House of Representatives

Tax Laws Amendment (2010 Measures No. 1) Bill 2010

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 5 Consolidation

Outline of chapter

5.1 Schedule 5 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to:

·
clarify the operation of certain aspects of the consolidation regime; and
·
improve interactions between the consolidation regime and other parts of the law.

Context of amendments

5.2 The consolidation regime applies primarily to a group of Australian resident entities wholly-owned by an Australian resident company that choose to form a consolidated group. Specific rules provide for the membership of certain resident wholly-owned subsidiaries of a foreign holding company (a multiple entry consolidated group (MEC group)).

5.3 Unless otherwise specified, references in this chapter to a consolidated group include a MEC group.

5.4 Following a choice to consolidate, members of a consolidated group are treated as a single entity for income tax purposes. Subsidiary entities lose their individual income tax identity on entry into the group and are treated as part of the head company.

5.5 A number of issues have arisen from the practical operation of the consolidation regime since its introduction in 2002. These amendments respond to those issues by clarifying the operation of certain aspects of the consolidation regime and improving interactions with other parts of the law.

Summary of new law

5.6 Schedule 5 to this Bill amends the consolidation provisions in the income tax law to clarify the operation of certain aspects of the consolidation regime and improve interactions between the consolidation regime and other parts of the law. In particular, the amendments will:

·
ensure that the tax cost that is set for an asset of a joining entity can be used for the purposes of applying other provisions of the income tax law;
·
subject to certain integrity rules, allow consolidated groups to convert to MEC groups, and vice versa, with minimal tax consequences;
·
improve the treatment of pre-capital gains tax (CGT) membership interests held in a joining entity;
·
clarify and improve the operation of various aspects of the tax cost setting rules that apply when an entity joins or leaves a consolidated group;
·
treat units in cash management trusts and certain rights to future income held by a joining entity as retained cost base assets;
·
repeal CGT event L7;
·
reduce the tax cost setting amount of a joining entity that has impaired debts at the joining time;
·
ensure the blackhole expenditure provisions that apply to consolidated groups also apply to MEC groups;
·
ensure that certain consolidation transitional rules apply to the head company of a group which has a substituted accounting period where the group consolidated after 30 June 2003 on a day before the first day of its income year;
·
improve the operation of the inter-entity loss multiplication rules for widely held companies;
·
modify the CGT timing rules where:

-
an entity which holds a CGT asset joins or leaves a consolidated group; and
-
a CGT event happens in relation to the asset which straddles the joining or leaving time;

·
modify the mechanism for making various choices relating to the formation of, or changes to, a consolidated group or MEC group;
·
modify the mechanism for working out the taxable income of consolidated groups that have life insurance company members in respect of intra-group transactions; and
·
modify the tax cost setting rules where an entity that has issued non-membership equity interests joins or leaves a consolidated group.

Comparison of key features of new law and current law

New law Current law
Use of the tax cost setting amount
The head company can use the tax cost setting amount of an asset for the purpose of working out the amount included in assessable income or allowed as a deduction when applying other provisions of the income tax law. The tax cost setting rules set the tax cost setting amounts for assets held by an entity that joins a consolidated group. When a tax consequence arises in relation to an asset for a head company, the tax cost setting amount is intended to be used by the head company to determine those tax consequences. However, for the purposes of applying certain provisions in the income tax law, the head company is unable to use the tax cost setting amount of an asset.
Group restructures
Subject to certain integrity rules, minimal tax consequences will arise for the ongoing members of the group when:

·
a consolidated group converts to a MEC group; or
·
a MEC group converts to a consolidated group.

Significant tax consequences arise for the on-going members of a group when:

·
a consolidated group converts to a MEC group; or
·
a MEC group converts to a consolidated group.

Pre-capital gains tax proportions
The pre-CGT status of membership interests held in a joining entity will be preserved by:

·
working out the proportion of pre-CGT membership interests in the joining entity; and
·
subject to integrity rules, attaching pre-CGT status to an equivalent proportion of membership interests when the entity leaves the group.

When an entity joins a consolidated group its membership interests cease to be recognised for income tax purposes. If the membership interests are pre-CGT assets, this status is preserved by attributing a pre-CGT factor to the underlying assets of the joining entity.
Modifications to the tax cost setting rules of a joining entity
When an entity joins a consolidated group, the amendments will, broadly:

·
ensure adjustments to the allocable cost amount are not double counted;
·
clarify the operation of the adjustment to the allocable cost amount in respect of certain pre-joining time CGT roll-overs that applied to a joining entity's assets; and
·
phase out the over-depreciation adjustment to the allocable cost amount.

Under the tax cost setting rules, the tax costs of a joining entity's assets are generally reset by allocating the joining entity's allocable cost amount to each of the joining entity's assets in proportion to their market value. This allocation process ensures that, broadly, the costs incurred by the head company to acquire the joining entity's membership interests are pushed down into the tax costs of the underlying assets of the joining entity.
The allocable cost amount is basically the sum of the cost bases of the head company's membership interests in the joining entity held by members of the joined group and the joining entity's liabilities. Several adjustments are made to this amount.
Modifications to the tax cost setting rules of a leaving entity
When an entity leaves a consolidated group, the amendments will, broadly:

·
clarify that the liabilities taken into account in working out the old group's allocable cost amount are the liabilities held just before the leaving time; and
·
ensure that an appropriate adjustment is made to the old group's allocable cost amount in respect of a liability when that liability was taken into account in working out the allocable cost amount for an entity that joined the group.

When an entity leaves a consolidated group, the tax costs of the membership interests in the leaving entity needs to be reconstructed.
Under the tax cost setting process that applies when an entity leaves a consolidated group, the old group's allocable cost amount is worked out to determine the tax costs of the membership interests in the leaving entity.
Modifications to the tax cost setting rules of a joining or leaving entity
When an entity joins or leaves a consolidated group, the amendments will, broadly:

·
clarify the accounting principles that apply to determine the accounting liabilities which are recognised under the tax cost setting rules;
·
clarify the scope and amount of the adjustment to the allocable cost amount in respect of inherited deductions; and
·
if the joining or leaving entity is a general insurance company, ensure that the tax cost setting rules apply appropriately to its deferred acquisition costs, deferred reinsurance expenses and recoveries receivable.

Some elements of the tax cost setting rules apply both:

·
when an entity joins a consolidated group; and
·
when an entity leaves a consolidated group.

Retained cost base assets
The range of assets that are treated as retained cost base assets will include:

·
units in cash management trusts held by a joining entity; and
·
certain rights to future income assets held by a joining entity.

Under the tax cost setting rules some assets are treated as retained cost base assets. The tax cost of a retained cost base asset is generally set at an amount that is equal to the joining entity's cost of the asset.
CGT event L7
CGT event L7 will be repealed. CGT event L7 happens when:

·
a liability that was taken into account in working out the allocable cost amount is discharged for a different amount; and
·
the allocable cost amount would have been different if the discharged amount was used at the joining time.

Reduction in the tax cost setting amount that exceeds the market value of certain retained cost base assets
The tax cost setting amount of an impaired debt held by a joining entity will be reduced by the amount of the capital gain arising under CGT event L3 (but not below zero). As a result, the capital gain arising under CGT event L3 will be reduced by an equivalent amount. A capital gain arises under CGT event L3 if the total tax cost setting amounts for all retained cost base assets exceed the joining entity's allocable cost amount.
Impaired debts qualify as retained cost base assets. The tax cost setting amount of impaired debts is the face value of those debts at the joining time.
As the face value of impaired debts is likely to be higher than the amount that could be recovered, the capital gain arising under CGT event L3 is overstated.
Blackhole expenditure for MEC groups
The cost base of a CGT asset held by a MEC group will include certain expenditure paid to a third party in relation to the asset. A capital gain arises if the capital proceeds received by a taxpayer when a CGT event happens to an asset exceed the asset's cost base.
Under the blackhole expenditure provisions, the cost base of a CGT asset held by a consolidated group (but not by a MEC group) includes certain expenditure paid to a third party in relation to the asset.
Transitional concessions for groups with substituted accounting periods
The transitional concession will apply where the head company of a consolidated group has a substituted accounting period and the group consolidated between 1 July 2003 and 30 June 2004 on a day that is on or before the first day of its income year. A transitional concession that allows the allocable cost amount of a joining entity to be increased by the undistributed, untaxed profits accrued to the group before 1 July 2003 applies to:

·
a consolidated group that came into existence before 1 July 2003; or
·
a consolidated group that came into existence between 1 July 2003 and 30 June 2004, provided that it came into existence on the first day of the income year of the head company starting after 30 June 2003.

Loss multiplication rules for widely held companies
A widely held company will not have a relevant equity interest or relevant debt interest in a loss company at a particular time under the inter-entity loss multiplication rules unless an entity has a controlling stake in the loss company and that entity has a direct or indirect interest in, or is owed a debt by, the widely held company in respect of which, broadly:

·
the entity could, if a CGT event happened to the interest or debt, make a capital loss that reflects any part of the loss company's overall loss; or
·
the entity has deducted an amount in respect of the interest or debt, where the deduction reflects any part of the loss company's overall loss.

The inter-entity loss multiplication rules apply to an entity that has a relevant equity interest or relevant debt interest in a loss company at a particular time.
Subject to certain exceptions, an entity has a relevant equity interest or relevant debt interest in a loss company at a particular time if, broadly, the entity has a controlling stake in the loss company and satisfies certain other tests.
Widely held companies have difficulty in satisfying the exceptions to these tests. As a result, in some circumstances the losses of a loss company receive no tax recognition at all.
CGT straddles
When a CGT event straddles the time that an entity joins or leaves a consolidated group, the CGT event will be taken to happen at the time that the circumstances which gave rise to the CGT event occurred - that is, for example, at the time of settlement of the relevant contract. Under the CGT rules, a capital gain or loss arises when a CGT event happens to an asset. A CGT event will usually happen at a time which is different to the time that the capital proceeds are received.
For example, if a contract is entered into for the disposal of a CGT asset, the CGT event happens at the time the contract is entered into (rather than at the time of settlement).
Difficulties arise where the period between the time that the contract is entered into and the time of settlement straddles the period an entity joins or leaves a consolidated group. In these circumstances, the entity that entered into the contract (and makes a capital gain or loss) will be different to the entity that holds the asset at the time of settlement (and receives the capital proceeds).
Choice to consolidate

The choices relating to the formation of, or changes to, a consolidated group or MEC group will need to be made in writing but will not need to be given to the Commissioner of Taxation (Commissioner). However, the head company of the group must still advise the Commissioner of relevant information relating to the choice in writing in the approved form.

·
C>Choices relating to the formation of, or changes to, a consolidated group or MEC group must be made in the approved form which is given to the Commissioner. These are the choices to:
·
consolidate a consolidatable group;
·
consolidate a potential MEC group;
·
consolidate a potential MEC group following a special conversion event;
·
make a new eligible tier-1 company a member of a MEC group; and
·
appoint a new provisional head company to a MEC group.

Difficulties have arisen where a choice has been ineffective because of a technical deficiency in completing the approved form.

Life insurance companies
Intra-group transactions of a consolidated group that has a life insurance company member will be recognised for the purposes of:

·
determining the amount of a head company's complying superannuation/FHSA class income and segregated exempt asset income; and
·
determining the value of the head company's complying superannuation/FHSA asset pool and segregated exempt assets.

Life insurance companies essentially carry on three different types of business:

·
ordinary business - which is taxed at 30 per cent;
·
complying superannuation/FHSA business - which is taxed at 15 per cent; and
·
immediate annuity business - which is non-assessable non-exempt income.

If a life insurance company joins a consolidated group, difficulties arise in identifying the income that relates to each class in respect of intra-group transactions.

Non-membership equity interests

Non-membership equity interests issued by an entity that joins or leaves a consolidated group will be appropriately recognised under the tax cost setting rules.

As a result, the allocable cost amount for a joining entity will be increased to reflect the amount received by the joining entity from the issue of non-membership equity interests.

In addition, when an entity leaves a consolidated group:

·
if the leaving entity has issued non-membership equity interests to entities that are members of the old group, a tax cost will arise for those membership interests; and
·
if the leaving entity has issued non-membership equity interests to entities that are not members of the old group, the old group's allocable cost amount for the leaving entity will be reduced to reflect the amount received by the old group from the issue of the non-membership equity interests.

Non-membership equity interests issued by an entity that joins or leaves a consolidated group are not recognised under the tax cost setting rules.

Consequently, when an entity joins a consolidated group, the allocable cost amount for the joining entity is understated.

When an entity leaves a consolidated group:

·
if the leaving entity has issued non-membership equity interests to entities that are members of the old group, no tax cost arises for those membership interests; and
·
if the leaving entity has issued non-membership equity interests to entities that are not members of the old group, the old group's allocable cost amount for the leaving entity is overstated.

Detailed explanation of new law

Part 1 - Use of the tax cost setting amount

5.7 When an entity joins a consolidated group, the cost of each asset of the joining entity is given a new tax cost setting amount under the tax cost setting rules in Division 705.

5.8 Section 701-55 ensures the new tax cost setting amount for an asset is used by the head company as the basis for applying other provisions in the income tax law. In this regard:

·
subsection 701-55(2) applies to treat the asset as if it were acquired by the head company at the joining time for an amount equal to its tax cost setting amount for the purposes of applying certain depreciating asset provisions;
·
subsection 701-55(3) applies to an asset that is trading stock for the purposes of Division 70 and deems the head company to have held the trading stock from the start of the income year in which the joining time occurs with a value equal to its tax cost setting amount;
·
subsection 701-55(4) applies to an asset that is a qualifying security for the purposes of Division 16E of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) and deems the head company to have acquired the asset at the joining time for a payment equal to its tax cost setting amount;
·
subsection 701-55(5) applies to adjust the cost base or reduced cost base of an asset so that it equals the asset's tax cost setting amount where the CGT provisions apply to the asset;
·
subsections 701-55(5A) and (5B) apply to an asset that is a financial arrangement and specifies the use of the tax cost setting amount for the purposes of applying Division 230; and
·
new subsection 701-55(5C), which is being inserted by this Bill, applies to an asset that is a right to future income covered by new section 716-410.

5.9 Subsection 701-55(6) is a residual or catch all provision that operates to treat the tax cost setting amount as the cost of an asset when any provision of the income tax law not specifically mentioned in section 701-55 applies to the asset.

5.10 The purpose of subsection 701-55(6) is to ensure that the tax cost setting amount of an asset (rather than its original tax cost) is used when applying a provision of the income tax law that is not specifically covered by subsections 701-55(2) to (5C). The determination of which provision in the income tax law is to apply to an asset is a question of fact that will depend on the particular circumstances of each case.

5.11 Subsection 701-55(6) is modified to ensure that it gives effect to its policy intent. Under these modifications, subsection 701-55(6) will apply where a provision of the income tax law, other than a provision specifically mentioned in subsections 701-55(2) to (5C), is to apply in relation to an asset by including an amount in assessable income, or by allowing an amount as a deduction, in a way that brings into account (directly or indirectly) any of the following amounts:

·
the cost of the asset;
·
outgoings incurred, or amounts paid, in respect of the asset;
·
expenditure in respect of the asset; or
·
an amount of a similar kind in respect to the asset.

[Schedule 5, item 3, subsection 701-55(6)]

5.12 In these circumstances, the other provision of the income tax law applies for the purposes of determining the amount included in assessable income or determining the amount of the deduction as if the cost, outgoing, expenditure or other amount had been incurred or paid to acquire the asset at the particular time for an amount equal to the tax cost setting amount. [Schedule 5, item 3, subsection 701-55(6)]

5.13 The deemed acquisition in subsection 701-55(6) solely facilitates the application of a provision of the income tax law to the tax cost setting amount for the purposes of determining the amount included in assessable income or allowed as a deduction. In this regard, the deemed acquisition does not affect the operation of the entry history rule (section 701-5) where pre-joining time facts may be relevant in determining which provision of the income tax law is to apply to the tax cost setting amount of an asset. [Schedule 5, item 3, note to subsection 701-55(6)]

5.14 These facts may include, for example:

·
the original acquisition date of an asset;
·
whether an asset is held on revenue account or capital account; and
·
whether the tax cost setting amount for an asset that is a reset cost base asset has been reduced to the asset's market value or terminating value under section 705-40.

5.15 The scope of the operation of subsection 701-55(6) is clarified by section 701-56, which specifies that:

·
subsection 701-55(6) does not override history (other than cost);
·
subsection 701-55(6) does not apply to trading stock; and
·
subsection 701-55(6) does not apply to certain capital expenditure provisions.

Subsection 701-55(6) does not override history (other than cost)

5.16 First, if subsection 701-55(6) applies in relation to an asset at a time an entity joins a consolidated group, the things that are taken to have happened in relation to the head company under the entry history rule (section 701-5) do not include:

·
the cost, outgoing, expenditure or other amount incurred or paid to acquire the asset by the joining entity; or
·
whether the cost, outgoing, expenditure or other amount incurred or paid by the joining entity to acquire the asset has been deducted by the joining entity before the joining time.

[Schedule 5, item 3, subsection 701-56(1)]

Example 5.1 : Consumable stores Company J operates a transport business and pays $100,000 to acquire a quantity of fuel on 25 June 2009. The fuel is for use in its transport business.Taxation Ruling No. IT 333 specifies that a deduction for consumables is allowed on either an incurred or usage basis, depending on the circumstances.

·
Where consumables are acquired to meet immediate requirements, deductions may be claimed in the income year in which the expenditure was incurred (the incurred basis).
·
Where the taxpayer builds up a store or stockpile of consumables in excess of immediate requirements, deductions may be claimed only as the consumables are used up (the usage basis).

Company J applies the incurred basis to deduct the amount paid to acquire the fuel ($100,000) in the 2008-09 income year.On 1 July 2009, Head Co acquires all the membership interests in Company J. As a result, Company J joins Head Co's consolidated group.Company J still holds 70 per cent of the fuel that it acquired on 25 June 2009 at the joining time. Under the tax cost setting rules, consumable stores are a reset cost base asset and the tax cost setting amount for the fuel is $70,000.Company J continues to apply the incurred basis to its transport business fuel acquisitions. Therefore, Head Co can deduct the tax cost setting amount for the fuel ($70,000) in the 2009-10 income year.The fact that another member of the consolidated group may be applying the usage basis to its consumables does not affect this outcome.However, if Company J had applied the usage basis to its fuel acquisitions, Head Co would generally deduct the tax cost setting amount for the fuel ($70,000) as the fuel is used.The consumable store of fuel is a CGT asset. However, subsection 701-55(5) does not apply to increase the cost base of the CGT asset by the tax cost setting amount for the fuel. In this regard, as Head Co can deduct the tax cost setting amount for the fuel under section 8-1, subsection 110-45(2) applies to prevent the tax cost setting amount from being included in the cost base of the CGT asset. Example 5.2 : Assets held on revenue account Company J is an investment company with a significant share portfolio. Company J regularly switches between investments to maximise dividend yields and any profit made on the sale of its shares constitutes ordinary income (per London Australia Investments Co Ltd v . FC of T (1977) 138 CLR 106). The shares are therefore held as revenue assets (as defined in section 977-50).Company J acquired two parcels of shares to add to its share portfolio:

·
parcel A for a cost of $100,000; and
·
parcel B for a cost of $80,000.

Company J subsequently joins Head Co's consolidated group. Under the tax cost setting rules:

·
the tax cost setting amount for the parcel A shares is $105,000; and
·
the tax cost setting amount for the parcel B shares is $82,000.

Head Co also holds the two parcels of shares on revenue account. It subsequently sells the parcel A shares for $120,000. The gain on the disposal of the shares is the difference between the disposal proceeds ($120,000) and the tax cost setting amount ($105,000) - that is, $15,000. Therefore, Head Co will include $15,000 in its assessable income as ordinary income (section 6-5) in respect of the disposal of the parcel A shares.The parcel A shares are a CGT asset. Therefore, subsection 701-55(5) applies to increase the cost base of the CGT asset by the tax cost setting amount for the parcel A shares. Consequently, Head Co makes a capital gain of $15,000 on the disposal of the shares. However, section 118-20 applies to reduce this capital gain to nil.Head Co also sells the parcel B shares for $75,000. The loss on the disposal of the shares is the difference between the disposal proceeds ($75,000) and the tax cost setting amount ($82,000) - that is, $7,000. Therefore, Head Co's can deduct $7,000 as a general deduction (section 8-1) in respect of the disposal of the parcel B shares.The parcel B shares are a CGT asset. Therefore, subsection 701-55(5) applies to increase the cost base of the CGT asset by the tax cost setting amount for the parcel B shares. However, Head Co does not make a capital loss on the disposal of the shares because Head Co can deduct the amount of the loss under section 8-1. Example 5.3 : Traditional securities Company J acquires two assets that are traditional securities (as defined in subsection 26BB(1) of the ITAA 1936) on 1 July 2005 - asset A was acquired for a cost of $10,000 and asset B for a cost of $20,000.Head Co acquires all of Company J's membership interests. Consequently, Company J joins Head Co's consolidated group.Under the tax cost setting rules, the traditional securities held by Company J are a reset cost base asset and:

·
the tax cost setting amount for asset A is $11,000; and
·
the tax cost setting amount for asset B is $19,000.

Head Co subsequently disposes of asset A for $13,000. Therefore, it makes a gain of $2,000 on the disposal of the asset - that is, the amount received on the disposal of the asset ($13,000) less the tax cost setting amount ($11,000). The amount of this gain is included in Head Co's assessable income under subsection 26BB(3).Head Co also disposes of asset B for $15,000. Therefore, it makes a loss of $4,000 on the disposal of the asset - that is, the amount received on the disposal of the asset ($15,000) less the tax cost setting amount ($19,000). Head Co can deduct the amount of this loss under subsection 70B(2).Note that if the securities are financial arrangements that are taxed under the taxation of financial arrangements provisions (Division 230), subsections 701-55(5A) and (5B) will apply to specify the use of the tax cost setting amount for the securities.

Subsection 701-55(6) does not apply to trading stock

5.17 Second, subsection 701-55(6) does not apply in relation to an asset that is trading stock. In this regard, if an asset is trading stock, subsection 701-55(3) applies to determine the use of the tax cost setting amount of the asset (even though a deduction may be allowed under section 8-1 in respect of the asset). [Schedule 5, item 3, subsection 701-56(2)]

Subsection 701-55(6) does not apply to certain capital expenditure provisions

5.18 Third, subsection 701-55(6) does not apply in relation to an asset if any of the following provisions apply to the asset:

·
Subdivision 40-F (Primary production depreciating assets);
·
Subdivision 40-G (Capital expenditure of primary producers and other landholders);
·
Subdivision 40-H (Capital expenditure that is immediately deductible);
·
Subdivision 40-I (Capital expenditure that is deductible over time), other than section 40-880 (Business related costs);
·
Subdivision 40-J (Capital expenditure for the establishment of trees in carbon sink forests);
·
Division 41 (Additional deduction for new business investment); and
·
Division 43 (Capital works).

[Schedule 5, item 3, subsection 701-56(3)]

5.19 The deductions allowed under these capital expenditure provisions are, in most cases, based on:

·
the original capital expenditure incurred by a taxpayer to construct or create the asset, rather than on the amount paid (by a subsequent or different taxpayer) to acquire the asset; or
·
the amount of capital expenditure incurred that is not associated with an asset.

5.20 Section 40-880 is excepted because it does not have this limitation. However, the tests in section 40-880 need to be satisfied for an amount to be deducted for business related costs. If those tests are satisfied, the amount of the deduction will be based on the tax cost setting amount for the relevant asset.

5.21 If a joining entity is entitled to a deduction under the capital expenditure provisions, the head company of the group may be entitled to a deduction because of the operation of the single entity rule (subsection 701-1(1)) and the entry history rule (section 701-5). The amount of the deduction is based on the remaining balance of the capital expenditure, rather than the tax cost setting amount allocated to the asset.

Example 5.4 : Capital works Company J holds a building at the time it joins Head Co's consolidated group. At the joining time, Company A has undeducted construction expenditure of $75,000 in relation to the building.Under the tax cost setting rules, the building is a reset cost base asset. The tax cost setting amount allocated to the building is $300,000.Generally, a taxpayer can deduct an amount for undeducted construction expenditure in relation to capital works under Division 43. The amount that can be deducted is the undeducted construction expenditure in relation to the capital works.The deduction under Division 43 is based on the construction costs of the capital works. Therefore, Head Co can deduct the balance of the undeducted construction expenditure ($75,000) under Division 43 by applying the entry history rule (section 701-5).Head Co cannot claim deductions for undeducted construction expenditure in relation to the building based on the tax cost setting amount allocated to the building.

Assets that give rise to bad debts

5.22 A deduction is allowed under section 25-35 for a debt, or part of a debt, that is written off as bad during an income year if, broadly:

·
the debt was included in the taxpayers' assessable income for an income year;
·
the debt is in respect of money that the taxpayer lent in the ordinary course of their business of lending money; or
·
the taxpayer bought the debt in the ordinary course of their business of lending money.

5.23 To overcome difficulties in applying section 25-35 to the tax cost setting amount for a debt, the operation of section 25-35 is modified to ensure that the head company can claim a deduction if the debt goes bad. [Schedule 5, item 4, subsection 716-400(1)]

5.24 The modifications apply if:

·
the tax cost of an asset was set at the time that an entity joins a consolidated group at the asset's tax cost setting amount;
·
the asset is a debt;
·
any of the following apply in relation to the asset:

-
the debt was included in the joining entity's assessable income before the joining time;
-
the debt was in respect of money that the joining entity lent before the joining time in the ordinary course of a business of lending money; or
-
the joining entity bought the debt before the joining time in the ordinary course of a business of lending money; and

·
the asset is not an intra-group asset (that is, section 701-58 does not apply to the asset).

