ADVANCE TAXATION:
ERRATA to assignment: If you are doing topic 1, assume that Duncan acquired the full allocation of 1000 shares, not $1000 value out of his maximum entitlement.
Case Study 1: EW Australia Ltd
EW Australia Ltd (EW), a large publicly listed, electrical wholesaler, decided to implement an employee share scheme. Under the terms of the share scheme it was available to all employees, who were eligible to purchase up to 1,000 ordinary shares at a discount of $1 per share below market value. At the time that the shares were issued the market value of the shares was $5.30. Employees could either purchase the shares outright or the company would finance the purchase through an employee share trust. The EW Employee Share Trust purchased the shares, and any dividends received were applied against the purchase price of the shares.
Under the employee share scheme the shares could not be sold for three years after the shares were acquired unless the employee left employment with the company.
Five years later EW initiated a share buyback as part of a corporate restructure. The company offered to buy back ordinary shares at a premium of $1 over market value. At the time that the share buy back was implemented the market value of the shares was $7.50. EW debited $6 per share against the share capital of the company.
Duncan was a storeman working for the company. He took up the opportunity to acquire the full allocation of $1,000 shares, through the employee share trust. During the year the shares were issued his taxable income was $75,000. He left the company two years later, and paid the amount required under the EW Employee Share Trust rules to obtain beneficial ownership of the shares.
Debbie, a section manager working for EW, acquired the shares outright when they were issued. Her taxable income was $135,000 in that year, and she drove a car branded with the company logo. The car was available for private use for the whole FBT year, and she utilised company parking available in the building located in Perth CBD. The car cost $45,000 after 1 April 2012, and she drove 22,000 km during the year.
Both employees accepted the share buy-back offer.
Required:
Discuss the income tax implications of these transactions to:
– Duncan
– Debbie and
– EW
You should assume that the current legislative provisions applied in the year that the shares were issued and the year of the share buy-back.
Case Study 2: Xena Pty Ltd
Xena Pty Ltd (Xena) is a subsidiary member of the Lawless Group Ltd (Lawless). The Group is consolidated for tax purposes. The Balance sheet for Xena shows the following balances at the end of the current financial year:
$ ,000
Assets
Cash 10
Loan to Lawless Ltd 140
Financial Assets 1,540 Note 1
Property 2,550 Note 2
Total Assets 4,300
Liabilities
Loan from external bank 3,200
Total liabilities 3,200
Net Assets 1,100
Represented by:
Share Capital 10
Retained Earnings 790
Note 1: Listed shares at current market value. The cost base is $800,000
Note 2: Current market value. The cost base is $1,500,000.
Gabrielle Pty Ltd (Gabrielle) is an unrelated company that pays substantial dividends. Xena has the opportunity to acquire a minority interest in Gabrielle, and is looking at methods to raise the necessary $500,000. Gaby held 1,000 shares in Gabrielle, and her shares have a cost base of $5 each.
Required:
Assuming that all entities involved in these arrangements are Australian residents, discuss the income tax consequences to Xena, Lawless, Gabrielle and Gaby of each of the following alternatives.
Option A: Xena issues 500 convertible notes with a face value of $1000 that will convert to 10 ordinary shares in Xena in seven years. The coupon rate is 5% per annum.
Option B: Xena will issue the lender 5,000 preference shares with a face value of $100 each and a dividend rate of 5%. In 7 years they will revert to ordinary shares.
Option C: Lawless is not satisfied with Xena acquiring a minority interest and initiates a takeover bid for Gabrielle. It makes an offer to purchase all shares in Gabrielle, issuing a $10 share in Lawless plus $10 cash for each share in Gabrielle. It succeeds in acquiring 85% of the shares in Gabrielle. Gaby accepts the offer.