House of Representatives

New Business Tax System (Consolidation) Bill (No. 1) 2002

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 8 - Limiting the use of transferred losses by a consolidated group

Outline of chapter

8.1 This chapter explains how much of a transferred loss may be deducted or applied by a head company. The rules are contained in Subdivision 707-C.

Context of reform

8.2 The use of transferred losses by a consolidated group is restricted so that losses will be used by a group at approximately the same rate they would have been used by the joining entity had it remained outside the group. The aim is to ensure that the treatment of transferred losses is not a motive in deciding to consolidate a group or in a consolidated group deciding to acquire a loss entity.

8.3 For that reason, the maximum amount of losses transferred by a joining entity that can be used by the group in an income year is determined by reference to the amount of the groups income considered to have been generated by the joining entity. The available fraction is a proxy for determining this amount. [Schedule 1, item 2, section 707-305]

8.4 The available fraction method departs from Recommendation 15.3 of A Tax System Redesigned . It was developed in consultation with interested taxpayers and their advisers after earlier consultations concluded that the method contained in Recommendation 15.3 would be inequitable in certain circumstances.

8.5 In addition, a concessional method for the use of transferred losses has been developed in recognition of this departure. The concession applies to a group that consolidates during the transitional period and is discussed in Chapter 9. Losses to which this concession applies are referred to in this explanatory memorandum as concessional losses .

Summary of new law

8.6 Losses of a particular sort generated by the consolidated group must effectively be used before transferred losses of the same sort. [Schedule 1, item 2, subsection 707-305(2) and paragraph 707-310(3)(b)]

8.7 The annual rate at which a head company can deduct or apply transferred losses is limited by their available fraction. The available fraction is basically the proportion that the loss entitys market value at the joining time bears to the value of the whole group at that time. [Schedule 1, item 2, sections 707-310 and 707-320]

Comparison of key features of new law and current law
New law Current law
A head companys use of transferred losses is limited by the available fraction (unless the concessional method applies). Under the available fraction method transferred losses are used at a rate that approximates the proportion of the groups income earned by the transferor . Losses may be transferred to the extent they can be used by the transferee .

Detailed explanation of new law

8.8 There are 2 broad categories of carry forward losses that a head company may use to reduce its income. They are:

·
losses generated by the consolidated group ( group losses ); and
·
losses generated by an entity before it became a member of the group and which it transfers to the head company on joining the group ( transferred losses ).

Transferred losses are kept in bundles

8.9 Loss bundles are formed when losses are transferred to a group for the first time by the entity that actually made them. All of the losses transferred by the entity that actually made them constitute a single bundle of losses. A loss bundle remains intact if it is transferred again. [Schedule 1, item 2, subsections 707-315(1) and (2)]

8.10 The losses in a bundle must all have been transferred at the same time. Were the loss entity to leave and subsequently rejoin the group, any losses transferred when rejoining would form a separate loss bundle.

8.11 A loss bundle ceases to exist if the losses in it can no longer be used because, for example, they have been fully deducted or reduced. [Schedule 1, item 2, subsections 707-315(3) and (4)]

8.12 A single available fraction is worked out for each loss bundle. The available fraction is used to limit the annual rate at which the bundles losses may be recouped by the head company. However, losses in one bundle may be subject to the available fraction for another loss bundle if the value (and loss) donor concession discussed in Chapter 9 applies.

How are the general loss rules modified for transferred losses?

8.13 Group losses are deducted or applied by the head company in accordance with the existing rules for the recoupment of company losses (i.e. the rules contained in Divisions 165 and 166 of the ITAA 1997). However, these rules are modified whenever the head company seeks to use transferred losses. These modifications simply overlay the existing loss rules. They do not displace the scheme of the existing loss rules. [Schedule 1, item 2, section 707-345]

8.14 The modifications are:

·
in some circumstances the COT is modified in its application to a head company [Schedule 1, item 2, Subdivision 707-B]:

-
this is discussed in Chapter 7;

·
in applying the SBT, a head company is not required to compare its business as a head company with the business it carried on as a single entity prior to consolidation [Schedule 1, item 2, section 707-400]:

-
this is discussed in Chapter 6;

·
group losses of a sort are effectively used ahead of transferred losses of the same sort [Schedule 1, item 2, paragraph 707-310(3)(b)]:

-
this broadly matches the current group loss transfer rules in Division 170 of the ITAA 1997. Under those rules, a company can only benefit from a transferred loss of a sort after using its own losses of the same sort;

·
a transferred loss may be used in the same income year in which the head company is taken to have made it [Schedule 1, item 2, subsection 707-140(2)]:

-
this overrides the general rule that an entity may only deduct or apply losses from earlier income years. It matches the existing loss transfer rule in section 170-15 of the ITAA 1997; and

·
the annual rate at which transferred losses can be used is limited by their available fraction [Schedule 1, item 2, section 707-310]:

-
an available fraction is worked out separately for each loss bundle. This limit is discussed in paragraphs 8.17 to 8.46.

8.15 The general rule that requires earliest losses to be used before later ones has no application within a bundle because all of the losses in a bundle will be taken to have been made in the same income year (i.e. the income year in which they were transferred).

8.16 However, losses in different bundles will have different ages if the bundles were acquired by the head company in different income years. There is no requirement that a bundle containing earlier losses must be exhausted before drawing upon a bundle containing later losses (i.e. there is no ordering between bundles).

Limit for using transferred losses

8.17 The use of transferred losses is limited by their available fraction. That is, they may only be offset against a fraction of the head companys income and gains. [Schedule 1, item 2, section 707-310]

What is the purpose of the available fraction?

8.18 The available fraction is a proxy for determining the proportion (i.e. fraction) of the groups income generated by the loss entity. A proxy is necessary because immediately after joining, the loss entitys activities are, for income tax purposes, merged with those of the head company so it is not possible to determine the amount of the groups income actually generated by the loss entity.

8.19 The available fraction limit ensures that transferred losses are used up at approximately the same rate they would have been used had the loss entity remained outside the group. The aim is to ensure that the decision to consolidate is not driven by the tax treatment of transferred losses.

