax rules, the realisation of a gain or loss upon the disposal of a parcel of shares by a revenue account shareholder is a taxable event. Therefore, revenue account shareholders making a gain or loss on any shares swapped for other shares as part of an amalgamation face the same tax consequences as if they had sold the shares for cash.
3.3.2 Rollover Relief
Ideally, taxes should not influence taxpayer preferences between different investment choices. However, any tax incurred on realisation of an investment spanning multiple tax periods changes taxpayer behaviour to the extent that taxpayers defer the tax liability by retaining an asset longer than they otherwise would. This is known as "lock-in". Lock-in influences are unavoidable in a realisation based income tax.
The Government is aware that some taxpayers believe that shareholder lock-in in relation to company amalgamations should be addressed by the provision of some form of shareholder rollover relief, which would enable a tax liability arising as a result of a share swap to be deferred until the shares acquired in the amalgamation were sold. Providing shareholder rollover relief only changes the timing of income recognition for tax purposes. The incentive to delay realisation is not eliminated. Indeed, if the shares acquired in an amalgamation increase further in value, rollover relief would exacerbate lock-in influences. Accordingly, the existence of lock-in does not support arguments that there is a sound policy basis for providing rollover relief.
In New Zealand only gains on shares held on revenue account are taxed. In Australia, Canada, and the United Kingdom rollover relief was not available prior to the introduction of comprehensive capital gains taxes in those jurisdictions. Thus, if anything, the experience of those jurisdictions suggests that the provision of rollover relief is not appropriate for New Zealand.
Introducing rollover relief would also result in tax considerations further distorting taxpayer decision-making by creating a bias towards amalgamation over other forms of sale or reorganisation.
Finally, the relief provisions that apply to corporate restructuring in other jurisdictions are understood to be among some of the most complex tax rules of those countries. These rules are apparently subject to considerable "tax planning". Under the circumstances, it does not appear necessary or appropriate to add to the Income Tax Act another layer of complexity that will increase opportunities for tax planning.
In summary, the current treatment of shares disposed of as part of a corporate reorganisation is consistent with the general realisation-based treatment of other taxable gains. The new Companies Act does not introduce any special feature in relation to amalgamations that is sufficient to warrant a departure from current tax treatment by the introduction of tax treatment inconsistent with general tax principles for taxpayers holding shares on revenue account. Accordingly, no legislative change is proposed.
3.4 Tax Treatment of Asset Transfers
3.4.1 Asset Transfers in an Amalgamation
The purpose of the amalgamation provisions in the new Companies Act is to simplify the administrative procedures that must be followed when two or more companies merge. Thus, the new amalgamation provisions are designed to minimise administrative impediments to corporate restructuring through amalgamations.
The Government favours extending to amalgamations the tax-free asset transfer treatment available to consolidated groups. Both consolidation and amalgamation can be used to achieve the same substantive restructuring. Tax rules should not influence which method (amalgamation or consolidation) taxpayers use in merging their corporate operations. In other words, the two different methods of restructuring should yield the same tax consequences.
The amalgamation of two or more companies can be viewed as a one-step procedure by which companies become wholly-owned (100 percent commonly-owned by the same shareholders) and then merge their assets into a single company. The consolidation regime can be used to achieve this result without triggering income tax consequences on the transfer of the merging companies' assets to a single company.
The Government proposes that amalgamation be dealt with by utilising the tax-free asset transfer rules of the consolidation regime.
3.4.2 Other Considerations
Consistent with the consolidation regime, the amalgamated company would inherit each transferor's tax cost for the asset (as well as the transferor's other tax attributes in respect of the asset).
The Valabh Committee has recommended an asset classification system under which tax consequences would be triggered when a taxpayer moves an asset out of the tax base. Accordingly, the Government considers it would be appropriate to implement rules that would trigger tax consequences when an asset moves from revenue to capital account as a result of an asset transfer made pursuant to an amalgamation.
In addition, tax-free treatment should only apply where the amalgamated company will be resident in New Zealand. Otherwise, assets could be transferred out of the New Zealand tax base free of tax consequences, thereby permanently avoiding (rather than deferring) New Zealand tax. Under the consolidation regime, only companies that are resident in New Zealand are eligible to be members of a consolidated group.
If the amalgamated company is a qualifying company, tax-free treatment should only apply if all amalgamating companies are also qualifying companies. Otherwise amalgamating a non-qualifying company into a qualifying company would enable qualifying company election tax to be avoided.
3.5 Losses and Imputation Credits
In the Government's view, an amalgamated company should be able to succeed to the losses and imputation credits of the amalgamating companies, subject to ensuring that the shareholder continuity rules and the limitations on loss grouping are not circumvented.
3.5.2 Losses - Implications of Shareholder Continuity and Loss Grouping Rules for Amalgamations
The tax treatment of companies that amalgamate should be consistent with the tax treatment of company losses generally. An amalgamated company should inherit the losses of an amalgamating company only when shareholder continuity and commonality tests are met.
3.5.3 Existing Shareholder Continuity Rules
The purpose of the loss carry-forward rules is to ensure that, to an extent, shareholders in a company at the time it incurred tax losses are still shareholders when the company utilises those losses. This is achieved through shareholder continuity rules that determine what tax losses a company may offset against its future income.
A company may carry forward its losses and offset them against income arising in subsequent income years provided that shareholder continuity of at least 49 percent is maintained throughout the period beginning with the year in which the loss is incurred and ending with the year to which the loss is carried forward (the "continuity period"). Shareholder continuity is maintained if at least 49 percent of the shares in the company are owned by the same persons throughout the continuity period.
