Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 7 - Overview of the general value shifting regime
Outline of chapter
7.1 This chapter contains an overview of the general value shifting regime (GVSR), comprising direct value shifting (DVS) and indirect value shifting (IVS) rules. The amendments discussed in this chapter are contained in Schedule 15 to this bill. Further discussion of the GVSR is contained in the following chapters:
- •
- Chapter 8: DVS rules affecting equity or loan interests in companies and trusts;
- •
- Chapter 9: DVS rules relating to creating rights in respect of non-depreciating assets;
- •
- Chapter 10: IVS rules;
- •
- Chapter 11: Control and common ownership tests and affected owner rules;
- •
- Chapter 12: Consequential amendments; and
- •
- Chapter 14: Regulation impact statement.
(Chapter 13 discusses amendments to loss integrity measures which contain a special value shifting rule).
7.2 The DVS rules (Chapters 8 and 9) are contained in:
- •
- Division 725 (direct value shifts affecting equity or loan interests in companies and trusts); and
- •
- Division 723 (direct value shifts by creating rights in respect of non-depreciating assets).
7.3 The IVS rules (Chapter 10) are contained in Division 727. This Division deals with indirect value shifts affecting equity or loan interests in companies and trusts, but only where the indirect value shift involves non-arms length dealings.
7.4 Schedule 15 inserts Divisions 723, 725 and 727 into the ITAA 1997. They replace the current value shifting rules, being Division 138 (value shifting by asset stripping), Division 139 (value shifting through debt forgiveness) and Division 140 (share value shifting) of the ITAA 1997.
7.5 Broadly, the new Divisions will commence on 1 July 2002 for all entities including those with SAPs. Division 723 will apply to rights created after 30 June 2002. Divisions 725 and 727 will apply to all value shifts happening after 30 June 2002, except for those happening under a scheme entered into before 27 June 2002.. These value shifts are to be addressed under the current value shifting rules. The current value shifting rules will also continue to apply in respect of value shifts that happen before 1 July 2002.
7.6 This chapter outlines:
- •
- the background to, and the underlying policy of, the new rules;
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- the important differences between the concepts of a direct value shift and an indirect value shift;
- •
- how the DVS and IVS rules interact and are likely to apply in practice;
- •
- the major situations when the rules will not apply; and
- •
- the income tax consequences or adjustments that follow if the rules apply.
Context of reform
7.7 The GVSR is a component of the New Business Tax System announced in Treasurers Press Release No. 58 of 21 September 1999 (refer to Attachment K). Further details were announced in Treasurers Press Release No. 16 of 22 March 2001. The proposal was further foreshadowed in the Minister for Revenue and Assistant Treasurers Press Release No. C57/02 of 14 May 2002.
7.8 The GVSR is based on Recommendations 6.12 to 6.16 of A Tax System Redesigned and will deliver significant integrity benefits to the New Business Tax System.
7.9 Value shifting rules are needed to prevent:
- •
- distortion of gains and losses when interests are sold, rendered worthless or otherwise come to an end; and
- •
- opportunities for inappropriate deferral or avoidance of tax liabilities where the value shift results in an interest decreasing in value, or inappropriate taxation where the value shift results in an interest increasing in value:
- -
- value shifting makes it possible for a taxpayer to bring forward losses and defer gains by shifting value out of assets which are due to be realised in the short term and into assets which are not due to be realised until some time later; and
- -
- value shifting arrangements distort the relationship between an assets market value and its adjustable value (e.g. cost base), thereby bringing inappropriate gains and losses to account upon realisation.
7.10 The current value shifting provisions are a patchwork of complex rules that have serious design flaws. For example:
- •
- only a limited number of value shifting arrangements, or arrangements involving particular structures, are addressed, for example:
- -
- share value shifting is addressed but value shifting involving interests in trusts is not;
- -
- direct value shifts involving equity are addressed, but not value shifting out of loans, or between loans and equity;
- -
- asset stripping provisions apply only to certain types of shifts involving certain types of assets or transactions, for example, where debts are forgiven, but not where assets are cancelled; or where asset transfers or creations occur at less than market value, and not where they occur at greater than market value; and
- -
- asset stripping provisions apply only to 100% commonly-owned (including group) companies: companies that are controlled but are less than 100% owned are not covered, and there is no coverage of trusts;
- •
- the existing law is complicated and beset by tests which makes compliance difficult and expensive;
- •
- some aspects of the existing value shifting provisions apply too widely which can lead to unintended outcomes (e.g. for in specie distributions in the asset stripping rules);
- •
- de minimis rules are for share value shifting rules, impractical, and for asset stripping rules, non-existent; and
- •
- there is no exclusion for small value entities (including small business) from complex areas of the value shifting rules where such rules need not apply to them to preserve integrity.
