When Type 1: Acquisition case applies
The Type 1: Acquisition case disallows all or part of a debt deduction of an entity for an income year if all of the following conditions are satisfied:
- An entity (the 'acquirer') acquires a CGT asset, or a legal or equitable obligation, either directly or indirectly, through one or more interposed entities, from one or more other entities (each of which is a 'disposer').
- One or more of the disposers is an 'associate pair' of the acquirer.
- The entity (relevant entity) that incurred the debt deduction is any of
- the acquirer
- an 'associate pair' of the acquirer
- an 'associate pair' of an 'associate disposer'.
- The relevant entity's debt deduction is wholly or partly in relation to any of
- the acquisition of CGT asset, or a legal or equitable obligation
- the acquirer's holding of the CGT asset, or legal or equitable obligation.
- The relevant entity's debt deduction is referable to an amount paid or payable, either directly or indirectly, to an 'associate pair' of the relevant entity, acquirer or associate disposer.
- The acquisition is not covered by an exception in section 820-423AA.
- The entity has not made a choice under subsection 820-46(4) to use the third-party debt test for the income year.
In applying the above conditions, you disregard the following paragraph (b) of the definition of 'acquire' in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997):
an entity does not acquire an item of intellectual property merely because a licence relating to a patent, design or copyright is surrendered to the entity.
The test time of an associate pair condition is when the acquisition occurs. The manipulation of the test time may trigger consideration of the specific anti-avoidance rule contained in section 820-423D.
Debt deductions disallowed under Type 1
Debt deductions referable to an amount paid or payable (directly or indirectly) to an associate pair are disallowed under Type 1 to the extent they are in relation to the acquisition or holding of the relevant CGT asset or legal or equitable obligation acquired from an associate pair.
Example 1: Type 1 – acquisition of a CGT asset
Finance Co lends $100 to Acquisition Co, an associate pair of Finance Co.
Acquisition Co uses the loan proceeds to acquire a CGT asset from Disposal Co, which is an associate pair of both Acquisition Co and Finance Co.
In the current income year, Acquisition Co pays an interest expense of $5 to Finance Co in relation to the $100 debt.
The DDCR will apply to disallow debt deductions for the $5 interest expense incurred by Acquisition Co. This is because the debt deductions are in relation to the acquisition of the CGT asset from Disposal Co, the associate disposer.
Excepted CGT assets for Type 1
The following 3 kinds of acquisitions of CGT assets are excluded from the DDCR under section 820-423AA:
- acquisition of a newly issued membership interest in either
- an 'Australian entity'
- a foreign entity that is a company
- acquisition of certain qualifying new tangible depreciating assets
- acquisition of certain debt interests issued by an associate pair.
Example 2: acquisition of excluded CGT assets
Entity 1, an Australian company, borrows $100 from Lend Co, an associate pair of Entity 1.
Entity 1 uses the proceeds of the borrowing to acquire $100 of shares in Entity 2, an Australian company. The shares had not previously been held by any entity.
In the current income year, Entity 1 pays an interest expense of $5 to Lend Co under the $100 related party borrowing.
Type 1 DDCR does not apply to disallow Entity 1's debt deductions for the $5 interest expense as those debt deductions are:
- in relation to the acquisition of an excluded CGT asset (new membership interests in an Australian company)
- not in relation to the acquisition or holding of a non-excluded CGT asset or legal or equitable obligation that was acquired from an associate pair.
End of example
Indirect acquisition covered by Type 1
Type 1 DDCR also applies to 'indirect' acquisitions of CGT assets. In this regard:
- In determining whether an acquisition(s) occurs indirectly through one or more interposed entities
- it is sufficient if the acquisition(s) exists between each entity
- it is not necessary to demonstrate that each acquisition in a series of acquisitions happened before the next acquisition.
- Type 1 DDCR may apply to disallow debt deductions in relation to the indirect acquisition by an entity of a CGT asset through an interposed entity. This is even if the indirect acquisition involves the direct acquisition by the first entity of an excepted CGT asset.
Example 3: indirect acquisition of CGT asset subject to Type 1 DDCR
Aus Co A borrows $1,000 from Lending Co, an associate pair of Aus Co A.
Aus Co A uses the proceeds of the borrowing to acquire 100% membership interest in Aus Co B, an associate pair of Aus Co A.
Aus Co B acquires a CGT asset from Aus Co C, an associate disposer of Aus Co B, for a consideration of $1,000.
Aus Co A, Aus Co B and Aus Co C will all be associate pairs of each other as Aus Co B is an associate of Aus Co A and of Aus Co C under section 318 of the Income Tax Assessment Act 1936 (ITAA 1936).
In the current income year, Aus Co A pays an interest expense of $33 under the $1,000 borrowing from Lending Co.
The DDCR will apply to disallow Aus Co A's debt deductions for the $33 interest expense since the debt deductions are in relation to the indirect acquisition of the CGT asset from Aus Co C.