3.5.4 Shareholder Continuity Rules and Amalgamations
An amalgamation would not provide a means of circumventing the shareholder continuity rules with respect to the amalgamating companies provided those rules continue to apply after the amalgamation. The amalgamated company would be considered to satisfy shareholder continuity with respect to the losses of an amalgamating company if at least 49 percent of the shares in the amalgamated company and 49 percent of the shares of the amalgamating company are owned by the same persons throughout the continuity period. The amalgamated company would be considered a continuation of the loss company for the purposes of the shareholder continuity test.
Of course, if at the time of the amalgamation more than one amalgamating company had carried forward tax losses, and those companies had different shareholders during the relevant continuity periods, the amalgamated company would need to keep track of the losses of each such company separately, even where those losses were incurred for the same income year.
3.5.5 Existing Loss Grouping Rules
The purpose of the loss grouping rules is to enable the losses of loss companies to offset the income of profit companies provided a minimum commonality of ownership is achieved. The application of the commonality of ownership test is separate and different from the shareholder continuity test.
Under current loss grouping rules, the losses of one company (both current losses and those carried forward) may be offset against the income of another company only if, throughout the period beginning with the year the loss is incurred and ending with the year of offset, a group of persons concurrently owns at least 66 percent of the shares in each of the companies. This group of shareholders is not restricted to persons who were shareholders at the time the losses were incurred. This requirement is often referred to as "shareholder commonality".
If a loss company wishes to group its losses with a profit company, and it has some losses that do not satisfy the shareholder commonality test, and other losses from subsequent years that do satisfy the shareholder commonality test, only those losses satisfying the shareholder commonality test may be used to offset the profit company's taxable income.
3.5.6 Loss Rules And Amalgamations
The Government considers that an amalgamated company should be allowed to inherit the losses of any amalgamating company if:
- The shareholder continuity rules continue to be satisfied with respect to the losses of that amalgamating company after the amalgamation.
- The losses of that amalgamating company could have been grouped against income realised by all other amalgamating companies immediately prior to the amalgamation.
If the losses of more than one of the amalgamating companies are carried into the amalgamated company, the losses of each predecessor company would continue to be identified separately in order to continue to test shareholder continuity. Where the losses arose in the same income year, the amalgamated company would be able to elect the set or sets of losses against which its income could be offset. Where no election is made, losses would be offset against assessable income on a pro rata basis.
Shareholder continuity would be measured by reference to ownership interests in the amalgamated company compared to ownership interests in the predecessor amalgamating company for the continuity period. Where the amalgamated company subsequently breaches shareholder continuity, any remaining losses carried over from the amalgamating company would be forfeited in the usual way.
A more lenient approach is possible in the consolidation regime as the members of the consolidated group continue as separate legal entities. Therefore, under consolidation, where a consolidated group contains a loss company with pre-consolidation losses that cannot be grouped with any other members of the consolidated group, the losses can be carried forward and offset against the loss company's income, as long as it continues to meet the loss carry-forward shareholder continuity requirements.
However, it is not practicable to develop rules regarding amalgamations that fully replicate this, as the amalgamating companies that form an amalgamated company have no continuing legal existence separate from the amalgamated company.
3.5.7 Imputation Credit Shareholder Continuity Rules
The purpose of imputation carry forward restrictions is to ensure that the imputation credits are enjoyed by substantially the same shareholders of the company as existed at the time the imputation credits arose.
The shareholder continuity rules apply to imputation credits in the same manner as to losses, except that the shareholder continuity threshold is 66 percent. Except for consolidated groups there are no provisions for grouping imputation credits between members of commonly-owned groups.
Consequently, an amalgamated company should be allowed to succeed to imputation credits of an amalgamating company if, after the amalgamation, the shareholder continuity requirement continues to be satisfied with respect to the relevant amalgamating company up to the period those credits are distributed by the amalgamated company.
The simplified amalgamation provisions in the new Companies Act are designed to remove unnecessary regulatory impediments to amalgamations. The provisions are not designed to create a bias towards amalgamations for their own sake.
Similarly, tax rules should not favour amalgamations over other similar forms of corporate restructuring. This means that tax rules regarding amalgamations should be more or less the same as current generally applicable rules regarding company and shareholder taxation. Tax rules relating to the amalgamation of two or more companies should be closely aligned with existing rules governing the carry forward and grouping of tax losses and the carry forward of imputation credits. Amalgamating companies should also be able to use the preferential asset transfer rules currently available to taxpayers through the consolidation regime, without needing to consolidate or group the amalgamating companies prior to amalgamation.
A tax liability would be triggered when shareholders trading on revenue account swap shares in an amalgamating company for shares in an amalgamated company. This is a continuation of existing law.
3.7 Summary of Proposals
It is proposed that the following income tax rules apply to company amalgamations:
- Revenue account shareholders in an amalgamating company will realise assessable income or loss on the exchange of their shares in the amalgamating company for shares in the amalgamated company. This requires no change to existing tax rules.
- The transfer of assets to an amalgamated company from the amalgamating companies will be tax-free, under rules similar to those that apply to consolidated groups.
- An amalgamated company will be allowed to succeed to losses of a particular amalgamating company if:
- the shareholder continuity requirement with respect to that amalgamating company continues to be satisfied; and
- immediately prior to the amalgamation, the losses of that amalgamating company could have been grouped against income of all other amalgamating companies.
- An amalgamated company will be allowed to succeed to imputation credits of an amalgamating company only if the shareholder continuity requirement continues to be satisfied with respect to that amalgamating company after the amalgamation.
- For the purposes of the shareholder continuity tests the losses and imputation credits of each predecessor company would continue to be separately identified by the amalgamated company. Where the losses arise in the same income year, the amalgamated company will be able to elect the set or sets of losses against which its assessable income could be offset. Where no election is made, losses would be offset against assessable income on a pro rata basis.