[Schedule 5, item 4, subsection 716-400(2)]

5.25 In these circumstances, subsection 716-400(3) clarifies that, in determining the extent to which the head company of the group can deduct an amount under section 25-35 in relation to the asset, the entry history rule (section 701-5) and subsection 701-55(6) have the effect that:

·
in a case where the debt was included in the joining entity's assessable income before the joining time - the head company is taken to have included an amount equal to the tax cost setting amount in its assessable income in respect of the debt before the joining time;
·
in a case where the debt was in respect of money that the joining entity lent before the joining time in the ordinary course of a business of lending money - the head company is taken to have lent an amount of money equal to the tax cost setting amount in the ordinary course of a business of lending money before the joining time; or
·
in a case where the joining entity bought the debt before the joining time in the ordinary course of a business of lending money - the head company is taken to have incurred expenditure equal to the tax cost setting amount in buying the debt in the ordinary course of a business of lending money before the joining time.

[Schedule 5, item 4, subsection 716-400(3)]

Example 5.5 : Australian dollar trade receivables Company J sells trading stock valued at $20,000 to a customer on credit (30 day terms) on 25 June 2009. As Company J is taxed on an accruals basis, it includes the amount derived ($20,000) in its assessable income for the 2008-09 income year. Therefore, on 30 June 2009, Company J holds an Australian dollar trade receivable of $20,000.On 1 July 2009, Head Co acquires all the membership interests in Company J. As a result, Company J joins Head Co's consolidated group.Under the tax cost setting rules, the Australian dollar trade receivable is a right to receive an amount of Australian currency, and therefore is a retained cost base asset (paragraph 705-25(5)(b)). The tax cost setting amount is the amount of Australian currency concerned - that is, $20,000.Head Co eventually collects $18,000 in respect of the Australian dollar trade receivable and writes off the balance of $2,000.Head Co can deduct the amount of the Australian dollar trade receivable written-off as a general deduction under section 8-1 or as a bad debt deduction under section 25-35.In this regard, for the purpose of applying section 25-35, as the debt was included in the Company J's assessable income before the joining time, Head Co is taken to have included an amount equal to the tax cost setting amount ($20,000) in its assessable income in respect of the debt before the joining time. Example 5.6 : Foreign currency trade receivables On 1 May 2003 Company J derives ordinary income of $100 by selling trading stock to Entity Z on credit for US$80. At that time, A$1 is equivalent to US$0.80.Company J joins Head Co's consolidated group on 1 July 2003 when A$1 is equivalent to US$0.75 and the trade receivable translates to A$106.67. Under the tax cost setting rules, a tax cost setting amount of A$106.67 is allocated to the trade receivable. As the trade receivable is a revenue asset in the hands of Company J, subsection 701-55(6) applies to the tax cost setting amount.Entity Z pays US$75 to Company J in settlement of its trade debt on 30 November 2003. At that time, under the exchange rate, A$1 is equivalent to US$0.78 and A$96.15 cash is received by Head Co.Head Co writes of the remainder of the US$5 owed as a bad debt.The amount that can be deducted under section 25-35 in respect of a foreign currency debt that was included in assessable income is the amount translated to Australian currency at the exchange rate applicable at the time of translating the income (Item 8A of Regulation 960.50.01 of the Income Tax Assessment Regulations 1997 ).Head Co is taken to have included an amount equal to the tax cost setting amount (A$106.67) in its assessable income in respect of the debt (paragraph 716-400(3)(a)). As section 715-370 applies to the debt, the exchange rate applicable at the time of translating the US$80 to A$106.67 is A$1 equals US$0.75 (being the rate applying at joining time).Consequently, Head Co can deduct an amount of A$6.67 (that is, A$106.67 - A$100) under section 25-35 for the US$5 written-off as a bad debt.As the amount received by Head Co (A$96.15) is less than the portion of the tax cost setting amount that relates to the US$75 received (A$100), a capital loss of A$3.85 (that is, A$96.15 - A$100) arises under CGT event C2.However, this difference is wholly attributable to the movement in the exchange rate from 1 July 2003 to 30 November 2003. Therefore, Head Co can deduct the amount of the difference (A$3.85) under section 8-1 (reducing the capital loss to nil).Division 775 does not apply to the right to receive foreign currency as, under the entry history rule, Head Co is taken to have acquired the right prior to 1 July 2003 and has not made an election under section 775-150 for the Division to apply to the right.However, if Division 775 did apply, the combined operation of subsection 701-55(6) and section 715-370 in respect of the tax cost setting amount for the debt would result in a forex realisation loss of A$3.85 arising under forex realisation event 2 (ceasing to have a right to receive foreign currency (section 775-45)).

5.26 In some cases a deduction for bad debts is allowed under the general deduction provision (section 8-1). If that provision applies to allow a deduction for a bad debt, the amount of the deduction will be based on the tax cost setting amount for the asset.

Deduction for tax cost setting amount for assets that are rights to future income assets

5.27 A joining entity may hold an asset at the joining time that represents:

·
a right to receive income for things it has already provided or done, but for which it is not yet entitled to bill (such as work-in-progress under a long-term construction contract); or
·
a right to receive income for things that are to be provided or done after the joining time.

5.28 The market value of the asset at the joining time will derive from the expected future income reduced by associated future outlays.

5.29 Where the joining entity was a wholly-owned subsidiary of the head company at the time the contract or agreement giving rise to the future income asset was created, the asset will be treated as a retained cost base asset and its tax cost setting amount will be limited to its terminating value, which in most cases is expected to be nil (see the amendments in Part 11 of this Schedule).

5.30 Where the joining entity was not a wholly-owned subsidiary of the head company at the time the contract or agreement giving rise to the future income asset was created, the asset will be a reset cost base asset and will receive a tax cost setting amount based on its relative market value at the joining time.

5.31 Uncertainties arise regarding when and how the tax cost setting amount allocated to such an asset may be recognised for the head company's tax purposes.

5.32 To overcome these uncertainties, if section 716-410 covers an asset, section 716-405 may apply in relation to the tax cost setting amount allocated to the asset. [Schedule 5, item 3, subsection 701-55(5C)]

5.33 Section 716-410 covers an asset if:

·
the asset is a right (including a contingent right) to receive an amount for the doing of a thing;
·
the asset is held by an entity just before the time it becomes a subsidiary member of a consolidated group; and
·
it is reasonable to expect that an amount will be included in the assessable income of the head company of the group after the joining time in relation to the right.

[Schedule 5, item 4, section 716-410]

5.34 Section 716-405 allows a deduction for the tax cost setting amount for an asset if:

·
an entity became a subsidiary member of a consolidated group; and
·
subsection 701-55(5C) applies in relation to the asset - that is, the asset is a 'right to future income' asset covered by section 716-410 that is held by the joining entity.

[Schedule 5, item 4, subsection 716-405(1)]

5.35 An asset covered by section 716-410 may be solely comprised of a right to future income. Alternatively, the asset may be a right that is embedded in a contract or agreement that includes a range of rights and associated obligations.

5.36 Where the right to future income asset is embedded in a contract or agreement that includes a range of rights and associated obligations, section 716-405 will apply to allow a deduction for that part of the tax cost setting amount for the asset that relates to the right to future income.

5.37 The deduction will be available to the entity that is qualified for a deduction under subsection 716-405(5) for the right to future income asset. In most cases this will be the head company of a consolidated group that holds the asset because of the single entity rule (subsection 701-1(1)). However, if an entity ceases to be a member of the consolidated group and takes the right to future income asset with it, the leaving entity will be entitled to the deduction. [Schedule 5, item 4, subsections 716-405(2) and (5)]

5.38 The amount that can be deducted in a particular income year is generally the unexpended tax cost setting amount for the right to future income asset, to the extent that an amount is included in the entity's assessable income for that income year in respect of the right to future income asset. [Schedule 5, item 4, paragraph 716-405(2)(a)]

5.39 However, unless subsection 716-405(3) applies, if the right to future income asset ceases to exist in an income year or it is reasonable to expect that no amount will be included in the assessable income of any entity for a later income year in respect of the asset, the amount that can be deducted in that income year by the entity that holds the asset at the time it ceases to exist or have any value is the unexpended tax cost setting amount for the asset. [Schedule 5, item 4, paragraph 716-405(2)(b)]

5.40 Subsection 716-405(3) applies to prevent the head company from being able to deduct the unexpended tax cost setting amount for the asset in an income year if:

·
another entity ceased to be a subsidiary member of the group in that income year; and
·
that other entity can deduct an amount for the right to future income asset because it is also qualified for a deduction under subsection 716-405(5) for the asset for that income year.

[Schedule 5, item 4, subsection 716-405(3)]

5.41 If the asset is disposed of, section 716-405 will not apply to allow a deduction for the unexpended tax cost setting amount. The income tax treatment of the asset on disposal will depend on the particular facts in each case. For example:

·
if the asset is a CGT asset that is taxed under the CGT provisions, subsection 701-55(5) will apply so that, in working out the amount of any capital gain or loss, the cost base or reduced cost base is increased by the unexpended tax cost setting amount; or
·
if the asset is taxed on revenue account, subsection 701-55(6) will apply so that, in working out the amount of any profit or loss, the tax cost of the asset is the unexpended tax cost setting amount.

5.42 The unexpended tax cost setting amount for the right to future income asset for an income year is the tax cost setting amount for the asset reduced by the amounts (if any) of all deductions under section 716-405 in respect of the asset for previous income years. [Schedule 5, items 4 and 5, paragraph 716-405(4)(a) and the definition of 'unexpended tax cost setting amount' in subsection 995-1(1)]

5.43 In addition, in determining the amount of a deduction for a right to future income asset for an income year for an entity that ceased to be a subsidiary member of the group in that income year, the tax cost setting amount is reduced by the amount (if any) that the head company of the group can deduct under section 716-405 in respect of the asset for that income year. [Schedule 5, items 4 and 5, paragraph 716-405(4)(b) and the definition of 'unexpended tax cost setting amount' in subsection 995-1(1)]

5.44 An amount that is deducted under section 716-405 for the tax cost setting amount for the right to future income asset:

·
cannot be deducted under any other provision in the income tax law;
·
is not taken into account in determining the amount included in assessable income of the head company or an entity that has ceased to be a member of the group for any income year for the asset;
·
is not taken into account in determining the amount of a deduction for the head company or an entity that has ceased to be a member of the group for any income year for the asset; and
·
is not taken into account in working out any of the elements of the CGT cost base of the asset.

[Schedule 5, item 4, subsection 716-405(6)]

5.45 As a consequential amendment, the table of deductions in section 12-5 is modified to refer to the deduction that is allowed under section 716-405. [Schedule 5, item 1, section 12-5]

Example 5.7 : Right to future income under a long-term construction contract Head Co acquires all of Company J's membership interests on 1 July 2010. Consequently, Company J joins Head Co's consolidated group.Company J has a partially completed construction contract at the joining time - that is, broadly, it has partially performed some work under the contract that has not yet been completed to a stage where a recoverable debt has arisen. For accounting purposes, Company J has estimated the amount of partly earned unbilled income as $15,000.Substantial gross revenues are expected to be generated under the contract with an estimated profit over the period of the contract of $500,000.Taxation Ruling TR 2004/13 addresses the question of what is an asset for the purposes of the tax cost setting rules. If, applying the principles in that ruling, the construction contract is identified as a separate asset, the market value of the asset must be determined using a recognised market valuation methodology.A valuer will typically have regard to a number of factors in determining the market value of the asset, such as:

·
the value of future work yet to be performed;
·
the remaining life of the asset;
·
forecast revenue;
·
the cost and charges of other assets that are related to the work that is yet to be performed; and
·
appropriate discount rates.

Having regard to these factors, the market value of the asset is determined to be $215,000.The construction contract is a reset cost base asset to which section 705-40 applies. The tax cost setting amount allocated to the asset under the tax cost setting rules is $180,000.Head Co can deduct the tax cost setting amount for the asset ($180,000) under section 716-405 because:

·
the asset is solely a right to receive an amount for the doing of a thing (being the unbilled work already done and the work yet to be done); and
·
it is reasonable to expect that the Head Co will include an amount in assessable income after the joining time in relation to the right.

During the 2010-11 income year, invoices issued in respect of the contract totalled $100,000. As a result, Head Co includes $100,000 in assessable income in that year. The contract is 10 per cent completed as at 30 June 2011.Taxation Ruling IT 2450 specifies two methods that are acceptable for accounting for the taxable income from long-term construction contracts - the basic approach and the estimated profits basis.If Company J uses the basic approach for income tax purposes, Head Co will be able to deduct $100,000 of the tax cost setting amount for the asset under section 716-405 in the 2010-11 income year. The unexpended tax cost setting amount ($80,000) will be deductible in the 2011-12 income year, provided that invoices equal to or exceeding that amount are issued, and a corresponding amount is included in assessable income, in that income year.If Company J uses the estimated profit (percentage of completion) basis for income tax purposes, Head Co will include $50,000 (10 per cent of the $500,000 total estimated profit) in its assessable income in the 2010-11 income year. Therefore Head Co will be able to deduct $50,000 of the tax cost setting amount for the asset under section 716-405 in the 2010-11 income year. The unexpended tax cost setting amount ($130,000) will be deductible in subsequent years as the assessable income is derived by Head Co under the contract.If the contract is completed and actual total profit is less than the tax cost setting amount for the asset ($180,000), then the balance of the unexpended tax cost setting amount would generally be deductible under section 716-405 at that time. Example 5.8 : Right to receive trailing commissions Head Co acquires all of Company J's membership interests on 1 July 2010. Consequently, Company J joins Head Co's consolidated group.Company J is a commission agent and reasonably expects to receive trailing commissions from an insurance company in respect of insurance products sold in the 2008-09 income year, provided customers do not terminate their insurance cover. Although no recoverable debt exists at the joining time, it is reasonable to expect that trailing commissions of $40,000 will be received during the 2010-11 and 2011-12 income years ($20,000 per year) from the sales in the 2008-09 income year.Taxation Ruling TR 2004/13 addresses the question of what is an asset for the purposes of the tax cost setting rules. If, applying the principles in that ruling, the right to trailing commissions is identified as a separate asset, the market value of the asset must be determined using a recognised market valuation methodology. The market value of the asset is determined to be $30,000.The asset is a reset cost base asset to which section 705-40 applies. The tax cost setting amount allocated to the asset under the tax cost setting rules is $30,000.Head Co can deduct the tax cost setting amount for the right to receive trailing commissions ($30,000) under section 716-405 because:

·
the asset is solely a contingent right to receive an amount for the doing of a thing (being the sale of insurance products prior to the joining time); and
·
it is reasonable to expect that the Head Co will include an amount in assessable income after the joining time in relation to the asset.

In the 2010-11 income year, Head Co derives trailing commissions of $19,000 which are included in assessable income. Therefore, Head Co will be able to deduct $19,000 of the tax cost setting amount for the asset in that income year.In the 2011-12 income year, Head Co derives trailing commissions of $17,000 which are included in assessable income. Therefore, Head Co will be able to deduct the balance of the unexpended tax cost setting amount for the asset ($11,000) in that income year. Example 5.9 : Land development agreement Head Co acquires all of Company J's membership interests on 1 July 2010. Consequently, Company J joins Head Co's consolidated group.Company J is a land development company that has acquired a development agreement over land owned by a third party. Under that right, Company J is entitled to develop and sell the land to customers as agent for the owner. It is also entitled to retain a proportion of the sale proceeds as its fee.Taxation Ruling TR 2004/13 addresses the question of what is an asset for the purposes of the tax cost setting rules. If, applying the principles in that ruling, the development agreement is identified as a separate asset, the market value of the asset must be determined using a recognised market valuation methodology. The market value of the asset is determined to be $6 million.The asset is a reset cost base asset to which section 705-40 applies. The tax cost setting amount allocated to the asset under the tax cost setting rules is $5 million.Head Co can deduct the tax cost setting amount for the development right ($5 million) under section 716-405 because:

·
the asset is solely a right to receive an amount for the doing of a thing (being the development and sale of land); and
·
it is reasonable to expect that the Head Co will include an amount in assessable income after the joining time in relation to the asset.

Each time Head Co sells, as agent, a subdivided block of land, it will include a proportion of the sale proceeds that is its fee in assessable income. Therefore, Head Co can progressively deduct the tax cost setting amount for the development right ($5 million) under section 716-405 over the income years it receives the fees and includes them in assessable income. Example 5.10 : Right to deferred management fees Company J operates a retirement village business and has a right to deferred management fees in respect of each resident's unit - that is, a right to fees that accrue over a resident's tenure in a retirement village unit but are not payable until the time the resident ceases to reside at the retirement village.Head Co acquires all of Company J's membership interests on 1 July 2010. Consequently, Company J joins Head Co's consolidated group.Taxation Ruling TR 2004/13 addresses the question of what is an asset for the purposes of the tax cost setting rules. If, applying the principles in that ruling, the right to deferred management fees is identified as a separate asset, the market value of the asset must be determined using a recognised market valuation methodology. The market value of the asset is determined to be $80,000.The asset is a reset cost base asset to which section 705-40 applies. The tax cost setting amount allocated to the asset under the tax cost setting rules is $80,000.Head Co can deduct the tax cost setting amount for the asset ($80,000) under section 716-405 because:

·
the asset is solely a contingent right to receive an amount for the doing of a thing (being the management of the retirement village); and
·
it is reasonable to expect that the Head Co will include an amount in assessable income after the joining time in relation to the asset.

Head Co derives management fees of $70,000, and includes this amount in its assessable income, when the resident ceases to reside in the retirement village in the 2015-16 income year. Therefore, Head Co can deduct part of the tax cost setting amount for the right to deferred management fees ($70,000) in the 2015-16 income year.The tax cost setting amount allocated to the right to deferred management fees ($80,000) exceeds the total management fees included in Head Co's assessable income ($70,000). However, as the right to deferred management fees comes to an end in the 2015-16 income year, Head Co can deduct the balance of the unexpended tax cost setting amount for the right ($10,000) in that income year. Example 5.11 : Rights to unbilled income for the supply of gas Company J carries on the business of supplying gas to its customers (being both domestic and commercial gas consumers) in very similar circumstances to those in FC of T v Australian Gas Light Co 83 ATC 4800; (1983) 15 ATR 105.In its profit and loss statement for the income year ended 30 June 2010, Company J recorded unbilled gas income of $25,000. Its balance sheet contained an unbilled gas asset of the same amount. The unbilled gas income is recognised as income for accounting purposes but has not yet been recognised as assessable income for income tax purposes in accordance with Taxation Ruling No. IT 2095.On 1 July 2010, Head Co acquires all of Company J's membership interests. As a result, Company J joins Head Co's consolidated group.Taxation Ruling TR 2004/13 addresses the question of what is an asset for the purposes of the tax cost setting rules. If, applying the principles in that ruling, the right to unbilled gas income is identified as a separate asset, the market value of the asset must be determined using a recognised market valuation methodology. The market value of the asset is determined to be $25,000.The asset is a reset cost base asset to which section 705-40 applies. The tax cost setting amount allocated to the asset under the tax cost setting rules is $20,000.Head Co can deduct the tax cost setting amount for the asset ($20,000) under section 716-405 because:

·
the asset is solely a contingent right to receive an amount for the doing of a thing (being the supply of gas); and
·
it is reasonable to expect that the Head Co will include an amount in assessable income after the joining time in relation to the asset.

Head Co derives assessable income for gas supplied in excess of $20,000 in the 2010-11 income year. This includes amounts derived for gas supplied by Company J as at 30 June 2010. Therefore, Head Co will be able to deduct the tax cost setting amount for the asset ($20,000) in that income year.

Land carrying trees and rights to fell trees

5.46 When a taxpayer fells trees for sale or manufacture, a deduction is available under section 70-120 for so much of the capital costs of acquiring land carrying trees as is referable to trees that have been felled in the income year.

5.47 A deduction is also available under section 70-120 for the capital cost of acquiring rights to fell trees, but only to the extent the amount paid is attributable to the trees that are felled in the income year. The amount that is attributable to the trees that are felled in the income year is generally worked out based on the relative market value of the trees that are felled to the land or rights.

5.48 Currently, if the trading stock provisions in Division 70 apply in relation to an asset, subsection 701-55(3) specifies the use of the tax cost setting amount. The provisions in the income tax law that allow a deduction for the capital costs relating to land carrying trees and to rights to fell trees (section 70-20) are in Division 70. However, the use of the tax cost setting amount specified in subsection 701-55(3) does not work appropriately for the purposes of applying section 70-120.

5.49 To avoid confusion, a technical amendment will clarify that subsection 701-55(6), rather than subsection 701-55(3), applies to specify how the head company uses the tax cost setting amounts allocated to land carrying trees and to rights to fell trees for the purpose of applying section 70-120. [Schedule 5, item 2, subsection 701-55(3)]

5.50 The joining entity's history relating to the deduction of amounts under section 70-120 is not inherited by the head company under the entry history rule (section 701-5) for the purpose of determining whether the head company is entitled to deductions under section 70-120 for the tax cost setting amount allocated to an asset that is land carrying trees. [Schedule 5, item 3, subsection 701-56(1)]

Example 5.12 : Land carrying trees Company J paid $850,000 to acquire land carrying trees. At that time $50,000 is set out in the contract as being attributable to the trees.Before the joining time, Company J fells 50 per cent of the trees, claiming a deduction of $25,000. Company J then replants trees on the land.Head Co acquires all of Company J's membership interests. Consequently, Company J joins Head Co's consolidated group.At the joining time, Head Co obtains a valuation of the land which documents that the market value of the land (including the trees) at the joining time is $900,000. The value attributable to the remaining trees is $25,000.Under the tax cost setting rules, the tax cost setting amount for the land (including the trees) is $850,000. Therefore, the tax cost setting amount attributable to the trees is $23,611 (that is, $25,000 / $900,000 × $850,000).Head Co subsequently fells the trees, and sells the timber for $50,000. Head Co will include the amount received on the sale of the timber ($50,000) in its assessable income and can deduct the tax cost setting amount attributable to the trees ($23,611) under subsection 70-120(4).

Interactions with Division 775 (Foreign currency gains and losses)

5.51 The primary purpose of Division 775 is to ensure that foreign currency gains and losses are recognised for income tax purposes.

5.52 The amendments clarify the time for determining the currency exchange rate effect where:

·
an entity becomes a subsidiary member of a consolidated group at a time;
·
taking into account the operation of the single entity rule (subsection 701-1(1)), the head company of the group held an asset at the joining time because the joining entity became a subsidiary member of the group;
·
the asset is a reset cost base asset at the joining time; and
·
in working out the asset's tax cost setting amount, the currency exchange rate of a particular foreign currency is taken into account in determining the market value of the asset.

[Schedule 5, item 6, subsection 715-370(1)]

5.53 In these circumstances, for the purposes of Division 775, the extent of any currency exchange rate effect after the joining time in relation to the asset is determined by reference to the currency exchange rate for the foreign currency at the joining time. [Schedule 5, item 6, subsection 715-370(2)]

Example 5.13 : Foreign currency trade receivable and forex realisation event 2 On 1 May 2010 Company J derives ordinary income of $100 by selling trading stock to Company Z on credit for US$80. At that time, A$1 is equivalent to US$0.80.Company J joins Head Co's consolidated group on 1 July 2010 when A$1 is equivalent to US$0.75 and the trade receivable translates to A$106.67. Under the tax cost setting rules, a tax cost setting amount of A$106.67 is allocated to the trade receivable.As Division 775 is to apply to the foreign currency trade receivable, subsection 701-55(6) applies to deem the tax cost setting amount to be an amount paid by the head company to acquire the asset at the joining time.As the trade receivable is a reset cost base asset and the US$ currency exchange rate applying at the joining time has been taken into account in working out its tax cost setting amount, section 715-370 also applies to the asset for the purpose of Division 775.The combined operation of subsection 701-55(6) and section 715-370 in respect of the asset results in the A$106.67 tax cost setting amount becoming the forex cost base of the debt (section 775-85) for the purpose of forex realisation event 2 (ceasing to have a right to receive foreign currency (section 775-45)).Subsection 701-55(6) and section 715-370 operate to treat the tax cost setting amount as an amount paid by Head Co at the joining time to acquire a right to receive US$80 for the purpose of forex realisation event 2.Company Z pays US$80 to Company J in settlement of its trade debt on 30 November 2010. At that time the exchange rate is A$1 equals US$0.78 and A$102.56 cash is received by Head Co.As the forex cost base of the debt is A$106.67, Head Co makes a forex realisation loss of A$4.11 under forex realisation event 2.

Application of Part 1

5.54 The amendments in Division 1 of Part 1 (that is, the amendments other than those which clarify interactions with the foreign currency gains and losses provisions (Division 775)) apply on or after 1 July 2002. [Schedule 5, item 7]

5.55 These amendments, which have been sought by taxpayers, are beneficial as they ensure that the head company of a consolidated group receives appropriate recognition for the tax cost setting amount allocated to an asset under the tax cost setting rules.

5.56 The amendments in Division 2 of Part 1, which clarify interactions with the foreign currency gains and losses provisions (Division 775) when an entity joins a consolidated group, apply from the date of introduction of this Bill into the House of Representatives. That is, the amendments will apply to an entity that joins a consolidated group on or after that date. [Schedule 5, item 7]

5.57 However, the head company of a consolidated group can make a choice to apply the amendments in Division 2 of Part 1 in relation to an entity that joins a consolidated group on or after 1 July 2002. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

[Schedule 5, item 7]

5.58 This option to apply the amendments from 1 July 2002 will ensure that taxpayers do not need to disturb past practices. However, it will allow consolidated groups to take advantage of the amendments, having regard to the compliance cost implications of applying the changes retrospectively.

Transitional treatment of foreign currency trade receivables

5.59 In Draft Taxation Determination TD 2004/D80 the Australian Taxation Office (ATO) advised that a capital gain would arise when an amount received in payment of a foreign currency denominated trade receivable exceeds its tax cost setting amount.

5.60 The ruling was withdrawn on 22 August 2006 following the former government's announcement to modify the operation of subsection 701-55(6).

5.61 To ensure taxpayer's are not disadvantaged by the withdrawal of Draft Taxation Determination TD 2004/D80, a transitional modification will be made to preserve the CGT character of the gain or loss that arises when the amount received in payment of a foreign currency denominated trade receivable exceeds its tax cost setting amount, provided the amount was derived between 1 July 2002 and 23 August 2006.

