House of Representatives

New Business Tax System (Consolidation) Bill (No. 1) 2002

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

Abbreviation Definition
AASB Australian Accounting Standards Board
A Platform for Consultation Review of Business Taxation: A Platform for Consultation
A Tax System Redesigned Review of Business Taxation: A Tax System Redesigned
ADF approved deposit fund
ASIC Australian Securities and Investment Commission
ATO Australian taxation Office
BAS business activity statement
CFC controlled foreign company
CGT capital gains tax
Commissioner Commissioner of Taxation
COT continuity of ownership test
December 2000 exposure draft New Business Tax System (Consolidation) Bill 2000 exposure draft
February 2002 exposure draft New Business Tax System (Consolidation) Bill 2002 exposure draft
GDP gross domestic product
ESAS Employee Share Acquisition Scheme
FBT fringe benefits tax
FIF foreign investment fund
GIC general interest charge
ITAA 1936 Income Tax Assessment Act 1936
ITAA 1997 Income Tax Assessment Act 1997
ITRA 1986 Income Tax Rates Act 1986
MEC multiple entry consolidated
PAYG pay as you go
PDF pooled deposit fund
PST pooled superannuation trust
RSA retirement savings account
SAC Statement of Accounting Concept
SAP substituted accounting period
SBT same business test
TAA 1953 Taxation Administration Act 1953
TSA tax sharing agreement
Thin Capitalisation legislation New Business Tax System (Thin Capitalisation) Act 2001

General outline and financial impact

Consolidated groups

The consolidation measure represents a significant change to the taxation of corporate groups. Due to its magnitude, the measure will be enacted progressively via a series of bills. Schedule 1 to this bill contains most of the key elements of the measure. Broadly, the rules contained in this bill will:

·
allow wholly-owned groups of entities to make a choice to consolidate and therefore be treated as a single entity for the purposes of determining income tax liability;
·
determine the membership of a consolidated group, including the membership of certain groups with a single non-resident head company;
·
determine the cost (for income tax liability purposes) of assets, including membership interests, in relation to consolidated groups;
·
allow, in certain circumstances, pre-consolidation losses to be transferred to the head company of a consolidated group, and prescribe how those losses may subsequently be used by the head company;
·
allow the transfer of franking credits to a consolidated group;
·
determine PAYG instalments for consolidated groups;
·
determine tax liability for income tax payments within a consolidated group where a head company fails to pay on time; and
·
remove certain existing grouping provisions, including those allowing transfer of losses and CGT roll-over relief for the transfer of assets between wholly-owned company groups.

Date of effect: Wholly-owned entity groups will be allowed to choose to consolidate under this scheme from 1 July 2002. The existing grouping provisions will continue to operate in parallel with the consolidation regime until 1 July 2003, subject to special rules applying to consolidated groups with a head company with a SAP. In general, such SAP groups will retain access to grouping provisions until the date of consolidation, provided that the head company chooses to consolidate from the first day of their next income year commencing after 1 July 2003.

Proposal announced: The proposals were announced in Treasurers Press Release No. 58 of 21 September 1999.

Financial impact: The consolidation measure is expected to cost approximately a billion dollars over the forward estimate period. This cost largely relates to the transitional concessions and the expectation that groups will be able to use their losses faster than is allowed under the current law.

Compliance cost impact: The measures in this bill are expected to reduce ongoing compliance costs by ensuring that:

·
intra-group transactions are ignored for taxation purposes, so that taxation and accounting treatment are more closely aligned;
·
administrative requirements, such as multiple tax returns and multiple franking account, losses, foreign tax credit, and PAYG obligations, are reduced; and
·
integrity measures aimed at preventing loss duplication, value shifting or the avoidance or deferral of capital gains within groups do not apply within a consolidated group.

The consolidation regime will necessitate some initial up-front costs for groups as they familiarise themselves with the new law, update software and notify the ATO of a choice to consolidate. Large corporate groups may incur greater start-up costs in determining the market values of group assets. These costs will be alleviated by a transitional measure under which the group can elect (prior to 1 July 2003) to bring assets into the group at their existing cost bases. Groups that form after the transitional period may use the market value guidelines developed by the ATO to minimise compliance costs.

Summary of regulation impact statement

Regulation impact on business

Impact: Medium to high.

Main points:

·
The consolidation measure will implement a system which treats wholly-owned groups as a single entity for income tax purposes.
·
Consolidation will address efficiency and integrity problems in the existing taxation of wholly-owned groups, including compliance and general tax costs, double taxation, tax avoidance through intra-group dealings, loss cascading and value shifting.
·
The regime will assist in the simplification of the tax system, resulting in both reduced taxpayer compliance costs and ATO administration costs, improve the efficiency of business restructuring and strengthen the integrity of the income tax system.
·
Wholly-owned groups that do not consolidate will no longer have access to grouping rules, which currently provide some of the benefits intended to be replaced by consolidation.

Chapter 1 - Overview of consolidation

Outline of explanatory memorandum

1.1 Where a consolidated group is formed, the group is treated as a single entity for income tax purposes. Broadly, this means that the subsidiary entities lose their individual income tax identities and are treated as parts of the head company of the consolidated group (rather than separate entities) for the purposes of determining income tax liability during the period in which they are members of the group.

1.2 The consolidation regime will apply primarily to a wholly-owned group of Australian resident entities that chooses to form a consolidated group for income tax purposes. In general, such a group must be wholly-owned by an Australian resident company. Specific rules provide for the membership of certain resident wholly-owned subsidiaries of a foreign holding company (MEC group). Eligible wholly-owned groups will be able to choose to form a consolidated group from 1 July 2002.

1.3 Chapter 2 deals with the core rules of consolidation, such as the single entity rule, and their consequences. Chapter 3 explains the rules dealing with the formation and membership of a consolidated group, including rules about the types of entities that are eligible to join, and making the choice to form a consolidated group. Chapter 4 deals with the membership rules relating to MEC groups.

1.4 The subsequent chapters deal with other specific rules necessary for the implementation of the consolidation regime, including:

·
setting of the cost of assets of entities that join or leave a consolidated group (including membership interests);
·
the transfer and use of losses relating to a pre-consolidation period;
·
the treatment of franking accounts in consolidated groups;
·
applying the PAYG instalments regime to members of consolidated groups in an appropriate way;
·
rules that apply where a head company fails to satisfy a group income tax related liability on time and which allow the recovery of that group liability directly from other members of the group; and
·
removal, cessation or modification of the existing loss transfer and CGT asset rollover grouping provisions under the ITAA 1997.

1.5 The general principles for taxation of consolidated groups - single entity rule, membership, setting of cost bases and treatment of losses - were contained in the December 2000 exposure draft. These rules were refined and reflected in the subsequent February 2002 exposure draft. The measures introduced in this bill take into account further submissions and feedback received following the release of the exposure drafts.

1.6 Subsequent legislation to be introduced to implement the remaining aspects of the consolidation regime will include the following topics:

·
further cost setting rules - including those applying to formation of a consolidated group, transitional rules, joining another consolidated group, MEC groups and trusts;
·
core rules applying to MEC groups;
·
life insurance;
·
interaction of the consolidation regime with international tax provisions;
·
treatment of attribution accounts and foreign tax credits;
·
interposition of a non-operating head company;
·
removal of the intercorporate dividend rebate;
·
treatment of imputation exempting and former exempting companies;
·
removal of grouping for thin capitalisation purposes; and
·
other consequential amendments, including further consequential amendments to PAYG instalments.

Context of reform

1.7 To promote business efficiency, as well as tax system integrity, A Tax System Redesigned recommended that groups of wholly-owned entities be permitted to choose to be taxed as a single entity rather than on an entity by entity basis.

1.8 The existing grouping provisions of the ITAA 1997 and the ITAA 1936 (such as those relating to loss transfer and CGT rollover relief for asset transfers) and the intercorporate dividend rebate allow groups of companies to obtain the benefits of single entity treatment for some purposes. In other respects, however, the income tax system continues to require each entity to account separately for intra-group transactions and intra-group debt and equity interests.

1.9 Consolidation will address both efficiency and integrity problems existing in the taxation of wholly-owned entity groups, many of which arise from this inconsistent treatment. These include:

·
compliance and general tax costs;
·
double taxation where gains are taxed when realised and then taxed again on the disposal of equity;
·
tax avoidance through intra-group dealings;
·
loss cascading by the creation of multiple tax losses from the one economic loss; and
·
value shifting to create artificial losses where there is no actual economic loss.

1.10 These problems will be addressed by ceasing to recognise multiple layers of ownership within a wholly-owned group and by treating wholly-owned groups as a single entity for income tax purposes.

1.11 The consolidation regime will therefore:

·
assist in the simplification of the tax system;
·
reduce both compliance costs and tax revenue costs associated with the existing tax treatment of company groups;
·
improve the efficiency of business restructuring; and
·
strengthen the integrity of the income tax system.

1.12 It is intended that the benefits to be achieved by consolidation as described above should therefore encourage wholly-owned groups to enter into the regime. Wholly-owned groups that choose to remain outside the consolidation regime will also lose entitlement to grouping rules which currently provide some of the benefits intended to be replaced by consolidation.

Comparison of key features of new law and current law

1.13 The following table summarises the key differences between the proposed tax treatment of consolidated groups and the treatment of wholly-owned groups under the current law.

New law Current law
A consolidated group is taxed as a single entity for all income tax purposes. Each entity in a wholly-owned group is taxed as a separate entity. For some purposes however, company groups can obtain benefits from being treated as a single entity.
All intra-group transactions are ignored. Only some intra-group transactions are ignored (e.g. certain asset transfers under CGT rollover).
Consolidation, and therefore grouping, is available not only to companies but also to trusts within a wholly-owned group.

In determining whether a company is wholly-owned, certain ESAS shares are disregarded.

The current grouping provisions are only available to the companies within a wholly-owned group.

The existence of ESAS shares in a company will prevent the company from qualifying as a wholly-owned subsidiary of its holding entity.

Gains realised within a consolidated group are recognised only once. There is the potential for the double taxation of economic gains.
Loss integrity and value shifting rules do not apply to transactions between the members of a consolidated group. Loss integrity and value shifting rules apply to transactions between the members of corporate groups.
Losses realised within a consolidated group are recognised only once. There is the potential for the duplication and cascading of losses. Loss integrity measures apply when there has been substantialduplication.
Losses and franking credits of the group are pooled. Losses can be transferred within a wholly-owned corporate group. Franking credits can be distributed within the group if attached to inter-group franked dividends.
Resident wholly-owned groups will be able to form a consolidated group despite the fact that the groups single parent company is a non-resident. A resident wholly-owned group of a non-resident parent company is able to access current grouping concessions.
In general, the head company of a consolidated group will be liable for the income tax debts of the group. Individual entities within a wholly-owned group are liable for individual income tax debts.
The head company of a consolidated group will be responsible for the PAYG instalments obligations of the group once the Commissioner gives it is an instalment rate worked out from its first assessment as the head company of that group. Individual entities within a wholly-owned group are responsible for PAYG instalments obligations on an individual basis.
Generally, loss transfer and CGT rollover relief rules no longer apply to wholly-owned groups. Wholly-owned groups of companies may use loss transfer provisions and CGT rollover relief.

Summary of new law

1.14 The following summarises the key principles of consolidation.

What does consolidation mean? Following a choice to consolidate, a consolidated group is to be treated as a single taxpaying entity for income tax purposes during the period of consolidation.
What is a consolidated group? A consolidated group consists of:

·
a head company; and
·
all of the subsidiary members of the group (if any).

In general, before a consolidated group can exist, there must be:

·
a consolidatable group in existence; and
·
an effective choice made by the head company of that group to consolidate the group.

What entities are eligible to be subsidiary members of a consolidated group? Broadly, all the wholly-owned resident subsidiaries of the head company, which may be companies, trusts or partnerships. Certain minority ESAS shares may be disregarded in determining whether a subsidiary is eligible to join a consolidated group.
Can the wholly-owned subsidiaries of a foreign resident company consolidate? Yes. Certain resident wholly-owned subsidiaries without a single resident head company may form a consolidated group known as a MEC group.
What tax history or tax attributes does a subsidiary member bring to a consolidated group? Generally, a subsidiary brings its income tax history into a consolidated group. Certain tax attributes such as franking credits and losses are brought into a consolidated group subject to specific rules.
What tax history or tax attributes does a subsidiary member take with it after leaving a consolidated group? Generally, a subsidiary leaves a consolidated group with the tax history relating to the assets and liabilities it takes out of the group. Tax attributes such as franking credits and losses remain with the group.
Can the head entity revoke the choice to consolidate? No.
When may a group make a choice to consolidate? Generally, from 1 July 2002.
What happens to grouping concessions if a wholly-owned group does not consolidate on 1 July 2002? Generally, in the first year of the consolidation regime, loss transfer and CGT rollover entitlements cease on the date of consolidation. If a choice to consolidate does not occur by 1 July 2003, grouping entitlements cease as of that date (except in limited circumstances applying to SAP groups that consolidate after 1 July 2003).

Detailed explanation of new law

1.15 The consolidation regime implements a set of recommendations made in A Tax System Redesigned. Those recommendations have led to the development of a set of rules that provide the basis on which groups are permitted to consolidate and be treated as a single entity for income tax purposes. The regime is underpinned by rules for the setting of cost of assets according to the asset-based model discussed in A Platform for Consultation and recommended by A Tax System Redesigned.

Key features of the foundations of the consolidation regime

Core rules

Single entity rule

1.16 Following a choice to consolidate, a group of wholly-owned entities is treated as a single entity for income tax purposes. Subsidiary members of the group are treated as parts of the head company rather than as separate income tax identities.

Inherited history rules

1.17 The head company inherits the income tax history of a subsidiary member when the latter joins a consolidated group. When a subsidiary member leaves a group, it takes with it only the income tax history that relates to the assets, liabilities and businesses it leaves with. This recognises that the entity is different from any entity that joined the group.

Cost setting rules

1.18 The cost setting rules set the cost for income tax purposes of assets of entities when they become subsidiary members of a consolidated group and of membership interests in those entities when they cease to be subsidiary members of the group.

1.19 These rules recognise that the head companys cost of becoming the holder of all of the assets is an amount, which reflects the cost to the group of acquiring the entity. When an entity leaves a group, the alignment of the head companys costs for membership interests in each entity and its assets is preserved by recognising the cost of those interests as an amount equal to the cost of the entitys assets at that time reduced by the amount of its liabilities.

Group membership and choice to consolidate

Ordinary groups

1.20 A consolidated group consists of an Australian resident head company and all of its Australian resident wholly-owned subsidiaries. The subsidiary members may be companies, trusts or partnerships. Separate rules may apply to foreign owned groups with no single Australian resident head company. In determining whether a subsidiary is wholly-owned for the purposes of the membership rules, ESAS shares are disregarded in certain circumstances.

1.21 The broad rationale underlying the rules that limit the types of entities that are eligible to be a member of a consolidated group is to ensure that consolidated groups receive a tax treatment like ordinary Australian resident companies and that relative concessional treatment is neither effectively gained by nor denied to entities by becoming a member of a consolidated group.

1.22 An eligible wholly-owned group becomes a consolidated group after notice of a choice to consolidate is given to the Commissioner. A decision to consolidate is irrevocable. Additional notification rules apply when an entity becomes, or ceases to be, a member of a consolidated group.

MEC groups

1.23 Specific rules allow certain resident wholly-owned subsidiaries of a foreign company to form a consolidated group known as a MEC group. Without this measure, wholly-owned resident subsidiaries of a foreign resident company would not be able to form a consolidated group in the absence of a single Australian resident head company unless they were restructured. The aim of this measure is to ensure that existing company groups that currently have access to grouping provisions (e.g. loss transfer and CGT rollover) will be able to form a consolidated group despite not having a single resident head company.

1.24 A MEC group consists of 2 or more eligible tier-1 companies of a foreign resident company and all the resident entities that are wholly-owned subsidiaries of those eligible tier-1 companies. Broadly, an eligible tier-1 company is the entity that is a foreign companys first tier of investment into Australia. A MEC group can be formed either by a choice being made to form a group or as a result of a consolidated group converting into a MEC group.

1.25 One of the eligible tier-1 companies in the MEC group will be treated as the head company of the group. The remaining members of the MEC group will be treated as subsidiary members of the group.

Losses

1.26 This measure also deals with the transfer to and utilisation of losses by a consolidated group. When an entity becomes a member of a consolidated group, its unused carry forward losses are tested to determine whether they can be transferred to the group. Broadly, a loss can only be transferred to the head company of a consolidated group if the loss could have been used outside the group by the entity seeking to transfer it.

1.27 The utilisation of losses transferred to a consolidated group is subject to an annual limit that is determined by reference to the fraction of the groups income and gains considered to have been generated by the entity that transferred the losses. This is referred to as the available fraction method.

1.28 Two concessions are provided for certain company losses transferred to a consolidated group when it forms during the transitional period (i.e. 1 July 2002 to 30 June 2004). The first concession increases the available fraction. It is provided in recognition that, under the existing group loss transfer rules, an entity can use its losses to shelter not just its own income but also the income of another member of the same wholly-owned group. The second concession allows eligible losses to be used over 3 years instead of by reference to their available fraction. This alternative loss utilisation method is provided in recognition that the available fraction method departs from the method in Recommendation 15.3 of A Tax System Redesigned.

Franking accounts in consolidated groups

1.29 Special imputation rules will apply to consolidated groups. During the period of consolidation, the head company of the group will maintain a single franking account for the consolidated group and subsidiary members will have inoperative franking accounts during the period in which they are members of a consolidated group. At the time at which a subsidiary member joins a consolidated group, any surplus in its franking account is transferred to the head companys franking account. If, however, the subsidiarys franking account is in deficit at the joining time, the subsidiary will be liable to pay franking deficits tax (and the deficit is extinguished).

1.30 During the period that a subsidiary is a member of a consolidated group, any franking credits or debits that would otherwise have arisen in the franking account of the subsidiary member (i.e. were it not a member of a consolidated group with an inoperative account) are attributed to the franking account of the head company.

1.31 Special rules deal with the franking of distributions by a subsidiary member of a consolidated group to members holding certain kinds of interests including ESAS shares and non-share equity interests.

PAYG instalments

1.32 This bill also contains consequential amendments that set out how the PAYG instalments rules will apply to the members of a consolidated group. The rules will ensure that a head company of a consolidated group will pay PAYG instalments towards its income tax liability in much the same way as any single company does now. The rules also explain what happens when an entity joins or leaves a consolidated group.

1.33 There are also special rules which are necessary for the transitional period from formation of a consolidated group until the head company of the group is given an instalment rate, by the Commissioner, that is worked out from the head companys first assessment as the head company of that group. These rules essentially provide that, during the transitional period, each member of the consolidated group will continue to pay PAYG instalments as it does under the current law, that is, as if it were not a member of a consolidated group. Instalments payable by the subsidiary members of a consolidated group in the transitional period will be credited against the assessment of tax payable by the head company of the group.

Group income tax liability

1.34 This measure also contains rules for determining the income tax liability within a consolidated group in the event of default of income tax payments by the head company. In the event of the head companys default, the income tax liability will be recovered directly from the subsidiary members of the group.

Removal of grouping provisions

1.35 Amendments in this Bill also remove certain existing grouping provisions of the ITAA 1997. Those that allow the transfer of losses and CGT rollover relief for transfer of assets between wholly-owned company groups will cease to apply following the introduction of the consolidation regime. Consequently, wholly-owned groups that do not choose to consolidate will, in general, no longer have access to grouping rules outside of consolidation.

1.36 These rules will be retained in a limited form for certain transactions. Resident subsidiaries in a wholly-owned group will retain the ability to transfer losses where that loss transfer involves an Australian branch of a foreign bank.

1.37 Further, CGT asset rollover relief will be retained for wholly-owned groups where assets are transferred between non-resident companies, or a non-resident company and the head company of a consolidated group or MEC group. Rollover relief will also be retained where an asset is transferred between a non-resident and a company that is not a member of a consolidatable group.

Further detail about the consolidation regime

1.38 The above key features and other supporting concepts are discussed in detail in the following chapters.

Table 1.1: Further details about consolidation
Topic Chapter
Core rules 2
Membership rules 3
Resident wholly-owned subsidiaries of a common foreign holding company 4
Cost setting rules 5
Transferring losses to a consolidated group 6
Determining whether a transferred loss can be used by a consolidated group 7
Limiting the use of transferred losses by a consolidated group 8
Transitional concessions for losses 9
Franking accounts in consolidated groups 10
Liability for the payment of tax where a head company fails to pay on time 11
PAYG instalments rules for consolidated groups 12
Removal of grouping provisions 13
Regulation impact statement 14

Application and transitional provisions

1.39 The consolidation regime applies from 1 July 2002.

Chapter 2 - Core rules

Outline of chapter

2.1 This chapter explains the core rules of the consolidation regime, comprising the:

·
single entity rule;
·
inherited history rules; and
·
cost setting rules for assets.

2.2 The rules are contained in Division 701 of the ITAA 1997.

Context of reform

2.3 Taxing groups as single entities addresses problems associated with the taxation of wholly-owned groups, identified in A Tax System Redesigned, such as:

·
tax impediments to business organisation - for example, compliance costs and possible tax costs of liquidating a redundant company in a wholly-owned group;
·
high compliance costs - for example, the costs of dealing with the tax implications of intra-group dividends;
·
double taxation - where gains realised in ordinary commercial transactions are taxed again on the disposal of equity;
·
tax avoidance through intra-group dealings - for example, manipulating dealings between group companies to reduce or defer tax;
·
loss cascading - where group companies (as well as companies that are less than 100% owned) can use a chain of companies to create multiple tax losses based on one initial economic loss; and
·
loss duplication - where losses realised in carrying on a business or on disposal of assets are realised again on the disposal of equity.

2.4 The single entity treatment, coupled with the inherited history rules and special rules for setting the cost for tax purposes of assets of entities joining and leaving consolidated groups, will:

·
simplify the tax system and reduce ongoing compliance costs;
·
promote economic efficiency by providing a taxation framework that allows Australian businesses to adopt organisational structures based more on commercial rather than tax considerations; and
·
promote equity by improving the integrity of the tax system.

Summary of new law

2.5 Following a choice to consolidate, a group of eligible wholly-owned entities is treated as a single entity for the purposes (core purposes) of working out its income tax liability or losses. Subsidiary entities lose their individual income tax identity on entry into a consolidated group and are treated as parts of the head company.

2.6 The following are some of the consequences of the single entity treatment for working out the groups income tax liability or losses:

·
the group lodges a single consolidated income tax return, removing the need for provision of income tax returns by individual subsidiary members;
·
the assets and liabilities of the subsidiary members are treated as if they were assets and liabilities of the head company;
·
the actions of the subsidiary members (e.g. acquisition or disposal of assets) are treated as if they had been undertaken by the head company; and
·
intra-group transactions are ignored.

2.7 The February 2002 exposure draft contained rules which provided that things that happened to a subsidiary entity before it joined the group could not be attributed to the head company for the purposes of working out its income tax liability or losses (entry clean slate rule). Similarly, when subsidiaries exited the consolidated group, they did so with a fresh income tax identity, so things that happened to them before they joined or while they were a member of a group cannot generally be taken into account in working out their post-consolidation income tax liability or losses (exit clean slate rule). Consultation identified that these rules created significant compliance costs as a consequence of certain assets and expenditure changing character from being on revenue account to capital account. As a consequence of consultation the clean slate approach was replaced with an inherited history approach.

2.8 The core rules provide for the inheritance of history where an entity becomes part of a consolidated group and where an entity leaves a consolidated group. Broadly, things that happened to an entity before it became a subsidiary member of the group are attributed to the head company for the core purposes discussed in paragraph 2.13 (entry history rule). Where a subsidiary leaves a group, the history in relation to the assets, liabilities and businesses that the entity takes with it will be taken into account in working out its post consolidation income tax liability or losses (exit history rule).

2.9 When an entity becomes a subsidiary member of a consolidated group the membership interests in the entity held by the group are ignored and the cost for tax purposes of the assets which become those of the head company is set in accordance with the cost setting rules. These rules recognise the cost of the assets as an amount reflecting the groups cost of acquiring the entity.

2.10 Rules that preserve the alignment between the head companys cost for membership interests in the entity and the entitys cost of assets also apply when an entity leaves a group. Immediately before a subsidiary member leaves a consolidated group, the head company recognises the membership interests in the leaving entity. The cost for income tax purposes of those interests is set at an amount that reflects the groups cost of the net assets of the leaving entity.

2.11 Where a subsidiary member leaves a consolidated group the exit history rule applies so that the assets the entity takes with it will retain their cost (for income tax purposes) in the hands of the entity.

Comparison of key features of new law and current law
New law Current law
A consolidated group is treated as a single entity for all income tax purposes. Each entity in a wholly-owned group is taxed as a separate entity. For some purposes, however, company groups can obtain benefits from being treated as a single entity.
Intra-group transactions will attract neither income tax consequences nor compliance costs for a consolidated group. Only some intra-group transactions will escape income tax consequences (e.g. CGT rollover relief is available for some assets but not revenue assets). All intra-group transactions will attract compliance costs.

Detailed explanation of new law

The single entity rule

2.12 The income tax treatment of a consolidated group flows from the rule that an entity is treated as part of the head company while it is a subsidiary member of a consolidated group. Actions of the subsidiaries are treated as actions of the head company, as this is the only entity the income tax law recognises for the purposes of working out the income tax liability or losses of a consolidated group. For example, a transfer of an asset from one subsidiary member to another is treated like a transfer from one division of a company to another division. Such a transaction could not have any income tax consequences, as no disposal between distinct entities would have occurred (an entity cannot transact with itself). [Schedule 1, item 2, section 701-1]

2.13 An entity is treated, for the core purposes, as part of the head company while it is a subsidiary member of a consolidated group. The core purposes also set out the reasons for which the inherited history rules apply. The core purposes are:

·
for the head company, working out its income tax liability or loss for any period during which it is the head company of a consolidated group, or any later income year [Schedule 1, item 2, subsection 701-1(2)] ; and
·
for a subsidiary member, working out its income tax liability or loss for any period during which it is a subsidiary member of a consolidated group, or any later income year [Schedule 1, item 2, subsection 701-1(3)] .

2.14 The single entity treatment applies only to the period during which the entity is a subsidiary member, but the purposes for which the treatment is recognised also extend to later income years. This is because there may be income tax consequences in later income years relating to:

·
the fact that the entity was treated as part of the head company rather than an individual entity during a period of membership of a consolidated group; and
·
things done while an entity was a subsidiary member of a consolidated group (and therefore taken to have been done by the head company).

2.15 The single entity rule also applies to partnerships and trusts, which have net income rather than taxable income. [Schedule 1, item 2, section 701-65]

2.16 The single entity rule will ensure that the ITAA 1997 and the ITAA 1936 operate in respect of a consolidated group as if the subsidiaries are absorbed into the head company, which is the relevant taxpayer. A number of implications flow from the application of this rule.

Consequences of the single entity rule

Accounting and returns

2.17 The consolidated group will:

·
effectively maintain a common tax accounting period for all its member entities;
·
keep consolidated accounts for certain tax purposes, for example franking, losses and foreign tax credits;
·
lodge a single income tax return, with no separate lodgment requirements imposed on its members.

Intra-group transactions

2.18 Transactions between members of a consolidated group will be ignored for income tax purposes. For example, payment of management fees between group members will not be deductible or assessable for income tax purposes. In addition, intra-group dividends will not be assessable or subject to the franking regime.

2.19 Assets can therefore be transferred between member entities without income tax consequences. This removes the need to adhere to formal CGT rollover arrangements and depreciation balancing adjustment relief. Similarly, there will be no need to undertake cost base adjustments following transactions that may otherwise be subject to the value shifting provisions of the ITAA 1997. Shares in a group company can be bought back without the possibility of triggering a capital gain or loss. A group company can be liquidated without the possibility of triggering either a deemed dividend or a capital gain or loss.

Treatment of assets

2.20 The assets, liabilities, etc. of the subsidiary member are treated for income tax purposes as if they were owned by the head company, as this is the only entity the income tax law recognises.

Liability

2.21 In general, the head company will be liable for the income tax-related liabilities of the consolidated group that are referable to the period of consolidation. Special rules apply to allow the recovery of income tax-related liabilities directly from other members of the group where the head company has failed to pay that group liability on time.

Other consequences of the single entity rule

2.22 Some examples of the effect of absorption of the subsidiaries into the head company (for the purposes of working out its income tax liability or losses) are that during consolidation:

·
the taxable income of the taxpayer under section 4-15 of the ITAA 1997 refers to that of the head company. This calculation is made on the basis that income and deductions are assessed or allowable under the ITAA 1997 to the head company only;
·
a provision such as section 262A of the ITAA 1936 (which refers to record keeping requirements) should be read as requiring the head company to adopt those obligations insofar as they relate to the assessment of its income tax liability. Under the single entity rule, those obligations rest with the head company as it is regarded as the taxpayer during the period of consolidation;
·
for the purpose of determining any relevant income tax consequences arising out of the holding or disposal of assets:

-
assets that a member entity brings into a consolidated group are taken to be held by the head company as well as assets that the entity acquires whilst a member of the group;
-
the head company is taken to hold any assets for so long as they are held by an entity while it is a subsidiary member of the group and to do anything in relation to those assets that is done by the subsidiary member;
-
if a CGT event happens in relation to any CGT assets held by any entity while a subsidiary member of the group, that event is taken to happen in relation to the asset while held by the head company and anything done by the subsidiary entity as part of the CGT event is taken to have been done by the head company; and
-
the trading stock that is sold between members of the same wholly-owned group will no longer be recognised as trading stock but will be treated as consumables. This is because, following consolidation, intra-group transactions are ignored for income tax purposes.

Things not affected by the single entity rule

2.23 Only income tax matters relating to the income tax activities of member entities while they are part of a consolidated group are currently embraced by the single entity rule. [Schedule 1, item 2, section 701-1]

2.24 This means that obligations or rights that relate to assessments of income tax in respect of periods prior to a subsidiary joining a consolidated group remain with that subsidiary. Any rights or obligations of a subsidiary in relation to an income tax assessment before the entity became a subsidiary member of a consolidated group continue to operate notwithstanding that the subsidiary has become a member of a consolidated group. For example, a subsidiary may pursue an objection in relation to an assessment of income tax for a pre-consolidation period at any time while it is in a consolidated group.

2.25 Only income tax obligations are comprehended by the single entity rule. For example, obligations such as FBT liability continue, as does a withholding obligation of the subsidiary under the ITAA 1936 or under the TAA 1953 while the subsidiary entity is a member of a consolidated group. An entitys obligation to collect the income tax payable by a third party is not related to working out that entitys income tax liability or losses. Therefore, an entitys withholding obligations relating to the tax payable by a third party continues despite the entity being a subsidiary member of a consolidated group.

Characterisation of assets and transactions

2.26 Following an election to consolidate, the single entity rule has the effect that for the purposes of assessing the income tax position of the head company, the head company is taken to hold all the assets and liabilities of its subsidiaries and to enter into the transactions of its subsidiaries. This is because the subsidiary members are treated as if they are parts of the head company for income tax purposes.

2.27 With the exception of intra-group dealings, the mere act of consolidation is not expected to change the character of transactions, where assets continue to be held by a consolidated group in the same manner as held by a member of the group prior to consolidation.

2.28 As is the situation under current law, it may be relevant to consider the nature of a transaction undertaken by a subsidiary member of a wholly-owned group in the context of the activities of the group as a whole, in order to determine the income tax character of a particular act or transaction in an assessment of the consolidated group. The income tax character of a transaction undertaken by a consolidated group will continue to be a question of fact to be determined in the light of all the relevant circumstances.

2.29 It is possible for assets of the same type to be held for dual purposes within one wholly-owned group. For example, at any point in time one piece of land may be held as trading stock (e.g. for the purposes of land development) while another may be held as a capital asset (e.g. for the purposes of housing business premises) by a group. If that wholly-owned group chooses to consolidate, the current law will apply using existing principles and case law. Transactions under consolidation are subject to the same scrutiny for the purposes of characterisation as those involving a single taxpayer.

Concepts supporting the single entity rule

Inherited history rules

2.30 As discussed, subsidiary members cease to be recognised as individual income tax identities upon consolidation. Rules are provided to identify the history that an entity takes with it into a consolidated group or takes with it when it leaves a group. This history can affect the future tax liabilities of the group that it joins. The inherited history can also affect future tax liabilities of a subsidiary member after it leaves a group. The inherited history rules reduce the compliance costs that would result if the previous history had been ignored and a clean slate approach (reflected in the February 2002 exposure draft) adopted.

Entry history rule

2.31 Everything that happened in relation to an entity before it became a subsidiary member of a consolidated group is taken to have happened in relation to the head company for the purposes of calculating the head companys income tax liability or tax losses after it becomes a member. The entry history rule does not affect an entitys responsibility for taxation liabilities relating to pre-consolidation periods. [Schedule 1, item 2, section 701-5]

What history is inherited?

2.32 As a consequence of the entry history rule a head company may be entitled to certain deductions for expenditure incurred by a joining entity prior to it joining the group. Examples are entitlements to deductions for expenditure on borrowing expenses, gift deductions (where the entitlement to the deduction is spread), water facilities, connecting power or telephone lines, certain business related costs and expenditure allocated to a project pool. A head company may also be entitled to a deduction for a debt that is brought into a consolidated group which subsequently goes bad.

2.33 A head company may also need to include assessable income as a consequence of something that happened to a joining entity prior to consolidation. For example, an entity may have received a prepayment for which the assessable income is included over the period of the provision of the services. A head company may also be assessable on the receipt of a recoupment of expenditure made by a subsidiary member prior to its entry into the group. Also an entity before joining a group may have elected to defer tax on the profit from the disposal or death of livestock or elected to defer the inclusion of the profit on a second wool clip.

2.34 Further comments on the consequences of the history rules is provided in paragraph 2.47.

What history is not inherited?

2.35 Only history in respect of things that affected taxable income or could affect a later taxable income of the head company is inherited. Consequently history in relation to franking credits and foreign tax credits would not be inherited.

2.36 Through the cost setting rules the head company is allocated a cost for the assets of an entity based on its cost of acquiring the entity. The history in relation to the cost of an asset will be affected where the cost of the asset is set on entry to consolidation. For example, there are rules for working out the decline in value of depreciating assets for which the tax cost is set on entry (see paragraph 2.53).

2.37 The history inherited under the entry history rule will be affected where another provision of the income tax law modifies the treatment that is to be given to the head company (see paragraph 2.81). For example there are specific rules dealing with the amount of losses that can be brought into a consolidated group when an entity becomes a subsidiary member.

Exit history rule

2.38 Where a subsidiary member leaves a consolidated group the entity takes with it the history in relation to the assets, liabilities and businesses that cease to be part of the head company as a consequence of its leaving. The exit history rule is narrower than the entry history rule. This reflects that the entity that leaves the group is a different entity to any entity that enters the group. This is a result of the ability to transfer assets and businesses within the group so that the entity that leaves may bear no resemblance to the entity that entered. [Schedule 1, item 2, section 701-40]

2.39 The exit history rule applies for the core purposes of working out the entitys income tax liability or loss for any period following it ceasing to be a part of the head company. [Schedule 1, item 2, subsection 701-40(1)]

What history is inherited?

2.40 The history that is inherited by an entity that leaves a consolidated group is the history relating to:

·
any assets;
·
any liabilities, including anything that is treated as a liability according to generally accepted accounting concepts; and
·
any businesses,

that the entity takes when it leaves the group. [Schedule 1, item 2, subsection 701-40(2)]

2.41 The meaning of liabilities in this context is broader than the meaning of liability in the context of the cost setting rules (i.e. step 2 of working out the allocable cost amount).

2.42 The history in relation to a business covers such things as the entitlements and obligations in respect of carrying on a business (such as a primary production business) or the carrying on of particular activities.

2.43 The discussion in paragraphs 2.32 and 2.33 will also be relevant when an entity leaves a group where it relates to an asset, liability or business that an entity takes with it when it leaves.

2.44 The history that is inherited by an entity when it leaves a consolidated group may relate to the history in respect of an asset, liability or business from the period before that asset, liability or business became part of the head company as a consequence of the entry history rule. [Schedule 1, item 2, subsection 701-40(3)]

What history will not be inherited?

2.45 Through the cost setting rules, an entity that leaves a group is allocated a cost for the assets consisting of liabilities owed to the entity by members of the consolidated group that it has left and assets consisting of membership interests in any of the former members of the group that leave at the same time. The history in relation to the cost of these assets will be affected where the cost of the asset is set on exit from a consolidated group.

2.46 The exit history rule will also be affected where another provision of the income tax law modifies the treatment that is to be given to the head company (see paragraph 2.81). For example, there are rules to ensure that losses are not taken by an entity that exits a group.

Other consequences of the inherited history rules

2.47 Some examples of the effect of the inherited history rules are:

·
The pre-CGT status of assets that are brought into a consolidated group by an entity that becomes a subsidiary member will be inherited as a consequence of the entry history rule. Likewise, the exit history rule will ensure that the pre-CGT status of assets that an entity takes with it when it leaves a consolidated group will be inherited by that entity. This maintains the current laws treatment of pre-CGT asset transfers within wholly-owned groups. However, any acquisition of membership interests in the entity would still cause pre-CGT status in the asset to be lost if it resulted in the ultimate owners not continuing to hold majority underlying interest in the asset.
·
Private income tax rulings issued to an entity before it becomes a member of a consolidated group will apply to the head company insofar as the relevant facts have not changed either by reason of consolidation (e.g. because they relate to intra-group transactions, which are ignored) or otherwise. Private income tax rulings that relate to particular assets, liabilities or businesses that a leaving entity takes out of a group will apply to the leaving entity insofar as the relevant facts have not changed either by reason of the entity ceasing to be a member of a consolidated group or otherwise.

Cost setting rules

2.48 The single entity rule is supported by rules that set the cost for income tax purposes of assets that a subsidiary member brings into the consolidated group. Rules also set the cost of certain assets where a subsidiary member leaves a consolidated group.

Cost setting rules - entry

2.49 The assets of subsidiary members, which are treated during consolidation as being assets of the head company, have their cost for tax purposes set at the joining time. The cost is set under rules that treat the head companys cost of acquiring the entity as its cost of acquiring the entitys assets, including its businesses. This cost is worked out and allocated to the individual assets according to rules explained in Chapter 5. [Schedule 1, item 2, section 701-10; Subdivision 705A]

Special rules for trading stock

2.50 Where the same item of trading stock has its cost set on being brought into a consolidated group more than once in the same income year for a head company then only the amount at which the cost is set on the last of the times it is set is taken into account for the head company. Multiple resetting of the same item of trading stock may occur, for example, where the same item is brought into a consolidated group by an entity and that item is taken by an entity that leaves and which subsequently rejoins the same consolidated group in the same income year. Only the last resetting is taken into account because under the cost setting rules this cost becomes the opening cost of the trading stock for the head company purposes and it is only appropriate to take it into account once. [Schedule 1, item 2, section 701-10(5)]

2.51 Where the same trading stock leaves a consolidated group (as a result of a subsidiary member leaving) or has its value set at the start of the income year (as a consequence of an entity becoming a subsidiary member) more than once in the same income year then the following rule will apply. The amount at which the trading stock has its cost for tax purposes set is only taken into account in working out the head companys terminating value for a particular occasion when a subsidiary member leaves where the tax cost setting occurs before the entity leaves and there are no intervening tax cost setting or subsidiary members leaving with the same trading stock. [Schedule 1, item 2, subsection 701-10(6)]

Excluded assets

2.52 No cost is allocated to those assets called excluded assets. An asset is an excluded asset if an amount has been deducted when working out the head companys amount to be allocated to the assets of the entity becoming a subsidiary member (see paragraph 4.42). [Schedule 1, item 2, subsection 701-10(7) and subsection 705-35(2)]

2.53 Section 701-55 explains the meaning of the expression a tax cost is set. In setting the tax cost of an asset to which the capital allowance provisions in Subdivisions 40-A to 40-D and sections 40-425 to 40-445 and the simplified tax system provisions in Subdivision 328 apply, the cost for tax purposes is set on the basis that those provisions apply as though:

·
the asset was acquired by the head company at the time the entity became a subsidiary member of the consolidated group with a reset cost for tax purposes;
·
the head company is taken to have chosen for the asset the same method of working out the decline in value (i.e. if the entity had chosen the prime cost method then the head company will be taken to have chosen the prime cost method);
·
if the prime cost method applies and the assets tax cost setting amount does not exceed the joining entitys terminating value for the asset - the asset is taken to have an effective life for the head company consisting of the remaining effective life of the asset at the time it becomes an asset of the head company;
·
if the prime cost method applies and the tax cost setting amount exceeds the joining entitys terminating value for the asset - the head company is required to make a new choice of effective life under section 40-95 (disregarding subsections (2) and (5) and any choice to use the effective life determined by the Commissioner is limited to one that is in force at the time the entity becomes a subsidiary member; and
·
if the diminishing value method applies - the asset is taken to have the same effective life for the head company as it had for the entity.

