Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 4 - Additional part-year rules
Outline of chapter
4.1 This chapter explains how amounts of income and deductions are divided between a head company and a subsidiary member that is only in the consolidated group for part of a year if the law attributes the income or deduction to a period rather than to a particular moment.
Context of reform
4.2 The existing provisions that split income and deductions between an entity that joins or leaves a consolidated group part-way through an income year and the groups head company only deal with amounts that are brought to account at a single moment (e.g. when they are derived or incurred). They do not deal with amounts that are brought to account over a period. The amendments address those period cases.
Summary of new law
4.3 The amendments apportion, between an entity and the head company of a consolidated group it joins or leaves in the year, the entitys assessable income and deductions that would normally be brought to account over several income years.
4.4 They do the same for the entitys immediately deductible capital expenditure and for its share of amounts from a partnership or trust in which it is a partner or beneficiary.
4.5 The apportionment divides the amounts between the entity and the groups head company according to how long in the year the entity was in the group.
4.6 The amendments also annualise amounts that an entity needs to count for its own part-year assessment to see if it has met the thresholds that trigger particular income tax provisions.
| New law | Current law |
|---|---|
| Amounts of an entitys assessable income and deductions that are spread over more than one income year are split between the entity and the head company of a consolidated group that it joins or leaves in the year. The split is based on how much of the year the entity spent in the group. | No equivalent. |
| Amounts of capital expenditure that are fully deductible in a single income year are also split between the entity and the head company on the same basis. | No equivalent. |
| An entitys share of a partnership loss, or of net income of a partnership or trust, is divided in a different way. In those cases, what is split between the entity and its head company are the underlying amounts of income and deductions that make up the net income or loss, rather than the net income or loss itself. Again, the split is based on how much of the year the entity spent in the group. | No equivalent. |
| Sometimes, an entity has to compare an amount to a threshold to see if particular income tax provisions are triggered. An entity with only a partial income year (because it joined or left a consolidated group) must first gross-up that amount to an annual figure. | No equivalent. |
Detailed explanation of new law
4.7 The existing provisions in section 701-30 of the May Consolidation Act work out the assessable income and deductions of an entity for the part of a year before it joins, or after it leaves a consolidated group (a non-membership period) as if that period were an income year of the entity. So, if the entity received dividends, for example, it would only bring to account those dividends that it received in a non-membership period. Those received while it was in a consolidated group would be brought to account by the head company instead.
4.8 However, those existing provisions do not deal with amounts that the law brings to account over a period. For example, if an entity is deducting a prepaid amount over 2 years, the provisions do not deal with what happens if the entity joins a consolidated group in the second of those years. The amendments are designed to address such cases.
4.9 The main amendments divide such spread amounts between the entity that has joined or left a consolidated group and the groups head company. This is done for 4 particular cases:
- •
- assessable income brought to account over 2 or more years;
- •
- deductions spread over 2 or more years;
- •
- capital expenditure that is made deductible in a single year; and
- •
- shares of the net income or loss of a partnership or trust.
4.10 Each of those cases deals with an amount that belongs to a period rather than just to a moment within a period.
4.11 The assessable income rule applies if an entity joins or leaves a consolidated group in an income year and some part of an amount of assessable income that is spread over 2 or more income years would have been assessable in the year:
- •
- to the entity , if it had not been in the group in that year; and
- •
- to the head company of the group, if the entity had been in the group for the whole year.
[Schedule 1, item 3, subsections 716-15(1), (2) and (4)]
4.12 If the rule applies, the part of the amount that would have been assessable in the year is divided between the entity and the head company. The entity would include this fraction of it in its assessable income:
days in both the entitys non-membership period
and
the spreading period / days in both the income year
and
the spreading period
[Schedule 1, item 3, subsection 716-15(5)]
4.13 The head company would include this fraction in its assessable income:
days in both the income year
and
the spreading period
and
on which the entity was in the group / days in both the income year
and
the spreading period
[Schedule 1, item 3, subsection 716-15(3)]
4.14 The spreading period is the period used to work out how the full amount is spread over the 2 or more income years [Schedule 1, item 3, subsection 716-15(6)] . For example, a taxpayer who elects (under section 385-105 of the ITAA 1997) to spread over 5 years the tax profit on disposal of diseased cattle, would have a spreading period from receipt of the proceeds of disposal until the end of the fourth later year.