5.62 The transitional modification will apply if:

·
the tax cost of a joining entity's asset was set at the joining time at the asset's tax cost setting amount;
·
the asset is a trade receivable that is denominated in foreign currency;
·
CGT event C2 happens to the asset between the joining time and 23 August 2006;
·
just before the CGT event, the head company of the group held the asset because of the operation of the single entity rule (subsection 701-1(1));
·
disregarding section 118-20, there is a capital gain or capital loss from the event; and
·
the head company makes a choice (which is reflected in the way that it completed its income tax return) to apply the transitional provision.

[Schedule 5, item 8]

5.63 In these circumstances, except to the extent that any capital gain or capital loss from the event is attributable to currency exchange rate fluctuations, the following provisions do not apply to the CGT event:

·
section 6-5 (about ordinary income);
·
any other provision that includes an amount in assessable income (other than a CGT provision);
·
section 8-1 (about amounts that can be deducted);
·
any other provision that allows a deduction for the amount; and
·
section 118-20 (which reduces a capital gain by the amount that it is otherwise assessable).

[Schedule 5, item 8]

5.64 This transitional provision will preserve the position set out in Draft Taxation Determination TD 2004/D80 until 23 August 2006. After that date, an asset that is a trade receivable denominated in foreign currency may be treated as being on revenue account. Subsection 701-55(6) will apply to ensure that the tax cost setting amount for the asset can be used to determine the amount that is included in assessable income or allowed as a deduction.

Part 2 - Group restructures

5.65 In this Part, references to a consolidated group do not include a MEC group.

5.66 Under the consolidation regime wholly-owned groups are treated as single taxpaying entities for their income tax purposes. Wholly-owned groups that have an Australian resident head company can form a consolidated group. Resident wholly-owned subsidiaries of a foreign holding company can form a MEC group.

5.67 When a change in the group structure occurs, it can result in:

·
a consolidated group converting to a MEC group (section 719-40); or
·
a MEC group converting to a consolidated group (section 703-55).

5.68 Currently, when a group conversion occurs, the old group ceases to exist and a new group comes into existence. As a result, significant tax consequences inappropriately arise for members of the old group that become members of the new group - that is, for entities that are ongoing members of the group. For example:

·
the tax cost setting rules that apply when an entity ceases to be a member of a consolidated group or MEC group operate to set the tax costs of the membership interests in each subsidiary member that leaves the old group, potentially causing a capital gain to arise if CGT event L5 happens; and
·
the tax cost setting rules that apply when an entity becomes a member of a consolidated group or MEC group operate to reset the tax costs of the assets of each subsidiary member that becomes a member of the new group.

Minimal tax consequences for ongoing members

5.69 Subdivision 719-BA will ensure that there will be minimal tax consequences when, at a particular time (the conversion time):

·
a consolidated group is created from a MEC group; or
·
a MEC group is created from a consolidated group.

[Schedule 5, item 15, subsection 719-120(1)]

New group retains the history of the old group

5.70 When Subdivision 719-BA applies, the head company of the new group will retain the history of the head company of the old group. That is, everything that happened in relation to the head company of the old group before the conversion time is instead taken to have happened in relation to:

·
if the head company of the old group is the same entity as the head company of the new group, that entity in its role as the head company of the new group; or
·
otherwise, the head company of the new group (just as if the head company of the new group had been the head company of the old group at all times before the conversion time).

[Schedule 5, item 15, subsection 719-125(1)]

5.71 The history that is retained by the head company of the new group includes everything that, immediately before the conversion time, was taken to have happened in relation to the head company of the old group because of:

·
the single entity rule (subsection 701-1(5));
·
the entry history rule (section 701-5);
·
the effects of a choice under section 703-75 to continue a consolidated group or MEC group after an interposed company becomes a new head company;
·
the effects under section 719-90 that arise because of a change in the head company of a MEC group; and
·
any previous applications of Division 719.

[Schedule 5, item 15, subsection 719-125(2)]

5.72 Consequently, if, for example, the old group is a MEC group and there has been one or more changes to the head company of the group prior to the conversion time, the entity that is the head company of the old MEC group at the conversion time is taken to have inherited all of the group's previous history just as if it had always been the head company of the group (section 719-90). The head company of the new consolidated group will retain all the relevant history of the old MEC group, including the history obtained because of the effects under section 719-90 that arise because of a change in the head company of the old MEC group.

5.73 The provisions that ensure the head company of the new group retains the history of the head company of the old group (subsections 719-125(1) and (2)) have effect for:

·
the head company core purposes in relation to an income year ending after the conversion time;
·
the entity core purposes in relation to an income year ending after the conversion time; and
·
the purpose of determining the balance of the franking account of the head company, or provisional head company, of the new group at or after the conversion time.

[Schedule 5, item 15, subsection 719-125(3)]

5.74 Therefore, for example, for the purposes of applying the joint and several liability provisions in Division 721, a tax-related liability that is a group liability of the head company of the old group will be a group liability of the head company of the new group. In addition, an entity that was a subsidiary member of the old group for part of the period to which the liability relates will be taken to be a subsidiary member of the new group in respect of that period.

5.75 Subsections 719-125(1) and (2) do not override:

·
the exit history rule (section 701-40); and
·
a provision of the income tax law to which the exit history rule is subject because of exceptions to the core rules (section 701-85).

[Schedule 5, item 15, subsection 719-125(4)]

5.76 Consequently, if, for example, the old group is a transitional group, the new group will also be a transitional group. Similarly, if an entity that is an ongoing member is a transitional entity or chosen transitional entity, the entity will retain that status. Therefore, sections 701-40, 701-45 and 701-50 of the Income Tax (Transitional Provisions) Act 1997 will apply when these entities leave the new group.

Certain provisions do not apply when an entity joins the new group

5.77 The provisions that ordinarily apply when an entity joins a consolidated group or MEC group, other than the single entity rule (subsection 701-1(1)), do not apply to an ongoing member that joins the group because of a group conversion. In particular, the following provisions do not apply:

·
CGT events L1, L2, L3, L4 and L8, which may apply when an entity joins a consolidated group or MEC group (Subdivision 104-L);
·
the modification to the operation of the same business test that ordinarily applies when an entity becomes a subsidiary member of a consolidated group or MEC group (section 165-212E);
·
the consolidation provisions in Part 3-90 that ordinarily apply when an entity joins a consolidated group or MEC group (other than the single entity rule and Subdivision 719-BA); and
·
the transitional consolidation provisions in Part 3-90 of the Income Tax (Transitional Provisions) Act 1997 that ordinarily apply when an entity joins a consolidated group or MEC group.

[Schedule 5, item 15, subsections 719-130(1) , ( 2) and (5)]

5.78 An entity is an ongoing member (and therefore obtains the benefit of section 719-130) only if it was a member of the old group just before the conversion time and becomes a member of the new group at that time. [Schedule 5, item 15, subsection 719-120(2)]

5.79 Therefore, section 719-130 does not apply to:

·
entities that are members of the new group but were not members of the old group just before the conversion
·
time - that is, entities that are new members of the group; or
·
entities that were members of the old group before the conversion time that cannot be members of the new group at that time, such as entities that were transitional foreign-held subsidiaries or transitional foreign-held indirect subsidiaries (see sections 701C-10 and 719-10 of the Income Tax (Transitional Provisions) Act 1997 ).

5.80 Some key impacts of switching-off the consolidation provisions in Part 3-90 that ordinarily apply when an entity joins a consolidated group or MEC group (other than the single entity rule and Subdivision 719-BA) are that:

·
the tax cost setting rules in Division 705 do not apply when an entity that is an ongoing member becomes a member of the new group as a result of a group conversion - consequently, the tax costs of the ongoing member's assets are not reset;
·
the loss transfer rules in Subdivision 707-A do not apply when an ongoing member becomes a member of the new group as a result of a group conversion - as a result, losses transferred from ongoing member to the head company of the old group are taken to be transferred to the head company on the new group.

Certain provisions do not apply when an entity leaves the old group

5.81 Similarly, unless the entity becomes an eligible tier-1 company in respect of the new MEC group, the following provisions that ordinarily apply when an entity leaves a consolidated group or MEC group will not apply when an ongoing member ceases to be a member of the group because of a group conversion:

·
CGT event L5, which ordinarily applies when an entity leaves a consolidated group or MEC group (Subdivision 104-L);
·
the consolidations provisions in Part 3-90 that ordinarily apply when an entity leaves a consolidated group or MEC group (other than Subdivision 719-BA); and
·
the transitional consolidation provisions in Part 3-90 of the Income Tax (Transitional Provisions) Act 1997 that ordinarily apply when an entity leaves a consolidated group or MEC group.

[Schedule 5, item 15, subsections 719-120(2) and 719-130(3) to (5)]

5.82 A key impact of switching-off the consolidation provisions in Part 3-90 that ordinarily apply when an entity leaves a consolidated group or MEC group (other Subdivision 719-BA) is that the tax cost setting rules in Division 711 do not apply when an the entity that is an ongoing member ceases to be a member of the old group as a result of a group conversion. Consequently, the tax costs of the membership interests in the on-going member are not reconstructed.

Certain provisions continue to apply

5.83 Where an on-going member becomes an eligible tier-1 company in respect of a new MEC group because a foreign resident company acquires all the membership interests, tax consequences will arise for the head company of the old consolidated group in respect of the disposal of the membership interests in the ongoing member to the foreign resident company. Therefore, the tax cost setting amount of those membership interests will be worked out under Division 711.

5.84 Where this eligible tier-1 company holds membership interests in another ongoing subsidiary member (that is, a lower tier subsidiary member) of the group, the old group's allocable cost amount for this lower tier subsidiary member will need to be worked out to determine the tax costs for the membership interests in the eligible tier-1 company. However, section 719-130 will ensure that CGT event L5 is not triggered in relation to the lower tier subsidiary member.

5.85 The disposal of the membership interests in the on-going member that becomes an eligible tier-1 company to a foreign resident company may result in the head company of the old group making:

·
a capital gain or loss under CGT event A1; or
·
a capital gain under CGT event L5.

5.86 However, if a capital gain arises under CGT event A1 and these membership interests are taxable Australian property (as defined in section 855-20) both before and after the CGT event, the CGT roll-over for companies in the same wholly-owned group (Subdivision 126-B) may apply.

5.87 The disposal of the membership interests has no effect on the underlying tax attributes of the old group, such as the tax cost and tax history of its assets. These attributes are transferred to the head company of the new MEC group under section 719-125.

5.88 Despite subsections 719-130(1) and (3), where a consolidated group is created from a MEC group as result of a conversion, Subdivision 719-K (sections 719-550 to 719-570), together with any other provision to the extent that it is necessary for the application of Subdivision 719-K, will continue to apply to an ongoing member of the group. [Schedule 5, item 15, subsection 719-120(2) and section 719-135]

5.89 Subdivision 719-K determines the tax cost setting amount for pooled interests when, among other things, an eligible tier-1 company ceases to be a member of a MEC group. Subject to the limitations set out in subsection 719-560(2), a pooled interest is a membership interest that an entity, other than an entity that is a member of the MEC group, holds in an eligible tier-1 company of the MEC group.

5.90 The following provisions will continue to apply when a MEC group is created from a consolidated group as result of a conversion:

·
sections 719-300 and 719-325, which will apply only if the conversion involves (or is due to) the acquisition of a new eligible tier-1 company (that is an expansion) and have the effect of:

-
deeming prior group losses to be transferred losses; and
-
if the group has existing bundles of transferred losses, adjusting the available fraction for each of those bundles and for prior group loss bundles; and

·
sections 719-700 and 719-720, which apply to set the reference time for the head company of the new MEC group at the time the group comes into existence for any future application of the loss integrity rules in Subdivisions 165-CC and 165-CD.

5.91 Section 719-130 does not affect the operation of these provisions because they are not triggered by an ongoing member joining a MEC group or leaving a consolidated group.

Certain provisions do not apply because a MEC group ceases to exist

5.92 If the new group is a consolidated group, the following provisions that ordinarily apply when a MEC group ceases to exist at the conversion time, or which apply merely because the potential MEC group of which the old group consisted ceases to exist at that time, do not apply:

·
section 719-280, which deems a continuity of ownership test failure to happen to the head company of the MEC group in relation to unused losses because a MEC group or potential MEC group ceases to exist;
·
section 719-465, which deems a continuity of ownership test failure to happen to the head company of the MEC group in relation to bad debts because a MEC group or potential MEC group ceases to exist;
·
sections 719-705 and 719-725, which deem a changeover time and an alteration time under the loss integrity rules for the head company of the group at the time a MEC group or potential MEC group ceases to exist; and
·
any other provision in Part 3-90, to the extent that the application of the provision is necessary for the application of any of those sections - this would include, for example, other provisions in Subdivisions 719-F, 719-I and 719-T.

[Schedule 5, item 15, section 719-140]

5.93 As a group conversion may not result in an actual change of ultimate beneficial ownership, it is inappropriate to deem a continuity of ownership test failure when a MEC group or potential MEC group ceases to exist because of a group conversion.

5.94 Section 719-125 ensures that the head company of the new consolidated group inherits the history of the old MEC group or potential MEC group just as if the head company of the new group had been the head company of the old group at all times before the conversion time (including the history obtained because of the effects under section 719-90 that arise when there is a change in the head company of the old MEC group). Therefore:

·
continuity of ownership test losses made by the old MEC group are taken to have been made by the head company of the new consolidated group at the time they were made;
·
continuity of ownership test losses transferred to the old MEC group are taken to have been transferred to the head company of the new consolidated group at the time they were transferred to the head company of the old MEC group under Subdivision 707-A; and
·
for the purposes of applying the continuity of ownership test after the conversion time, the head company of the new consolidated group inherits the history of any ownership changes to the old MEC group - this will override the ownership history of the company prior to the time that it became the head company of the old MEC group.

5.95 In addition, as the new group is a consolidated group, the provisions in Subdivision 719-F which modify the continuity of ownership test for MEC groups will not apply to the group after the conversion time.

Consequential amendments

5.96 Sections 703-65 to 703-80 contain special rules if a shelf company is interposed into a consolidated group or MEC group and becomes the head company of the group. When the special rules apply, everything that happened in relation to the original head company before the completion time is taken to have happened in relation to the interposed company instead of in relation to the original head company.

5.97 A consequential amendment will clarify that everything that happened in relation to the original head company because of a group conversion involving a MEC group is also taken to have happened in relation to the interposed company (which becomes the new head company). [Schedule 5, items 9 and 10, paragraph 703-75(2)(d)]

5.98 Similarly, sections 719-90 and 719-95 set out the consequences that arise when there is a change in the head company of a MEC group since the previous income year. In these circumstances, everything that happened in relation to the original head company before the start of the income year for which there is a new head company is taken to have happened in relation to the new head company.

5.99 A consequential amendment will clarify that everything that happened in relation to the original head company because of a group conversion involving a MEC group is also taken to have happened in relation to the new head company. [Schedule 5, item 14, paragraph 719-90(2)(ca)]

5.100 In addition, consequential amendments will clarify that:

·
the members of a MEC group are the head company of the group and the subsidiary members of the group; and
·
the members of a potential MEC group are, broadly, the eligible tier-1 companies of the group and the subsidiary members of the group.

[Schedule 5, items 11, 12 and 16, subsection 719-25(3) and the definition of 'member' in subsection 995-1(1)]

Circumstances in which a company is eligible to be appointed as the provisional head company of a MEC group

5.101 Where the provisional head company of a MEC group ceases to be wholly-owned by its foreign holding company (that is, a cessation event happens), it is no longer eligible to be the head company of the group. In these circumstances, the MEC group will need to appoint a new provisional head company so that the group can continue to exist.

5.102 Where a MEC group is created part way through an income year and a cessation event happens to the original provisional head company in the same income year as the MEC group was created, the new provisional head company must have been a member of the MEC group from the start of the original provisional head company's income year (subparagraph 719-65(3)(d)(ii)).

5.103 Therefore, if the MEC group comes into existence after the start of the original provisional head company's income year because, for example, a MEC group is created from a consolidated group, and the cessation event happens before the end of that income year, the MEC group is effectively prevented from appointing a new provisional head company because no company is capable of satisfying the requirements in subparagraph 719-65(3)(d)(ii).

5.104 To overcome this difficulty, a company will be eligible to be appointed as the new provisional head company of a MEC group in these circumstances provided the company was a member of the MEC group from the time the MEC group came into existence. [Schedule 5, item 13, subparagraph 719-65(3)(d)(i)]

Application of Part 2

5.105 The amendments in Part 2 (other than the amendment in item 13 to modify the circumstances in which a company is eligible to be appointed as the provisional head company of a MEC group) apply from 27 October 2006. That is, the amendments will apply to:

·
a consolidated group that is created from a MEC group on or after 27 October 2006; or
·
a MEC group that is created from a consolidated group on or after 27 October 2006.

[Schedule 5, item 17]

5.106 However, the head company of a consolidated group or MEC group can make a choice to apply the amendments in Part 2 (other than the amendment in item 13) from 1 July 2002. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

[Schedule 5, item 17]

5.107 The amendments, which were announced by the former government on 27 October 2006, were sought by affected taxpayers and are beneficial as they will significantly reduce compliance costs.

5.108 The option to apply the amendments from 1 July 2002 will allow consolidated groups and MEC groups that are adversely affected by the operation of the current law to take advantage of the amendments, having regard to the compliance cost implications of applying the changes retrospectively.

5.109 The amendment in item 13 to modify the circumstances in which a company is eligible to be appointed as the provisional head company of a MEC group applies from 1 July 2002. [Schedule 5, item 17]

5.110 This amendment, which has been sought by taxpayers, is beneficial as it will allow greater access to certain transitional concessions that were available on the introduction of the consolidation regime.

Part 3 - Pre-CGT proportions

5.111 When an entity joins a consolidated group its membership interests cease to be recognised for income tax purposes. If those membership interests are pre-CGT assets (that is, interests acquired before 20 September 1985 that have not stopped being pre-CGT assets under the CGT provisions), the existing law preserves this status by attributing a pre-CGT factor to the underlying assets of the joining entity.

5.112 Due to the mechanics of the pre-CGT factor calculation, depending on the circumstances, only a proportion of the pre-CGT status of the group's membership interests in a joining entity is maintained when that entity later leaves the group. As a result, small and medium sized groups that have a significant proportion of pre-CGT membership interests may be disadvantaged by electing into the consolidation regime.

5.113 To overcome these concerns, the mechanism for preserving the pre-CGT status of membership interests in a joining entity will be modified. The new mechanism will involve working out the proportion (measured by market value) of membership interests in the joining entity that have pre-CGT status - that is, the pre-CGT proportion. The pre-CGT proportion is used when an entity leaves a consolidated group to work out the number of its membership interests that are pre-CGT assets. [Schedule 5, items 18, 19 and 34, subsection 705-125(1) and the definition of 'pre-CGT proportion' in subsection 995-1(1)]

5.114 The pre-CGT proportion is the amount worked out using the formula:

(Market value of pre-CGT membership interests / Market value of all memebership interests)

where:

·
the market value of pre-CGT membership interests is the sum of the market value of each membership interest in the joining entity that:

-
is held by a member of the group at the joining time; and
-
is a pre-CGT asset; and

·
the market value of all membership interests is the sum of the market value of each membership interest in the joining entity that is held by a member of the group at the joining time.

[Schedule 5, item 20, subsection 705-125(2)]

5.115 When the entity ceases to be a member of the consolidated group, subject to integrity rules, some or all of the membership interests in the leaving entity will be treated as pre-CGT assets. [Schedule 5, items 25 and 26, subsection 711-65(1)]

5.116 This includes a leaving entity that ceases to be a member of a consolidated group because it is a wholly-owned subsidiary of another entity that ceases to be a member of the group. [Schedule 5, item 26, subsection 711-65(1A)]

5.117 The membership interests in the leaving entity that are treated as pre-CGT assets is worked out using the formula:

(Number of membership interests in the leaving entity held by members of the old group) x (leaving entity's pre-CGT proportion)

5.118 For the purposes of applying the formula, the leaving entity's pre-CGT proportion is the amount worked out under section 705-125. [Schedule 5, item 28, subsection 711-65(4)]

Example 5.14 : Pre-CGT proportion - single class of shares Company J has 10,000 ordinary shares on issue. Head Co owns all 10,000 shares, 8,000 of which are pre-CGT assets. The remaining 2,000 shares are post-CGT assets.On 1 July 2002 Head Co forms a consolidated group. Company J is a subsidiary member of the group. The net market value of Company J at the joining time is $450,000. Each share has a market value of $45.The pre-CGT proportion of the membership interests in Company J is calculated as follows:

(Market value of pre-CGT shares / Market value of all shares)

= ($360,000 / $450,000)

= 80 per cent.

On 1 July 2004, Head Co sells 1,000 shares to a third party. As a result, Company J leaves Head Co's consolidated group.The pre-CGT proportion of Head Co's membership interests in Company J is 80 per cent. Therefore, 8,000 shares are pre-CGT assets.Head Co chooses to sell 1,000 shares that are pre-CGT assets. Therefore, of the 9,000 shares that Head Co continues to hold in Company J:

·
7,000 shares are pre-CGT assets; and
·
2,000 shares are post-CGT assets.

Example 5.15 : Pre-CGT proportion - more than one class of shares Company Z has 50 class A shares and 50 class B shares on issue.Head Co owns:

·
25 of Company Z's class A shares - these shares are pre-CGT assets as they were acquired by Head Co prior to 20 September 1985 and have not stopped being pre-CGT assets under the CGT provisions; and
·
30 of Company Z's class B shares - these shares are post-CGT assets as they were acquired by Head Co after 19 September 1985.

Company Y, which is wholly-owned by Head Co, owns:

·
25 of Company Z's class A shares - these shares are pre-CGT assets as they were acquired by Company Y prior to 20 September 1985 and have not stopped being pre-CGT assets under the CGT provisions; and
·
20 of Company Z's class B shares - these shares are post-CGT assets as they were acquired by Company Y after 19 September 1985.

On 1 July 2003, Head Co forms a consolidated group. Company Y and Company Z are subsidiary members of the group.The net market value of Company Z at the joining time is $5 million. The market value of each Class A share is $60,000 ($3 million in total) and the market value of each Class B share is $40,000 ($2 million in total).The pre-CGT proportion of the membership interests in Company Z is 60 per cent, calculated as follows:

(Market value of pre-CGT shares / Market value of all shares)

= ($3,000,000 / $5,000,000)

= 60 per cent.

After the consolidated group is formed the following intra-group transactions occur;

·
Company Z buys back the 20 Class B shares held by Company Y (leaving Head Co with 30 Class B shares in Company Z); and
·
Company Y sells the 25 Class A shares it holds in Company Z to another subsidiary member (Company W).

As these are intra-group transactions, they are ignored by Head Co for income tax purposes.On 15 May 2008, Head Co sells 25 Class A shares and 30 Class B shares that it holds in Company Z to a third party. As a result, Company Z leaves Head Co's consolidated group.As Company Z has two classes of shares, the pre-CGT proportion is applied separately to each class as if the shares in that class were all the shares held by the old group in the leaving entity. Therefore:

·
30 of the class A shares are pre-CGT assets (that is, 50 × 60 per cent); and
·
18 of the class B shares are pre-CGT assets (that is, 30 × 60 per cent).

In relation to the shares that are sold:

·
Head Co chooses to treat all of the 25 Class A shares as pre-CGT assets; and
·
18 class B shares (out of the 30 shares that are sold) are pre-CGT assets.

Head Co continues to hold 25 Class A shares in Company Z, 5 of which are pre-CGT assets.

Application of Division 149 to the head company

5.119 Division 149 sets out when an asset acquired before 20 September 1985 will stop being a pre-CGT asset for CGT purposes.

5.120 Broadly, for an asset's pre-CGT status to be maintained, entities must be able to demonstrate that the same ultimate owners who held (directly or indirectly) more than 50 per cent of the beneficial interests in the asset, and in the ordinary income derived from the asset, just before 20 September 1985 have continued to hold more than 50 per cent of these interests at the relevant time.

5.121 An integrity rule will apply to ensure broadly consistent treatment for membership interests in a leaving entity that are taken to be pre-CGT assets under the pre-CGT proportion rules.

5.122 The integrity rule will apply if the leaving entity held assets when it became a subsidiary member of the old group (disregarding the single entity rule (subsection 701-1(1)), and:

·
some or all of the assets stopped being pre-CGT assets under Division 149 at a time (the Division 149 time) when they were held by the head company of the group (because of the single entity rule), provided that the leaving entity was a subsidiary member of the group at that time; or
·
some or all of the assets would have stopped being pre-CGT assets under Division 149 at a time (also the Division 149 time) when they were held by the head company of the group (because of the single entity rule) if they had been pre-CGT assets just before that time, provided that the leaving entity was a subsidiary member of the group at that time.

[Schedule 5, item 30, subsection 711-70(1)]

5.123 If the integrity rule applies, the pre-CGT proportion of a leaving entity at the leaving time is taken to be nil. [Schedule 5, item 30, subsection 711-70(2)]

5.124 In addition, if the integrity rule applies, an adjustment may be made to the old group's allocable cost amount for the leaving entity.

5.125 The purpose of this adjustment is to provide, broadly, parity with the outcome that would arise if Division 149 applied to an entity that is not a member of a consolidated group. The integrity rule adjusts the tax costs of the membership interests in the leaving entity on the assumption that, because of Division 149, those membership interests lost their pre-CGT status at the time when the integrity rule applies.

5.126 The amount of the adjustment is worked out by comparing the amount worked under subsection 711-70(4) (the subsection 711-70(4) amount) with the amount worked out under subsection 711-70(6) (the subsection 711-70(6) amount).

·
If the subsection 711-70(4) amount exceeds the subsection 711-70(6) amount, the old group's allocable cost amount for the leaving entity is increased by the amount of the excess.
·
If the subsection 711-70(4) amount is less than the subsection 711-70(6) amount, the old group's allocable cost amount for the leaving entity is reduced by the amount of the shortfall.

[Schedule 5, item 30, subsection 711-70(3)]

5.127 The subsection 711-70(4) amount is:

·
if the tax cost setting rules in Subdivision 705-A applied in relation to the leaving entity at the time it became a subsidiary member of the old group, the total of the amounts that were taken into account under subsection 711-65(1) for membership interests in the leaving entity at that time; or
·
otherwise, the total of the amounts that would have been taken into account under subsection 711-65(1) for membership interests in the leaving entity at the time it became a subsidiary member of the old group assuming that the tax cost setting rules in Subdivision 705-A (rather than the rules in Subdivisions 705-B or 705-D) had applied in relation to the leaving entity at that time.