8.20 If the loss entity later leaves the consolidated group, its losses remain with the head company of the group. The available fraction attributable to the losses continues to be used to determine the amount of the losses that can be deducted or applied by the head company. While a loss entity that leaves a group ceases to contribute income to the group, the cash or assets received by the group on the sale of the loss entity continue to generate income for the group, leaving the groups income generating capacity unchanged.

Applying the available fraction

8.21 Having identified the losses in a bundle available for use (e.g. because the COT or SBT is satisfied in respect of them) it is then necessary to work out the amount of those losses that can be used. This is done using the bundles available fraction.

8.22 Broadly, the available fraction for the bundle is applied to each category of the groups income or gains. The results are taken to be the head companys only income or gains of each type. On the basis of that assumption, the head company works out the amount of losses of each sort it can use from the bundle. [Schedule 1, item 2, section 707-310]

8.23 This is essentially a 3 step process:

·
Step 1: work out the amount of each income or gain category as specified in column 2 of the table in subsection 707-310(3):

-
this is the groups total income or gains for each category less relevant deductions including group losses and concessional losses (but not transferred losses whose use is limited by their available fraction);

·
Step 2: multiply each category amount by the bundles available fraction:

-
the result is taken to be the head companys only income or gains for that category as specified in column 1 of the table in subsection 707-310(3);

·
Step 3: on the basis of that assumption, work out a notional taxable income for the head company:

-
the amount of losses of each sort from the bundle used in working out that notional taxable income can then be used in working out the head companys actual taxable income.

Step 1: Work out each (column 2) income or gain category

8.24 The income and gain categories reflect the general loss quarantining rules in the existing law and therefore cover:

·
capital gains;
·
foreign income;
·
exempt film income;
·
film income;
·
other exempt income; and
·
other assessable income.

8.25 The description of each category amount to which the available fraction is applied draws upon existing tax law concepts. However, each is worked out in accordance with the principles discussed in paragraphs 8.26 and 8.27.

8.26 First, each amount is worked out having regard to the head companys income or gains apart from this provision (section 707-310). This is a drafting device which ensures that the starting point is the head companys actual income and gains (as opposed to its notional income and gains that result from applying the available fraction). It also ensures that any choices provided by both the ITAA 1936 and ITAA 1997 that are relevant to the calculation of the companys actual income and gains are imported into this notional process. [Schedule 1, item 2, paragraph 707-310(3)(a)]

8.27 Second, before applying the available fraction, each income or gain category is reduced by any relevant deductions, including group losses and concessional losses of the relevant sort (but not transferred losses whose use is limited by their available fraction). The available fraction is applied to the remaining income and gains as they are the only income and gains which need to be sheltered by available fraction losses. [Schedule 1, item 2, paragraph 707-310(3)(b), column 2 of the table; Schedule 2, item 2, subsection 707-350(2) of the Income Tax (Transitional Provisions) Act 1997]

8.28 Take for example the last (column 2) category amount. It is the amount that would have been the head companys taxable income if it had not had any capital gains, foreign income or film income. Capital gains, foreign and film income are excluded because, consistent with the general loss quarantining rules, they are each dealt with in their own separate categories. The reference to taxable income ensures that relevant assessable income is reduced by deductions before applying the available fraction. The additional rules discussed in paragraph 8.27 ensure that these deductions include group losses and concessional losses but not other transferred losses.

Step 2: Multiply each income or gain category by the available fraction

8.29 Multiply each of the step 1 income or gain categories by the bundles available fraction. The results do not translate directly to the amount of the bundles losses of that sort that can be used. Instead they represent the fraction of the groups income or gains that can be said to have been generated by the assets of the original loss entity. The results form the basis for working out under step 3 the amount of losses in the bundle that can be used.

Step 3: Work out a notional taxable income for the head company

8.30 The head company cannot use any more losses from the bundle than it could have used had the step 2 results been its only income and gains of the relevant type listed in column 1 of the table in subsection 707-310(3).

8.31 In order to work out the amount of losses the head company could have used had the results been its only income or gains, it will need to work out a notional taxable income. The amount of transferred losses of each sort from the bundle used in working out that notional taxable income becomes the amount of transferred losses of those sorts from that bundle that can be used by the head company when it works out its actual taxable income. [Schedule 1, item 2, subsections 707-310(1) and (2)]

8.32 Transferred losses from the relevant bundle are the only deductions to be taken into account in working out the notional taxable income. All other deductions have already been taken into account in working out the category amounts. [Schedule 1, item 2, subsections 707-310(4) and (5)]

8.33 For example, the result of applying the available fraction to the (column 2) category amount for item 6 in the table in subsection 707-310(3) is said to be the head companys assessable income (other than net capital gains, foreign income or film income). The result is said to be assessable income to facilitate the deduction of transferred losses in working out a notional taxable income. (Tax losses are deducted from assessable and not taxable income.) But in working out that notional taxable income the deductions already used in working out the amount to which the available fraction was applied are not used again.

8.34 Also, consistent with the general loss rules, tax losses from a bundle can be offset against the bundles notional net capital gain (i.e. the fraction of capital gains remaining after deducting the bundles available net capital losses). This flows naturally from the process of working out the notional taxable income (see Examples 8.1 to 8.3).

Special rule for deducting transferred losses from exempt income

8.35 Tax losses must first be deducted against exempt income. Therefore, the available fraction is also applied to a groups exempt income. However, the end result of working out a notional taxable income will be a single amount of tax losses that can be used from the bundle (i.e. the total amount of tax losses for deduction against the groups exempt and assessable income). That is, tax losses notionally offset against exempt income and those notionally deducted against assessable income are together the amount of tax losses from the bundle that could have been used.