4.15 Together, the entity and the head company would return as assessable income the whole part of the spread amount that falls into the income year.
Example 4.1: Spread insurance receipts
Fresian Ltd operates a cattle stud. In year 1, it loses some calves to attacks by wild dogs and, on 1 December, derives a right to a $30,000 insurance receipt. It elects (under section 385-130 of the ITAA 1997) to return only 20% ($6,000) of that in year 1, and a further 20% in each of the next 4 years.
On 1 May of year 1, Fresian joins the Charolet consolidated group. Because the insurance receipt is being returned as assessable income over more than one income year, the spreading rules will apply to split the $6,000 between Fresian and Charolet.
The part of the spreading period in year 1 is the 212 days from the derivation of the insurance receipt until the end of the year. Fresians non-membership period is the 304 days from the start of the year until 30 April. The period that is common to both is the 151 days from 1 December until 30 April. So, Fresian will include $4,273.58 in its assessable income for year 1:
$6,000 * (151 / 212) + $4,273.58
Fresian will have spent 61 days of year 1 in the Charolet group and all of that would have fallen into the spreading period. Therefore, Charolet will include $1,726.42 in its assessable income for year 1:
$6,000 * (61 / 212) = $1,726.42
Between them, they will include the whole:
$4,273.58 + $1,726.42 = $6,000
4.16 The spread deductions rule works in much the same way as the income rule. It applies if an entity joins or leaves a consolidated group in an income year and some part of a deductible amount that is spread over 2 or more income years would have been deductible in the year:
- •
- to the entity , if it had not been in the group in that year; and
- •
- to the head company of the group, if the entity had been in the group for the whole year.
[Schedule 1, item 3, subsections 716-25(1), (3) and (5)]
4.17 The part of the deductible amount that falls into the income year would be divided between the entity and the head company using exactly the same fractions that were used in the income case [Schedule 1, item 3, subsections 716-25(4) and (6)] . Together, the entity and the head company would claim the whole part of the deductible amount that falls into that income year.
4.18 The spreading period is the period used to work out how the full amount is spread over the 2 or more income years. [Schedule 1, item 3, subsection 716-25(7)]
Example 4.2: Prepayments
Continuing the previous example, Fresian incurred $5,000 on 1 January in year 1 for regular cattle market analyses for 2 years. The prepayments rules would allow only $1,240 of that to be deducted in year 1. Because the prepayment is being deducted over more than one income year, the spreading rules will apply to split that $1,240 deduction between Fresian and Charolet.
In this case, the part of the spreading period that falls into year 1 runs from 1 January until the end of the year (181 days). 120 days are in both the spreading period and Fresians non-membership period. So, Fresian will deduct $3,314.92 in year 1:
$5,000 * (120 / 181) = $3,314.92
Charolet will deduct $1,685.08:
$5,000 * (61 / 181) = $1,685.08
Between them, they will deduct the full:
$3,314.92 + $1,685.08 = $5,000
4.19 Deductions for depreciation are not covered by the spreading rule for deductions. It would not be appropriate to calculate a single deductible amount for depreciation to spread evenly across the year because the tax cost of depreciating assets is reset when an entity joins a consolidated group. The resetting means that the daily depreciation before the joining time can be different to that afterwards. [Schedule 1, item 3, subsection 716-25(2)]
4.20 Since depreciation is excluded from the spreading rule for deductions, the head company and the joining (or leaving) entity will instead each work out their own depreciation deduction for the part of the year that the asset is theirs.