[Schedule 5, item 30, subsection 711-70(4)]

5.128 For these purposes, if a membership interest in the leaving entity was a pre-CGT interest when the entity joined the group, the amount that taken into account under subsection 711-65(1) for the membership interest is taken to be the market value of the interest just after the Division 149 time (rather than the amount actually taken into account under subsection 711-65(1) at the joining time). [Schedule 5, item 30, subsection 711-70(5)]

5.129 The subsection 711-70(6) amount is the amount of the old group's allocable cost amount worked out on the assumption that the leaving entity ceased to be a subsidiary member of the old group just after the Division 149 time. [Schedule 5, item 30, subsection 711-70(6)]

Example 5.16 : Application of Division 149 to the head company Head Co was incorporated on 1 July 1980 with share capital of $1,000 (1,000 ordinary shares). Suzanne and Wayne were each issued with 500 ordinary shares in Head Co.Subco A was incorporated on 1 July 1983 with a share capital of $680 (680 ordinary shares). All of those ordinary shares were immediately issued to Head Co.Subco B was incorporated on 1 August 1983 with share capital of $400 (400 ordinary shares). At that time, 280 ordinary shares were issued to Subco A. Subco A acquired the remaining 120 ordinary shares in 2000 for $1,583 (when the market value of Subco B was $5,275).On 1 July 2002, Head Co formed a consolidated group, with Subco A and Subco B as subsidiary members of the group.The market value and terminating value Subco A's assets and liabilities as at 1 July 2002 are as follows:

Subco A Market value ($) Terminating value ($)
Assets
Cash 930 930
Land and buildings (pre-CGT) 3,000 400
Shares in Subco B 5,765 1,863
Total assets 9,695 3,193
Equity
Share capital 680
Retained taxed profits 2,513
Total equity 3,193
The pre-CGT proportion of Subco A is 100 per cent.Under the tax cost setting rules in Division 705, the assets brought into the group by Subco A receive the following tax cost setting amounts:

·
Cash $930
·
Land and buildings (pre-CGT) $775
·
Shares in Subco B $1,488

The market value and terminating value Subco B's assets and liabilities as at 1 July 2002 are as follows:
Subco B Market value ($) Terminating value ($)
Assets
Cash 405 405
Trading stock 2,300 2,300
Plant and equipment 1,360 1,360
Goodwill (pre-CGT) 4,000 0
Total assets 5,795 4,065
Liabilities
Creditors 2,300 2,300
Net assets 5,765 1,765
Equity
Share capital 400
Retained taxed profits 1,365
Total equity 1,765
The pre-CGT proportion of Subco B is 70 per cent (that is, 280 / 400).Under the tax cost setting rules in Division 705, the assets brought into the group by Subco B receive the following tax cost setting amounts:

·
Cash $405
·
Trading stock $1,347
·
Plant and equipment $796
·
Goodwill (pre-CGT) $2,343

After formation of the consolidated group, Suzanne sells 30 of the ordinary shares she owns in Head Co to Melissa.The share sale by Suzanne results in Division 149 applying to:

·
the pre-CGT land and buildings asset brought into the group by Subco A; and
·
the pre-CGT goodwill asset brought into the group by Subco B.

The market value of the land and buildings asset at the time that Division 149 applies is $3,000. Therefore, for CGT purposes, the asset is taken to have been acquired by Head Co for $3,000 at that time.The market value of the goodwill asset at the time that Division 149 applies is $4,000. Therefore, for CGT purposes, the asset is taken to have been acquired by Head Co for $4,000 at that time. Division 149 adjustment to the old group's allocable cost amount for Subco B As Division 149 applies to the goodwill asset brought into the group by Subco B, the pre-CGT proportion allocated to Subco B's membership interests will be taken to be nil if it ceases to be a subsidiary member of the group (subsections 711-70(1) and (2)).To compensate for the loss of the pre-CGT proportion, the old group's allocable cost amount for Subco B is adjusted when it leaves the group.The Division 149 adjustment is worked out in three steps. For these purposes, it is assumed that the assets, liabilities and market value of Subco B just after the Division 149 time are the same as at 1 July 2002.Step 1 is to work out the subsection 711-70(4) amount for the membership interests in Subco B, which is the sum of:

·
the amount taken into account under section 705-65(1) for the 120 ordinary shares acquired after 20 September 1985, on the assumption that Subdivision 705-A applied to work out the tax cost setting amount for Subco B when it joined the group - that is, $1,583; and
·
the amount that would have been included for the 280 ordinary shares acquired prior to 20 September 1985 if Subco B had joined the group just after the Division 149 time - that is, $4,036 (that is, $5,765 × 70 per cent).

Therefore, the subsection 711-70(4) amount is $5,619.Step 2 is to work out the subsection 711-70(6) amount, which is the old group's allocable cost amount for Subco B on the assumption that if it left the group just after the Division 149 time, as follows:

·
the terminating values of Subco B's assets just before the leaving time (step 1 of the old group's allocable cost amount) is $6,548 - that is, the sum of the following amounts:

-
Cash $405
-
Trading stock $1,347
-
Plant and equipment $796
-
Goodwill $4,000

·
reduced by the amount of Subco B's liabilities just before the leaving time (step 4 of the old group's allocable cost amount) - that is, $2,300.

Therefore, the subsection 711-70(6) amount is $4,248.Step 3 is to compare the subsection 711-70(4) amount with the subsection 711-70(6) amount. The subsection 711-70(4) amount ($5,619) exceeds the subsection 711-70(6) amount ($4,248) by $1,371.Therefore, if Subco B leaves the group, the old group's allocable cost amount for Subco B will be increased by $1,371. Division 149 adjustment to the old group's allocable cost amount for Subco A As Division 149 applies to the land and buildings asset brought into the group by Subco A, the pre-CGT proportion allocated to Subco A's membership interests will be taken to be nil if it ceases to be a subsidiary member of the group (subsections 711-70(1) and (2)).To compensate for the loss of the pre-CGT proportion, the old group's allocable cost amount for Subco A is adjusted when it leaves the group.The Division 149 adjustment is worked out in three steps. For these purposes, it is assumed that the assets, liabilities and market value of Subco A just after the Division 149 time are the same as at 1 July 2002.Step 1 is to work out the subsection 711-70(4) amount for the membership interests in Subco A. As all the membership interests in Subco A are pre-CGT assets, the subsection 711-70(4) amount is the amount that would have been included for the 680 ordinary shares acquired prior to 20 September 1985 if Subco A had joined the group just after the Division 149 time - that is, $9,695.Step 2 is to work out the subsection 711-70(6) amount, which is the old group's allocable cost amount for Subco A on the assumption that if it left the group just after the Division 149 time. As Subco A has no liabilities, the subsection 711-70(6) amount is the terminating values of Subco A's assets just before the leaving time (step 1 of the old group's allocable cost amount). Therefore, the subsection 711-70(6) amount is $9,549 - that is, the sum of the following amounts:

-
Cash $930
-
Land and buildings $3,000
-
Shares in Subco B $5,619

The terminating value for the shares in Subco B ($5,619) is the old group's allocable cost amount for those shares just after the Division 149 time ($4,248) increased by the adjustment made under paragraph 711-70(3)(a) ($1,371).Step 3 is to compare the subsection 711-70(4) amount with the subsection 711-70(6) amount. The subsection 711-70(4) amount ($9,695) exceeds the subsection 711-70(6) amount ($9,549) by $146.Therefore, if Subco B leaves the group, the old group's allocable cost amount for Subco B will be increased by $146.

Application of CGT event K6

5.130 CGT event K6 (section 104-230) happens if certain CGT events happen to pre-CGT shares in a company or pre-CGT interests in a trust and, just before the time of the event, the market value of the post-CGT property of the company or trust, or of other entities in which the company or trust has a direct or indirect interest, is 75 per cent or more of the net value of the company or trust.

5.131 An integrity rule will apply to ensure broadly consistent treatment for membership interests in a leaving entity that are taken to be pre-CGT assets under the pre-CGT proportion rules.

5.132 The integrity rule will apply if the leaving entity ceases to be a member of the old group and, as a result, one of the following CGT events happens to one or more of its membership interests:

·
CGT event A1 (disposal of a CGT asset);
·
CGT event C2 (cancellation, surrender and similar endings of an intangible CGT asset);
·
CGT event E1 (creating a trust over a CGT asset);
·
CGT event E2 (transferring a CGT asset to a trust); or
·
CGT event E8 (disposal by a beneficiary of a capital interest in a trust).

[Schedule 5, item 30, subsection 711-75(1)]

5.133 In these circumstances, two modifications are made to the operation of CGT event K6 (section 104-230).

5.134 The first modification to the operation of CGT event K6 is that, for the purpose of applying subsections 104-230(2) and (8) in relation to those membership interests:

·
the single entity rule (subsection 701-1(1)) is disregarded for the purpose of working out the net value of the leaving entity, which includes working out the market value of both the pre-CGT and post-CGT property; and
·
subsection 104-230(2) is applied just before the leaving time (rather than just before the other event happened).

[Schedule 5, item 30, subsection 711-75(2)]

5.135 The single entity rule is still taken into account for the purpose of determining whether the property mentioned in subsection 104-230(2) for the leaving entity was acquired on or after the 20 September 1985. Consequently, if the property is pre-CGT property for the head company's tax purposes, then it will be pre-CGT property for the purposes of applying subsection 104-230(2), even if it was transferred to the leaving entity by another member of the group after joining time.

5.136 In the case where two or more entities leave the group at the same time (that is, a multiple exit (section 711-55)), the property referred to in subsection 104-230(2) may include membership interests in another entity which leaves the group at the leaving time. The pre-CGT proportion rules in section 711-65 apply to determine which of those membership interests are post-CGT assets for the purposes of applying subsection 104-230(2).

5.137 As the single entity rule is disregarded for the purpose of working out the net value of the leaving entity, intra-group acquisitions of property by the leaving entity or the discharge or release of intra-group liabilities may still be taken into account for the purpose of applying subsection 104-230(8). The intra-group transaction would be taken into account if, for example, the acquisition, discharge or release was done for a purpose of ensuring that the requirement in subsection 104-230(2) would not be satisfied in a particular situation.

5.138 The second modification to the operation of CGT event K6 is that, for the purpose of determining the sum of the cost bases of the property mentioned in subsection 104-230(6), the cost base of an asset that is included in that property is taken to be:

·
if the asset has its tax cost set at the leaving time under section 701-50 - the asset's tax cost setting amount;
·
if the terminating value of the asset is taken into account in working out the step 1 amount under section 711-25 for the leaving entity - the asset's terminating value; or
·
if the asset is taken into account in working out the step 3 amount under section 711-40 for the leaving entity - the value of the asset taken into account for that purpose.

[Schedule 5, item 30, subsection 711-75(3)]

Consequential amendments

5.139 Consequential amendments will:

·
modify a cross reference in subsection 705-125(4);
·
repeal the existing pre-CGT factor rules in sections 705-165, 705-205 and 705-245, the note to subsection 711-65(2), subsection 711-65(5), sections 713-245 and 713-270; and
·
repeal the definition of 'pre-CGT factor' in subsection 995-1(1).

[Schedule 5, items 21 to 24, 27, 29 and 31 to 33, sections 705-125, 705-165 , 705-205, 705-245, 711-65, 713-245, 713-270 and the definition of 'pre-CGT factor' in subsection 995-1(1)]

Application of Part 3

5.140 The amendments in Part 3 apply from the date of introduction of this Bill into the House of Representatives. That is, the amendments will apply to an entity that joins a consolidated group on or after that date. [Schedule 5, item 35]

5.141 However, the head company of a consolidated group can make a choice to apply the amendments in Part 3 to an entity that joins a consolidated group on or after 1 July 2002. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

[Schedule 5, item 35]

5.142 This option to apply the amendments from 1 July 2002 will allow consolidated groups that are adversely affected by the operation of the current law to take advantage of the amendments, having regard to the compliance cost implications of applying the changes retrospectively.

Modifications to the tax cost setting rules when an entity joins a consolidated group

5.143 Under the tax cost setting rules, the tax costs of a joining entity's assets are generally reset by allocating the joining entity's allocable cost amount to each of the joining entity's assets in proportion to their market value. This allocation process ensures that, broadly, the costs incurred by the head company to acquire the joining entity's membership interests are pushed down into the tax costs of the underlying assets of the joining entity.

5.144 The allocable cost amount is basically the sum of the cost bases of the head company's membership interests in the joining entity held by members of the joined group and the joining entity's liabilities. Several adjustments are made to this amount.

5.145 The amendments will clarify and improve the operation of the tax cost setting rules when an entity joins a consolidated group to:

·
ensure adjustments to the allocable cost amount are not double counted;
·
clarify the operation of the adjustment to the allocable cost amount in respect of certain pre-joining time CGT roll-overs that applied to a joining entity's assets; and
·
phase out the over-depreciation adjustment to the allocable cost amount.

Part 4 - No double counting of amounts in the allocable cost amount

5.146 Under the tax cost setting rules, several adjustments are made to the allocable cost amount. In some circumstances the adjustments to the allocable cost amount can be duplicated. As a result, the tax costs allocated to the joining entity's assets can be distorted.

5.147 A duplication can arise, for example, because integrity measures in the income tax law prevent the duplication of losses by reducing the cost base of shares. This adjustment to the cost base of shares causes a potential double adjustment to the allocable cost amount because:

·
it may be reflected in an adjustment to step 1;
·
it may be reflected in reduced undistributed profits of the joining entity at step 3; and / or
·
it may be reflected in the tax losses of the joining entity at step 5.

5.148 The object of section 705-62 is to prevent a particular amount from being taken into account more than once when calculating the allocable cost amount for the joining entity for the purpose of promoting the object of Subdivision 705-A. [Schedule 5, item 36, subsection 705-62(1)]

5.149 The object of Subdivision 705-A, which is set out in subsections 705-10(2) and (3), is broadly:

·
to recognise the head company's cost of becoming a holder of the joining entity's assets as an amount reflecting the group's cost of acquiring the entity; and
·
to align the costs of the assets with the costs of membership interests, and to preserve this alignment until the entity ceases to be a subsidiary member, in order to:

-
prevent double taxation of gains and duplication of losses; and
-
remove the need to adjust costs of membership interests in response to transactions that shift value between them, as the required adjustments occur automatically.

5.150 Section 705-62 applies if two or more provisions of the income tax law operate with the result of:

·
altering the allocable cost amount for the joining entity because of a particular economic attribute of the joining entity; or
·
altering the allocable cost amount for another entity that becomes a subsidiary member of the group at the joining time because of a particular economic attribute of the joining entity.

[Schedule 5, item 36, subsection 705-62(2)]

5.151 The economic attributes of the joining entity include:

·
the joining entity's retained profits;
·
the joining entity's distributions of profits to other entities;
·
the joining entity's realised and unrealised losses;
·
the joining entity's deductions;
·
the joining entity's accounting liabilities (within the meaning of subsection 705-70(1)); and
·
consideration received by the joining entity for issuing membership interests in itself.

[Schedule 5, item 36, subsection 705-62(6)]

5.152 Where section 705-62 applies, the head company can choose which alteration is made. The choice must be made in writing by the day on which the head company lodges its income tax return for the income year in which the joining time occurs or within such further time as the Commissioner allows. [Schedule 5, item 36, paragraph 705-62(3)(a) and subsections 705-62(4) and (5)]

5.153 If the head company does not make a choice, only the alteration that is most appropriate, in the light of the object of Subdivision 705-A, is to be made. [Schedule 5, item 36, paragraph 705-62(3)(b)]

Example 5.17 : No double counting of adjustments to the allocable cost amount Holding Co incorporates Admin Co with $200,000. Admin Co uses the $200,000 to incorporate Beta Co. Beta Co realises a tax loss of $50, and has assets of $150,000 remaining.There is an alteration in underlying majority ownership of Holding Co so that Subdivision 165-CD applies to reduce the reduced cost base of Admin Co's membership interests in Beta Co, and Holding Co's membership interests in Admin Co, by $50,000 to $150,000. For the purposes of this example, any tax effects arising as a result of the alteration have been ignored.Holding Co then forms a consolidated group.Under the current law, the tax cost setting rules apply to Admin Co as follows.

·
Step 1 of the allocable cost amount is the reduced cost base of Holding Co's membership interests in Admin Co (that is, $150,000) - the reduced cost base of the membership interests is used because the market value of those membership interests is less than or equal to their reduced cost base.
·
No other steps apply, so Holding Co's allocable cost amount for Admin Co is $150,000.
·
This allocable cost amount will be allocated to the membership interests in Beta Co (the only asset of Admin Co).

Under the current law, the tax cost setting rules apply to Beta Co as follows.

·
Step 1 of the allocable cost amount is the reduced cost base of Admin Co's membership interests in Beta Co (that is, $150,000).
·
The step 1 amount is reduced by the amount of losses accruing to joined group before the joining time (that is, $50,000) under step 5 of the allocable cost amount.
·
Holding Co's allocable cost amount for Beta Co is $100,000.
·
This allocable cost amount will be allocated to the assets of Beta Co.

This is an inappropriate outcome. Holding Co invested $200,000 in Admin Co which, in turn, invested $200,000 in Beta Co. Beta Co had a tax loss of $50,000. Therefore, the correct tax cost setting amount for both companies should be $150,000.Applying section 705-62, the allocable cost amount for Admin Co will be unchanged - that is, it will continue to be $150,000.However, to prevent double counting, Holding Co chooses to ignore the step 5 adjustment. This is because the loss has already been taken into account in calculating the step 1 amount for Beta Co. As a result, the allocable cost amount for Beta Co will be increased to $150,000.

Application of Part 4

5.154 The amendments in Part 4 apply from the date of introduction of this Bill into the House of Representatives. That is, the amendments will apply to an entity that joins a consolidated group on or after that date. [Schedule 5, item 37]

5.155 However, the head company of a consolidated group can make a choice to apply the amendments in Part 4 to an entity that joins a consolidated group on or after 1 July 2002. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

[Schedule 5, item 37]

5.156 This option to apply the amendments from 1 July 2002 will allow consolidated groups that are adversely affected by the operation of the current law to take advantage of the amendments, having regard to the compliance cost implications of applying the changes retrospectively.

5.157 Where a choice is made to apply the amendments retrospectively (so that the joining time occurs before the day on which this Bill obtains Royal Assent), a transitional rule allows the choice to determine the alteration to the allocable cost amount which is most appropriate (that is, the choice in subsection 705-62(4)) to be made on or before 30 June 2011, or within such further time as the Commissioner allows. [Schedule 5, item 38]

Part 5 - Pre-joining time roll-overs

5.158 Step 3A (section 705-93) adjusts the allocable cost amount for a joining entity where the joining entity has a deferred capital gain or loss that arose because of a CGT roll-over from a foreign resident company before the joining time.

5.159 The step 3A amount is also adjusted where there has been a pre-formation time CGT roll-over of an asset from the head company to a member of the wholly-owned group (section 705-150).

5.160 The adjustment at step 3A of the allocable cost amount is intended to prevent the deferred gain or loss arising from the pre-joining time CGT roll-over of an asset between members of the same wholly-owned group from being included in the tax costs of a joining entity's assets as a result of the tax cost setting process. This adjustment removes the amount of the deferred gain or loss from the allocable cost amount and prevents it from being indefinitely deferred for tax purposes.

5.161 Currently the step 3A adjustment is deficient because, for example:

·
the adjustment does not apply if a subsequent CGT event (such as CGT event G1) happened to the roll-over asset where that CGT event does not cause the deferred gain or loss to be brought to account for tax purposes;
·
the adjustment may apply inappropriately when an entity becomes a member of a consolidated group after the tax costs of its membership interests has been set under Division 711 because it left another consolidated group; and
·
the amount of the adjustment under section 705-150 may be incorrect.

5.162 To overcome these concerns, section 705-93 will be modified so that a step 3A amount arises where:

·
before the joining time, there was a Subdivision 126-B roll-over or a former section 160ZZO roll-over in relation to an asset (existing paragraph 705-93(1)(a));
·
at the joining time, as a result of the Subdivision 126-B roll-over or the former section 160ZZO roll-over, the roll-over asset has a deferred roll-over gain or a deferred roll-over loss;
·
the originating company in relation to the Subdivision 126-B roll-over, or the transferor in relation to the former section 160ZZO roll-over:

-
was a foreign resident; or
-
is the head company in relation to the joined group;

·
the recipient company in relation to the Subdivision 126-B roll-over, or the transferee in relation to the former section 160ZZO roll-over:

-
was an Australian resident; and
-
is a spread entity in relation to the joined group;

·
if the recipient company was previously a subsidiary member of another consolidated group, the conditions in section 104-182 (which prevents CGT event J1 from happening if the recipient company ceases to be a subsidiary member of a consolidated group at the time the group breaks up) were not satisfied at any time in relation to the other group between:

-
the time of the Subdivision 126-B roll-over and the joining time; or
-
the time of the former section 160ZZO roll-over and the joining time;

·
the roll-over asset is not a pre-CGT asset at the joining time (existing paragraph 705-93(1)(e)); and
·
the roll-over asset becomes that of the head company of the joined group because the single entity rule (subsection 701-1(1)) applies when the joining entity becomes a subsidiary member of the group (existing paragraph 705-93(1)(f)).

[Schedule 5, items 41 to 45, paragraphs 705-93(1)(a) to (d)]

5.163 The step 3A amount is the amount of the deferred roll-over gain or the deferred roll-over loss. [Schedule 5, item 46, subsection 705-93(2)]

5.164 If the step 3A amount is a deferred roll-over gain, the allocable cost amount is reduced by the amount of the deferred roll-over gain. If the step 3A amount is a deferred roll-over loss, the allocable cost amount is increased by the amount of the deferred roll-over loss. [Schedule 5, item 40, item 3A in the table in section 705-60]

5.165 An asset has a deferred roll-over gain at a particular time if:

·
before that time there was a CGT roll-over in relation to a disposal or a CGT event that happened in relation to the asset; and
·
as a result of the roll-over, all or part of a capital gain from the CGT event was disregarded.

[Schedule 5, item 50, paragraphs (a) and (b) of the definition of 'deferred roll-over gain' in subsection 995-1(1)]

5.166 The amount of the deferred roll-over gain is the amount of the capital gain that was disregarded, reduced by the amount (if any) by which the gain has been taken into account in working out a net capital gain or net capital loss in relation to the asset between the roll-over time and the particular time. [Schedule 5, item 50, the definition of 'deferred roll-over gain' in subsection 995-1(1)]

5.167 An asset has a deferred roll-over loss at a particular time if:

·
before that time there was a CGT roll-over in relation to a disposal or a CGT event that happened in relation to the asset; and
·
as a result of the roll-over, all or part of a capital loss from the CGT event was disregarded.

[Schedule 5, item 51, paragraphs (a) and (b) of the definition of 'deferred roll-over loss' in subsection 995-1(1)]

5.168 The amount of the deferred roll-over loss is the amount of the capital loss that was disregarded, reduced by the amount (if any) by which the loss has been taken into account in working out a net capital gain or net capital loss in relation to the asset between the roll-over time and the particular time. [Schedule 5, item 51, the definition of 'deferred roll-over loss' in subsection 995-1(1)]

5.169 A stick entity , in relation to a consolidated group, means a member of the group that is:

·
the head company of the group;
·
a chosen transitional entity; or
·
a transitional foreign-held subsidiary.

[Schedule 5, item 53, paragraph (a) of the definition of 'stick entity' in subsection 995-1(1)]

5.170 A stick entity , in relation to a MEC group, means a member of the group that is:

·
the head company of the group;
·
a chosen transitional entity;
·
a transitional foreign-held subsidiary; or
·
an eligible tier-1 company.

[Schedule 5, item 51, paragraph (b) of the definition of 'stick entity' in subsection 995-1(1)]

5.171 A spread entity , in relation to a consolidated group or a MEC group, means a member of the group that is not a stick entity in relation to the group. [Schedule 5, item 52, the definition of 'spread entity' in subsection 995-1(1)]

5.172 Section 705-147 modifies the operation of step 3A of the allocable cost amount (section 705-93) in the case of a group formation to:

·
apportion the step 3A amount among the first level interposed entities; and
·
take account of a roll-over asset that is a membership interest in an entity that becomes a subsidiary member at the formation time.

5.173 As a result of the amendments to section 705-93, consequential amendments to section 705-147 clarify the scope of its operation and remove redundant elements of the section. [Schedule 5, item 47, subsection 705-147(3)]

5.174 Section 705-150 adjusts the step 3A amount for pre-formation time CGT roll-overs by the head company to a subsidiary member. The amendments broaden the scope of section 705-93. As a result, section 705-150 is no longer necessary and is therefore being repealed. [Schedule 5, item 48]

5.175 As a result of the modifications to section 705-93 and the repeal of section 705-150, consequential amendments will:

·
remove the reference to section 705-150 in paragraph 104-505(1)(b); and
·
replace the reference to section 705-150 with a reference to section 705-93 in section 126-165 of the Income Tax (Transitional Provisions) Act 1997 .

[Schedule 5, items 39 and 54, paragraph 104-505(1)(b) of the ITAA 1997 and section 126-165 of the Income Tax (Transitional Provisions) Act 1997]

5.176 Section 705-227 modifies the operation of step 3A of the allocable cost amount (section 705-93) for linked entities that join a consolidated group to:

·
apportion the step 3A amount among the first level interposed entities; and
·
take account of a roll-over asset that is a membership interest in a linked entity that is held by another linked entity.

5.177 As a result of the amendments to section 705-93, consequential amendments to section 705-227 clarify the scope of its operation and remove redundant elements of the section. [Schedule 5, item 49, subsection 705-227(3)]

Application of Part 5

5.178 The amendments in Part 5 apply from 1 July 2002. [Schedule 5, item 55]

5.179 These amendments, which ensure that the income tax law operates as originally intended, prevent the duplication of capital gains in some circumstances and therefore are beneficial to taxpayers.

Part 6 - Phasing out over-depreciation adjustments

5.180 In some cases the amount of the reset tax cost setting amount that would otherwise apply to an over-depreciated asset of a joining entity is reduced (section 701-50).