Other than where a new choice is required, the effective life that is used for this purpose is the effective life that was chosen and being used by the entity just before it became a subsidiary member of the consolidated group. This may be different to the relevant Commissioners determination of effective life at that time. [Schedule 1, item 2, subsection 701-55(2)]

2.54 For the purposes of setting the cost for tax purposes of an asset to which the trading stock provisions in Division 70 of the ITAA 1997 apply, those provisions apply as though the assets become trading stock of the head company at the start of the income year in which the entity becomes a subsidiary member of the group. [Schedule 1, item 2, subsection 701-55(3)]

2.55 In setting the cost for tax purposes of an asset to which Division 16E of Part III of the ITAA 1936 applies, those provisions apply as though the asset was acquired by the head company at the time the entity became s subsidiary member of the consolidated group with a reset cost for tax purposes. [Schedule 1, item 2, subsection 701-55(4)]

2.56 In setting the cost for tax purposes of an asset to which the CGT provisions apply, those provisions apply as though the cost base or reduced cost base is reduced or increased so that the cost base or reduced cost base is equal to the cost that is set. [Schedule 1, item 2, subsection 701-55(5)]

2.57 In setting the cost for tax purpose of an asset to which provisions not covered in the discussion in paragraphs 2.53 to 2.56, the provisions apply as though the assets cost is reset. [Schedule 1, item 2, subsection 701-55(6)]

2.58 Under the cost setting rules the cost for assets that become assets of the head company when an entity becomes a subsidiary member are set at the tax cost setting amount. Table 2.1 sets out what is the assets tax cost setting amount in the particular circumstances.

Table 2.1: Tax cost setting amount
Circumstances in which the assets tax cost is set: The assets tax cost setting amount is:
Setting the cost to head company of assets brought into a consolidated group when an entity becomes a subsidiary member (i.e. where section 701-10 applies). The amount worked out under the cost setting rules (see discussion in Chapter 5).
Setting the cost to head company of membership interests in an entity that leaves a consolidated group (i.e where section 701-15 applies) The amount worked out under section 711-15 (where a single or section 711-55 (where more than one entity exits) (see Chapter 5).
Setting the cost to head company of assets consisting of liabilities owed to members of a consolidated group by an entity that leaves the group (i.e. where section 701-20 applies). The market value of the asset.
Setting the cost of assets for an entity that leaves a consolidated group for assets consisting of liabilities owed to the entity by members of the group (i.e. where section 701-45 applies). The market value of the asset.
Setting the cost of membership interests which an entity becomes holder on leaving a consolidated group (i.e. where section 701-50 applies). The amount worked out under section 711-55 (see Chapter 5).

[Schedule 1, item 2, section 701-55]

2.59 There are no tax consequences for an entity as a result of joining a consolidated group except where the rules dealing with transactions between entities that merge on consolidation apply (see paragraphs 2.70 to 2.74). On joining a group, for the purposes of working out the subsidiarys income tax liability or tax loss for the period up to the joining time, the subsidiary is taken to have disposed of each item of trading stock it brings into the group for an amount equal to:

·
if the item was on hand at the beginning of the income year, its value under section 70-40;
·
if the asset was not on hand at the beginning of the income year:

-
for livestock, the cost of the asset; or
-
for other assets, the amount, if any, of the expense in acquiring the item.

This ensures that there are no tax consequences for the entity in respect of the trading stock as a consequence of the entity becoming a subsidiary member of the group. [Schedule 1, item 2, subsection 701-35(4)]

2.60 Other than the impact of the rules for transactions between entities that merge on consolidation, the entity is not taken to have disposed of its other assets, or incurred any income tax consequences, as a consequence of becoming a subsidiary member of a consolidated group. [Schedule 1, item 2, section 701-35]

2.61 The subsidiary will be entitled to a deduction for the decline in value of its depreciating assets in the period up to the joining time under the capital allowances provisions of the existing income tax law.

Cost setting rules - exit

2.62 Where a subsidiary member leaves a consolidated group the head company recognises, just before the time the entity leaves, the membership interests in the leaving entity. These membership interests would not be recognised whilst the entity was a member of the group. The cost for the membership interests is set at a cost equal to the head companys cost for the net assets that the leaving entity takes with it. This preserves the alignment between the cost for membership interests in the entity and its assets. The rules for working out the cost for the net assets are explained in Chapter 5. [Schedule 1, item 2, section 701-15]

2.63 Where a number of related entities leave the group, at the one time, the same principle (discussed in paragraph 2.62) applies to the membership interests held by one entity in any of the other entities (see Chapter 5). [Schedule 1, item 2, section 701-50]

2.64 Where a subsidiary member leaves a consolidated group with a liability owing to a member of the group, the liability is recognised for income tax purposes as an asset of the head company just before the time it leaves. The cost for income tax purposes of such an asset at the time it leaves is set at its market value at that time. Such an asset would not be recognised whilst the entity was a group member because intra-group transactions are ignored under the single entity rule. [Schedule 1, item 2, section 701-20 and item 3 in the table in section 701-60]

2.65 There are no income tax consequences for the head company as a result of an entity leaving the group except where the rules dealing with transactions between entities that separate apply (see paragraphs 2.75 to 2.77). When an entity leaves a consolidated group, the head company is taken to dispose of each item of trading stock the leaving entity takes with it from the group for an amount equal to:

·
if the item was on hand at the beginning of the income year, its value under section 70-40 of the ITAA 1997;
·
if the asset was not on hand at the beginning of the income year,

-
for livestock, the cost of the asset; or
-
for other assets, the amount, if any, of the expenditure incurred in acquiring it.

2.66 Other than the impact of rules for transactions between entities that separate, the head company is not taken to have disposed of its other assets, or incurred any income tax consequences, as a consequence of the assets leaving the consolidated group. This ensures that there are no tax consequences for the head company in respect of the trading stock as a consequence of the entity leaving the group. [Schedule 1, item 2, section 701-25]

2.67 Where an entity that leaves a consolidated group takes with it an asset consisting of liabilities owed to it by members of the group the tax cost of that asset is set, at the leaving time, at an amount equal to the market value of the asset at that time. [Schedule 1, item 2, section 701-45 and item 3 in the table in section 701-60]

2.68 Other assets that the leaving entity takes with it from the head company will, as a consequence of the exit history rule, have the same cost for tax purposes as they would for the head company at the time the entity left the group. Consequently, for example, CGT assets will have the same cost base or reduced cost base as they had for the head company at the time the entity leaves the group. Similarly, trading stock and depreciating assets take their respective costs and adjustable values that they had for the head company. In relation to calculating the decline in value for depreciating assets an entity that leaves a group will be taken to have made the same choice of method for working out the decline in value as the asset had immediately before it ceased to be held by the head company.

Exceptions to core rules

Pre-existing arrangements between a consolidated group and entities that become or cease to be subsidiary members of the group

2.69 Ongoing arrangements of various kinds involving income and expenditure can exist between a consolidated group and an entity that becomes a subsidiary member or ceases to be a subsidiary member of the group. Examples of such arrangements include loans subject to interest, provision of property under a lease or prepayment for the future provision of goods or services, including insurance. These arrangements, which can straddle the joining or leaving time, are disregarded for income tax purposes whilst the entity is a subsidiary member of the group. Therefore, specific provision is required to ensure that the appropriate amount of assessable income and deductions are brought to account for things occurring under such arrangements when the entity that becomes a subsidiary member or ceases to be a subsidiary member is outside the group.

Where identities merge

2.70 Where an arrangement exists between an entity that becomes a subsidiary member and an existing member of its joined group, the total of pre-joining time deductions under the arrangement are aligned with the amount of service provided under the arrangement up to the joining time. The amount of deductions required to achieve this alignment is worked out using the formula :

(proportion of all things to be done under the arrangement that were done before the joining time) * (total deductions under the arrangement)

[Schedule 1, item 2, section 701-70]

2.71 Where the amount of deductions allowable for earlier income years is less than the amount required for the alignment of deductions with service provided up to the joining time, the balance of deductions required to achieve that alignment then becomes allowable. In the case of the joining entity, the balance of deductions is allowable for the income year that ends at the joining time. In the case of the head company, the balance of deductions is allowable for the income year that includes the joining time.

2.72 Where the amount of deductions allowable for earlier income years is more than the amount required for the alignment, the alignment is achieved by including the excess deductions in assessable income. The amounts are included in assessable income in the same years as additional deductions would have been allowed, if that were required for alignment (see paragraph 2.71).

2.73 Where the amount of assessable income for earlier income years is more or less than the amount required for the alignment of assessable income with service provided up to the joining time, the balance of assessable income required to achieve that alignment is then made. This alignment is achieved in a similar manner as for deductions. If the amount of assessable income for earlier years is less than proportionate to the services provided up to the joining time, the balancing amount is added to assessable income. If amount of assessable income for earlier years is more, the balancing amount is an allowable deduction. Adjustments to align assessable income with service provided are made for the same income years as adjustments to align deductions would be made, if required.

2.74 Where the head company and the entity that becomes a subsidiary member were previously members of the same consolidated group and the arrangement was in place when the parties ceased to be members of that group, the only things taken into account in relation to the arrangement are things to be done, deductions allowable for expenditure and amounts to be included in assessable income after they ceased to be members of that group. If the head company and the entity that becomes a subsidiary member were previously members of the same consolidated group on more than one occasion, this provision is applied by reference to the most recent of those occasions.

Where identities separate

2.75 Where an arrangement exists between an entity that ceases to be a subsidiary member and a member of the group it is leaving, the total of post-leaving time deductions under the arrangement are aligned with the amount of service to be provided under the arrangement after the leaving time. The amount of deductions to be allowed to achieve this alignment is worked out using the formula :

(proportion of all things to be done under the arrangement that are to be done after the leaving time) * (total deductions under the arrangement)

[Schedule 1, item 2, section 701-75]

2.76 Where the deductions that would otherwise be allowable to:

·
a leaving entity, for the income year that starts at the leaving time and all subsequent income years; or
·
a head company for the income year that includes the leaving time and all subsequent years,

are different from the amount allowable under the formula, the deductions are adjusted so that they equal the amount under the formula.

2.77 Similarly, where the amounts that would otherwise be assessable to:

·
an entity that ceases to be a subsidiary member, for the income year that starts at the leaving time and all subsequent income years; or
·
a head company for the income year that includes the leaving time and all subsequent years,

are disproportionate to the things to be done under the arrangement after the leaving time, the amounts assessable are adjusted in the same manner as that for deductions.

Accelerated depreciation

2.78 The tax history that is inherited by a head company where a subsidiary member becomes part of the head company will be affected by the tax cost setting rules. A consequence of the tax cost setting rules is that the cost history in respect of an asset will be affected where the tax cost is reset on entry to a consolidated group. In particular, in setting the tax cost for depreciating assets subject to Subdivisions 40-A to 40-D and sections 40-425 to 40-445 of the ITAA 1997, those capital allowance provisions apply as though the assets were acquired at the time the entity joins the group. Consequently, the history in respect of entitlement to accelerated depreciation is lost, because the history in respect of the original acquisition date is lost when the asset has its cost reset for tax purposes on entry to a consolidated group.

2.79 However, a head company will be entitled to accelerated depreciation in respect of a depreciating asset that is brought into the consolidated group when an entity becomes a subsidiary member of the group where:

·
the head companys tax cost setting amount for a depreciating asset when a subsidiary member joins a consolidated group is not more than the subsidiary members terminating value (see paragraph 5.28) for that asset; and
·
the subsidiary member was entitled to accelerated depreciation.

[Schedule 1, item 2, section 701-80]

2.80 The head company can also choose to reduce the cost that is set for the depreciating asset to the subsidiarys terminating value for that asset (see paragraphs 5.42 and 5.43).

Other exceptions to the core rules

2.81 The operation of the core rules is subject to any contrary provisions in Part 3-90 or in another part of the income tax law [Schedule 1, item 2, section 701-85] . For example, the operation of the inherited history rules will be affected by the rules covering the treatment of losses and franking credits. These rules are discussed in Chapters 6 to 10.

Accounting for non-membership periods of a subsidiary entity

2.82 When a subsidiary entity becomes a member of a consolidated group part way through the income year, it ceases to be a taxpayer in its own right because of the operation of the single entity rule during consolidation. When a subsidiary member leaves a group part way through an income year, it becomes a taxpayer again, but is different from when it became a subsidiary member because intra-group transactions such as asset transfers between group members are ignored. While the single entity rule alone would achieve the correct calculation of income tax liability and losses of an entity that is outside a consolidated group for one part of an income year (either because it becomes a member or leaves the group part way through the income year), it would not ensure the separate income tax and loss calculations in an income year during which it has more than one such period.

2.83 Special rules therefore operate to ensure that pre- and post-consolidation calculations are undertaken separately, and that there is no netting off between any 2 or more parts of the same income year in which the entity is outside a group (of course, it has no taxable income during its period/s of membership of a consolidated group). For consistency, these rules apply whether the entity is outside a consolidated group for one only, or more than one, period during the income year. This treatment reflects the fact that an entity loses its individual income tax identity upon joining a consolidated group, and when it leaves it is different for income tax purposes from the entity that became a subsidiary member. This is because intra-group transactions such as asset transfers between group members are ignored, so an entity may leave the consolidated group with assets and businesses completely different from those it had when it entered the group. [Schedule 1, item 2, section 701-30]

2.84 Notional figures are worked out for the entitys taxable income, income tax payable on that taxable income and any losses for each part of the income year in which the entity is outside a group. These figures are worked out as if the start and end of that part were the start and end of the income year, ignoring things that happened in any other such periods. [Schedule 1, item 2, subsections 701-30(3) and (4)]

2.85 The entitys income tax liability for the financial year is worked out by adding the notional income tax liability figures (calculated for each part of the income year in which it is outside a group) rather than by reference to the entitys taxable income for the whole year. [Schedule 1, item 2, subsections 701-30(3), (5) and (6)]

2.86 The entity can have a loss for the income year only if it has a loss in the part of the income year ending at the end of the income year [Schedule 1, item 2, subsection 701-30(7)] . This is because when an entity joins a consolidated group either its losses are transferred into the group in accordance with the loss transfer rules (described in Chapter 6) or they are effectively cancelled and cannot be used by any entity [Schedule 1, item 2, section 707-150] . Because notional income tax liability is worked out separately for each part of the income year in which the entity is a taxpayer in its own right, losses in a later part of the income year cannot be used to offset income in an earlier part. [Schedule 1, item 2, subsection 701-30(3)]

2.87 These rules apply equally to entities with SAPs.

Example 2.1 A group consolidates mid-way through its income year. The subsidiaries work out their income tax liabilities for the part of the income year up to joining time as if the start and end of that period were the start and end of its income year respectively.

Example 2.2 In one income year, an entity is a single taxpayer, then becomes a subsidiary member of a consolidated group part way through the year and subsequently leaves the group without immediately joining another group. During that income year, there are 2 parts of the year in which the entity is a taxpayer in its own right.For example, in the first part of the year, the entity has tax payable of $10,000, worked out by reference to its notional taxable income for that part.While the entity is a member of a consolidated group it is not a taxpayer but part of the head company, and so does not have any taxable income, income tax liability or losses in respect of that part of the income year.The entity has a loss of $5,000 for the part of the income year after it left the consolidated group. The entity is able to carry forward this loss, subject to the normal loss utilisation rules, for its future use. Nil tax is payable in respect of this part.The total amount of tax payable by the entity for the whole of the financial year is:

$10,000 + nil = $10,000

The entity has a loss of $5,000 for the income year.

Application and transitional provisions

2.88 The consolidation regime will apply from 1 July 2002.

2.89 Under rules to be introduced in a later bill a head company may elect on formation of a consolidated group to adopt the transitional option of using a joining entitys terminating value as its cost for the assets that are brought into the group by the subsidiary members.

Consequential amendments

2.90 There are various consequential amendments to the ITAA 1997 in relation to the measures discussed in this chapter. These amendments are related to the rules for working out an entitys income tax liability or losses if the entity becomes and ceases to be a member of a consolidated group in a single income year (section 701-30). [Schedule 3, Part 1, item 1]

2.91 Consequential amendments have been made to subsection 995-1(1) to include references to new dictionary terms. [Schedule 5, items 10, 19, 27, 30, 31 and 32]

Chapter 3 - Membership rules

Outline of chapter

3.1 This chapter explains the rules dealing with the formation of a consolidated group, including rules dealing with the types of entities eligible to join such a group. It also explains the notification rules that will apply when there are changes in membership of a consolidated group.

Context of reform

3.2 Consistent with Recommendation 15.1(i) of A Tax System Redesigned, certain groups of wholly-owned entities will be provided with a choice to be taxed as a single consolidated entity.

3.3 In order to give practical meaning to the concept of a single Australian taxpayer, entry into the consolidation regime is generally restricted to those groups who have a resident holding company at the head of the group. Certain wholly-owned groups in Australia that do not have a common Australian holding company between the non-resident parent and the Australian resident subsidiaries may instead choose to form a MEC group. Rules relating to the formation and income tax treatment of MEC groups are discussed in Chapter 4.

3.4 Although consolidation is optional, if a group consolidates, all of the resident holding companys eligible resident wholly-owned subsidiaries, (whether companies, partnerships or trusts) must be included in the consolidated group. This rule is referred to as the all in principle and will also apply to entities acquired in the future.

3.5 The all in principle allows intra-group transactions to be ignored for tax purposes. Consolidation therefore offers major advantages to entity groups in terms of both reduced complexity and flexibility in commercial operations. Departure from the all in principle would add considerable complexity to the consolidation regime and could compromise the integrity of the regime by allowing unintended tax benefits to be obtained from transactions between member and non-member entities.

3.6 In determining whether an entity is a wholly-owned subsidiary, in some cases employee shares are to be disregarded. This gives effect to Recommendation 15.2(a)(i) of A Tax System Redesigned. Debt interests are also to be ignored. This is broadly in line with the proposal in A Tax System Redesigned, whichproposed that the concept of finance shares be used to identify debt. The broad term finance shares has now been superseded by the debt/equity rules in Division 974 of the ITAA 1997 as a basis for identifying debt interests.

3.7 The inclusion of discretionary trusts and hybrid trusts in consolidated groups on the basis of a wholly-owned test departs from the recommendation in A Tax System Redesigned. The new test avoids introducing unnecessary complexity into the regime.

3.8 Certain entities are prevented from being a member of a consolidated group. Broadly, the provisions limiting the types of entities that can be a member of a consolidated group are designed to ensure that consolidated groups generally receive a tax treatment like ordinary Australian resident companies and that, in general, concessional tax treatment is neither effectively gained by nor denied to entities by becoming a member of a consolidated group.

Summary of new law

3.9 The following summarises the key requirements for formation and membership of a consolidated group.

What is a consolidated group? A consolidated group consists of:

·
a head company; and
·
all of the subsidiary members of the group (if any).

In general, before a consolidated group can be brought into being there must be:

·
a consolidatable group in existence; and
·
an effective choice made by the head company of that group to consolidate the group.

What is a consolidatable group? A consolidatable group is a group of entities that is eligible to be consolidated.

A consolidatable group consists of:

·
a head company; and
·
all of the subsidiary members of the group,

provided there is, in addition to the head company, at least one subsidiary member.

What is a head company? A head company is generally an ordinary Australian resident company that is not a subsidiary member of a consolidatable or consolidated group.
What is a subsidiary member of a consolidatable or consolidated group? Broadly, an entity is eligible to be a subsidiary member of a consolidatable or consolidated group if:

·
it is a resident company, trust or partnership;
·
it is a wholly-owned subsidiary of the head company;
·
it would not/does not effectively gain or lose concessional tax treatment by being a subsidiary member of a consolidated group; and
·
any entities interposed between itself and the head company of the group are subsidiary members of the group, nominees or certain non-resident entities.

What entities are excluded from being a member of a consolidated group? Certain entities (such as PDFs) that receive different tax treatment, including concessional tax treatment, compared to ordinary Australian resident companies cannot be a member of a consolidated group. In addition, certain entities that would effectively gain concessional treatment by being a subsidiary member of a consolidated group headed by an ordinary Australian resident company cannot be subsidiary members.
Can the head company revoke the choice to consolidate? No.
What happens when an entity is no longer eligible to be a head company? Any choice to consolidate by the entity will cease to have effect. Therefore, any consolidated group headed by the entity will cease to exist.
What happens when a consolidated group no longer has subsidiary members? The consolidated group will continue to exist even though there are no subsidiary members of the group.
Comparison of key features of new law and current law
New law Current law
Consolidation is available to certain groups of wholly-owned entities that may comprise companies, partnerships and trusts.

Consolidation provisions used to work out whether an entity is a wholly-owned subsidiary of the head company are based on, but are more flexible than, the current definition of 100% subsidiary. This definition is relevant to determining whether an entity is a member of a wholly-owned group.

The rules for consolidation are intended to replace the current grouping provisions. Currently grouping concessions may only be accessed by companies that are members of the same wholly-owned group.

Detailed explanation of new law

What is a consolidated group?

3.10 A consolidated group is brought into existence by a choice to treat a consolidatable group of entities (see paragraphs 3.21 to 3.24) as a consolidated group. The company that was the head company of the consolidatable group on the day from which the choice will take effect is responsible for making the choice. [Schedule 1, item 2, paragraph 703-5(1)(a)]

3.11 When a consolidatable group becomes a consolidated group, all of the members of the consolidatable group will become members of the consolidated group. [Schedule 1, item 2, subsection 703-5(3)]

3.12 The members of a consolidatable group are:

·
the head company; and
·
all of the subsidiary members of the group.

[Schedule 1, item 2, subsection 703-15(1)]

3.13 The cessation of a MEC group can also bring a consolidated group into existence. This will occur if the cessation of a MEC group happens because the entity that is the sole eligible tier-1 company in the MEC group fails to satisfy the conditions for being an eligible tier-1 company and immediately after this time that entity meets the conditions for being a head company of a consolidated group [Schedule 1, item 2, paragraph 703-5(1)(b) and subsection 703-55(1)] . Chapter 4 explains the terms MEC group and eligible tier-1 company.

3.14 When a MEC group converts to a consolidated group, all of the entities that were members of the MEC group immediately before it ceased to exist will become members of the consolidated group. In particular, the company that was the sole eligible tier-1 company of the MEC group will become the head company of the consolidated group and every entity (if any) that was a subsidiary member of the MEC group will become a subsidiary member of the consolidated group. [Schedule 1, item 2, subsection 703-55(2)]

3.15 At any point in time while the consolidated group is in existence, the members of the group will consist of all of the subsidiary members of the consolidated group (if any) together with the head company. [Schedule 1, item 2, subsection 703-15(1)]

3.16 An important effect of these rules is that a subsidiary member does not have an option not to be part of a consolidated group if a choice outlined in paragraph 3.10 has been made or where the consolidated group has been brought into existence by the cessation of a MEC group.

3.17 Further, a change in the composition of a consolidated group will generally not affect its existence, so long as the same head company exists [Schedule 1, item 2, paragraph 703-5(2)(a)] . This means, for example, that if, after a consolidated group comes into existence, there are no subsidiary members of the group and the only member of the group is the head company, the consolidated group will remain in existence. Such a group will consist only of the head company. [Schedule 1, item 2, subsection 703-5(3)]

3.18 However, where the head company no longer satisfies the prerequisites for being a head company, the consolidated group will cease to exist [Schedule 1, item 2, paragraph 703-5(2)(a)] . An example of where this could occur is where the head company becomes a subsidiary member of a consolidatable or consolidated group.

3.19 A consolidated group will also cease to exist if the head company of the group becomes a member of a MEC group. [Schedule 1, item 2, paragraph 703-5(2)(b)]

3.20 The key concept underlying the formation of a consolidated group is in most cases the existence of a consolidatable group. This concept will now be discussed, along with the categories of entities that are members of a consolidatable group.

Consolidatable groups and their members

3.21 Consolidatable group is the label used to describe a type of group that is eligible to be consolidated.

3.22 A consolidatable group consists of:

·
a head company; and
·
all of the subsidiary members of the group.

[Schedule 1, item 2, subsection 703-10(1)]

3.23 As was discussed in paragraph 3.12, an entity that is either a head company or a subsidiary member of a consolidatable group will be a member of that group. [Schedule 1, item 2, subsection 703-15(1)]

3.24 A consolidatable group will only exist if there exists a head company and at least one subsidiary member [Schedule 1, item 2, subsection 703-10(2)] . Generally a head company existing alone without any subsidiary members is not eligible to consolidate. This is not withstanding that a consolidated group can continue to exist even if the group loses all of its subsidiary members after formation and subsequently consists of the head company alone.

What is a head company?

3.25 Broadly, a head company is an entity that:

·
is a company;
·
has an income tax rate that is or equals the general company tax rate applied to some or all of its taxable income (if any);
·
is not a type of entity that is specifically precluded from being a member of a consolidatable or consolidated group;
·
is an Australian resident but not a prescribed dual resident; and
·
is not a subsidiary member of a consolidatable or consolidated group.

[Schedule 1, item 2, subsection 703-15(2), item 1 in the table]

3.26 Note that the definition of head company contained in Division 166 and section 995-1 of the ITAA 1997 will be consequentially amended. [Schedule 3, items 3 to 16; Schedule 5, item 11]

3.27 The first 3 dot points in paragraph 3.25 are collectively referred to as the income tax treatment requirements. The fourth requirement is referred to as the Australian residence requirement, while the fifth requirement is known as the ownership requirement. [Schedule 1, item 2, subsection 703-15(2)]

Income tax treatment requirements

3.28 The income tax treatment requirements are central in ensuring that consolidated groups generally receive a tax treatment like ordinary companies. Subsidiary members of a consolidated group will be treated as parts of the head company rather than as separate entities under the rule providing for single entity treatment for consolidated groups. This means that the tax treatment that is effectively received by subsidiary members of a consolidated group will be determined by the tax treatment that is received by the head company of the group.

Requirement 1: The entity must be a company

3.29 To qualify as a head company, an entity must be a company as defined in section 995-1 of the ITAA 1997.

3.30 A corporate limited partnership will also satisfy this requirement. This is consistent with the objective of ensuring consolidated groups generally receive a tax treatment like ordinary companies because these partnerships are effectively treated as companies for income tax purposes.

3.31 In relation to corporate unit trusts and public trading trusts, these entities cannot be head companies because the tax treatment of these entities is not identical to that of ordinary resident companies. For example, the trust loss measures contained in Schedule 2F of the ITAA 1936 apply to these entities. Also, corporate unit trusts and public trading trusts are currently unable to access all of the grouping concessions that are being replaced by the consolidation measures.

3.32 In the December 2000 exposure draft, entities that were covered by the then proposed non-fixed trust rules were eligible to be a head entity (now head company). This is no longer the case. The previous approach reflected the proposal to afford these entities the same tax treatment as companies.

Requirement 2: The entity must have the general company tax rate (or an equivalent rate) applied to some or all of its taxable income

3.33 This requirement generally excludes companies from being eligible to be a head company of a consolidatable or consolidated group if they receive concessional tax treatment. This is achieved by requiring some or all of the taxable income of a company to be taxed at a rate that is or equals the general corporate tax rate.

3.34 If concessionally taxed companies were able to be a head company of a consolidated group, the concessions that these companies receive may be made available to all entities in the group through the single entity rule. The exclusion is designed to prevent this. Otherwise, consolidation may unintentionally extend these concessions to entities that are not otherwise entitled to them.

3.35 Some companies that have a rate of tax less than the company tax rate applying to some of their taxable income will satisfy requirement 2. These companies will not be excluded from being a member, including a head company, of a consolidated group because those concessional rates often apply only to special types of income that are peculiar to those companies (e.g. life insurance companies). Existing rules that quarantine special classes of income that are subject to concessional rates of tax will apply in the context of a consolidated group.

3.36 Certain non-profit companies that have the corporate tax rate phased in on their taxable income will also satisfy requirement 2. While this is inconsistent with the rationale for requirement 2, if such a company continues to qualify for this special tax treatment when it is a head company of a consolidated group, the maximum benefit that could be obtained from the group (as a consequence of it being headed by the company) is negligible.

Requirement 3: The entity must not be of a type that is specifically excluded from being a member of a consolidatable or consolidated group

3.37 Entities that are specifically excluded from being a member of a consolidatable or consolidated group are detailed in Table 3.1. These entities are prevented from being a member of a consolidatable or consolidated group because of the way their income is treated for income tax purposes [Schedule 1, item 2, subsection 703-20(1)] . Requirement 3 is therefore a further mechanism to exclude from a consolidated group certain entities that do not receive a tax treatment like ordinary companies, including certain entities that receive concessional treatment relative to ordinary Australian resident companies. As discussed in paragraphs 3.33 and 3.34, the application of this feature in the head company context is designed to ensure that the concessions available to such entities do not apply to other members of the consolidated group and that the group receives a tax treatment like an ordinary resident company.

Table 3.1: Entities which cannot be members of a consolidatable or consolidated group
This entity is excluded under because
An entity to which Division 50 of the ITAA 1997 applies. Subsection 703-20(2), item 1 in the table. The total ordinary and statutory income of these companies is exempt from income tax.
A recognised medium credit union (as defined under section 6H of the ITAA 1936). Subsection 703-20(2), item 2 in the table. These credit unions have a threshold placed on the tax payable on their taxable income, even though they are subject to the corporate tax rate.
An approved credit union (as defined under section 23G of the ITAA 1936) that is not a recognised medium credit union or a recognised large credit union (as defined under section 6H of the ITAA 1936). Subsection 703-20(2), item 3 in the table. These credit unions are entitled to an exemption under section 23G of the ITAA 1936 for interest received from non-corporate members.
Certain cooperative companies (as defined under section 117 of the ITAA 1936). Subsection 703-20(2), item 4 in the table. These companies would be allowed a special deduction under paragraph 120(1)(c) of the ITAA 1936 if at the time they applied an amount of their assessable income as described under that paragraph.
An entity that is a PDF (as defined under section 995-1 of the ITAA 1997) at the end of the income year (see paragraph 3.40). Subsection 703-20(2), item 5 in the table. These entities are subject to a concessional rate of tax compared to the general company tax rate.
A company that is a film licensed investment company at the time (as defined in section 375-855 of the ITAA 1997). Subsection 703-20(2), item 6 in the table. Tax losses or net capital losses cannot be transferred to or from these companies. Further, section 375-880 of the ITAA 1997 prevents these companies from claiming deductions for expenditure on a film where the amount spent is an amount of Film Licensed Investment Company concessional capital.
A trust that is:

·
a complying superannuation entity;
·
a non-complying ADF; or
·
a non-complying superannuation fund,

(as those terms are defined in section 267 of the ITAA 1936).

Subsection 703-20(2), item 7 in the table. The taxable income of these entities is subject to tax at rates other than the general company tax rate.

3.38 A company that becomes a PDF during an income year and is still a PDF at the end of the income year will not be eligible to be a member, including a head company, of a consolidated or consolidatable group for the entire income year. [Schedule 1, item 2, subsection 703-20(2), item 5 in the table]

3.39 In the February 2002 exposure draft, companies subject to the mutuality principle were excluded from membership of a consolidatable or consolidated group. Such a company was precluded from being a head company because it does not derive assessable income from its members. Therefore, any amount received by a subsidiary member of a consolidated group headed by such a company from a member of that company would be effectively ignored. The amount would otherwise have been assessable income of the subsidiary member.

3.40 In response to submissions, however, the Government now considers that where a company continues to be subject to the mutuality principle when it is a head company of a consolidated group, the tax outcome outlined in paragraph 3.39 is conceptually appropriate in the context of single entity treatment. The exclusion has therefore been removed.

Australian residence requirements

3.41 Only companies that are Australian residents can be a head company of a consolidatable or consolidated group. This reflects the position that consolidated group treatment is generally only available to Australian resident entities.

3.42 Companies that are prescribed dual residents are ineligible to be a head company of a consolidatable or consolidated group on the basis that prescribed dual residents do not receive the same tax treatment as ordinary resident companies. In particular, wholly-owned groups headed by prescribed dual residents are currently unable to access the grouping concessions that are being replaced by the consolidation measures.

Ownership requirements

3.43 A head company must not be a subsidiary member of a consolidatable or consolidated group. This requirement reflects the general principle that a company can only be either a head company or a subsidiary member of a consolidatable group (whether or not the group is consolidated), but it cannot be both.

3.44 Without this rule, a company could potentially be a member of more than one consolidated group. For example, a company could be a head company of one consolidated group while being a subsidiary member of another consolidated group. This is unworkable, as the activities of the company cannot be appropriately attributed to one group in preference to the other.

3.45 It is possible for an entity to be neither a head company nor a subsidiary member of a consolidatable or consolidated group. This could occur for a number of reasons. An example is where the entity is of a type that is specifically precluded from being a member of a consolidatable or consolidated group (see paragraph 3.37).

3.46 It is also possible for an entity to be a head company of a consolidatable group or consolidated group whilst being a wholly-owned subsidiary of another entity (see paragraphs 3.63 to 3.80 for a discussion on wholly-owned subsidiaries) provided that the head company is not a subsidiary member of a consolidatable or consolidated group.

What is a subsidiary member of a consolidatable or consolidated group?

3.47 An entity is eligible to be a subsidiary member of a consolidatable group or consolidated group if:

·
the entity is a trust, a partnership or a company other than a non-profit company;
·
in the absence of single entity treatment, some or all of its taxable income would be taxed at a rate that is or equals the general company tax rate (applies only if the entity is a company);
·
it is not an entity that is specifically precluded from being a member of a consolidatable or consolidated group;
·
the entity passes an Australian residence test;
·
the entity is a wholly-owned subsidiary of the head company; and
·
any entities that are interposed between the head company and itself are subsidiary members (of the group), nominees or certain non-resident entities.

[Schedule 1, item 2, subsection 703-15(2), item 2 in the table]

3.48 The first 3 requirements are collectively known as the income tax treatment requirements. The fourth requirement is referred to as the Australian residence requirement, and together the fifth and sixth requirements are known as the ownership requirements. [Schedule 1, item 2, subsection 703-15(2)]

3.49 Working out whether an entity is a subsidiary member of a consolidatable or consolidated group is important for 2 reasons:

·
to determine who the members (if any) of a consolidated or consolidatable group are;and
·
an entity that is a subsidiary member of a consolidatable or consolidated group cannot itself be a head company of a consolidated or a consolidatable group.

Income tax treatment requirements

3.50 The income tax treatment requirements have been discussed in paragraphs 3.28 to 3.40 (although the discussion did not extend to trusts, partnerships or the requirement that an entity be a company other than a non-profit company). The earlier discussion focused on the need for a head company to meet these requirements. In this context, requiring a head company to satisfy these conditions ensures consolidated groups generally receive a tax treatment like ordinary companies. It also ensures that, in general, the concessions received by particular entities are not effectively received by all of the subsidiary members of a consolidated group headed by such an entity.

3.51 The reason for limiting the membership requirements in relation to subsidiary members is slightly different. These conditions are directed at preserving an entitys concessional tax treatment. More specifically, the conditions ensure that an entity does not effectively lose relative concessional treatment by being a subsidiary member of a consolidated group headed by a company that does not receive relative concessional treatment. For example, due to the operation of the single entity rule, the income of an entity to which Division 50 of the ITAA 1997 applies would no longer be exempt from income tax if the entity were permitted to be a subsidiary member of a consolidated group headed by an ordinary Australian resident company. It is important to prevent these entities and other concessionally taxed entities from being subsidiary members because, as mentioned in paragraph 3.16, a subsidiary member does not have an option not to be part of a consolidated group if a choice outlined in paragraph 3.10 has been made or where the consolidated group has been brought into existence by the cessation of a MEC group.

3.52 Paragraph 3.51 is also the basis for the exclusion of non-profit companies from subsidiary membership (as these companies receive concessional tax treatment in the sense that they generally have the corporate tax rate phased in on their taxable income). The term non-profit company is defined in subsection 3(1) of the ITRA 1986.

3.53 The income tax treatment requirements also act as an integrity measure to generally prevent certain entities from effectively gaining relative concessional treatment by being a subsidiary member of a consolidated group headed by a company that does receive relative concessional treatment. For example, the income of a non-complying superannuation fund would be concessionally taxed if it were permitted to be a subsidiary member of a consolidated group headed by a company that has some or all of its taxable income taxed at the general company tax rate. This is because the taxable income of a non-complying superannuation fund is taxed at a rate higher than the general company tax rate.

3.54 In the February 2002 exposure draft, companies subject to the mutuality principle were excluded from being a member of a consolidatable or consolidated group on the basis that these companies do not derive assessable income from their members. This exclusion no longer applies and in the context of subsidiary membership, this is appropriate given that intra-group transactions within a consolidated group are ignored for the purposes of determining the head companys income tax liability.

3.55 Companies in addition to trusts and partnerships may be eligible to be subsidiary members of a consolidatable or consolidated group. The inclusion of most trusts as subsidiary members of a consolidated group is appropriate on the basis that income generally maintains its character as it flows through the trust to the beneficiaries or objects. Likewise, most partnerships (other than corporate limited partnerships) are simply conduits through which amounts flow-through to the partners.

3.56 The inclusion of trusts and partnerships in a consolidated group is also important to ensure generally that companies that are currently members of the same wholly-owned group under section 975-500 of the ITAA 1997 can continue to access grouping benefits within the confines of a consolidated group. Certain trusts and partnerships, for example, may currently form part of the ownership structure of such wholly-owned groups.

Australian resident requirements

3.57 As discussed in paragraph 3.41, the requirement to pass a residency test reflects the general principle that consolidated group treatment is generally only available to Australian resident entities.

3.58 The Australian residence test that must be satisfied depends on the nature of the entity being tested.

The test that applies to companies

3.59 If the entity is a company (including a corporate limited partnership), it must be an Australian resident (but not a prescribed dual resident) [Schedule 1, item 2, subsection 703-15(2), column 3 of item 2 in the table] . The term Australian resident is defined in section 995-1 of the ITAA 1997.

The tests that apply to trusts

3.60 The type of test that needs to be satisfied depends on the type of trust being tested. The purpose of this approach is to avoid overlap with the other separate regimes that presently govern non-resident trusts. It also helps to ensure that the head companys income is subject to income tax only where appropriate taxing rights exist.

3.61 The relevant tests are summarised in Table 3.2.

Table 3.2: Australian residence requirements for trusts
Trust type Tests to be satisfied
A trust other than a unit trust. The trust must be a resident trust estate for the income year for the purposes of Division 6 of Part III of the ITAA 1936.
A unit trust other than a corporate unit trust or a public trading trust. The trust must be:

·
a resident trust estate for the income year for the purposes of Division 6 of Part III of the ITAA 1936; and
·
a resident trust for CGT purposes for the income year.

A corporate unit trust or a public trading trust. The trust must be a resident unit trust (as defined in whichever one of sections 102H and 102Q of the ITAA 1936 is relevant) for the income year.

[Schedule 1, item 2, section 703-25 and subsection 703-15(2), column 3 of item 2 in the table]

Partnerships

3.62 No residency test applies to partnerships (other than corporate limited partnerships) [Schedule 1, item 2, subsection 703-15(2), column 3 of item 2 in the table] because a partnership will be a resident partnership for most income tax purposes where at least one of the partners is a resident. In a consolidation context, this will mean that a partnership whose partners are subsidiary members (having satisfied the Australian residence requirements themselves) will be a resident partnership for most income tax purposes. It is therefore unnecessary to impose a further residency test on partnerships.

Ownership requirements

The entity is a wholly-owned subsidiary of the head company

3.63 The rules for working out whether an entity is a wholly-owned subsidiary of the head company are based on the definition of 100% subsidiary in section 975-505 of the ITAA 1997. Among the differences between the rules for wholly-owned subsidiaries and the section 975-505 definition of 100% subsidiary are that:

·
the rules for wholly-owned subsidiaries apply to companies, partnerships and trusts, whereas section 975-505 only applies to companies; and
·
the rules for wholly-owned subsidiaries (specifically, special rules 1 and 2 outlined in paragraphs 3.72 to 3.80) will treat an entity as a wholly-owned subsidiary in circumstances that would otherwise prevent the entity from being a wholly-owned subsidiary. An example is where minor holdings of shares in a company have been issued under employee share acquisition arrangements. There are no such provisions in section 975-505.