4.21 Capital expenditure is not normally deductible unless a particular provision makes it so. The provisions that do that (e.g. depreciation) usually allow deductions to be claimed over a period that approximates the consumption of benefits from the expenditure (e.g. depreciation is claimed over an assets effective life as its value declines).
4.22 However, a few provisions allow an amount of capital expenditure to be fully deducted in a single income year, even though the expenditures benefits will be consumed over a longer period (e.g. expenditure on a landcare operation on primary production land - see Subdivision 40-G of the ITAA 1997). These provisions serve particular policy objectives (usually to encourage certain activities). Even though such expenditure might be incurred or paid at a single moment, the deduction represents the consumption of benefits over a longer period, so it is appropriate that it be attributed evenly to the year into which that period is compressed.
4.23 The rule for one-year capital expenditure works in much the same way as the spread deductions rule. It applies if an entity joins or leaves a consolidated group in an income year and the whole of an amount of capital expenditure would have been deductible in the year:
- •
- to the entity , if it had not been in the group in that year; and
- •
- to the head company of the group, if the entity had been in the group for the whole year.
[Schedule 1, item 3, subsections 716-70(1), (2) and (4)]
4.24 The deduction for the capital expenditure would be divided between the entity and the head company using essentially the same fractions that were used in the income case. [Schedule 1, item 3, subsections 716-70(3) and (5)]
4.25 In this case, the spreading period used in applying those fractions is the period from the time that an entity would become entitled to deduct the amount until the end of that income year. [Schedule 1, item 3, subsection 716-70(6)]
4.26 Together, the entity and the head company would deduct the full amount of the deductible capital expenditure.
4.27 The amendments deal specifically with cases where a partner in a partnership, or a beneficiary in a trust, is a subsidiary member of a consolidated group for only part of a year. They do not deal with cases where the partnership or trust itself joins or leaves a consolidated group. In those cases, the part-year rules would apply to the partnership or trust in the same way that they apply to any other entity that joins or leaves a consolidated group. [Schedule 1, item 3, section 716-75]
4.28 A share of the net income of a trust, or the net income or loss of a partnership, will usually attach to a partner or beneficiary at a single moment (usually the end of the year). However, like the one-year capital expenditure case, that amount is really attributable to the entire year rather than to that single moment, so should be apportioned between the partner or beneficiary and the head company.
4.29 That apportionment could have been done on a simple daily basis but that would not necessarily be appropriate. For example, a partnership might deduct an amount for interest paid when the partner was outside the consolidated group. A daily apportionment would distribute some of the benefit of that interest expense to the head company, even though it was incurred before the partner joined the consolidated group.
4.30 To deal with such issues, the amendments attribute the partners or beneficiarys shares of the underlying partnership or trust income and deductions:
- •
- for each non-membership period - to the partner or beneficiary; and
- •
- for each period when the partner or beneficiary was in a consolidated group - to the groups head company.
4.31 Working out of the result for particular periods like this, by referring to the underlying partnership or trust amounts, is intentionally like the way partnership cases are dealt with in the current-year loss rules in Division 165 of the ITAA 1997 (for partners that are companies) and Division 268 of Schedule 2F to the ITAA 1936 (for partners that are trusts).
Details of the mechanism - the partner or beneficiary
4.32 The rules dividing partnership and trust amounts only apply if, in the absence of consolidation, an entity would have included a share of the net income of a partnership or trust in its assessable income for an income year, or deducted a share of the net loss of a partnership. [Schedule 1, item 3, section 716-75]
4.33 If that entity was in a consolidated group for only part of the year, it will return as assessable income its share of :
- •
- the partnerships or trusts assessable income that is reasonably attributable to a non-membership period of the entity; and
- •
- the non-membership periods percentage (worked out on a daily basis) of any assessable income of the partnership or trust that cant reasonably be attributed to a particular period in the year.
