Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 8 - Technical amendments to consolidation
Outline of chapter
8.1 This chapter explains various technical amendments concerning the losses rules, periods in which taxpayers must notify the Commissioner and the MEC group membership rules.
Context of reform
8.2 In response to suggestions made during the consultation process the following technical amendments have been made:
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- the rectification of technical deficiencies in the consolidation losses rules; and
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- correcting an anomaly in the existing MEC group membership rules that unnecessarily restricts the ability of companies to join an existing consolidated group or MEC group.
Summary of new law
Amendments to the losses rules
Amendments to Subdivision 707-B
8.3 Amendments to Subdivision 707-B of the May Consolidation Act will ensure that the COT operates appropriately in relation to structures where an entity outside the group is interposed between the head company and a subsidiary that has transferred certain losses to the head company.
Ensuring losses cannot leave a consolidated group
8.4 Amendments will also ensure that losses cannot leave a consolidated group with a leaving subsidiary pursuant to the exit history rule.
A head companys use of its own losses may be apportioned in the formation year
8.5 Where a consolidated group forms part way through the head companys income year, the head companys use of its own prior year losses (transferred to itself on consolidation) will be unrestricted in respect of income broadly attributable to the pre-consolidation period. The head companys use of its own losses continues to be subject to their available fraction in respect of income attributable to the post-consolidation period.
Amendments to the MEC group membership rules
8.6 The amendments to the MEC group membership rules will ensure that an eligible tier-1 company acquired by a new foreign parent company is not required to join the same consolidated group or MEC group as other eligible tier-1 companies acquired at that time by the foreign parent except where the foreign parent acquires all of the eligible tier-1 companies in an existing MEC group.
| New law | Current law |
|---|---|
| In determining whether a head company has passed the COT in respect of a COT loss (see paragraph 8.7) transferred to it by another company (the test company), changes to the membership interest or voting power of an entity interposed between the head company and the test company are not taken into account. | In determining whether a head company has passed the COT in respect of a COT loss transferred to it by another company (the test company), changes to the membership interest or voting power of an entity interposed between the head company and the test company are taken into account. |
| Losses cannot leave a consolidated group with a leaving subsidiary. | It could be argued that losses can leave a consolidated group with a leaving subsidiary pursuant to the exit history rule. |
| Where a consolidated group forms part way through the head companys income year, the head companys use of its own losses (transferred to itself) will be unrestricted in respect of income broadly attributable to the pre-consolidation period. | The head companys use of its own transferred losses is subject to their available fraction from the start of the income year in which the group formed. |
| Where a foreign parent company acquires some, but not all, of the eligible tier-1 companies in an existing MEC group, those acquired eligible tier-1 companies will not be required to join the same consolidated group or MEC group. | Where a foreign parent company acquires some, but not all, of the eligible tier-1 companies in an existing MEC group, those eligible tier-1 companies may join another consolidated group or MEC group only if all the acquired companies join the same group. |
Detailed explanation of new law
Amendments to the losses rules
Amendments to Subdivision 707-B
8.7 Subdivision 707-B of the May Consolidation Act includes modifications to the application of the COT in relation to COT losses transferred to the head company of a consolidated group by a joining subsidiary. (COT losses are losses transferred because the COT was passed.) The modifications essentially ensure that anything that happens after the transfer time to membership interests or voting power in a subsidiary member of the group, and that would be relevant in determining whether the joining subsidiary passed the COT, is not taken to have happened. This is consistent with the consolidation single entity principle.
8.8 The provisions in the May Consolidation Act did not deal with cases where there was an entity outside the group (e.g. a non-resident entity) interposed between the head company and the subsidiary that transferred the losses to the head company. Those provisions did not therefore ignore changes in membership or voting power in such an interposed entity. The amendments will ensure that in these cases changes in ownership or voting power of the interposed entity are also effectively ignored for the purposes of applying the COT. [Schedule 6, items 1 and 2]
Ensuring losses cannot leave a consolidated group
8.9 The amendments close off any argument that losses of a consolidated group, either incurred by the group or transferred to the head company when a subsidiary joined the group, could leave the group with a leaving subsidiary pursuant to the exit history rule. Such an outcome would be inconsistent with the policy intent of the consolidation regime which requires that losses remain with the head company of the group. [Schedule 6, item 5, section 707-410]
A head companys use of its own losses may be apportioned in the formation year
8.10 Section 707-335 of the May Consolidation Act will be amended to ensure that a head companys use of its own prior year losses, transferred to itself on formation of the consolidated group, will be unrestricted for the pre-formation period. Their use for the post-formation period will continue to be subject to their available fraction.
8.11 A head companys use of its own prior year losses is subject to their available fraction from the start of the income year in which the group is formed. That is, where a group is formed part way through the head companys income year, the head company does not receive the benefit of the unrestricted use of its own losses for the period from the start of the income year until formation.
8.12 On formation of a consolidated group, losses made by a company (in its capacity as a single entity) for income years prior to the formation year may be transferred to the company (in its capacity as the head company of the group). An available fraction is calculated for the transferred losses which is used to limit their annual rate of use by the group.