5.181 The over-depreciation adjustment prevents the indefinite deferral of tax on the profits sheltered due to the over-depreciation of the asset. This can arise where the accelerated depreciation of assets has brought forward the joining entity's depreciation deductions, thus deferring the payment of tax on its profits. The profits remain untaxed when the entity joins the group where:

·
the asset is over-depreciated at that time;
·
the profits have been distributed to another entity that was entitled to the former inter-corporate dividend rebate; and
·
the profits have not been distributed to another entity that did not have access to the former inter-corporate dividend rebate.

5.182 Currently, to work out whether the reset tax cost setting amount of an over-depreciated asset of a joining entity needs to be reduced by an over-depreciation adjustment, the joining entity needs to determine whether it paid unfranked or partly franked dividends to shareholders that were entitled to the former inter-corporate dividend rebate prior to the joining time. The inter-corporate dividend rebate for unfranked dividends was removed from 1 July 2004 following the introduction of the simplified imputation system.

5.183 To reduce compliance costs, a joining entity will have to look only at the five years of dividend history prior to the joining time to determine whether an over-depreciation adjustment is required. [Schedule 5, item 56, paragraph 705-50(2)(b)]

5.184 As a consequence, the over-depreciation adjustment ceases to have any effect after 1 July 2009. Therefore, the over-depreciation adjustment is being repealed with effect from that date. [Schedule 5, items 58 to 77, sections 705-50, 705-55, 705-57, 705-59, 705-190, 713-225, 713-230, 715-900, 716-330, 716-340 and the definitions of 'over-depreciated' and 'over-depreciation' in subsection 995-1(1) of the ITAA 1997 and sections 126-165, 701-40 and 705-305 of the Income Tax (Transitional Provisions) Act 1997]

Application of Part 6

5.185 The amendments in Part 6 that modify the operation of the over-depreciation adjustment apply in relation to entities that become members of a consolidated group between 9 May 2007 and 30 June 2009. [Schedule 5, item 57]

5.186 In this regard, these amendments, which were sought by an industry representative body, are beneficial to taxpayers as they will significantly reduce compliance costs.

5.187 The amendments to repeal the over-depreciation adjustment apply in relation to entities that become members of a consolidated group on or after 1 July 2009. [Schedule 5, item 78]

Modifications to the tax cost setting rules when an entity leaves a consolidated group

5.188 When an entity leaves a consolidated group, the tax costs of the membership interests in the leaving entity are reconstructed. That is, the tax cost setting amount for each membership interest held in the leaving entity by members of the old group is worked out by, broadly, allocating a proportion of the old group's allocable cost amount to each membership interest (section 711-15).

5.189 The amendments will clarify and improve the operation of the tax cost setting rules when an entity leaves a consolidated group to:

·
clarify that the liabilities taken into account in working out step 4 of the old group's allocable cost amount are the liabilities held just before the leaving time; and
·
ensure that an appropriate adjustment is made to the amount included at step 4 of the old group's allocable cost amount in respect of a liability when that liability was taken into account in working out the allocable cost amount for an entity that joined the group.

Division 1 of Part 7 - Leaving time liabilities: Timing

5.190 When an entity leaves a consolidated group, the group's cost of the membership interests in the leaving entity is set so that it reflects the cost to the group of the net assets of the leaving entity. The cost of the membership interests in the leaving entity is determined by working out the old group's allocable cost amount. The old group's allocable cost amount broadly consists of the terminating values of the leaving entity's assets less the value of the liabilities and certain equity interests of the leaving entity.

5.191 For these purposes, the liabilities that are included in step 4 of the old group's allocable cost amount are the liabilities of the leaving entity at the leaving time (section 711-45).

5.192 In Handbury Holdings Pty Ltd v Commissioner of Taxation [2009] FCAFC 141, a subsidiary member left a consolidated group when a debt held by a non-group member was converted to equity. The taxpayer argued that the debt was not included in step 4 of the old group's allocable cost amount because it was not a liability that the leaving entity takes with it when it ceases to be a subsidiary member of the group.

5.193 The Full Federal Court concluded that subsection 711-45(1) includes liabilities held by the leaving entity just before the leaving time. As a result, the debt is included in step 4 of the old group's allocable cost amount.

5.194 However, to remove any doubt, the amendments will clarify that step 4 of the old group's allocable cost amount applies to liabilities of the leaving entity that exist just before the leaving entity ceases to be a subsidiary member of the group - that is, just before the leaving time. [Schedule 5, items 79 to 86, sections 711-20, 711-25, 711-45 and 713-265]

Application of Division 1 of Part 7

5.195 The amendments in Division 1 of Part 7 apply from the date of introduction of this Bill into the House of Representatives. That is, the amendments will apply to an entity that leaves a consolidated group on or after that date. [Schedule 5, item 87]

5.196 However, the amendments in Division 1 of Part 7 are disregarded for the purposes of interpreting:

·
sections 711-20, 711-25, 711-45 and 713-265, as they applied before the date of introduction of this Bill into the House of Representatives; and
·
any other provision of the ITAA 1997 or the Income Tax (Transitional Provisions) Act 1997 , as that provision applied before the date of introduction of this Bill into the House of Representatives, to the extent that it relates to section 711-20, 711-25, 711-45 or 713-265.

[Schedule 5, item 87]

5.197 In this regard, the purpose of the amendments in Division 1 of Part 7 is to clarify the operation of sections 711-20, 711-25, 711-45 and 713-265. However, the amendments are not intended to alter the practical operation of the relevant provisions as reflected by the decision of the Full Federal Court in the Handbury Holdings case.

Division 2 of Part 7 - Leaving time liabilities: Adjustment of the step 4 amount

5.198 Currently, subsection 711-45(8) adjusts the amount of the liability that is subtracted from the old group's allocable cost amount for a joining entity under step 4 if:

·
the liability was taken into account in working out the allocable cost amount for a subsidiary member when it joined a consolidated group (under Division 705);
·
the entry amount of the liability taken into account at that time is different to the step 4 exit amount of the liability; and
·
the entry allocable cost amount was different from what it would have been if the exit amount instead of the entry amount, had been taken into account in working it out.

5.199 In these circumstances, for the purpose of applying step 4, the liability is taken to be equal to the entry amount.

5.200 Subsection 711-45(8) is being modified to clarify its operation and reduce compliance costs by limiting the circumstances in which it applies.

5.201 As a result, the amount of liability included at step 4 of the old group's allocable cost amount under section 711-45 will be adjusted under subsection 711-45(10) if the four conditions in subsection 711-45(8) are satisfied.

5.202 The first condition is that subsection 711-45(5) applies to the liability. That is, if:

·
an amount (the exit liability amount) was added for the liability under subsection 711-45(5); or
·
the liability is covered by subsection 711-45(5), but no amount was added for it under that subsection - that is, the exit liability amount is zero.

[Schedule 5, item 88, paragraph 711-45(8)(a)]

5.203 Subsection 711-45(5) adjusts the amount of an accounting liability that is subtracted from the old group's allocable cost amount if the liability is an accounting liability that is taken into account at a later time for income tax purposes than for accounting purposes (such as a liability that is an employee provision or a movement in a foreign currency liability).

5.204 The second condition in subsection 711-45(8) is that the liability was taken into account in working out the allocable cost amount (the original entry allocable cost amount) for a subsidiary member (whether or not the leaving entity) of the old group in accordance with Division 705. [Schedule 5, item 88, paragraph 711-45(8)(b)]

5.205 The third condition in subsection 711-45(8) is that the exit liability amount is not the same as the entry liability amount. The entry liability amount is the amount of the liability that was taken into account in working out the original entry allocable cost amount after any adjustments made under:

·
section 705-70, 705-75 or 705-80; and
·
subsection 711-45(9).

[Schedule 5, item 88, paragraph 711-45(8)(c)]

5.206 The entry liability amount is generally the amount of the liability that was actually included at step 2 of the joined group's allocable cost amount for a joining entity.

5.207 However, the entry liability amount is adjusted if, at a time when the leaving entity was a subsidiary member of the old group, the head company paid an amount which reduced the liability. In this event, the entry liability amount is reduced by the amount of the reduction. [Schedule 5, item 88, subsection 711-45(9)]

5.208 In addition, if the payment gave rise to an amount being included in the assessable income of the head company, the entry liability amount is further reduced by the following amount:

assessable amount x corporate tax rate.

[Schedule 5, item 88, subsection 711-45(9)]

5.209 Alternatively, if the payment gave rise to a deduction for the head company, the entry liability amount is increased by the following amount:

amount deducted x corporate tax rate.

[Schedule 5, item 88, subsection 711-45(9)]

5.210 Where the entry liability amount is reduced to nil after the application of subsection 711-45(9), then the liability taken into account at step 4 on exit will no longer be the same as the liability taken into account on entry. Therefore, the step 4 amount for the liability will not be adjusted under subsection 711-45(10).

5.211 The fourth condition in subsection 711-45(8) applies only if the liability is:

·
a provision for annual leave or long service leave; or
·
a provision for a liability contingent on a future event (such as a warranty provision).

[Schedule 5, item 88, paragraph 711-45(8)(d)]

5.212 In these circumstances, the step 4 amount for the liability will be adjusted under subsection 711-45(10) only if:

·
in the case of a liability that was (in accordance with the accounting principles that the leaving entity would have used if it had prepared its financial statements just before the time it joined the consolidated group) a current liability at the joining time, the leaving time occurs less than one year after the joining time; or
·
in any other case, the leaving time occurs less than four years after the joining time.

[Schedule 5, item 88, paragraph 711-45(8)(d)]

5.213 The purpose of the fourth condition is to reduce compliance costs because of the difficulty in tracking these types of liabilities. In addition:

·
in the case of a current liability, the liability would generally have been fully paid out in the year after the joining time; and
·
in the case of a non-current liability relating to a provision, the liability would generally have been fully paid out within four years after the joining time.

5.214 Where the four conditions in subsection 711-45(8) are satisfied, subsection 711-45(10) applies to adjust the step 4 amount:

·
if the entry liability amount exceeds the exit liability amount, the step 4 amount is increased by the amount of the excess; or
·
if the entry liability amount falls short of the exit liability amount, the step 4 amount is reduced by the amount of the shortfall.

[Schedule 5, item 88, subsection 711-45(10)]

Example 5.18 : Provision for employee leave entitlements Head Co acquires all of the membership interests in Company J on 1 July 2010. As a result, Company J joins Head Co's consolidated group.Company J's financial reports at the joining time includes a total liability of $275,000 that is a provision for employee leave. Part of the liability ($55,000) is classified as a current liability. The remainder ($220,000) is classified as a non-current liability.In working out the allocable cost amount for Company J at the joining time (the original entry allocable cost amount), the amount included at step 2 (the entry liability amount) for the employee provision is $192,500 - that is:

·
$38,500 for the current liability - in this regard, subsection 705-75(1) applies to reduce the amount of the accounting liability ($55,000) by the amount of the future income tax deduction in respect of the liability ($55,000 × 30 per cent = $16,500); and
·
$154,000 for the non-current liability - in this regard, subsection 705-75(1) applies to reduce the amount of the accounting liability ($220,000) by the amount of the future income tax deduction in respect of the liability
·
($220,000 × 30 per cent = $66,000).

After the joining time, Head Co makes leave payments of $60,000 to employees of Company J.On 1 August 2012, Company J leaves Head Co's consolidated group as all of its membership interests are acquired by a third party entity.Company J's financial reports at the leaving time includes a total liability of $285,000 that is a provision for employee leave. Part of the liability ($50,000) is classified as a current liability. The remainder ($235,000) is classified as a non-current liability.The amount included under subsection 711-45(1) as a liability for the provision for employee leave is $285,000. As Company J will be entitled to a future income tax deduction in respect of the liability, subsection 711-45(3) applies to reduce this amount to $199,500 - that is, by the amount of the future income tax deduction

($285,000 × 30 per cent = $85,500).

As the liability is taken into account for income tax purposes only when it is incurred (that is, at a later time than the time it is recognised for accounting purposes), subsection 711-45(5) applies to reduce the amount for the liability at step 4 to nil - that is to the amount of the payment that would be necessary to discharge the liability just before the leaving time without an amount being included in assessable income of, or allowable as a deduction to, the head company. This overrides the amount included at subsection 711-45(1) and the reduction at subsection 711-45(3).However, to the extent that the employee leave provision is a non-current liability, the step 4 amount will be adjusted under subsection 711-45(10) because the four conditions in subsection 711-45(8) are satisfied.

·
The first condition is satisfied because the non-current liability is covered by subsection 711-45(5) and the exit liability amount is nil.
·
The second condition is satisfied because the non-current liability was taken into account in working out the original allocable cost amount for a joining entity.
·
The third condition is satisfied because the exit liability amount (nil) is not the same as the entry liability amount ($150,500) - the entry liability amount is the sum of:

-
the amount taken into account at step 2 of the original allocable cost amount - $154,000;
-
reduced by the amount paid by Head Co to reduce the non-current liability - $5,000 (that is, the amount paid by Head Co after the joining time ($60,000) less the amount of the current liability at that time ($55,000);
-
increased by the product of the amount deducted by Head Co ($5,000) multiplied by the corporate tax rate (30 per cent) - $1,500.

·
The fourth condition is satisfied because, even though the liability is a provision for employee leave, the liability was a non-current liability at the joining time and the leaving time is within four years of the joining time.

Therefore, subsection 711-45(10) applies to alter the step 4 amount for the employee leave provision. As the entry liability amount ($150,500) exceeds the exit liability amount (nil), the step 4 amount is increased by the amount of the excess ($150,500).To the extent that the employee provision is a current liability, the step 4 amount will not be adjusted under subsection 711-45(10). This is because the fourth condition in subsection 711-45(8) is not satisfied in respect of the liability - that is, the provision for employee leave was a current liability at the joining time and the leaving time is more than one year after the joining time. Example 5.19 : Foreign exchange liability - partial repayment after the joining time Head Co acquires all of the membership interests in Company J on 1 July 2009. As a result, Company J joins Head Co's consolidated group.Prior to joining time Company J borrowed US$100. At that time, A$1 was equivalent to US$0.80. Company J therefore received A$125 cash on issue of the foreign exchange (forex) liability.At the joining time, A$1 is equivalent to US$0.75. Therefore, Company J's financial reports at the joining time include a forex liability of A$133.33 and a forex loss of A$8.33. As the loss is not deductible for income tax purposes, Company J has a deferred tax asset of A$2.50.In working out the allocable cost amount for Company J at the joining time (the original entry allocable cost amount), the amount for the forex liability included at step 2 (the entry liability amount) is A$130.83. In this regard, under subsection 705-75(1), the step 2 amount is the amount of the accounting liability (A$133.33) reduced by the amount of the future income tax deduction in respect of the liability ($2.50).Head Co repays US$50 of the US$100 forex liability after the joining time. At the time of the repayment, A$1 is equivalent to US$0.85. Therefore, Head Co makes a repayment of A$58.82 and realises a foreign exchange gain of A$3.68 for tax purposes. After taking into account the tax cost to Head Co of the gain, the repayment has an after-tax cost of A$59.92 (A$3.68 × 30 per cent = A$1.10).On 30 June 2013, Company J leaves Head Co's consolidated group as all of its membership interests are acquired by a non-group member.When Company J leaves the consolidated group, A$1 is equivalent to US$0.85. Therefore, Company J's financial reports at the leaving time include a forex liability of A$58.82.The amount included under subsection 711-45(1) for the forex liability is A$58.82.However, as the movement in the forex liability is taken into account for income tax purposes only when it is incurred (that is, at a later time than the time it is recognised for accounting purposes), subsection 711-45(5) applies to increase the amount for the forex liability at step 4 to A$62.50 - that is to the amount of the payment that would be necessary to discharge the forex liability just before the leaving time without an amount being included in assessable income of, or allowable as a deduction to, the head company. This overrides the amount included at subsection 711-45(1).The step 4 amount for the forex liability will be adjusted under subsection 711-45(10) because the four conditions in subsection 711-45(8) are satisfied.

·
The first condition is satisfied because an amount was added for the liability under subsection 711-45(5) - that is, the exit liability amount is A$62.50.
·
The second condition is satisfied because the liability was taken into account in working out the original allocable cost amount for a joining entity.
·
The third condition is satisfied because the exit liability amount (A$62.50) is not the same as the entry liability amount (A$70.91) - the entry liability amount is the sum of:

-
the amount taken into account at step 2 of the original allocable cost amount - A$130.83;
-
reduced by the amount paid by Head Co to reduce the liability - A$58.82; and
-
further reduced by the product of the amount included in Head Co's assessable income (A$3.68) multiplied by the corporate tax rate (30 per cent) - A$1.10.

·
The fourth condition is satisfied because it does not apply to a forex liability.

Therefore, subsection 711-45(10) applies to alter the step 4 amount for the forex liability. As the entry liability amount (A$70.91) exceeds the exit liability amount (A$62.50), the step 4 amount is increased by the amount of the excess (A$8.41).

Application of Division 2 of Part 7

5.215 The amendments in Division 2 of Part 7 apply from the date of introduction of this Bill into the House of Representatives. That is, the amendments will apply to an entity that leaves a consolidated group on or after that date. [Schedule 5, item 89]

Modifications to the tax cost setting rules when an entity joins or leaves a consolidated group

5.216 Some elements of the tax cost setting rules apply both:

·
when an entity joins a consolidated group; and
·
when an entity leaves a consolidated group.

5.217 The amendments will clarify and improve the operation of the tax cost setting rules when an entity joins or leaves a consolidated group to:

·
clarify the accounting principles that apply to determine the accounting liabilities which are recognised under the tax cost setting rules;
·
clarify the scope and amount of the adjustment to the allocable cost amount in respect of inherited deductions; and
·
if the joining or leaving entity is a general insurance company, ensure that the tax cost setting rules apply appropriately to its deferred acquisition costs, deferred reinsurance expenses and recoveries receivable.

Part 8 - Accounting principles

5.218 The amendments in Part 8 clarify the accounting principles that apply to determine the accounting liabilities which are recognised under the tax cost setting rules when an entity joins or leaves a consolidated group.

Modifications when an entity joins a consolidated group

5.219 When an entity joins a consolidated group, the allocable cost amount for the joining entity is increased by the value of its liabilities at the joining time (step 2 in the table in section 705-60).

5.220 Generally, as a starting point, the step 2 amount includes the value of a joining entity's liabilities that are recognised under the accounting standards or under statements of accounting concepts made by the Australian Accounting Standards Board.

5.221 Where the joining entity does not apply the accounting standards or statements of accounting concepts to prepare a statement of its financial position, the liabilities of the joining entity that can or must be recognised under those standards as at the joining time must be taken into account for the purposes of working out the step 2 amount.

5.222 In Envestra Ltd v Federal Commissioner of Taxation [2008] FCA 249; 2008 ATC 20-012, the Federal Court confirmed that a joining entity cannot adopt an accounting standard to measure a liability for consolidation purposes if it did not adopt that accounting standard for the recognition and measurement of the liability for financial reporting purposes.

5.223 For the avoidance of doubt, the amendments will modify the tax cost setting rules to confirm this position.

5.224 That is, the amendments clarify that a matter is in accordance with the accounting principles if it is in accordance with:

·
accounting standards; or
·
if there are no accounting standards applicable to the matter, authoritative pronouncements of the Australian Accounting Standards Board that apply to the preparation of financial statements.

[Schedule 5, item 111, the definition of 'accounting principles' in subsection 995-1(1)]

5.225 In this regard, authoritative pronouncements of the Australian Accounting Standards Board can be relevant in the preparation of financial statements and would be considered when recognising and measuring accounting liabilities (and other elements on the balance sheet). These include:

·
the Urgent Issue Group Interpretations;
·
the Framework for the Preparation and Presentation of Financial Statements;
·
statements of accounting concepts issued by the Australian Accounting Standards Board; and
·
other authoritative pronouncements of the Australian Accounting Standards Board.

5.226 Broadly, when an entity joins a consolidated group, the joining entity's accounting principles for tax cost setting must be applied for the purposes of working out the allocable cost amount for the joining entity. These are the accounting principles that the joining entity would use if it were to prepare its financial statements just before the joining time. [Schedule 5, items 97 and 112, subsection 705-70(3) and the definition of 'accounting principles for tax cost setting' in subsection 995-1(1)]

5.227 In practical terms, the joining entity's accounting principles for tax cost setting are:

·
the accounting principles that the joining entity actually used to prepare its financial reports just before the joining time; or
·
if the joining entity did not prepare financial reports just before the joining time, the accounting principles that it would use if it were to prepare its financial reports just before the joining time.

5.228 In this regard, if the joining entity used audited accounts as the basis for preparing its financial reports just before the joining time, the accounting principles applied in the preparation of those audited accounts are the joining entity's accounting principles for tax cost setting.

5.229 Therefore, for the purpose of working out step 2 of the allocable cost amount for a joining entity, the amendments clarify that the liabilities that are taken into account are those liabilities that, in accordance with the joining entity's accounting principles for tax cost setting, are liabilities of the entity. That is

·
for the purpose of applying section 705-70 (other than subsection 705-70(1A)), the liabilities of the joining entity that are taken into account are those liabilities that, in accordance with the joining entity's accounting principles for tax cost setting, are liabilities of the entity;
·
the adjustment to step 2 under section 705-80, if any, applies to an accounting liability that is taken into account at a later time than is the case in accordance with the joining entity's accounting principles for tax cost setting; and
·
if an adjustment is made to step 2 of the allocable cost amount under section 705-85, the step 2 amount is increased by, if relevant, the market value of each thing that, in accordance with the joining entity's accounting principles for tax cost setting, is equity in the entity at the joining time, where the thing is also a debt interest.

[Schedule 5, items 94, 95, 98 and 99, subsections 705-70(1), 705-80(1) and 705-85(3)]

5.230 Subsection 705-70(1A) applies if the amount of an accounting liability of a joining entity would be different when it becomes an accounting liability of the joined group. In these circumstances, the different amount is treated as the amount of the liability. A consequential amendment ensures that the effect of subsection 705-70(1A) is unchanged. [Schedule 5, item 96, subsection 705-70(1A)]

5.231 Finally, consequential amendments clarify that, when an entity joins a consolidated group:

·
the tax cost setting rules in relation to finance leases under section 705-56 applies to a lease held by the joining entity that, in accordance with its accounting principles for tax cost setting, is classified as a finance lease;
·
the consolidation provisions apply separately to each asset and liability even if, in accordance with accounting principles, they are required to be set off against each other (section 701-58);
·
the exception for the treatment of linked assets and liabilities in section 701-59 refers to the assets and liabilities of the joining entity that, in accordance with the entity's accounting principles for tax cost setting, are linked; and
·
the undistributed profits taken into account under step 3 of the allocable cost amount (section 705-90) are the amounts that, in accordance with the joining entity's accounting principles for tax cost setting, are retained profits of the entity.

[Schedule 5, items 91 to 93, 100 and 101, subsections 705-56(1), 705-58(1), 705-59(2), and 705-90(2)]

Modifications when an entity leaves a consolidated group

5.232 When an entity leaves a consolidated group, the old group's allocable cost amount is reduced by the value of the liabilities that the leaving entity takes with it when it ceases to be a member of the old group (step 4 in the table in section 711-20).

5.233 Broadly, when an entity leaves a consolidated group, the leaving entity's accounting principles for tax cost setting must be applied for the purposes of working out the old group's allocable cost amount for the leaving entity. These are the accounting principles that the group would use if it were to prepare its financial statements just before the joining time. [Schedule 5, items 104 and 112, subsection 711-45(1A) and the definition of 'accounting principles for tax cost setting' in subsection 995-1(1)]

5.234 In practical terms, the leaving entity's accounting principles for tax cost setting are:

·
the accounting principles that the group actually used to prepare its financial reports just before the leaving time; or
·
if the group did not prepare financial reports just before the leaving time, the accounting principles that it would use if it were to prepare its financial reports just before the leaving time.

5.235 In this regard, if the group used audited accounts as the basis for preparing its financial reports just before the leaving time, the accounting principles applied in the preparation of those audited accounts are the leaving entity's accounting principles for tax cost setting.

5.236 Therefore, for the purpose of working out step 4 of the old group's allocable cost amount for a leaving entity, the amendments clarify that the liabilities that are taken into account are those liabilities that, in accordance with the leaving entity's accounting principles for tax cost setting, are liabilities of the leaving entity just before the leaving time. Therefore:

·
the liabilities that are recognised under step 4 of the old group's allocable cost amount (section 711-45) are those things that, in accordance with the leaving entity's accounting principles for tax cost setting, are liabilities of the leaving entity just before the leaving time;
·
the adjustment to step 4 of the old group's allocable cost amount under subsection 711-45(5) applies to an accounting liability that is taken into account at a later time for tax purposes than for accounting purposes in accordance with the leaving entity's accounting principles for tax cost setting; and
·
if subsection 711-45(7) applies, step 4 of the old group's allocable cost amount is increased by the market value of each thing that, in accordance with the leaving entity's accounting principles for tax cost setting, is equity in the leaving entity just before the leaving time, where the thing is also a debt interest.

[Schedule 5, items 102 to 106, subsections 711-45(1), 711-45(5) and 711-45(7)]

5.237 In addition, when an entity leaves a consolidated group, the amendments clarify that the exit history rule (section 701-40) applies, so far as is relevant, to any liability or other thing that, in accordance with the accounting principles, is a liability. [Schedule 5, item 90, subsection 701-40(2)]

Modifications when a partnership joins or leaves a consolidated group

5.238 Under Subdivision 713-E, special modifications are made to the tax cost setting rules when:

·
an entity that is a partner in a partnership becomes a subsidiary member of a consolidated group; or
·
a partnership becomes, or ceases to be, a member of a consolidated group.

5.239 The amendments modify these special rules so that:

·
when a partner in a partnership becomes a subsidiary member of a consolidated group, the modification to the treatment of partnership liabilities under the tax cost setting rules applies to things that, in accordance with the accounting principles that the partnership would use if it were to prepare financial statements just before the joining time, are liabilities of the partnership at the joining time; and
·
when a partner in a partnership leaves a consolidated group, the modification to the treatment of partnership liabilities under the tax cost setting rules applies to things that, in accordance with the accounting principles that the partnership would use if it were to prepare financial statements just before the leaving time, are liabilities of the partnership at the leaving time.