[Schedule 1, item 3, subsections 716-85(1) and (3) and section 716-100]
4.34 The entitys share of the assessable income (and deductions) of a partnership or trust is a percentage that equals:
- •
- its percentage interest in the partnerships net income or loss; or
- •
- the percentage of the trusts income to which it is presently entitled.
[Schedule 1, item 3, section 716-90]
Example 4.3: Subsidiarys share of trust income
Lumosure Tiles Pty Ltd is a 50% beneficiary of a fixed trust. On 1 November in year 1, Lumosure is bought by the Hotel Bathrooms consolidated group and becomes a subsidiary member. The trust is not a member of the group.
At the end of year 1, the trust works out its net income as $2.5 million, of which Lumosures share is $1.25 million. The trusts net income is made up this way:
Assessable income Deductions Totals 1 Jul to 31 Oct (123 days) 600,000 (125,000) 475,000 1 Nov to 30 Jun (242 days) 2,170,000 (185,000) 1,985,000 Unattributable amounts 60,000 (20,000) 40,000 1 Jul to 30 Jun (365 days) 2,830,000 (330,000) 2,500,000
Since Lumosure is presently entitled to a share of the trusts net income, it would have included that share in its assessable income if it had never joined the group. Therefore, the provisions will apply to split the underlying amounts between Lumosure and Hotel Bathrooms.
Lumosures non-membership period runs from 1 July to 31 October. It will therefore return its 50% share ($300,000) of the trusts assessable income for that period. It will also return a proportion of its share of the $60,000 assessable income that is not attributable to a particular part of the year. That proportion is worked out on a daily basis:
50% * $60,000 * (123 / 365) = $10,109.59
Lumosure will therefore return $310,109.59 as assessable income from the trust for year 1.
4.35 The entity will also deduct its share of :
- •
- the partnerships or trusts deductions that are reasonably attributable to a non-membership period of the entity; and
- •
- the non-membership periods percentage (worked out on a daily basis) of those deductions of the partnership or trust that can not reasonably be attributed to any particular period in the year.
[Schedule 1, item 3, subsections 716-85(2) and (3) and section 716-100]
Example 4.4: Subsidiarys share of trust deductions
Continuing the previous example, Lumosure will deduct its 50% share ($62,500) of the trusts deductions attributable to its non-membership period. It will also deduct a proportion of its share of the $20,000 trust deductions that are not attributable to a particular period in the year. It uses the same apportionment method as it used for assessable income:
%50 * $20,000 * (123 / 365) = $3,369.86
Lumosure will therefore deduct $65,869.86 in relation to the trust for year 1.
4.36 Only income and deductions that would have gone into working out the partnerships or trusts net income or partnership loss if the entity had never been in a consolidated group can be apportioned between the entity and the head company. A reason why amounts might not be counted is that the current year loss rules can prevent part-year losses being deducted if there is a sufficient change of ownership during a year. [Schedule 1, item 3, section 716-95]
Details of the mechanism - the head company
4.37 If the rules apply to apportion part of a partnership or trust amount to a subsidiary that is a partner or beneficiary, they will also apply to apportion the rest of it to the head company of the entitys consolidated group.
4.38 If the entity was in a consolidated group for only part of the year, the head company will bring to account as assessable income the entitys share of :
- •
- the partnerships or trusts assessable income that is reasonably attributable to a period when the entity (but not the partnership or trust) was in the consolidated group; and
- •
- such a periods percentage (worked out on a daily basis) of any assessable income of the partnership or trust that can not reasonably be attributed to a particular period in the year.
