While a clear exit is often considered a vital part of a transaction, uncertainty still exists as to when a clear exit may be achieved.

1. Introduction
While the law relating to “clear exits” is
reasonably simple at a conceptual level,
many uncertainties remain as to how a
clear exit (also known as a “clean exit”) is
achieved in the context of the acquisition
of a subsidiary member (or subsidiary
members) of an Australian tax consolidated
group (TCG). This article does not seek
to identify and opine on all technicalities
relating to clear exits, but seeks to provide
guidance on certain practical matters
(often faced by transaction tax/M&A tax
practitioners) in relation to how a clear exit
may be achieved.
The discussion below will also consider
what Australian Taxation Office
commentary and guidance (or lack
thereof) exists on the matter. We note that,
during November 2013, the ATO issued
PS LA 2013/5 which is effectively a rewrite
(albeit with some subtle differences)
of chapter 35 of the ATO’s archived
receivables policy. It is the authors’ view
that the release of PS LA 2013/5 was a
missed opportunity to simplify and clarify
the interpretation of the provisions relating
to clear exits (broadly, Div 721 of the
Income Tax Assessment Act 1997 (Cth)
(ITAA97)), and how a clear exit can be
practically achieved.
What is a clear exit?
If the head company of a TCG fails to
pay a group (income tax) liability by its
due time, the subsidiary members of
the TCG are jointly and severally liable
for a TCG’s group (income tax) liability
unless that liability is covered by a valid
tax sharing agreement (TSA).1
Where a
group liability is covered by a valid TSA
and a subsidiary member (known as a
contributing member) remains a member of
the TCG, a contributing member’s liability
is limited to its share of the group liability
as calculated under the TSA (known as the
contribution amount).2
Unsurprisingly, potential acquirers of
members of TCGs are not inclined to
accept joint and several liability for all
or part of a TCG’s group liability in the
event that a member or members of a
TCG are acquired. Accordingly, Div 721
allows subsidiary members to leave clear
of a TCG’s group liability that falls due
after completion (including amended
assessments in certain circumstances)
where a valid TSA exists and provided a
range of criteria are satisfied.
Does a valid TSA exist?
Broadly, for there to be a valid TSA, the
following requirements must be satisfied:
(1) an agreement exists between the head
company and one or more contributing
members before the due time for the
group liability;
(2) the contribution amount for each
contributing member can be
determined; and
(3) the contribution amounts must
represent a reasonable allocation of
the group liability.
Despite these (among other) apparently
benign requirements, PS LA 2013/5 implies
that the Commissioner of Taxation may
pursue a subsidiary member that has
left a group with an invalid TSA in place.
Accordingly, care should be taken when
drafting and executing a TSA to ensure that
the Commissioner cannot pursue an exited
subsidiary member(s) of a TCG.
What is a reasonable
allocation?
When determining what a “reasonable
allocation” is, the TSA does not have to
prescribe a particular amount. The amount
may be a fixed/variable percentage of
the overall liability, an amount based on
“notional” contributions to taxable income,
or an amount based on an appropriate
formula (see para 108 of PS LA 2013/5).
In practice, a commonly used (and
accepted) allocation method is to allocate
the total group liability to each contributing
member based on each member’s
“notional income”. Typically, the “notional
income” of each contributing member
is calculated in accordance with the tax
rules, subject to modifying assumptions
outlined in the TSA (eg ignoring inter-group
dividends and losses etc). PS LA 2013/5
confirms that the Commissioner broadly
accepts this approach. However, with the
exception of an obviously unreasonable
allocation, the practice statement does
not outline what might constitute an
unreasonable allocation, and the only case
that refers to the “reasonableness” concept
is Re Mcgrath (as liquidators of HIH
Insurance Ltd)3
in which Barrett J mentions
the principle (but does not provide any
detailed guidance).
Often, discussion and/or contention
arises between advisers over whether a
particular allocation principle (as per the
TSA) is reasonable. Ultimately, whether an
allocation is reasonable is a matter of fact
and degree. In this context, and noting
that the relevant law on this matter is yet to
be tested in court, practitioners generally
adopt a pragmatic view on the matter
and ensure that the methodology in the
TSA is broadly in accordance with those
mentioned in PS LA 2013/5 (refer above).
Chapter 35 explicitly concedes that an
allocation of the group liability under a
reasonable allocation may well be less than
the “actual” liability of the member had
it not been a member of a consolidated
While a clear exit is often considered a vital part of a transaction, uncertainty still
exists as to when a clear exit may be achieved.
by Adam Woodward, CTA, and Mark Taylor, Ernst & Young
How clear is your exit?
