Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)
Chapter 1 - Capital gains tax - amendments relating to value shifting
1.1 The provisions contained in Part 1 of Schedule 1 of the Bill will amend the capital gains tax (CGT) provisions in Division 19A of Part IIIA of the Income Tax Assessment Act 1936 (the Act) . Division 19A operates to prevent timing advantages that could arise when assets are transferred and values are shifted between shares and loans in commonly owned transferor and transferee companies. The Schedule also contains other technical amendments designed to simplify and clarify the operation of Division 19A.
1.2 The main purpose of the amendments is to reduce compliance costs for corporate taxpayers especially in relation to assets being transferred as part of corporate restructures. The amendments are in response to submissions received which have emphasised that the continued application of Division 19A in its current form could act as a disincentive to corporate restructuring.
1.3 The amendments, which were foreshadowed by the Treasurer in the 1995-96 Budget, apply to assets transferred after 7.30 pm AEST on 9 May 1995. [Item 17]
1.4 Division 19A applies to transfers of assets between companies under 'common ownership' (as defined at section 160ZZRB) and provides for adjustments to the cost bases of shares and loans held in the transferor and transferee companies in circumstances where a 'value shift' is taken to have occurred. The Division provides a number of tests to be applied in determining whether there has been a value shift, and therefore whether consequential cost base adjustments are required.
1.5 In the absence of cost base adjustments, companies under common ownership could transfer assets for low or negligible consideration, and realise a capital loss (or reduced capital gain) on a subsequent disposal of shares or loans in the transferor company. It would be inappropriate to allow a capital loss (or reduced gain) in these circumstances where the transferred asset remains within the commonly owned group of companies.
1.6 The criteria, methods and formulae for determining whether cost base adjustments are required are contained in sections 160ZZRE, 160ZZRF and 160ZZRFA. The criteria include:
- whether the transferred asset is a pre or post CGT asset in the hands of the transferor;
- whether the asset was acquired by the transferor company before or after the date of 'common ownership' with the transferee. Sections 160ZZRE (post CGT assets) and 160ZZRFA (pre CGT assets) deal with assets acquired when the transferor and the transferee are under common ownership and section 160ZZRF deals with both pre and post CGT assets acquired before common ownership occurs; and
- the consideration paid for the asset, the asset's market value and cost base (indexed or reduced) for CGT purposes.
1.7 The proposed amendments to Division 19A will:
- provide an outline for the Division as amended by this Bill [item 2; new subsection 160ZZRAAA] . The amendments will also introduce new subdivision headings as partitions within the Division. New Subdivision A contains the Division's outline and interpretation provisions and new Subdivision B details how the existing provisions apply and how the amendments being proposed will apply to grouped and depreciable assets. New Subdivisions C and D contain amendments to deal with grouped and depreciable assets respectively. Existing provisions which deal with other assets and other adjustments are to be within new Subdivisions E and F respectively;
- introduce an anti-avoidance measure so that cost base adjustments will be made to shares or loans in a company in respect of newly created assets, which are vested in a related company. For example, rights relating to an existing underlying asset could be created and vested in a related company for consideration less than its market value while ownership of the underlying asset remains with the transferor [item 5; new section 160ZZRBA] ;
- simplify the tests used to determine whether a value shift has occurred where an asset that was acquired by a commonly owned company before it came to be under common ownership with the transferee company is transferred to another group company. These amendments, which compare the consideration for the transfer of the asset with the asset's market value at the time of common ownership (indexed from common ownership to when the transfer occurs), are contained in new Subdivisions A and C;
- enable a commonly owned company to group assets which are transferred to a particular transferee company in a given year of income for the purposes of applying Division 19A [new Subdivision C] ;
- insert new rules to be applied in determining when a value shift will be taken to have occurred as a consequence of the transfer of a depreciable asset between commonly owned companies [new Subdivision D] ;
- modify and extend the current tests used in subsection 160ZZRE(6) to determine whether a value shift has occurred. The current provisions only apply where shares, loans or shares of different classes are owned by the same taxpayer. The amendments will recognise situations where interests in the transferor are held by more than one member of the company group [items 10 and 11] ;
- make technical and consequential amendments to the operation of Division 19A as it relates to consequential adjustments to the cost bases of indirectly held interests in a transferor company (to reflect the value shift) and compensatory increases in the cost bases of equity interests in a transferee company [items 3, 9, 15 and 16; new subsection 160ZZRE(1B)] .