The general test to determine whether an entity is a wholly-owned subsidiary of the head company

3.64 To be a wholly-owned subsidiary of the head company (the holding entity), all of the membership interests in the entity (the subsidiary entity) must be beneficially owned by:

·
the holding entity;
·
one or more wholly-owned subsidiaries of the holding entity; or
·
a combination of the holding entity and one or more wholly-owned subsidiaries of the holding entity.

[Schedule 1, item 2, subsection 703-30(1)]

3.65 This rule is capable of multiple applications. This means that an entity can only be a wholly-owned subsidiary of the head company (the holding entity) if it is either a wholly-owned subsidiary of the holding entity or a wholly-owned subsidiary of a wholly-owned subsidiary of the holding entity. [Schedule 1, item 2, subsection 703-30(2)]

3.66 For the purposes of the general wholly-owned subsidiary test in paragraph 3.64, membership interest means each interest or set of interests or each right or set of rights in relation to an entity by virtue of which you are a member [Schedule 5, item 41, section 960-135] . An entity will be a member of another entity in circumstances set out in Table 3.3.

Table 3.3: Entities and their members
Entity Member
A company. A member of the company or a stockholder in the company.
A partnership. A partner in the partnership.
A trust (except a corporate unit trust or a public trading trust). A beneficiary, unit holder or object of the trust.
A corporate unit trust or a public trading trust. A unit holder of the trust.

[Schedule 5, item 41, subsection 960-130(1)]

3.67 If 2 or more entities jointly hold interests or rights that give rise to membership of another entity, each of them is a member of the other entity. [Schedule 5, item 41, subsection 960-130(2)]

3.68 An entity is not a member of another entity just because it holds interests or rights in that other entity that are debt interests [Schedule 5, item 41, subsection 960-130(3)] . Thus, debt interests do not constitute membership interests. Such interests will therefore be disregarded when determining whether an entity is a wholly-owned subsidiary. Debt interests are disregarded because these interests do not establish control and therefore should not be considered when contemplating the ownership structure of the group.

3.69 Division 974 of the ITAA 1997 explains what a debt interest is. Division 974 will have application from 1 July 2002 for the purposes of the consolidation rules (including the general wholly-owned subsidiary test in paragraph 3.64) to determine whether an interest or right that is held by an entity in relation to another entity on or after 1 July 2002 is a debt interest (and therefore, whether it is a membership interest) in the other entity. This will be the case irrespective of whether the debt and equity test amendments (as defined in item 118 of Schedule 1 to the New Business Tax System (Debt and Equity) Act 2001) apply to transactions in relation to the interest or right at the relevant time. [Schedule 2, item 2, section 703-30]

3.70 Non-share equity interests (e.g. a convertible note that is not a debt interest) are rarely relevant in determining ownership of companies. Given that this is the case, for consolidation purposes the equity interest classification rules, contained in Division 974, are not used to determine whether an interest or right that is held by an entity in relation to another entity is a membership interest in that other entity. Other provisions within the income tax law that relate to the ownership of companies, including the current definition of 100% subsidiary in section 975-505 of the ITAA 1997, also generally do not rely on the definition of equity interest and its related concepts. This means, for example, that an interest that is an equity interest under Division 974 may not necessarily be a membership interest for consolidation purposes.

Special rules

3.71 As mentioned in paragraph 3.63, an entity may be treated as if it were a wholly-owned subsidiary despite failing the general test in paragraph 3.64 if the conditions in the special rules are satisfied. These special rules are discussed in paragraphs 3.72 to 3.80.

Special rule 1: Treating entities as wholly-owned subsidiaries by disregarding employee shares

3.72 An entity will be taken to be a wholly-owned subsidiary of another entity, if it is not otherwise so only because certain shares acquired under an ESAS are:

·
beneficially owned in it; or
·
beneficially owned in a company that is interposed between it and another entity.

This is achieved by treating those shares as not existing. [Schedule 1, item 2, subsections 703-35(2) and (3)]

3.73 The purpose of this special rule is to ensure an entity can be part of a consolidatable group if it is only the presence of these shares that is preventing it from being part of that group. Without this rule, it is likely the benefits of being in a consolidated group will be denied to an entity whose equity is effectively wholly-owned by a head company of a consolidatable group. [Schedule 1, item 2, subsection 703-35(1)]

3.74 Shares issued under an ESAS arrangement will only be disregarded if:

·
the percentage of ordinary shares owned by entities under the scheme does not exceed 1% of the number of ordinary shares in the company [Schedule 1, item 2, subsection 703-35(4)] ; and
·
the additional criteria outlined in paragraph 3.75 are met.

3.75 The additional criteria are as follows:

·
the share must have been acquired:

-
by the entity in relation to the employment of the entity or services provided by the entity in accordance with subsections 139C(1) and (2) of the ITAA 1936; or
-
as the result of the exercise of a right that the entity acquired in the circumstances set out in those subsections;

·
all of the shares available for acquisition under the scheme must be ordinary shares or rights in respect of ordinary shares;
·
at the time the share was acquired, the entity did not hold a legal or beneficial interest in more than 5% of the shares in the company, and was not in a position to cast or control the casting of more than 5% of the maximum number of votes at a general meeting, as required by subsections 139CD(6) and (7) of the ITAA 1936;
·
the company is not covered by section 139DF of Division 13A of the ITAA 1936 because the business of the company is the acquisition, sale or holding of shares, securities or other investments, and the entity is employed by both that company and another company in the same company group; and
·
at the time at which the share was acquired, an offer to acquire shares or rights in the company or in a holding company must have been available to 75% of the permanent employees of the employing company (the employer).

[Schedule 1, item 2, subsection 703-35(5)]

3.76 If all of the conditions in paragraph 3.75 are satisfied except the last mentioned condition, the share may still be disregarded if the Commissioner has made a determination under subsection 139CD(8) of the ITAA 1936 that this condition was taken to have been satisfied because the Commissioner considered that the employer had done everything reasonably practicable to ensure the condition was satisfied. [Schedule 1, item 2, subsection 703-35(6)]

3.77 The criteria in paragraphs 3.75 and 3.76 are broadly based on the rules in Division 13A of Part III of the ITAA 1936, which provides generally for the taxation treatment of shares and rights acquired under employee share schemes. However, as implied by paragraphs 3.75 and 3.76, not all of the requirements of Division 13A must be met for a share to be disregarded. In particular, the shares or rights do not have to be issued at a discount (i.e. for a consideration less than the market value of the share or right).

Special rule 2: Treating entities held through non-fixed trusts as wholly-owned subsidiaries

3.78 An entity (the test entity) will nevertheless be treated as a wholly-owned subsidiary of another entity despite there being a trust that is not a fixed trust interposed between it and the head company of the group. This is achieved by treating the interposed trust as a fixed trust and all of its objects as beneficiaries. [Schedule 1, item 2, subsection 703-40(2)]

3.79 The purpose of this special rule is to ensure that an entity is not prevented from being a subsidiary member of a consolidatable or consolidated group just because there is a trust other than a fixed trust interposed between the test entity and the head company of the group. [Schedule 1, item 2, subsection 703-40(1)]

3.80 Due to the nature of the interposed trust, it may not be possible to beneficially own membership interests in the test entity. This means that, in the absence of special rule 2, it may not be possible for the test entity to be a wholly-owned subsidiary of the head company (and thus a subsidiary member of a consolidatable or consolidated group). This result would be an unnecessary compromise of the all in principle.

Any entities that are interposed between the head company and itself are subsidiary members (of the group), nominees or certain non-resident entities

3.81 Any entities interposed between the entity being tested (the test entity) and the head company of a consolidatable or consolidated group must be either:

·
a subsidiary member of the group; or
·
an entity that holds membership interests in the test entity or a subsidiary member of the group (that is interposed between the head company and the test entity) only as a nominee of one or more entities that are members of the group.

[Schedule 1, item 2, subsections 703-45(1) and (2)]

3.82 In the absence of this requirement, an entity could be a subsidiary member of a consolidatable or consolidated group despite there being a non-member entity (other than a nominee) interposed between it and the head company that was ineligible to be a subsidiary member of the group.

3.83 If an entity (other than a nominee) within the ownership structure of a consolidated group is not a member of the consolidated group, the integrity of the consolidation regime (including the single entity rule) may be compromised by allowing unintended benefits to be obtained from transactions between member and non-member entities, unless special rules were developed to eliminate these unintended consequences.

3.84 On the other hand, it is desirable to allow interposed entities that are nominees of either the head company or a subsidiary member of the group to remain external to the group because this leads to the intended result of reflecting the substance underlying common membership interest holding arrangements and does not compromise the objects of single entity treatment.

3.85 In certain circumstances, the interposed entity requirements in paragraph 3.81 are relaxed to allow certain resident companies, trusts and partnerships to be members of a consolidatable or consolidated group despite one or more non-member foreign resident entities being interposed between the resident entities and the head company of the group [Schedule 1, item 2, subsection 703-45(1)] . The rules in paragraph 3.81 are relaxed in order to relieve certain wholly-owned groups of the burden of restructuring.

3.86 The test to establish whether an entity (the test entity) can be a subsidiary member of a consolidatable or consolidated group despite the existence of one or more interposed non-resident entities will be determined by the nature of the entity being tested. The relevant tests (referred to as the interposed foreign resident tests) are outlined in paragraphs 3.87 and 3.88 and illustrated in Example 3.6.

Interposed Foreign Resident Tests

The test that applies where the test entity is a company

3.87 Where the test entity is a company, it will qualify as a subsidiary member of a consolidatable or consolidated group if:

·
there is at least one entity interposed between the test entity and the head company of the group that is either:

-
a foreign resident company (referred to as a non-resident company); or
-
a trust that does not meet the residency requirements set out in Table 3.2 (referred to as a non-resident trust);

·
each entity interposed between the test entity and the head company of the group is one of the following:

-
an entity that is a subsidiary member of the group;
-
a non-resident company;
-
a non-resident trust;
-
an entity that holds membership interests in an entity interposed between it and the test entity, or in the test entity, only as a nominee of one or more entities each of which is a member of the group, a non-resident trust or a non-resident company; or
-
a partnership, where each partner is a non-resident company or a non-resident trust; and

·
the test entity would be a subsidiary member of the group if it was assumed that each of the following interposed entities was a subsidiary member of the group:

-
each interposed entity that is a non-resident company; and
-
each interposed entity that is a non-resident trust.

[Schedule 1, item 2, subsection 703-45(3)]

The test that applies where the test entity is a trust or partnership

3.88 If the test entity is a trust or partnership, it will be a subsidiary member of a consolidatable or consolidated group provided that it would be a subsidiary member of the group had the head company beneficially owned all of the membership interests beneficially owned by each company that qualifies as a subsidiary member because the test in paragraph 3.87 is satisfied. [Schedule 1, item 2, subsection 703-45(4)]

3.89 The interposed foreign resident tests effectively allow the interposed non-resident entities to be disregarded for the purposes of determining who is a subsidiary member of a consolidatable or consolidated group. However, the non-resident entities will not themselves become subsidiary members of the consolidatable or consolidated group.

Examples of the operation of the membership rules

3.90 Examples 3.1 to 3.6 demonstrate the application of the membership rules in some different circumstances.

Example 3.1

Operation of the membership rules, example 3.1

Holbrook Co is an ordinary Australian resident company that beneficially owns 100% of the membership interests in Shellharbour Co, another ordinary Australian resident company, and is the only beneficiary of Seymour Trust, which is an Australian resident fixed trust (that complies with section 703-25).In turn, Shellharbour Co beneficially owns 100% of the membership interests in Sunbury Co, an ordinary Australian resident company and is an object of Sorrento Trust, an Australian resident non-fixed trust (that complies with section 703-25), along with Holbrook Co.Seymour Trust beneficially owns 100% of the membership interests in Symonston Co, an ordinary Australian resident company, and 100% of the membership interests in Stuttgart Co, which is a non-resident company.Assume in this example that neither Seymour Trust nor Sorrento Trust are trusts of a type that are specifically precluded from being a member of a consolidatable or consolidated group (see section 703-20). What entity or entities are eligible to be a head company? Only Holbrook Co is a head company in this example.Applying subsection 703-15(2), item 1 in the table, Holbrook Co:

·
meets the income tax treatment requirements because:

-
it is a company;
-
it has the general company tax rate applied to some or all of its taxable income; and
-
it is not a type of entity that is specifically precluded from being a member of a consolidatable or consolidated group (see section 703-20);

·
meets the Australian residence requirements because it is an Australian resident and not a prescribed dual resident; and
·
meets the ownership requirements because it is not a wholly-owned subsidiary of an entity that meets the income tax treatment and the Australian residence requirements.

Shellharbour Co, Sunbury Co and Symonston Co meet the income tax treatment and Australian residence tests (being ordinary Australian resident companies). However, they do not meet the ownership requirements as they are wholly-owned subsidiaries of another entity that meets the income tax treatment and Australian residence requirements - Holbrook Co.Seymour Trust and Sorrento Trust do not satisfy the income tax treatment requirements because they are not companies. Also, they are wholly-owned subsidiaries of a holding entity, Holbrook Co, and thus fail the ownership requirements.Being a non-resident company that is a wholly-owned subsidiary of a holding entity, Holbrook Co, Stuttgart Co fails the Australian residence and ownership requirements. What entity or entities are subsidiary members? Shellharbour Co, Seymour Trust, Sunbury Co, Sorrento Trust and Symonston Co are subsidiary members of a consolidatable group with Holbrook Co as the head company.Shellharbour Co is a subsidiary member of the consolidatable group headed by Holbrook Co under subsection 703-15(2), item 2 in the table because Shellharbour Co:

·
meets the income tax treatment requirements because:

-
it is a company other than a non-profit company;
-
it has some or all of its taxable income taxed at the general company rate; and
-
it is not an entity that is specifically precluded from being a member of a consolidatable or consolidated group (see section 703-20);

·
meets the Australian residence requirements because it is an Australian resident and not a prescribed dual resident; and
·
meets the ownership requirements because it is a wholly-owned subsidiary of Holbrook Co (because all of the membership interests in Shellharbour Co are beneficially owned by holding entity, Holbrook Co).

Seymour Trust is a subsidiary member of a consolidatable group headed by Holbrook Co under subsection 703-15(2), item 2 in the table. This is because Seymour Trust is an Australian resident trust (satisfying section 703-25) that is not covered by the list of entities that are specifically precluded from being a member of a consolidatable or consolidated group and it is a wholly-owned subsidiary of holding entity, Holbrook Co (all of its membership interests are beneficially owned by Holbrook Co). That is, Seymour Trust meets the income tax treatment, Australian residence and ownership tests.Sunbury Co, Sorrento Trust and Symonston Co are also subsidiary members of a consolidatable group headed by Holbrook Co under subsection 703-15(2), item 2 in the table. Sunbury Co and Symonston Co are ordinary Australian resident companies and Sorrento Trust is a resident trust (satisfying section 703-25) that is not covered by the list of entities that are specifically precluded from being a member of a consolidatable or consolidated group. These entities therefore satisfy the income tax treatment and Australian residence requirements. Sunbury Co and Symonston Co meet the ownership requirements because all of their membership interests are beneficially owned by wholly-owned subsidiaries of Holbrook Co (Shellharbour Co in the case of Sunbury Co and Seymour Trust in the case of Symonston Co). Further, each entity that is interposed between either Sunbury Co or Symonston Co and holding entity Holbrook Co is a subsidiary member of Holbrook Co. Sorrento Trust satisfies the ownership requirements as together Holbrook Co and Shellharbour Co, a wholly-owned subsidiary of Holbrook Co, beneficially own all of its membership interests. Further, Shellharbour Co, which is interposed between Sorrento Trust and Holbrook Co, is a subsidiary member of Holbrook Co. Subsection 703-30(2) ensures that the previous applications of the wholly-owned subsidiary rule for Shellharbour Co and Seymour Trust (explained earlier in this example) also apply in testing Sunbury Co, Sorrento Trust and Symonston Co.Stuttgart Co is not eligible to be a subsidiary member of a consolidatable group as it fails the Australian residence requirements - it is a non-resident company. What consolidatable groups are there? There is one consolidatable group, whose members consists of Holbrook Co as the head company and Shellharbour Co, Seymour Trust, Sunbury Co, Sorrento Co and Symonston Co as subsidiary members. If Holbrook Co makes an effective choice to consolidate the group under section 703-50, this group will become a consolidated group under paragraph 703-5(1)(a).

Example 3.2 Assume the same facts as Example 3.1, except Hotham Co, an ordinary Australian resident company, acquires 100% of the shares in Holbrook Co and becomes the beneficial owner of all of the membership interests in Holbrook Co. What consolidatable groups are there? Again there is only one consolidatable group, however now Hotham Co is the head company.Holbrook Co loses its status as a head company because it has become a wholly-owned subsidiary of another entity that meets the income tax and residency requirements (Hotham Co) - see subsection 703-15(2), column 4 of item 1 in the table. Therefore, under subsection 703-15(2), item 2 in the table, Holbrook Co becomes a subsidiary member of the consolidatable group headed by Hotham Co. If Holbrook Co had chosen to consolidate the group in Example 3.1, that consolidated group would cease to exist - see paragraph 703-5(2)(a).Under subsection 703-15(2), item 2 in the table, Shellharbour Co, Seymour Trust, Sunbury Co, Sorrento Trust and Symonston Co are all subsidiary members of a consolidatable group headed by Hotham Co.Hotham Co must make a choice to consolidate this group before it becomes a consolidated group.

Example 3.3

Operation of the membership rules, example 3.3

This example modifies Example 3.1, the differences being:

·
ABC is a nominee of Holbrook Co and holds all of the shares in Shellharbour Co on behalf of Holbrook Co; and
·
Seymour Trust is a non-fixed trust.

What consolidatable groups are there? There is only one consolidatable group consisting of Holbrook Co as head company and Shellharbour Co, Seymour Trust, Sunbury Co, Sorrento Trust and Symonston Co as subsidiary members.Holbrook Co is a head company in this example for reasons cited in Example 3.1.Applying subsection 703-15(2), item 2 in the table, Shellharbour Co meets the income tax treatment and Australian residence requirements as it is an ordinary Australian resident company. It meets the ownership requirements because it is a wholly-owned subsidiary of Holbrook Co (Holbrook Co beneficially owns all of the membership interests in Shellharbour Co despite these shares being held by ABC). In this example, the exception in section 703-45 applies to ensure that Shellharbour Co is a subsidiary member of a consolidatable group headed by Holbrook Co despite there being a non-member entity interposed between Holbrook Co and Shellharbour Co, as the non-member entity is ABC which holds membership interests in Shellharbour Co as a nominee of head company, Holbrook Co. ABC is not a subsidiary member of the consolidatable group headed by Holbrook Co as it fails the ownership requirements (its membership interests are not beneficially owned by Holbrook Co and it is therefore not a wholly-owned subsidiary of Holbrook Co).Seymour Trust, Sunbury Co and Sorrento Trust are subsidiary members of a consolidatable group headed by Holbrook for reasons discussed in Example 3.1. However, there is one difference flowing from the introduction of ABC - being the application of section 703-45. In this scenario, section 703-45 is satisfied because each entity interposed between either Sunbury Co or Sorrento Trust and Holbrook Co is either a subsidiary member of Holbrook Co (Shellharbour in this instance) or a nominee of head company, Holbrook Co (ABC).Being an ordinary resident company, Symonston Co satisfies the income tax treatment and Australian residence tests in subsection 703-15(2), item 2 in the table. Under section 703-40, it is a wholly-owned subsidiary of Holbrook Co because it would have been a wholly-owned subsidiary of Holbrook Co had Seymour Trust been a fixed trust and Holbrook Co been a beneficiary (rather than an object). It therefore satisfies the ownership requirements in subsection 703-15(2), item 2 in the table.As discussed in Example 3.1, Stuttgart Co cannot be a subsidiary member of a consolidatable group headed by Holbrook Co as it fails the Australian residence requirements (it is a non-resident company).

Example 3.4

Operation of the membership rules, example 3.4

This is a modified version of Example 3.1. The differences are:

·
Hawthorn Co is a PDF throughout the income year and replaces Holbrook Co;
·
Southampton Co is a non-resident company and replaces Shellharbour Co;
·
Smiggins Co is an ordinary Australian resident company and replaces Seymour Trust; and
·
Stapley Co replaces Stuttgart Co and is an ordinary Australian resident company whose membership interests are 99% beneficially owned by Smiggins Co and Oslo Co, a non-resident company, beneficially owns the other 1% of the membership interests.

What entity or entities are eligible to be a head company? Sunbury Co, Smiggins Co and Stapley Co are eligible to be head companies under subsection 703-15(2), item 1 in the table.Both Sunbury Co and Smiggins Co meet the income tax treatment and Australian residence requirements, being ordinary Australian resident companies. They are both wholly-owned subsidiaries of another entity (Hawthorn Co in the case of Smiggins Co, and Southampton Co and Hawthorn Co in the case of Sunbury Co). However, they both satisfy the ownership tests because they are not wholly-owned subsidiaries of entities that meet the income tax treatment and Australian residence requirements (discussed later in this example).Being an ordinary Australian resident company, Stapley Co satisfies the income tax treatment and Australian residence requirements. It meets the ownership requirements because it is not a wholly-owned subsidiary of another entity that meets the income tax treatment and Australian residence requirements.Hawthorn Co, Southampton Co, Sorrento Trust and Symonston Co are not eligible to be head companies for the following reasons:

·
Hawthorn Co fails the income tax treatment requirements because it is an entity that is specifically precluded from being a member of a consolidatable or consolidated group - see section 703-20;
·
Southampton does not meet the Australian residence requirements because it is a non-resident company;
·
Sorrento Trust does not meet the income tax treatment criterion because it is an entity other than a company; and
·
Symonston Co is a wholly-owned subsidiary of an entity that meets the income tax treatment and Australian residence requirements (all of its membership interests are beneficially owned by Smiggins Co).

What entity or entities are subsidiary members? Symonston Co qualifies as a subsidiary member of a consolidatable group headed by Smiggins Co under subsection 703-15(2), item 2 in the table. Being an ordinary Australian resident company Symonston Co satisfies the income tax treatment and Australian residence requirements. It meets the ownership requirements because it is a wholly-owned subsidiary of Smiggins Co. What consolidatable groups are there? There is only one consolidatable group consisting of Smiggins Co as the head company and Symonston Co as a subsidiary member.For there to be a consolidatable group there must exist a head company and at least one subsidiary member - see subsection 703-10(2). Although Sunbury Co and Stapley Co meet the definition of head company, they are not head companies of a consolidatable group as neither Sunbury Co nor Stapley Co have any subsidiary members. If either of these entities were to become the beneficial owner of all of the membership interests in an entity eligible to be a subsidiary member, a consolidatable group would exist at that time. What if the interests owned by Oslo were debt interests? The interests owned by Oslo would be disregarded for the purposes of working out whether Stapley Co was a wholly-owned subsidiary of another entity because these interest do not constitute membership interests as defined in section 960-135. With these interests disregarded, Stapley Co would be treated as if it were a wholly-owned subsidiary of holding entity, Smiggins Co. Stapley Co would therefore be a subsidiary member of the consolidatable group headed by Smiggins Co.

Example 3.5

Operation of the membership rules, example 3.5

In this example, all of the entities are ordinary Australian resident companies (companies that are Australian residents and not prescribed dual residents, taxed at the general company tax rate and not subject to any concessions).Company A and Company B are wholly-owned subsidiaries of holding entity, Head Co, as Head Co beneficially owns all of the membership interests in these companies.Collectively, Company A and Company B beneficially own all of the membership interests in Company C, disregarding the shares beneficially owned in Company C that were issued under employee share acquisition arrangements. Thus, Company C is a wholly-owned subsidiary of holding entity, Head Co. Company D is also a wholly-owned subsidiary of Head Co as it is a wholly-owned subsidiary of Company B, which is a wholly-owned subsidiary of Head Co. This means that Company E is a wholly-owned subsidiary of holding entity, Head Co, too (because Company C and Company D together beneficially own all the membership interests in Company E, and are themselves wholly-owned subsidiaries of Head Co).There are no entities interposed between Company C, Company D or Company E and Head Co that are ineligible to be subsidiary members of a consolidatable group headed by Head Co.Therefore, a consolidatable group of entities exist consisting of Head Co as the head company and Company A, Company B, Company C, Company D and Company E as subsidiary members.

Example 3.6

Operation of the membership rules, example 3.6

This example illustrates how the interposed foreign resident tests in paragraphs 3.87 and 3.88 are intended to operate.C is an Australian resident company that beneficially owns 100% of the membership interests in D, a non-resident company. D in turn beneficially owns all of the membership interests in E, an Australian resident company.E beneficially owns all of the membership interests in G, a non-resident company and is the only beneficiary of F, which is a resident fixed trust.G is the only beneficiary of H, a resident fixed trust and beneficially owns all of the membership interests in I, an Australian resident company.In this example it can be assumed that:

·
C is eligible to be a head company of a consolidatable or consolidated group under subsection 703-15(2), item 1 in the table;
·
E & I (Australian resident companies) and F & H (Australian resident fixed trusts ) satisfy the income tax treatment and Australian resident requirements under subsection 703-15(2), item 2 in the table that are prerequisite conditions for being a subsidiary member of a consolidatable or consolidated group. Being non-resident companies, D and G fail the later requirements and thus, these entities are unable to be subsidiary members of a consolidatable or consolidated group; and
·
D, E, F, G, H and I are wholly-owned subsidiaries of head company, C. These entities therefore satisfy the first limb of the ownership requirements under subsection 703-15(2), item 2 in the table that need to be met in order to qualify as a subsidiary member of a consolidatable or consolidated group.

The remaining requirement relevant to determining whether E, F, H and I can qualify as subsidiary members of a consolidatable or consolidated group headed by C is therefore the second limb of the ownership requirements, specifically the interposed foreign resident tests outlined in paragraphs 3.87 and 3.88.E satisfies the interposed foreign resident test in paragraph 3.87 because there is only one entity interposed between it and the head company, C, and that entity (D) is a foreign resident company. Further, E would otherwise qualify as a subsidiary member if it was assumed that D was a subsidiary member of the group. E is therefore eligible to be a subsidiary member of the consolidatable or consolidated group headed by C.F satisfies the interposed foreign resident test in paragraph 3.88 as it would be a subsidiary member of the group if it was assumed that C (the head company) beneficially owned all of the membership interests that were beneficially owned by E. F therefore qualifies as a subsidiary member of the consolidatable or consolidated group headed by C.H does not meet the interposed foreign resident test in paragraph 3.88 because it would not be a subsidiary member of the group if it was assumed that C (the head company) beneficially owned all of the membership interests that were beneficially owned by E. H is therefore not eligible to be a subsidiary member. H cannot be a subsidiary member of the group because, as intra-group transactions within a consolidated group are ignored, it would not be possible to calculate the net income of the trust for the purpose of assessing the beneficiary, G, who would not be a member of the group.I does not meet the interposed foreign resident test in paragraph 3.87 and consequently will also not qualify as a subsidiary member. I does not satisfy the interposed foreign resident test as there is a resident entity, H, interposed between it and C, the head company of the group, who is not a member of the group. Whilst the interposed foreign resident tests allow certain non-member entities to be interposed between the head company of the group and the test entity, each of those entities must be foreign resident entities.Therefore, one consolidatable group (or consolidated group - if e.g., a choice under section 703-50 has been made by C) of entities exist consisting of C as the head company and E and F as subsidiary members. If H was instead a company, both H and I would satisfy the conditions in the interposed foreign resident tests and qualify as subsidiary members of the group too.

How does a head company choose to consolidate a consolidatable group?

3.91 A choice to consolidate a consolidatable group must be in the approved form and must specify a day (after 30 June 2002) from which the group will be consolidated. The company that makes the choice must have been the head company of the consolidatable group on the day specified in the choice. However, the company that makes the choice need not be the head company of the group when it gives the Commissioner the choice (unless the choice is given to the Commissioner on the day specified in the choice). [Schedule 1, item 2, subsections 703-50(1) and (4)]

3.92 The choice may be given to the Commissioner on any day within the period beginning on the day specified in the choice and ending on the day that the groups first consolidated income tax return is lodged. However, if there is no requirement to lodge this income tax return, the choice can be given to the Commissioner on any day within the period, beginning on the day specified in the choice and ending on the last day within the period that lodgement of such an income tax return would have been required had there been a requirement to lodge this return. [Schedule 1, item 2, subsection 703-50(3)]

3.93 Once given to the Commissioner, the choice is irrevocable and remains effective until the consolidated group ceases to exist. [Schedule 1, item 2, subsections 703-50(2) and (4)]

3.94 Further, the day specified in the notice of choice, from which the group will be consolidated, cannot be amended. [Schedule 1, item 2, subsection 703-50(2)]

3.95 A choice has no effect if the Commissioner is satisfied that the notice of choice contains information that is incorrect in a material particular. The Commissioner may nevertheless give effect to an incorrect choice of this type by giving the head company written notice that the choice is effective. [Schedule 1, item 2, subsections 703-50(5) and (6)]

3.96 A choice to consolidate under the ordinary membership rules for consolidated groups, the subject of this chapter, will have no effect where it is given by a company that is a member of a MEC group on the date specified in the choice (on or after which the group would otherwise have been treated as consolidated). [Schedule 1, item 2, subsection 703-50(7)]

Events affecting a consolidated group

Membership changes generally do not affect the existence of a consolidated group

3.97 Consistent with the principle that the choice of a head company to consolidate is irrevocable, a change in the membership of a consolidated group will generally not affect the existence of that consolidated group. The consolidated group will continue to exist so long as the same head company exists as a head company, unless the head company becomes a member of a MEC group. [Schedule 1, item 2, subsection 703-5(2)]

Notice of events affecting a consolidated group

3.98 The head company must give notice to the Commissioner in the approved form within 28 days of an entity becoming a member of a consolidated group, or within 28 days of the exit of a subsidiary member from a consolidated group. [Schedule 1, item 2, subsection 703-60(1), items 1 and 2 in the table]

3.99 If a consolidated group ceases to exist, the company that was the head company of the group must notify the Commissioner within 28 days of that event in the approved form. [Schedule 1, item 2, subsection 703-60(1), item 3 in the table]

3.100 If an event outlined in paragraph 3.98 or 3.99 happens to a consolidated group that comes into existence by a choice to consolidate being given to the Commissioner (see paragraph 3.10), and the event happens more than 28 days before the choice is made, the company that makes the choice must give notice to the Commissioner in the approved form of the event at the same time as the choice is made [Schedule 1, item 2, subsection 703-60(2)] . For example, a company that gives the Commissioner a choice to consolidate a consolidatable group of entities must at the same time notify the Commissioner in the approved form of any entities that have become subsidiary members of the consolidated group more than 28 days before the choice is given to the Commissioner.

3.101 The requirements in paragraphs 3.98 or 3.99 do not apply if a consolidated group that comes into existence because a MEC group ceases to exist (see paragraph 3.13) comes into existence before a notice of choice to consolidate that MEC group is given to the Commissioner, and an event in the relevant paragraph happens to the consolidated group more than 28 days before a notice of choice to consolidate that MEC group is given. In these circumstances, the head company of the consolidated group must give the Commissioner notice in the approved form of the event at the same time as the notice of choice to consolidate the MEC group is given. [Schedule 1, item 2, subsection 703-60(3)]

3.102 Section 388-55 of the TAA 1953 allows the Commissioner to defer the time within which an approved form is required to be given to the Commissioner.

Application and transitional provisions

3.103 The consolidation regime will apply from 1 July 2002.

Consequential amendments

3.104 Consequential amendments have been made to subsection 995-1(1), Subdivision 960-G and Division 166 of the ITAA 1997 [Schedule 3, items 3 to 16; Schedule 5, items 1, 6, 7, 11, 14 to 17, 29 and 39] . Amendments have also been made to section 703-30 of the Income Tax (Transitional Provisions) Act 1997 [Schedule 2, item 2, section 703-30] .

Chapter 4 - Resident wholly-owned subsidiaries of a common foreign holding company

Outline of chapter

4.1 This chapter provides for certain resident wholly-owned subsidiaries of a foreign company to form a consolidated group known as a MEC group.

Context of reform

4.2 Under the membership rules for consolidated groups contained in Chapter 3, a consolidatable group consists of a single resident head company and all the resident wholly-owned subsidiaries of the head company. Without this measure, wholly-owned resident subsidiaries of a foreign resident company would not be able to form a consolidated group in the absence of a resident head company unless they were restructured. The underlying rationale of this measure is to ensure that existing company groups that currently have access to grouping provisions (e.g. loss transfer and CGT rollover) will be able to form a consolidated group despite not having a single resident head company.

Summary of new law

Changes from February 2002 exposure draft

4.3 The rules governing the formation and membership of a MEC group differ significantly from those included in the February 2002 exposure draft. As a result of submissions received, wholly-owned Australian resident subsidiaries of a foreign resident company will now not be prevented from forming a consolidated group where the foreign resident has more than one strand of investment into Australia. Each entry level entity within each strand of investment will be free to choose to:

·
group with other entry level entities and form a MEC group;
·
form a consolidated group; or
·
remain unconsolidated.

4.4 This approach, whilst adding more complexity to the law, will meet the operational needs of certain foreign owned groups which operate their subsidiaries on an autonomous basis.

Formation and membership of a MEC group

4.5 A MEC group is formed by 2 or more eligible tier-1 companies making an irrevocable choice to consolidate a potential MEC group derived from those eligible tier-1 companies. Broadly, an eligible tier-1 company is a company that is the first level of investment in Australia by a foreign resident company. Each of the eligible tier-1 companies making the choice must be wholly-owned subsidiaries of the same non-resident holding company (the top company) on the day the choice takes effect. The eligible tier-1 companies must jointly nominate one of themselves to be the provisional head company of the MEC group. An eligible tier-1 company can only be a provisional head company if all its membership interests are held by entities that are not members of the MEC group.

4.6 A MEC group can also be formed as a result of an ordinary consolidated group converting to a MEC group. This will occur when the head company of the consolidated group is also an eligible tier-1 company of a top company and subsequently one or more other companies become eligible tier-1 companies of the same top company. A MEC group will form in these circumstances if the head company of the consolidated group notifies the Commissioner that a MEC group is to come into existence as a result of the other companies becoming eligible tier-1 companies of the top company.

4.7 The members of a MEC group comprise those eligible tier-1 companies of a top company that made the choice to consolidate the potential MEC group as well as all the resident entities that are wholly-owned subsidiaries of those eligible tier-1 companies. Subsidiaries that are wholly-owned by 2 or more eligible tier-1 companies are also members of a MEC group.

4.8 Where a MEC group is formed as a result of a consolidated group converting to a MEC group, the members of the MEC group comprise the head company and subsidiary members of the former consolidated group, the eligible tier-1 companies that became members of the MEC group at the time it formed as well as all the resident entities that are wholly-owned subsidiaries of those eligible tier-1 companies.

4.9 A MEC group can be expanded after initial formation to include companies that subsequently become eligible tier-1 companies of the top company. The provisional head company is required to notify the Commissioner of the event for such an expansion to be valid. Where an eligible tier-1 company becomes a member in these circumstances, resident entities that are wholly-owned subsidiaries of the company will also become members of the MEC group.

Cessation of a MEC group

4.10 Once formed, a MEC group will continue to exist until the potential MEC group ceases to exist, the group ceases to have a provisional head company or all the members of the MEC group become members of another MEC group following a change in the identity of the top company.

Head company and subsidiary members of a MEC group

4.11 The provisional head company of the MEC group at the end of an income year of that company is treated as the head company of the MEC group for that part of the income year in which the group was in existence. Accordingly, where the MEC group existed throughout the income year, the provisional head company will be treated as the head company from the beginning of the income year - even where the company was only appointed as the provisional head company part way through the income year. The remaining members of the MEC group will be the subsidiary members of the group.

4.12 Subsequent legislation will deal with interactions between the MEC group membership rules and the other aspects of the consolidation measure such as the core rules, the cost setting rules and the rules for losses.

Change in provisional head company

4.13 A MEC group continues to exist following a provisional head company of the group ceasing to satisfy the conditions for being a provisional head company provided another eligible tier-1 company in the group is appointed as a replacement provisional head company no later than 28 days from the time the former provisional head company ceased to satisfy those conditions.

Comparison of key features of new law and current law
New law Current law
A MEC group is treated as a consolidated group and taxed as a single entity. Each entity in a wholly-owned group is taxed as a separate entity. For some purposes, however, company groups can obtain benefits from being treated as a single entity.

Detailed explanation of new law

Formation and membership of a MEC group

How does a MEC group come into existence?

4.14 A MEC group can be formed in one of 2 ways - firstly as a result of a choice being made to form the group and secondly as a result of a consolidated group converting to a MEC group. [Schedule 1, item 2, subsection 719-5(1); Schedule 5, item 13, subsection 995-1(1) of the ITAA 1997]

Choosing to form a MEC group

4.15 A MEC group is formed as a result of a choice by 2 or more eligible tier-1 companies of a top company jointly notifying the Commissioner of their choice to consolidate the potential MEC group derived from those eligible tier-1 companies. The eligible tier-1 companies must specify a day in the notice as the day from which the group will begin to exist, which may be any day after 30 June 2002.

4.16 What constitutes an eligible tier-1 company and a potential MEC group derived from one or more eligible tier-1 companies is discussed in paragraphs 4.65 to 4.69 and 4.42 to 4.53 respectively. Paragraphs 4.108 to 4.119 contain a full discussion on how a choice to form a MEC group is made.

Consolidated group becoming a MEC group

4.17 A MEC group is also formed when a consolidated group converts to a MEC group. The conversion of a consolidated group to a MEC group is referred to as a special conversion event . [Schedule 1, item 2, subsection 719-40(1); Schedule 5, item 28, subsection 995-1(1) of the ITAA 1997]

4.18 A special conversion event will happen if the head company of a consolidated group is an eligible tier-1 company of a top company and one or more other companies subsequently become eligible tier-1 companies of the same top company. [Schedule 1, item 2, paragraphs 719-40(1)(a) to (c)]

4.19 However, a MEC group will only form in these circumstances if the head company of the consolidated group:

·
notifies the Commissioner that a MEC group is to come into existence as a result of the other companies becoming eligible tier-1 companies of the top company; and
·
it meets the qualifications for being a provisional head company of the MEC group.

Notification to be given to the Commissioner

4.20 The notification to the Commissioner by the head company of the consolidated group that the MEC group is to form must be in writing and in an approved form and must be given to the Commissioner within the period:

·
beginning at the time the other companies became eligible tier-1 companies of the top company; and
·
ending on the day on which the head company of the consolidated group lodges its income tax return for the income year in which the companies became eligible tier-1 companies of the top company.

[Schedule 1, item 2, paragraphs 719-40(1)(e) and 719-40(2)(a)]

4.21 However, if the head company of the consolidated group does not have to give an income tax return for that income year, the period during which the choice can be given will end at the end of the period within which the company would have been required to give an income tax return had it been required to give an income tax return for that period. [Schedule 1, item 2, paragraph 719-40(2)(b)]

4.22 If the head company does not notify the Commissioner within the specified period that the MEC group is to form, the company will continue to be the head company of the consolidated group and the MEC group will be taken not to have formed. The Commissioner may defer the time within which the notification is to be given under section 388-55 of the TAA 1953.

4.23 The notification must also specify those companies which are to become members of the MEC group as a result of becoming eligible tier-1 companies of the top company. Not all the eligible tier-1 companies of the top company will be eligible to become members of the MEC group. The head company will only be able to specify a particular company as joining the MEC group if:

·
it was not a member of a MEC group at the time it became an eligible tier-1 company of the top company; or
·
it was a member of a MEC group at that time but the head company also specifies each company who was an eligible tier-1 company of that MEC group as joining the new MEC group provided they are eligible.

[Schedule 1, item 2, paragraphs 719-40(1)(e) and (f)]

4.24 The head company of the consolidated group is prevented from specifying some, but not all, of the eligible tier-1 companies of a MEC group because specifying only some would cause the MEC group of which the eligible tier-1 companies were members to cease to exist. The cessation of the MEC group in these circumstances would be inconsistent with the irrevocability status of a choice to consolidate a potential MEC group. Requiring the head company to specify all of the eligible tier-1 companies who were members of the MEC group ensures either:

·
that the MEC group continues to exist with those companies as eligible tier-1 company members; or
·
that the MEC group ceases to exist with those eligible tier-1 companies becoming members of the new MEC group formed as a result of the special conversion event.

The head company must meet qualifications to be a provisional head company

4.25 A special conversion event will only happen if the head company of the consolidated group would meet the qualifying conditions for being a provisional head company of the MEC group were it to form. A company will meet these conditions if:

·
the company is an eligible tier-1 company of a top company; and
·
no membership interests in the company are beneficially owned by another member of the group.