[Schedule 5, items 107 to 110, subsections 713-225(6) and 713-265(4)]

Application of Part 8

5.240 The amendments in Part 8 apply from the date of introduction of this Bill into the House of Representatives. That is, the amendments will apply to an entity that joins or leaves a consolidated group on or after that date. [Schedule 5, item 113]

5.241 In this regard, the amendments are intended to remove doubt but are consistent with the operation of the current law, as confirmed by the Federal Court's decision in the Envestra case.

Part 9 - Inherited deductions

5.242 When an entity joins a consolidated group, the allocable cost amount of a joining entity is reduced by certain deductions that are inherited by the head company under step 7 of the allocable cost amount (section 705-115). The purpose of this adjustment is to ensure that inherited deductions do not give rise to both a higher allocable cost amount and a future income tax deduction - that is, the adjustment prevents the head company from getting a double benefit.

5.243 Expenditure on certain assets acquired on or before 13 May 1997 (such as capital works expenditure on buildings) is specifically excluded from being an inherited deduction. This preserves the benefit of transitional provisions that grandfather the CGT cost base treatment of these assets.

5.244 To ensure that this exclusion operates as intended, inherited deductions that are covered by step 7 will not include deductions under section 43-15 for undeducted construction expenditure in relation to an asset if the asset was acquired by the joining entity before 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 1997. [Schedule 5, item 114, subsection 705-115(3)]

5.245 When an entity leaves a consolidated group, the old group's allocable cost amount is increased by the amount of deductions of the head company inherited by the leaving entity under step 2 (section 711-35).

5.246 A technical amendment will clarify that the step 2 amount is worked out by multiplying all the deductions of the head company inherited by the leaving entity by the corporate tax rate (currently 30 per cent). This will ensure that there is no duplication of the tax benefit associated with inherited deductions when an entity leaves a consolidated group. [Schedule 5, item 115, subsection 711-35(1)]

5.247 In addition, inherited deductions that are covered by step 2 will not include deductions under section 43-15 for undeducted construction expenditure in relation to an asset that, because of the exit history rule (section 701-40), the leaving entity is taken to have acquired before 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 1997. [Schedule 5, item 116, subsection 711-35(3)]

Application of Part 9

5.248 The amendments in items 114 and 116 of Part 9, which modify the tax cost setting rules that apply when an entity joins or leaves a consolidated group to clarify that inherited deductions do not include certain deductions for undeducted construction expenditure, apply from 1 July 2002. [Schedule 5, item 117]

5.249 These amendments, which ensure that the income tax law operates as originally intended, reduce the adjustment for inherited deductions under the tax cost setting rules and therefore are beneficial to taxpayers.

5.250 The amendment in item 115 of Part 9, which modifies the amount of the adjustment for inherited deductions under the tax cost setting rules that apply when an entity leaves a consolidated group, applies from the date of introduction of this Bill into the House of Representatives. That is, the amendment will apply to an entity that leaves a consolidated group on or after that date. [Schedule 5, item 117]

Part 10 - General insurance companies

5.251 General insurance companies are taxed on movements in the value of the unearned premium reserve and movements in the value of the outstanding claims liabilities.

·
The unearned premium reserve broadly represents the amount of premium income received by a general insurance company in an income year that relates to risk coverage in a subsequent income year.
·
The outstanding claims liabilities broadly represent the present value of the amount that a general insurance company determines to be necessary to set aside to pay outstanding claims.

5.252 A general insurance company can deduct the amount of any increase in the value of these amounts over an income year. The amount of any decrease in the value of these amounts over an income year is included in assessable income.

5.253 The basis for working out the value of the unearned premium reserve and the value of the outstanding claims liabilities under the income tax law is different to the basis for working out those amounts under the accounting standards. In particular, there are differences between the income tax treatment and the accounting treatment of:

·
deferred acquisition costs - that is, certain costs incurred by a general insurance company in an income year in connection with issuing insurance policies that relate to benefits that are received by the company in a later income year;
·
deferred reinsurance expenses - that is, certain reinsurance expenses incurred by a general insurance company in an income year in connection with reinsurance policies that relate to benefits that are received by the company in a later income year; and
·
recoveries receivable - that is, amounts expected to be received under reinsurance policies and from other sources in relation to claims that have been incurred.

5.254 The differences between the income tax treatment and the accounting treatment of deferred acquisition costs, deferred reinsurance expenses and recoveries receivable cause distortions to arise under the tax cost setting rules.

5.255 To remove these distortions, the tax cost setting rules will be modified where a general insurance company joins or leaves a consolidated group and brings or takes with it:

·
deferred acquisition costs in relation to the company's unearned premium reserve;
·
deferred reinsurance expenses in relation to the company's unearned premium reserve; and
·
recoveries receivable in relation to the company's outstanding claims.

[Schedule 5, item 118, subsections 713-725(1) and (4)]

5.256 If a general insurance company joins a consolidated group:

·
the step 2 amount of the allocable cost amount for the joining entity is reduced by the amount of the deferred acquisition costs, deferred reinsurance expenses and recoveries receivable; and
·
the deferred acquisition costs, deferred reinsurance expenses and recoveries receivable are taken to have a market value of zero for the purposes of working out their tax cost setting amount under section 705-35 - as a result, they will have a tax cost setting amount of nil.

[Schedule 5, item 118, subsection 713-725(2)]

5.257 If a general insurance company leaves a consolidated group:

·
the step 4 amount of the old group's allocable cost amount for the leaving entity is reduced by the amount of the deferred acquisition costs, deferred reinsurance expenses and recoveries receivable; and
·
the deferred acquisition costs, deferred reinsurance expenses and recoveries receivable are taken to have a terminating value of zero for the purposes of working out step 1 of the old group's allocable cost amount under section 711-25.

[Schedule 5, item 118, subsection 713-725(3)]

Application of Part 10

5.258 The amendments in Part 10 apply in relation to a general insurance company that joins or leaves a consolidated group on or after 1 July 2002. [Schedule 5, item 119]

5.259 In this regard, the amendments, which were sought by representatives of the general insurance industry, are beneficial as they will reduce compliance costs by confirming existing industry practice.

Part 11 - Retained cost base assets

5.260 Under the tax cost setting rules, the cost of some assets is set at an amount that is equal to the joining entity's cost of those assets. These assets are known as retained cost base assets (as distinct from reset cost base assets) and include, among other things:

·
Australian currency; and
·
a right to receive a specified amount of Australian currency (such as a bank deposit).

5.261 The amendments will ensure that retained cost base assets include:

·
units in cash management trusts; and
·
certain rights to future income assets.

Division 1 of Part 11 - Cash management trusts

5.262 Currently units held by a joining entity in a cash management trust are reset cost base assets. This causes undue compliance costs to arise where the cash management trust is effectively used like a bank account to meet day-to-day business needs. For example, a capital gain or capital loss will arise whenever an amount is withdrawn from the cash management trust.

5.263 Therefore, to reduce compliance costs, a unit in a cash management trust will be a retained cost base asset if:

·
the redemption value of the unit is expressed in Australian dollars; and
·
the redemption value of the unit cannot increase.

[Schedule 5, item 121, paragraph 705-25(5)(ba)]

5.264 The tax cost setting amount for a unit in a cash management trust that is a retained cost base asset is generally equal to the amount of Australian currency concerned - that is, the face value of the unit. [Schedule 5, item 120, subsection 705-25(2)]

5.265 A cash management trust is a trust of a kind that is commonly known as a cash management trust where all the units in the trust carry the same rights. [Schedule 5, item 122, the definition of 'cash management trust' in subsection 995-1(1)]

Application of Division 1 of Part 11

5.266 The amendments in Division 1 of Part 11 apply from the date of introduction of this Bill into the House of Representatives. That is, the amendments will apply to an entity that joins a consolidated group on or after that date. [Schedule 5, item 126]

5.267 However, the head company of a consolidated group can make a choice to apply the amendments in Division 1 of Part 11 to an entity that joins a consolidated group on or after 1 July 2002. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

[Schedule 5, item 126]

5.268 This option to apply the amendments from 1 July 2002 will allow consolidated groups that effectively treated units in cash management trusts as retained cost base assets to retain that treatment. Other consolidated groups will also be able to choose to apply the amendments from 1 July 2002 if they wish, having regard to the compliance cost implications of applying the changes retrospectively.

Division 2 of Part 11 - Rights to future income assets

5.269 Rights to future income assets (such as work in progress) held by a joining entity are reset cost base assets. This is appropriate if the joining entity was acquired by the head company prior to the joining time and held the rights to future income assets at the time of acquisition. In these circumstances, the amount paid by the head company to acquire the joining entity would reflect the value of the rights to future income assets at that time.

5.270 However, distortions can arise under the tax cost setting rules if rights to future income assets are owned by the group before the joining time and accrue to the head company.

5.271 To overcome these distortions, rights to future income assets held by a joining entity that accrue to the head company will be treated as retained cost base assets.

5.272 That is, a right that is an asset covered by section 716-410 will be a retained cost base asset if, at the time the right was created:

·
the head company was the head company of a consolidatable group; and
·
the joining entity was a subsidiary member of the consolidatable group.

[Schedule 5, items 124 and 125, paragraph 705-25(5)(d)]

5.273 An asset is covered by section 716-410 if

·
the asset is a right (including a contingent right) to receive an amount for the doing of a thing;
·
the asset is held by an entity just before the time it becomes a subsidiary member of a consolidated group; and
·
it is reasonable to expect that an amount will be included in the assessable income of the head company of the group after the joining time in relation to the right.

[Schedule 5, item 4, section 716-410]

5.274 An asset covered by section 716-410 may be solely comprised of a right to future income. Alternatively, the asset may be right that is embedded in a contract or agreement that includes a range of rights and associated obligations.

5.275 If a right to future income asset covered by section 716-410 is a retained cost base asset, the asset's tax cost setting amount will be equal to the joining entity's terminating value for the asset. [Schedule 5, item 123, subsection 705-25(4B)]

5.276 The asset's terminating value is generally the amount that would be the asset's cost base just before the joining time if the asset were a CGT asset (subsection 705-30(5)). In most cases, the terminating value of a right to future income asset held by a joining entity that accrues to the head company will be nil.

Example 5.20 : Long-term construction contract Head Co acquired all the membership interests in Company J on 1 July 1999.On 15 March 2003, Company J entered into a long-term construction contract with a third party.Head Co formed a consolidated group on 1 July 2003 and Company J became a subsidiary member of the group.At that time, Company J has partially performed work under the construction contract that has not yet been completed to a stage where a recoverable debt has arisen. For accounting purposes, Company J has estimated the amount of partly earned unbilled income as $15,000.Substantial gross revenues are expected to be generated under the contract with an estimated profit over the period of the contract of $500,000. The market value of the asset at the joining time is determined to be $215,000.The contract is an asset that is covered by section 716-410 because:

·
the asset is solely a right to receive an amount for the doing of a thing (being the unbilled work already done and the work yet to be done);
·
the asset is held by Company J just before the time it became a subsidiary member of Head Co; and
·
it is reasonable to expect that an amount will be included in the assessable income of Head Co after the joining time in relation to the right.

The asset will be a retained cost base asset because it is a right to future income asset covered by section 716-410 and, at the time the right was created:

·
Head Co was the head company of a consolidatable group; and
·
Company J was a subsidiary member of the consolidatable group.

The tax cost setting amount for the bundle of rights that make up the contract is equal to Company J's terminating value for the asset, being its cost base just before the joining time. As the asset has a nil cost base at this time, the tax cost setting amount of the contract is nil. Example 5.21 : Unbilled income for the supply of gas Company J has been wholly-owned by Head Co since it was incorporated on 1 July 1990.Head Co formed a consolidated group on 1 July 2002. Therefore, Company J became a subsidiary member of the group.Company J carries on the business of supplying gas to its customers (being both domestic and commercial gas consumers) in circumstances similar to those considered in FC of T v Australasian Gas Light Co 83 ATC 4800; (1983) 15 ATR 105.In its profit and loss statement for the income year ended 30 June 2002, Company J had recorded unbilled gas income of $25,000. Its balance sheet contains an unbilled gas asset of the same amount. The unbilled gas income is recognised as income for accounting purposes but has not yet been recognised as assessable income for income tax purposes in accordance with Taxation Ruling No. IT 2095.The unbilled gas is an asset that is covered by section 716-410 because:

·
the asset is a right to receive an amount for the doing of a thing (being the supply of gas);
·
the asset is held by Company J just before the time it became a subsidiary member of Head Co; and
·
it is reasonable to expect that an amount will be included in the assessable income of Head Co after the joining time in relation to the right.

The asset will be a retained cost base asset because it is a right to future income asset covered by section 716-410 and, at the time the right was created:

·
Head Co was the head company of a consolidatable group; and
·
Company J was a subsidiary member of the consolidatable group.

The tax cost setting amount for the unbilled gas asset is equal to Company J's terminating value for the asset, being its cost base just before the joining time. As the asset has a nil cost base at this time, the tax cost setting amount of the asset is nil.

Application of Division 2 of Part 11

5.277 The amendments in Division 2 of Part 11 apply in relation to a consolidated group on or after 1 July 2002. [Schedule 5, item 126]

5.278 In this regard, the amendments were sought by affected consolidated groups. The amendments are beneficial as they remove distortions that arise under the tax cost setting process.

Part 12 - Removal of CGT event L7

5.279 CGT event L7 (section 104-30) happens when:

·
a liability that was taken into account in working out the allocable cost amount for a subsidiary member at the joining time is discharged for a different amount; and
·
the allocable cost amount would have been different if the discharged amount was used at the joining time.

5.280 A capital gain arises under CGT event L7 if the amount of the liability ultimately discharged (the realised amount) is less than the amount taken into account at the joining time. A capital loss arises if the realised amount is greater than the amount taken into account at the joining time.

5.281 The value of liabilities that is used for tax cost setting purposes is generally the accounting value of those liabilities at the joining time (section 705-70).

5.282 The circumstances in which liabilities are discharged for an amount that is different to the accounting value at the joining time are generally limited to long standing provisions for liabilities that are contingent on future events (such as general insurance policy liabilities, life insurance policy liabilities, warranties and provisions for long service or annual leave).

5.283 In many cases movements in the value of liabilities are taxed under other provisions of the income tax law, such as the provisions for the taxation of financial arrangements (Division 230) and the general insurance provisions (Division 321 in Schedule 2J to the ITAA 1936).

5.284 In an arm's length acquisition case, the accounting value of the liabilities at the joining time genuinely reflects the value of those liabilities at that time - that is, it is the best estimate of those liabilities at the joining time and is not open to manipulation.

5.285 In addition, the value of long standing liability provisions tends to be calculated on a pooled basis, rather than on an individual basis. Tracking individual liabilities to determine whether the amount included at step 2 of the allocable cost amount for an individual liability exceeded the amount for which the liability was discharged places an unreasonable compliance cost burden on affected groups.

5.286 Therefore, as movements in the value of liabilities are usually taxed under other provisions of the income tax law and to reduce compliance costs, CGT event L7 (section 104-530) will be repealed. [Schedule 5, item 128]

5.287 Consequential amendments will be made to:

·
remove references to CGT event L7 in the table of CGT events in section 104-5;
·
remove references to CGT event L7 in the table that sets out rules about the cost base and reduced cost base of a CGT asset in section 110-10; and
·
repeal section 701-34 of the Income Tax (Transitional Provisions) Act 1997 (which provides that CGT event L7 does not happen in respect of certain liabilities).

[Schedule 5, items 127, 129 and 130, sections 104-5 and 110-10 of the ITAA 1997 and section 701-34 of the Income Tax (Transitional Provisions) Act 1997]

Application of Part 12

5.288 The amendments in Part 12 apply on or after 1 July 2002. [Schedule 5, item 131]

5.289 In this regard, the amendments are beneficial to taxpayers and will remove an unreasonable compliance cost burden on affected groups.

5.290 Anecdotal evidence suggests that no capital gains or losses have arisen under CGT event L7. However, as a transitional rule, if a taxpayer has made a capital loss under CGT event L7 prior to the introduction of this Bill into the House of Representatives, that capital loss will be preserved. [Schedule 5, item 131]

Part 13 - Reduction in the tax cost setting amount that exceeds the market value of certain retained cost base assets

5.291 A capital gain arises under CGT event L3 if the total tax cost setting amounts for all retained cost base assets exceed the joining entity's allocable cost amount (section 104-510). A capital loss cannot arise under CGT event L3.

5.292 Impaired debts qualify as retained cost base assets because they are a right to receive a specified amount of Australian currency. The tax cost setting amount of impaired debts is the face value of those debts at the joining time.

5.293 However, the face value of the debt is likely to be higher than the amount that could be recovered under the debt (that is, the market value of the debt). Therefore, the amount taken into account in working out the capital gain under CGT event L3 does not reflect the amount of the debt that is likely to be recovered. Consequently, the capital gain arising under CGT event L3 is overstated.

5.294 To overcome this concern, the tax cost setting amount of an asset of a joining entity will be reduced if:

·
the asset is a retained cost base that is a right to receive a specified amount of Australian currency covered by paragraph 705-25(5)(b);
·
the market value of the asset is less than the tax cost setting amount of the asset - the tax cost setting amount is the amount of Australian currency concerned; and
·
the head company makes a capital gain under CGT event L3 (disregarding this modification) as a result of the joining entity becoming a subsidiary member of the group.

[Schedule 5, item 132, subsection 705-27(1)]

5.295 Where an asset satisfies these conditions, the tax cost setting amount of the asset will be reduced by the amount of the capital gain arising under CGT event L3, but not below zero. [Schedule 5, item 132, subsection 705-27(1)]

5.296 As the tax cost setting amount of the asset is reduced, the capital gain arising under CGT event L3 will also be reduced by an equivalent amount (paragraph 104-510(1)(b)). The amount of the capital gain might be reduced to nil.

5.297 However, the amount of the reduction under subsection 705-27(1) is reduced if:

·
the asset is an intra-group asset of the consolidated group;
·
the joining entity has been entitled to a deduction for an income year ending on or before the joining time because the market value of the asset is less than the specified amount of Australian currency; and
·
the accounting liability that corresponds to the asset has not been reduced under subsection 705-75(2) because it is an intra-group liability.

[Schedule 5, item 132, subsection 705-27(2)]

5.298 In these circumstances, the amount of the reduction under subsection 705-27(1) is reduced by the amount of the deduction (but not below zero). [Schedule 5, item 132, subsection 705-27(2)]

5.299 An asset is an intra-group asset if the requirements in subsection 701-58(1) are satisfied in relation to the asset. Those requirements are, broadly:

·
the tax cost of the asset was set at the joining time because an entity became a subsidiary member of the group;
·
ignoring the operation of the single entity rule (subsection 701-1(1)), the entity held the asset at the joining time; and
·
taking into account the operation of the single entity rule, the head company of the group did not hold the asset at the joining time.

5.300 If the tax cost setting amount of two or more of a joining entity's assets could be reduced under subsections 705-27(1) and (2), a reduction is made sequentially to the tax cost setting amounts of each of those assets. [Schedule 5, item 132, paragraph 705-27(3)(a)]

5.301 The head company can choose the sequence of assets to which the reduction applies. However, if the head company does not make such a choice, the reduction applies sequentially to each of the assets according to the time at which they were created, from the earliest to the latest. [Schedule 5, item 132, paragraphs 705-27(3)(b) and (c)]

5.302 The head company's choice must be made by the day on which the head company lodges its income tax return for the income year in which the CGT event happened or within a further time allowed by the Commissioner. The way that the head company prepares its income tax return is sufficient evidence of the making of the choice. [Schedule 5, item 132, subsections 705-27(4) and (5)]

5.303 Once the amount of the capital gain arising under CGT event L3 is reduced to nil, no further reductions of the tax cost setting amount can be made under section 705-27.

5.304 As a consequence of these changes, paragraph 705-35(1)(b) is modified to remove a reference to section 705-25. [Schedule 5, item 133, paragraph 705-35(1)(b)]

Application of Part 13

5.305 The amendments in Part 13 apply from the date of introduction of this Bill into the House of Representatives. That is, the amendments will apply to an entity that joins a consolidated group on or after that date. [Schedule 5, item 134]

5.306 However, the head company of a consolidated group can make a choice to apply the amendments in Part 13 to an entity that joins a consolidated group on or after 1 July 2002. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

[Schedule 5, item 134]

5.307 This option to apply the amendments from 1 July 2002 will allow consolidated groups that are adversely affected by the operation of the current law to take advantage of the amendments, having regard to the compliance cost implications of applying the changes retrospectively.

Part 14 - Blackhole expenditure for MEC groups

5.308 In this Part, references to a consolidated group do not include a MEC group.

5.309 A capital gain arises if, broadly, the capital proceeds received by a taxpayer when a CGT event happens to a CGT asset exceed the cost base of that asset.

5.310 The cost base of a CGT asset consists of five elements. One of those elements is incidental costs incurred by the taxpayer (section 110-35). The ninth category of incidental costs is expenditure that:

·
is incurred by the head company of a consolidated group to an entity that is not a member of the group;
·
reasonably relates to a CGT asset held by the head company; and
·
is incurred because of a transaction between members of the group.

5.311 The ninth category of incidental costs was inserted into the income tax law with effect from 1 July 2005 as part of the business related costs amendments (section 40-880) to ensure the head company of a consolidated group gets appropriate tax recognition for costs paid to third parties in respect of intra-group transactions affecting CGT assets held by the group.

5.312 A technical amendment will ensure that consistent treatment applies to the head company of a MEC group that pays costs to third parties in respect of intra-group transactions affecting CGT assets held by the group. [Schedule 5, item 135, paragraph 110-35(10)(a)]

Application of Part 14

5.313 The amendments in Part 14 apply to CGT events happening on or after 1 July 2005 (that is, from the commencement of the business related costs amendments). [Schedule 5, item 136]

5.314 In this regard, the amendments are beneficial as they ensure that MEC groups get appropriate tax recognition for costs paid to third parties in respect of intra-group transactions affecting CGT assets they hold by the group (in the same way as consolidated groups).

Part 15 - Transitional concessions for groups with substituted accounting periods

5.315 Under a transitional concession that applied when the consolidation regime commenced, the allocable cost amount of a joining entity could be increased by the undistributed, untaxed profits accrued to the group before 1 July 2003 (former section 701-30 of the Income Tax (Transitional Provisions) Act 1997 ). This concession provided groups with an outcome that could be achieved through the payment of an unfranked dividend to the head company prior to the removal of the inter-corporate dividend rebate.

5.316 This transitional concession applied to:

·
a consolidated group that came into existence before 1 July 2003; or
·
a consolidated group that came into existence between 1 July 2003 and 30 June 2004, but only if it came into existence on the first day of the income year of the head company starting after 30 June 2003.

5.317 The transitional concession will be modified so that, where a consolidated group came into existence between 1 July 2003 and 30 June 2004, the concession applies only if the group came into existence on or before the first day of the income year of the head company starting after 30 June 2003. [Schedule 5, items 137 and 138, subsection 701-30(1) of the Income Tax (Transitional Provisions) Act 1997]

5.318 Therefore, if the head company of a consolidated group had a substituted accounting period that ended, for example, on 31 March 2004, a joining entity can access the transitional concession provided the group came into existence on or before 31 March 2004.

Application of Part 15

5.319 The amendments in Part 15 apply to a consolidated group only if the head company of the group makes a choice to apply the amendments. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

[Schedule 5, item 139]

Revocation of choice for transitional entities

5.320 Under section 701-1 of the Income Tax (Transitional Provisions) Act 1997 a consolidated group could access the transitional concessions that applied at the commencement of the consolidation regime if:

·
the group qualified as a transitional group; and
·
an entity which joined the group qualified as a transitional entity.

5.321 The transitional concessions applied to a transitional entity only if the head company of the group made a choice for the entity to be a chosen transitional entity (section 701-5 of the Income Tax (Transitional Provisions) Act 1997 ). The choice for the entity to be a chosen transitional entity was irrevocable, unless the revocation took place before 1 January 2006 (subsection 701-5(4) of the Income Tax (Transitional Provisions) Act 1997 ).

5.322 A transitional rule will extend the period for revoking an irrevocable choice that was made before 1 January 2006 where:

·
the head company of a consolidated group makes a choice to apply the modification made by Part 15; and
·
the group came into existence:

-
on or after 1 July 2003; and
-
on a day other than the first day of the income year of the head company starting after 1 July 2003.

[Schedule 5, item 140]

5.323 In these circumstances, the head company will be able to revoke a choice that was made before 1 January 2006 for a transitional entity to be, or not to be, a chosen transitional entity. The head company will be able to revoke its earlier choice within six months of this Bill receiving Royal Assent. [Schedule 5, item 140]

5.324 The purpose of this transitional amendment is to ensure that affected consolidated groups can effectively access the relevant transitional concessions.

Part 16 - Loss multiplication rules for widely held companies

5.325 If one or more entities are interposed between individual shareholders and a company with realised or unrealised losses (a loss company), the company's losses could be reflected in the value of shares and loans held between such entities (inter-entity interests) when they are sold or otherwise realised.

5.326 The inter-entity loss multiplication rules in Subdivision 165-CD ensure that the economic losses of companies do not get inappropriate multiple tax recognition when inter-entity interests are sold or otherwise realised. Section 165-115K provides that the inter-entity loss multiplication rules apply where, broadly:

·
an alteration time happens in respect of a loss company; and
·
an entity has relevant equity interests or relevant debt interests in the loss company immediately before the alteration time.

5.327 Section 165-115X provides that an entity (other than an individual) has a relevant equity interest in a loss company at a particular time if, broadly:

·
the entity has a controlling stake in the loss company; and
·
the entity directly or indirectly has interests in the loss company that give it control of, or the ability to control, (either directly or indirectly through interposed entities) 10 per cent or more of the voting power, dividend rights, or capital distribution rights of the loss company.

5.328 However, a company will not have a relevant equity interest if it satisfies the exception in subsection 165-115X(3).