[Schedule 1, item 3, paragraph 716-80(1)(a), subsection 716-80(2) and section 716-100]
Example 4.5: Head companys share of trust income
Continuing the previous example, Hotel Bathrooms will return Lumosures share of the assessable income of the trust for the period when Lumosure was in the group (from 1 November to 30 June). That comes to $1,085,000 (50% of $2,170,000). It will also return a proportion of Lumosures share of the $60,000 assessable income that is not attributable to a particular part of the year. That proportion is worked out on a daily basis:
%50 * $60,000 * (242 / 365) = $19,890.41
Hotel Bathrooms will therefore return $1,104,890.41 as assessable income from the trust. Together with Lumosures $310,109.59 a total of $1,415,000 will have been returned. This is exactly equal to Lumosures 50% share of the trusts assessable income for year 1.
4.39 The head company will also deduct the entitys share of :
- •
- the partnerships or trusts deductions that are reasonably attributable to a period when the entity (but not the partnership or trust) was in the consolidated group; and
- •
- such a periods percentage (worked out on a daily basis) of those deductions of the partnership or trust that can not reasonably be attributed to any particular period in the year.
[Schedule 1, item 3, paragraph 716-80(1)(b), subsection 716-80(2) and section 716-100]
Example 4.6: Head companys share of trust deductions
Completing the previous example, Hotel Bathrooms will deduct Lumosures share of the trusts deductions for the period from 1 November to 30 June. That comes to $92,500 (50% of $185,000). It will also return a proportion of Lumosures share of the $20,000 deductions that are not attributable to a particular part of the year. That proportion is worked out on a daily basis:
%50 * $20,000 * (242 / 365) = $6,630.14
Hotel Bathrooms will therefore deduct $99,130.14 in respect of the trust. Together with Lumosures $65,869.86 a total of $165,000 will have been deducted. This is exactly equal to Lumosures 50% share of the trusts $330,000 deductions for year 1.
Relationship between apportionment rules and the current year loss rules
4.40 The existing current year loss rules in Division 165 of the ITAA 1997 apply to companies that experience a 50% change in their ownership or control during an income year. There are similar rules for trusts in Schedule 2F to the ITAA 1936.
4.41 Those current year loss rules separate a year into periods, divided at points where such changes in control occur. Generally, a loss from one of those periods cant be used by the entity to offset income either in other periods or in later years. Those rules cover much the same ground as the apportionment rules in the amendments, so the interaction between them needs to be understood. There are 2 cases; first where the end of a period under the current year loss rules does not coincide with the entity joining a consolidated group and secondly when it does.
End of current year loss period does not coincide with joining time
4.42 The current year loss rules might apply without the apportionment rules in cases where there is a partial acquisition of an entity. For example, an entity might change its ownership or control by more than 50% but not be wholly-owned by a consolidated group. Alternatively, the entity might be acquired by a group of entities that has not yet formed a consolidated group. If the entity joins a consolidated group later in the same year, both the current year loss rules and the apportionment rules could apply in the year to the joining entitys income and deductions.
4.43 In such cases, the apportionment rules in the amendments would apply to distribute amounts between the head company and the joining company. However, the joining entity would apply the current year loss rules to divide its non-membership period into sub-periods and to distribute its income and deduction amounts between them.
End of current year loss period coincides with joining time
4.44 If the current year loss rules and the apportionment rules could both apply at the same point (e.g. if a consolidated group buys 100% of a company at a single moment in the year), there would be potential conflicts between them. However, there are two reasons why that cant occur.
4.45 First, the apportionment rules would be expected to prevail because they are aimed at a specific situation and the current year loss rules are more general (applying to all changes of ownership, not just those arising because of consolidation). With interpretation, one would usually prefer the specific to the general.
4.46 Secondly, and more significantly, the provisions actually dont admit cases where both can relevantly apply at once. This is best illustrated by thinking about the simple case where a group buys a company halfway through the year (although the reasoning applies equally to more complex cases). The companys non-membership period to that point is treated as an income year for the purposes of working out its taxable income (see subsection 701-30(3) of the May Consolidation Act). The current year loss rules wont apply in this case because the only relevant change in the companys ownership or control is at the end of the deemed year when it joins the group (see section 165-35 of the ITAA 1997). The current year loss rules could apply if there is some other change during the deemed year, as discussed in paragraphs 4.42 and 4.43.