7.11 These design flaws, with others, mean the existing value shifting rules are unsustainable in the new environment that includes consolidation. The GVSR will address these flaws in a comprehensive and systemic way.
7.12 The GVSR will ensure, among other things:
- •
- the consistent application of value shifting rules to interests in companies, and in fixed and non-fixed trusts (i.e. not just shares);
- •
- that control tests apply to determine affected entities (thereby excluding almost all interests in listed entities) and for closely-held entities only, common ownership and active participation tests support the control framework;
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- there is a consistent treatment of transactions with the same economic effect, through the use of a generalised concept of value shifting transactions and events;
- •
- that compliance costs are minimised by a realistic targeting of the measures - this is achieved by an appropriate range of exclusions and safe-harbours, by a de minimis exception, and by excluding small business entities where this is appropriate; and
- •
- the integrity of the proposed consolidation regime, and of the CGT rules generally, is enhanced.
Summary of new law
7.13 Following is a summary of the new law in respect of the key principles of the GVSR.
| What is the GVSR? | The GVSR consists of DVS rules and IVS rules that impact primarily on equity and loan interests in companies and trusts. There is a special DVS rule that deals with rights created over non-depreciating assets. |
| What is a value shift? | Usually, a value shift occurs when something is done that results in the value of one thing increasing (or being issued at a discount to market value), and the value of another thing decreasing. |
| What value shifts are subject to the GVSR? | There are 3 main areas.
The DVS rules deal mainly with shifts in value involving equity and loan interests in a single entity. Such a shift might arise from the issue of new interests at a discount, or from the variation of interests existing rights (refer to Chapter 8). There is also a DVS rule dealing with the realisation of a non-depreciating asset at a loss where the loss (or part of it) arises because of a right created over the asset in an associate, and the market value of the right was not fully brought to tax on creation. There are back-up provisions if the asset has been subject to a CGT roll-over (including a replacement-asset roll-over), or if those replacement assets are themselves rolled over (refer to Chapter 9). The IVS rules deal with value shifts between entities where the entities have not dealt at arms length (refer to Chapter 10). This impacts upon the values of interests held directly or indirectly in those entities, so the value shifting effect countered is referred to as indirect . |
| Who is affected by the GVSR? | Broadly, the DVS rules impact on the controllers and their associates, of an entity, or active participants (if the entity is closely-held) in a value shifting scheme involving the entity, and in limited cases on the owner of an asset over which a right has been created at undervalue in favour of an associate, or the owner of replacement interests if the asset has been rolled over.
The IVS rules impact on certain entities with interests (affected owners) in a losing or gaining entity in relation to an indirect value shift. A losing entity is one that loses value because of the shift. A gaining entity is one that gains value. To be an affected owner, one must be, broadly speaking, a controller, or associate of a controller, of the losing and gaining entityor a common ownership, or an active participant test must be satisfied. The active participant and common ownership tests apply only to closely-held entities. Generally, the GVSR will not affect owners of interests who do not satisfy some controller/associate test, are not common owners (where there is more than one entity) and have not actively participated in the scheme (refer to Chapter 11 for who is an affected owner). |
| What assets are affected by the GVSR? | The GVSR generally only applies to equity or loans (including options and rights to acquire equity or loans) in a company or trust, that are owned by an affected owner.
Non-depreciating assets which decrease in value because of rights created in associates over them, together with replacement interests if such assets are rolled over, are also within the GVSR. The DVS rules apply to interests held directly in entities whereas the IVS rules can apply to interests held directly, or indirectly, in entities. There are different consequences for particular interests according to whether the interest is held on capital account, or as a revenue asset or as trading stock.. |
| What is the effect of a value shift? | The consequences of a value shift for an owner of an interest depend upon whether the DVS or IVS rules apply.