1.8 The amendments referred to above are explained in the following sections.
1.9 Any asset deemed under subsections 160M(6) and (7) (for example the right to exploit a trademark) to have been created and disposed of by a taxpayer will generally be, for the purposes of Division 19A, a post CGT, post common ownership asset.
1.10 Paragraphs 160M(6A)(c) and 160M(7)(d) provide that the cost base of such assets for CGT purposes will be limited to the amount of any costs which are incidental to the disposal of the asset. To determine whether a value shift has occurred for the purposes of Division 19A in relation to post CGT/post common ownership assets, section 160ZZRE requires a comparison between the consideration for the transfer of the asset and the lesser of the asset's indexed cost base or market value.
1.11 As the indexed cost base of such assets will be nil, Division 19A cannot currently apply where the asset is vested in a commonly owned company for low or nil consideration.
1.12 The Bill proposes an amendment to Division 19A so that the cost base, the indexed cost base and the reduced cost base of an asset to which subsections 160M(6) or (7) apply at a particular time will be equal to the market value of the asset at that time. [Item 5; new section 160ZZRBA]
1.13 Therefore, where the consideration for the transfer of the newly created asset is less than its market value, the cost bases of shares and loans in the company creating the new asset will be reduced pursuant to section 160ZZRE by an amount equal to the amount by which the market value of the asset exceeds the consideration for the transfer.
1.14 Where a transferred asset was acquired prior to the date of common ownership of the transferor and transferee companies, subsections 160ZZRF(2) and (3) require a determination of reasonable cost base adjustments in shares and loans in the transferor having regard to a number of tests. Section 160ZZRB provides the criteria which must be satisfied for two companies to be treated as being under common ownership for the purposes of applying Division 19A.
1.15 Subsections 160ZZRF(2) and (3) deal with assets acquired by the transferor after 19 September 1985 (post CGT assets) and before 20 September 1985 (pre CGT assets) respectively.
1.16 The tests in subsection 160ZZRF(2) to determine whether the cost base adjustments are reasonable for post CGT assets have regard to (at paragraph 160ZZRF(2)(e)) the consideration given on disposal of the asset to the transferee. There is no comparable test in subsection 160ZZRF(3) in relation to pre CGT assets. The amendments proposed will achieve consistency in this regard.
1.17 The Bill proposes an amendment to the operation of these provisions in relation to both pre and post CGT assets acquired before the time of common ownership of the transferor and transferee companies. Taxpayers may elect that, where the consideration for the transfer of a pre common ownership asset exceeds the 'indexed common ownership market value' amount of the asset, the tests in section 160ZZRF will be taken to have been satisfied. [Item 13; new subsections 160ZZRF(4) and (6)]
1.18 The 'indexed common ownership market value' amount is determined by the application of an indexation factor to the amount that was the market value of the asset at the time that the transferor and transferee companies came under common ownership. [Item 5; new subsection 160ZZRBB(1)]
1.19 The Bill proposes the repeal of the tests in subsections 160ZZRF(2) and 160ZZRF(3) [item 12] and the introduction of new subsection 160ZZRF(5) which will apply in relation to both pre and post CGT assets. The matters required to be considered in new subsection 160ZZRF(5), to determine whether cost base reductions to a share or loan are required as a consequence of the transfer of a pre common ownership asset are a restatement of the matters contained in existing subsection 160ZZRF(3).
1.20 As illustrated in the example below, the current application of Division 19A could result in cost base reduction calculations being required in circumstances where no overall value shift has actually taken place in respect of interests held in the transferor. This is because Division 19A does not recognise and account for higher consideration given for the transfer of a second asset.
1.21 Company A transfers a post common post/ownership CGT asset to commonly owned company B for consideration of $50. The indexed cost base of the asset is $100 and its market value is $150. In the course of the same group restructure, another asset is transferred by company A to B for cash consideration of $100. This asset has an indexed cost base of $50. By section 160ZZRE, a value shift of $50 has occurred in relation to the first asset, and the cost base of shares and loans in company A must therefore be reduced. However, the increased consideration given for the transfer of the second asset, is not taken into account.
1.22 In addition, currently where a group of assets is transferred, whether consequential cost base reductions are required and the extent of those cost base reductions must be determined on an asset by asset basis. This leads to unnecessary compliance costs for taxpayers.
1.23 The Bill proposes to introduce a new Subdivision C into Division 19A to provide that, at the election of a transferor company, assets to be transferred to a particular transferee company in a given year of income may be 'grouped' for the purposes of the applying the Division [item 8] . All of the assets in a particular group must be transferred to the same transferee in the same year of income of the transferor [new subsection 160ZZRDE(3), new paragraphs 160ZZRDF(1)(b), 160ZZRDG(1)(b), and 160ZZRDH(1)(c)] .