8.36 However, a special rule ensures that in working out the head companys actual taxable income, tax losses can commence to be offset against assessable income provided they have been used against exempt income to the same extent they were under the notional process. In the absence of this rule, the general loss rules would require the head company, in working out its actual taxable income, to first offset its transferred tax losses against its total exempt income (and not just against a fraction of it). [Schedule 1, item 2, section 707-340]

Example 8.1: Farrah Fabrics (bundle 1) The Farrah Fabrics consolidated group is working out the groups taxable income for the 2003-2004 income year.The groups capital gains for the income year are $900. The groups capital losses for the income year are $200.The groups only other assessable income is $9,000. Its deductions relating to that income are $990. Its group tax loss carried forward from the previous income year is $60.The groups remaining transferred losses at that time, and their available fractions, are set out in the table. Assume that the COT or SBT is passed in respect of all these losses.

Loss bundle Available fraction Unused transferred losses
Bundle 1 0.146 $50 net capital losses

$3,000 tax losses (not film)

Bundle 2 0.214 $100 net capital losses

$5,000 tax losses (not film)

The rest of this example works out the amount of losses that can be used from bundle 1 . Example 8.2 works out the amount of losses that can be used from bundle 2. Step 1: Work out the categories of group income or gains Category: capital gainsReduce the groups capital gains for the income year by its group capital losses for that year: $900 - $200 = $700Category: other assessable incomeReduce other assessable income by current year deductions and prior year group tax loss: $9,000 - ($990 + $60) = $7,950 Step 2: Apply bundle 1s available fraction to each category Category: capital gains

0.146 * $700 = $102

Category: other assessable income

0.146 * $7,950 = $1,160

Step 3: Work out a (notional) taxable income for bundle 1 As a result of step 2, it is assumed that Farrah Fabrics only capital gain is $102. On the basis of that assumption, the whole of the $50 net capital loss from bundle 1 can be used. This results in a (notional) net capital gain for bundle 1 of $52 ($102 - $50).This result is used as Farrah Fabrics completes the process of working out a notional taxable income for bundle 1:
Assessable income ($) Deductions ($)
net capital gain 52 tax losses (bundle 1) 1,212
other assessable income 1,160
Total 1,212 Total 1,212
Therefore, Farrah Fabrics is able to use $1,212 of its tax losses from bundle 1. These tax losses are in part attributable to the $52 net capital gain. This is consistent with the general loss rules which permit tax losses to be offset against net capital gains.

Example 8.2: Farrah Fabrics (bundle 2) This example continues Example 8.1 by working out the amount of losses that can be used from bundle 2 . It also draws the bundle 1 and 2 results together in working out Farrah Fabrics actual taxable income. Step 1: Work out the categories of group income or gains These are the same as for Example 8.1.Category: capital gains - $700Category: other assessable income - $7,950 Step 2: Apply bundle 2s available fraction to each category Category: capital gains

0.214 * $700 = $150

Category: other assessable income

0.214 * $7,950 = $1,701

Step 3: Work out a (notional) taxable income for bundle 2 As a result of step 2, it is assumed that Farrah Fabrics only capital gain is $150. On the basis of that assumption, the whole of the $100 net capital loss from bundle 2 can be used. This results in a (notional) net capital gain for bundle 2 of $50 ($150 - $100).This result is used as Farrah Fabrics completes the process of working out a notional taxable income for bundle 2:
Assessable income ($) Deductions ($)
net capital gain 50 tax losses (bundle 2) 1,751
other assessable income 1,701
Total 1,751 Total 1,751
Farrah Fabrics is able to use $1,751 of its tax losses from bundle 2. These tax losses are in part attributable to the $50 net capital gain. Again, this reflects the general loss rules which permit tax losses to be offset against net capital gains. Work out Farrah Fabrics taxable income First, work out Farrah Fabrics net capital gain:
Capital gains ($) Capital losses ($)
capital gain 900 group capital losses 200
net capital losses (bundle 1) 50
net capital losses (bundle 2) 100
Total 900 Total 350
Farrah Fabrics net capital gain is $550 ($900 - $350).
Assessable income ($) Deductions ($)
net capital gain 550 deductions 990
other 9,000 group loss 60
tax losses (bundle 1) 1,212
tax losses (bundle 2) 1,751
Total 9,550 Total 4,013
Farrah Fabrics taxable income is $5,537 ($9,550 - $4,013).

Example 8.3: Digby Department Store The Digby Department Store consolidated group is working out its taxable income for the 2004-2005 income year.The groups assessable foreign income for the income year (ignoring transferred losses) is $2,000. Its foreign deductions relating to that class of income are $200.The groups exempt income is $1,000.The groups assessable income from its domestic trading operations is $8,000. Its deductions relating to that income are $1,500.The group has a single bundle of transferred losses. Its available fraction and remaining losses for that bundle are set out in the table. Assume that the COT or SBT is passed in respect of these losses.

Available fraction Unused transferred losses
0.400 $350 foreign losses

$4,000 tax losses (not film)

Step 1: Work out the categories of group income or gains Category: foreign incomeReduce the groups assessable foreign income by its foreign income deductions: $2,000 - $200 = $1,800Category: exempt income$1,000Category: other assessable incomeReduce other assessable income by current year deductions:

$8,000 - $1,500 = $6,500

Step 2: Apply the bundles available fraction to each category Category: foreign income

0.4 * $1,800 = $720

Category: exempt income

0.4 * $1,000 = $400

Category: other assessable income

0.4 * $6,500 = $2,600

Step 3: Work out a (notional) taxable income for the bundle First, reduce the fraction of assessable foreign income worked out under step 2 by the bundles available foreign loss: $720 - $350 = $370.This shows that Digby can use the whole of its $350 transferred foreign loss.Second, offset $400 of the transferred tax losses against the fraction of exempt income worked out under step 2.Third, complete the process of working out a notional taxable income:
Assessable income ($) Deductions ($)
assessable foreign income 370 tax losses 2970
other 2,600
Total 2,970 Total 2,970
This assumes the group (in working out its actual taxable income) has elected under section 79DA of the ITAA 1936 to offset the bundles tax losses against foreign income to the extent it exceeds foreign losses.Digby can therefore use the following amounts of transferred losses:

·
$350 foreign loss;
·
$400 tax losses against exempt income; and
·
$2,970 tax losses against assessable income.