A direct value shift can result in:
An indirect value shift does not cause a deemed gain or loss to arise but can result in adjustments to realised losses and gains or adjustments to adjustable values to realign these values in accordance with shifts in market value (refer to Chapters 8 and 9 for DVS consequences and Chapter 10 for IVS consequences generally). |
| Is there any need to show a tax avoidance purpose? | No, the measures apply to value shifting schemes without any requirement for finding a tax avoidance purpose, whether main, dominant or incidental. Part IVA of the ITAA 1936 is not excluded from applying in the case of a value shift. |
| Does the GVSR apply to all value shifts? | No, the GVSR only applies to material value shifts. There are
de minimis
exceptions for:
There are also a number of exclusions and safe-harbours, especially in the IVS rules. |
| What are some ways in which the consequences of the GVSR can be avoided? | The GVSR can be avoided completely by:
|
| How does the GVSR relate to consolidated groups? | The GVSR does not affect interests in consolidated group members that are reconstructed under the consolidation rules.
The GVSR applies to dealings between non-consolidated entities, as well as to dealings between consolidated groups and non-group entities, where relevant control etc. thresholds and various other requirements are met. This ensures that there is no advantage in keeping less than 100% controlled entities outside aconsolidated group for the purpose of value shifting with them, or from electing not to consolidate groups of 100% owned entities in the expectation of deriving tax advantages from value shifting. Rules dealing with value shifting out of interests in entities forming part of consolidated or MEC groups where the interests are not reconstructed under the consolidation rules will be included in a later bill. Other interaction issues between the GVSR and consolidated or MEC groups will also be addressed. |
| New law | Current law |
|---|---|
| The GVSR will generally apply to all arrangements which materially change the market value of
interests
in entities.
A realisation of a non-depreciating asset at a loss where a right is, or has been, created for less than market value consideration in an associate is also potentially within the GVSR. Special rules apply if the asset is subject to a roll-over (refer to Chapter 9). |
Only certain forms of value shifting are addressed:
|
| DVS rules apply to arrangements where value is shifted from an equity or loan interest in a company or trust, by direct means such as a variation of rights, or issue of interests at undervalue (refer to Chapter 8).
The value shift can occur between shares owned by the same entity or by different entities. There will be a special relieving rule where a direct value shift reverses. |
Division 140 applies to arrangements where value is shifted from a share in a company, by direct means such as a variation of rights, or issue of interests at undervalue.
The value shift can occur between shares owned by the same entity or by different entities. There is no relieving rule for a share value shift that reverses. |
| IVS rules apply where the provision of economic benefits by companies or trusts to another entity results in a shift of value. Usually, there will be a shifting of value between direct or indirect interests in those entities (refer to Chapter 10). | Divisions 138 and 139 only apply to assets and forgiven debts (between 100% owned companies) and not services (although rights in relation to services may currently be captured by Division 138).
Adjustments are required only to direct and indirect interests in the companies involved in the value shift. |
| The GVSR applies to value shifts involving interests in companies, and in fixed and non-fixed trusts.
The GVSR can apply to any entity that owns an asset from which a right is created in an associate at less than market value. |
Value shifts involving assets owned by, or interests in, companies are caught by the current law. |
| The relevant valuation standard is market value, although there are a number of proxies for market value that can be used as a substitute for it in particular cases. | The relevant valuation standard is market value, although there are some proxies for market value that can be used as a substitute for it in particular cases. |
| The GVSR can affect controllers and their associates, as well as common owners, their associates, and owners who have actively participated in the value shift (where the entity is, or entities are, closely-held).
Common ownership for IVS purposes requires that the entities be closely-held and can be less than 100% commonality, but not less than 80% commonality (on an associate inclusive basis). There is no need for common owners of 2 entities to hold interests in the same proportions in both, although where their proportional interests are not the same, at least one owner must (on an associate inclusive basis) have a stake in each entity that is, or exceeds 40% or there must be a group of 16 or fewer owners who (on an associate inclusive basis) hold the 80% or greater stake (refer to Chapter 11). |
Divisions 138 and 139 only apply where there are 2 companies under 100% common ownership (whether because of interests held in the same proportions or 100% grouping).