1.24 Under the amendments proposed, assets may be allocated to the following three groups [new subsection 160ZZRDE(2)] :
- depreciable property group
- pre-common ownership group; and
- post-common ownership group.
1.25 These groups are described in more detail below.
1.26 The criteria which determine whether an asset can be allocated to a depreciable asset group are contained in new subsections 160ZZRDF(1) and (2) and include the following:
- the asset is a depreciable asset [paragraph 160ZZRDF(1)(a)] ;
- the asset's original cost to the transferor was less than $1million [paragraph 160ZZRDF(1)(c)] ; and
- the asset is not a building [paragraph 160ZZRDF(1)(d)] .
1.27 Item 4 introduces new definitions into section 160ZZRA of the Act for 'original cost' and 'written down value' of an asset for the purposes of applying Division 19A as amended by the Bill. Original cost means the consideration for the last acquisition of the asset and the written down value is defined as the greater of the book written down value and the depreciated value for tax purposes.
1.28 New Subdivision D contains the provisions for the application of Division 19A to depreciable assets. Subdivision D will apply to depreciable assets where the total consideration for the disposal of the depreciable assets is less than the sum of the written down values of the assets in the group [new paragraph 160ZZRDF(2)(a)] . In addition the sum of the market values of the assets in the group must not exceed the sum of the written down values of the assets in the group by more than 10% [new paragraph 160ZZRDF(2)(b)] .
1.29 By grouping depreciable assets, the Division will be applied as if all the grouped assets were one asset that:
- was disposed of for the sum of the consideration received for all the grouped assets [new paragraph 160ZZRDF(3)(b)] ; and
- had a written down value equal to the sum of the written down values of all the grouped assets [new paragraph 160ZZRDF(3)(c)] .
1.30 Depreciable assets may be pre or post CGT assets which were acquired before or after the date of common ownership of the companies.
1.31 An asset can be allocated to this group if, in addition to meeting certain other criteria, it was acquired by the transferor before the transferor and transferee came under common ownership [new paragraph 160ZZRDG(1)(a)] . As with depreciable assets, for an asset to be within this group its original cost must be less than $1 million, and the asset cannot be land or a building [new paragraphs 160ZZRDG(1)(c) and (d)] .
1.32 The acquisition time in relation to common ownership is the main distinguishing feature between pre-common and post-common asset groups. An asset can be allocated to the post-common asset group if, in addition to meeting certain other criteria, it was acquired by the transferor:
- on or after 20 September 1985; and
- at or after the time when the transferor and transferee came under common ownership. [New paragraph 160ZZRDH(1)(a)]
1.33 The condition imposed whereby a post-common ownership asset must be a post CGT asset means that section 160ZZFRA, which applies to pre CGT assets, will have no application in relation to the grouping provisions. As with depreciable and pre-common assets, other criteria to be satisfied for an asset to be within the post-common ownership asset group are that its original cost is to be less than $1 million and the asset cannot be land or a building. [New paragraphs 160ZZRDH(1)(c) and (d)]
1.34 In relation to pre common and post common ownership asset groups, the proposed amendments provide that existing tests and cost base reduction formulae set out in sections 160ZZRF [new subsections 160ZZRDG(2) and (3)] and 160ZZRE [new subsections 160ZZRDH(2) and (3)] are to be applied as if the group of assets were a single asset.
1.35 For assets in the pre common ownership group, section 160ZZRF will apply if the total consideration received on disposal is less than the sum of all the indexed common ownership market values at the time of disposal of those assets. [New subsection 160ZZRDG(2)]
1.36 For assets in the post-common ownership group, section 160ZZRE will apply if the sum of the total consideration on disposal of those assets is less than the sum of the 'indexed threshold amounts' in respect of all the assets in the group. [New subsection 160ZZRDH(2)]
1.37 The indexed threshold amount for an asset is defined as the lesser of the indexed cost base and the market value of each asset. [Item 9; new subsection 160ZZRE(1B)]
1.38 New section 160ZZRDI is necessary to enable Division 19A to apply appropriately in situations where a share or a loan in a transferor comes into existence after the time when the first of a group of assets is disposed of during a year of income but before the transfer of the last asset to be included in the group. [Item 8]
1.39 Grouped assets are deemed to have been disposed of at the time when the first asset in a group was transferred (the adjustment time), regardless of when in the year of income the actual transfer of the asset occurs. Therefore, a share or loan may relate to an asset which is transferred and which, by virtue of the new grouping provisions, will be deemed to have been transferred before the share came into existence. Cost base adjustments would be inappropriately limited to shares and loans held by the transferor prior to the adjustment time even though value had been shifted out of the share or loan subsequently created. By new subsection 160ZZRDI(3) where subsection 160ZZRDI(1) applies in relation to a share or loan, the share or loan will be taken to have been existence at the adjustment time. An exception applies if new shares are issued in replacement of a share that is, or is to be cancelled [new subsection 160ZZRDI(2)] .