4.26 As the head company of the consolidated group is an eligible tier-1 company, the first condition is automatically met. The second condition will be met if none of the membership interests in the head company are beneficially owned by another member of the potential MEC group derived from the head company and all of the companies that became eligible tier-1 companies of the top company. [Schedule 1, item 2, paragraph 719-40(1)(d)]

Example 4.1

Second qualifying condition for being a provisional head company, example 4.1

X Co is a foreign resident company with a wholly-owned Australian resident subsidiary A Co who is the head company of a consolidated group comprising itself and D Co. X Co subsequently acquires another foreign resident company Y Co who has 2 wholly-owned Australian resident subsidiaries B Co and C Co. A special conversion event will occur if A Co notifies the Commissioner in writing no later than the time it lodges its income tax return for the income year in which B Co and C Co became eligible tier-1 companies of the top company, X Co, that it wishes the MEC group to form.The notice provided to the Commissioner by A Co must specify which eligible tier-1 companies are to join the MEC group. If B Co and C Co had not previously formed a MEC group, A Co could specify both of those companies to join the group or alternatively specify either of them to join. If B Co and C Co had previously formed a MEC group, A Co must specify both of those companies to join the group, otherwise the MEC group will not form.If notification is given by A Co to the Commissioner within the specified period, the MEC group will form with effect from the time B Co and C Co became eligible tier-1 companies of the top company X Co. A Co will be the provisional head company of the MEC group as none of the membership interests in it are beneficially owned by members of the potential MEC group derived from A Co, B Co and C Co. If some of the membership interests in A Co were held by a member of the potential MEC group derived from A Co, B Co and C Co, A Co would not satisfy the qualifying conditions for being the provisional head company of a MEC group which would cause the MEC group not to form.

A MEC group becoming a consolidated group

4.27 A MEC group may also convert to a consolidated group in some circumstances - a full discussion on when a MEC group may become a consolidated group is contained in paragraphs 3.13 and 3.14.

A MEC group and a consolidated group to be mutually exclusive

4.28 A choice made by an eligible tier-1 company to form a consolidated group will not have effect if it is a member of a MEC group. Similarly, an eligible tier-1 company cannot choose to form a MEC group if it is a member of a consolidated group. Chapter 3 contains a full discussion on when a choice to form a consolidated group will have effect. Paragraphs 4.108 to 4.119 contain a full discussion on when a choice can be made to form a MEC group.

Membership of a MEC group

4.29 The members of a MEC group at any time will comprise the members of the potential MEC group derived from the eligible tier-1 companies who are members of the MEC group at that time [Schedule 1, item 2, subsections 719-5(2) to (4)] . The membership of a potential MEC group derived from one or more eligible tier-1 companies is discussed in paragraphs 4.42 to 4.53.

4.30 One of the members of the MEC group who is an eligible tier-1 company will be taken to be the head company of the group. The remaining members of the MEC group will be treated as subsidiary members of the group [Schedule 5, item 29, subsection 995-1(1) of the ITAA 1997] . Which eligible tier-1 company is taken to be the head company of the group is discussed in paragraphs 4.106 and 4.107. [Schedule 1, item 2, section 719-25]

Eligible tier-1 companies that are member of the MEC group

4.31 The eligible tier-1 companies that are members of a MEC group consist of:

·
the eligible tier-1 companies which are called for the purposes of this explanatory memorandum the original eligible tier-1 companies; and
·
the eligible tier-1 companies which are called for the purposes of this explanatory memorandum the new eligible tier-1 companies.

Original eligible tier-1 companies

4.32 The companies that qualify as the original eligible tier-1 companies of a MEC group differ depending on whether the MEC group was formed:

·
as a result of a choice by 2 or more eligible tier-1 companies to consolidate the potential MEC group derived from those companies; or
·
as a result of a special conversion event happening.

A MEC group formed by a choice

4.33 The original eligible tier-1 companies who are members of a MEC group formed by choice are those companies who were a party to the choice and which have continued to be eligible tier-1 companies of the top company since the day that the choice to consolidate the potential MEC group had effect. [Schedule 1, item 2, subsection 719-5(2)]

A MEC group formed by a special conversion event

4.34 The original eligible tier-1 companies who are members of a MEC group formed by a special conversion event are:

·
the head company of the consolidated group who notifies the Commissioner that the MEC group is to form as a result of the special conversion event happening; and
·
each of the eligible tier-1 companies specified by the head company in that notice as joining the MEC group.

4.35 However a company will only qualify as an original eligible tier-1 company if it has continued to be an eligible tier-1 company of the top company since the time that the special conversion event happened. [Schedule 1, item 2, subsection 719-5(3)]

New eligible tier-1 companies

4.36 A company will be a member of a MEC group as a new eligible tier-1 company if:

·
after the MEC group is formed it becomes an eligible tier-1 company of the top company; and
·
the provisional head company of the MEC group notifies the Commissioner that the company is to become a member of the MEC group.

[Schedule 1, item 2, paragraphs 719-5(4)(a) to (c) and subsection 719-5(5)]

4.37 The notification to the Commissioner by the provisional head company of the MEC group must be in writing and in an approved form and must be given to the Commissioner within the period:

·
beginning at the time the other companies became eligible tier-1 companies of the top company; and
·
ending on the day on which the head company of the MEC group lodges its income tax return for the income year in which the companies became eligible tier-1 companies of the top company.

[Schedule 1, item 2, paragraphs 719-5(6)(a) to (d)]

4.38 However, if the head company of the MEC group does not have to give an income tax return for that income year, the period during which the choice can be given will end at the end of the period within which the company would have been required to give an income tax return had it been required to give an income tax return for that period. [Schedule 1, item 2, paragraphs 719-5(6)(a) to (c) and (e)]

4.39 If the notification is not received by the Commissioner within the period specified, the Commissioner has a discretion under section 388-55 of the TAA 1953 to defer the time within which the notification is to be given.

4.40 Not all companies that become eligible tier-1 companies of the top company will be eligible to become new eligible tier-1 members of the MEC group. The provisional head company of the MEC group will only be able to specify a particular company as joining the group if:

·
it was not a member of another MEC group at the time it became an eligible tier-1 company of the top company; or
·
it was a member of another MEC group at that time but the provisional head company also specifies each company who was an eligible tier-1 company of that other MEC group as joining the new MEC group provided they are eligible.

[Schedule 1, item 2, paragraphs 719-5(4)(c) and (d)]

4.41 The provisional head company of the MEC group is prevented from specifying some, but not all, of the eligible tier-1 companies of the other MEC group because specifying only some would cause the other MEC group to cease to exist. The cessation of the other MEC group in these circumstances would be inconsistent with the irrevocability status of the choice to consolidate that MEC group. Requiring the provisional head company to specify all of the eligible tier-1 companies who were members of the other MEC group ensures either:

·
that the other MEC group continues to exist with those companies as eligible tier-1 company members; or
·
that the other MEC group ceases to exist with those eligible tier-1 companies becoming new eligible tier-1 company members of the MEC group of which the provisional head company is a member.

Example 4.2

Provisional head company to specify all of the eligible tier-1 companies, example 4.2

X Co is a foreign resident company with 2 wholly-owned Australian resident subsidiaries, A Co and B Co, who are members of a MEC group. A Co is the provisional head company of the MEC group. X Co subsequently acquires another foreign resident company Y Co who has 3 wholly-owned Australian resident subsidiaries C Co, D Co and E Co.C Co and D Co may become new eligible tier-1 company members of the MEC group comprising A Co and B Co if the provisional head company of that group, A Co, notifies the Commissioner in writing that it wishes those companies to become members of the group. The notification must be given to the Commissioner no later than the day on which A Co, the head company of the group, lodges its income tax return for the income year in which C Co and D Co became eligible tier-1 companies of the top company, X Co.The notice provided to the Commissioner by A Co must specify which eligible tier-1 companies are to join the MEC group. If C Co and D Co had not previously formed a MEC group, A Co could specify both of those companies to join the group or alternatively specify either of them to join. If C Co and D Co had previously formed a MEC group, A Co must specify both of those companies to join the group.If notification is given by A Co to the Commissioner within the specified period, the companies specified will be taken to have become new eligible tier-1 company members of the MEC group with effect from the time those companies became eligible tier-1 companies of the top company X Co.

What is a potential MEC group?

4.42 Identifying who are members of a potential MEC group is important as the membership of a MEC group at a particular time will comprise all the members of the potential MEC group derived from the eligible tier-1 companies who are members of the MEC group at that time. The membership of a potential MEC group derived from one or more eligible tier-1 companies of a top company consists of:

·
those eligible tier-1 companies;
·
those entities who qualify under what is called for the purposes of this explanatory memorandum the standard membership tests; and
·
those entities who qualify under what is called for the purposes of this explanatory memorandum the interposed foreign resident entity tests.

[Schedule 1, item 2, subsection 719-10(1); Schedule 5, item 22, subsection 995-1(1) of the ITAA 1997]

Standard membership tests

4.43 The following entities will qualify to be members of a potential MEC group derived from one or more eligible tier-1 companies under the standard membership tests:

·
all the companies who are wholly-owned subsidiaries of an eligible tier-1 company of a top company from which the potential MEC group is being derived and which:

-
are an Australian resident company, but not a prescribed dual resident;
-
are not a non-profit company as defined in subsection 3(1) of the ITRA 1986; and
-
meet the income tax treatment requirements discussed in paragraphs 3.28 to 3.40 for being a member of a consolidated group;

·
all the trusts who are wholly-owned subsidiaries of an eligible tier-1 company of a top company from which the potential MEC group is being derived and which:

-
meet the Australian residency requirements discussed in paragraphs 3.60 and 3.61 - a trust that meets these requirements is referred to in the remainder of this chapter as a resident trust; and
-
is not of a type which is specifically excluded from being a member of a consolidated group - paragraph 3.37 contains a list of these types of trusts; and

·
all the partnerships who are wholly-owned subsidiaries of an eligible tier-1 company of a top company from which the potential MEC group is being derived.

[Schedule 1, item 2, subsection 719-10(1), columns 1 and 2 and paragraph (a) in column 3 in the table]

4.44 For the purpose of determining whether an entity is a wholly-owned subsidiary of an eligible tier-1 company, it is to be assumed that all the membership interests that are beneficially owned by the eligible tier-1 companies from which the potential MEC group is being derived are owned by a single one of those eligible tier-1 companies. [Schedule 1, item 2, subsection 719-10(1), paragraph (b) in column 3 in the table]

4.45 An entity will only qualify to be a member of a potential MEC group under the standard membership tests if each entity interposed between the eligible tier-1 company and the entity being tested are also members of the potential MEC group or, alternatively, hold membership interests only as a nominee of one or more entities each of which is a member of the potential MEC group. [Schedule 1, item 2, subsections 719-10(2) and (3)]

4.46 As the members of the potential MEC group will become the members of the MEC group, allowing an entity to be interposed who is not a member of the potential MEC group could result in inappropriate capital gains and losses arising upon a subsequent disposal of membership and debt interests in the entity. The gains and losses could arise because value shifting adjustments would not be made to those interests if value was shifted between other members of the MEC group.

Interposed foreign resident entity tests

4.47 The interposed entity requirements outlined in paragraph 4.45 are relaxed in a specific set of circumstances to allow certain resident companies, trusts and partnerships to become members of the potential MEC group despite one or more foreign resident entities being interposed between the resident entities and an eligible tier-1 company of the top company from which the potential MEC group is being derived.

4.48 The interposed foreign resident entity tests are designed to allow resident entities to become members of a potential MEC group without requiring the group to restructure in order for the entities to qualify under the standard membership tests.

4.49 Different tests apply under the interposed foreign resident entity tests depending on whether the entity is a company or a trust or partnership.

Tests for companies

4.50 A company will qualify as a member of a potential MEC group under these tests if:

·
there is at least one entity interposed between the company and an eligible tier-1 company of a top company from which the potential MEC group is being derived that is either:

-
a foreign resident company; or
-
a trust that does not meet the residency requirements set out in paragraph 3.61 - a trust that does not meet these requirements is referred to in the remainder of this chapter as a non-resident trust;

·
each entity interposed between the company and an eligible tier-1 company of the top company from which the potential MEC group is being derived is either:

-
an entity that qualifies as a member of the potential MEC group under either the standard membership tests or the interposed foreign resident entity tests;
-
a foreign resident company;
-
a non-resident trust;
-
an entity that holds membership interests only as a nominee of one or more of the previously mentioned entities; or
-
a partnership, where each partner is a foreign resident company or a non-resident trust; and

·
the company would qualify under the standard membership tests if it was assumed that each of the following interposed entities was a member of the potential MEC group:

-
each interposed entity that is a foreign resident company; and
-
each interposed entity that is a non-resident trust.

[Schedule 1, item 2, subsection 719-10(4)]

Tests for trusts or partnerships

4.51 A trust or partnership will qualify as a member of a potential MEC group under the interposed foreign resident entity tests if it would qualify under the standard membership tests if it was assumed that each company that satisfied the interposed foreign resident entity tests were one of the eligible tier-1 companies of the top company from which the potential MEC group is being derived. [Schedule 1, item 2, subsection 719-10(5)]

4.52 The interposed foreign resident entity tests effectively allow the interposed foreign resident entities to be disregarded for the purposes of determining who is a member of a potential MEC group. The foreign resident entities will not themselves become members of the potential MEC group under the interposed foreign resident entity tests. Example 4.3 illustrates further which entities qualify as members of a potential MEC group under these tests.

Example 4.3

Example 4.3 illustrates further which entities qualify as members of a potential MEC group under these tests

Assume B Co and C Co are eligible tier-1 companies of a top company, A Co. C Co holds all the membership interests in a foreign resident company, D Co. D Co has 2 wholly-owned Australian resident subsidiaries, an Australian resident company, E Co, and a resident trust, F. E Co also holds all the membership interests in another foreign resident company, G Co. G Co has 2 wholly-owned Australian resident subsidiaries, a resident trust, H, and an Australian resident company, I Co.Assume B Co and C Co, both of which are eligible tier-1 companies, have chosen to form a MEC group. The membership of the MEC group will consist of the members of the potential MEC group derived from those eligible tier-1 companies.E Co will qualify as a member of the potential MEC group derived from B Co and C Co under the interposed foreign resident entity tests because there is only one entity interposed between it and the eligible tier-1 company of the top company and that entity is a foreign resident company. Trust F will also qualify as a member under the interposed foreign resident entity tests as it would satisfy the standard membership tests if it was assumed that E Co was an eligible tier-1 company from which the potential MEC group is being derived.Trust H will not satisfy either the standard membership tests or the interposed foreign resident entity tests. Trust H cannot be a member of the group because, as intra-group transactions within a MEC group are disregarded, it would not be possible to calculate the net income of the trust for the purpose of assessing the beneficiary, G Co, who would not be a member of the group.I Co will also not satisfy either the standard membership tests or the interposed foreign resident entity tests. I Co cannot be a member of the group as there is a resident entity, Trust H, interposed between it and an eligible tier-1 company of the top company from which the potential MEC group is being derived who is not a member of the group. Whilst the interposed foreign resident entity tests allow certain entities to be interposed that are not members of the group, each of those entities must be foreign resident entities.If Trust H was instead a company, both H Co and I Co would be members of the potential MEC group under the interposed foreign resident entity tests.

A potential MEC group may consist of a single entity

4.53 A potential MEC group derived from an eligible tier-1 company may consist of that company alone. Whilst it is arguable that a potential MEC group would be in existence in these circumstances in any event, subsection 719-30(6) is included in this bill to counter arguments that a potential MEC group, being a group of entities, must consist of at least 2 entities. [Schedule 1, item 2, subsection 719-10(6)]

What is a wholly-owned subsidiary?

4.54 An entity is a wholly-owned subsidiary of another entity if all the membership interests in the subsidiary entity are beneficially owned by the holding entity or a wholly-owned subsidiary of the holding entity or any combination of the holding entity and its wholly-owned subsidiaries. Paragraphs 3.63 to 3.70 contain a full discussion on when an entity will be a wholly-owned subsidiary of another entity.

4.55 In determining whether an entity is a wholly-owned subsidiary, certain employee shares are allowed to be held in a company without affecting the wholly-owned status of the company. Special rules also apply to ensure that an entity that is held through a non-fixed trust is not prevented from being treated as a wholly-owned subsidiary. The rules relating to employee shares and non-fixed trusts are discussed in paragraphs 3.71 to 3.80. [Schedule 1, item 2, sections 719-30 and 719-35]

What is a top company?

4.56 The top company is the reference point from which all Australian resident wholly-owned subsidiaries are identified. It is these wholly-owned subsidiaries that may become members of a potential MEC group.

4.57 A top company must be a foreign resident company and, in general, must not be a wholly-owned subsidiary of another company [Schedule 5, item 36, subsection 995-1(1) of the ITAA 1997] . This ensures the widest possible group of Australian resident subsidiaries who currently access grouping benefits (such as loss transfer) together can become members of the same MEC group if they choose. [Schedule 1, item 2, paragraph 719-20(1)(a) and item 1 in the table]

4.58 A top company may be a wholly-owned subsidiary of a foreign resident trust even where that trust has a wholly-owned Australian resident subsidiary. The foreign trust is not used as the reference point for identifying the Australian resident subsidiaries eligible to become members of the one MEC group because any wholly-owned Australian resident subsidiary of the trust would not currently be able to access grouping benefits with any wholly-owned Australian resident subsidiaries of the foreign resident company.

4.59 A company will still qualify as a top company if it is a wholly-owned subsidiary of an Australian resident company:

·
that is a prescribed dual resident;
·
that is of a type which is specifically excluded from being a member of a consolidated group - paragraph 3.37 contains a list of these types of companies; or
·
where no part of its taxable income (if any) would be taxable at a rate that is or equals the general company tax rate.

[Schedule 1, item 2, subsection 719-20(1), column 4 of item 1 in the table]

4.60 A foreign resident company will not qualify as a top company if it is a wholly-owned subsidiary of an Australian resident company that does not satisfy any of the 3 tests listed in paragraph 4.59. This is because wholly-owned Australian resident subsidiaries of the foreign resident company will qualify as subsidiary members of a consolidated group or a consolidatable group under the rules discussed in paragraphs 3.85 to 3.89 - those rules being the equivalent tests for consolidated groups to the interposed foreign resident entity tests discussed in paragraphs 4.47 to 4.52. Example 4.4 illustrates the operation of those rules.

Example 4.4

Example 4.4 illustrates the operation of rules discussed in paragraphs 3.85 to 3.89

Assume that A Co and B Co are both Australian resident companies and wholly-owned subsidiaries of a foreign resident company F Co. In general, F Co will not qualify as a top company as it is a wholly-owned subsidiary of another company, X Co. However, F Co will qualify as a top company if X Co is, for example, a company of a type which is specifically excluded from being a member of a consolidated group.X Co cannot qualify as a top company as it is an Australian resident company. If X Co satisfies the tests for being a head company of a consolidated group, A Co and B Co may qualify as subsidiary members of a consolidated group under the rules discussed in paragraphs 3.85 to 3.89 - those rules being the equivalent tests for consolidated groups to the interposed foreign resident entity tests discussed in paragraphs 4.47 to 4.52.

What is a tier-1 company?

4.61 The membership of a MEC group consists of the members of a potential MEC group derived from the eligible tier-1 companies of the top company who are members of the MEC group. Accordingly, identifying whether a company is an eligible tier-1 company is fundamental to determining the membership of the MEC group. The first step in identifying whether a company is an eligible tier-1 company is determining whether the company meets the tests for being a tier-1 company.

4.62 A company will be a tier-1 company if:

·
it is a wholly-owned subsidiary of a top company;
·
it is an Australian resident and not a prescribed dual resident;
·
it has all or some of its taxable income (if any) taxed at a rate that is or equals the general company tax rate;
·
it is not a company of a type which is specifically excluded from being a member of a consolidated group - paragraph 3.37 contains a list of these types of companies; and
·
it must not be a wholly-owned subsidiary of a company that is an Australian resident other than one:

-
that is a prescribed dual resident;
-
that is of a type which is specifically excluded from being a member of a consolidated group - paragraph 3.37 contains a list of these types of companies; or
-
where no part of its taxable income (if any) would be taxable at a rate that is or equals the general company tax rate.

[Schedule 1, item 2, paragraph 719-20(1)(b) and item 2 in the table; Schedule 5, item 35, subsection 995-1(1)]

4.63 Because tier-1 companies are potentially capable of becoming the head company of a MEC group, the category of entities who qualify as tier-1 entities is restricted to companies. This is consistent with the membership rules for consolidated groups which allow only companies to be head entities of a group. Chapter 3 contains more details on why only companies can be the head entity of a group.

4.64 In applying the tests for determining whether an entity is a tier-1 company, special rules will apply to treat certain companies as wholly-owned subsidiaries of another Australian resident company in some circumstances. Example 4.5 illustrates the operation of those rules. [Schedule 1, item 2, subsection 719-20(2)]

Example 4.5

Example 4.5 illustrates the tests for determining whether an entity is a tier-1 company

Assume that A Co, B Co, C Co and D Co are all Australian resident companies. F Co is the top company. A Co, B Co and D Co could all potentially be tier-1 companies as none of them is a wholly-owned subsidiary of another Australian resident company. Despite this, special rules will apply to treat D Co as a wholly-owned subsidiary of another Australian resident company because all of the membership interests in D Co are beneficially owned by B Co and C Co both of which are wholly-owned subsidiaries of the top company F Co.

What is an eligible tier-1 company?

4.65 Only those tier-1 companies that qualify as eligible tier-1 companies can become members of a MEC group. Allowing all tier-1 companies to become members of a MEC group could result in inappropriate capital gains and losses arising upon a subsequent disposal of membership and debt interests in certain entities that are interposed between 2 tier-1 companies. The gains and losses could arise because value shifting adjustments would not be made to those interests if value was shifted between other members of the MEC group.

4.66 A tier-1 company will not qualify as an eligible tier-1 company if:

·
there is at least one entity interposed between it and the top company which meets one of the tests listed in paragraph 4.67; and
·
one of the following entities holds a membership interest in that particular interposed entity:

-
another tier-1 company of a top company;
-
a wholly-owned subsidiary of another tier-1 company of a top company; or
-
an entity that holds membership interests only as a nominee of one or more of the previously mentioned entities.

[Schedule 1, item 2, subsections 719-15(1) and (2) and paragraph 719-15(3)(c); Schedule 5, item 9, subsection 995-1(1) of the ITAA 1997]

4.67 An interposed entity will only disqualify a tier-1 company from being an eligible tier-1 company if it meets one of the following tests:

·
it is a company that is a foreign resident;
·
it is a company that is a prescribed dual resident;
·
it is a non-resident trust;
·
it is a resident trust that is not a wholly-owned subsidiary of another tier-1 company of the top company;
·
it is an entity of a type which is specifically excluded from being a member of a consolidated group - paragraph 3.37 contains a list of these types of companies;
·
it is a non-profit company as defined in subsection 3(1) of the ITRA 1986 and is a wholly-owned subsidiary of another tier-1 company of the top company; or
·
it is a company that is an Australian resident where no part of its taxable income (if any) would be taxable at a rate that is or equals the general company tax rate.

[Schedule 1, item 2, paragraph 719-15(3)(a)]

4.68 An interposed entity that meets one of the tests in paragraph 4.67 will not disqualify a tier-1 company from being an eligible tier-1 company if the entity only holds membership interests as a nominee of one or more entities each of which is:

·
another tier-1 company of the top company; or
·
an entity that is a wholly-owned subsidiary of another tier-1 company of a top company.

[Schedule 1, item 2, paragraph 719-15(3)(b)]

4.69 In working out whether a tier-1 company meets the tests for being an eligible tier-1 company, several of the tests require ascertaining whether a particular entity is a wholly-owned subsidiary of another tier-1 company of the top company. In applying those tests, it is to be assumed that all the membership interests that are beneficially owned by tier-1 companies of the top company were owned by a single tier-1 company of the top company. [Schedule 1, item 2, subsection 719-15(4)]

Example 4.6

Example of working out whether a tier-1 company meets the test for being an eligible tier-1 company

A foreign resident holding company, A Co, has wholly-owned subsidiaries B Co and C Co, which are also foreign resident companies. In turn, B Co and C Co have wholly-owned subsidiaries that are Australian resident companies D Co and E Co, and F Co, respectively. E Co has an Australian resident wholly-owned subsidiary G Co.A Co will qualify as the top company and D Co, E Co and F Co will qualify as tier-1 companies of the top company. However, only D Co and E Co will qualify as eligible tier-1 companies of the top company. F Co will not qualify as an eligible tier-1 company of the top company as there is a foreign resident company, C Co, interposed between it and another tier-1 company, E Co, of the top company.F Co will also not qualify as a member of the potential MEC group derived from the eligible tier-1 companies D Co and E Co under the interposed foreign resident entity tests discussed in paragraphs 4.47 to 4.52 as it is not a wholly-owned subsidiary of either of those eligible tier-1 companies. F Co would be able to choose to form a consolidated group provided it has at least one subsidiary member.

Application of sections 703-20 and 703-25

4.70 The tests in Division 719 for determining whether an entity is a top company, a tier-1 company or a member of a potential MEC group are to be applied at any particular point in time during an income year. However, the definitions of those terms refer to certain tests contained in section 703-20 (about entities who are not eligible to be members of a consolidated group) and section 703-25 (about Australian residence requirements for trusts) which are based on an income year.

4.71 For the purpose of applying the tests in Division 719 which apply at a particular point in time, the tests contained in sections 703-20 and 703-25 will be satisfied if the time occurs within the income year referred to in those sections. [Schedule 1, item 2, section 719-45]

When does a MEC group cease to exist?

4.72 A MEC group comprising the members of a potential MEC group derived from one or more eligible tier-1 companies of a top company will cease to exist when:

·
the potential MEC group ceases to exist;
·
there is a change in the identity of the top company and the eligible tier-1 companies that were members of the group immediately before the change become members of another MEC group immediately after the change; or
·
there ceases to be a provisional head company of the group.

[Schedule 1, item 2, subsection 719-5(7)]

4.73 The 3 events which cause a MEC group to cease to exist are discussed in detail in paragraphs 4.74 to 4.86.

A potential MEC group ceasing to exist

4.74 A potential MEC group derived from one or more eligible tier-1 companies will cease to exist when:

·
none of those companies are eligible tier-1 companies of the top company; or
·
there is a change in the identity of the top company and the eligible tier-1 companies that were members of the group immediately before the change are not the same as the eligible tier-1 companies that are members of the group immediately after the change.

[Schedule 1, item 2, subsection 719-10(7)]

No eligible tier-1 companies

4.75 A potential MEC group must be derived from at least one eligible tier-1 company for it to be in existence. Thus a potential MEC group will cease to exist when there are no longer any eligible tier-1 companies of the top company from which the potential MEC group was derived remaining. [Schedule 1, item 2, paragraph 719-10(7)(a)]

Example 4.7

Example of No eligible tier-1 companies

A Co is an eligible tier-1 company of a top company, F Co, and is a member of a MEC group. The membership of the MEC group comprises the members of the potential MEC group derived from A Co, which would consist of A Co and B Co.If F Co disposes of some, but not all, of its membership interests in A Co, A Co would cease to be an eligible tier-1 company of the top company. As A Co is no longer an eligible tier-1 company, the potential MEC group that was previously derived from A Co would cease to exist. This would cause the MEC group to also cease to exist.The MEC group may automatically convert to a consolidated group in these circumstances provided A Co satisfies the conditions for being the head company of a consolidated group.

Change in identity of the top company

4.76 A potential MEC group derived from one or more eligible tier-1 companies of a top company will also cease to exist as a result of a change in identity of the top company if the eligible tier-1 companies that are members of the group immediately before the change in identity of the top company differ from the eligible tier-1 companies that are members of the group immediately after the change. [Schedule 1, item 2, paragraph 719-10(7)(b)]

4.77 The identity of a top company would change, for instance, where the former top company becomes a wholly-owned subsidiary of another foreign resident company or where the top company disposes of the membership interests it holds, either directly or indirectly, in the eligible tier-1 companies.

4.78 A change in identity of a top company will not affect the continuity of a potential MEC group derived from one or more eligible tier-1 companies if the eligible tier-1 companies that were members of the group immediately before the change are the same as the eligible tier-1 companies that are members of the group immediately after the change. [Schedule 1, item 2, paragraphs 719-10(8)(a) to (d)]

4.79 Furthermore, the change in identity of the top company will not affect the status of any of those companies as eligible tier-1 companies of the top company. This is important because a company will only qualify as either an original eligible tier-1 company member or a new eligible tier-1 company member of a MEC group if it has been an eligible tier-1 company of the top company at all times since:

·
in the case of an original eligible tier-1 company member - since the group came into existence; and
·
in the case of a new eligible tier-1 company member - since the company became an eligible tier-1 company of the top company.

4.80 By ensuring a companys status, as an eligible tier-1 company of a top company is not affected by a change in identity of the top company, the eligible tier-1 companies would continue to qualify as either original eligible tier-1 company members or new eligible tier-1 company members of the MEC group. [Schedule 1, item 2, paragraphs 719-10(8)(a) to (c) and (e)]

Example 4.8

Change in identity of the top company

The foreign resident company A Co has 2 foreign resident wholly-owned subsidiaries B Co and C Co. B Co and C Co have Australian resident wholly-owned subsidiaries D Co and E Co, and F Co and G Co respectively. F Co has an Australian resident wholly-owned subsidiary H Co.D Co, E Co, F Co and G Co, all of which are eligible tier-1 companies, choose to form a MEC group on 1 September 2002 the members of which comprise the members of the potential MEC group derived from those eligible tier-1 companies. Scenario 1 On 30 May 2003, A Co simultaneously sells all of its membership interests in B Co and C Co to X Co and Y Co respectively. X Co and Y Co are 2 separate independent parties who are not members of the same wholly-owned group. The change in identity of the top company will cause the potential MEC group derived from D Co, E Co, F Co and G Co to cease to exist because the eligible tier-1 companies who were members of the potential MEC group immediately before the change are not the same as the eligible tier-1 companies that are members of the group immediately after the change.As the potential MEC group has ceased to exist, the MEC group comprising the members of the potential MEC group derived from D Co, E Co, F Co and G Co will also cease to exist. Scenario 2 On 30 May 2003, Y Co acquires all the membership interests in C Co. This will cause F Co, G Co and H Co to cease to be members of the potential MEC group as F Co and G Co are no longer eligible tier-1 companies of the top company A Co. As F Co and G Co have ceased to be eligible tier-1 companies of the top company, those companies along with H Co will cease to be members of the MEC group. The MEC group, comprising the members of the potential MEC group derived from D Co and E Co, will continue to exist.On 30 June 2003, X Co acquires all of the membership interests in B Co. X Co will be the new top company. The potential MEC group derived from D Co and E Co will continue to exist after the change in identity of the top company because both companies were eligible tier-1 companies of the top company, A Co, before the change in top company and continue to be eligible tier-1 companies of the new top company, X Co, after the change.The change in identity of the top company will also not affect the continuation of the MEC group as the change will not affect the status of D Co and E Co as eligible tier-1 companies of the top company. Accordingly, D Co and E Co would continue to be original eligible tier-1 company members of the MEC group. Scenario 3 On 30 May 2003, X Co acquires all of the membership interests in A Co. X Co will be the new top company. The potential MEC group derived from D Co, E Co, F Co and G Co will continue to exist after the change in identity of the top company because those companies were eligible tier-1 companies of the top company, A Co, before the change in top company and continue to be eligible tier-1 companies of the new top company, X Co, after the change.The change in identity of the top company will also not affect the continuation of the MEC group as the change will not affect the status of D Co, E Co, F Co and G Co as eligible tier-1 companies of the top company. Accordingly, D Co, E Co, F Co and G Co would continue to be original eligible tier-1 company members of the MEC group.If the eligible tier-1 companies had chosen to form 2 MEC groups (one comprising D Co and E Co and the other F Co and G Co) instead of the one group, the change in identity of the top company would produce the same outcome. The potential MEC group derived from D Co and E Co and the potential MEC group derived from F Co and G Co would both continue to exist. In addition, the change in identity of the top company would not affect the status of any of those companies as original eligible tier-1 company members of their respective MEC groups.

Eligible tier-1 companies become members of another MEC group

4.81 A MEC group comprising the members of a potential MEC group derived from one or more eligible tier-1 companies of a top company will cease to exist when:

·
there is a change in the identity of the top company; and
·
the eligible tier-1 companies that were members of the MEC group immediately before the change become members of another MEC group immediately after the change.

[Schedule 1, item 2, paragraph 719-5(7)(b)]

4.82 Eligible tier-1 companies would become members of another MEC group following a change in identity of a top company if:

·
they became original eligible tier-1 company members of a MEC group which formed as a result of a special conversion event happening upon the companies becoming eligible tier-1 companies of the new top company; or
·
they became new eligible tier-1 company members of an existing MEC group.

Example 4.9

Eligible tier-1 companies become members of another MEC group

On 1 July 2003, A Co and B Co choose to form a MEC group the members of which comprise the members of the potential MEC group derived from those companies. A Co is appointed as the provisional head company of the group. Also on 1 July 2003, C Co and D Co choose to form a separate MEC group.On 1 September 2004, X Co acquires all of the membership interests in Y Co. As a result of C Co and D Co becoming eligible tier-1 companies of the new top company X Co, A Co, the provisional head company of the MEC group, may notify the Commissioner in writing specifying that C Co and D Co are to join the MEC group comprising A Co, B Co and E Co.If notification is given to the Commissioner by A Co, C Co and D Co will become new eligible tier-1 company members of that group. As C Co and D Co have become members of another MEC group, the MEC group of which they were previously members will cease to exist.Assume now that instead of A Co and B Co forming a MEC group on 1 July 2003, B Co instead chooses to form a consolidated group consisting of itself as head company and E Co as a subsidiary member. As a result of C Co and D Co becoming eligible tier-1 companies of the new top company X Co, B Co, the head company of the consolidated group, may notify the Commissioner in writing that a MEC group is to form and specify C Co and D Co as becoming original eligible tier-1 company members of that MEC group.If notification is given to the Commissioner by B Co, the MEC group of which C Co and D Co were previously members will cease to exist as both companies have become members of another MEC group immediately after the change in identity of the top company.

No provisional head company of the group

4.83 A MEC group comprising the members of a potential MEC group derived from one or more eligible tier-1 companies of a top company will cease to exist when there ceases to be a provisional head company of the MEC group. [Schedule 1, item 2, paragraph 719-5(7)(c)]

4.84 The eligible tier-1 companies who make the choice to consolidate the potential MEC group derived from those eligible tier-1 companies must jointly appoint one of those companies to be the provisional head company of the group. If a MEC group is formed as a result of a special conversion event happening, the head company of the consolidated group which notifies the Commissioner in writing that the MEC group is to form, is taken to be the provisional head company of the group.

4.85 Where a company ceases to be the provisional head company of a MEC group, a replacement provisional head company must be appointed by the remaining eligible tier-1 companies in the group. Notification of the replacement provisional head company must be given to the Commissioner within 28 days of the cessation. The Commissioner has a discretion under section 388-55 of the TAA 1953 to defer the time for lodgement of the notification.

4.86 Failure to appoint a replacement within the specified period will result in the MEC group ceasing to exist with effect from the time that the group ceased to have a provisional head company. If a replacement company is appointed, the appointment will take effect from the time that the previous provisional head company ceased to qualify as the provisional head company. A change in provisional head company of a MEC group will therefore not affect the continuation of the group provided a replacement is appointed within the period allowed for notification.

Provisional head company of a MEC group

Who qualifies as a provisional head company?

4.87 A company must satisfy 2 conditions to qualify as the provisional head company of a MEC group.

Condition 1

4.88 A company will only qualify as a provisional head company of a MEC group if:

·
it is an eligible tier-1 company of the top company; and
·
no membership interests in the company are beneficially owned by entities that are members of the MEC group.

[Schedule 1, item 2, subsection 719-65(1)]

4.89 Membership interests in the provisional head company must be beneficially owned by entities that are not members of the MEC group to ensure the rules which set a cost for assets of group members, as discussed in Chapter 5, can apply as intended upon formation of the MEC group.

Condition 2

4.90 The second qualifying condition only applies if a company is appointed as a provisional head company of the MEC group because a cessation event has occurred in relation to the previous provisional head company of the group. To be appointed as a provisional head company of the MEC group in these circumstances, a company must have been a member of the group since the beginning of the income year of the former provisional head company in which the cessation event happened. [Schedule 1, item 2, subsections 719-65(2) and (3)]

4.91 An exception will apply where:

·
the MEC group was formed as a result of a choice being made by 2 or more eligible tier-1 companies of a top company to consolidate the potential MEC group derived from those eligible tier-1 companies; and
·
the cessation event happened in the income year of the first provisional head company of the MEC group in which the group came into existence.

4.92 Where these circumstances exist, a company will qualify to be the provisional head company of the group if it has been a member of the group since the time the group came into existence. [Schedule 1, item 2, subsections 719-65(2) and (3)]

4.93 The provisional head company must be a member of the MEC group from the beginning of the income year in which the cessation event happens because a provisional head company may eventually become the head company of the MEC group for the whole of the income year. Without this requirement, the head company would be assessed, in its capacity as head company of the group, on income it derived in its own capacity prior to joining the group during the income year.

Accounting period of a replacement provisional head company

4.94 A replacement provisional head company of a MEC group must take on the same accounting period as that adopted by the first provisional head company of the group. This will ensure continuity and prevent the accounting period of the head company of the group exceeding 12 months. [Schedule 1, item 2, section 719-70]

4.95 The eligible tier-1 companies in a MEC group may have different accounting periods pre-consolidation. If the accounting period of a replacement provisional head company was not taken to be the same as that adopted by the former provisional head company, different accounting periods would apply depending on who was appointed as the replacement provisional head company of the group. [Schedule 1, item 2, section 719-70]

4.96 The adoption of the former provisional head companys accounting period by the replacement provisional head company does not prevent the latter company from requesting leave from the Commissioner to adopt an accounting period that ends on another date.

How does a company become the provisional head company?

4.97 How a company is appointed as a provisional head company of a MEC group differs depending on whether:

·
the company is appointed as the first provisional head company of the group; or
·
as a subsequent provisional head company of the group.

First provisional head company of a MEC group

4.98 The method of appointment of the first provisional head company of a MEC group differs depending on whether the group was formed:

·
as a result of a choice being made by 2 or more eligible tier-1 companies to consolidate the potential MEC group derived from those eligible tier-1 companies; or
·
as a result of a special conversion event happening.

A MEC group formed by a choice

4.99 At the time a notice of choice to form a MEC group is given to the Commissioner, the eligible tier-1 companies who made the choice must jointly appoint one of those companies which satisfy the qualifying conditions to be the provisional head company of the group [Schedule 5, item 24, subsection 995-1(1) of the ITAA 1997] . The appointment of the provisional head company must be included in the notice of choice and will start to have effect at the time the MEC group comes into existence. [Schedule 1, item 2, subsections 719-60(1) and (4)]

A MEC group formed from a special conversion event

4.100 If a MEC group is formed as a result of a special conversion event happening in relation to a potential MEC group, the head company of the consolidated group that notifies the Commissioner in writing that the MEC group is to form will be taken to have been appointed by the eligible tier-1 company members of the MEC group as the provisional head company of the group [Schedule 5, item 24, subsection 995-1(1) of the ITAA 1997] . The appointment of the company as the provisional head company of the group starts to have effect at the time the event happens. [Schedule 1, item 2, subsection 719-60(2)]

4.101 Once a company that qualifies as a provisional head company is appointed as the provisional head company of a MEC group, the company remains the provisional head company of the group until a cessation event happens to the company. The appointment of the provisional head company cannot be revoked or resigned. A cessation event happens when either:

·
the company ceases to exist; or
·
the company ceases to satisfy the qualifying conditions for being a provisional head company.

[Schedule 1, item 2, subsections 719-60(5) and (6); Schedule 5, item 5, subsection 995-1(1) of the ITAA 1997]

Subsequent provisional head company of a MEC group

4.102 If a cessation event happens to the provisional head company of a MEC group, the Commissioner must be notified of another company that has been appointed as the provisional head company within 28 days after the event [Schedule 5, item 24, subsection 995-1(1) of the ITAA 1997] . Notification of the appointment must be given to the Commissioner in writing in an approved form and must be made jointly by all the companies that were eligible tier-1 company members of the group just after the cessation event. The Commissioner has a discretion under section 388-55 of the TAA 1953 to defer the time for lodgement of the notice. [Schedule 1, item 2, subsection 719-60(3)]

4.103 If a cessation event happens to a provisional head company more than 28 days before a choice to form a MEC group is given to the Commissioner, notification of the appointment of a replacement provisional head company must instead be given to the Commissioner on the day the notice of the choice is given. [Schedule 1, item 2, subsection 719-60(3)]

4.104 If the Commissioner is not notified of the replacement provisional head company within the specified time, the MEC group will cease to exist at the time the cessation event happens to the last provisional head company of the group.