Division 140 requires there to be a controller of the company at some stage during the value shifting scheme. |
| Gains in relation to an interest in an entity will sometimes be realised at the time of a decrease in value of the interest under a direct value shift.
Gains may arise where value is shifted between interests of different owners, or from post-CGT to pre-CGT interests on capital account of the same owner, or between interests with a different tax character of the same owner (e.g. from a trading stock interest to an interest on capital account). A direct value shift involving the creation of a right out of a non-depreciating asset may result in an increased gain or reduced loss upon realisation of the non-depreciating underlying asset. Gains and losses will not be triggered in respect of an indirect value shift, but realised losses on affected interests in the losing entity or gains on affected interests in the gaining entity may be adjusted, or adjustments to adjustable values (e.g. cost bases and reduced cost bases) of these interests may be made just before the time of the value shift to address the effect of it. Unlike adjustments under current Divisions 138 and 139, IVS reductions to adjustable values may be made on a loss-focused basis, that is, only if the value shift would have led to the interest realising a loss if it was disposed of at the time of the value shift. |
Capital gains may arise under Division 140 in the case of:
Gains and losses are not triggered under Division 138 or 139, there are only cost base and reduced cost base adjustments. |
| Losses cannot be made on a value shifting arrangement. | Losses cannot be made on a value shifting arrangement. |
| Entities that are eligible to be in the STS or have (with affiliated and connected entities) net assets that would not exceed the $5 million small business CGT maximum net asset value threshold are excluded from having to make adjustments under the IVS rules. | There are no excluded entities. |
| The GVSR include
de minimis
exceptions for:
|
Division 140 contains a
de minimis
exception of 5% in respect of a particular interest or $100,000 in respect of the entire scheme.
Divisions 138 and 139 do not have any de minimis exceptions. |
Detailed explanation of new law
Direct value shifting - involving interests in companies or trusts
7.14 DVS rules apply to arrangements where value is shifted from an equity or loan interest held directly in a company or trust, such that an existing direct interest in the same company or trust increases in market value. Alternatively, a new interest in the company or trust can be issued at a discount to market value which devalues other interests in the entity. [Schedule 15, item 1, section 725-145]
7.15 The decrease must be reasonably attributable to some thing or things done under a scheme. The required nexus between the thing or things done and the decrease in value is a lower standard than direct causation. Things done that would satisfy this nexus include a company proposing to buy-back shares in it, or a variation of rights that attach to an interest in an entity. [Schedule 15, item 1, paragraph 725-145(1)(b)]
7.16 DVS rules may apply even if the parties involved deal at arms length, or the thing done is done for market value consideration. This is because the essence of a direct value shift is that it involves a disposal of economic value, without a legal disposal, at least where value passes between different persons.
7.17 The DVS rules deal with the shifting of value out of equity or loan interests (interests) in a single company or trust, usually to other interests which correspondingly increase in value in the company or trust. [Schedule 15, item 1, section 725-160]
7.18 The DVS rules do not apply to all companies and trusts and they do not apply to all interest holders. Essentially, there is a control requirement (affecting controllers and their associates) and where this is satisfied any active participants may also be affected (but only for closely-held entities). [Schedule 15, item 1, sections 725-55, 725-80 and 725-85]
What are the consequences of a direct value shift?
7.19 A direct value shift can result in the happening of a taxing event and adjustments to adjustable values (e.g. cost bases), or simply in adjustments to such values. [Schedule 15, item 1, Subdivisions 725-C to E]
7.20 The precise consequences of a direct value shift will depend upon whether the interests affected by value shifting:
- •
- have increased or decreased in value (or been issued at a discount to market value);
- •
- are held on capital account, and then whether pre-CGT or post-CGT assets;
- •
- are held as revenue assets;
- •
- are held as trading stock; and/or
- •
- could have, prior to the value shift, realised a gain or loss for income tax purposes.
7.21 Where a shift has the same economic effect as a part disposal of an asset to another person (e.g. a transfer of value to an associate), it is broadly treated as if it were a part disposal, allocating a proportionate part of the interests adjustable value (e.g. cost base) to the value shifted to be compared against the amount of value shifted (equivalent to a disposal price).