Step 4: Work out Digby Department Stores taxable income First, offset tax losses against exempt income: $1,000 - $400 = $600The fact that Digby still has exempt income will not prevent its remaining tax losses ($2,970) being offset against assessable income.Second, reduce assessable foreign income by the bundles available foreign loss: $2,000 - $350 = $1,650.
Assessable income ($) Deductions ($)
assessable foreign income 1,650 deductions (foreign) 200
other 8,000 deductions (other) 1,500
tax losses 2,970
Total 9,650 Total 4,670
Digby Department Stores taxable income is $4,980 ($9,650 - $4,670).

The available fraction applies for only part of the income year

8.37 The use of transferred losses is apportioned if their available fraction applied for only part of the income year. The apportionment rule is drafted as a general principle so that if either of the 2 trigger events occur the group cannot use more of its transferred losses than is reasonable having regard to the matters listed. [Schedule 1, item 2, section 707-335]

8.38 The rule is triggered if:

·
the losses were transferred to the head company by another entity after the start of the head companys income year; or
·
an available fraction is adjusted during the year to take account of the transfer of another loss bundle or because there has been a capital injection or a non-arms length transaction (in these cases the available fraction will have different numerical values for different periods of the income year).

Subsidiary transfers losses during head companys income year

8.39 Apportionment in this case ensures that a subsidiarys losses are only offset against income generated by the group after the subsidiary became a member. This is the only part of the groups income to which the subsidiary could have contributed. This is consistent with the available fraction being a proxy for determining the proportion of the groups income generated by the loss entity. [Schedule 1, item 2, paragraph 707-335(1)(a)]

8.40 In the absence of this rule, losses transferred by a subsidiary that joins a group on, for example, the second last day of the groups income year, could be used in reducing the groups income for the whole of the income year (i.e. for a period during which the subsidiary was not a member of the group and so could not have contributed to the income generated by the group).

8.41 This apportionment does not apply to losses transferred by a company to itself in its capacity as a head company. That is, even if the head company chooses to consolidate the group part way through the head companys income year, the head companys own losses can be used during the formation year without apportionment (but subject to their available fraction). The only time a groups use of its head company losses will be apportioned is if the available fraction changes during the income year.

8.42 However, a groups use of losses transferred by a subsidiary member will be apportioned if the group forms part way through the head companys income year and the subsidiary joins at the formation time (see Example 8.4).

Available fraction changes during the income year

8.43 Apportionment in this case ensures that an adjusted available fraction that is less than the previous fraction only applies from the date of the event that triggered the adjustment. (An adjustment can only result in the same or a reduced fraction.) This allows the group the benefit of the previous higher fraction for the period of its application. [Schedule 1, item 2, paragraph 707-335(1)(b)]

8.44 The rule is triggered in this situation if the available fraction changes during the income year while the losses were held by the head company (called the transferees loss-holding period ).

8.45 Generally, the transferees loss-holding period is the groups income year. However, it starts later if the loss bundle was transferred to the head company by another entity after the start of the income year. In that case, the loss-holding period starts at the transfer time. This caters for the fact that both trigger events can occur during the same income year. Also, the period ends earlier if, before the end of the income year, the head company becomes a subsidiary member of another group - at that time the losses commence to be held by a different transferee. [Schedule 1, item 2, subsection 707-335(2)]

Matters to be taken into account

8.46 In determining a reasonable use of losses if the trigger events occur, regard must be had to all relevant matters, including:

·
the general method prescribed for working out the maximum amount of losses that can be used:

-
that is, the apportionment must be consistent with the method discussed in paragraphs 8.17 to 8.36;

·
the number of days in the transferees loss-holding period:

-
this factor is relevant to both trigger events. Essentially it is only income attributable to this period against which the relevant losses can be offset;

·
the value or values of the relevant available fraction during the loss-holding period and the number of days in the period for which the fraction had a particular value:

-
again these factors are relevant to both trigger events. They ensure that the use of losses is apportioned on the basis of the number of days in the holding period for which the available fraction held a particular value;

·
however, if the head company transferred the losses to itself after the start of its income year, their available fraction for any of the loss-holding period that occurs before that transfer is the initial value of the available fraction:

-
this factor would only be relevant if a head companys own losses were transferred part way through its income year and their available fraction was subsequently adjusted. It ensures that the number of days in the loss-holding period for which the first available fraction is relevant includes the period from the start of the income year until the transfer (if that is later). That is, an available fraction for a head companys own losses applies from the beginning of its income year.

[Schedule 1, item 2, subsection 707-335(3)]

Example 8.4 The group forms part way through the head companys income year. Sub Loss Co joins as a subsidiary member at the formation time. The groups use of Sub Loss Cos losses should be apportioned on the basis of 265/365.

diagram: apportioning of loss 265/365

Example 8.5 The group forms part way through the head companys income year. Sub Loss Co joins as a subsidiary after formation but before the end of the income year. The groups use of Sub Loss Cos losses should be apportioned on the basis of 65/365.

diagram: apportioning of loss 65/365

Example 8.6 The group is in existence for the whole income year. Loss Co 1 joins the group part way through the head companys income year. Loss Co 2 joins after Loss Co 1 but before the end of the income year.Loss Co 1 has 2 available fractions and they should be applied 200/365 and 65/365.The groups use of losses transferred by Loss Co 2 should be apportioned 65/365.

diagram: apportioning of loss 65/365

Example 8.7 Loss Co 1 joins part way through the income year. After that, but before the end of the income year, the group is acquired by another group.The original groups use of the losses transferred to it by Loss Co is apportioned 200/280. The new groups use of Loss Cos losses should be apportioned 85/365.