4.105 The appointment of a replacement provisional head company comes into effect after the cessation event happens provided the company satisfies the qualifying conditions for being a provisional head company at that time. [Schedule 1, item 2, subsections 719-60(3) and (4)]

A provisional head company to be treated as the head company

4.106 If the income year of a company that is the provisional head company of a MEC group ends, the provisional head company is taken to have been the head company of the MEC group for the whole of its income year or for the period the MEC group was in existence if that is less than the income year. [Schedule 1, item 2, subsections 719-75(1) and (2); Schedule 5, item 11, subsection 995-1(1) of the ITAA 1997]

4.107 If a MEC group ceases to exist, the company that is the provisional head company immediately before the time the MEC group ceases to exist is taken to be the head company of the MEC group for that part of its income year in which the group was in existence. [Schedule 1, item 2, subsection 719-75(3); Schedule 5, item 11, subsection 995-1(1) of the ITAA 1997]

Choosing to form a MEC group

Who can make a choice to form a MEC group

4.108 A MEC group can only be formed when there are at least 2 eligible tier-1 companies of the same top company. A MEC group can be formed from any 2 or more eligible tier-1 companies of a top company and there is no restriction on more than one MEC group being formed in relation to the same top company. A MEC group cannot begin to exist if there is only one eligible tier-1 company. However, a single eligible tier-1 company may choose to form a consolidated group provided it has at least one subsidiary member.

4.109 To form a MEC group, 2 or more eligible tier-1 companies of a top company must jointly notify the Commissioner of their choice to consolidate the potential MEC group derived from those eligible tier-1 companies. The notification to the Commissioner must be in writing and in the approved form.

4.110 The notice must state the date the group is to form, which must be after 30 June 2002. Once the choice to form a MEC group takes effect, which will be from the day specified in the notice, it cannot be revoked and the specification of the commencement day cannot be altered. [Schedule 1, item 2, subsections 719-50(1) and (2) and subsection 719-55(1)]

4.111 An eligible tier-1 company may not make a choice to consolidate a potential MEC group if:

·
it is already a member of a consolidated group; or
·
it is already a member of a MEC group.

[Schedule 1, item 2, paragraph 719-50(1)(c)]

4.112 Preventing an eligible tier-1 company from making a choice to form a MEC group in these circumstances ensures the irrevocability aspect of an earlier choice to form either a MEC group or a consolidated group is not disturbed.

Time period for giving the choice to the Commissioner

4.113 The notice informing the Commissioner of the choice to form a MEC group must be given to the Commissioner at any time during the period:

·
beginning on the day the group commences; and
·
ending on the day on which the first head company of the group lodges its income tax return for the income year in which the group came into existence.

[Schedule 1, item 2, paragraphs 719-50(3)(a) to (d)]

4.114 However, if the head company of the group does not have to give an income tax return for that income year, the period during which the choice can be given will end at the end of the period within which the company would have been required to give an income tax return had it been required to give an income tax return for that period. [Schedule 1, item 2, paragraphs 719-50(3)(a) to (c) and (e)]

Eligible tier-1 company ceases to exist before a choice is made

4.115 A choice to consolidate a potential MEC group must be made by all the eligible tier-1 companies who will become original eligible tier-1 company members of the MEC group. However, as a choice to consolidate a potential MEC group is not required to be given to the Commissioner until the date of lodgement of the head companys income tax return for the income year in which the group commenced, it is possible that an eligible tier-1 company may cease to exist prior to the choice being made.

4.116 If an eligible tier-1 company that was in existence on the day the MEC group would commence has ceased to exist prior to the day on which the choice is given to the Commissioner, the company may still become an original eligible tier-1 company member of the MEC group despite not being a party to the choice.

4.117 If, having regard to all relevant circumstances, it would be reasonable to conclude that the company would have been a party to the choice had it continued to exist, the company that has ceased to exist will be taken to have authorised the company that is the first head company of the MEC group to have made the choice on its behalf. Where it is reasonable to reach this conclusion, the company will become an original eligible tier-1 company member from the time the group came into existence. [Schedule 1, item 2, paragraphs 719-50(4)(a) to (d)]

4.118 The company is also taken to have authorised the first head company of the group to have made an appointment of the first provisional head company of the group on its behalf as well as any subsequent appointment of a replacement provisional head company where the appointment has effect prior to the time when the company ceased to exist. [Schedule 1, item 2, paragraphs 719-50(4)(a) to (c) and (e)]

The choice contains incorrect information

4.119 If the notification of the choice to form a MEC group contains information that is materially incorrect, the choice will not take effect unless the Commissioner notifies the provisional head company that the choice is effective. [Schedule 1, item 2, subsections 719-55(2) and (3)]

Example 4.10

The choice contains incorrect information

A foreign resident holding company, A Co has wholly-owned subsidiaries B Co and C Co, which are also foreign resident companies. In turn, B Co and C Co have wholly-owned Australian resident subsidiaries D Co and E Co, and F Co and G Co, respectively. F Co has an Australian resident wholly-owned subsidiary H Co.D Co, E Co, F Co and G Co all qualify as eligible tier-1 companies. Various MEC groups could be formed comprising any combination of 2 or more of the eligible tier-1 companies of the top company A Co. As F Co is the head company of a consolidatable group, it will not be able to form a MEC group with other eligible tier-1 companies if it has already made a choice to form a consolidated group. Similarly an eligible tier-1 company that has already made a choice to become a member of a MEC group would not be eligible to make a choice to become a member of another MEC group.Assume D Co, E Co and F Co jointly choose to consolidate the potential MEC group derived from those eligible tier-1 companies. D Co, E Co and F Co must specify in the notice of choice the company that will be the provisional head company of the group. D Co and F Co both satisfy the qualifying conditions for being a provisional head company. E Co does not satisfy the conditions for being a provisional head company as D Co holds some of the membership interests in E Co. Providing the company appointed as the provisional head company still qualifies as a provisional head company at the end of its income year, it will be the head company of the MEC group for the whole of the income year or for the period the MEC group was in existence if that is less than a year.

Notification of events

4.120 The provisional head company of a MEC group is required to notify the Commissioner of certain changes to the membership of a MEC group. The notification must be in an approved form and, in general, must be given to the Commissioner within 28 days of the change to the membership of the group. [Schedule 1, item 2, subsection 719-80(1), column 3 in the table and paragraph 719-80(2)(c)]

4.121 The following changes to the membership of a MEC group will require notification by the provisional head company of the group:

·
an entity becoming a member of a MEC group; and
·
an entity ceasing to be a member of a MEC group.

[Schedule 1, item 2, subsection 719-80(1), items 1 and 2 in the table]

4.122 In addition, the company that is the provisional head company of a MEC group must notify the Commissioner if it ceased to be the provisional head company of the group. If the company ceased to be the provisional head company because it ceased to exist, the notification is instead to be made by the person, if any, who was the public officer of the company just before it ceased to exist. [Schedule 1, item 2, subsection 719-80(1), item 3 in the table]

4.123 The 28 day period within which notification of a change in membership must be given to the Commissioner is extended in some cases. An extension beyond 28 days applies where:

·
the change in membership occurs more than 28 days before the day on which notice of the choice to form the MEC group is given to the Commissioner; or
·
the change in membership occurs in relation to a MEC group that formed as a result of a special conversion event happening and the change occurs more than 28 days before the day on which notice of the choice to form the consolidated group, which subsequently converted to a MEC group, is given to the Commissioner.

4.124 Where the circumstances for an extension of time exist, the notification is instead to be given to the Commissioner on the same day as the choice to form the MEC group or the consolidated group is given to the Commissioner. [Schedule 1, item 2, paragraphs 719-80(2)(a) and (b)]

Application and transitional provisions

4.125 The consolidation regime will apply from 1 July 2002.

Consequential amendments

4.126 Consequential amendments have been made to subsection 995-1(1) to include references to new dictionary terms. [Schedule 5, items 5, 9, 11, 13, 22, 24, 28, 29, 35 and 36]

Chapter 5 - Cost setting rules

Outline of chapter

5.1 The rules explained in this chapter deal with assets of subsidiary entities that join or leave a consolidated group. The costs for income tax purposes of the assets of an entity are reset upon its becoming a subsidiary member of a consolidated group. The costs are reset so that they reflect the cost to the group of acquiring the entity. When an entity ceases to be a subsidiary member of the group, the group is recognised as having a cost for the membership interests in the subsidiary. This cost is equal to the groups cost for the net assets of that entity.

5.2 This chapter explains the rules for:

·
a subsidiary entity joining an existing consolidated group (contained in Subdivision 705-A); and
·
subsidiary entities leaving a consolidated group (contained in Division 711).

5.3 The chapter also contains illustrative examples of applications of those rules.

5.4 The cost setting rules explained in this chapter are to be modified in the case of a MEC group. The modifications are to be contained in a later bill.

Context of reform

5.5 The treatment of assets of entities joining a consolidated group is based on the asset-based model discussed in A Platform for Consultation and recommended by A Tax System Redesigned.

5.6 This model dispenses entirely with income tax recognition of separate entities within a consolidated group. It treats a consolidated groups cost of acquiring a subsidiary entity as the cost to the group of acquiring the assets of that entity. A groups cost of acquiring an entity includes the liabilities of the entity that become liabilities of the group. This cost also includes the liabilities that the acquired entity owes to existing members of the acquiring consolidated group.

5.7 A consolidated groups cost for membership interests in a subsidiary member when it leaves a consolidated group is determined based on the cost to the group for the net assets of the subsidiary.

5.8 This treatment of the acquisition and disposal of subsidiary entities by a consolidated group prevents the double taxation of gains and duplication of losses arising within the group and allows for assets to be transferred between members of the group without requiring cost base adjustments to address value shifting.

Summary of new law

An entity joining an existing consolidated group

5.9 When an existing consolidated group completes the acquisition of an entity that is eligible to become a member of a consolidated group, the acquired entity becomes a subsidiary member of the consolidated group and the cost of acquiring the entity (allocable cost amount) is treated as the cost to the group of the entitys assets. The groups cost for each of the assets is worked out by allocating the allocable cost amount for the acquired entity among the entitys assets. The groups cost for each asset, worked out in this way, provides the basis for determining the cost of the asset to the group for CGT, trading stock and capital allowance purposes.

5.10 A consolidated groups allocable cost amount for a joining entity consists of the groups cost of acquiring the membership interests in the joining entity and the amount of liabilities of the joining entity at the joining time. The allocable cost amount also reflects certain retained earnings, distributions, losses and entitlements to future deductions of the joining entity.

5.11 The case of a single entity becoming a subsidiary member of a consolidated group provides the basic rules for determining the cost of the assets of a joining entity to a consolidated group. Other cases, including the initial formation of a consolidated group, will operate by modifying these rules.

Pre-CGT status

5.12 The pre-CGT status of assets is unaffected by the entities, holding those assets, joining or leaving a consolidated group. The pre-CGT status of membership interests in an entity joining a consolidated group is preserved by transferring it to the assets the entity brings to the group. The assets do not themselves acquire pre-CGT status but are attributed a factor that results in recognition of pre-CGT status for membership interests in an entity that leaves the group with those assets.

Entities leaving a consolidated group

5.13 Immediately before an entity leaves a consolidated group, the groups cost, for income tax purposes, of its 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.

5.14 Where a leaving entity holds membership interests in one or more other subsidiary members of the group, those entities also will be ineligible to remain in the group. The rules for a single entity leaving are adapted to determine costs for membership interests in all such leaving entities and to provide each leaving entity with a cost for any membership interests it holds in other leaving entities.

Comparison of key features of new law and current law
New law Current law
A consolidated groups cost of acquiring an entity is treated as the groups cost for the assets of that entity. A groups cost for the net assets a group entity at the time the group first disposes of membership interests in the entity sets the groups cost for its membership interests in that entity. Income tax consequences on disposal of an asset by a wholly-owned subsidiary are calculated by reference to the cost of the asset to the subsidiary. No regard is given to the groups cost of acquiring the entity, including where the asset was acquired before the subsidiary came to be wholly-owned by the group.

Acquisition or disposal of an entity by a holding company is dealt with only as an acquisition or disposal of membership interests in the entity.

Detailed explanation of new law

A single entity joining an existing consolidated group

5.15 These rules for a single entity joining an existing consolidated group are the basic case of an entity joining a consolidated group. The rules for this case do not apply to:

·
group formation;
·
one consolidated group joining another consolidated group;
·
entities linked through membership interests joining a consolidated group in consequence of one of them joining; or
·
an entity joining an existing consolidated group where the entity is held by the head company through one or more non-resident entities.

[Schedule 1, item 2, section 705-15]

5.16 When an entity (the joining entity) becomes a subsidiary member of a consolidated group (the joined group) it is generally treated for income tax purposes as being a part of the head company.

5.17 The rules for a head company fall into 3 main parts:

·
allocation of the cost of acquiring a joining entity among the assets that the entity brings to the consolidated group (the groups costs for the assets of the joining entity - see paragraphs 5.18 to 5.53);
·
working out the cost of acquiring the joining entity (the allocable cost amount - see paragraphs 5.54 to 5.105);
·
preservation of unrealised losses relating to membership interests in a joining entity (see paragraphs 5.106 to 5.107); and
·
preservation of the pre-CGT status of membership interests in the joining entity (see paragraphs 5.108 to 5.113).

A groups cost for the assets of a joining entity

5.18 A joined groups cost of acquiring a joining entity is treated as the head companys cost of acquiring the assets of the joining entity. The head companys cost for each of the assets of the joining entity is set with effect from the time the entity becomes a subsidiary member of the group (the joining time). This overrides the groups inherited history of the joining entity insofar as that history would affect the head companys cost for each asset.

5.19 An asset, for the purposes of the cost setting rules, is anything of economic value which is brought into a consolidated group by an entity that becomes a subsidiary member of the group. This includes those assets which subsequently cease to be recognised as a consequence of the single entity rule whilst the asset is within the consolidated group.

5.20 The set cost for an asset (the tax cost setting amount) will be the relevant cost for all income tax purposes including for the purposes of the CGT, capital allowance and trading stock provisions.

5.21 The elements for setting a head companys cost for each asset are:

·
setting a cost for the retained cost base assets, by reference to their terminating value (see paragraphs 5.22 to 5.28);
·
setting a cost for the reset cost base assets (see paragraphs 5.29 to 5.53), taking account of special rules for:

-
goodwill (see paragraphs 5.34 to 5.36);
-
revenue assets (see paragraphs 5.37 to 5.41);
-
accelerated depreciation (see paragraphs 5.42 and 5.43);
-
over-depreciated assets (see paragraphs 5.44 to 5.52); and
-
order of application of restrictions and reductions (see paragraph 5.53).

Retained cost base assets

5.22 To simplify compliance, a head companys cost for certain assets (retained cost base assets) is set equal to the joining entitys cost for those assets.

5.23 A retained cost base asset is Australian currency or a right to receive a specified amount of Australian currency (other than a right that is a marketable security within the meaning of section 70B of the ITAA 1936) or an entitlement that is subject to a prepayment. However, assets that are Australian currency and that are trading stock or collectables of a joining entity are not retained cost base assets. [Schedule 1, item 2, subsection 705-25(5)]

5.24 The amount treated as a head companys cost for each retained cost base asset of a joining entity that is Australian currency or a right to receive Australian currency is the amount of Australian currency concerned. This will avoid the compliance costs that would arise in dealing with these assets if their cost was set at an amount that was different to their nominal value. [Schedule 1, item 2, subsection 705-25(2)]

5.25 If a retained cost base asset is a qualifying security within the meaning of Division 16E of Part III of the ITAA 1936, a head companys cost for it is the joining entitys terminating value for the security. This is an amount such that if the joining entity were to dispose of the security for that amount at the joining time, it would cause neither an amount to be added to the assessable income of, nor a deduction to be allowed to, the joining entity. [Schedule 1, item 2, subsection 705-25(3)]

5.26 If a retained cost base asset is an entitlement to a pre-paid service or other entitlement arising from a pre-paid amount, a head companys cost for it is the amount of the head companys entitlement to deductions in relation to the pre-paid amount arising because of the head companys inheritance of entitlements of the joining entity. [Schedule 1, item 2, subsection 705-25(4)]

5.27 If the total amount to be treated as a head companys cost for retained cost base assets of a joining entity exceeds the joined groups allocable cost amount for the joining entity, the head company of the consolidated group will make a capital gain equal to the excess. Rules to provide the CGT event under which the capital gain will arise will be included in a later bill.

Terminating value of an asset of a joining entity

5.28 The terminating valuesof assets of a joining entity are relevant for the head companys cost base for retained cost base assets that are qualifying securities within the meaning of Division 16E of Part III of the ITAA 1936 (see paragraph 5.25), revenue assets (paragraphs 5.38 and 5.39), accelerated depreciation assets (paragraph 5.42), and over-depreciated assets (paragraphs 5.47 and 5.48). A joining entitys terminating values for assets of different types are set out in Table 5.1. [Schedule 1, item 2, section 705-30]

Table 5.1: Terminating value of an asset of a joining entity
If an asset of a joining entity is The terminating value of the asset is
Trading stock that was on hand at the beginning of the income year ending at the joining time. The value at which it was taken into account by the joining entity at that time under Division 70.
Trading stock that was livestock acquired by the joining entity by natural increase during the income year. The cost as provided for under section 70-50.
Other trading stock that was acquired by the joining entity during the income year. The amount of the outgoing incurred by the joining entity in connection with the acquisition of the trading stock.
A qualifying security (within the meaning of Division 16E of Part III of the ITAA 1936) that is not trading stock. The amount of the consideration that the joining entity would need to receive if it were to dispose of the asset just before the joining time in order for no amount to be included in, or deductible from, the joining entitys assessable income under section 159GS of the ITAA 1936.
A depreciating asset. Its adjustable value just before the joining time.
A CGT asset that is neither trading stock nor a depreciating asset. Its cost base just before the joining time.
Any other asset. The amount that would have been its cost base just before the joining time if it were a CGT asset.

Reset cost base assets

5.29 The allocable cost amount remaining after deducting an amount equal to a head companys set costs for the retained cost base assets of a joining entity is allocated among the reset cost base assets other than excluded assets. [Schedule 1, item 2, section 705-35]

5.30 A reset cost base asset is any asset that is not a retained cost base asset. An asset is an excluded asset if an amount has been deducted in respect of the asset when working out a head companys allocable cost amount for a joining entity. [Schedule 1, item 2, subsections 705-35(1) and (2)]

5.31 A head company is not attributed a cost for excluded assets (no allocable cost amount is allocated to them). This is because the allocable cost amount has already been reduced to take account of these assets (see paragraphs 5.96 to 5.102). [Schedule 1, item 2, subsection 705-35(2)]

5.32 An asset of the joining entity being a right to future tax deductions for a loss would be an excluded asset where an amount was subtracted for the loss in steps 5 or 6 in working out the allocable cost amount. Also, an asset being a right to a certain future tax deduction would be an excluded asset where an amount was subtracted for that deduction in step 2 or 7 in working out the allocable cost amount.

5.33 The amount set as a head companys cost for each reset cost base asset, other than excluded assets, of a joining entity is worked out in 3 steps:

·
step 1 - determine the joined groups allocable cost amount for the joining entity (discussed in paragraphs 5.54 to 5.105);
·
step 2 - the allocable cost amount is reduced by the total of the payments for the retained cost base assets. If the result of this step is zero (or would be a negative amount), then the amount treated as the head companys cost for each reset cost base asset is zero; and
·
step 3 - any remaining allocable cost amount is allocated to each of the joining entitys reset cost base assets in proportion to their market values. The amount allocated to each asset is the head companys cost for the asset for income tax purposes. If there are no reset cost base assets, the result of step 2 is instead treated as a capital loss of the head company. Rules to provide the CGT event under which the capital loss will be included in a later bill.

Example 5.1: Resetting costs for assets On 1 July 2002, Head Co, the head company of a consolidated group, completed a staged acquisition of all of the membership interests in D Co. This causes D Co to join the consolidated group. At that time, D Cos assets are $100 cash (a retained cost base asset) and 2 reset cost base assets - Asset A (market value $300) and Asset B (market value $200).The set costs for the assets brought into the group by D Co are worked out as follows:

First, the groups allocable cost amount for D Co is worked out. Suppose this is $500. (The difference between this cost ($500) and the market value of the assets ($600) would be accounted for by unrealised appreciation of the assets accruing to membership interests already held by Head Co before the completion of Head Cos acquisition of D Co.)
Secondly, Head Cos set cost for D Cos retained cost base asset (the $100 cash) is $100. The allocable cost amount ($500) is reduced by the set costs for the retained cost base assets ($100), leaving $400 for allocation to the reset cost base assets.
Finally, the $400 is allocated to the reset cost base assets in proportion to their market values. For Asset A, the amount allocated is $240 ($300 $500 $400). For Asset B, the amount allocated is $160 ($200 $500 $400).

Head Cos set costs for Asset A and Asset B are $240 and $160 respectively.

Goodwill

5.34 Any synergistic goodwill accruing to assets or businesses of a group, other than assets and businesses brought into the group by the joining entity, as a consequence of the groups ownership and control of the joining entity will be treated as a reset cost base asset of the joining entity. As for other reset cost base assets, this synergistic goodwill has an amount determined as its cost to the head company. This amount will determine the cost base of this goodwill for CGT purposes.

5.35 The market value of an entity can reflect its potential to add to the value of the existing assets of potential acquirers. Therefore, the market value of the whole of this goodwill can be taken as the amount of any excess of the market value of the joining entity at the joining time over the market value of the net identifiable assets of the joining entity at that time. It is, therefore, appropriate to treat all elements of this goodwill as reset cost base assets of the entity even though some of the added value may accrue to assets or businesses already owned by the joined group. [Schedule 1, item 2, subsection 705-35(3)]

Example 5.2: Goodwill On 1 July 2002, Head Co, the head company of an existing consolidated group, acquired all of the membership interests in Z Co. This causes Z Co to join the consolidated group.At that time, the market value of Z Cos net identifiable assets (excluding goodwill) is $1 million. However, the market value of Z Co is determined to be $1.5 million. At the time Z Co joins the consolidated group, goodwill with a market value of $500,000 is treated as one or more CGT assets of Z Co.

5.36 The treatment of goodwill when an entity leaves a consolidated group is discussed in paragraph 5.141.

Restriction on reset costs of revenue assets

5.37 The amount of the reset cost of a reset cost base asset may be restricted in certain circumstances. The restriction addresses the potential for unrealised capital losses to be converted to revenue losses when an entity joins a consolidated group. This can occur where assets still held by a joining entity have declined in value after the group it is joining purchased membership interests in it.

5.38 The restriction applies to reset cost base assets that, after the joining time, are effectively treated for income tax purposes on revenue account (e.g. trading stock and depreciating assets). [Schedule 1, item 2, subsection 705-40(2)]

5.39 The restriction applies where the reset cost worked out for the asset exceeds both the market value of the asset and the joining entitys terminating value for the asset (see paragraph 5.28). In these circumstances, the reset cost is reduced to the greater of those 2 amounts. [Schedule 1, item 2, subsection 705-40(1)]

5.40 The amount by which the reset cost is reduced is then allocated and added to each of the reset cost base assets whose reset cost has not been reduced under the restriction. The allocation is in proportion to the market values of those assets, except that the amount allocated to a revenue asset cannot cause its reset cost to exceed the limit specified in this section. [Schedule 1, item 2, subsection 705-40(3)]

Example 5.3: Capping reset costs for revenue assets Headco, the head company of a consolidated group, purchased 90% of the membership interests in Ayco for $90 when Ayco had trading stock with a market value of $10 and land with a market value of $90. Subsequently the land declined in value and when Headco purchased the remaining membership interests, for $8, Ayco had trading stock with a market value of $20 and land with a market value of $60.Upon the completion of the acquisition of Ayco, Ayco becomes a subsidiary member of Headcos consolidated group. Headcos allocable cost amount for Ayco is $98, comprised solely of the cost of acquiring the membership interests. If the allocable cost amount were allocated to the assets Ayco brings to the group in proportion to their market values, the reset costs for the assets would be:

Asset Market Value ($) Reset Cost ($)
Trading stock 20 25.50
Land 60 73.50
Total 80 98.00
However, the reset cost for trading stock cannot exceed the greater of its market value or Aycos terminating value for it. Supposing the market value is greater, this rule requires that the reset cost for the trading stock be reduced by $5.50. This amount can be added to the reset cost for the land. Headcos costs for the assets brought to the group by Ayco become $20 for the trading stock and $78 for the land.

5.41 If the reset costs for all of the reset cost base assets of a joining entity are reduced by the restriction, the head company of the joined group makes a capital loss equal to the total amount by which the allocable cost amount cannot be allocated. Rules to provide the CGT event under which the capital loss will arise will be included in a later bill.

Reduction in reset costs for accelerated depreciation assets

5.42 Retention by a head company of a joining entitys entitlement to accelerated depreciation for any of its depreciating assets is conditional upon the reset cost for the asset not being greater than the joining entitys terminating value (see paragraph 5.28).

5.43 In order to retain entitlement to accelerated depreciation for an asset, a head company can choose to reduce the reset cost for the asset to the joining entitys terminating value for that asset. Where this occurs, the excess reset cost amount is not allocated to other assets. [Schedule 1, item 2, section 705-45]

Over-depreciated assets and the intercorporate dividend rebate

5.44 In certain circumstances there may be a reduction to the amount of the reset cost that would otherwise apply to over-depreciated assets of a joining entity. An asset is over-depreciated at a particular time if there has been some depreciation (i.e. a reduction in its adjustable value) and its market value exceeds its adjustable value. The amount of over-depreciation of the asset is the excess of its market value over its adjustable value. [Schedule 1, item 2, subsection 705-50(6)]

5.45 The reduction applies to prevent an increase in the adjustable value of a depreciating asset where there has been tax deferral resulting from the over-depreciation of the asset. Without the reduction, the rules for consolidation would permit an increase in the adjustable value of an asset despite its over-depreciation resulting in tax deferral of indefinite duration.

5.46 The potential for indefinite deferral arises where a company held an asset that was over-depreciated and income sheltered from tax by over-depreciation was distributed as an unfranked dividend to a recipient that was entitled to the intercorporate dividend rebate. This can occur where such a company becomes a subsidiary member of a consolidated group and:

·
the asset is held continuously by the company until its joining time; and
·
the asset remains over-depreciated at the joining time.

This last condition is required because the over-depreciation of an asset continues to be a net shelter from income tax only so long as the asset continues to be over-depreciated. Over-depreciation of an asset can be diminished through time through deductions for depreciation that are lower than they would have been but for the earlier over-depreciation, or eliminated by a balancing adjustment on the disposal of the asset.

5.47 Consistent with the rationale outlined in paragraphs 5.45 and 5.46, a reduction in the payment for an asset applies where:

·
the reset cost for the asset (its cost for depreciation purposes) is more than its adjustable value to the joining entity at the joining time (the terminating value) [Schedule 1, item 2, paragraph 705-50(2)(a)] ;
·
the joining entity paid an unfranked or partly franked dividend during the period between when it acquired the asset and its joining time [Schedule 1, item 2, paragraph 705-50(2)(b)] ;
·
the dividends, to the extent they were unfranked, were paid out profits that were untaxed because of the over-depreciation of the asset, where the over-depreciation did not contribute to a tax loss that was deducted at step 5 in working out the allocable cost amount [Schedule 1, item 2, paragraph 705-50(3)(a)] ; and
·
an amount representing the unfranked dividend had not been paid, before the joining time, as a dividend to a recipient that was not entitled to the intercorporate dividend rebate [Schedule 1, item 2, paragraph 705-50(3)(b)] .

5.48 The amount of the reduction is the lesser of:

·
the amount of income that continues to be sheltered from tax; or
·
the amount by which the reset cost would, apart from this provision, exceed the joining entitys terminating value of the asset.

[Schedule 1, item 2, subsection 705-50(2)]

Example 5.4: Unfranked dividend and over-depreciated asset T Co and U Co each contributed $50 to capitalise K Co. K Co applied the $100 to acquire a depreciating asset and generated cash flow income of $40. K Co claimed depreciation of $40 for income tax but its depreciation for financial reporting purposes was $10. After allowing for the deferred income tax liability of $9 (30% of ($40 - $10), K Co had an after-tax profit of $21 ($40 - $10 - $9). This enabled K Co, before 30 June 2001, to pay an unfranked dividend of $21 shared equally between T Co and U Co. K Co then became inactive and did not claim any further depreciation before 1 July 2002. On 1 July 2002 T Co formed a consolidated group and immediately afterwards it purchased U Cos stake in K Co for $50 (representing 50% of $100, that is, the market value of K Cos depreciating asset ($90) plus K Cos cash ($19) less K Cos deferred tax liability for its over-depreciated asset ($9)).T Co does not elect under the transitional measures to reset the cost for K Cos assets (under the transitional provisions, for which legislation is being prepared). T Cos allocable cost amount for K Co is $109, which is comprised its cost for membership interests ($100) and K Cos deferred tax liability for the depreciable asset ($9). This allocable cost amount is allocated $19 to K Cos cash (a retained cost base asset) and, in the first instance, $90 for the depreciating asset.The reduction to the reset cost for the depreciating asset to limit tax deferral would be the lesser of:

·
the over-depreciation at K Cos joining (i.e. $30 ($90 - $60)); and
·
the unfranked part of the dividends paid by K Co which satisfy the conditions in paragraphs 705-45(2)(b) to (d) (i.e. $21),

but not with the effect of reducing the reset cost below K Cos terminating value for the asset (i.e. $60).In this case, reset cost for the depreciating asset is reduced from $90 to $69.As a transitional measure (for which legislation is being prepared), T Co can elect that an amount up to the $21 reduction be added back to the terminating value of this asset for the head company, for the purpose of determining the deemed payment for the purchase of membership interests in an entity that owns the asset when it leaves the consolidated group.

5.49 A reduction in the reset cost may also apply where an asset has been received by a joining entity subject to rollover and the transferor paid dividends that were sheltered from tax because of over-depreciation of the asset in its hands. [Schedule 1, item 2, subsection 705-50(4)]

5.50 A reduction may also apply in relation to an asset held by a joining entity where:

·
the asset had been an over-depreciated asset of another consolidated group that formed before 1 July 2004 (this date is to be specified in the transitional rules - legislation for the transitional rules will be included in a later Bill);
·
because of a choice made under the transitional rules, some or all of the original reduction for over-depreciation was added back for the purpose of working out the groups original cost for its membership interests when the joining entity left the other consolidated group;
·
the asset was held by the joining entity when it left the other consolidated group and was continuously held by the joining entity from the time it left the other consolidated group until the joining time; and
·
the asset was over-depreciated at the current joining time.

5.51 The amount of any reduction in this case is the lesser of:

·
the amount of the prior reduction that was added back when the joining entity left the original consolidated group; or
·
the amount of over-depreciation at the current joining time.

[Schedule 1, item 2, subsection 705-50(5)]

5.52 In the circumstances outlined in paragraph 5.51, the income originally sheltered from tax may not be taxed to the original consolidated group when it disposes of the entity holding the asset. This is because the group is able to elect, under transitional rules, to use a terminating value for the asset that disregards adjustments for sheltered income in determining the groups deemed payment for the membership interests in the leaving entity. Therefore, to limit the tax deferral, adjustments for income sheltered from tax may still be required when the joining entity joins the latter consolidated group.

Order of application of provisions

5.53 The resetting of the cost for a depreciating asset could be subject to more than one of:

·
the restriction on reset costs of revenue assets (see paragraphs 5.37 to 5.41;
·
the reduction in reset costs for accelerated depreciation assets (paragraphs 5.42 and 5.43); and
·
the adjustment for over-depreciated assets (paragraphs 5.44 to 5.52).

When this occurs, different sequences in applying these provisions can produce different outcomes. In all cases the outcome that is most favourable to the consolidated group is consistent with the policy objectives of the provisions. However, the sequence in applying the provisions that is most favourable to a consolidated group can vary according to the specific circumstances. For this reason, provision has been made that the head company can choose the sequence in which these provisions apply. If the head company does not make a choice, the provisions apply in the sequence in which they appear in the legislation. [Schedule 1, item 2, section 705-55]

What is a joined groups allocable cost amount for a joining entity?

5.54 A joined groups allocable cost amount for a joining entity determines the aggregate of the reset cost for assets of the joining entity to the joined group. The amount reflects the cost to the joined group of acquiring the joining entity (see discussion of the cost setting rules in Chapter 2). That cost consists of the groups cost of acquiring the membership interests in the joining entity and the liabilities of the joining entity at the joining time. Adjustments are made to reflect certain undistributed profits, distributions, deductions and losses of the joining entity.

5.55 A joined groups allocable cost amount for a joining entity is worked out in 7 steps which are discussed in paragraphs 5.56 to 5.105 [Schedule 1, item 2, section 705-60] . Where a consolidated group acquires the whole of the membership interests in an entity in a single transaction (a non-incremental acquisition), only steps 1, 2, 6 and 7 can apply. Steps 3, 4 and 5 make adjustments to the allocable cost amount for profits that accrue, distributions made and losses that accrue to membership interests that are continuously owned by the acquiring consolidated group prior to the joining time. Therefore, these steps only apply where the acquisition of membership interests in an entity by a consolidated group occurs over time (an incremental acquisition). Steps 3 to 5 can also apply where there is an interval of time between the formation of a wholly-owned group that is eligible to form a consolidated group and the time from which the head company chooses that the group be taxed as a consolidated group (deferred consolidation).

Diagram 5.1: Working out the joined group's allocation amount

Step 1: Determine the cost of membership interests in the joining entity

5.56 The first step in determining a groups allocable cost amount for a joining entity is to add up the costs for all of the membership interests in a joining entity that are held by members of the group joined. The cost used for each membership interest is the amount that would be the cost (the relevant cost) for determining the CGT outcome if the membership interest were disposed of at the joining time. This amount reflects part of the groups cost of acquiring the joining entity.

5.57 If, at the joining time, the market value of a membership interest is greater than or equal to its cost base, the cost base is the relevant cost. Otherwise, the relevant cost is the greater of the market value of the interest or the reduced cost base of the interest. [Schedule 1, item 2, subsection 705-65(1)]

5.58 This single cost base will limit the circumstances where assets of a consolidated group will have a reduced cost base that is different from their cost base.

5.59 No amount is to be added for indexation when determining the cost base of pre-CGT membership interests. A joined groups pre-CGT status for membership interests is preserved within consolidation (see paragraphs 5.108 to 5.113). [Schedule 1, item 2, subsection 705-65(2)]

5.60 Where, at the joining time, there are outstanding cost base adjustments for membership interests, the cost base to be used when recognising a single cost for membership interests is the cost base after making those adjustments. The cost base adjustments may be required because of, for example, an earlier loss or asset transfer or a value shift. [Schedule 1, item 2, subsection 705-65(3)]

5.61 As these outstanding cost base adjustments are brought to account at the joining time, the adjustments will have no further application in relation to membership interests in the joining entity. [Schedule 1, item 2, subsection 705-65(4)]

5.62 Examples of provisions under which relevant cost base adjustments may be required at the joining time are set out in Table 5.2.

Table 5.2: Provisions under which cost base adjustments may be required
Provision What the provision is about
Section 170ZP of the ITAA 1936. Transfers of net capital losses within company groups.
Division 19A of Part IIIA of the ITAA 1936. Transfers of assets between companies under common ownership.
Division 19B of Part IIIA of the ITAA 1936. Share value shifting arrangements.
Division 138. Value shifts between companies under common ownership.
Division 139. Value shifting through debt forgiveness.
Division 140. Share value shifting.
Subdivision 170-B. Transfers of net capital losses within wholly-owned groups of companies.
Subdivision 170-C. Transfers of tax losses and net capital losses within wholly-owned groups of companies.

5.63 The reduced cost base of a membership interest should be increased by any reduction to this cost base previously made under subsection 110-55(7) for distributions of certain profit. This is done in order to prevent this adjustment being made twice, because the allocable cost amount is also reduced in step 4 for any distributions of profit in excess of profits accruing directly or indirectly to the head company (see paragraphs 5.86 and 5.87). [Schedule 1, item 2, subsection 705-65(5)]

5.64 An existing group members cost of acquiring a right or option (issued by a joining entity) to acquire membership interests in the joining entity is also counted as part of the groups cost of acquiring the membership interests of the joining entity. [Schedule 1, item 2, subsection 705-65(6)]

Step 2: Add liabilities of the joining entity

5.65 The second step in determining a groups allocable cost amount for a joining entity is to add amounts that are the joining entitys liabilities in accordance with accounting standards or statements of accounting concepts made by the Australian Accounting Standards Board. A joining entitys liabilities reflect part of the cost to the group of acquiring the joining entity, because:

·
liabilities the joining entity owed to third parties become liabilities of the consolidated group (which includes the joining entity); and
·
liabilities that the joining entity owed to existing members of the consolidated group cease to be assets of the group.

5.66 The amount is worked out by adding up all of a joining entitys liabilities at the joining time that, in accordance with accounting standards or statements of accounting concepts made by the Australian Accounting Standards Board, can or must be identified in the entitys statement of financial position. [Schedule 1, item 2, subsection 705-70(1)]

5.67 SAC 4: Definition and Recognition of the Elements of Financial Statements (March 1995) defines liabilities to be the future sacrifices of economic benefits that the entity is presently obliged to make to other entities as a result of past transactions or other past events. Aside from satisfying the definition of liability, recognition criteria must also be satisfied. In accordance with SAC 4, a liability should be recognised in the statement of financial position when and only when:

(a)
it is probable that the future sacrifice of economic benefits will be required; and
(b)
the amount of the liability can be measured reliably.

5.68 The accounting standards and statements of accounting concepts may not apply to all entities. However, if an entity joins a consolidated group then it is necessary to identify the relevant liabilities by reference to those liabilities that can or must be identified under the accounting standards or statements of accounting concepts. This requirement enables consistent rules to be applied in determining the allocable cost amount for all entities that join a consolidated group.

5.69 An amount is not to be added as a liability if it arises because of a joining entitys ownership of an asset where, on disposal of the asset, the liability will transfer to the new owner. The amount of such a liability should be taken into account in working out the market value of the asset when allocating the allocable cost amount for the joining entity to the assets of the joining entity. An example of such a liability would be a liability to rehabilitate a mine site, where under legislation or license, the liability will transfer to the new owner on disposal of the mine. [Schedule 1, item 2, subsection 705-70(2)]

5.70 If some or all of a liability will be a deduction to the head company when the liability is discharged, the amount of the liability to be taken into account is reduced by the amount that will be a deduction multiplied by the general company tax rate. This is so that only the net cost to the group of the liability is taken into account as a cost of acquiring the entity. [Schedule 1, item 2, subsection 705-75(1)]

5.71 The amount taken into account for a liability of a joining entity which is a debt or other liability owed to the joined group is affected by the market value of the asset (reflecting the liability) owned by the joined group. If the market value is equal to or more than the groups cost base for the asset, the amount to be added is the groups cost base. If the market value is less than or equal to the groups reduced cost base, the amount to be added is the groups reduced cost base. If the market value falls between the groups cost base and reduced cost base, the amount to be added is the market value of the asset. [Schedule 1, item 2, subsection 705-75(2)]

5.72 If a liability of a joining entity is a pre-CGT asset of an existing member of a joined group, an amount is not added for indexation in determining the members cost base for the asset (see paragraph 5.59). Also, if any adjustments would be made, under existing provisions of the income tax law, to the members cost base or reduced cost base if the member were to dispose of its asset (the liability of the joining entity), those adjustments are made where the cost base or reduced cost base is taken into account for working out the groups step 2 amount for the liability. These rules correspond to rules for determining a groups cost base and reduced cost base for membership interests in a joining entity (see paragraphs 5.60 to 5.62) [Schedule 1, item 2, subsection 705-75(3)]

5.73 Where a liability, or a change in the amount of a liability, is taken into account, under generally accepted accounting principles, sooner than occurs for income tax and if the liability were taken into account at the earlier time for income tax this would cause the allocable cost amount to be different, the amount of the liability is adjusted for the purposes of step 2. The amount of the adjustment is the amount required to cause the allocable cost amount to be the amount that it would be if the liability were taken into account for income tax purposes at that earlier time. Examples of such liabilities are employees accrued entitlements to paid leave and liabilities that are designated in a foreign currency. [Schedule 1, item 2, subsection 705-80(1)]

Example 5.5: Increase in the amount of a liability recognised for accounting but not for income tax M Co, the head company of a consolidated group, acquires 80% of the membership interests in N Co for $800 when N Cos only asset is the goodwill of a business which has a market value of $1,000. After operating for an income year, N Co breaks even on cash account but accrues a liability of $100 for employees accrued leave entitlements. Assuming a company tax rate of 30%, N Co recognises a deferred tax asset of $30 (30% of $100) in respect of the liability for employees leave entitlements. M Co then acquires the remaining 20% of the membership interests in N Co for $186 (20% (1,000 + 30 - 100)), the market value of N Cos goodwill still being $1,000. N Co then becomes a member of M Cos consolidated group.If M Cos allocable cost amount for N Co were worked out disregarding the adjustment for differences in the time a liability is taken into account for general accounting purposes and for income tax, the allocable cost amount would be $1,056, comprised of $986 for the cost base of membership interests (step 1 in working out the allocable cost amount) and $70 for liabilities (the after-tax value of the liability for employees leave - step 2).However, if the liability were taken into account for income tax at the same time as for general accounting, N Co would have a carry-forward tax loss of $100 at the joining time. M Cos allocable cost amount for N Co, worked out under this assumption, would be $1,000, comprised $986 for the cost base for membership interests (step 1), plus $100 for liabilities (the full amount of the liability for employees entitlements is added at step 2 as the deduction for income tax has already been claimed), less $80 for an owned loss (80% of $100 at step 5) and less a further $6 for an acquired loss (30% of ($100 - $80) at step 6).Therefore, for working out the allocable cost amount, the amount for the liability for employees leave is reduced by $56. The allocable cost amount is, then, $1,000, made up of $986 for cost of membership interests (step 1) and $14 for liabilities of the joining entity (step 2).The whole of the allocable cost amount is allocated to the goodwill. No amount is allocated to the deferred tax asset consisting of the entitlement to a deduction for the employees leave as it is an excluded asset - because an amount was deducted for the future tax deduction at step 2.