4.47 Even if the current year loss rules could apply to this case, a loss made in the companys non-membership period could not be transferred to the head company. Losses can only be transferred if they are made in an income year that ends before the company joins a consolidated group (see paragraph 707-115(1)(b) and subsection 707-405(1) of the May Consolidation Act) and this non-membership period is a deemed income year that ends at the joining time. It follows that, even if the two sets of rules could apply at the same time, they would have no relevant effect.
4.48 Joining or leaving a consolidated group does not affect an entitys income year. So, it is possible for an entity with one income year to join (or leave) a consolidated group that, because of a SAP, has a different income year.
4.49 Such cases can affect the apportionment rules. Rather than extensively detailing how they are to be dealt with, the amendments use a general principles approach. They require amounts to be apportioned between periods in the most appropriate way, having regard to the other apportionment rules and to the objects of the consolidation provisions. In particular, they require apportionment in a way that recognises each item only once for each purpose (e.g. the same amount should not be assessed twice or deducted twice). [Schedule 1, item 3, section 716-800]
4.50 The income tax law contains a number of provisions that permit, or deny, particular treatments on the basis of whether some threshold is met. For example, a company can only claim a deduction for 125% of some R & D expenditure if its aggregate R & D amount for the year is more than $20,000 (e.g. see subsection 73B(14) of the ITAA 1936). Entities that only have partial years because of joining or leaving a consolidated group would obviously find it harder to meet such thresholds.
4.51 The amendments address that problem by annualising the amounts for those partial years. They do that by multiplying the amount from the start of the year to the end of the non-membership period by:
365 / days in that period
[Schedule 1, item 3, section 716-850]
4.52 The amount being annualised may include amounts that arose before the non-membership period but are attributed to the entity by the entry and exit history rules. Counting those amounts as well as the amounts arising in the particular non-membership period reduces the chances that the annualising will distort the result. Indeed, if the non-membership period lasts to the end of the income year, this approach would result in the actual amounts for the year, rather than an annualised figure, being compared to the threshold.
Example 4.7: Qualifying for the 125% R & D deduction
Sturmovik Products Ltd incurs the following non-contracted R & D expenditure over an income year:
4,000 3,000 7,000 8,000 91 days 91 days 92 days 91 days
The unshaded parts are non-membership periods. The shaded parts are periods when Sturmovik is in a consolidated group - the amounts from those periods are attributed to Sturmovik by the exit history rule.
Sturmovik can only claim a 125% deduction for the $3,000 it spent in its first non-membership period if it meets the $20,000 threshold set by subsection 73B(14) of the ITAA 1936. It would annualise the $7,000 for the year to date ($3,000 actual + $4,000 attributed) by multiplying it by 365/182, giving it $14,038. Since that is less than the threshold, it can only claim a 100% deduction for the $3,000.
In its second non-membership period, Sturmovik would annualise its $22,000 for the year to date ($8,000 actual + $14,000 attributed from earlier periods) by 365/365, leaving it with $22,000. As that is above the threshold, it can claim the 125% deduction for the $8,000 expended.
Consequential amendments
4.53 The existing rules work out an entitys taxable income for the part of a year before it joins, or after it leaves, a consolidated group, as if each such part-year were a separate income year. Those rules are amended to make it clear that amounts that go into working out the taxable income must either be exclusively allocated to only one such part-year or apportioned between several part-years (which is the aspect added by the amendments). [Schedule 1, item 1, paragraph 701-30(3)(c)]
4.54 An existing note to the rules for the part-year cases is amended to also cover the effect of the amendments. [Schedule 1, item 2, note to subsection 701-30(3)]
4.55 The dictionary of defined terms to the ITAA 1997 is amended to include a definition of spreading period . The amendment refers readers to the specific provisions in the apportionment rules that define that expression. [Schedule 1, item 4, section 995-1, definition of spreading period]