Xena Pty Ltd 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:
Loan to Lawless Ltd 140
Financial Assets 1,540 Note 1
Property 2,550 Note 2
Total Assets 4,300
Loan from external bank 3,200
Total liabilities 3,200
Net Assets 1,100
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 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.
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: Immediately prior to issuing the preference shares, Lawless repays $40,000 of the amount it owes to Xena. This is used to reduce the bank debt. Does this make any difference to your advice in relation to Option B?
Option D: Lawless Ltd is not satisfied with Xena acquiring a minority interest and initiates a takeover bid for Gabrielle Ltd. 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 held 1,000 shares in Gabrielle Ltd., and her shares had a cost base of $5 each.
Option E: When undertaking the due diligence inquiries Lawless discovers that Gaby has been living in an apartment owned by Gabrielle Pty Ltd for the whole of this financial year, carried on the balance sheet at $460,000. She has been paying rent of $300 pw. Another apartment in the same building has recently been leased for $500 pw. Lawless also asks for advice on the consequences of this arrangement.
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