Example 5.6: Decrease in the amount of a liability recognised for accounting but not for income tax S Co, the head company of a consolidated group, acquires 90% of the membership interests in T Co for $9 when T Co has assets with a market value of $100 and a foreign currency liability with an Australian currency value of $90. During the remainder of its income year, T Co has neither taxable income nor a tax loss and, due to a movement in the exchange rate, the Australian currency value of its foreign exchange liability decreases to $80. S Co then acquires the remaining membership interests in T Co for $1.70 (T Co has an asset with a market value of $100, a foreign exchange liability with an Australian currency value of $80 and an exposure to income tax of $3 - assuming a 30% company tax rate - on the decline in the Australian currency value of the foreign exchange liability) and T Co becomes a subsidiary member of S Cos consolidated group.If S Cos allocable cost amount for T Co were worked out without regard to the adjustment for differences in the time at which the change in the value of the foreign exchange liability is taken into account for general accounting and for income tax, the allocable cost amount would be $93.70, comprised of:

·
$10.70 for cost base for membership interests (step 1 in working out allocable cost amount); plus
·
$83.00 for liabilities (step 2 - $80 for the foreign currency liability and $3 for the deferred tax liability).

Alternatively, if S Cos allocable cost amount for T Co were worked out assuming that changes in the foreign currency liability are taken into account for income tax at the same time as for general accounting, the allocable cost amount would be $100, comprised of:

·
$10.70 for cost base for membership interests (step 1); plus
·
$83.00 for liabilities ($80 for the foreign currency liability and $3 for income tax - step 2); plus
·
$6.30 for the portion of the frankable undistributed profits that accrued to S Cos continuously held membership interests in T Co (90% of $7 - step 3).

The allocable cost amount is $6.30 greater ($100 - $93.70) where the income tax treatment of the foreign currency liability is aligned with the general accounting treatment. Therefore, $6.30 is added to the amount of the liability for the purpose of working out S Cos allocable cost amount for T Co. The allocable cost amount is $100, comprised of:

·
$10.70 for cost base for membership interests (step 1 in working out allocable cost amount); and
·
$89.30 for liabilities (step 2 - $86.30 for the foreign currency liability and $3 for the deferred tax liability).

$6.30 of the $10 decline in the Australian currency value of the foreign exchange liability is added to the actual amount of the liability at the joining time because, if the liability had been realised just before the joining time, it would have caused an increase in the amount of frankable undistributed profits accruing to S Cos continuously held membership interests ($6.30 (90% $7)) added at step 3 - see paragraphs 5.80 and 5.85.The outcome is that there is no change to the aggregate cost base for S Cos assets. This is appropriate as S Co has not realised any profits or losses for income tax purposes.

5.74 Where all of the historical information required for calculating the adjustment for differences in the time at which changes in the amounts of liabilities are taken into account for general accounting and income tax purposes is not available, the amount of the adjustment should be determined on the most reliable basis for estimation available. [Schedule 1, item 2, subsection 705- 80(2)]

5.75 Where there are employee shares in a joining entity that are disregarded in determining whether the joining entity is a wholly-owned subsidiary of the head company, those shares are treated as a liability of the joining entity at an amount equal to the market value of those shares at the joining time. [Schedule 1, item 2, subsection 705-85(1)]

5.76 The amount added at step 2 for disregarded employee shares will be reduced where the employee shares were issued after the joined group acquired membership interests in the joining entity. Part of these employee shares is not treated as liabilities because it represents part of the price paid by the head company for its interest in the assets of the joining entity which were subsequently paid to employees. The rule applies to the head companys contribution to the discount on the employee shares, that is, to the excess of the market value of the employee share interests over the consideration given for their acquisition by the employees. [Schedule 1, item 2, subsection 705-85(2)]

5.77 The amount of the reduction is determined by applying to the market value of each employee share at the time it was acquired by the employee the factor derived from the following formula:

formula to calculate the reduction

where:

·
market value of head companys membership interests is the market value, just before the employee share interest was acquired by the employee, of any membership interests that the head company held, directly or indirectly in the joining entity, continuously from that time until the joining time.
·
market value of all membership interests is the market value of all membership interest in the joining entity just before the employee share interest was acquired.

Example 5.7: Employee shares Headco, the head company of a consolidated group, owns 90%, by value, of the membership interests in Zedco when Zedco issues employee shares. The employees are not required to make any payment for the shares which have a value of $3 at their time of acquisition. Headco subsequently acquires the minority interests in Zedco apart from the employee shares. As the employee shares are not more than 1% of the ordinary shares in Zedco, Zedco becomes a subsidiary member of Headcos consolidated group (see paragraph 3.72).Applying the formula for working out the factor gives:

90% * [($3-$0) / $3] = 0.9

The amount of the reduction for each share is $2.70 (0.9 $3).If, at the joining time, the employee shares in Zedco have a market value of, say, $3.30, the amount to be added to the step 2 liability amount for each employee share would be $0.60 ($3.30 - $2.70).

5.78 Rights or options to acquire membership interests in a joining entity that were issued by the joining entity and are not held by a member of the joined group are treated as liabilities of the joining entity for the purpose of step 2 in working out the allocable cost amount. This is because the joined group will have to acquire these rights or options prior to them being exercised to preserve the entitlement of the joining entity to remain a subsidiary member of the consolidated group. The amount treated as a liability of the joining entity is the market value of the rights and options at the joining time. [Schedule 1, item 2, paragraph 705-85(3)(a)]

5.79 Specific provision is also made for treating debt interests covered by Subdivision 974-B as liabilities of a joining entity where those debt interests are regarded as equity interests for general accounting purposes. Specific provision is required because these debt interests are excluded from the definition of membership interests (see paragraph 3.68) but are not covered by the general definition of liabilities for step 2 in working out the allocable cost amount because they do not fall within the accounting definition of liabilities (see paragraphs 5.65 to 5.67). The amount to be included for these debt interests, at step 2 in working out the allocable cost amount, is their market value at the joining time. [Schedule 1, item 2, paragraph 705-85(3)(b)]

Step 3: Add undistributed, frankable profits accruing to the joined group

5.80 The third step in determining a groups allocable cost amount for a joining entity is to add the sum of fully franked dividends the head company would have received from the joining entity under specified hypothetical conditions. [Schedule 1, item 2, subsection 705-90(1)]

5.81 The hypothetical conditions are that:

·
the undistributed profits of the joining entity at the joining time (except profits that recouped losses that accrued to the joined group before the joining time) were distributed as dividends as they accrued;
·
the dividends were franked to the maximum extent that would be possible if income tax on the profits was paid as the profits accrued; and
·
entities interposed between the head company and the joining entity successively distributed any fully franked dividends they received immediately upon receiving them.

[Schedule 1, item 2, subsections 705-90(2) and (3)]

5.82 Whether a loss accrued prior to the joining time is identified by drawing a parallel between the loss and a profit that accrued to the joined group. [Schedule 1, item 2, subsections 705-90(4) and (5)]

5.83 Effectively, a loss that accrued to a joined group is so much of a tax loss, net capital loss or overall foreign loss of a joining entity that, as it accrued, accrued to membership interests held by members of the joined group. The membership interests held by members of the existing group may be either actual membership interests in the joining entity or indirect interests in the joining entity held through holding membership interests in other entities. The membership interests are only those that are held continuously by members of the joined group from when the loss accrued until the joining time.

5.84 The purpose of this step is, consistent with the imputation system, to prevent double taxation by allowing a consolidated group a cost for retained taxed or taxable profits that accrued to membership interests when the membership interests were held by the consolidated group (as can occur where there is an incremental acquisition of an entity). The groups allocable cost amount is spread across all of the joining entitys assets at the joining time, including assets that represent earnings whilst the group has held membership interests that have been retained in the entity. Therefore, not to add an amount for these retained earnings in the allocable cost amount would result in double taxation upon the disposal of those assets. The step is not intended to prevent the double taxation of profits derived under the classical system of company taxation that existed before the imputation system was introduced.

Example 5.8: Undistributed frankable profits On 1 July 1998, Head Co subscribed $6 for 60% of the membership interests in X Co. On 1 July 2002, Head Co forms a consolidated group and acquires the remaining 40% of the membership interests in X Co for $32. At that time, X Co has taxed retained profits of $70, and one reset cost base asset with a cost base and market value of $80.In the absence of any adjustment, Head Cos allocable cost amount for X Co would be $38, being the cost base of Head Cos membership interests in X Co ($6 + $32). The reset cost for the asset brought into the group by X Co would be $38. If this asset were subsequently sold for its market value ($80), a capital gain of $42 would be realised. The taxation of the capital gain would represent double taxation of the 60% of the $70 retained profits of X Co that accrued to Head Cos continuously held membership interests.The adjustment under this step would increase the groups allocable cost amount in relation to X Co by $42 to $80. This would become the cost for tax purposes for the reset cost base asset brought into the group by X Co.

5.85 Historical records that would facilitate precise identification of the income tax payable on profits of a joining entity that were earned during a particular period may not be available to the group joined. Therefore, provision is made that the head company can use the most reliable basis for estimation that is available. Similar provision is made for estimation of the amount of a loss or a profit that accrued to a joined group during a period. [Schedule 1, item 2, subsection 705-90(6)]

Step 4: Subtract pre-joining time distributions of profits that were earned before the membership interests were acquired or which recouped a loss

5.86 The fourth step in determining a groups allocable cost amount for a joining entity is to subtract distributions to the head company (directly, or indirectly by distribution to an entity in which the head company has a direct or indirect membership interest) by the joining entity out of certain profits. The profits are profits that either:

·
did not accrue to membership interests continuously held by members of the joined group until the joining time; or
·
recouped a loss that accrued to membership interests continuously held by members of the joined group until the joining time.

[Schedule 1, item 2, section 705-95]

5.87 The purpose of this step is to prevent the reset costs for a joining entitys assets reflecting an amount paid for the membership interests in the entity that was later (but before it became a member of the joined group):

·
recovered through distributions; or
·
lost and, following the recoupment of the loss, the profit that recouped the loss was distributed.

Example 5.9: Cost of membership interests recovered through distributions On 29 September 2002, Head Co, the head company of a consolidated group, acquired 70% of the membership interests in F Co for $420. At that time, F Co had assets with a market value of $600, including undistributed taxed profits of $100. On 30 September 2002, F Co paid a fully franked dividend of $100, of which Head Co received $70. Following the distribution, the assets of F Co have a market value of $500.On 1 October 2002, Head Co purchased the remaining 30% of membership interests in F Co for $150 and F Co becomes a subsidiary member of Head Cos consolidated group. In the absence of any other adjustments, the groups allocable cost amount for F Co would be $570 (reflecting the cost to Head Co of acquiring the membership interest in F Co). This would then be allocated to F Cos assets, which have a market value of only $500. An immediate disposal of all of those assets would result in a capital loss of $70, despite Head Co having suffered no economic loss.The step 4 adjustment makes the required reduction in the allocable cost amount for F Co. Step 4 in working out the allocable cost amount will subtract the $70 dividend paid by F Co to Head Co on 30 September 2002. It does so because the $70 was a distribution of profits that were earned before Head Co acquired the membership interests in respect of which the dividend was paid. Example 5.10: Dividend out of profits that recoup a loss that accrued to membership interests continuously held by the joined group On 1 July 2002, Top Co, the head entity of a consolidated group, acquired 60% of the membership interests in Subco for $60. At that time, Subco had assets with a market value of $100. In the year ended 30 June 2003, Subco made a loss of $30. In the year ended 30 June 2004, Subco made a profit of $30. Subco distributed this profit as an unfranked dividend on 1 July 2004 and Top Co receives $18 of the dividend.On 2 July 2004, Top Co purchased the remaining 40% of the membership interests in Subco for $28 (reflecting a market value for Subcos assets of $70) and Subco became a subsidiary member of Top Cos consolidated group. Top Cos allocable cost amount for Subco is $70, consisting of $88 for the cost of membership interests (step 1 in working out the allocable cost amount) less $18 for a dividend paid to Top Co out of profits that recouped a loss that accrued to membership interests continuously held by Top Co (step 4).In the absence of the adjustment for distributions out of profits that recoup owned losses, the Top Cos allocable cost amount for Subco would be $88, which would reinstate Top Cos share of the loss in an unrealised form when treated as Top Cos cost for Subcos assets.

Step 5: Subtract losses accruing to continuously held membership interests

5.88 The fifth step in determining a groups allocable cost amount for a joining entity is to subtract the carry forward tax losses and net capital losses of the joining entity to the extent that those losses accrued to membership interests that were directly or indirectly owned by the head company and were continuously held by the head company until the joining time (a groups owned component of the losses of a joining entity). [Schedule 1, item 2, subsection 705-100(1)]

5.89 Determination of whether a loss accrued to a membership interest that was continuously held by the head company (i.e. the joined group) is discussed at paragraphs 5.82 and 5.83.

Example 5.11: An owned loss Jayco, the head company of a consolidated group, acquired 90% of the membership interests in Kayco on 28 February 2003. In April 2003, Kayco disposed of an asset and realised a capital loss of $30 on the disposal. That $30 became Kaycos carry-forward net capital loss for the year ended 30 June 2003.On 1 July 2004, Jayco purchased the remaining 10% of the membership interests in Kayco and Kayco became a subsidiary member of Jaycos consolidated group. In considering whether Kaycos net capital loss should be deducted in working out the allocable cost amount, it was determined that $10 of the loss in value of the asset on which the capital loss was realised occurred after Jayco acquired a 90% stake in Kayco. Therefore, $9 of the loss is required to be deducted (at step 5) in working out the allocable cost amount.

5.90 A carry-forward loss is only subtracted at step 5 in working out the allocable cost amount to the extent that the loss does not have the effect of reducing the amount that is added at step 3 . A loss will have the effect of reducing the amount at step 3 if the loss:

·
reduces the amount of undistributed profits (other than profits that recouped certain losses) of a joining entity at its joining time that accrued to members of the joined group in respect of their continuously held membership interests; and
·
those undistributed profits could have been fully franked as they accrued.

Example 5.12: An owned loss that reduces the undistributed profits added at step 3 Subco was formed with a paid up capital of $100. Of this, $90 was contributed by Holdco in exchange for 90% of the membership interests. Minco subscribed $10 for the remaining 10% of the membership interests.Holdco is the head company of a consolidated group.In its first year of operation, Subco had a profit before tax of $10. Subco subsequently paid income tax of $3 but did not distribute any of the profit as a dividend. In the next year, Subco made a tax loss of $7.Immediately upon the completion of this second year, Holdco purchased Mincos interest in Subco for $10.21 and Subco became a subsidiary member of Holdcos consolidated group. The price Holdco paid for Mincos interest reflected an expectation that Holdco would be able to utilise Mincos share of Subcos carry-forward tax loss - the value attributed to the deduction being $0.21 (see below).Holdcos allocable cost amount for Subco is $100, comprised $100.21 for its cost base for membership interests (the step 1 amount) less $0.21 (($7 - $6.30) 30% - the company income tax rate) for the acquired component of Subcos carry-forward tax loss (the step 6 amount). Nothing is deducted for the owned part of the loss (at step 5) ($6.30 being 90% $7) because this element reduces the amount that would otherwise be added for owned frankable undistributed profits (at step 3).

5.91 Without this step, a consolidated group could get a double benefit for the owned component of a joining entitys losses. The group could get the benefit of deducting the losses when working out its future taxable income. In addition, allocable cost amount properly attributable to assets that had been lost would be allocated to the assets remaining after the losses.

5.92 This step also prevents a benefit from an owned loss being reinstated through a higher cost for remaining assets where the loss is not permitted to be transferred to the head company or is cancelled by the head company (see Chapter 6).

Step 6: Subtract an amount for certain losses transferred to the head company

5.93 The sixth step in determining a joined groups allocable cost amount for a joining entity is to subtract an amount for the groups acquired losses of the joining entity that are transferred to the head company and not cancelled. The amount subtracted for these losses is the amount of the losses multiplied by the company tax rate. [Schedule 1, item 2, section 705-110]

5.94 The groups acquired losses of the joining entity are those tax losses, net capital losses and overall foreign losses of the joining entity at the joining time that did not accrue to membership interests that were continuously held by members of the joined group from when the loss accrued until the joining time.

5.95 Consistent with the treatment of acquired deductions of a joining entity (see paragraph 5.96), this adjustment reflects the amount by which the loss would reduce the head companys tax liability when the loss is deducted if the company tax rate is unchanged from its rate at the joining time.

Example 5.13: An acquired loss Trader Co subscribed $100 for all of the membership interests in a new company, Z Co. Z Co used the $100 to acquire 2 assets for $60 and $40 respectively. Trader Co and Z Co do not form a consolidated group.Subsequently, Z Co disposed of its second asset for $0, realising a net capital loss of $40 ($0 - $40).On 1 July 2004, Head Co, the head company of a consolidated group, acquires all of the membership interests in Z Co for $72. The price paid for Z Co reflects the unchanged market value ($60) of the asset Z Co acquired for $60 and an amount ($12) for Z Cos net capital loss, which is able to be transferred to Head Co.Head Cos allocable cost amount for Z Co is $60, comprised $72 at step 1 for the cost of membership interests less $12 (30% of $40) at step 6 for the acquired loss multiplied by the company tax rate.The whole of the allocable cost amount is allocated to the asset with a market value of $60 and none to the deferred tax asset for the net capital loss. Nothing is allocated to the deferred tax asset because it is an excluded asset (see paragraphs 5.31 to 5.32).

Step 7: Subtract an amount for certain deductions to which the head company is entitled

5.96 The seventh step in determining a groups allocable cost amount for a joining entity is to deduct an amount for certain deductions inherited by the head company for expenditure incurred by the joining entity prior to the joining time. The amount deducted is calculated in accordance with the following formula:

owned deductions + (acquired deductions * general company tax rate)

where:

·
owned deductions are deductions for expenditure incurred by the joining entity that, at the time the expenditure was incurred, was in respect of membership interests that were directly or indirectly owned by the head company continuously until the joining time; and
·
acquired deductions are deductions for expenditure incurred by the joining entity that are not owned deductions.

[Schedule 1, item 2, subsection 705-115(1)]

5.97 The deductions referred to are deductions for expenditure inherited from the joining entity because of section 701-5 that when incurred would not have been included in or would not reduce the cost of an asset of the joining entity. These are unclaimed deductions for expenditure incurred prior to the joining time where the expenditure is not allowed in full as a tax deduction when incurred. For example, the deduction for the expenditure is spread over a number of income years. [Schedule 1, item 2, paragraph 705-115(2)(a)]

5.98 Examples of the deductions for expenditure that could be included in this step are:

·
expenditure allocated to a software development pool (sections 40-450 to 40-460);
·
capital expenditure associated with certain projects and certain business related costs (Subdivision 40-I);
·
borrowing expenses (section 25-25); and
·
certain gifts where the deduction is spread over 5 years. Cultural gifts (section 30-248), environmental gifts (section 30-249B) and heritage gifts (section 30-249E).

5.99 There would be circumstances where the above expenditure would have been included in, or would have reduced, the cost for tax purposes of an asset of the joining entity.

5.100 Where the expenditure has contributed to the cost of an asset it should not be included in this step. Examples of deductible expenditure that does contribute to the cost of an asset are:

·
Expenditure deductible under Subdivision H of Division 3 of Part III of the ITAA 1936 (deductibility of certain advance expenditure) would be included in the cost of an asset of the joining entity being a right to future services.
·
Expenditure incurred on capital works (Division 43 of the ITAA 1997) in respect of buildings acquired after 13 May 1997, subject to certain transitional provisions, would reduce the cost of a CGT asset as the Division 43 deduction is claimed.
·
Expenditure acquiring a depreciating asset reduces the adjustable value of the asset as the depreciation deductions are claimed.

5.101 Section 110-40 applies to CGT assets acquired before 7.30pm on 13 May 1997. To ensure that deductions in regard to certain expenditure will not reduce the allocable cost amount at this step, it is necessary to exclude from subsection 705-115(2) a deduction to which section 110-40 applies. [Schedule 1, item 2, paragraph 705-115(2)(b)]

5.102 A reduction should not be made at this step to the extent that the expenditure that gave rise to the deduction reduced the amount of the undistributed profit that is added at step 3 (paragraphs 5.80 to 5.85). Expenditure will have the effect of reducing the amount at step 3 if the expenditure:

·
reduces the amount of undistributed profits (other than profits that recouped certain losses) of a joining entity at its joining time that accrued to members of the joined group in respect of their continuously held membership interests; and
·
these profits could have been fully franked as they accrued.

See Example 5.12 which is about how losses should not be subtracted at step 5 to the extent that the loss does not have the effect of reducing the amount that is added at step 3. [Schedule 1, item 2, paragraph 705-115(2)(c)]

When is a membership interest continuously held?

5.103 Steps 3 to 5 in the calculation of the allocable cost amount require that profits and losses of a joining entity be worked out for the period that each membership interest in the joining entity was continuously held. Generally this would be the period that:

·
starts when the head company starts to hold directly or indirectly membership interests in the joining entity which the head company continues to hold until the joining time; and
·
ends at the joining time.

[Schedule 1, item 2, section 705-105]

5.104 However, a membership interest will be taken not to have been held continuously if, before the joining time, the cost base or the reduced cost base of the membership interest was taken by a provision of the income tax law to be the market value at a particular time. Where this occurs the membership interest is taken not to have been held by the head company prior to the time the cost base was taken to be its market value.

Example 5.14: Continuity of holding a membership interest At 1 July 1997, Head Co owns 50% of the membership interests in each of L Co and M Co. On 1 July 1998, L Co acquires 60% of the membership interests in P Co. On 1 July 1999, L Co transfers its interest in P Co to M Co. There is no rollover relief available in relation to the disposal. On 1 July 2002, Head Co acquires the remaining membership interests in L Co and M Co, and chooses to form a consolidated group. On 1 July 2003, M Co acquires the remaining 40% of the membership interests in P Co which causes P Co to join the consolidated group.Head Co first began to hold an indirect interest in P Co (the joining entity) on 1 July 1998. However, the continuity of holding in relation to this interest is broken when L Co transfers its interest in P Co to M Co without rollover. The period during which this membership interest will be taken to have been held continuously will start on 1 July 1999 (i.e. when M Co first held membership interests in P Co which were then held continuously until the joining time).

5.105 Table 5.3 contains examples of provisions within the income tax law that set the cost base and reduced cost base of membership interests in an entity to market value at a particular time. If 2 or more of the provisions apply, the interest is taken to have been acquired at the latest of the times specified.

Table 5.3: Certain deemed acquisitions under the CGT provisions
Provision What the provision is about
Section 160ZZS of the ITAA 1936 and Subdivision C of Division 20 of Part IIIA of the ITAA 1936. Changes in majority underlying interests in pre-CGT assets.
Paragraph 160ZZOA(1)(e) of the ITAA 1936. Companies ceasing to be related after application of section 160ZZO (on rollover for asset transfers between related companies).
Subsection 160M(12) of the ITAA 1936. Becoming an Australian resident.
Subsection 104-175(8) of the ITAA 1997. Company ceasing to be a member of a wholly-owned group after rollover.
Subsection 136-40(3) of the ITAA 1997. Becoming an Australian resident.
Subsections 149-30(1) or 149-70(2) of the ITAA 1997. When an asset stops being a pre-CGT asset.

Preservation of unrealised losses relating to membership interests in a joining entity

5.106 Some or all of a groups membership interests in a joining entity may have become subject to Subdivision 165-CC of the ITAA 1997. The effect of this is that the group would be able to take losses on disposal of these interests into account only if it satisfies the SBT. To preserve this effect when the joining entity becomes part of the head company, the application of Subdivision 165-CC is transferred to the assets the joining entity brings into the consolidated group. It applies to each of these CGT assets in the proportion:

(market value of membership interests subject to Subdivision 165-CC just before the joining time) / (market value of all membership interests just before the joining time)

[Schedule 1, item 2, subsections 705-120(1) to (3)]

5.107 If any of the assets of a joining entity were subject to Subdivision 165-CC, apart from the effect explained in paragraph 5.107, they are not subject to Subdivision 165-CC as assets of the consolidated group [Schedule 1, item 2, subsection 705-120(4)] . The continued application of Subdivision 165-CC to these assets is not required because resetting their cost based on the groups cost for membership interests itself fulfils the purpose of preventing the duplication of a loss realised by the vendors of membership interests in the joining entity.

Preservation of pre-CGT status of membership interests in a joining entity

5.108 The pre-CGT status of membership interests in a joining entity are an attribute of the assets of the group being joined (as opposed to being an attribute of the assets of the joining entity). Therefore, unlike the pre-CGT status of the assets of a joining entity that is preserved by the entry history rule, this status would be lost without a special rule to preserve it. This reflects that within a consolidated group intra-group membership interests are disregarded as the groups cost for membership interests is stored in its cost for assets.

5.109 Pre-CGT status for membership interests is preserved:

·
where the head company of a joined group directly holds membership interests in the joining entity that are pre-CGT assets; and
·
where any of the subsidiary members of the joined group have a pre-CGT factor for membership interests that they hold in the joining entity.

5.110 The pre-CGT status of those interests is preserved by attaching a pre-CGT factor to the assets of the joining entity at the joining time, other than those that are current assets in accordance with the accounting standards [Schedule 1, item 2, subsections 705-125(1) and (2)] . The term current asset is defined in AASB: 1010 Recoverable Amount of Non-Current Assets (December 1999) in paragraph 9.1 as meaning an asset that:

(a)
is expected to be realised in, or is held for sale or consumption in, the normal course of the entitys operating cycle;
(b)
is held primarily for trading purposes or for the short-term and is expected to be realised within twelve months of the reporting date; or
(c)
is cash or a cash-equivalent asset which is not restricted in its use beyond twelve months or the length of the operating cycle, whichever is greater.

5.111 This allows a proportion of the membership interests in an entity that leaves a consolidated group to be treated as pre-CGT assets by reference to the pre-CGT factors of assets in the leaving entity (see paragraphs 5.146 to 5.152). The entity that leaves will not necessarily be the same entity whose membership interests were pre-CGT assets of the joined group.

5.112 The pre-CGT factor that applies to each asset, that is not a current asset, is obtained by adding:

·
the market values of the pre-CGT membership interests in the joining entity that are held directly by the head company; and
·
the products of market values of the membership interests in the joining entity that are held by subsidiary members of the joined group and their respective pre-CGT factors,

and dividing this sum by the sum of the market values of all the assets of the joining entity at the joining time that are not current assets. However, if the amount calculated in this way would be more than one, the pre-CGT factor is one. [Schedule 1, item 2, subsection 705-125(3)]

5.113 The pre-CGT factor only attaches to assets that existed at the joining time and is lost if the asset is disposed of directly (rather than indirectly by way of disposing of an entity which takes the asset with it). The factor is not attached to any replacement asset.

What happens when an entity leaves a consolidated group?

5.114 Division 711 contains the rules for setting the head companys cost of membership interests in subsidiary entities when they leave a consolidated group. Entities may leave a consolidated group where the group continues to exist and where the group ceases to exist. The situations where the group ceases to exist are discussed in paragraphs 5.14 to 5.15. This Division does not apply when the consolidated group joins another consolidated group. Proposed law dealing with the case of a consolidated group joining another consolidated group will be contained in a later bill.

Membership interests in the leaving entity

5.115 Where a subsidiary member (the leaving entity) leaves a consolidated group (the old group) the head company recognises, just before the time the entity leaves, the membership interests in the leaving entity. These membership interests would not be recognised whilst the entity was a member of the group. The cost for the membership interests is set at a cost equal to the head companys cost for the net assets that the leaving entity takes with it. This preserves the alignment between the costs for membership interests in the entity and its assets. The time at which the leaving entity leaves the old group is called the leaving time. [Schedule 1, item 2, section 701-15]

5.116 The recognition of the membership interests in the leaving entity does not apply to membership interests held by someone other than a member of the old group (i.e. the holder of an employee share).

5.117 Matters relating to the head companys recognition of the membership interests in the leaving entity are:

·
the setting of the cost of membership interests when a single entity leaves (see paragraphs 5.118 to 5.141);

-
steps in working out the old groups allocable cost amount (see paragraphs 5.118 to 5.135);
-
more than one class of membership interests (see paragraphs 5.136 to 5.138);
-
head companys terminating value for an asset (see paragraph 5.139);
-
where there is a capital loss on disposal of membership interests (see paragraph 5.140); and
-
treatment of goodwill (see paragraph 5.141).

·
where a group of entities leave at the same time (see paragraphs 5.142 and 5.143);
·
membership interests potentially subject to Subdivision 165-CC (see paragraphs 5.144 to 5.146); and
·
pre-CGT status for membership interests (see paragraphs 5.147 to 5.153).

The setting of the cost of membership interests when a single entity leaves

5.118 The cost of the membership interests in the leaving entity is determined by working out the old groups allocable cost amount for the leaving entity. The old groups allocable cost amount for the leaving entity reflects the cost of the net assets that the leaving entity takes with it as well as certain adjustments and is determined in 6 steps. [Schedule 1, item 2, section 711-20]

Diagram 5.2: Old group's allocable cost amount

Step 1: Terminating values of assets

5.119 The first step in determining the old groups allocable cost amount for a leaving entity is to add up the head companys terminating values (see paragraph 5.139) of all the assets that the head company holds at the leaving time because the leaving entity is taken to be part of the head company. [Schedule 1, item 2, subsection 711-25(1)]

Step 2: Certain deductions inherited from the head company

5.120 The second step in determining the old groups allocable cost amount is to add an amount for deductions that the leaving entity inherits from the head company. The amount to be added is calculated in accordance with the following formula:

owned deductions + (acquired deductions * general company tax rate)

where:

·
owned deductions are for expenditure inherited from the head company because of section 701-40 that when incurred would not have been included in or would not reduce the cost of an asset of the head company or a joining entity. These are unclaimed deductions for expenditure incurred prior to the leaving time where the expenditure is allowed as a tax deduction over more than one year of income; and
·
acquired deductions are deductions that were acquired deductions of the head company under subsection 705-115(1) (see paragraph 5.96).

5.121 For examples of the deductions that are covered by this step refer to paragraphs 5.98 to 5.101 dealing with deductions inherited by the head company when an entity joins a consolidated group. [Schedule 1, item 2, section 711-35]

Step 3: Liabilities owed by members of the old group

5.122 The third step in determining the old groups allocable cost amount is to add the amount relating to any liabilities actually owed by members of the old group to the leaving entity at the leaving time. The amount is the market value of all those assets of the leaving entity at that time. This element of the allocable cost amount is separately identified because, whilst an entity is a member of a consolidated group, liabilities it is owed by other members of the group are not recognised for income tax purposes. [Schedule 1, item 2, subsection 711-40(1)]

5.123 However, a group could gain an unwarranted advantage where the creation of an asset in a leaving entity before its leaving time would have been a CGT event but is a disregarded transaction because of the single entity rule. This can arise where the asset created in the joining entity is a liability of a continuing member of the group. To prevent an unwarranted advantage arising from this source, specific provision is made that, instead of the market value of the leaving entitys asset, the amount that would have been a groups allowed cost in relation to the disregarded CGT event is added at step 3 in working out the groups cost base for its membership interests in the leaving entity. [Schedule 1, item 2, subsection 711-40(2) and (3)]

Example 5.15: Intra group dealing prior to the leaving time Within a consolidated group, land with a market value of $10 million is leased to a group entity, Lefco, for 99 years for a rental of $1 per year. The group had a cost base for this land of $2 million.With this lease as Lefcos only asset, the group sells all of its membership interests in Lefco.The head companys cost for the groups membership interests in Lefco is set at $2 million, because that is the cost that would be allowed to the group for the CGT event constituted by the terms of the lease of the land to Lefco.

Step 4: Liabilities of the leaving entity

5.124 The fourth step in determining the old groups allocable cost amount is to subtract the amount of the leaving entitys liabilities. The amount is worked out by adding up all of a leaving entitys liabilities at the leaving time that, in accordance with accounting standards or statements of accounting concepts made by the Australian Accounting Standards Board, can or must be identified in the entitys statement of financial position. [Schedule 1, item 2, subsection 711-45(1)]

5.125 An amount is not to be added as a liability if it arises because of a leaving entitys ownership of an asset where, on disposal of the asset, the liability will transfer to the new owner. [Schedule 1, item 2, subsection 711-45(2)]

5.126 If some or all of the liability will be a deduction to the leaving entity when the liability is discharged, the amount of the liability to be taken into account is reduced by the amount that will be a deduction multiplied by the general company tax rate. [Schedule 1, item 2, subsection 711-45(3)]

5.127 Where a liability of a leaving entity is owed to a member of the old group then the amount of any such liability instead equals its market value. [Schedule 1, item 2, subsection 711-45(4)]

5.128 Where a liability, or a change in the amount of a liability, is taken into account under generally accepted accounting principles, sooner than occurs for income tax then the amount of any such liability is instead the payment that would be necessary to discharge the liability just before the leaving time without giving rise to a taxable gain nor an allowable deduction to the head company. Refer to paragraph 5.73 for the discussion of how these rules apply to a joining entity. [Schedule 1, item 2, subsection 711-45(5)]

5.129 The step 4 amount is increased by the market value of any employee share interests disregarded under section 703-35. [Schedule 1, item 2, subsection 711-45(6)]

5.130 A further amount is included at step 4 equal to the market value of any debt interests in the leaving entity that are equity for accounting purposes. A specific provision is required to have these debt interests taken into account as liabilities because they are not recognised as liabilities for accounting purposes. [Schedule 1, item 2 subsection 711-45(7)].

Step 5: Ensuring Subdivision 165-CC is not avoided

5.131 The fifth step in determining the old groups allocable cost amount is to subtract the amount determined under subsection 711-50 which applies where there are unrealised net losses and Subdivision 165-CC applies. This step ensures that the head company is not able to avoid the denial of certain losses by disposing of assets via an entity leaving a consolidated group rather than disposing of the assets directly. [Schedule 1, item 2, section 711-50]

5.132 Section 711-50 applies where:

·
one or more of the assets of the leaving entity are assets to which Subdivision 165-CC would apply if there were a loss on their disposal; and
·
Subdivision 165-CC applies to the asset because the asset was an asset of the group when a changeover time occurred in relation to the head company,

the amount included at step 5 in determining the old groups allocable cost amount for the leaving entity is equal to the sum of the denied amounts. [Schedule 1, item 2, subsections 711-50(1) and (2)]

5.133 Any reduction in net asset values as a consequence of the application of section 711-50 will be taken into account as capital losses, deductions or trading stock losses for the purposes of the future application of section 165-115BB to the head company. Taking any reduction in net asset value into account as losses or deductions for the purposes of section 165-115BB has the effect of reducing the head entitys residual unrealised net loss so that the amount by which future losses or deductions of the head company can be denied under this section is correspondingly reduced. [Schedule 1, item 2, subsection 711-50(3)]

Step 6: The old groups allocable cost amount

5.134 If the resulting old groups allocable cost amount after steps 1 to 5 would be negative, it is instead taken to be nil, and the head company is taken to have made a capital gain equal to the negative amount [Schedule 1, item 2, step 6 in the table in subsection 711-20(1)] . Consequential amendments to provide for a capital gain are not included in the accompanying legislation.

5.135 In order to work out the cost of each membership interest in the leaving entity it is necessary to divide the old groups allocable cost amount for the leaving entity by the number of membership interests in the leaving entity. [Schedule 1, item 2, paragraph 711-15(1)(c)]

More than one class of membership interests in the leaving entity

5.136 If there is more than one class of membership interests in the leaving entity, membership interests of different classes may have different market values. In such instances, the cost of membership interests of different classes will also be proportional to the market values of the membership interests. [Schedule 1, item 2, paragraph 711-15(1)(b)]

5.137 Where the head company holds rights or options to membership interests in the leaving entity issued by the leaving entity these rights or options will be treated as if they are a different class of membership interest. [Schedule 1, item 2, subsection 711-15(2)]

5.138 The cost of each membership interest is calculated by:

·
first allocating the groups cost for the net assets of the leaving entity among the different classes in proportion to the aggregate of the market values of each class; and
·
then dividing the cost for the net assets allocated to each class by the number of membership interests in the class.

[Schedule 1, item 2, paragraph 711-15(1)(c)]

Head companys terminating value for an asset

5.139 The head companys terminating value for an asset is the amount that would need to be received for the asset to result in no tax consequences for the consolidated group as a result of the assets leaving the group via a disposal of membership interest. Consequently, there are generally no tax liability outcomes for a head company from the exit, as such, of an entity - as distinct from disposals of membership interests in an exited entity. The exception, where a tax liability could arise, is where the rules dealing with transactions between entities that separate when an entity leaves a consolidated group (see paragraphs 2.75 to 2.77). Table 5.4 provides guidance on determining the head companys terminating value of assets. [Schedule 1, item 2, section 711-30]

Table 5.4: Terminating values of assets of a head company
If the asset of the head company is The terminating value of the asset is
Trading stock that was on hand at the beginning of the income year in which the leaving time occurred. The value at which it was taken into account by the head company at that time under Division 70 of the ITAA 1997.
Trading stock that was livestock acquired by the head company by natural increase during the income year. The cost as provided for under section 70-50 of the ITAA 1997.
Other trading stock that was acquired by the head company during the income year. The amount of the outgoing incurred by the head company in connection with the acquisition of the trading stock or, if there was no such outgoing, nil.
A qualifying security (within the meaning of Division 16E of Part III of the ITAA 1936) that is not trading stock. The amount of the consideration that the head company would need to receive if it were to dispose of the asset just before the leaving time in order for no amount to be included in, or deductible from, the head companys assessable income under section 159GS of the ITAA 1936.
A depreciating asset. Its adjustable value at the leaving time.
A CGT asset that is neither trading stock nor a depreciating asset. Its cost base just at the leaving time.
Any other asset. The amount that would have been its cost base at the leaving time if it were a CGT asset.