5.329 Similarly, section 165-115Y provides that an entity (other than an individual) has a relevant debt interest in a loss company at a particular time if, broadly, the entity has a controlling stake in the loss company and:

·
the entity is owed a debt by the loss company of not less than $10,000; or
·
the entity is owed a debt by an entity (the debtor entity) other than the loss company of not less than $10,000 where the debtor entity has a relevant equity interest or relevant debt interest in the loss company.

5.330 However, a company will not have a relevant debt interest if it satisfies the exception in subsection 165-115Y(4).

5.331 Widely held companies have difficulty in satisfying the exceptions in subsections 165-115X(3) and 165-115Y(4). As a result, in some circumstances the losses of a loss company receive no tax recognition at all.

5.332 To address these concerns, the inter-entity loss multiplication rules will be modified to make it easier for widely held companies to claim capital losses or deductions on the disposal of direct and indirect interests in loss companies. These modifications will significantly reduce compliance costs for widely held companies.

5.333 A 'widely held company' is defined in subsection 995-1(1) to mean, broadly:

·
a company whose shares are listed for quotation in the official list of an approved stock exchange; or
·
a company that has more than 50 members, unless no more than 20 persons had rights to at least 75 per cent of the value of the shares in the company or at least 75 per cent of the voting power or dividend rights of the company.

Circumstances in which a widely held company will have a relevant equity interest

5.334 For the purpose of applying the inter-entity loss multiplication rules, a widely held company will not have a relevant equity interest in a loss company at a particular time unless an entity has a controlling stake in the loss company and that entity has a direct or indirect interest in, or is owed a debt by, the widely held company in respect of which:

·
the entity could, if a CGT event happened in respect of the interest or debt, make a capital loss (other than a capital loss that would be disregarded) that reflects any part of the loss company's overall loss; or
·
the entity has deducted or can deduct, or could deduct at a later time, an amount in respect of the cost of the acquisition, or a net loss on the disposal, of the interest or debt, where the deduction reflected or would have reflected, or would reflect, any part of the loss company's overall loss.

[Schedule 5, item 141, subsections 165-115X(2A) and (2B)]

5.335 However, subsection 165-115X(2A) will not apply to a widely held company in respect of a particular time if an entity that had a direct or indirect interest in, or was owed a debt by, the widely held company at an earlier time, and had a controlling stake in the loss company at that earlier time:

·
made a capital loss (other than a capital loss that was disregarded) because a CGT event happened in respect of the interest or debt, where the capital loss reflected any part of the loss company's overall loss; or
·
has deducted or could have deducted at an earlier time, or could deduct at a later time, an amount in respect of the cost of the acquisition, or a net loss on the disposal, of the interest or debt, where the deduction reflected or would have reflected, or would reflect, any part of the loss company's overall loss.

[Schedule 5, item 141, subsection 165-115X(2C)]

5.336 Consequential amendments will clarify that subsections 165-115X(3) and (4), which exclude certain interests from being relevant equity interests, do not apply to widely held companies. [Schedule 5, items 142 and 143, subsections 165-115X(3A) and (4)]

Circumstances in which a widely held company will have a relevant debt interest

5.337 For the purpose of applying the inter-entity loss multiplication rules, a widely held company will not have a relevant debt interest in a loss company at a particular time unless an entity has a controlling stake in the loss company and that entity has a direct or indirect interest in, or is owed a debt by, the widely held company in respect of which:

·
the entity could, if a CGT event happened in respect of the interest or debt, make a capital loss (other than a capital loss that would be disregarded) that reflects any part of the loss company's overall loss; or
·
the entity has deducted or can deduct, or could deduct at a later time, an amount in respect of the cost of the acquisition, or a net loss on the disposal, of the interest or debt, where the deduction reflected or would have reflected, or would reflect, any part of the loss company's overall loss.

[Schedule 5, item 144, subsections 165-115Y(3A) and (3B)]

5.338 However, subsection 165-115Y(3A) will not apply to a widely held company in respect of a particular time if an entity that had a direct or indirect interest in, or was owed a debt by, the widely held company at an earlier time, and had a controlling stake in the loss company at that earlier time:

·
made a capital loss (other than a capital loss that was disregarded) because a CGT event happened in respect of the interest or debt, where the capital loss reflected any part of the loss company's overall loss; or
·
has deducted or could have deducted at an earlier time, or could deduct at a later time, an amount in respect of the cost of the acquisition, or a net loss on the disposal, of the interest or debt, where the deduction reflected or would have reflected, or would reflect, any part of the loss company's overall loss.

[Schedule 5, item 144, subsection 165-115Y(3C)]

5.339 Consequential amendments will clarify that subsections 165-115Y(4) and (5), which exclude certain interests from being relevant debt interests, do not apply to widely held companies. [Schedule 5, items 145 and 146, subsections 165-115Y(4A) and (5)]

Application of the inter-entity loss multiplication rules to consolidated groups

5.340 Subdivision 715-B clarifies how the inter-entity loss multiplication rules in Subdivision 165-CD apply when a company or trust leaves a consolidated group.

5.341 Consequential amendments will ensure that:

·
the consequences which arise under section 715-255 when a loss company leaves a consolidated group apply only if the head company has a relevant equity interest under section 165-115X in the leaving entity at the leaving time;
·
the consequences which arise under section 715-270 when a trust that is taken to be a loss company leaves a consolidated group apply only if the head company has a relevant equity interest under section 165-115X in the leaving entity at the leaving time; and
·
for the purposes of determining whether the head company has a relevant equity interest in a loss company or trust that leaves a consolidated group, the operation of the single entity rule (subsection 701-1(1)) is disregarded in applying subsections 165-115X(2C) and (4).

[Schedule 5, items 147 to 150, paragraph 715-255(1)(ba), subsections 715-255(1A), 715-270(5) and (5A)]

Application of the inter-entity loss multiplication rules to MEC groups

5.342 Subdivision 719-T clarifies how the inter-entity loss multiplication rules in Subdivision 165-CD apply to MEC groups.

5.343 A MEC group is wholly-owned by a foreign resident top company. The amendments modify the operation of the inter-entity loss multiplication rules for MEC groups where the foreign resident top company is a widely held company.

5.344 The amendments apply for the purpose of determining whether the head company of a MEC group has a relevant equity interest or relevant debt interest in a loss company at a particular time - that is:

·
at the time that section 715-255 or 715-270 applies; or
·
at the time the head company disposes of an equity interest or a debt interest in a loss company that is not a member of the MEC group.

5.345 That is, for the purpose of applying the inter-entity loss multiplication rules in Subdivision 165-CD, the head company of a MEC group is treated as not having a relevant equity interest or relevant debt interest in a loss company at a particular time if the top company of the group is a widely held company at that time, and

·
if the interest is an equity interest - because of subsections 165-115X(2A), (2B) and (2C), the top company does not have a relevant equity interest under section 165-115X in the loss company at that time; or
·
if the interest is a debt interest - because of subsections 165-115Y(3A), (3B) and (3C), the top company does not have a relevant debt interest under section 165-115Y in the loss company at that time.

[Schedule 5, item 151, subsections 719-740(1) and (3)]

5.346 In addition, if the interest is an equity interest, for the purposes of paragraph 719-740(1)(b), the operation of the single entity rule (subsection 701-1(1)) is disregarded in determining whether subsection 165-115X(2C) has the effect that the top company has a relevant equity interest under section 165-115X in the loss company at a particular time. [Schedule 5, item 151, subsection 719-740(2)]

Application of Part 16

5.347 The amendments in Part 16 apply on or after 1 July 2002. [Schedule 5, item 152]

5.348 In this regard, the amendments are beneficial to, and have been sought by, taxpayers as they will make it easier make it easier for widely held companies to claim capital losses or deductions on the disposal of direct and indirect interests in loss companies. These modifications will significantly reduce compliance costs for widely held companies.

Part 17 - CGT straddles

5.349 Under the CGT rules, a capital gain or loss arises when a CGT event happens to a CGT asset. For a number of CGT events, the CGT event is taken to happen at a time which is different to the time when the capital proceeds are received.

5.350 For example CGT event A1 happens when there is a change in beneficial ownership of a CGT asset (subsections 104-10(1) and (2)). In most cases the change in beneficial ownership of the CGT asset will occur at the time of settlement of a contract or when the capital proceeds are received. However, if the CGT event happened because the taxpayer entered into a contract, CGT event A1 is taken to happen at the time when the contract was entered into (subsection 104-10(3)).

5.351 Difficulties arise where the period between the time that the contract is entered into and the time of settlement straddles the time that an entity joins or leaves a consolidated group. That is, for example:

·
if an entity enters into a contract to dispose of a CGT asset, and, prior to settlement, the entity joins a consolidated group - the entry-sell case; or
·
if a member of a consolidated group enters into a contract to dispose of a CGT asset, and prior to settlement, the member leaves the group - the exit-sell case.

5.352 In these circumstances, the entity that entered into the contract (and makes a capital gain or loss) is different to the entity that holds the asset at the time of settlement (and receives the capital proceeds).

5.353 To overcome these difficulties, the CGT timing rules will be modified when an entity joins or leaves a consolidated group and the CGT event straddles the joining or leaving time.

5.354 In the entry-sell case, the CGT event in relation to a CGT asset will be taken to happen at the time when the circumstances that gave rise to the CGT event first existed if:

·
an entity becomes a subsidiary member of a consolidated group;
·
disregarding the operation of the single entity rule (subsection 701-1(1)), the joining entity held the CGT asset at the joining time;
·
taking into account the operation of the single entity rule, the head company of the group held the CGT asset at the joining time; and
·
a CGT event happened in relation to the asset at a time before the joining time, but the circumstances that gave rise to the CGT event first existed at a time on or after the joining time.

[Schedule 5, item 153, subsections 716-860(1) and (3)]

5.355 In the exit-sell case, the CGT event in relation to a CGT asset will be taken to happen at the time when the circumstances that gave rise to the CGT event first existed if:

·
an entity ceases to be a subsidiary member of a consolidated group;
·
taking into account the operation of the single entity rule, the head company of the group held the asset just before the leaving time;
·
disregarding the operation of the single entity rule, the leaving entity held the asset just after the leaving time; and
·
a CGT event happened in relation to the asset at a time before the leaving time, but the circumstances that gave rise to the CGT event first existed at a time on or after the leaving time.

[Schedule 5, item 153, subsections 716-860(2) and (3)]

5.356 A CGT event will straddle the joining or leaving time generally if the CGT event arises where a contract or some other agreement has been entered before the joining or leaving time - that is, when CGT event A1, C2, D3, E8, F1, F4 or F5 happens to a CGT asset. The modified timing rule for each of these events is outlined in Table 5.1.

Table 5.1 : Modified CGT timing rules where a CGT event straddles the joining or leaving time
CGT event Time the CGT event ordinarily happens Time the circumstances that gave rise to the CGT event first existed
A1 - Disposal of a CGT asset When the contract is entered into. When the change of beneficial ownership occurs.
C2 - Cancellation, surrender and similar endings When the contract is entered into. When ownership of the intangible asset ends.
D3 - Granting a right to income from mining When the contract is entered into. When the right to receive ordinary income or statutory income is granted.
E8 - Disposal by beneficiary of a capital interest When the contract is entered into. When the change of beneficial ownership of the beneficiary's interest occurs.
F1 - Granting a lease When the contract is entered into. When the lease, or the renewal or extension of the lease, starts.
F4 - Lessee receives payment for changing a lease When the term of a lease is varied or waived. When the payment from the lessor is received.
F5 - Lessor receives payment for changing a lease When the term of a lease is varied or waived. When the payment from the lessee is received.

Example 5.22: CGT straddle - The entry-sell case Sub Co enters into a contract to sell an asset on 1 May 2010. On 1 June 2010, Head Co acquires Sub Co. As a result, Sub Co becomes a subsidiary member of Head Co's consolidated group. The contract settles on 1 August 2010.Head Co will make a capital gain or loss under CGT event A1 at the time when the circumstances that gave rise to the CGT event first existed - that is, when the change in beneficial ownership of the asset occurs. This would be the time of settlement of the contract. Example 5.23 : CGT straddle - The exit-sell case Sub Co is a member of Head Co's consolidated group. Head Co enters into a contract to sell an asset on 1 May 2010. On 1 June 2010, Sub Co leaves the consolidated group and takes the CGT asset with it. The contract settles on 1 July 2010.Sub Co will make a capital gain or loss under CGT event A1 at the time when the circumstances that gave rise to the CGT event first existed - that is, when the change in beneficial ownership of the asset occurs. This would be the time of settlement of the contract.

Application of Part 17

5.357 The amendments in Part 17 apply in relation to CGT events that happen after 8 May 2007 - that is, after the date of announcement. [Schedule 5, item 154]

5.358 In this regard, the amendments are beneficial as they provide certainty to taxpayers and potentially prevent double taxation.

Part 18 - Choice to consolidate

5.359 A consolidated group is formed when the head company of a consolidatable group makes a choice to form a consolidated group (section 703-50). Currently, notice of the choice in the approved form must be given to the Commissioner. The group is taken to be consolidated from the day specified in the choice.

5.360 Similarly, a MEC group is formed when, broadly:

·
a choice is made by two or more eligible tier-1 companies of a top company (that is, broadly, the foreign resident owner of the group), which is given to the Commissioner in the approved form, that the potential MEC group derived from the eligible tier-1 companies is to be consolidated (section 719-50); or
·
a special conversion event happens to a potential MEC group derived from the eligible tier-1 company of a top company, which is notified to the Commissioner in the approved form (section 719-40).

5.361 Further, if a company becomes a new eligible tier-1 company of a top company after a MEC group comes into existence, the provisional head company must give the Commissioner a notice in the approved form in order for that new eligible tier-1 company to become a member of the MEC group (section 719-5).

5.362 Finally, if a cessation event happens to the provisional head company of a MEC group, the eligible tier-1 companies that are or were members of the group immediately after the cessation event may make a choice to appoint a new provisional head company. The choice must be given to the Commissioner in the approved form within 28 days of the cessation event (section 719-60).

5.363 The requirement that these choices must be given to the Commissioner in the approved form for the choice to have effect is causing administrative difficulties. Cases have arisen where wholly-owned corporate groups have operated for several years on the basis that they have formed a consolidated group or MEC group, without having made an effective choice to consolidate because of a technical deficiency in completing the approved form.

5.364 This problem was compounded by a recent court decision ( MW MacIntosh Pty Ltd v Commissioner of Taxation [2009] FCAFC 88) which has caused some practical difficulties relating to the time that the choice must be made.

5.365 To overcome these concerns, the amendments will modify the mechanism for making the following choices:

·
the choice to consolidate a consolidatable group;
·
the choice to consolidate a potential MEC group;
·
the choice to consolidate a potential MEC group following a special conversion event;
·
the choice for a new eligible tier-1 company to become a member of a MEC group; and
·
the choice for a new provisional head company to be appointed to a MEC group after the group has formed.

5.366 These choices will no longer need to be given to the Commissioner in the approved form to be effective. Instead, the choice will need to be made in writing but will not need to be given to the Commissioner. However, the head company of the group must give the Commissioner relevant information relating to the choice.

5.367 Therefore, the amendments will alleviate the administrative difficulties that arise when, for example:

·
a head company of a consolidatable group or potential MEC group has inadvertently failed to notify the Commissioner of a choice to consolidate by a specified day but nevertheless has lodged an income tax return on the basis that the group was consolidated from that day;
·
a consolidatable group or potential MEC group has chosen to consolidate but has inadvertently notified the Commissioner of the choice using the wrong approved form; or
·
the approved form notifying the Commissioner that a consolidatable group or potential MEC group has chosen to consolidate contains a clerical error that has the effect of making the choice to consolidate ineffective.

5.368 In these circumstances, the amendments will ensure that a choice to consolidate a consolidatable group or potential MEC group remains effective despite the administrative defects relating to the written notice notifying the Commissioner of that choice.

Choice to consolidate a consolidatable group

5.369 The head company of a consolidatable group can make a choice to form a consolidated group from the day specified in the choice. The choice must be in writing. [Schedule 5, item 155, subsection 703-50(1)]

5.370 The choice must be made no later than:

·
if the head company is required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company is not required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, item 157, subsection 703-50(3)]

5.371 A choice that is made in writing under section 703-50 to consolidate a consolidatable group does not need to be given to the Commissioner.

5.372 However, if a consolidated group comes into existence from a day specified in a choice that is made under section 703-50 to consolidate a consolidatable group, the head company of the group must give the Commissioner a notice in the approved form containing the following information:

·
the identity of the head company;
·
the day specified in the choice on which the consolidatable group is taken to consolidate;
·
the identity of each subsidiary member of the group on that day;
·
the identity of each entity that was a subsidiary member of the group on that day but has left the group when the notice is given;
·
the identity of each entity that was not a subsidiary member of the group on that day but joined the group after that day and is a subsidiary member of the group when the notice is given; and
·
the identity of each entity that joined the group after that day but is no longer a subsidiary member of the group when the notice is given.

[Schedule 5, items 156 and 159, subsections 703-50(1) and 703-58(1)]

5.373 The notice must be given to the Commissioner:

·
if the head company is required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - by the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company is not required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - by the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, item 159, subsection 703-58(2)]

5.374 If the notice under section 703-58 contains a technical defect, that defect does not affect the choice to consolidate a consolidatable group.

5.375 Consequential amendments will:

·
remove redundant provisions that have the effect of making the choice ineffective if it contains incorrect information and allow the Commissioner to give effect to the choice despite the wrong information;
·
ensure that the operation of paragraphs 701-5(2)(a) and 701D-15(3)(a) of the Income Tax (Transitional Provisions) Act 1997 are unaffected by the amendments; and
·
ensure that the operation of paragraph 45-885(1)(e) of the Taxation Administration Act 1953 (TAA 1953) is unaffected by the amendments.

[Schedule 5, items 158, 189 to 191, subsections 703-50(5) and (6) of the ITAA 1997, paragraphs 701-5(2)(a) and 701D-15(3)(a) of the Income Tax (Transitional Provisions) Act 1997 and paragraph 45-885(1)(e) of the TAA 1953]

5.376 When an entity joins or leaves a consolidated group, or when a consolidated group ceases to exist, notification in the approved form of the event must generally be given to the Commissioner within 28 days of the event (subsection 703-60(1)). The time for giving the notification to the Commissioner is modified where certain events happen before the Commissioner is notified that the group has come into existence (subsections 703-60(2) and (3)).

5.377 Consequential amendments will ensure that the effect of subsections 703-60(2) and (3) is maintained.

5.378 That is, subsection 703-60(2) modifies the time for giving notice to the Commissioner that an entity joins or leaves a consolidated group, or that a consolidated group ceases to exist, where:

·
the consolidated group comes into existence on a day specified in a choice under section 703-50; and
·
the notifiable event happens before the relevant notice is given to the Commissioner under section 703-58.

[Schedule 5, item 160, subsection 703-60(2)]

5.379 In these circumstances, the head company of the group must give the Commissioner notice in the approved form of the event no later than:

·
if the head company is required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company is not required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, items 161 and 162, subsections 703-60(2) and (2A)]

5.380 Similarly, subsection 703-60(3) modifies the time for giving notice to the Commissioner that an entity joins or leaves a consolidated group, or that a consolidated group ceases to exist, where:

·
the consolidated group comes into existence at a time under subsection 703-55(1) because a MEC group ceased to exist at that time;
·
the MEC group came into existence under paragraph 719-5(1)(a) because a choice under section 719-50 is made after that time; and
·
the event happens before the relevant notice is given to the Commissioner under section 719-76.

[Schedule 5, items 163 and 164, subsection 703-60(3)]

5.381 In these circumstances, the head company of the group must give the Commissioner notice in the approved form of the event no later than:

·
if the head company is required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company is not required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, items 165 and 166, subsections 703-60(3) and (4)]

Choice to consolidate a potential MEC group

5.382 The eligible tier-1 companies of a potential MEC group can jointly make a choice to form a MEC group on and after the day specified in the choice. The choice must be in writing. [Schedule 5, item 172, subsection 719-50(1)]

5.383 The choice must be made no later than:

·
if the head company of the MEC group is required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company of the MEC is not required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, item 178, subsections 719-50(3) and (3A)]

5.384 A choice to consolidate a potential MEC group under section 719-50 is taken to have effect from the day specified in the choice. [Schedule 5, item 180, section 719-55]

5.385 However, only the eligible tier-1 companies that exist on a particular day can choose to consolidate a potential MEC group from the day the choice takes effect. The MEC group that results from the choice to consolidate a potential MEC group cannot include an eligible tier-1 company of a top company that did not exist at the time the choice takes effect. In this regard, an eligible tier-1 company of a top company that comes into existence after the MEC group has formed can join the MEC group from the time that it comes into existence (subsection 719-5(4)).

5.386 The choice that is made in writing under section 719-50 to consolidate a potential MEC group does not need to be given to the Commissioner.

5.387 However, if a MEC group comes into existence on a day specified in a choice that is made under section 719-50 to consolidate a potential MEC group, the head company of the group must give the Commissioner a notice in the approved form containing the following information:

·
the identity of the head company;
·
the day specified in the choice on which the MEC group comes into existence;
·
the identity of each eligible tier-1 company of the top company in relation to the MEC group on that day;
·
the identity of each subsidiary member of the group on that day;
·
the identity of each entity that was a subsidiary member of the group on that day but has left the group when the notice is given;
·
the identity of each entity that was not a subsidiary member of the group on that day but joined the group after that day and is a subsidiary member of the group when the notice is given; and
·
the identity of each entity that joined the group after that day but is no longer a subsidiary member of the group when the notice is given.

[Schedule 5, items 177 and 183, subsections 719-50(1), 719-76(1) and (2)]

5.388 The notice must be given to the Commissioner:

·
if the head company of the MEC group is required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - by the day on which that the company gives its income tax return to the Commissioner for that income year; or
·
if the head company of the MEC group is not required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - by the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, item 183, subsection 719-76(3)]

5.389 If the notice under section 719-76 contains a technical defect, that defect does not affect the choice to consolidate a potential MEC group.

5.390 Consequential amendments will:

·
ensure that subsection 719-50(4) continues to apply when a company ceases to be an eligible tier-1 company before a notice under section 719-76 is given to the Commissioner;
·
remove redundant provisions that have the effect of making the choice ineffective if it contains incorrect information and allow the Commissioner to give effect to the choice despite the wrong information; and
·
ensure that the operation of section 45-935 of the TAA 1953 is unaffected by the amendments.

[Schedule 5, items 179, 180 and 192, paragraph 719-50(4)(b) and section 719-55 of the ITAA 1997 and section 45-935 of the TAA 1953]

5.391 When an entity joins or leaves a MEC group, or when a cessation event happens to the provisional head company of a MEC group, notification in the approved form of the event must generally be given to the Commissioner within 28 days of the event (section 719-80). The time for giving the notification to the Commissioner is modified where certain events happen before the Commissioner is notified that the group has come into existence.

5.392 Consequential amendments will ensure that the effect of section 719-80 is maintained.

5.393 That is, subsection 719-80(2) modifies the time for giving notice to the Commissioner that an entity joins or leaves a consolidated group, or when a cessation event happens to the provisional head company of a MEC group, where:

·
the MEC group comes into existence because of a choice under section 719-50; and
·
the event happens before the relevant notice is given to the Commissioner under section 719-76.

[Schedule 5, item 184, paragraph 719-80(2)(a)]

5.394 In these circumstances, the head company of the group must give the Commissioner notice in the approved form of the event no later than:

·
if the head company is required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company is not required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, items 185 and 188, paragraph 719-80(2)(a) and subsection 719-80(3)]

5.395 Subsection 719-80(2) also modifies the time for giving notice to the Commissioner that an entity joins or leaves a consolidated group, or when a cessation event happens to the provisional head company of a MEC group, where:

·
the consolidated group comes into existence because of a special conversion event - that is, because a consolidated group converted to a MEC group;
·
the consolidated group came into existence because a choice under section 703-50 in relation to the group; and
·
the notifiable event happens before the relevant notice is given to the Commissioner under section 703-58.

[Schedule 5, item 186, paragraph 719-80(2)(b)]

5.396 In these circumstances, the head company of the group must give the Commissioner notice in the approved form of the event no later than:

·
if the head company is required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company is not required to give the Commissioner an income tax return for the income year during which the day specified in the choice occurs - the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, items 187 and 188, paragraph 719-80(2)(b) and subsection 719-80(3)]

Special conversion event happens to a potential MEC group

5.397 A special conversion event happens if, broadly, a consolidated group becomes a potential MEC group and makes a choice to form a MEC group - that is, if a consolidated group converts to a MEC group on a particular day (section 719-40).

5.398 If a special conversion event happens, the company that is an eligible tier-1 company and the head company of the consolidated group can make a choice in writing:

·
specifying the companies that are eligible tier-1 companies of the top company; and
·
stating that a MEC group is to come into existence at that time as a result of the specified companies becoming eligible tier-1 companies of the top company.

[Schedule 5, items 172 and 173, paragraph 719-40(1)(e)]

5.399 In addition, if an eligible tier-1 company that is specified in the choice was a member of another MEC group immediately before the time the choice was made and all the eligible tier-1 companies in that other MEC group became eligible tier-1 companies of the top company at that time, then each eligible tier-1 company in that other MEC group must be specified in the choice. [Schedule 5, item 174, paragraph 719-40(1)(f)]

5.400 The choice must be made no later than:

·
if the head company of the MEC group is required to give the Commissioner an income tax return for the income year during which the special conversion event happens - the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company of the MEC group is not required to give the Commissioner an income tax return for the income year during which the special conversion event happens - the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, items 172 and 176, paragraph 719-40(1)(e) and subsection 719-40(2)]

5.401 The choice that is made in writing under section 719-40 to consolidate a potential MEC group following a special conversion event does not need to be given to the Commissioner.

5.402 However, if a MEC group comes into existence because of a choice under section 719-40 to consolidate a potential MEC group following a special conversion event, the head company of the group must give the Commissioner a notice in the approved form containing the following information:

·
the identity of the head company;
·
the time that the special conversion event happens - that is, the day on which the MEC group comes into existence;
·
the identity of each eligible tier-1 company of the top company in relation to the MEC group on that day;
·
the identity of each subsidiary member of the group on that day;
·
the identity of each entity that was a subsidiary member of the group on that day but has left the group when the notice is given;
·
the identity of each entity that was not a subsidiary member of the group on that day but joined the group after that day and is a subsidiary member of the group when the notice is given; and
·
the identity of each entity that joined the group after that day but is no longer a subsidiary member of the group when the notice is given.

