Rights issues

In a very welcome development, the Assistant Treasurer announced today that the Government will amend the tax legislation to ensure that the value of rights issues is not subject to tax at the time of issue.

The announcement reverses the outcome of a High Court decision earlier this year (“McNeil’s case”) which held that a shareholder derived assessable income when the company issued renounceable rights to her that enabled her to sell her shares back to the company.

1. Announcement

The Assistant Treasurer’s announcement says that,

"shareholders issued with rights by companies seeking to raise capital will not have an income tax liability at the time of issue"

and that,

"consequential amendments will be made to the capital gains tax rules to ensure that rights issued by companies are treated consistently".

In other words, it seems that there should be no income tax or capital gains tax exposure for shareholders at the time a company makes a rights issue. 

Although it is not expressed in this way, it seems implied in the announcement that this “no taxation” treatment will be afforded to all shareholders – to those like McNeil who hold their shares on capital account, and to shareholders who hold their shares as trading stock or as revenue assets.

Existing provisions will usually produce the result that the exercise of rights and options will not generate assessable income or a capital gain.  The combined effect of these provisions and the Assistant Treasurer’s announcement today should be that any income or capital gain will be generated only when the shareholder deals with their rights or options, or with the shares that result from taking up the offer.

2. Some questions

At the moment, the Press Release refers only to “rights [issued by] by companies seeking to raise capital …”  This leaves some questions on the table.

First, it remains to be seen whether the legislation eventually produced will extend to rights issues made by unit trusts or groups that have stapled interests.  One could reasonably expect that it will.

The “rights” issued by the company in McNeil’s case had been issued free to shareholders.  There is a further question whether the legislation will extend to an instrument issued by the company for a price, but a price which is less than its value.

The Press Release refers only to the issue of “rights.”  It remains to be seen whether the legislation will extend to similar instruments involved in capital raising that involve an option or embedded option.  One could reasonably expect that the legislation will extend to the issue of options, but query whether it will also apply to the issue of convertible notes or converting instruments.

Finally, the announcement expressly addresses only one of the many possible ramifications of the McNeil decision.  There is still the more general question about how to deal with instruments (which might not involve an express or embedded option) that come to shareholders because of their shareholding in the company and which have immediate value.  The Press Release does not contemplate such resolving all of the problems that the McNeil decision has created; just this one.

3. Commencement

The announcement says that “the amendments will apply from the 2001-02 income year [which] will prevent any adverse application of McNeil’s case to companies and their shareholders.”

Unfortunately, handling the commencement might not be so simple.  The High Court’s judgment revealed a proposition which has, unbeknown to almost everyone, been the law in Australia since it first had an income tax.  (The Press Release is arguably, therefore, a little misleading when it says that the Government proposes, “restoring the taxation treatment of rights issues that existed before the [McNeil] decision.”)   Hence, reversing the effect of this judgment from 2001-02 will leave the potential application of the judgment to prior years unaffected.  For most taxpayers that potential exposure will be irrelevant – the tax statute of limitations will render them immune from any adjustment made now.  But for taxpayers who for whatever reason cannot rely on the statute of limitations, the potential exposure to tax for years prior to 2001-02 will potentially remain.

For more information, please contact,

Ernest Chang
61 2 9225 5965
ernest.chang@gf.com.au

Adrian O’Shannessy
61 3 9288 1723
adrian.o’shannessy@gf.com.au