7.22 The shift can give rise to a taxing event, and adjustments to adjustable values occur in relation to interests that decrease in value and increase in value to ensure that inappropriate outcomes do not arise on their ultimate realisation.
7.23 In all but one case, where the shift occurs between interests of the same tax character owned by the same person, the relationship of adjustable value to market value is realigned to prevent opportunities for crystallising losses or reduced gains on devalued interests but deferring gains or reduced losses on interests that have increased in value. This is done by adjusting the adjustable values of the affected decreased and increased value interests.
7.24 If the shift is from post-CGT to pre-CGT interests (that are not trading stock or revenue assets) of the same person, or between a persons interests of different tax character (i.e. capital account, revenue account or trading stock), a taxing event as well as realignment of adjustable value may occur.
7.25 There is no taxing event allowing a loss on a direct value shift.
Example 7.1
Lee owns all one million A class shares in company Wolf Pty Ltd, which have a market value of $20 each, and Yorgie owns one million B class shares in the same company, which have a market value of $10 each.
Lee and Yorgie agree to vary the rights attaching to both classes of shares, resulting in the market value of the A class shares decreasing by $10 each and the market value of the B class shares increasing, also by $10 each.
The total market value of Lees A class shares has fallen by $10 million and the total market value of Yorgies B class shares has increased correspondingly by $10 million. Thus, there has been a direct value shift from Lee to Yorgie of $10 million.
This has the same economic effect as if Lee disposed of half of his shareholding to Yorgie. Assuming the total cost base for all Lees shares is $5 million, Lee makes capital gains of $7.5 million and his total cost bases for the A class shares is reduced to $2.5 million.
Yorgie must make cost base uplifts to avoid double taxation. Assuming his shares had cost bases of $4 million his cost bases in total are increased to $14 million.
Direct value shifting - creation of rights out of, or over, a non-depreciating underlying asset
7.26 The DVS rules can also apply where value is shifted:
- •
- from a non-depreciating asset (the underlying asset) owned by any entity;
- •
- to an asset (a newly created right) held by an associate;
- •
- by the creation of that right for less than market value, where the market value of the right exceeds the consideration recognised for tax purposes by more than $50,000; and
- •
- the underlying asset is realised (in full or in part) by the entity that created the right (or an entity that acquired the underlying asset under a CGT roll-over) at a loss attributable at least in part to the right (or the underlying asset is rolled over and the loss could be obtained on realisation of replacement interests).
[Schedule 15, item 1, sections 723-10 and 723-15]
7.27 Broadly, the loss realised by the entity is denied to the extent it is attributable to the right (and comparable adjustments are made to ensure that the loss cannot be realised on replacement interests if the underlying asset has been rolled over). [Schedule 15, item 1, sections 723-10 and 723-15]
Example 7.2
Fry Co owns land with a reduced cost base of $40 million and a market value of $45 million. Fry Co grants a 6 year lease to Jones Trust, an associate, for no premium and no rental is to be paid under the lease. The market value of the land decreases by $10 million to $35 million as a result of the creation of this right.
Fry Co then disposes of its reversionary interest in the land to a third party in an arms length dealing for $35 million.
This ensures Fry Co and its associate retain rent free use of the land for the 6 years, and that a capital loss of $5 million would but for the DVS rule be realised. However, economically, no loss has been suffered.
This DVS rule denies Fry Co the $5 million capital loss.
If Fry Co did not sell the land until after the 6 year period had expired, there would be no reduction to any capital loss made on its realisation because the right no longer affects its market value.
7.28 Division 723 can apply where the underlying asset is dealt with on capital account, or is an item of trading stock or a revenue asset. There are special rules to reduce or remove the impact of the Division where the right has been realised and a capital gain or assessable income accrues to an associate. There are also special rules to deal with situations where the underlying asset is rolled over, including where replacement interests for a roll-over are involved.
7.29 IVS rules deal with the consequential effects on the values of interests that are held directly or indirectly in entities involved in a non-arms length dealing, for example, transferring an asset, or providing services at under or over value.