[Schedule 5, items 175 and 183, subsections 719-40(1), 719-78(1) and (2)]

5.403 The notice must be given to the Commissioner:

·
if the head company of the MEC group is required to give the Commissioner an income tax return for the income year during which the special conversion event happens - by the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company of the MEC group is not required to give the Commissioner an income tax return for the income year during which the special conversion event happens - by the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, item 183, subsection 719-78(3)]

5.404 If the notice under section 719-78 contains a technical defect, that defect does not affect the choice to consolidate a potential MEC group following a special conversion event.

New eligible tier-1 companies of a MEC group

5.405 If a company becomes a new eligible tier-1 company of a top company at a time after a MEC group comes into existence, the provisional head company can make a choice in writing:

·
specifying the company; and
·
stating that the company is to become a member of the MEC group with effect from that time.

[Schedule 5, item 167, paragraph 719-5(4)(c)]

5.406 In addition, if the eligible tier-1 company that is specified in the choice was a member of another MEC group immediately before the time the choice was made and all the eligible tier-1 companies in that other MEC group became eligible tier-1 companies of the top company at that time, then each eligible tier-1 company in that other MEC group must be specified in the choice. [Schedule 5, item 168, paragraph 719-5(4)(d)]

5.407 The choice must be made no later than:

·
if the head company of the MEC group is required to give the Commissioner an income tax return for the income year during which the company becomes an eligible tier-1 company of the top company - the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company of the MEC group is not required to give the Commissioner an income tax return for the income year during which the company becomes an eligible tier-1 company of the top company - the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, items 167 and 171, paragraph 719-5(4)(c) and subsections 719-5(6) and (6A)]

5.408 If a choice under section 719-5 is made, a new eligible tier-1 company covered by the choice will become a member of the MEC group with effect from the day that it became an eligible tier-1 company of the top company. [Schedule 5, item 169, paragraph 719-5(4)(f)]

5.409 However, a choice for a new eligible tier-1 company to become a member of a MEC group will not be valid if, for example, that eligible tier-1 company did not exist at the time the choice takes effect.

5.45.The choice that is made in writing under section 719-5 for a new eligible tier-1 company to become a member of a MEC group does not need to be given to the Commissioner.

5.411 However, if a new eligible tier-1 company becomes a member of a MEC group because of a choice under section 719-5, the head company of the group must give the Commissioner a notice in the approved form containing the following information:

·
the identity of the head company;
·
the day on which the new eligible tier-1 company became a member of the MEC group - that is, the day the company became an eligible tier-1 company of the top company;
·
the identity of each eligible tier-1 company of the top company in relation to the MEC group at that time because of the choice;
·
the identity of each entity that becomes a subsidiary member of the group at that time because of the choice; and
·
the identity of each entity that was a subsidiary member of the group at that time because of the choice but has left the group when the notice is given.

[Schedule 5, items 170 and 183, section 719-40 and subsections 719-77(1) and (2)]

5.412 The notice must be given to the Commissioner:

·
if the head company is required to give the Commissioner an income tax return for the income year during which the company becomes an eligible tier-1 company of the top company - by the day on which the company gives its income tax return to the Commissioner for that income year; or
·
if the head company is not required to give the Commissioner an income tax return for the income year during which the company becomes an eligible tier-1 company of the top company - by the last day in the period within which the company would be required to give the Commissioner such a return if it were required to give the Commissioner such a return.

[Schedule 5, item 183, subsection 719-77(3)]

5.413 If the notice under section 719-77 contains a technical defect, that defect does not affect the choice for the new eligible tier-1 company to become a member of the MEC group.

5.414 Only a provisional head company that exists on the relevant day can choose to include a new eligible tier-1 company in its existing MEC group.

5.415 If an eligible tier-1 company comes into existence after a MEC group has been formed, it is not included in the MEC group under the written choice to consolidate, as it was not a member of the potential MEC group that was consolidated. A further choice must be made in writing to include that eligible tier-1 company in the group.

5.416 Under the current law, both the choice to consolidate and the choice to include a new eligible tier-1 company in a MEC group must be made in the approved form in order to be effective. In the majority of cases, the approved forms given to the Commissioner will contain sufficient information to be considered both a written choice, and a notice of that written choice under the new provisions.

5.417 However, where a defect in an original approved form is such that it is unclear that a written choice was made to include a new eligible tier-1 company in a MEC group, the choice may not be effective.

Appointment of a provisional head company after formation

5.418 If a cessation event happens to the provisional head company of a MEC group, the eligible tier-1 companies that are or were members of the group immediately after the cessation event may make a choice in writing jointly appointing a new provisional head company of the group. The appointment is taken to have come into force immediately after the cessation event. [Schedule 5, items 181 and 182, subsections 719-60(1) and (3)]

5.419 The choice must generally be made within 28 days of the cessation event (subsection 719-60(3)).

5.420 The choice that is made in writing under subsection 719-60(3) for the appointment of a new provisional head company following a cessation event does not need to be given to the Commissioner.

5.421 However, if a choice is made under subsection 719-60(3) to appoint a new provisional head company following a cessation event, the provisional head company must give the Commissioner a notice in the approved form containing the following information:

·
the identity of the provisional head company;
·
the day on which the choice is made; and
·
the day on which the cessation event occurs.

[Schedule 5, item 183, subsections 719-79(1) and (2)]

5.422 The notice must be given to the Commissioner no later than:

·
if the group came into existence because a choice has been made under section 719-50 to form a MEC group and the event happens more than 28 days before a notice of a choice under section 719-76 is given - the day on which the notice of a choice under section 719-76 is given; or
·
otherwise - 28 days after the cessation event.

[Schedule 5, item 183, subsection 719-79(3)]

5.423 If the notice under section 719-79 contains a technical defect, that defect does not affect the choice to appoint a new provisional head company following a cessation event.

Application of the amendments in Part 18

5.424 The amendments in Part 18 apply from 1 July 2002. [Schedule 5, item 193]

5.425 In this regard, the amendments are beneficial to taxpayers and, in the vast majority of cases, will have no retrospective impact. That is, where an effective choice has been made before the introduction of the amendments, that choice is not affected by the amendments and no further information needs to be given to the Commissioner.

5.426 However, where a choice made prior to the introduction of these amendments is ineffective because of a defect in the approved form, the amendments may allow that defect to be corrected.

5.427 Consequently, the amendments will overcome difficulties that have arisen, for example, where some wholly-owned corporate groups have operated for a number of years on the basis that they have formed a consolidated group or MEC group, without having made an effective choice to consolidate because notice has not been given to the Commissioner in the approved form.

Part 19 - Life insurance companies

5.428 Division 320 contains special rules for life insurance companies.

5.429 Life insurance companies essentially carry on three different types of business:

·
ordinary business - taxable income in respect of this business is taxed at the corporate tax rate of 30 per cent;
·
complying superannuation/FHSA business - taxable income in respect of this business is taxed at the complying superannuation fund and first home saver account (FHSA) rate of 15 per cent; and
·
immediate annuity business - income relating to this business is non-assessable non-exempt income.

5.430 To ensure that income belonging to each class of business is clearly identified, assets belonging to each class must be segregated.

·
Assets relating to the complying superannuation/FHSA business are called complying superannuation/FHSA assets (section 320-170).
·
Assets relating to immediate annuity business are called segregated exempt assets (section 320-225).

5.431 The value of assets and liabilities in each segregated pool must be valued annually (sections 320-175 and 320-230). Excess assets held in a segregated pool must be transferred out of that pool at the end of each income year (sections 320-180 and 320-235). Certain transactions between the different classes of business are specifically recognised for tax purposes (sections 320-200 and 320-255).

5.432 If a life insurance company joins a consolidated group, the head company is taken to be a life insurance company (section 713-505). The purpose of section 713-505 is to ensure that Division 320 applies to the head company of the group.

5.433 When Division 320 was introduced in 2000, many life insurance companies invested the assets belonging to each class of business by acquiring membership interests in wholly-owned subsidiaries. The segregated asset income of each class could be clearly identified by the income flowing from the relevant membership interests.

5.434 Under the consolidation regime, the life insurance company and all of its wholly-owned subsidiaries (other than those subsidiaries covered by section 713-510) are members of the same consolidated group. Therefore, as a consequence of the single entity rule (subsection 701-1(1)), the membership interests that a life insurance company holds in a wholly-owned subsidiary entity are no longer recognised. This has caused practical difficulties for the head company in identifying the segregated asset income of each class.

5.435 Further difficulties arise because the segregated assets of a life insurance company may include other types of intra-group assets (in addition to membership interests) that need to be recognised to identify the segregated asset income of each class, such as:

·
a bank account held by the life insurance company with another member of the group;
·
a leasing arrangement between the life insurance company and another member of the group; or
·
an immediate annuity policy issued by the life insurance company to another member of the group.

5.436 To overcome these difficulties, if a life insurance company is a member of a consolidated group, the single entity rule (subsection 701-1(1)) will be disregarded for the purposes of working out:

·
amounts of the head company's ordinary income and statutory income derived from segregated exempt assets that are non-assessable non-exempt income (see paragraph 320-37(1)(a));
·
the head company's taxable income of the complying superannuation class (see section 320-137);
·
the head company's tax loss of the complying superannuation/FHSA class (see section 320-141);
·
the total transfer value of the head company's complying superannuation/FHSA assets (see paragraph 320-175(1)(a));
·
the amount of the head company's complying superannuation/FHSA liabilities (see paragraph 320-175(1)(b));
·
the total transfer value of the head company's segregated exempt assets (see paragraph 320-230(1)(a)); and
·
the amount of the head company's exempt life insurance policy liabilities (see paragraph 320-230(1)(b)).

[Schedule 5, items 194 and 198 to 201, subsections 713-510A(1) and (3)]

5.437 However, if the life insurance company is a subsidiary member of the group, these modifications do not apply:

·
for the purposes of working out the tax cost setting amount of an asset of the life insurance company when it becomes a subsidiary member of the group; and
·
for the purposes of working out the tax cost setting amount of a membership interest in the life insurance company if it ceases to be a subsidiary member of the group.

[Schedule 5, item 194, subsection 713-510A(2)]

5.438 Prior to the introduction of first home saver accounts in 2007:

·
the complying superannuation/FHSA class was called the virtual pooled superannuation trust (PST) class;
·
complying superannuation/FHSA assets were called virtual PST assets, and
·
complying superannuation/FHSA liabilities were called the virtual PST liabilities.

5.439 Consequential amendments reflect this change of terminology. [Schedule 5, items 198 to 201, subsection 713-510A(3)]

5.440 In addition, a consequential amendment will repeal sections 713-553 to 713-560. Those provisions were inserted to ensure that the income tax law operated appropriately when, prior to joining the group, a life insurance company had issued an immediate annuity policy to another company that has joined the same consolidated group as the life insurance company. As this is an intra-group transaction that will be appropriately recognised under the proposed amendments, these specific rules will no longer be necessary. [Schedule 5, items 195 and 196]

Application of the amendments in Part 19

5.441 The amendments in Part 19 apply from 1 July 2002. [Schedule 5, item 197]

5.442 In this regard, the amendments are beneficial to taxpayers as they confirm existing practice and will ensure that life insurance companies can calculate their taxable income correctly.

5.443 The technical amendments to update terminology apply on or after the commencement of the First Home Savers Accounts (Consequential Amendments) Act 2008 . [Schedule 5, item 202]

Part 20 - Non-membership equity interests

5.444 A gap exists in the tax cost setting rules when an entity that joins or leaves a consolidated group has issued non-membership equity interests - that is, interests that are neither membership interests nor liabilities. An example of non-membership equity interests is convertible notes.

5.445 As a result, when an entity that has issued non-membership equity interests joins a consolidated group, the tax costs of the entity's assets are understated because of the exclusion of these interests from the tax cost setting calculation.

5.446 When an entity that has issued non-membership equity interests leaves a consolidated group:

·
if the leaving entity has issued non-membership equity interests to entities that are members of the old group, no tax cost arises for those membership interests; and
·
if the leaving entity has issued non-membership equity interests to entities that are not members of the old group, the old group's allocable cost amount for the leaving entity is overstated.

5.447 The tax cost setting rules will be modified where an entity that has issued non-membership equity interests joins or leaves a consolidated group.

5.448 As a result, the allocable cost amount for a joining entity will be increased to reflect the amount received by the joining entity from the issue of non-membership equity interests.

5.449 In addition, when an entity leaves a consolidated group:

·
if the leaving entity has issued non-membership equity interests to entities that are members of the old group, a tax cost will arise for those membership interests; and
·
if the leaving entity has issued non-membership equity interests to entities that are not members of the old group, the old group's allocable cost amount for the leaving entity will be reduced to reflect the amount received by the old group from the issue of the non-membership equity interests.

What is a non-membership equity interest?

5.450 A non-membership equity interest in an entity is defined to mean an interest in the entity at a time, to the extent that it is not an accounting liability (within the meaning of subsection 705-70(1)) in the entity at that time, if:

·
the interest is not a membership interest (as defined in section 960-135) in the entity at that time; and
·
the interest is not a debt interest (as defined in Subdivision 974-B) in the entity at that time.

[Schedule 5, item 219, definition of 'non-membership equity interest' in subsection 995-1(1)]

5.451 In this regard, for the purpose of determining the extent to which an interest is not an accounting liability within the meaning of subsection 705-70(1):

·
each reference in subsection 705-70(1) to the joining entity is treated as being a reference to the entity; and
·
the reference in subsection 705-70(1) to the joining time is treated as being a reference to the time that the definition of non-membership equity interest is being applied.

[Schedule 5, item 219, definition of 'non-membership equity interest' in subsection 995-1(1)]

5.452 Examples of the types of interests in an entity that will typically qualify as non-membership equity interests include:

·
a right or option (including a contingent right or option) created or issued by the entity to acquire a membership interest in the entity; and
·
a convertible note created or issued by the entity.

Modifications when a joining entity has non-membership equity interests on issue

5.453 When an entity joins a consolidated group, the tax costs of the joining entity's assets are generally reset by allocating the joining entity's allocable cost amount to each of the joining entity's assets in proportion to their market value. This allocation process ensures that, broadly, the costs incurred by the head company to acquire the joining entity's membership interests are pushed down into the tax costs of the underlying assets of the joining entity.

5.454 Step 1 of the allocable cost amount is, broadly, the costs of the membership interests in the joining entity (section 705-65). For these purposes, certain rights and options to acquire membership interests in the joining entity which are held by the members of the joined group are treated as if they were membership interests in the joining entity (subsection 705-65(6)).

5.455 The scope of subsection 705-65(6) will be broadened so that, if at the joining time a member of the joined group holds a non-membership equity interest in the joining entity, then the non-membership equity interest is treated as a membership interest for the purposes of step 1 of the allocable cost amount. [Schedule 5, item 203, subsection 705-65(6)]

5.456 As a result, in most cases the cost bases of non-membership equity interests that members of the joined group hold in the joining entity will be included in step 1 of the allocable cost amount.

5.457 Step 2 of the allocable cost amount is, broadly, the value of the joining entity's accounting liabilities (section 705-70). However, the step 2 amount is increased by, among other things, the market value of certain rights and options to acquire membership interests in the joining entity which are held by a person who is not a member of the joined group (paragraph 705-85(3)(a)).

5.458 Paragraph 705-85(3)(a) will be modified so that the step 2 amount is increased by the amount that would be the balance of the joining entity's non-share capital account, assuming that:

·
if it is not a company, the joining entity were a company;
·
each non-membership equity interest (if any) in the joining entity held at the joining time by a person other than a member of the joined group were a non-share equity interest in the joining entity; and
·
those non-share equity interests (if any) were the only non-share equity interests in the joining entity.

[Schedule 5, item 205, paragraph 705-85(3)(a)]

5.459 As a result, the step 2 amount will effectively be increased by the amount received by the joining entity from the issue of non-membership equity interests to a person who is not a member of the joined group.

5.460 Consequential amendments will modify various provisions so that they appropriately refer to non-membership equity interests (rather than to rights or options to acquire membership interests). [Schedule 5, items 204 and 206 to 212, subsections 705-85(3), 705-145(5), 705-195(1) and (2), 705-200(1) and (3) and 705-225(5)]

Modifications when a leaving entity has non-membership equity interests on issue

5.461 When an entity leaves a consolidated group, the tax costs of the membership interests in the leaving entity are reconstructed. That is, the tax cost setting amount for each membership interest held in the leaving entity by members of the old group is worked out by, broadly, allocating a proportion of the old group's allocable cost amount to each membership interest (section 711-15).

5.462 For these purposes, certain rights and options to acquire membership interests in the leaving entity which are held by the members of the old group are treated as if they were a separate class of membership interests in the leaving entity (subsection 711-15(2)).

5.463 The scope of subsection 711-15(2) will be broadened so that, if at the leaving time a member of the old group holds a non-membership equity interest in the leaving entity, then the non-membership equity interest is treated as if:

·
it were a membership interest in the leaving entity; and
·
it were of a different class than any other membership interest in the leaving entity.

[Schedule 5, item 213, subsection 711-15(2)]

5.464 As a result, the tax costs of any non-membership equity interests in the leaving entity held by members of the old group will be worked out by allocating part of the old group's allocable cost amount to those non-membership equity interests.

5.465 The old group's allocable cost amount for a leaving entity is, broadly, the sum of the terminating value of the leaving entity's assets (step 1 of the old group's allocable cost amount (section 711-25)) less the value of its accounting liabilities and the value of membership interests held in the leaving entity that are not held by members of the old group (step 4 of the old group's allocable cost amount (section 711-45)).

5.466 Section 711-45 will be modified so that the step 4 amount is increased by the amount that would be the balance of the leaving entity's non-share capital account, assuming that:

·
if it is not a company, the leaving entity were a company;
·
each non-membership equity interest (if any) in the leaving entity held just before the leaving time by a person other than a member of the old group were a non-share equity interest in the leaving entity; and
·
those non-share equity interests (if any) were the only non-share equity interests in the leaving entity.

[Schedule 5, item 215, subsection 711-45(6B)]

5.467 As a result, the step 4 amount will effectively be increased by the amount received by the old group from the issue of non-membership equity interests in the leaving entity to a person who is not a member of the old group.

5.468 Consequential amendments will modify various provisions so that they appropriately refer to non-membership equity interests (rather than to rights or options to acquire membership interests). [Schedule 5, items 216 to 218, subsections 715-50(6), 715-255(6) and 715-270(6)]

Application of Part 20

5.469 The amendments in Part 20 apply from the date of introduction of this Bill into the House of Representatives. That is, the amendments will apply to an entity that joins or leaves a consolidated group on or after that date. [Schedule 5, item 220]

5.470 However, the head company of a consolidated group can make a choice to apply the amendments in Part 20 to an entity that joins or leaves a consolidated group on or after 1 July 2002. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

[Schedule 5, item 220]

5.471 This option to apply the amendments from 1 July 2002 will allow consolidated groups that are adversely affected by the operation of the current law to take advantage of the amendments, having regard to the compliance cost implications of applying the changes retrospectively.

Application and transitional provisions

Measures that apply from 1 July 2002

5.472 The following measures apply from 1 July 2002 (that is, from the commencement of the consolidation regime):

·
the amendments in Division 1 of Part 1 which ensure the tax cost setting amount allocated to a joining entity's assets is used for the purposes of applying other provisions of the income tax law;
·
the amendment in item 13 of Part 2, which modifies the circumstances in which a company is eligible to be appointed as the provisional head company of a MEC group;
·
the amendments in Part 5, which modify the treatment of pre-joining time roll-overs under the tax cost setting rules that apply when an entity joins a consolidated group;
·
the amendments in items 114 and 116 of Part 9, which modify the tax cost setting rules that apply when an entity joins or leaves a consolidated group to clarify that the adjustment for inherited deductions does not apply to certain deductions for undeducted construction expenditure;
·
the amendments in Part 10, which modify the operation of the tax cost setting rules that apply when an entity joins or leaves a consolidated group for general insurance companies;
·
the amendments in Division 2 of Part 11, which ensure that certain rights to future income assets are treated as retained cost base assets;
·
the amendments in Part 12, which repeal CGT event L7;
·
the amendments in Part 15, which ensure certain consolidation transitional rules apply to the head company of a group which has a substituted accounting period where the group consolidated on or after 1 July 2003 on a day prior to the first day of its income year;
·
the amendments in Part 16, which modify the operation of the loss multiplication rules for widely held companies;
·
the amendments in Part 18, which modify the way that a choice to consolidate is made; and
·
the amendments in Part 19, which modify the mechanism for working out the taxable income of consolidated groups that have life insurance company members in respect of intra-group transactions.

[Schedule 5, items 7, 17, 55, 117, 119, 126, 131, 139, 152, 193 and 202]

5.473 These amendments, which were sought by taxpayers, are beneficial because, broadly, they ensure that the consolidation provisions operate as intended and confirm established practice.

5.474 Business and professional groups representing taxpayers involved in the consultation process support the application of these measures from 1 July 2002.

Measures that apply from 1 July 2005

5.475 The amendments in Part 14, which ensure that the blackhole expenditure provisions that apply to consolidated groups also apply to MEC groups, apply from 1 July 2005 (that is, from the commencement of the blackhole expenditure provisions). [Schedule 5, item 136]

5.476 These amendments are beneficial as they ensure that MEC groups get appropriate tax recognition for costs paid to third parties in respect of intra-group transactions affecting CGT assets they hold by the group (in the same way as consolidated groups).

Measures that apply from 27 October 2006, but with an option to apply the measure from 1 July 2002

5.477 The amendments in Part 2, which allow consolidated groups to convert to MEC groups, and vice versa, with minimal tax consequences (other than the modification to the circumstances in which a company is eligible to be appointed as the provisional head company of a MEC group), apply to conversion events which happen on or after 27 October 2006 (that is, from the date of announcement). [Schedule 5, item 17]

5.478 However, the head company of a consolidated group or MEC group can make a choice to apply the amendments in Part 2 from 1 July 2002. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

[Schedule 5, item 17]

5.479 These amendments were sought by affected taxpayers and are beneficial as they will substantially reduce unnecessary compliance costs.

5.480 The option to apply the amendments from 1 July 2002 will allow consolidated groups and MEC groups that are adversely affected by the operation of the current law to take advantage of the amendments, having regard to the compliance cost implications of applying the changes retrospectively.

5.481 Business and professional groups representing taxpayers involved in the consultation process support the optional application of these measures from 1 July 2002.

Measures that apply from 8 May 2007

5.482 The following measures apply after 8 May 2007 (that is, from the date of announcement):

·
the amendments in Division 1 of Part 6, which phase out the over-depreciation adjustment to the allocable cost amount; and
·
the amendments in Part 17, which modify the CGT timing rules where a CGT event that happens to a CGT asset straddles the time that an entity joins or leaves a consolidated group.

[Schedule 1, items 57 and 154]

5.483 These amendments were sought by affected taxpayers. Business and professional groups representing taxpayers involved in the consultation process support the application of these measures from 8 May 2007.

Measures that apply from 1 July 2009

5.484 The amendments in Division 2 of Part 6, which repeal the over-depreciation adjustment provisions, apply from 1 July 2009. [Schedule 5, item 78]

Measures that apply from the date of introduction, but with an option to apply the measure from 1 July 2002

5.485 Some measures in this Bill apply from the date of introduction of this Bill into the House of Representatives. However, the head company of a consolidated group can make a choice to apply the amendments on or after 1 July 2002. The choice:

·
must be made on or before 30 June 2011, or within such further time as the Commissioner allows; and
·
must be made in writing.

5.486 These measures are:

·
the amendments in Division 2 of Part 1, which clarify interactions with the foreign currency gains and losses provisions (Division 775) when an entity joins a consolidated group;
·
the amendments in Part 3, which improve the treatment of pre-CGT membership interests of a joining entity;
·
the amendments in Part 4, which ensure that amounts are not double counted when working out the allocable cost amount of a joining entity;
·
the amendments in Division 1 of Part 11, which ensure that units held in cash management trusts are treated as retained cost base assets;
·
the amendments in Part 13, which reduce the tax cost setting amount of a joining entity where that amount exceeds the market value of certain retained cost base assets; and
·
the amendments in Part 20, which modify the tax cost setting rules where an entity that has issued non-membership equity interests joins or leaves a consolidated group.

[Schedule 5, items 7, 35, 37, 126, 134 and 220]

5.487 These amendments, which were sought by taxpayers, are beneficial. However, taxpayers have taken different positions on the operation of the current law in relation to these issues.

5.488 Therefore, the option to apply the amendments from 1 July 2002 will ensure that taxpayers do not need to disturb past practices. However, it will allow consolidated groups to take advantage of the amendments, having regard to the compliance cost implications of applying the changes retrospectively.

5.489 Business and professional groups representing taxpayers involved in the consultation process support the optional application of these measures from 1 July 2002.

Measures that apply from the date of introduction

5.490 The following measures apply from the date of introduction of this Bill into the House of Representatives:

·
the amendments in Part 7, which modify the treatment of liabilities under the tax cost setting rules that apply when an entity leaves a consolidated group;
·
the amendments in Part 8, which clarify the accounting principles that are used under the tax cost setting rules that apply when an entity joins or leaves a consolidated group; and
·
the amendment in item 113 of Part 9, which modifies the amount of the adjustment for inherited deductions under the tax cost setting rules that apply when an entity leaves a consolidated group.

[Schedule 5, items 87, 89, 113, and 117]

Amendment of assessments

5.491 Generally, the Commissioner can amend an assessment of a company, other than a small business entity, within four years from the date of the notice of assessment (section 170 of the ITAA 1936).

5.492 As a number of these amendments apply from 1 July 2002, the period for amending assessments will be extended. That is, the operation of section 170 will be modified so that it does not prevent the amendment of an assessment if:

·
the assessment was made before the commencement of Schedule 5;
·
the amendment is made within two years after that date; and
·
the amendment is made for the purpose of giving effect to the amendments in Schedule 5.

[Section 4]


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