diagram: apportioning of loss 85/365

Example 8.8

diagram: weighted average

On formation of the group (part way through Head Cos income year) Head Co transfers a loss bundle with an available fraction of 0.6.As a result of the groups subsequent acquisition of Sub Loss Co, the available fraction for Head Cos loss bundle is reduced to 0.42.When Sub Loss Co joins the group it transfers a loss bundle to Head Co with an available fraction of 0.3.How does Head Co apportion its use of transferred losses?One approach would be for Head Co to work out a single weighted average available fraction for each loss bundle. The weighting would reflect the number of days in the income year for which each different fraction was relevant. These weighted available fractions would then be used in working out how much of the losses from each bundle could be used (i.e. in applying the 3 steps discussed in paragraph 8.23).Weighted average fraction for Head Cos bundle:
0.6 * (140 / 365) = 0.230
0.42 * (225 /365) = 0.259
Total 0.489
Weighted average fraction for Sub Loss Cos bundle:
0.3 * (225 / 365) = 0.185

Calculating the available fraction

8.47 A loss bundles available fraction is the proportion the joining loss entitys modified market value bears to the market value of the whole group when the bundle is first transferred to a head company (the initial transfer time ). The fraction is increased if the value donor concession discussed in Chapter 9 applies. It is adjusted if any of the events in Table 8.1 happen (e.g. the group acquires a new loss entity). [Schedule 1, item 2, section 707-320]

Calculating an available fraction for losses transferred for the first time

8.48 Losses transferred for the first time may be either:

·
the losses of a single entity that becomes the member of a consolidated group; or
·
the group losses of a head company that is acquired by another group.

8.49 In those cases, the available fraction is calculated like this:

modified market value of the loss entity or group / adjusted market value of the head company

[Schedule 1, item 2, subsection 707-320(1)]

8.50 Values are worked out as at the initial transfer time and are discussed in paragraphs 8.74 to 8.86. The value of the head company (transferee) includes the value of subsidiary members of the group, including the loss entity. That is, the value of the head company is essentially the value of the whole group. This flows from the single entity rule which treats subsidiary members as parts of the head company.

Adjusting the available fraction

8.51 Available fractions are adjusted to ensure they continue to approximate the proportion of the groups income that can be said to be generated by the relevant loss entity.

8.52 For example, a groups available fractions are adjusted whenever the group acquires another loss entity (or group) or the groups market value is increased as a result of a capital injection or a non-arms length transaction. A groups available fractions must also be adjusted if they total more than one. For the purpose of this explanation, the events giving rise to an adjustment are referred to as adjustment events. [Schedule 1, item 2, subsection 707-320(2)]

8.53 Table 8.1 identifies the adjustment events. The adjusted available fraction is worked out by multiplying the existing available fraction by the factor identified at the relevant item in the table. An adjustment event can never result in an increased available fraction.

Table 8.1: Available fraction adjustments
Item no. Adjustment event Factor
1 Previously transferred loss bundles are transferred to a new head company. The lesser of one and this fraction:

market value of the old group / market value of the new joined group

2 Previously transferred loss bundles are transferred to a new head company and, at the same time, the old group also transfers its group losses to the new head company.

the lesser of the available fraction for group losses and 1 / the total of available fractions for all bundles being transferred

3 Existing group with transferred losses acquires new loss bundles.

1 - the total of the available fractions for all the new loss bundles that have been transferred to the head company

4 There is an increase in the market value of the group as a result of an injection of capital or a non-arms length transaction.

market value of the group just before the event / (market value of the group just before the event + amount of the increase)

5 Available fractions total more than one.

1 / total of available fractions

Adjustment event 1 - previously transferred losses are transferred again

8.54 This event occurs when:

·
the head company of a consolidated group (the old group) joins another consolidated group (the new group);
·
the old group transfers losses to the new group; and
·
those losses had been previously transferred to the old group.

8.55 The available fraction for each bundle of previously transferred losses is adjusted by multiplying it by the factor at item 1 in Table 8.1, if the factor is less than one. If the factor is one or more, then each available fraction is multiplied by one and therefore remains unchanged. [Schedule 1, item 2, item 1 of the table in subsection 707-320(2)]

8.56 The market value of the old group is included in the numerator as if the group had continued to exist as a single entity. The market values of the old and new groups are worked out as at the time the old group joins the new group. The new group is the whole group including the old group. [Schedule 1, item 2, subsection 707-330(2)]

8.57 Unlike the formula for calculating an available fraction for a bundle of losses transferred for the first time, this factor does not use modified or adjusted market values. This is because the original available fractions were calculated to take account of the assumptions in paragraph 8.74 as well as any relevant capital injections and non-arms length transactions. Therefore, they can simply be adjusted to reflect the proportion that the old groups market value bears to the value of the new group at the transfer time.

Adjustment event 2 - previously transferred and group losses are both transferred

8.58 This event occurs when the old group transfers to the new group both previously transferred losses and its own group losses. First, an available fraction for the bundle of group losses is worked out using the formula for losses transferred for the first time. Second, the available fraction for each bundle of previously transferred losses is adjusted by multiplying it by the factor for adjustment event 1. [Schedule 1, item 2, subsection 707-320(1) and subsection 707-320(2), item 1 in the table]

8.59 Each of these available fractions (i.e. for group losses and previously transferred losses) is then adjusted by multiplying each by the factor at item 2 in Table 8.1. This factor caps the total of the available fractions for the joining group so their total does not exceed what would otherwise have been the available fraction for the group losses. This ensures the available fractions bear the correct proportion to each other. It also ensures they bear the correct proportion to the available fractions for any loss bundles already held by the acquiring group. [Schedule 1, item 2, item 2 of the table in subsection 707-320(2)]

Adjustment event 3 - when another loss entity joins the group

8.60 A groups available fractions are adjusted if the group acquires another loss entity or loss group. Each available fraction is adjusted by multiplying it by the factor at item 3 in Table 8.1. A head company may choose to cancel the transfer of all its incoming losses to avoid this adjustment. [Schedule 1, item 2, item 3 in the table in subsection 707-320(2)]

Adjustment event 4 - capital injections and non-arms length transactions

8.61 A groups available fractions are adjusted if the groups market value is increased as a result of capital injected into the group or a non-arms length transaction involving the group. This increase in the groups income generating capacity reduces the proportion of income that loss entities within the group can be regarded as generating. Therefore, each available fraction is adjusted by multiplying it by the factor at item 4 in Table 8.1 (see also the discussion in paragraphs 8.92 to 8.102). [Schedule 1, item 2, item 4 in the table in subsection 707-320(2)]

Adjustment event 5 - available fractions total more than one

8.62 If a groups available fractions total more than one, it would incorrectly indicate that the group can generate more income than it actually does. The factors for adjustment events 1, 2 and 3 have in-built mechanisms for ensuring that, in those cases, a groups available fractions cannot total more than one.