7.30 An indirect value shift occurs if:
- •
- economic benefits are provided by one entity to another (whether or not it receives anything in return) in connection with a scheme;
- •
- the entities are not dealing at arms length;
- •
- the market value of the benefits received is not equal to the market value of the benefits provided, such that there is a losing entity and a gaining entity;
- •
- the losing entity must be either a company or a trust (except certain superannuation entities); and
- •
- the gaining entity can be any kind of entity.
[Schedule 15, item 1, sections 727-100 and 727-150]
7.31 The IVS rules are not attracted if parties deal at arms length, or where economic benefits are exchanged for market value [Schedule 15, item 1, paragraph 727-100(b) and subsection 727-150(3)] . The transfer of assets at market value will not affect the value of the entities involved, nor will it affect the value of interests in those entities. Certain events that may not strictly amount to a provision of economic benefits by one entity to another (e.g. something that constitutes a direct value shift) may be captured by the IVS rules.
7.32 The losing and gaining entities need not be a party to the scheme [Schedule 15, item 1, subsection 727-150(5)] . A party to the scheme is an entity that participates in the entering into or carrying out of the scheme. Whether or not an entity is a party to the scheme is not relevant to how the measures operate.
Example 7.3
Down Co transfers an asset with a market value of $300,000 to the Up Trust in return for a single cash payment of $100,000, in a non-arms length dealing.
Ming owns all of the shares in Down Co and all the interests in Up Trust. As a consequence, the market value of Mings shares in Down Co has declined by $200,000 and the market value of her interests in Up Trust has increased by $200,000.
There has been an indirect value shift of $200,000 from Mings shares in Down Co to her interests in Up Trust.
7.33 The IVS rules do not operate on the primary value shift arising from the non-arms length dealing. That is, the IVS rules do not adjust the quantum of the benefits for tax purposes generally (i.e. they do not adjust assessable income or deductions in respect of the provision or receipt of those benefits). However, they do address the consequential or indirect effects of the value shift upon:
- •
- the value of interests held in the losing entity and the gaining entity; and
- •
- the value of direct and indirect interests held in entities that own interests in the losing entity and gaining entity.
[Schedule 15, item 1, Subdivisions 727-F to H]
7.34 They do not deem any taxing point to arise at the time of the shift. Rather they may adjust (directly) a loss or gain on realisation of an affected interest under the realisation time method or, where a choice is made, certain adjustable values of the interest (e.g. CGT cost base) may be adjusted as at the time of the shift itself (which will ultimately affect the outcomes on realisation of the interests) under the AVM.
7.35 While the realisation time method allows entities to disregard the effect of an indirect value shift unless an interest in the losing entity is realised at a loss, reductions of gains for interests in the gaining entity are, broadly speaking, limited to the amount of realised losses reduced under this method. It does not apply to cases where the value shift means that losses that would otherwise be made on interests in the gaining entity are reduced. [Schedule 15, item 1, Subdivision 727-G]
7.36 Because the realisation time method can limit relief for interests realised in the gaining entity, a choice may be made to make adjustments to the adjustable values of interests in both the losing and gaining entity as at the time of the value shift. The adjustments to interests in the losing entity may be made on a loss-focused basis, that is, only making a reduction to the extent that the shift would have resulted in a loss on the interest if it were realised at the time of the shift, with increases to the adjustable values of interests in the gaining entity broadly limited by reductions. Greater uplifts may be obtained in certain circumstances if the reductions are not loss-focused so this method may also be chosen.
7.37 Generally, a choice cannot be made to use an adjustable value adjustment approach after the time for lodging a tax return for the year in which any interest in the losing entity or gaining entity is first realised. [Schedule 15, item 1, Subdivision 727-H]
Example 7.4
A Co, B Co, C Co and D Co all have the same ultimate controller. In a non-arms length dealing, C Co sells an asset with a market value of $10 million to D Co for $5 million. There has been a shift of $5 million from C Co to D Co.
The IVS rules do not have any effect on the transaction between D Co (gaining entity) or C Co (losing entity).
But they may impact on tax consequences for interests held directly or indirectly in D Co and C Co.