TAXATION IN AUSTRALIA | VOL 49(10) 635
MERGERS & ACQUISITIONS

2. MERGERS & ACQUISITIONS
group.4
However, an equivalent paragraph
has not been rewritten into the practice
statement. Practitioners should be aware of
this, and note that the Commissioner may
rely on this omission in the event of a future
dispute in relation to a transaction and/or
an exit from the group.
Not all members of the TCG
have acceded to the TSA
Strictly speaking, s 721-25(1)(a) only
requires a TSA to have been entered
into between the head company and
one or more contributing members.
Paragraphs 103 to 106 of PS LA 2013/5
indicate that a TSA can still be valid even
if some members of the TCG have not
acceded to it (provided the reasonable
allocation requirement is not negatively
impacted). Accordingly, the key to
understanding whether the failure of a
subsidiary member of a TCG to accede
to a TSA has caused it to be invalid will
be to understand if that entity would have
affected the allocation of the group liability
among the contributing members.
In practice, the only way to obtain a high
level of comfort in relation to this is to
enquire with the vendor and review the
available information (including stand-alone
income tax calculations) on each member
of the TCG to ensure that those members
which are not also contributing
members do not adversely impact the
reasonableness of the allocation to the
contributing members under the TSA.
In practice, vendors rarely, if ever, allow
visibility over the wider TCG during a tax
due diligence exercise, so it is practically
difficult to obtain a high degree of comfort
on this issue in many situations.
Other factors which may cause
a TSA to be invalid
Before turning our mind to how a clear exit
may be achieved, it is worth flagging a few
additional factors which may cause a TSA
to be invalid and that should be front of
mind when conducting diligence/ensuring
a clear exit:
(1) two TSAs cover the same particular
group liability (if the original TSA has
been replaced, it is necessary to
ensure that the new TSA completely
voids the earlier TSA);
(2) a copy of the TSA was not provided to
the Commissioner by the head company
within 14 days of a request; and
(3) the TSA refers to item 25 of the table in
s 721-10(2) ITAA97 (this section covers
certain tax-related liabilities of the head
company) but the TSA was not entered
into before 1 July 2010.
“Clear exit”
As discussed briefly above, “clear exit”
refers to a subsidiary member leaving
a TCG clear of joint and several liability
in respect of group liabilities that do
not fall due prior to the leaving time
(eg completion). To obtain a clear exit:
(1) the leaving subsidiary must leave the
consolidated group before the due
time;
(2) there must not be a purpose
of prejudicing recovery by the
Commissioner; and
(3) before the leaving time, the leaving
subsidiary must pay to the head
company its contribution amount or,
otherwise, a “reasonable estimate”
of the contribution amount for group
liabilities that are not yet due (the
“clear exit payment”).
Quite clearly, as it is often not possible to
determine the precise contribution amount,
one of the most crucial criteria in achieving
a clear exit is ensuring that a reasonable
estimate of the contribution amount is
calculated (and made) pre-exit. As stated in
PS LA 2013/5 (at para 156), reasonableness
is determined, and depends, on the
circumstances at the time of the exit. Given
that the payment is for undue liabilities at
the time of the exit, generally a notional
income tax calculation is required (as
at the exit date) and such calculation
requires consideration of future taxable
transactions, audits, court cases or other
matters which may trigger tax liabilities of
the TCG post-exit.
It is fair to say that para 80 of PS LA 2013/5
creates a level of doubt over the operation
of the “clear exit” provisions in the context
of an amended assessment on the
basis that it contends that an amended
assessment relates to the same single
liability. However, the practice statement
also indicates that there may be more
than one debt arising under the single
liability and that, although an amended
assessment relates to the same group
liability, it has a different due time (which is
critical for the application of the “clear exit”
provisions).5
Paragraph 193 of the practice statement
confirms that a “clear exit” is possible from
a future amended assessment where, at
the time of the exit, no future amended
assessment is expected or, alternatively,
where the clear exit payment incorporates
a reasonable estimate of a future liability
as a result of an expected amended
assessment. Importantly, PS LA 2013/5
does not provide any guidance as to how
to reasonably estimate the quantum and
allocation of a future amended assessment
where the ATO is undertaking a review or
an audit of the TCG at the leaving time.