Where there is a capital loss on disposal of membership interests

5.140 If it is necessary to work out whether the head company makes a capital loss as a result of a CGT event that happens after the leaving time in relation to any of the membership interests, the amount of the cost of the membership interest is instead worked out as if the terminating value of any CGT asset (that is not trading stock, a qualifying security or a depreciable asset) is instead equal to its reduced cost base just before the leaving time. [Schedule 1, item 2, subsection 711-20(2)]

Treatment of goodwill

5.141 For the purpose of working out the cost of membership interest in the leaving entity, goodwill will be an asset of a leaving entity where it can be demonstrated that goodwill is leaving the group or is lost to the group as a result of the leaving entity ceasing to be a member of the group. This could occur, for example, because the goodwill is linked to assets of the leaving entity, or because of the entity leaving, some synergy is lost to the group. [Schedule 1, item 2, subsection 711-25(2)]

Where a group of entities leave at the same time

5.142 Where, at the leaving time, the leaving entity holds membership interests in other subsidiary members of the consolidated group, then those other subsidiary members will also cease to be members of the group at the leaving time. In these situations, the cost of the membership interests in each of the leaving subsidiaries must be worked out on a bottom-up basis. This ensures that the assets of an entity (the first entity) that are membership interests in another leaving member of the group are first given a cost, which will then be used to determine the terminating value of that asset in working out the cost of membership interests in the first entity. [Schedule 1, item 2, section 711-55]

Example 5.16: Multiple leaving entities On 30 June 2003, M Co (the leaving entity) leaves a consolidated group (the old group). M Co, before the leaving time, owned all the shares in B Co and C Co. B Co owned all the shares in D Co and E Co. The companies were all members of the consolidated group.The leaving entity and all those companies ceased to be members of the consolidated group at the leaving time.In order to work out the cost of the membership interests in the leaving entities it is necessary to first work out the cost of the membership interests in companies C, D and E.Next, work out the cost of the membership interests in B Co, taking into account the cost just worked out for its assets consisting of shares in companies D and E.Finally, work out the cost of the membership interests in the leaving entity, taking into account the cost worked out for the membership interests for companies B and C.

5.143 Consideration is being given to the rules required to prevent loss duplication where a group of entities leave at the same time.

Membership interests potentially subject to Subdivision 165-CC

5.144 Where some or all of a groups membership interests in a joining entity are potentially subject to Subdivision 165-CC at its joining time, a proportion of each of the CGT assets of the joining entity that are brought into the group is subsequently treated as being potentially subject to Subdivision 165-CC (see paragraphs 5.106 and 5.107). If any of these assets become assets of a leaving entity, a proportion of each of the groups membership interests in the leaving entity are made potentially subject to Subdivision 165-CC. The proportion is the proportion of the groups cost for membership interests in the leaving entity that is referable to the proportions of any assets of the leaving entity that were made potentially subject to Subdivision 165-CC upon the entry of an entity into the group. [Schedule 1, item 2 section 711-60]

5.145 However, if these assets are also potentially subject to Subdivision 165-CC because there was a changeover time in relation to the head company, they are not taken into account in determining the proportions of the assets of the leaving entity made potentially subject to Subdivision 165-CC. These assets are dealt with in step 5 of working out the old groups allocable cost amount.

5.146 Assets and membership interests are potentially, rather than actually, subject to Subdivision 165-CC because Subdivision 165-CC only applies where a loss is made in respect of an asset or membership interest.

Pre-CGT status for membership interests

5.147 Where, just before the leaving time, any of the assets held by the head company that the leaving entity takes with it had a pre-CGT factor (discussed in paragraphs 5.108 to 5.113), a number of the membership interests in the leaving entity held by members of the group will be treated as not being subject to CGT. [Schedule 1, item 2, section 711-65]

5.148 The number of membership interests that will be treated in this way is determined by multiplying the leaving entitys pre-CGT proportion by the number of membership interests in the leaving entity held by members of the consolidated group. The result of this calculation is rounded down to the nearest whole number (if not already a whole number) or to zero if the result is more than zero but less than one. [Schedule 1, item 2, subsection 711-65(4)]

5.149 The leaving entitys pre-CGT proportion is calculated by dividing the aggregate of the market values of the pre-CGT factor components of the assets of the entity by the aggregate market value of the whole of its assets. For this purpose, the market value of the pre-CGT component of an asset is the market value of the asset multiplied by its pre-CGT factor. [Schedule 1, item 2, subsection 711-65(5)]

5.150 The design of the rules for preserving pre-CGT membership interests takes into account that a group has a discretion regarding the amount of the liabilities that an entity will have when leaving. If the rules had embodied an assumption that a leaving entity would have a specific amount of liabilities that is greater than zero, a group would be able to increase the proportion of the membership interests of a leaving entity that are pre-CGT assets by reducing the amount of liabilities of the leaving entity below the assumed amount. The rules have adopted the simplest design that would prevent manipulation, i.e. that a leaving entity does not have any liabilities. Therefore, groups will maximise the retention of pre-CGT status for equity by not attaching liabilities to leaving entities that have assets with pre-CGT factors.

5.151 The number of membership interests in the leaving entity held by members of the group that are treated as not being subject to CGT has effect regardless of when the membership interests were actually acquired. [Schedule 1, item 2, subsection 711-65(2)]

5.152 If there are 2 or more classes of membership interests in the leaving entity, the rules discussed in paragraphs 5.136 and 5.138 operate separately in relation to each class as if the interests in that class were all of the interests in the leaving entity. [Schedule 1, item 2, subsection 711-65(6)]

5.153 Where 2 or more entities cease to be subsidiary members of the old group at the same time the number of membership interests that are deemed to be pre-CGT assets is worked out on a bottom-up basis, like that for working out the costs for membership interests (see paragraph 5.142). Membership interests in a leaving entity (the first entity) that are determined to be pre-CGT assets are assigned a pre-CGT factor of one for the purpose of working out the numbers of pre-CGT membership interests in leaving entities that hold membership interests in the first entity - and so on. Where more than one entity holds membership interests in the first entity, the head company can choose which (up to the number permitted by the formula) of the membership interests in the first entity shall be pre-CGT assets. [Schedule 1, item 2, section 711-70]

What happens when the group ceases to exist?

5.154 A consolidated group will cease to exist where:

·
all the membership interests in the head company are acquired by another consolidated group (see paragraphs 5.155 and 5.156); or
·
the head company otherwise ceases to be eligible to continue to be a head company (see paragraph 5.157).

Where the group joins another consolidated group

5.155 A leaving entity may cease to be a member of an existing consolidated group because the head company of the existing consolidated group becomes a wholly-owned subsidiary of:

·
the head company of another existing consolidated group (which will result from its acquisition by one or more members of that group); or
·
a company eligible to be a head company. This can occur through a change in ownership of some or all of the membership interests in the head company or as a result of the existing owner of the head company becoming a company eligible to be a head company that immediately forms a consolidated group.

5.156 When the group joins another consolidated group the relevant rules for the treatment of the assets of the consolidated group are those that apply when a consolidated group joins an existing consolidated group (proposed law dealing with the case of a consolidated group joining another consolidated group will be contained in a later bill). The rules about leaving a consolidated group will not apply. [Schedule 1, item 2, subsection 711-5(1)]

Where a head company ceases to be eligible to remain as head company (other than because it joins another consolidated group)

5.157 Upon a change in the status of a head company that renders the head company ineligible to remain as the head company of a consolidated group, the head company ceases to be eligible to hold the assets of its subsidiary members in the capacity of the head company of a consolidated group. Where this occurs each of the subsidiary members of the group will be treated as leaving entities.

Application and transitional provisions

5.158 The consolidation regime will apply from 1 July 2002.

5.159 Under rules to be introduced in a later bill a company may elect on formation of a consolidated group to adopt the transitional option of using a joining entitys terminating value as its cost for the assets that are brought into the group by the subsidiary members.

Consequential amendments

5.160 Consequential amendments have been made to subsection 995-1(1) to include references to new dictionary terms. [Schedule 5, items 2, 20, 21, 23, 25 and 33]

Chapter 6 - Transferring losses to a consolidated group

Outline of chapter

6.1 This chapter explains:

·
which losses may be transferred to the head company of a consolidated group; and
·
the effects of transferring a loss.

6.2 The rules are contained in Subdivisions 707-A and 707-D.

6.3 Modifications to the general loss rules which will apply in determining whether a transferred loss can be used by a head company are explained in Chapter 7.

6.4 The rules that limit the amount of a transferred loss that may be used by the head company are discussed in Chapter 8. Concessions available to groups that form during the transitional period are discussed in Chapter 9.

Context of reform

6.5 The scheme for consolidated groups is based on the principles recommended by A Tax System Redesigned. One of the principles is that a company or trust entering a consolidated group should be able to bring its losses into the group.

6.6 The rules that provide for this are designed to ensure that the use of a joining entitys losses by the group approximates the rate at which they would have been used had the entity not joined the group. A Tax System Redesigned identified a large store of unused losses in the taxation system. Allowing losses to be automatically transferred to a group and used against group income without restriction would be too costly to the revenue.

6.7 Two main sets of rules govern losses and consolidated groups. To the extent these specific loss rules are inconsistent with the single entity or entry history rules discussed in Chapter 2, they override the single entity and entry history rules. [Schedule 1, item 2, section 701-90]

6.8 First, the amount of losses that can be transferred to a consolidated group is restricted by ensuring that entities seeking to transfer losses to a consolidated group pass, at the transfer time, modified versions of the current tests for deducting or applying losses.

6.9 Second, the rate at which transferred losses can be used by the group is restricted. The method by which this is achieved departs from that recommended by A Tax System Redesigned. The new method was developed in consultation with interested taxpayers and their advisers and is discussed in Chapter 8.

6.10 The provisions allowing the transfer (and use) of losses are not designed to facilitate the earlier or greater use of those losses. Rather, they ensure that the tax system does not stand in the way of commercial group restructures, impediments to which will be removed by the introduction of the consolidation regime.

Summary of new law

Transferring losses to a consolidated group

6.11 Each time an entity becomes a member of a consolidated group (whether as head company or a subsidiary) its unused carry-forward losses are tested to determine whether they can be transferred to the group. [Schedule 1, item 2, Subdivision 707-A]

6.12 Broadly, a loss can only be transferred to the head company of a consolidated group if the loss could have been used outside the group by the entity seeking to transfer it (called the joining entity). That is, the loss can be transferred if the joining entity could have deducted or applied the loss in the period immediately before transfer assuming it had sufficient income or gains of the relevant kind. Losses are tested for this purpose at the time the joining entity becomes a member of a group (called the joining time).

6.13 Basically, the joining entity applies the general rules for deducting or applying prior year losses as though the 12 months prior to the entity joining the group were the loss claim year. This will generally involve ascertaining whether, for the period since the loss was incurred up until the joining time, the joining entity has maintained substantially the same ownership or the same business. These ownership and business tests are modified to ensure they work appropriately as transfer tests.

The effects of transfer

6.14 A transferred loss is taken to have been made by the head company to which it is transferred. This means the head company may either use the loss in working out its taxable income or transfer it to another group of which it becomes a subsidiary member. A loss transferred by a subsidiary member of a group is no longer available for use by the subsidiary, even if it subsequently leaves the group. [Schedule 1, item 2, subsections 707-105(1) and 110(1)]

6.15 Losses that do not satisfy the transfer tests are effectively cancelled in that they may not be used by any entity. [Schedule 1, item 2, subsection 707-105(2)]

Comparison of key features of new law and current law
New law Current law
All entities that can be members of a consolidated group (i.e. most companies and trusts) may transfer losses to the group. Only companies may transfer losses to members of the same wholly-owned group. There is no provision for the transfer of losses by or to a trust.
All loss types (i.e. tax losses, net capital losses and foreign losses) may be transferred, provided they satisfy the transfer tests. Only tax losses and net capital losses may be transferred. There is no provision for the transfer of foreign losses.
All of an entitys losses are tested when the entity joins a consolidated group. Those that pass are transferred to the group for possible later use by the group. Those that do not are effectively cancelled. Losses may be transferred for use in a particular income year. But only to the extent the transferee has sufficient income, in that income year, against which the loss can be offset.
The head company can choose to cancel the transfer of a loss. Losses are transferred by agreement between the transferor and transferee. There is therefore no provision for cancellation of a transfer.
Losses made by a joining entity before it became a member of the group may be transferred to the group, provided they satisfy the transfer tests. Losses may only be transferred if the transferor and transferee were both members of the same wholly-owned group from when the loss was made until the time of transfer.

Detailed explanation of new law

Which losses can be transferred to a consolidated group?

6.16 The following losses may be transferred to a consolidated group:

·
tax losses (including film losses);
·
net capital losses; and
·
foreign losses.

[Schedule 1, item 2, subsection 707-115(1) and definition of sort of a loss in subsection 701-5(4)]

6.17 These are losses that have been realised by the joining entity before the joining time.

6.18 Two broad categories of losses may be transferred:

·
those that have been generated by the joining entity; and
·
those that have previously been transferred to the joining entity.

6.19 This reflects the fact that an individual entity may join a consolidated group or, alternatively, the head company of one consolidated group may become a subsidiary member of another group. A head company joining another group may have both loss types - those generated by the group and those transferred into the group.

6.20 If the joining entity is also the head company of the group, the losses it generated as a single entity are transferred to itself in its capacity as head company.

6.21 There are generally 3 steps to be followed each time an entity seeks to transfer losses to the head company of a consolidated group:

·
step 1 - the entity works out its taxable income (or loss) for the period up to the time it joins the group;
·
step 2 - the entity identifies the amount of its unused carry-forward losses as at the joining time; and
·
step 3 - the entity determines whether those losses satisfy the modified tests for using them.

Step 1: Work out taxable income up to consolidation

6.22 Where an entity joins a group as a subsidiary member part way through the entitys income year, it must work out its taxable income up to the joining time. The rules for this are discussed in Chapter 2.

6.23 In working out the pre-joining taxable income, carry-forward losses from previous income years are deducted or applied. A loss worked out for this pre-consolidation (or non-membership) period is also available for transfer.

Step 2: Work out the amount of unused carry-forward losses

6.24 An entity may only transfer carry-forward losses that have not previously been used or otherwise reduced (e.g. under the debt forgiveness rules) for an income year (or a non-membership period) that ends at or before the joining time. [Schedule 1, item 2, subsection 707-115(2)]

6.25 Broadly, an entity utilises a loss if it takes it into account in working out its taxable income. Specifically, if it:

·
deducts a tax loss from assessable or exempt income;
·
applies a net capital loss in reducing capital gains; or
·
takes into account an overall foreign loss in respect of a class of assessable foreign income in reducing that income.

[Schedule 1, item 2, definition of utilises a loss in subsection 707-110(2)]

6.26 Therefore, for example:

·
losses deducted or applied in working out taxable (or exempt) income up to the joining time are not available for transfer; and
·
any losses that result from working out a final tax position for an income year (or non-membership period) that ends at the joining time are available for transfer.

[Schedule 1, item 2, section 701-35, paragraph 707-115(1)(b), and section 707-405]

Step 3: Work out which unused carry-forward losses satisfy the use tests

6.27 Only unused carry-forward losses that, at the joining time, also satisfy the tests for utilising them may be transferred. These tests are discussed in paragraphs 6.36 to 6.89. [Schedule 1, item 2, section 707-120]

How are the tests applied for transferring losses to a group?

6.28 The normal loss recoupment tests apply as though the joining entity had sought to use the loss in an income year that ended immediately after it joined the group.

Assumptions to be used in applying the transfer tests

6.29 Because those tests are normally only triggered when a loss is actually claimed, some assumptions are made to facilitate their use as loss transfer tests. The tests are applied to an unused carry-forward loss as though:

·
the entity had sought to claim the loss for an income year called the trial year (the trial year generally starts 12 months before, and ends immediately after, the entity joined the group);
·
the entity has sufficient income of the relevant type against which its losses may be offset;
·
the entity had not joined the group:

-
since a subsidiary entity cannot use its own losses after joining a consolidated group, the transfer tests (which test whether the joining entity could have used the losses) must pretend the entity had not joined the group; and

·
the entity was a wholly-owned subsidiary of the head company if it joined as a subsidiary member:

-
this clarifies that the previous assumption does not alter the ownership structure of a subsidiary member (which means that changes that cause it to enter the group are taken into account in determining whether the loss can be transferred).

[Schedule 1, item 2, subsection 707-120(1)]

6.30 The transfer tests may also be applied to losses generated in the income year of consolidation as a result of working out a final taxable income under step 1. That is, the usual rule that losses may only be used if they were incurred in a prior year is overridden so that the transfer tests can be applied to step 1 losses. [Schedule 1, item 2, subsection 707-120(4)]

6.31 The assumptions are supplemented by some modifications to the ownership and business tests to ensure they work appropriately as transfer tests.

Distinguishing between transfer and recoupment tests

6.32 Because the tests work slightly differently when applied to determine whether a loss can enter a consolidated group, it is important to distinguish their use as transfer tests from their normal application in determining whether a loss can be used (i.e. as recoupment tests).

6.33 In particular, the transfer process must be distinguished from the step 1 process of working out taxable income up to the joining time. In working out its taxable income up to the joining time, an entity may have used the relevant tests to deduct or apply losses. That occurs first. Transfer tests then apply for the purpose of determining whether any unused losses can be transferred to the head company.

6.34 However, events such as ownership changes that have occurred from the time the loss was incurred until immediately after the joining time may be relevant to both processes.

6.35 The application of the ownership and business tests as transfer tests must also be distinguished from their subsequent use by the head company as recoupment tests when seeking to use transferred losses.

How do the loss recoupment tests work as transfer tests?

6.36 The entities and the tests relevant to each of them are listed in Table 6.3 (at the end of this chapter). The tests can broadly be categorised as follows:

·
continuity of ownership;
·
control;
·
same business; and
·
pattern of distributions.

6.37 The way in which each of them works as a transfer test is discussed in paragraphs 6.39 to 6.89. All of the tests are applied on the basis of the assumptions discussed in paragraphs 6.29 to 6.31.

6.38 The company tests for revenue and net capital losses are contained in Part 3-5 of the ITAA 1997. The company tests for foreign losses are those contained in sections 80A and 80DA of the ITAA 1936. The trust tests for revenue and foreign losses are contained in Schedule 2F to the ITAA 1936.

Transfer test - continuity of ownership

6.39 The COT applies to companies and the 50% stake test applies to trusts.

6.40 Broadly, a company satisfies the COT if, from the start of the income year in which it made the loss until the end of the income year in which it claims the loss, the same individuals have, directly or indirectly (through the continuous holding of the same shares or interests):

·
control of more than 50% of the voting power in the company;
·
rights to more than 50% of the companys dividends; and
·
rights to more than 50% of the companys capital distributions.

6.41 Corporate limited partnerships that are treated as companies because of section 94J of the ITAA 1936 also apply these tests, though they are not required to test maintenance of voting power.

6.42 The 50% stake test for trusts operates in a broadly similar manner, though trusts are not required to examine voting power.

6.43 If the test is passed, the loss may generally be used and therefore transferred. However, if the entity is a company, it must also satisfy the control test. Further, if the entity is a non-fixed trust, it must also pass the pattern of distributions test (if relevant) and a control test.

Testing ownership over a period

6.44 Most companies and trusts to which the ownership test is relevant are required to test ownership continuously from the commencement of the income year in which the loss was incurred until the end of the income year in which it is sought to be deducted or applied (referred to as the ownership test period or test period).

6.45 Because the trial year ends immediately after joining time, the relevant test periods for transfer purposes also end immediately after joining time. Therefore, a joining entity that would normally be required to test continuously must test its ownership from the commencement of the income year in which the loss was incurred until immediately after joining time.

6.46 The test has deliberately been extended until after the joining time to ensure that ownership changes that occur as part of a consolidation event are taken into account.

6.47 While the trial year ensures that the ownership test period ends immediately after joining time, it does not affect the commencement of the ownership test period. This period continues to start at the start of the loss year. This means the ownership test period may start before or after the start of the trial year.

Example 6.1 Subco joins a consolidated group on 1 December 2004. It incurs a loss during the pre-consolidation (or non-membership) period from 1 July 2004 to the joining time. The trial year is from 1 December 2003 to 1 December 2004. However, ownership is tested during the period from the commencement of the loss year (1 July 2004) to just after the joining time (1 December 2004).

owner test period

6.48 However, listed public companies and their 100% subsidiaries are only required to test ownership each time there is an abnormal trading in their shares and at the end of an income year (including the income year in which the loss is claimed). An entity required to test ownership at the end of the income year will be required to test immediately after joining to see whether losses may be transferred. Again, any changes in ownership that result in the entity joining a consolidated group will be taken into account.

Testing ownership where the loss has been previously transferred

6.49 Broadly, a head company seeking to transfer a previously transferred loss need only test its ownership from the time the loss was first transferred to it. However, there are further modifications to the ownership test if the loss was previously transferred to it by another company because that other company satisfied the ownership test. These modifications are discussed in Chapter 7.

Transfer test - control

6.50 There are 2 control tests:

·
that which applies to companies - it is failed if a person starts to control the entitys voting power for the purpose of gaining a tax benefit or advantage; and
·
that which applies to non-fixed trusts - it is failed if, at any time during the test period, a group commences to control the trust (e.g. so it can obtain beneficial enjoyment of the capital or income of the trust).

6.51 Again the tests are applied as though the test period ended immediately after the joining time. It continues to start from the beginning of the loss year. Therefore, the purpose of the groups acquisition of a company may be relevant in determining whether the company passes the control test and so can transfer losses.

Transfer test - same business

6.52 A company that fails the ownership or control tests, may nonetheless use (and therefore transfer) losses if it passes an SBT.

6.53 When used as a recoupment test, the SBT is basically passed if the business a company carries on during the income year in which it seeks to use the loss is the same as the one it carried on immediately before the ownership or control changed.

6.54 However, when used as a transfer test, the SBT is modified in 2 ways. First, by modifying the periods during which the same business must be carried on. This is discussed in paragraphs 6.55 to 6.74. Second, by applying an additional test if the loss was previously transferred because the SBT was passed. This is discussed in paragraphs 6.75 to 6.84.

Same business test - modifying the periods during which it applies

6.55 The SBT is modified so that there is a period of sufficient length to which it can be applied, given that the change in ownership and the joining time may coincide. This is achieved by ensuring that, on transfer, one of the periods during which the joining entitys business is tested is the trial year . This is basically the 12 months before the joining time. [Schedule 1, item 2, subsections 707-120(1) and (2)]

6.56 However, the period will be less than 12 months if the joining entity did not exist for the whole of the 12 months prior to the joining time. In that case, the trial year only extends back to when the entity came into existence. The trial year may also be less than 12 months where the joining entity had previously been a subsidiary member of another consolidated group. In that case, the trial year does not go back any further than the time it last ceased to be a member of a consolidated group.

6.57 Also, in applying the SBT as a transfer test, the test period effectively ends immediately before the joining time. This is achieved by assuming that the business carried on by the joining entity at and just after the joining time is the same as the business it carried on just before the joining time. [Schedule 1, item 2, subsection 707-120(3)]

6.58 A further rule ensures that a head company seeking to transfer (previously) transferred losses is not required to compare its business as a head company with the business it carried on as a single entity prior to consolidation. In the absence of this rule, it may prove difficult for a head company to pass the SBT if such a comparison was required. [Schedule 1, item 2, section 707-400]

6.59 For example, a company (the original head company) chooses to consolidate a group on 1 April 2004. Losses are transferred to it at that time. On 1 June 2004 the original head company is acquired by a new group. Between those 2 dates the original head company fails the ownership test in respect of the transferred losses so they can only be transferred to the new group if the transfer SBT (referred to in paragraph 6.54) is passed. In the absence of this rule, the trial year concept would require the original head company to test its ownership for a minimum 12 month period which would cover both its business as a single entity and as a head company of a consolidated group.

6.60 This rule applies to any of the transfer SBTs including the additional test discussed in paragraphs 6.75 to 6.84. However, it does not apply if the head company is seeking to transfer the loss to itself on initial formation of the group. The rule is not needed in that context as only the business of the head company as a single entity will be tested. The rule has been drafted in general terms so is also capable of applying to a head company seeking to actually use or recoup a transferred loss.

6.61 Additional modifications are made to the test periods for losses made for an income year starting after 30 June 1999. These are discussed in paragraphs 6.62 to 6.74.

Same business test - companies

6.62 As stated in paragraph 6.61, the test to be applied depends on the income year in which the loss was made.

Table 6.1: Same business transfer tests for companies
Item no. In these circumstances Test the joining entitys business at these points
1 The loss was made by the joining entity for an income year starting after 30 June 1999.

·
just before the end of the income year in which the loss was made;
·
the income year in which the joining entity first fails the ownership or control tests; and
·
the trial year.

2 The loss was made by the joining entity for an income year starting before 1 July 1999.

·
just before the ownership or control tests were first failed; and
·
the trial year.

[Schedule 1, item 2, subsections 707-120(1) and 707-125(1) to (3)]

6.63 A loss made by the joining entity means either a loss that was actually made by the joining entity or one it is taken to have made as a result of being transferred to it previously (i.e. when it was a head company).

6.64 Therefore, the test in item 1 in Table 6.1 will also apply to a loss that has been the subject of one or more previous transfers for whatever reason. However, if the loss was previously transferred as a result of the SBT having been passed, there is an additional test that must be applied. This is discussed in paragraphs 6.75 to 6.84.

6.65 A previously transferred loss will always be covered by item 1 in Table 6.1 because transferred losses are taken to have been made by the head company in the income year of transfer. Given that the consolidation regime does not commence until 1 July 2002, this will always be an income year starting after 30 June 1999.

6.66 The test points of the same business transfer tests that refer to a failure of the ownership or control tests necessarily refer to a failure that occurs after the commencement of the income year in which the loss was made. That is, these test points are linked to a failure of the ownership or control tests during the ownership test period.

6.67 The same business transfer test for losses made in an income year that starts after 30 June 1999 is stricter than the normal same business recoupment test. It is stricter because it tests at an additional point, namely just before the end of the income year in which the loss was made, and because it tests the whole of the income year in which the ownership or control tests are failed. This assists in giving the test integrity when used as a transfer test. Integrity is required because of the possibility that some or all of the test points will overlap or coincide.

6.68 Further integrity is built in by the concept of a trial year, which generally ensures that the business is tested for a minimum 12 month period. The trial year test point applies regardless of when the loss was made.

6.69 The acquisition of an entity may result in both the first change in ownership and entry of the entity into the group. In the absence of a 12 month test period, losses could be transferred and the SBT would be ineffective.

Example 6.2 The joining entity makes a loss for the 2002-2003 income year which ended on 30 June 2003. It joins a consolidated group on 2 July 2003. On joining, it fails the ownership test.If the existing SBT for recoupment of losses applied, the joining entity would only need to carry on the same business:

·
immediately before 2 July 2003 (as that is when the change in ownership occurred); and
·
for the 2 days from commencement of the 2003 income year (as, in the absence of a trial year rule, that would effectively be the loss claim year).

Instead, the proposed 3 point test applies. That means the joining entity must carry on the same business for the whole of the 12 months before the joining time (i.e. from 2 July 2002 to the joining time).

6.70 Examples 6.3 to 6.5 show 3 possibilities for losses made in an income year starting after 30 June 1999, depending on the extent to which the testing points overlap.

Example 6.3: The test points are 3 separate periods

Losses made in income year: The test points are three seperate periods

The joining entity must compare its business at 3 points:

·
just before the end of the 2000-2001 income year (the loss year);
·
the whole of the 2002-2003 income year (the year COT is failed); and
·
1 November 2003 to 1 November 2004 (the trial year).

Example 6.4: The test points are 2 separate periods

Losses made in income year: The test points are two seperate periods

The joining entity must compare its business at 2 points:

·
just before the end of the 2000-2001 income year (the loss year); and
·
the whole of the 2004-2005 income year (the year the COT is failed and the trial year overlap).

Example 6.5: All 3 test points overlap

Losses made in income year: All 3 test points overlap

The entity must compare its business just before the end of the 2004-2005 income year (the loss year) with that carried on during the whole of the 2004-2005 income year (the year the COT is failed and the trial year overlap).

6.71 The requirement that a minimum 12 month period be tested may result in the joining entitys business being tested for a period prior to the commencement of the income year in which the loss was made. That is, before the commencement of the ownership test period.

Example 6.6 An entity joins a consolidated group on 1 November 2004. It makes a loss for the non-membership period 1 July 2004 to the joining time. In testing its loss at the joining time, it is found that the COT is failed.Applying the 3 point test, the joining entity must carry on the same business for the 12 months before the joining time (i.e. from 1 November 2003 to the joining time).

Same business test - listed public companies (and their 100% subsidiaries)

6.72 Tests similar to those set out in Table 6.1 also apply to listed public companies and their 100% subsidiaries.

6.73 However, when seeking to claim a loss, those entities are only required to test their ownership each time there is abnormal trading in their shares and at the end of each income year, including the year in which the loss is claimed.

6.74 These special testing rules are contained in Division 166 of the ITAA 1997. They apply to listed public companies and their 100% subsidiaries. The rules in Division 166 are modified as set out in Table 6.2.

Table 6.2: Same business transfer tests for listed public companies and their 100% subsidiaries
Item no. In these circumstances Test the joining entitys business at these points
1 The loss was made by the joining entity for an income year starting after 30 June 1999.

·
just before the end of the income year in which the loss was made;
·
the income year in which the joining entity first finds there is no substantial continuity of ownership as a result of testing at the prescribed times; and
·
the trial year.

2 The loss was made by the joining entity for an income year starting before 1 July 1999.

·
just before the joining entity first finds there is no substantial continuity of ownership as a result of testing at the prescribed times; and
·
the trial year.

[Schedule 1, item 2, subsections 707-120(1) and 707-125(1) and (4)]

Transfer test - previously transferred SBT losses

6.75 A loss that has been transferred because the joining entity satisfied an SBT is referred to in this explanatory memorandum as an SBT loss (though that expression does not appear in the law).

6.76 SBT losses may only be transferred again if the loss passes an additional test. [Schedule 1, item 2, subsection 707-135(1)]

6.77 This additional test applies to the second transfer of the loss and to each subsequent transfer of the loss. It applies even if the COT is passed at the second or subsequent transfer time.

6.78 Under the additional test, a loss transferred because an SBT was passed may only be transferred again if the entity transferring the loss carried on the same business at these times:

·
just before the end of the income year in which the loss was previously transferred to it (this is also the income year in which the loss was taken to have been made); and
·
during the trial year.

[Schedule 1, item 2, subsection 707-135(2)]

6.79 This test is additional in that it is only applied after the usual (ownership and same business) transfer tests have been applied, and then only if one of those tests have been passed. (If the usual tests are failed the loss is effectively cancelled and the provision imposing this test can therefore not apply.)

6.80 If the additional test is passed, the loss will be transferred. If it is failed, the loss will effectively be cancelled.

Comparing the additional business test to the usual one

6.81 The usual SBT only applies on transfer if the ownership or control tests are failed. However, the additional test applies even if the ownership or control tests have been passed.

6.82 For that reason, the additional test is contained entirely within the consolidation rules. It does not rest upon the normal deduction rules, or rely upon their triggers as do, for example, the same business transfer tests set out in Tables 6.1 and 6.2.

Why is there an additional test for transferring SBT losses?

6.83 A transferred loss is taken to be made by the head company to which it is transferred in the income year in which the transfer occurs. This effectively erases the previous failure of the ownership test if the loss is an SBT loss. Therefore, there may be no failure of the ownership test when the loss is sought to be transferred subsequently to the head company of another group. For example, the second group may acquire the first group simply by increasing its ownership percentage in the head company of the first group from 90% to 100%.

6.84 In the absence of the additional test, an SBT loss would only need to pass the SBT when transferred the first time. It could then effectively be transferred subsequently without further SBT testing. That result would be contrary to the way in which the loss would be treated had it not been transferred at all. That is, in order to deduct the loss outside a consolidated group, the loss entitys business immediately before the ownership change is compared with its business in the claim year. The additional test ensures that this is effectively what will happen each time an SBT loss is sought to be transferred.

Transfer test - pattern of distributions

6.85 The pattern of distributions test is one of the loss recoupment tests for non-fixed trusts. The test is triggered where there is a distribution of income in the loss claim year and in at least one of the 6 earlier income years. The test is also triggered where there is a distribution of capital in the loss claim year and in at least one of the 6 earlier income years.

6.86 The test requires a comparison of the distribution made in the loss claim year with distributions made in the 6 earlier income years. The test is passed if more than 50% of a trusts income and capital distributions are made (directly or indirectly) for each of the test years to the same individuals.

6.87 Before a loss can be transferred to a head company, it is tested to ascertain whether it can be utilised during the trial year - usually a period commencing 12 months before the joining time and ending just after the joining time. Normally, the pattern of distributions test requires an examination of trust distributions made in test income years. Where a trust joins the group part way through its income year, the trial year does not match an income year. This makes it difficult to determine the test income years and their distributions.

6.88 Therefore, where the pattern of distributions test is applied as a transfer test, the trial year is modified to be the income year in which the trust joins the consolidated group. [Schedule 1, item 2, subsections 707-130(1) to (3)]

6.89 A trust may make a distribution after the time it joins a group. In working out whether this distribution is counted in determining if the pattern of distributions test is passed as a transfer test, the test only takes account of distributions that are attributable to income or capital of the trust before the joining time. [Schedule 1, item 2, subsection 707-130(4)]

Transferring part year losses

6.90 A special rule ensures that losses referable to only part of an income year can be transferred. It also ensures they are tested on transfer over a period that reflects the fact that they were effectively made for a shortened income year.

6.91 A loss is referable to part of an income year if:

·
an entity joins a group as a subsidiary member, or exits a group, part way through its income year; and
·
it makes a loss for the shortened income period just before it joined, or just after it exited, the group.

6.92 These shortened income periods are called non-membership periods . The rules explaining non-membership periods and for working out taxable income or a loss for such periods are contained in the core rules discussed in Chapter 2. The special losses rule simply ensures that a non-membership period loss can be transferred and is appropriately tested at the transfer time. The rule is that a non-membership period loss made by an entity is, for the purpose of Division 707, taken to be a loss made by the entity for an income year that matches the length of the non-membership period. [Schedule 1, item 2, section 707-405]

Example 6.7

Non-membership period

During its 2003-2004 income year the entity in this example is a member of group 1 for the first period, is a member of no group for the second period (i.e. its non-membership period) and a member of group 2 for the third period.Assume that under the core rules it worked out a loss for its non-membership period. The special losses rule ensures that:

·
the non-membership period loss is ascribed actual loss status (only a loss made for a non-membership period that ends at the end of an income year is an actual loss for an income year) [Schedule 1, item 2, section 701-35] ; and
·
in determining whether the loss can be transferred to group 2 the entitys ownership is tested only from the start of the non-membership period (the definition of trial year ensures that, if necessary, the entitys business is also only tested from the start of the period).

How is a transferred loss treated in the hands of the head company?

6.93 A loss transferred to a head company is taken to be made by the head company for the income year in which the transfer occurs. This means the loss may be used by the head company.

6.94 Other effects of transferring a loss to a head company are:

·
the loss retains its original loss type;
·
the groups use of a transferred loss may depend on whether the COT or SBT was passed in respect of the loss at the transfer time; and
·
all losses transferred by a particular joining entity constitute a bundle which is assigned an available fraction - this is discussed in Chapter 8.

The head company is taken to have made the transferred loss

6.95 The loss is taken to have been made by the head company to which it is transferred. The joining entity is taken not to have made the loss which means that an entity that joins a group as a subsidiary member is no longer able to use the loss. [Schedule 1, item 2, subsection 707-140(1)]

6.96 This means the loss may be used by the head company in working out its taxable income (subject to limitations) or may be transferred to another group of which the head company becomes a wholly-owned subsidiary.

6.97 A transferred loss will continue to be taken as having been made by the head company to which it is transferred, unless the loss is transferred again. This means the limits on the use of transferred losses will continue to apply to an entity even if it ceases to be a head company because, for example, it becomes a non-resident.

A transferred loss is taken to have been made for the transfer year

6.98 A transferred loss is taken to have been made by the head company for the income year in which the transfer occurs. [Schedule 1, item 2, subsection 707-140(1)]

6.99 It may be used by the head company in the same income year in which the transfer occurs. This overrides the general rule that an entity may only deduct or apply losses from earlier income years, thereby matching the existing loss transfer rule in section 170-15 of the ITAA 1997. [Schedule 1, item 2, subsection 707-140(2)]

6.100 However, where a debt of the head company is forgiven (in accordance with Subdivision 245-B in Schedule 2C to the ITAA 1936) in the income year in which the loss transfer occurs, subsections 245-105(5) and (6) apply as if the head company made the transferred loss for an earlier year. This ensures the loss can be reduced by the net forgiven amount of the debt as only prior year losses can be reduced under the debt forgiveness rules. [Schedule 1, item 2, subsection 707-140(3)]

6.101 Even though all transferred losses are taken to be made by the head company in the transfer year (i.e. refreshed), the head company will need to test the ownership of the loss entity from the start of the actual loss year if the loss entity is a company and the loss was transferred because the COT was passed. These rules are discussed in Chapter 7.

Transferred losses retain their original loss type

6.102 The different loss types are tax losses (including film losses), net capital losses and foreign losses. All losses retain their status as one of these types, even after transfer. Each type is a sort of a loss. [Schedule 1, item 2, definition of sort of a loss in subsection 701-5(4)]

6.103 A groups use of a transferred loss may depend on which of the loss recoupment tests were met at the transfer time

6.104 As discussed in paragraph 6.75, a loss that has been transferred because the joining entity satisfied an SBT is referred to as an SBT loss. A transferred loss that has passed the ownership test may still be an SBT loss. For example, a company may pass the ownership test, fail the control test, but pass the SBT. The loss will be an SBT loss because, in the end, passing the SBT was the reason the loss was able to be transferred.

6.105 SBT losses are not subject to further business testing in the hands of the head company unless the head company fails the COT or seeks to transfer the loss again.

6.106 A loss that has been transferred because the joining entity satisfied an ownership test is referred to in this explanatory memorandum as a COT loss (though that expression does not appear in the law).

6.107 Whether a loss is an SBT loss or a COT loss is relevant:

·
in determining whether the loss can be used by a head company:

-
special rules apply in determining whether a COT loss transferred to a head company by another company can be used (see Chapter 7);

·
in determining which of the 2 methods for limiting the use of transferred losses applies:

-
the concessional method for using transferred losses may only be used for some COT losses transferred by a company (see Chapter 9); and

·
in applying the SBT as a transfer test:

-
losses that have previously been transferred because the SBT was passed can only be transferred again if they satisfy an additional SBT (see paragraphs 6.75 to 6.84).

Cancelling the transfer of a loss

6.108 A head company can choose to cancel the transfer of a loss. The choice cannot be revoked. If the choice is made, the transfer is taken never to have occurred which means that the loss itself is effectively cancelled in that it can never be used by any entity. [Schedule 1, item 2, section 707-145 and subsection 707-150(1)]

6.109 A head company may wish to cancel a loss transfer to avoid adjusting the rate at which it can use its existing transferred losses. The rate of use of transferred losses is discussed in Chapter 8. The cancellation of a loss transfer may also affect the calculation of the allocable cost amount for the joining loss entity (discussed in Chapter 5).

The effect on the joining entity

6.110 A loss transferred by an entity that becomes a subsidiary member may never be used by the entity, even if the entity subsequently leaves the group.

6.111 This is because, after transfer, an entity that joins as a subsidiary member is taken not to have made the loss. This would prevent it using the loss either while it is a subsidiary member or after it leaves the group. The single entity rule also means a transferred loss is not available for use by a subsidiary while it is a member of the group. [Schedule 1, item 2, section 701-5 and paragraph 707-140(1)(b)]

6.112 A loss that is unable to be transferred is effectively cancelled in that it cannot be used by any entity for an income year ending after the joining time. There is one exception. A loss that is not transferred because it is required for use in a non-membership period that ends before the joining time may still be used for that period. [Schedule 1, item 2, section 707-150]

6.113 If the head company chooses to cancel the transfer of a loss, the transfer is taken not to have occurred. Again, the loss may never be used by any entity for an income year ending after the joining time. [Schedule 1, item 2, sections 707-145 and 707-150]

Application and transitional provisions

6.114 The consolidation regime will apply from 1 July 2002.

Consequential amendments

6.115 Consequential amendments have been made to subsection 995-1(1) of the ITAA 1997 to include references to new dictionary terms. [Schedule 5, items 10, 19, 26, 27, 32, 34, 37 and 38]

Table 6.3: Which loss tests apply to which entities
These entities Apply these loss tests
Ownership [F1] Control Same business Pattern of distribution
Company . . .
Listed public company (and 100% owned subsidiary) . . .
Ordinary fixed trust .
Unlisted widely-held trust .
Unlisted very widely-held trust .
Wholesale widely-held trust .
Non-fixed trust  (if applicable)    (if applicable)

Chapter 7 - Determining whether a transferred loss can be used by a consolidated group

Outline of chapter

7.1 This chapter explains rules that will apply in determining whether a transferred loss can be used by a head company (i.e. whether it can be deducted or applied by the head company or transferred to another group). The rules are in the form of modifications to the general loss recoupment tests for companies. The rules are contained in Subdivision 707-B.