No adjustment need be made using the realisation time method unless an interest in the losing entity (C Co) is realised at a loss. If that happens, for example, if B Co sells its interest in C Co, the loss it would otherwise have made of $5 million is reduced to nil to take account of the effect of the value shift.
Similarly, if A Co then sells its interest in D Co for a gain that is $5 million more than it would otherwise have made but for the value shift, the gain may be reduced by an amount of $5 million.
But if A Co sells its interest in D Co first, no realised losses would have been denied, and no relief would be available for the realisation of D Co.
Thus, a choice may be made to make a full set of adjustable value adjustments in respect of interests in both the losing and gaining entity immediately before the time of the indirect value shift.
As previously noted, the adjustments may be done using a loss-focused approach, or may be done using a non-loss focused approach, if considered advantageous by the entity making the choice.
For example, the loss-focused approach would reduce the values for tax purposes of A Cos interest in B Co by $5 million, and B Cos interest in C Co also by $5 million as at the time of the value shift, and correspondingly increase the adjustable value of A Cos interest in D Co by $5 million (assuming it remains reflected in its value when realised).
If, however, the value of C Co was still $10 million (rather than $5 million) after the shift, then no reductions would be made under the loss-focused approach for direct and indirect interests in C Co and no uplifts would be available for the interests in D Co.
A choice to use a non-loss focussed approach would result in reductions of $5 million in relation to the direct and indirect interests in C Co, in order to obtain up to a $5 million increase for the interests in D Co.
Which entities are affected by IVS?
7.38 Indirect value shifts will only have consequences for affected owners. Affected owners can arise in the following situations:
- •
- the losing and gaining entities have the same ultimate controller;
- •
- if the entities are closely-held, they have 80% common-owners; or
- •
- at least one of the above tests is met and there is at least one active participant in the scheme and the entities are closely-held.
[Schedule 15, item 1, section 727-530]
7.39 The IVS rules do not tax gains or allow losses because of the value shift between the losing and gaining entities, but they may require adjustments to adjustable values (both up and down) to account for the value shifted, or reductions to realised losses or gains. This ensures no inappropriate tax outcomes if, for example, some interests are sold before others.
7.40 An indirect value shift has no consequences if:
- •
- it is not greater than $50,000 [Schedule 15, item 1, section 727-215] ;
- •
- services are provided for at least their direct cost or no more than a commercially realistic price [Schedule 15, item 1, sections 727-230 and 727-235] ;
- •
- in many cases, an asset is transferred for at least its cost [Schedule 15, item 1, section 727-220] ;
- •
- it consists of a distribution [Schedule 15, item 1, section 727-250] ; or
- •
- in most cases, if value is shifted down a wholly-owned chain of entities [Schedule 15, item 1, section 727-260] .
7.41 Some specific exclusions apply if the realisation time method is applied to make the IVS adjustments. These include most value shifts which principally involve services, unless certain criteria are satisfied (e.g. the shifts have to be significant in dollar terms and meet set criteria). It is also not necessary to adjust for a value shift that happened more than 4 years before realisation of an interest, if the shift is less than $500,000. [Schedule 15, item 1, section 727-700 and paragraph 727-610(2)(d)]
7.42 Entities that are eligible to be in the STS, or would satisfy the $5 million maximum net asset value threshold for the CGT small business concessions, are not required to make adjustments under the IVS rules. [Schedule 15, item 1, subsections 727-470(2) and (3)]
Interaction between the direct value shift and indirect value shift
7.43 Although the DVS and IVS rules have different operative elements, it is possible for one set of facts to potentially attract both sets of value shifting measures. In these cases, the DVS rules take precedence. [Schedule 15, item 1, Subdivision 722-L]
Example 7.5: Interaction of DVS (interests) with IVS
Controller Co causes Plato Co to issue redeemable preference shares with a face value and market value of $200,000 to Aristotle Co who pays $40,000. This is a direct value shift under Division 725. Controller Co owns the interests that decrease in value.
This also gives rise to an indirect value shift under Division 727. Plato Co (losing entity) provides economic benefits with a greater market value than what he receives from Aristotle Co (gaining entity). The IVS rules will not apply to Controller Co or Aristotle Cos interests in Plato Co.