1.40 Sections 160ZZRE and 160ZZRF, which are referred to in the Background to this chapter, currently operate in the same way in relation to the transfer between companies under common ownership of a depreciable asset as for any other asset. To comply with the current provisions, a transferor is required to determine the market value of each asset.
1.41 The Bill will insert new Subdivision D to provide specific formulae for determining the cost base reductions in respect of shares and loans in a transferor company where a value shift takes place as a consequence of the transfer of a depreciable asset. The criteria to be satisfied for an asset to be a depreciable asset are contained in new subsection 160ZZRDB(1) [item 8] and described in Section 3 above.
1.42 Under the amendments proposed in relation to depreciable assets, the transferor will merely be required to compare the consideration given for the transfer of the asset with the written down value of the asset. The concept of written down value is explained in Section 3 above. [Item 4]
1.43 The application of new Subdivision D is not elective. New subsection 160ZZRDB(2) [item 8] in new Subdivision B provides that new Subdivision E (which contains existing sections 160ZZRE and 160ZZRF) will not have any operation in relation to assets to which Subdivision D applies. It would generally be expected that the written down value of a depreciable asset will be less than either its indexed cost base or its indexed common ownership market value described in new subsection 160ZZRBB(1) which is inserted by Item 5 .
1.44 If the asset being disposed of is not a depreciable asset, then sections 160ZZRE, 160ZZRF or 160ZZRFA may apply in relation to the transfer and it will be necessary to go though the tests set out in whichever is the relevant section.
1.45 Once the tests to determine whether the asset being transferred is a depreciable asset are satisfied, the formulae in new Subdivision D, are applied to determine if cost base reductions to shares and loans in the transferor company are required. These tests are substantially the same as the existing tests in section 160ZZRE which apply to transfers of post CGT assets acquired after the time of common ownership of the transferor and transferee companies. [Item 8, new sections 160ZZRDJ, 160ZZRDK, 160ZZRDL, 160ZZRDM and 160ZZRDN]
1.46 Where both shares and loans are held in a transferor company, cost base reductions are applied firstly across the shares, and only to the loans if the cost base of all the shares has been reduced to nil. [New subsection 160ZZRDL(4)]
1.47 New subsection 160ZZRDJ provides that the cost base adjustments to shares in the transferor company will be required where the consideration for the disposal of the asset is less than the written down value of the asset [item 4] . For these purposes the operation of subsection 160ZD(2) which deems market value to have been received for the disposal of an asset where no consideration is received, or the amount received is less than the market value of the asset is specifically excluded by section 160ZZRA. Therefore the written down value must be compared to the actual consideration given.
1.48 To determine the amount by which the cost base of each post CGT share in the transferor is to be reduced, each share is taken to have been disposed of for an amount equal to the indexed cost base of the share [item 8, new subsection 160ZZRDJ(2)] and reacquired for a new cost base reflecting the proportionate value reduction of the share [new subsections 160ZZRDJ(3), (4) and (5)] .
1.49 To determine this proportionate reduction in value, the market value of the share is compared to the market value of all shares (both pre and post CGT) held in the transferor company. [New subsection 160ZZRDJ(5)]
1.50 There may be shares of more than one class held in the transferor company. These may or may not be held by the same taxpayer. New section 160ZZRDK provides that where different classes of shares are held in a transferor, and the application of cost base reductions as provided by the formula in new subsection 160ZZRDJ(5) would be unreasonable, then cost base reductions will instead be made on a 'reasonable' basis. Subsection 160ZZRE(6) is an equivalent provision in Division 19A.
1.51 The criteria for determining whether cost base reductions are 'reasonable' are set out at new section 160ZZRDK. The taxpayer is required to have regard to the circumstances in which post CGT shares in the transferor were acquired, and the extent to which their market value is reduced as a consequence of the value shift. That is, the cost base reductions should reflect the value that has been shifted out of the post CGT shares.