8.13 A head company that joins a consolidated group part way through its income year does not work out its taxable income or loss up to the joining time (unlike subsidiary members). Therefore, in the absence of an apportionment rule, the head company would be obliged to apply the available fraction for its own transferred losses to its income and gains for the whole year to determine the amount of the losses it could use that year.
8.14 The available fraction is a proxy for determining the amount of the groups income that can be regarded as having been generated by the transferring loss entity. It is not appropriate for that proxy to be applied in respect of income generated by the head company as a single entity prior to formation of the group. An amendment will therefore be made to section 707-335 of the May Consolidation Act to allow the head company to apportion its use of its own losses in the formation year. Apportionment will be on the basis of the number of days in the pre-formation period. [Schedule 6, items 3 and 4, paragraphs 707-335(1)(a) and 707-335(3)(e)]
8.15 Also, apportioning a head companys use of its own losses in this way better matches the treatment of subsidiary members who can use and transfer their own losses for their non-membership period prior to joining.
8.16 The apportionment rule in section 707-335 of the May Consolidation Act is drafted as a general principle in that if it applies in respect of a transferred loss, the group cannot use more of the loss than is reasonable having regard to the matters listed. This means 2 changes must be made:
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- first, the rule will be amended so that it now applies in any case where a head companys own losses are transferred to itself during the income year
[Schedule 6, item 3, paragraph 707-335(1)(a)]:
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- currently the rule only applies to a head companys own losses transferred to itself during the income year if there is also a subsequent adjustment to the numerical value of their available fraction during the year (e.g. because another loss entity joined the group); and
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- second, the principle in paragraph 707-335(3)(e) will be repealed and another substituted
[Schedule 6, item 4, paragraph 707-335(3)(e)]:
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- the repealed principle ensured that the first available fraction for a head companys own loss bundle applied from the start of the formation income year until the adjustment of the numerical value of the fraction during that year.
8.17 The new principle treats a head companys own losses transferred to itself as being in a bundle with an available fraction of one for the pre-formation period. Giving the losses an available fraction of one ensures that their use is unrestricted for the pre-formation period.
8.18 The other principles set out in section 707-335 are also relevant. For a more detailed discussion of the other principles, see paragraph 8.46 of the explanatory memorandum relating to the May Consolidation Act.
Example 8.1
A group forms on day 101 of its head companys income year.
A $700 prior year tax loss is transferred from the head company to itself. The available fraction for the loss is taken to be one before the group forms. After formation, the available fraction works out to be 0.300.
For that income year, the head company has income of $600 (and no deductions). The maximum amount of the loss that the head company can use for the year may be worked out like this:
Period prior to consolidation
$600 * (100 / 365) * 1 = $164
Period after consolidation
$600 * (265 / 365) * 0.300 = $131
The maximum amount of tax losses the head company can use from its bundle for the income year is $295 ($164 + $131).
Amendments to the MEC group membership rules
8.19 Where a company becomes an eligible tier-1 company in relation to a top company from which an existing MEC group (the first MEC group ) has formed, the provisional head company of the group may specify in a notice to the Commissioner that it wishes the company to join the group as a new eligible tier-1 company member. Similar rules also apply where the company becomes an eligible tier-1 company in relation to a top company which wholly-owns the head company of a consolidated group. In these instances, the head company may specify in a notice to the Commissioner that a MEC group (also referred to as the first MEC group ) is to come into existence with both companies as original eligible tier-1 company members of the group.
8.20 Rules currently apply to ensure certain companies must be specified in the notice to the Commissioner if at least one of the companies specified was a member of another MEC group (the second MEC group ) immediately before the time it became an eligible tier-1 company of the top company. In these circumstances, each eligible tier-1 company of the second MEC group that became an eligible tier-1 company of the top company of the first MEC group must be specified in the notice for the notification to take effect.
8.21 Whilst this rule is appropriate where all of the eligible tier-1 companies in the second MEC group are acquired by the top company of the first MEC group, it is unnecessarily restrictive where only some of those companies are acquired by the top company of the first MEC group. In those instances, as the eligible tier-1 companies have exited the second MEC group as a result of their acquisition by the top company, those companies should be treated in the same manner as any other company acquired by the top company who was not previously a member of a MEC group.
8.22 The rule discussed in paragraph 8.20 will now be restricted in its operation to the circumstances where all of the eligible tier-1 companies in the second MEC group are acquired by the top company of the first MEC group [Schedule 8, items 4 and 5, paragraphs 719-5(4)(d) and 719 40(1)(f)]. Restricting the operation of the rule in this manner will continue to ensure consistency with the irrevocability status of the choice to consolidate the second MEC group by ensuring either:
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- the second MEC group continues to exist; or
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- all of the members of the second MEC group become members of the first MEC group.
Application and transitional provisions
Amendments to the MEC group membership rules
8.23 The amendments will apply in relation to notices given under paragraphs 719-5(4)(c) and 719-40(1)(e) irrespective of whether they were given before, at or after the commencement of item 6 of Schedule 8 to this bill. [Schedule 8, item 6]