7.44 Other circumstances may arise where it is appropriate for both the DVS and IVS rules to be triggered.
Example 7.6: Interaction of DVS (rights) and IVS
An entity may create rights in an associate in respect of a non-depreciating asset which causes an IVS to occur.
Assume that Down Co and Up Co have the same ultimate controller. Owner Co creates a right over land that it owns in favour of Right Co, an associate, for no consideration. This results in a decrease in the market value of land. Owner Co then sells the land to an arms length party at its (now reduced) market value for a loss.
Under the DVS created rights rule, Owner Cos loss may be reduced. Under the IVS rules, the creation of the right is the one-sided provision of an economic benefit from Owner Co to Right Co in a non-arms length dealing. As Down Co and Up Co have the same ultimate controller, the IVS rules will apply. Down Co and Up Cos respective cost bases in Owner Co and Right Co may need to be adjusted (as well as cost bases of interests held in Down Co and Up Co by their members) unless the realisation time method is used.
This demonstrates how consequences under both DVS and IVS rules might be triggered by the same events.
| Feature | DVS - interests in companies and trusts | DVS - creating a right | IVS |
|---|---|---|---|
| Where are the rules located? | Division 725. | Division 723. | Division 727. |
| Consequences | There are 2 types of consequences:
|
Loss denied or reduced upon realisation or part realisation of the underlying non-depreciating asset (underlying asset). There may also be consequences for replacement interests if the underlying asset has been rolled over. | Under the realisation time approach, reductions to realised losses for interests in the losing entity and reductions to gains for interests in the gaining entity. The quantum of adjustments for interests in the gaining entity are linked to adjustments in the losing entity.
Under the optional adjustable value approach, adjustments to the adjustable values of interests in the losing entity and the gaining entity as at the time of the value shift. A loss-focused or non-loss focused approach may be used. |
| What sort of value shift is within the scope of the GVSR? | Interests in a company or trust that decrease in value because of something done under a scheme.
There must be a corresponding increase in market value of another interest in that company or trust, or an interest issued at undervalue. |
Where a right is created in an associate over an underlying asset and a decrease in the market value of that asset is attributable at least in part to the existence of the right. . | Where entities enter into unequal arrangements (by not dealing at arms length), which consequently impact upon the values of interests held directly or indirectly in those entities. |
| Are there any arrangements excluded or safe-harbours provided? | Issue of new interests at market value.
Share buy-backs at less than market value to which Division 16K of the ITAA 1936 applies - but uplifts may be available as if reductions occurred under DVS. There are special rules for neutral value shifts, value shifts that reverse and bonus issues. |
Rights created for full market value consideration. Rights created that effect a part realisation of the underlying asset. Rights created upon death. Rights created that are conservation covenants. | General exclusions and safe-harbours (realisation time method or AVM).
Exclusions and safe-harbours only for realisation time method.
|
| Are there de minimis rules? | DVS of less than $150,000 for the entire scheme. | Yes, where the shortfall on creating the right (i.e. the excess of the market value of the right over the amount recognised for tax purposes) is $50,000 or less. | Yes, where indirect value shift is $50,000 or less. |
| What types of assets can be subject to a value shift? | Interests in a company or trust, consisting of equity or loans (including options or rights to acquire).
Interests may be held on capital account, revenue account or as trading stock. |
Any asset, other than a depreciating asset.
Asset may be held on capital account, revenue account or as trading stock. |
Interests in a company or trust, consisting of equity or loans (including options or rights to acquire).
These interests can be held on capital account, revenue account or as trading stock. |
| Who are affected owners? | Entities that own equity or loan interests in the target entity and:
|
An entity that created the right and realises the underlying asset, or an entity thatacquires the underlying asset under a roll-over, provided that the right is held by an associate of that entity when it realises the underlying asset. An entity that holds replacement interests where the underlying asset has been rolled over (or replacement interests for a roll-over of those replacement interests) may be affected. | Entities that own equity or loan interests in the losing or gaining entity and:
|
| Entities excluded from making adjustments | Nil. | Nil. | Interest holders that are eligible to be STS taxpayers or who satisfy the small business CGT maximum net asset value threshold ($5 million or less net assets). |
| Can the GVSR apply within a consolidated group? | No. | No. | No. |