Generally, an indirect value shift happens when entities that are not dealing at arm's length engage in a non-market value transaction. The value shifting effect is referred to as 'indirect' because it affects the values of interests held in those entities. Such value shifts distort the relationship between the market value of the interests and their values for tax purposes. The indirect value shifting rules seek to address this distortion.
The rules can affect equity and loan interests in the losing or gaining entity for an indirect value shift where those entities are commonly controlled or commonly owned. A losing entity is a company or trust that loses value because of the shift. A gaining entity gains value. The rules nullify the effect of the value shift either by:
- making adjustments to the value of the interests for tax purposes just before the time of the value shift, or
- making adjustments to losses or gains arising when those interests are realised.
Example: indirect value shift
- 'Pinnacle Co' controls (for value shifting purposes) 'A Co' and 'B Trust'.
- A Co transfers an asset with a market value of $1 million to B Trust in exchange for a single cash payment of $300,000 in a non-arm's length dealing.
- The indirect value shifting rules may apply either to:
- adjust the values for tax purposes of Pinnacle Co's interests in A Co and B Trust because of this arrangement, or
- reduce any loss Pinnacle Co may make on subsequently realising interests in A Co, or reduce any gain it may make on realising interests in B Trust.
The indirect value shifting rules do not impact on the underlying transaction that causes the value shift (that is, the transfer of the asset from 'A Co' to 'B Trust'). The tax treatment of that transaction is determined under the general capital gains tax rules and income rules.