8.63 However, it may still be possible, for example, on formation or after a series of adjustments that a groups available fractions total more than one. If they do, they are proportionally reduced. Each available fraction is reduced by dividing it by the total available fractions (see item 5 in Table 8.1). This adjustment only applies after completion of the available fraction calculation and other relevant adjustments. [Schedule 1, item 2, item 5 in the table in subsection 707-320(2) and subsection 707-320(3)]

8.64 In determining whether available fractions total more than one, only take account of available fractions for bundles that still exist. A bundle ceases to exist if none of the losses in it (including those that are taken to be in it under the value and loss donor concession discussed in Chapter 9) can be used or otherwise reduced. [Schedule 1, item 2, subsections 707-315(3) and (4)]

Several adjustment events

8.65 A single loss transfer may trigger more than one adjustment event (e.g. an old group transfers losses to a new group and the new group has existing loss bundles). If this occurs, then the adjustment calculations are made in the same order as they appear in Table 8.1. The results of earlier calculations are used in making the calculations under a later item (see also Example 8.11). [Schedule 1, item 2, subsection 707-320(3)]

More about the available fraction calculation

Available fractions are rounded to 3 decimal places

8.66 Available fractions are calculated and then adjusted to 3 decimal places. The third decimal place is rounded up if the fourth decimal place is 5 or more. [Schedule 1, item 2, subsection 707-320(4)]

When will an available fraction be zero?

Numerator is zero

8.67 The available fraction works out as zero if the modified market value of the joining entity (i.e. the numerator) is nil. Such an entity is not in an income producing position and therefore the bundle of losses transferred by it does not have an available fraction. This means the group will not be able to use any of the losses transferred by that entity, unless value is added to the modified market value of the entity by another group member under the value donor concession discussed in Chapter 9.

Available fraction would otherwise be a negative amount

8.68 An available fraction will be zero if it would otherwise be a negative amount. This could occur in applying the factor for adjustment event 3 if the incoming available fractions totalled more than one. [Schedule 1, item 2, subsection 707-320(6)]

When will an available fraction be one?

8.69 The available fraction may work out as one if all of the groups losses and value are pooled in a single bundle under the value and loss donor concession. This can only occur where all of the group members and their losses are fully groupable (all losses transferable to every other member in the group) under the current loss transfer rules (see Chapter 9).

8.70 The available fraction is also one if the modified market value of the joining entity is a positive amount (the numerator) but the adjusted market value of the group joined (the denominator) is nil. This matches what occurs naturally if the numerator is greater than the denominator and the denominator is also a positive amount. It reflects the fact that any income generated by the group will be attributable to the loss entity and therefore the entitys losses can be used to offset that income without restriction. However, if a group with a nil value has more than one loss entity with a positive value, this rule will mean that each available fraction is more than one and so the groups available fractions will total more than one. In that case, each available fraction is proportionally reduced under item 5 of Table 8.1. [Schedule 1, item 2, subsections 707-320(2) and (5)]

Head company can choose to cancel transferred losses

8.71 A head company can choose to cancel the transfer of a loss. The choice is made on a loss by loss (as opposed to bundle by bundle) basis. [Schedule 1, item 2, subsection 707-145(1)]

8.72 A head company may choose to cancel a loss to:

·
avoid adjusting the available fractions for its existing loss bundles under adjustment event 3 (though it would need to cancel all its incoming losses to achieve this); or
·
achieve a better outcome under adjustment event 2 which caps available fractions when both group and previously transferred losses are transferred.

8.73 A choice to cancel the transfer of a loss cannot be changed. The effect of the cancellation is that the transfer is treated as if it had never occurred. Cancelled losses can never be used or transferred by any entity for a period after the loss entity has joined the group. [Schedule 1, item 2, subsections 707-145(2) and (3)]

Values used in calculating the available fraction

Modified market value of a single joining entity

8.74 The modified market value of a joining entity (relevant to working out the initial available fraction) is its market value, assuming:

·
it has no losses and the balance of its franking account is nil;
·
the subsidiary members of the group at the joining time are separate entities and not parts of the head company; and
·
its market value did not include an amount that is attributable (directly or indirectly) to a membership interest in any other group member (with one exception).

[Schedule 1, item 2, subsection 707-325(1)]

Assume no tax attributes

8.75 In working out the modified market value the market value of a joining entity is worked out as though it did not have losses or franking credits. The value is worked out as if these attributes did not exist because they do not enhance the joining entitys income generating capacity. This means, for example, that a loss entity with no assets other than its losses will have a nil available fraction which will prevent its losses being used by the group (unless the value donor concession discussed in Chapter 9 applies). [Schedule 1, item 2, paragraph 707-325(1)(a)]

Override the single entity rule

8.76 In working out that market value, a joining entity (whether the head company or other entity) is treated as a separate entity. This overrides the single entity rule which would otherwise treat subsidiary members as parts of the head company. [Schedule 1, item 2, paragraph 707-325(1)(b)]

Assume no interests in other group members

8.77 The modified market value of the joining entity is worked out on the assumption that its market value did not include any amounts directly or indirectly attributable to membership interests in other group members. Such amounts are reflected in the market value of those other group members. Ignoring them prevents double counting.