1.52 If the cost base reduction rules have applied in relation to the shares in a transferor company, and as a consequence the cost bases of all post CGT shares in the transferor have been reduced to nil, or there are no post CGT shares in a transferor [new section 160ZZRDL] , it is necessary to determine whether consequential cost base adjustments are also required to post CGT loans held in the transferor company [new section 160ZZRDM] .
1.53 The section will only apply to loans where the value of the loan will be reduced as a consequence of the transfer of the asset. The formula provided by [new section 160ZZRDM] will apply to all non arms length loans subject to [new section 160ZZRDN] which is described at paragraph 1.57 below.
1.54 Where the threshold tests are satisfied, the loan will be taken to have been disposed of [new subsection 160ZZRDM(1)] and re-acquired for an amount which reflects the 'total excess share reduction amount' [new subsections 160ZZRDM(2), (3), (5) and (6)] .
1.55 The total excess share reduction amount is the proportion of the difference between the consideration received for the transfer of the asset and the written down value of the asset which has not been offset by a share reduction amount as described in new subsection 160ZZRDJ(5).
1.56 Where no amount of the total excess share reduction amount has been applied to reduce the cost base of post CGT shares in the transferor (for example if there are none) then the whole amount of the share reduction amount will be available to reduce the cost base of qualifying loans. [New subsection 160ZZRDM(4)]
1.57 If there is more than one loan in the transferor company, whether held by a related company or otherwise and whether or not arms length, the general rules are modified so that the cost base of the loan is reduced on a 'reasonable' basis having regard to the circumstances in which the loan was acquired and the extent of the actual value that has been shifted out of the loan. A disproportionate actual value shift may occur between (for example) secured and unsecured loans. [New section 160ZZRDN]
1.58 Section 160ZZRE operates to determine the amount by which the cost base, indexed cost base or reduced cost base of directly held shares in (or, in some cases, loans to) the transferor will be reduced as a result of the transfer of an asset.
1.59 Subsection 160ZZRE(6) operates to provide relief from the formulae in subsections (3) and (4) where the application of those formulae would produce unreasonable results in relation to cost base reductions. The subsection prevents the operation of subsections (3) and (4) and modifies the cost base reductions having regard to the circumstances in which the post CGT share or loan was acquired and the extent of the reduction in the market value of the post CGT share or loan.
1.60 As currently drafted, subsection 160ZZRE(6) only applies where pre and post CGT shares and loans, shares of different classes or more than one loan are owned by the same taxpayer. However, where a value shift occurs, the reduction in the value of shares and loans in the transferor company will be spread across all shareholders and/or creditors.
1.61 The Bill proposes an amendment to the tests referred to in paragraph 160ZZRE(6)(b) to remove the current restriction that the shares and loans to which subsection 160ZZRE(6) relates must belong to the same taxpayer. [Items 10 and 11; new sub-subparagraphs 160ZZRE(6)(b)(ii)A and B]
1.62 Section 160ZZRG currently applies to reduce the cost base, the indexed cost base or the reduced cost base of underlying interests in the transferor, through shares or loans, acquired after 19 September 1985. Section 160ZZRH operates to increase the relevant cost base of a share or underlying interest in a share in the transferee company acquired after 19 September 1985.
1.63 The current application of subsection 160ZZRD(2) limits the operation of sections 160ZZRG and 160ZZRH to situations where section 160ZZRE applies. That is, where consideration for the transfer is less than the indexed cost base or the market value of the asset.
1.64 The Bill proposes an amendment to remove the current limitations to the operation of sections 160ZZRG and 160ZZRH. This will be achieved by deleting subsection 160ZZRD(2) and replacing it with new subsection 160ZZRE(1B) which will not limit the operation of sections 160ZZRG and 160ZZRH. [Items 3, 7 and 9]
1.65 New Subdivision F will head existing sections 160ZZRG and 160ZZRH. Section 160ZZRG applies to reduce the relevant cost base of underlying interests, acquired after 19 September 1985, through holding shares in or providing loans to the transferor company who disposes of an asset which results in a shift in value under the Division. Section 160ZZRH applies in a compensatory manner to increase the relevant cost base of interests in the transferee company.
1.66 Because of the restructure of the Division through the use of Subdivisions, the existing references in paragraph (d) of section 160ZZRH to operative provisions in Division 19A will be replaced with references to the new Subdivisions containing those provisions [item 15] . Further, a new subsection 160ZZRH(2) will be introduced to ensure that increases in the interests in the transferee (from acquiring an asset) under existing section 160ZZRH will not exceed the total of the adjustments made under 'earlier sections' in Division 19A in relation to that asset [item 16] .