In this context, the question arises as to
how practitioners practically calculate this
amount and whether such calculation is
sufficient.
To take this issue further, to adequately
consider whether an amended assessment
may trigger a head company liability for a
member post-exit, tax due diligence may
be required on the entire TCG (and not just
the target/target entities). Comprehensive
due diligence would involve understanding
the tax profile of the entire TCG, confirming
whether ATO activity is ongoing (or
anticipated), reviewing the income tax
calculations of the TCG and stand-alone
income tax calculations for the leaving
members, reviewing “clear exit” payment
calculations prior to the exit, and sighting
a receipt for any clear exit payment prior to
the exit.
In a live deal context, it is often the case
that a practitioner will not have visibility
over the tax affairs of entities not being
acquired (which makes the above
consideration of the group’s tax position
almost impossible). While it may be prudent
to enquire with the vendor in relation to
possible amended assessments/ATO
activities for the broader group (and obtain
representations in this regard), we note
that commentary contained in para 194 of
the archived chapter 35 (which indicated
that a “clear exit” may be unaffected by
an amended assessment if it related to
activities of another contributing member
and the exited entity was not aware) has
been omitted from PS LA 2013/5. Hence,
this omission suggests that the ATO
requires identification and consideration
of a possible amended assessment for
the group as a whole (and ignorance
of liabilities of non-target entities is not
adequate).
As above, this area is clearly grey and it
is possible that latent risk will lie with the
purchaser of a subsidiary of a TCG, even if
a “clear exit” is purportedly made, because
the tax due diligence exercise will not
be able to confirm whether the clear exit
payment is a reasonable estimate of the
group liabilities that fall due after the exit.
TAXATION IN AUSTRALIA | MAY 2015636

3. MERGERS & ACQUISITIONS
Acquisition of entire TCG
An often-forgotten but important “clear
exit” scenario occurs when a company
acquires an entire TCG. If a subsidiary
member leaves the “new” TCG, was also
a member of the acquired TCG and did
not obtain a clear exit from the acquired
TCG, that subsidiary still retains joint
and several liability for group liabilities
of the acquired TCG, including future
amended assessments. It remains to be
seen as to whether the Commissioner
would practically seek to recover from
a subsidiary of a previous TCG in
such a circumstance.
Contractual clawback
Some TSAs contain a clause which
requires a leaving member to pay to the
head company the leaving member’s
share of a future amended assessment
so that, even if a clear exit is achieved
pursuant to s 721-35 ITAA97, a clear exit
is not commercially obtained (as there
may be a contractual liability owing
post-completion/exit).
There are several approaches to such a
clause but the key message is that any
diligence report or advice should highlight
this matter if it arises. The simplest
solution is to advise the client to sever the
ongoing liability to the head company by
inserting appropriate language in the TSA
exit deed or share purchase agreement.
However, commercially, a vendor may not
accept such an approach. Alternatively,
the purchaser may be happy to accept
a “capped” amount which it considers
commercially tolerable (it equally may not
accept anything). Importantly, the TCG’s
tax funding agreement (if one exists)
should also be reviewed, as sometimes
tax funding agreements contain a similar
clause.
Conclusion
While the above is only a sample of
matters which practitioners face when
attempting to achieve a clear exit, it is clear
that significant uncertainties remain and
the tax risks associated with transacting
persist. Although the Commissioner had
the opportunity to clarify many of these
matters in PS LA 2013/5, unfortunately,
the practice statement leaves many
fundamental questions unanswered and/or
uncertain (due in part to certain omissions
when compared to chapter 35). This article
does not profess to outline all of the issues
and uncertainties associated with Div 721
ITAA97, and importantly, the fundamental
principles of “reasonable allocation” and
“reasonable estimate” are yet to be tested
in the courts.
Despite the Commissioner indicating that
he will pursue exited members as a last
resort,6
it may only be a matter of time
before the Commissioner considers the
quantum of an unpaid tax liability to be
sufficient to warrant an attempt to recover
from a solvent exited member.
Adam Woodward, CTA
Director
Ernst & Young
Mark Taylor
Senior Consultant
Ernst & Young
Disclaimer
The material and opinions contained in this article are
those of the authors, and not those of Ernst & Young or
anyone else.
References
1 S 721-15(3) ITAA97.
2 S 721-30 ITAA97.
3 [2009] NSWSC 1244.
4 Chapter 35, para 106.
5 S 5-5(7) ITAA97.
6 PS LA 2013/5, para 144.
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