8.78 If the joining entity has a membership interest in another member of the group (e.g. shares in a member company) the market value is worked out as if the amount attributable to that interest were not included in its market value. However, if the joining entity has a membership interest in a non-member company the market value includes the amount attributable to that interest. But, if that non-member company itself has a membership interest in the head company of the group the value attributable to that interest, and included in the value of the joining entitys membership interest in the non-member, is excluded from the joining entitys market value (i.e. this would be an amount indirectly attributable to a membership interest in a member of the group). [Schedule 1, item 2, paragraph 707-325(1)(c)]

8.79 There is one exception. A joining entitys modified market value may include value contributed by a trust but the value is limited to the amount attributable to the joining entitys fixed entitlement to income or capital of the trust. The inclusion of this value recognises that outside consolidation the trusts income is sheltered from income tax by the joining entitys losses. In determining this amount, it is necessary to exclude value attributable (directly or indirectly) to membership interests in other group members, unless those other group members are themselves trusts in which a fixed entitlement is held. [Schedule 1, item 2, paragraph 707-325(1)(d)]

8.80 However, a joining entitys modified market value cannot include the value of a trust that:

·
itself transferred losses to the head company (because the value that trust will be counted in working out its own available fraction (though the head company could choose to cancel the transfer of losses by the trust in which case its value could be counted); or
·
is a corporate unit trust or a public trading trust (because these trusts are taxed like companies as opposed to receiving flow-through treatment and so, outside consolidation, their income cannot be sheltered from income tax by a beneficiarys losses).

[Schedule 1, item 2, subparagraphs 707-325(1)(c)(i) and (ii)

Example 8.9

modified market value

A consolidated group forms consisting of a head company, 4 subsidiary companies and a fixed trust. Loss Co (and A Co) are beneficiaries of the fixed trust - they each hold a fixed entitlement to 50% of the income and capital of the trust.The modified market value for Loss Co is worked out by determining its market value assuming it:

·
has no losses and the balance of its franking account is nil;
·
is a separate entity (and not just a part of the head company); and
·
has no value directly or indirectly attributable to membership interests in other group members, except for a fixed entitlement to income and capital of the trust:

-
Loss Cos interest in B Co is not taken into account;
-
However, Loss Cos fixed entitlement to income and capital of the trust (that is not attributable to the trusts interest in C Co) can be counted.

These assumptions do not exclude the taking into account of value attributable to membership interests Loss Co has in entities outside the group. Therefore, Loss Co may count the value of its interest in the foreign subsidiary.

Adjusted market value of the head company

8.81 The adjusted market value of the head company to which the losses are initially transferred (i.e. the transferee) is the head companys market value at the transfer time, ignoring any losses it has and assuming that its franking account balance is nil. The value of these attributes is ignored because they do not contribute to the groups earning capacity. [Schedule 1, item 2, subsection 707-320(1)]

8.82 This is essentially the market value of the whole group. That is, as a result of the single entity rule, the market value of the head company includes the value of subsidiary members of the group, including the loss entity. It also includes the value of interests held by group members in entities outside the group. Therefore, in Example 8.9 the value of the head company would include the value of interests held by the loss company in the foreign subsidiary.

Value of a joining entity that was a head company

8.83 When the head company of one group (the old group) joins another group (the new group) and transfers losses to that new group the modified market value of the old group at loss transfer time is the value used in working out the available fraction for the transferred losses. [Schedule 1, item 2, subsections 707-330(1) and (2)]

8.84 In other words, the single entity rule applies so that in working out the value of the ex-head company of the old group all of the subsidiary members of the old group at the loss transfer time are treated as a part of the ex-head company (and not as a separate member of the new group).

8.85 The losses transferred may be group losses (in which case the ex-head company must work out its modified market value) or previously transferred losses (in which case adjustment event 1 requires the market value of the old group, the transferor, to be determined).

8.86 If the losses are group losses, the single entity rule will also apply to the period the old group was in existence prior to the joining time. That is, the modified market value of the ex-head company is worked out as if each subsidiary member of the group had been a part of the ex-head company while it was a subsidiary member of the old group. This ensures that capital injected into (or non-arms length transactions involving) subsidiary members of the old group before it joins the new group are taken into account in working out the ex-head companys modified market value. [Schedule 1, item 2, subsections 707-330(1) and (3)]

Maintaining the integrity of the available fraction

8.87 The calculation of available fractions is a crucial component of the rules for loss utilisation by consolidated groups. As such, special rules are necessary to maintain the integrity of those calculations. These rules prevent the inflation of available fractions from certain events occurring prior to consolidation. In addition, adjustment event 4 in Table 8.1 ensures that available fractions are appropriately adjusted to reflect certain events occurring post-consolidation.

Pre-consolidation events that increase market value

8.88 An increase in the value of a loss entity is excluded from the entitys modified market value if the increase is as a result of either:

·
an injection of capital into the loss entity, its associate or, if the loss entity is a trust, an associate of its trustee; or
·
a non-arms length transaction that involved the loss entity, its associate or, if the loss entity is a trust, an associate of its trustee.

[Schedule 1, item 2, subsections 707-325(2) and (4)]

8.89 The amount excluded is the lesser of:

·
the difference between the loss entitys market value at the joining time and what would have been its market value if the injection or transaction had not occurred; and
·
the total increase in the entitys market value that occurred after each (capital injection or non-arms length transaction) event.

[Schedule 1, item 2, subsection 707-325(3)]

8.90 Framing the reduction in this way ensures that no reduction is required if the event has not actually resulted in an increased available fraction as at the joining time. It also ensures the reduction does not include the compounding effects of the increase in value. That is, if additional value has been built up as a result of profitably utilising the original increase, then the reduction is only the amount of the original increase.

8.91 These rules prevent a loss entity from inflating its market value before it joins a consolidated group in order to obtain a higher available fraction. They apply to events that occur in the 4 years before the loss entity joins the group [Schedule 1, item 2, paragraph 707-325(2)(a)] . However, they do not apply to events that occur before 9 December 2000 [Schedule 2, item 2, section 707-329 of the Income Tax (Transitional Provisions) Act 1997] .

Post-consolidation events that increase market value

8.92 A groups available fractions are adjusted if the groups market value is increased as a result of either:

·
an injection of capital into the group or an associate of the group; or
·
a non-arms length transaction that involved the group or an associate of the group.

[Schedule 1, item 2, subsection 707-320(2), item 4 in the table]

8.93 These events increase the income generating capacity of the group which reduces the proportion of income a loss entity can be regarded as generating. If these events occur, the groups available fractions are adjusted using the factor at item 4 in Table 8.1.

More about events that increase value

8.94 These events may affect the initial calculation of an available fraction if they happen to a joining entity pre-consolidation. They may also result in the available fraction being adjusted if the events happen to the group post-consolidation.

8.95 Pre-consolidation events only become relevant after an initial modified market value has been worked out for a joining entity. However, a joining entitys modified market value is worked out ignoring or excluding value attributable, directly or indirectly, to membership interests in other group members. To the extent value has already been ignored (because it was represented in the value of a group membership interest) it will not be considered again in assessing the effects of these events. [Schedule 1, item 2, paragraphs 707-325(1)(d) and (2)(b)]

8.96 Post-consolidation, the events are only relevant if they trigger an increase in the market value of the whole group. This can only occur in this context as a result of an injection of capital or non-arms length transaction involving entities external to the group.

8.97 The expression injection of capital is not defined and therefore takes its ordinary meaning. Capital is generally understood as the wealth of an entity, whether in money or property. The use of the word injection conveys that the capital or wealth has been introduced from outside the entity (or group) in the sense that it has not been obtained from the entitys (or groups) own resources. The simplest example of an injection of capital is the payment of cash to an entity as consideration for membership interests in the entity.

8.98 Non-arms length transaction is also not defined though it is specified that the transaction must involve an associate of the entity or group. These events are only relevant if they trigger an increase in the value of a joining entity or a group. There would be no increase in value for example, if the entity or group acquired an asset from an associate for which it paid full consideration.

8.99 Examples of transactions that may lead to an increase in value of an entity or group are:

·
transferring an asset to the entity or group for less than market value consideration;
·
forgiving a debt owed by the entity or group;
·
lending money to the entity or group on non-commercial terms; and
·
paying the entity or group an inflated price for goods or services.

Exception to rules regarding events that increase market value

8.100 The pre- and post-consolidation capital injection events do not apply to an injection of capital:

·
into a listed public company through a dividend reinvestment scheme, provided the entity to which shares are issued held a share in the listed public company before the capital injection; or
·
in association with an acquisition of shares under an employee share scheme if the scheme is one described in the rules dealing with membership of a consolidated group. (Minor holdings of shares in a company issued under certain employee share arrangements will not prevent the company being a subsidiary member of a consolidated group, see Chapter 3.)

[Schedule 1, item 2, subsection 707-325(5)]

8.101 The exceptions recognise that such schemes are unlikely to be exploited pre-consolidation to increase available fractions. Excluding these schemes from the rules will also reduce compliance costs for consolidated groups as market valuations will not need to be made as a result of operating these schemes after consolidation.

General anti-avoidance rule

8.102 In addition to the specific rules to prevent the inflation of an available fraction, the general anti-avoidance provisions of Part IVA of the ITAA 1936 may apply where values relevant to the calculation of an available fraction are manipulated as part of a scheme entered into with the sole or dominant purpose of increasing an available fraction (or otherwise increasing the rate of utilisation of losses by a consolidated group).

Examples of calculating and adjusting available fractions

Example 8.10

Example 1 of calculating and adjusting available fractions

The Cellar Door Sales group consolidates. At the initial transfer time, the groups market value is $10,000.Available fractions for the head companys loss bundles are:
head company: $5,000 / $10,000 = 0.5
A: $3,000 / $10,000 = 0.3
B: $2,000 / $10,000 = 0.2

Example 8.11 Cellar Door Sales is taken over by another consolidated group, All Over Australia Liquor Distributors.At this time, the Cellar Door Sales Groups modified market value is $13,000 (the same as its market value). Cellar Door Sales now has a group loss in addition to its previously transferred losses.The market value of the new group (All Over Australian Liquor Distributors and Cellar Door Sales is $35,000).

Example 2 of calculating and adjusting available fractions

Cellar Door Sales 1. Calculate an available fraction for the loss bundle containing the group loss:

$13,000 / $35,000 = 0.371

2. Adjust the available fractions for the previously transferred loss bundles:
head co: 0.5 ($13,000 / $35,000) = 0.186
A: 0.3 ($13,000 / $35,000) = 0.111
B: 0.2 ($13,000 / $35,000) = 0.074
0.371
3. Cap the available fractions:
Group loss 0.371 * (0.371 / 0.742) = 0.186
head co: 0.186 * (0.371 / 0.742) = 0.093
A: 0.111 * (0.371 / 0.742) = 0.056
B: 0.074 * (0.371 / 0.742) = 0.037
0.372
Note: 0.742 is the sum of the available fractions calculated under steps 1 and 2 (i.e. 0.371 + 0.186 + 0.111 + 0.074). All Over Australia Liquor Distributors Recalculate the available fractions for the loss bundles held by the head company of All Over Australia Liquor Distributors before the takeover:
C: 0.115 * (1 - / 0.372) = 0.072
D: 0.162 * (1 - / 0.372) = 0.102

Application and transitional provisions

8.103 The consolidation regime will apply from 1 July 2002.

8.104 Two transitional measures are included in the Income Tax (Transitional Provisions) Act 1997 that may affect a groups use of its transferred losses. Both apply to certain losses transferred to a group that consolidates during the transitional period (i.e. 1 July 2002 to 30 June 2004).

8.105 The first increases a loss entitys modified market value (and therefore its available fraction) by a portion of the modified market value of another group member with whom the entity could have grouped its losses under Division 170 of the ITAA 1997 (the value and loss donor rules). The second allows certain company COT losses to be used over 3 years instead of in accordance with their available fraction (the concessional loss method). Both are discussed in Chapter 9.

Consequential amendments

8.106 Consequential amendments have been made to subsection 995-1(1) to include references to new dictionary terms. [Schedule 5, items 3, 4 and 18]


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