7.2 The rules that limit the amount of a transferred loss that can be deducted or applied are discussed in Chapter 8.

Context of reform

7.3 Losses transferred to a group are taken to have been made by the head company of the group for the income year in which the transfer occurred (see paragraphs 6.98 to 6.101). This allows the head company to use those losses. That process effectively erases pre-consolidation ownership changes in the original loss entity. In the absence of any further rules, all transferred losses would be refreshed in the hands of the head company.

7.4 That outcome is inappropriate where the original loss entity is a company and the loss is transferred because the COT is passed. It would allow a faster or greater use of losses than would occur outside consolidation and would therefore place loss companies that consolidate at a considerable advantage over non-consolidated companies.

7.5 Therefore, in these cases, pre-consolidation changes in ownership of a loss company continue to count in determining whether the COT is passed in respect of the loss post-consolidation. This will preserve the effect of sections 165-165 and 166-170 of the ITAA 1997 which provide that the only shares and interests to be counted in determining whether a company has passed the COT are exactly the same shares and interests held by the same persons.

7.6 However, in other situations, things that happen before a loss is transferred to a head company are ignored in determining whether the head company can use the loss.

Summary of new law

7.7 In determining whether a head company has passed the COT in respect of a COT loss transferred to it by another company, pre-consolidation ownership changes in the company that actually made the loss are relevant (though intra-group changes post-consolidation are not). The pre-consolidation changes are measured from the start of the actual loss year. [Schedule 1, item 2, section 707-210]

7.8 Essentially in this case the COT is applied to the company that actually made the loss (called the test company), but on the assumption that intra-group changes in the ownership of the test company post-consolidation are ignored. Passage or failure of the COT by the test company is then attributed to the head company for the purpose of proceeding to work out whether the head company can use the loss.

7.9 But in all other cases, the loss recoupment tests are applied directly to the head company in determining whether the head company can use a transferred loss. For the purpose of applying recoupment tests directly to the head company, the loss year is taken to start at the loss transfer time. This ensures that things that happened to the head company before the loss was transferred to it (and which may have already been taken into account in transfer testing the loss) are not taken into account again in determining whether the head company can use the loss. [Schedule 1, item 2, section 707-205]

7.10 This modifies the rule that a loss transferred to a head company is taken to be made by the head company for the income year in which the transfer occurred. That is, where the transfer occurs part way through the head companys income year, the loss year is taken to start at the transfer time instead of at the beginning of the transfer year.

Comparison of key features of new law and current law
New law Current law
In determining whether a head company has passed the COT in respect of a COT loss transferred to it by another company, the ownership of that other company is tested, subject to certain assumptions, from the start of the loss year until the end of the income year for which the head company seeks to use the loss. Ownership of a company seeking to use a prior year loss is tested from the start of the loss year until the end of the loss claim year.
In other cases, a head companys ability to use a transferred loss is determined by applying the loss recoupment tests directly to the head company. For those purposes, the loss year is taken to start at the time the loss was transferred to the head company. Transferred losses are taken to be made by the transferee in the same income year in which they were made by the transferor.

Detailed explanation of new law

The ownership history of a company COT loss is preserved

7.11 Broadly the rule (as described in paragraph 7.12) ensures that in determining whether COT losses can be used by a head company, pre-consolidation changes in the original loss company are recognised (including those that led to it joining the group). However, the only post-consolidation changes that are relevant are those that occur to the head company (i.e. intra-group changes are ignored).

7.12 The rule applies to a loss transferred to a head company by another company because the ownership test in section 165-12 of the ITAA 1997 (i.e. the COT) was passed in respect of the loss at the transfer time. In determining whether the head company can use the loss, the head company is taken to have passed the COT only if the test company would have passed the COT assuming:

·
the test company could have used the loss; and
·
there are no changes in the groups interests in the test company after it joined the group.

[Schedule 1, item 2, subsections 707-210(1) and (2)]

7.13 The test company is generally the first company to have made the loss. That is, the company that actually made the loss or a head company that is taken to have made the loss because it was transferred to it by the trust that actually made it. The test company concept is discussed further in paragraphs 7.26 to 7.31.

7.14 Therefore, the head company passes the COT if the test company would have passed on the basis of the assumptions. This involves applying the COT rules applicable to the test company. A failure of the COT by the test company is attributed to the head company. This enables the head company to apply the relevant SBT to determine whether it can use the loss. The control test (discussed in paragraph 6.50) is also applied to the head company (and not the test company). [Schedule 1, item 2, subsections 707-210(5) and (6)]

Which losses does the rule apply to?

7.15 The rule applies to losses transferred because the COT was passed (COT losses). The rule does not apply to a head company if the loss was transferred to it because an SBT was passed (SBT losses). This is consistent with the fact that ownership changes in the transferor company have already been considered in determining that the SBT had to be met in order to transfer the loss. Therefore, SBT losses are effectively refreshed in the hands of the transferee (head company). [Schedule 1, item 2, subsection 707-210(1)]

7.16 Also, the rule does not apply if both the section 165-12 ownership test and the SBT in subsections 165-15(2) and (3) are passed. This is the SBT that applies if the control test is failed. If the control SBT is passed then the loss is more properly categorised as an SBT loss because in the end an SBT was the reason the loss was transferred, even though the ownership test was also passed. [Schedule 1, item 2, paragraph 707-210(1)(b)]

7.17 Passage of the additional transfer SBT is discussed in paragraphs 6.75 to 6.84 and has no bearing on the application of the rule.

7.18 The rule only applies to a head company if the COT loss was transferred to it by another company. It does not apply if the loss was transferred to it by a trust. Changes in the ownership of a trust prior to it joining a consolidated group are not taken into account in determining whether the trusts losses can be used by the group (but are relevant in determining whether the trusts losses can be transferred to the group). Only changes in the head company of the group after the transfer time are relevant.

The first assumption

7.19 The first assumption, as it applies to a test company that is a subsidiary member, turns off the rule that the transferred loss is now taken to have been made by the head company. This reinstates the loss as having been made by the test company for the income year in which it was actually made (though only for the purpose of this rule). [Schedule 1, item 2, paragraph 707-210(4)(a)]

7.20 Where the test company and the head company are the same entity the assumption simply reinstates the original loss year. [Schedule 1, item 2, paragraph 707-210(4)(b)]

The second assumption

7.21 The second assumption is that, anything that happens after the transfer time to membership interests or voting power in an entity that was a subsidiary of the group at the transfer time, and that would be relevant in determining whether the test company passed the COT, is taken not to have happened. [Schedule 1, item 2, paragraph 707-210(4)(c)]

7.22 Essentially the assumption freezes the ownership structure of the group as at the transfer time. It ensures that, consistent with the single entity rule, intra-group ownership changes (and changes in voting power) are ignored in determining whether the loss can be used by the group. It effectively ignores changes to membership interests in subsidiary members that exist at the transfer time and to new membership interests in subsidiary members issued after that time.

7.23 This assumption works because at the joining time the head company must generally hold, directly or indirectly, 100% of the membership interests in the test company. By assuming there is no change in that holding post-consolidation, any changes in the ownership of the head company can be taken to be changes, in the same percentage, to the test company. This equates to only testing changes above the head company level and ignoring those below.

7.24 The second assumption will also ignore a test companys exit from the group. This ensures that the head company can use the loss even if the test company has left the group. Also, any ownership changes leading to that exit would not be counted in determining whether the head company could use the loss. This is consistent with the general consolidation model which provides that tax attributes transferred to the group at the joining time remain with the group (for use by the group) even if the entity that transferred those attributes leaves the group.

7.25 If the losses are transferred on a second or subsequent occasion, there is an additional assumption. It is that, anything that happened, after the transfer to the new head company, to membership interests or voting power in the old head company that would be relevant in determining whether the test company passed the COT, is taken not to have happened. This additional assumption essentially freezes the ownership structure of the new group after the transfer. It applies as many times as the losses are transferred. [Schedule 1, item 2, paragraph 707-210(4)(d)]

The test company

7.26 The test company is the company to which the COT is applied in determining whether the head company can use the loss. The test company is the first company to have made the loss. That is:

·
the company that actually made the loss; or
·
an earlier head company that was taken to have made the loss because the loss was transferred to that earlier head company by the trust that actually made it.

[Schedule 1, item 2, subsections 707-210(1) and (3)]

7.27 Therefore, if the loss was originally made by a trust, the test company is the head company to which the loss was first transferred.

7.28 However, if the loss was transferred by a company as an SBT loss, the transferor company is not the test company. Instead, the transferee (head) company is the test company.

7.29 If the loss is transferred on more than one occasion as an SBT loss, then the test company is the last of the companies to which the loss has been so transferred. [Schedule 1, item 2, subsection 707-210(3)]

7.30 So the test company may be a company that was previously a head company (an earlier head company) to which the loss was transferred. If the loss was transferred to such a test company part way through the test companys income year, then for the purpose of applying the COT to the test company, the test companys loss year is taken to have started at the transfer time. This ensures that things that happened to a test company before the loss was transferred to it are not taken into account. It matches the rule that applies in some cases to a head company when recoupment tests are applied to the head company (see paragraphs 7.39 to 7.42). [Schedule 1, item 2, subsection 707-210(7)]

Examples identifying the test company

7.31 Examples 7.1 to 7.4 explain how to identify the test company where a loss passes through a chain of loss owners because it is transferred on more than one occasion. Assume in each example that the loss has been transferred to each new head company as a COT loss, unless it is specifically stated that the loss was transferred as an SBT loss.

Example 7.1

Example indentifying the test company

H co 1 and H co 2 only pass the COT if the test company (i.e. the initial loss-maker) would have passed it on the basis of the assumptions referred to in paragraph 7.26.

Example 7.2

Example indentifying the test company

The rule does not apply to H co 1 (because the loss was transferred to it as an SBT loss). H co 2 only passes the COT if H co 1 would have passed it on the basis of the assumptions referred to in paragraph 7.26.

Example 7.3

Example indentifying the test company

The rule does not apply to H co 1 (because the loss was transferred to it by a trust). H co 2 only passes the COT if H co 1 would have passed it on the basis of the assumptions referred to in paragraph 7.26.

Example 7.4

Example indentifying the test company

H co 1 and 2 only pass the COT if the first test company (i.e. the initial loss-maker) would have passed it on the basis of the assumptions referred to in paragraph 7.26.H co 4 only passes the COT if the second test company (H co 3) would have passed it on the basis of the assumptions referred to in paragraph 7.26.

A test companys COT failure is attributed to the head company

7.32 If, as a result of applying the rule, the test company would have failed the COT, then the head company is taken to fail the COT.

7.33 The time at which the head company is taken to fail the COT is relevant in applying the SBT to the head company. The time is determined by reference to the time the COT would have been failed by the test company. That time depends on whether the test company is an ordinary company to which Division 165 applied or a listed public company (or 100% subsidiary) to which Division 166 applied.

7.34 The head company is taken to have failed the COT at the time the test company would have failed if Division 165 applied to the test company. The head company is taken to have failed the COT just before the end of the test companys test time that triggered the failure if Division 166 applied. The test time will have been the time of abnormal trading in the test company or the end of the test companys income year. [Schedule 1, item 2, subsection 707-210(5)]

7.35 Regardless of whether Division 165 or 166 has applied to the test company, a further link rule is needed to ensure that the SBT can be applied if Division 166 applies to the head company. The link rule deems the time described in paragraph 7.34 to be the head companys test time for the purpose of applying the SBT in subsection 166-5(5). [Schedule 1, item 2, subsection 707-210(6)]

Interaction with the modified SBT

7.36 If the head company is applying the rule to determine whether it can transfer the loss to a new group, then the rules that determine timing of a COT failure must interact correctly with the modified SBT that applies on transfer (see paragraphs 6.52 to 6.74).

7.37 First, the timing of the head companys COT failure will be plugged into the modified SBT. This means the head company may be required to test its business for the whole of the income year in which it is taken to have failed the COT. [Schedule 1, item 2, subparagraph 707-125(4)(a)(ii) and subsection 707-125(5)]

7.38 Second, the modification to subsection 166-5(5) discussed in paragraph 7.35 will have no application to the modified SBT which makes its own (and different) modifications to the SBT test time for listed public companies. [Schedule 1, item 2, subsection 707-125(6)]

Example 7.5

Interaction with modified SBT

The loss year is the income year starting on 1 July 2001 and ending on 30 June 2002. For the purpose of this example, assume that all shares carry equal voting, and dividend and capital distribution rights.As per the diagram, Head Co initially holds 80% of Loss Co. On 30 June 2002, Head Co acquires X Cos 20% interest in Loss Co. Head Co then chooses to form a consolidated group (comprising Head Co, Loss Co and Z Co) from 1 July 2002. Transferring the loss to Head Co On consolidation, Loss Cos loss is tested to determine whether it is transferred to Head Co. (The rule that preserves the history of a COT loss does not apply to the initial transfer of a loss so is not relevant at this point.)Assuming Head Cos acquisition of the final 20% of Loss Co was the only change in the ultimate beneficial ownership of Loss Co since the start of the loss year, the loss is transferred to Head Co as a COT loss. Head Co seeks to use the loss for the 2003-2004 income year In determining whether Head Co can use the loss, the rule that preserves the ownership history of a COT loss applies. Head Co can use the loss if Loss Co could have used it assuming there were no changes in Head Cos interest in Loss Co after Loss Co joined the group.Between the time the group was formed (1 July 2002) and the end of the loss claim year (30 June 2004) Head Co disposed of Loss Co and, as a result, Loss Co has left the group. This is irrelevant in determining whether Head Co can use the loss, because intra-group ownership changes after the loss was transferred are ignored. However, after the group formed, A sold 40% of its interest in Head Co to B. By itself, this sale would not cause Head Co to fail the COT. But because the rule requires examination of Loss Cos ability to claim the loss, the 20% change that occurred prior to consolidation (when Head Co acquired X Cos 20% interest in Loss Co) is also relevant.When the pre-consolidation changes in Loss Co are taken into account, together with the post-consolidation changes in Head Co, it can be seen that only 48% of Loss Cos ultimate beneficial ownership has continued from the start of the loss year until the end of the loss claim year. This means that Head Co fails the COT and so can only deduct the loss if it passes the SBT.
Loss Cos ultimate shareholders - 30 June 2004
Shareholder Shareholdings that can be counted to pass the COT Percentage held
A (10% * 80%) 8%
B (50% * 80%) 40%
Total 48%

Modification of the loss year for a transferred loss

7.39 This modification applies in situations where the loss recoupment tests are being applied directly to a head company. Broadly, only things that happen to the head company after a loss has been transferred to it are relevant in determining whether the company can use that loss.

7.40 The head company to which a loss is transferred is taken to have made the loss for the income year in which the transfer occurs [Schedule 1, item 2, subsection 707-140(1)] . However, if the transfer occurs part way through the head companys income year, then the loss year is modified so that it starts at the transfer time [Schedule 1, item 2, section 707-205] .

7.41 Essentially this means that the ownership test period starts at the transfer time (i.e. changes in the ownership or control of the head company before that time are not relevant in determining whether the loss can be used).

7.42 Examples of situations where this rule will be relevant are:

·
an SBT loss is transferred to a head company part way through the head companys income year:

-
in determining whether the head company can use the loss, the ownership test period for the purpose of applying the COT starts at the loss transfer time;

·
a loss is transferred by a trust to a head company part way through the head companys income year:

-
in determining whether the head company can use the loss, the ownership test period for the purpose of applying the COT starts at the loss transfer time;

·
a head company is taken to have failed the COT because the test company failed as a result of applying the rule discussed in paragraphs 7.11 to 7.38.

-
in determining whether the head company passes the SBT it must, under subsection 165-13(2) of the ITAA 1997, identify a continuity period which starts at the loss transfer time;

·
a head company passes the COT because the test company passes as a result of applying the rule discussed in paragraphs 7.11 to 7.38:

-
in determining whether the head company also passes the control test in section 165-15 of the ITAA 1997, the loss year starts at the transfer time.

Application and transitional provisions

7.43 The consolidation regime will apply from 1 July 2002.

Chapter 8 - Limiting the use of transferred losses by a consolidated group

Outline of chapter

8.1 This chapter explains how much of a transferred loss may be deducted or applied by a head company. The rules are contained in Subdivision 707-C.

Context of reform

8.2 The use of transferred losses by a consolidated group is restricted so that losses will be used by a group at approximately the same rate they would have been used by the joining entity had it remained outside the group. The aim is to ensure that the treatment of transferred losses is not a motive in deciding to consolidate a group or in a consolidated group deciding to acquire a loss entity.

8.3 For that reason, the maximum amount of losses transferred by a joining entity that can be used by the group in an income year is determined by reference to the amount of the groups income considered to have been generated by the joining entity. The available fraction is a proxy for determining this amount. [Schedule 1, item 2, section 707-305]

8.4 The available fraction method departs from Recommendation 15.3 of A Tax System Redesigned. It was developed in consultation with interested taxpayers and their advisers after earlier consultations concluded that the method contained in Recommendation 15.3 would be inequitable in certain circumstances.

8.5 In addition, a concessional method for the use of transferred losses has been developed in recognition of this departure. The concession applies to a group that consolidates during the transitional period and is discussed in Chapter 9. Losses to which this concession applies are referred to in this explanatory memorandum as concessional losses.

Summary of new law

8.6 Losses of a particular sort generated by the consolidated group must effectively be used before transferred losses of the same sort. [Schedule 1, item 2, subsection 707-305(2) and paragraph 707-310(3)(b)]

8.7 The annual rate at which a head company can deduct or apply transferred losses is limited by their available fraction. The available fraction is basically the proportion that the loss entitys market value at the joining time bears to the value of the whole group at that time. [Schedule 1, item 2, sections 707-310 and 707-320]

Comparison of key features of new law and current law
New law Current law
A head companys use of transferred losses is limited by the available fraction (unless the concessional method applies). Under the available fraction method transferred losses are used at a rate that approximates the proportion of the groups income earned by the transferor. Losses may be transferred to the extent they can be used by the transferee.

Detailed explanation of new law

8.8 There are 2 broad categories of carry forward losses that a head company may use to reduce its income. They are:

·
losses generated by the consolidated group (group losses); and
·
losses generated by an entity before it became a member of the group and which it transfers to the head company on joining the group (transferred losses).

Transferred losses are kept in bundles

8.9 Loss bundles are formed when losses are transferred to a group for the first time by the entity that actually made them. All of the losses transferred by the entity that actually made them constitute a single bundle of losses. A loss bundle remains intact if it is transferred again. [Schedule 1, item 2, subsections 707-315(1) and (2)]

8.10 The losses in a bundle must all have been transferred at the same time. Were the loss entity to leave and subsequently rejoin the group, any losses transferred when rejoining would form a separate loss bundle.

8.11 A loss bundle ceases to exist if the losses in it can no longer be used because, for example, they have been fully deducted or reduced. [Schedule 1, item 2, subsections 707-315(3) and (4)]

8.12 A single available fraction is worked out for each loss bundle. The available fraction is used to limit the annual rate at which the bundles losses may be recouped by the head company. However, losses in one bundle may be subject to the available fraction for another loss bundle if the value (and loss) donor concession discussed in Chapter 9 applies.

How are the general loss rules modified for transferred losses?

8.13 Group losses are deducted or applied by the head company in accordance with the existing rules for the recoupment of company losses (i.e. the rules contained in Divisions 165 and 166 of the ITAA 1997). However, these rules are modified whenever the head company seeks to use transferred losses. These modifications simply overlay the existing loss rules. They do not displace the scheme of the existing loss rules. [Schedule 1, item 2, section 707-345]

8.14 The modifications are:

·
in some circumstances the COT is modified in its application to a head company [Schedule 1, item 2, Subdivision 707-B]:

-
this is discussed in Chapter 7;

·
in applying the SBT, a head company is not required to compare its business as a head company with the business it carried on as a single entity prior to consolidation [Schedule 1, item 2, section 707-400]:

-
this is discussed in Chapter 6;

·
group losses of a sort are effectively used ahead of transferred losses of the same sort [Schedule 1, item 2, paragraph 707-310(3)(b)]:

-
this broadly matches the current group loss transfer rules in Division 170 of the ITAA 1997. Under those rules, a company can only benefit from a transferred loss of a sort after using its own losses of the same sort;

·
a transferred loss may be used in the same income year in which the head company is taken to have made it [Schedule 1, item 2, subsection 707-140(2)]:

-
this overrides the general rule that an entity may only deduct or apply losses from earlier income years. It matches the existing loss transfer rule in section 170-15 of the ITAA 1997; and

·
the annual rate at which transferred losses can be used is limited by their available fraction [Schedule 1, item 2, section 707-310]:

-
an available fraction is worked out separately for each loss bundle. This limit is discussed in paragraphs 8.17 to 8.46.

8.15 The general rule that requires earliest losses to be used before later ones has no application within a bundle because all of the losses in a bundle will be taken to have been made in the same income year (i.e. the income year in which they were transferred).

8.16 However, losses in different bundles will have different ages if the bundles were acquired by the head company in different income years. There is no requirement that a bundle containing earlier losses must be exhausted before drawing upon a bundle containing later losses (i.e. there is no ordering between bundles).

Limit for using transferred losses

8.17 The use of transferred losses is limited by their available fraction. That is, they may only be offset against a fraction of the head companys income and gains. [Schedule 1, item 2, section 707-310]

What is the purpose of the available fraction?

8.18 The available fraction is a proxy for determining the proportion (i.e. fraction) of the groups income generated by the loss entity. A proxy is necessary because immediately after joining, the loss entitys activities are, for income tax purposes, merged with those of the head company so it is not possible to determine the amount of the groups income actually generated by the loss entity.

8.19 The available fraction limit ensures that transferred losses are used up at approximately the same rate they would have been used had the loss entity remained outside the group. The aim is to ensure that the decision to consolidate is not driven by the tax treatment of transferred losses.

8.20 If the loss entity later leaves the consolidated group, its losses remain with the head company of the group. The available fraction attributable to the losses continues to be used to determine the amount of the losses that can be deducted or applied by the head company. While a loss entity that leaves a group ceases to contribute income to the group, the cash or assets received by the group on the sale of the loss entity continue to generate income for the group, leaving the groups income generating capacity unchanged.

Applying the available fraction

8.21 Having identified the losses in a bundle available for use (e.g. because the COT or SBT is satisfied in respect of them) it is then necessary to work out the amount of those losses that can be used. This is done using the bundles available fraction.

8.22 Broadly, the available fraction for the bundle is applied to each category of the groups income or gains. The results are taken to be the head companys only income or gains of each type. On the basis of that assumption, the head company works out the amount of losses of each sort it can use from the bundle. [Schedule 1, item 2, section 707-310]

8.23 This is essentially a 3 step process:

·
Step 1: work out the amount of each income or gain category as specified in column 2 of the table in subsection 707-310(3):

-
this is the groups total income or gains for each category less relevant deductions including group losses and concessional losses (but not transferred losses whose use is limited by their available fraction);

·
Step 2: multiply each category amount by the bundles available fraction:

-
the result is taken to be the head companys only income or gains for that category as specified in column 1 of the table in subsection 707-310(3);

·
Step 3: on the basis of that assumption, work out a notional taxable income for the head company:

-
the amount of losses of each sort from the bundle used in working out that notional taxable income can then be used in working out the head companys actual taxable income.

Step 1: Work out each (column 2) income or gain category

8.24 The income and gain categories reflect the general loss quarantining rules in the existing law and therefore cover:

·
capital gains;
·
foreign income;
·
exempt film income;
·
film income;
·
other exempt income; and
·
other assessable income.

8.25 The description of each category amount to which the available fraction is applied draws upon existing tax law concepts. However, each is worked out in accordance with the principles discussed in paragraphs 8.26 and 8.27.

8.26 First, each amount is worked out having regard to the head companys income or gains apart from this provision (section 707-310). This is a drafting device which ensures that the starting point is the head companys actual income and gains (as opposed to its notional income and gains that result from applying the available fraction). It also ensures that any choices provided by both the ITAA 1936 and ITAA 1997 that are relevant to the calculation of the companys actual income and gains are imported into this notional process. [Schedule 1, item 2, paragraph 707-310(3)(a)]

8.27 Second, before applying the available fraction, each income or gain category is reduced by any relevant deductions, including group losses and concessional losses of the relevant sort (but not transferred losses whose use is limited by their available fraction). The available fraction is applied to the remaining income and gains as they are the only income and gains which need to be sheltered by available fraction losses. [Schedule 1, item 2, paragraph 707-310(3)(b), column 2 of the table; Schedule 2, item 2, subsection 707-350(2) of the Income Tax (Transitional Provisions) Act 1997]

8.28 Take for example the last (column 2) category amount. It is the amount that would have been the head companys taxable income if it had not had any capital gains, foreign income or film income. Capital gains, foreign and film income are excluded because, consistent with the general loss quarantining rules, they are each dealt with in their own separate categories. The reference to taxable income ensures that relevant assessable income is reduced by deductions before applying the available fraction. The additional rules discussed in paragraph 8.27 ensure that these deductions include group losses and concessional losses but not other transferred losses.

Step 2: Multiply each income or gain category by the available fraction

8.29 Multiply each of the step 1 income or gain categories by the bundles available fraction. The results do not translate directly to the amount of the bundles losses of that sort that can be used. Instead they represent the fraction of the groups income or gains that can be said to have been generated by the assets of the original loss entity. The results form the basis for working out under step 3 the amount of losses in the bundle that can be used.

Step 3: Work out a notional taxable income for the head company

8.30 The head company cannot use any more losses from the bundle than it could have used had the step 2 results been its only income and gains of the relevant type listed in column 1 of the table in subsection 707-310(3).

8.31 In order to work out the amount of losses the head company could have used had the results been its only income or gains, it will need to work out a notional taxable income. The amount of transferred losses of each sort from the bundle used in working out that notional taxable income becomes the amount of transferred losses of those sorts from that bundle that can be used by the head company when it works out its actual taxable income. [Schedule 1, item 2, subsections 707-310(1) and (2)]

8.32 Transferred losses from the relevant bundle are the only deductions to be taken into account in working out the notional taxable income. All other deductions have already been taken into account in working out the category amounts. [Schedule 1, item 2, subsections 707-310(4) and (5)]

8.33 For example, the result of applying the available fraction to the (column 2) category amount for item 6 in the table in subsection 707-310(3) is said to be the head companys assessable income (other than net capital gains, foreign income or film income). The result is said to be assessable income to facilitate the deduction of transferred losses in working out a notional taxable income. (Tax losses are deducted from assessable and not taxable income.) But in working out that notional taxable income the deductions already used in working out the amount to which the available fraction was applied are not used again.

8.34 Also, consistent with the general loss rules, tax losses from a bundle can be offset against the bundles notional net capital gain (i.e. the fraction of capital gains remaining after deducting the bundles available net capital losses). This flows naturally from the process of working out the notional taxable income (see Examples 8.1 to 8.3).

Special rule for deducting transferred losses from exempt income

8.35 Tax losses must first be deducted against exempt income. Therefore, the available fraction is also applied to a groups exempt income. However, the end result of working out a notional taxable income will be a single amount of tax losses that can be used from the bundle (i.e. the total amount of tax losses for deduction against the groups exempt and assessable income). That is, tax losses notionally offset against exempt income and those notionally deducted against assessable income are together the amount of tax losses from the bundle that could have been used.

8.36 However, a special rule ensures that in working out the head companys actual taxable income, tax losses can commence to be offset against assessable income provided they have been used against exempt income to the same extent they were under the notional process. In the absence of this rule, the general loss rules would require the head company, in working out its actual taxable income, to first offset its transferred tax losses against its total exempt income (and not just against a fraction of it). [Schedule 1, item 2, section 707-340]

Example 8.1: Farrah Fabrics (bundle 1) The Farrah Fabrics consolidated group is working out the groups taxable income for the 2003-2004 income year.The groups capital gains for the income year are $900. The groups capital losses for the income year are $200.The groups only other assessable income is $9,000. Its deductions relating to that income are $990. Its group tax loss carried forward from the previous income year is $60.The groups remaining transferred losses at that time, and their available fractions, are set out in the table. Assume that the COT or SBT is passed in respect of all these losses.

Loss bundle Available fraction Unused transferred losses
Bundle 1 0.146 $50 net capital losses

$3,000 tax losses (not film)

Bundle 2 0.214 $100 net capital losses

$5,000 tax losses (not film)

The rest of this example works out the amount of losses that can be used from bundle 1. Example 8.2 works out the amount of losses that can be used from bundle 2. Step 1: Work out the categories of group income or gains Category: capital gainsReduce the groups capital gains for the income year by its group capital losses for that year: $900 - $200 = $700Category: other assessable incomeReduce other assessable income by current year deductions and prior year group tax loss: $9,000 - ($990 + $60) = $7,950 Step 2: Apply bundle 1s available fraction to each category Category: capital gains

0.146 * $700 = $102

Category: other assessable income

0.146 * $7,950 = $1,160

Step 3: Work out a (notional) taxable income for bundle 1 As a result of step 2, it is assumed that Farrah Fabrics only capital gain is $102. On the basis of that assumption, the whole of the $50 net capital loss from bundle 1 can be used. This results in a (notional) net capital gain for bundle 1 of $52 ($102 - $50).This result is used as Farrah Fabrics completes the process of working out a notional taxable income for bundle 1:
Assessable income ($) Deductions ($)
net capital gain 52 tax losses (bundle 1) 1,212
other assessable income 1,160
Total 1,212 Total 1,212
Therefore, Farrah Fabrics is able to use $1,212 of its tax losses from bundle 1. These tax losses are in part attributable to the $52 net capital gain. This is consistent with the general loss rules which permit tax losses to be offset against net capital gains.

Example 8.2: Farrah Fabrics (bundle 2) This example continues Example 8.1 by working out the amount of losses that can be used from bundle 2. It also draws the bundle 1 and 2 results together in working out Farrah Fabrics actual taxable income. Step 1: Work out the categories of group income or gains These are the same as for Example 8.1.Category: capital gains - $700Category: other assessable income - $7,950 Step 2: Apply bundle 2s available fraction to each category Category: capital gains

0.214 * $700 = $150

Category: other assessable income

0.214 * $7,950 = $1,701

Step 3: Work out a (notional) taxable income for bundle 2 As a result of step 2, it is assumed that Farrah Fabrics only capital gain is $150. On the basis of that assumption, the whole of the $100 net capital loss from bundle 2 can be used. This results in a (notional) net capital gain for bundle 2 of $50 ($150 - $100).This result is used as Farrah Fabrics completes the process of working out a notional taxable income for bundle 2:
Assessable income ($) Deductions ($)
net capital gain 50 tax losses (bundle 2) 1,751
other assessable income 1,701
Total 1,751 Total 1,751
Farrah Fabrics is able to use $1,751 of its tax losses from bundle 2. These tax losses are in part attributable to the $50 net capital gain. Again, this reflects the general loss rules which permit tax losses to be offset against net capital gains. Work out Farrah Fabrics taxable income First, work out Farrah Fabrics net capital gain:
Capital gains ($) Capital losses ($)
capital gain 900 group capital losses 200
net capital losses (bundle 1) 50
net capital losses (bundle 2) 100
Total 900 Total 350
Farrah Fabrics net capital gain is $550 ($900 - $350).
Assessable income ($) Deductions ($)
net capital gain 550 deductions 990
other 9,000 group loss 60
tax losses (bundle 1) 1,212
tax losses (bundle 2) 1,751
Total 9,550 Total 4,013
Farrah Fabrics taxable income is $5,537 ($9,550 - $4,013).

Example 8.3: Digby Department Store The Digby Department Store consolidated group is working out its taxable income for the 2004-2005 income year.The groups assessable foreign income for the income year (ignoring transferred losses) is $2,000. Its foreign deductions relating to that class of income are $200.The groups exempt income is $1,000.The groups assessable income from its domestic trading operations is $8,000. Its deductions relating to that income are $1,500.The group has a single bundle of transferred losses. Its available fraction and remaining losses for that bundle are set out in the table. Assume that the COT or SBT is passed in respect of these losses.

Available fraction Unused transferred losses
0.400 $350 foreign losses

$4,000 tax losses (not film)

Step 1: Work out the categories of group income or gains Category: foreign incomeReduce the groups assessable foreign income by its foreign income deductions: $2,000 - $200 = $1,800Category: exempt income$1,000Category: other assessable incomeReduce other assessable income by current year deductions:

$8,000 - $1,500 = $6,500

Step 2: Apply the bundles available fraction to each category Category: foreign income

0.4 * $1,800 = $720

Category: exempt income

0.4 * $1,000 = $400

Category: other assessable income

0.4 * $6,500 = $2,600

Step 3: Work out a (notional) taxable income for the bundle First, reduce the fraction of assessable foreign income worked out under step 2 by the bundles available foreign loss: $720 - $350 = $370.This shows that Digby can use the whole of its $350 transferred foreign loss.Second, offset $400 of the transferred tax losses against the fraction of exempt income worked out under step 2.Third, complete the process of working out a notional taxable income:
Assessable income ($) Deductions ($)
assessable foreign income 370 tax losses 2970
other 2,600
Total 2,970 Total 2,970
This assumes the group (in working out its actual taxable income) has elected under section 79DA of the ITAA 1936 to offset the bundles tax losses against foreign income to the extent it exceeds foreign losses.Digby can therefore use the following amounts of transferred losses:

·
$350 foreign loss;
·
$400 tax losses against exempt income; and
·
$2,970 tax losses against assessable income.

Step 4: Work out Digby Department Stores taxable income First, offset tax losses against exempt income: $1,000 - $400 = $600The fact that Digby still has exempt income will not prevent its remaining tax losses ($2,970) being offset against assessable income.Second, reduce assessable foreign income by the bundles available foreign loss: $2,000 - $350 = $1,650.
Assessable income ($) Deductions ($)
assessable foreign income 1,650 deductions (foreign) 200
other 8,000 deductions (other) 1,500
tax losses 2,970
Total 9,650 Total 4,670
Digby Department Stores taxable income is $4,980 ($9,650 - $4,670).

The available fraction applies for only part of the income year

8.37 The use of transferred losses is apportioned if their available fraction applied for only part of the income year. The apportionment rule is drafted as a general principle so that if either of the 2 trigger events occur the group cannot use more of its transferred losses than is reasonable having regard to the matters listed. [Schedule 1, item 2, section 707-335]

8.38 The rule is triggered if:

·
the losses were transferred to the head company by another entity after the start of the head companys income year; or
·
an available fraction is adjusted during the year to take account of the transfer of another loss bundle or because there has been a capital injection or a non-arms length transaction (in these cases the available fraction will have different numerical values for different periods of the income year).

Subsidiary transfers losses during head companys income year

8.39 Apportionment in this case ensures that a subsidiarys losses are only offset against income generated by the group after the subsidiary became a member. This is the only part of the groups income to which the subsidiary could have contributed. This is consistent with the available fraction being a proxy for determining the proportion of the groups income generated by the loss entity. [Schedule 1, item 2, paragraph 707-335(1)(a)]

8.40 In the absence of this rule, losses transferred by a subsidiary that joins a group on, for example, the second last day of the groups income year, could be used in reducing the groups income for the whole of the income year (i.e. for a period during which the subsidiary was not a member of the group and so could not have contributed to the income generated by the group).

8.41 This apportionment does not apply to losses transferred by a company to itself in its capacity as a head company. That is, even if the head company chooses to consolidate the group part way through the head companys income year, the head companys own losses can be used during the formation year without apportionment (but subject to their available fraction). The only time a groups use of its head company losses will be apportioned is if the available fraction changes during the income year.

8.42 However, a groups use of losses transferred by a subsidiary member will be apportioned if the group forms part way through the head companys income year and the subsidiary joins at the formation time (see Example 8.4).

Available fraction changes during the income year

8.43 Apportionment in this case ensures that an adjusted available fraction that is less than the previous fraction only applies from the date of the event that triggered the adjustment. (An adjustment can only result in the same or a reduced fraction.) This allows the group the benefit of the previous higher fraction for the period of its application. [Schedule 1, item 2, paragraph 707-335(1)(b)]

8.44 The rule is triggered in this situation if the available fraction changes during the income year while the losses were held by the head company (called the transferees loss-holding period ).

8.45 Generally, the transferees loss-holding period is the groups income year. However, it starts later if the loss bundle was transferred to the head company by another entity after the start of the income year. In that case, the loss-holding period starts at the transfer time. This caters for the fact that both trigger events can occur during the same income year. Also, the period ends earlier if, before the end of the income year, the head company becomes a subsidiary member of another group - at that time the losses commence to be held by a different transferee. [Schedule 1, item 2, subsection 707-335(2)]

Matters to be taken into account

8.46 In determining a reasonable use of losses if the trigger events occur, regard must be had to all relevant matters, including:

·
the general method prescribed for working out the maximum amount of losses that can be used:

-
that is, the apportionment must be consistent with the method discussed in paragraphs 8.17 to 8.36;

·
the number of days in the transferees loss-holding period:

-
this factor is relevant to both trigger events. Essentially it is only income attributable to this period against which the relevant losses can be offset;

·
the value or values of the relevant available fraction during the loss-holding period and the number of days in the period for which the fraction had a particular value:

-
again these factors are relevant to both trigger events. They ensure that the use of losses is apportioned on the basis of the number of days in the holding period for which the available fraction held a particular value;

·
however, if the head company transferred the losses to itself after the start of its income year, their available fraction for any of the loss-holding period that occurs before that transfer is the initial value of the available fraction:

-
this factor would only be relevant if a head companys own losses were transferred part way through its income year and their available fraction was subsequently adjusted. It ensures that the number of days in the loss-holding period for which the first available fraction is relevant includes the period from the start of the income year until the transfer (if that is later). That is, an available fraction for a head companys own losses applies from the beginning of its income year.

[Schedule 1, item 2, subsection 707-335(3)]

Example 8.4 The group forms part way through the head companys income year. Sub Loss Co joins as a subsidiary member at the formation time. The groups use of Sub Loss Cos losses should be apportioned on the basis of 265/365.

diagram: apportioning of loss 265/365

Example 8.5 The group forms part way through the head companys income year. Sub Loss Co joins as a subsidiary after formation but before the end of the income year. The groups use of Sub Loss Cos losses should be apportioned on the basis of 65/365.

diagram: apportioning of loss 65/365

Example 8.6 The group is in existence for the whole income year. Loss Co 1 joins the group part way through the head companys income year. Loss Co 2 joins after Loss Co 1 but before the end of the income year.Loss Co 1 has 2 available fractions and they should be applied 200/365 and 65/365.The groups use of losses transferred by Loss Co 2 should be apportioned 65/365.

diagram: apportioning of loss 65/365

Example 8.7 Loss Co 1 joins part way through the income year. After that, but before the end of the income year, the group is acquired by another group.The original groups use of the losses transferred to it by Loss Co is apportioned 200/280. The new groups use of Loss Cos losses should be apportioned 85/365.

diagram: apportioning of loss 85/365

Example 8.8

diagram: weighted average

On formation of the group (part way through Head Cos income year) Head Co transfers a loss bundle with an available fraction of 0.6.As a result of the groups subsequent acquisition of Sub Loss Co, the available fraction for Head Cos loss bundle is reduced to 0.42.When Sub Loss Co joins the group it transfers a loss bundle to Head Co with an available fraction of 0.3.How does Head Co apportion its use of transferred losses?One approach would be for Head Co to work out a single weighted average available fraction for each loss bundle. The weighting would reflect the number of days in the income year for which each different fraction was relevant. These weighted available fractions would then be used in working out how much of the losses from each bundle could be used (i.e. in applying the 3 steps discussed in paragraph 8.23).Weighted average fraction for Head Cos bundle:
0.6 * (140 / 365) = 0.230
0.42 * (225 /365) = 0.259
Total 0.489
Weighted average fraction for Sub Loss Cos bundle:
0.3 * (225 / 365) = 0.185

Calculating the available fraction

8.47 A loss bundles available fraction is the proportion the joining loss entitys modified market value bears to the market value of the whole group when the bundle is first transferred to a head company (the initial transfer time). The fraction is increased if the value donor concession discussed in Chapter 9 applies. It is adjusted if any of the events in Table 8.1 happen (e.g. the group acquires a new loss entity). [Schedule 1, item 2, section 707-320]

Calculating an available fraction for losses transferred for the first time

8.48 Losses transferred for the first time may be either:

·
the losses of a single entity that becomes the member of a consolidated group; or
·
the group losses of a head company that is acquired by another group.

8.49 In those cases, the available fraction is calculated like this:

modified market value of the loss entity or group / adjusted market value of the head company

[Schedule 1, item 2, subsection 707-320(1)]

8.50 Values are worked out as at the initial transfer time and are discussed in paragraphs 8.74 to 8.86. The value of the head company (transferee) includes the value of subsidiary members of the group, including the loss entity. That is, the value of the head company is essentially the value of the whole group. This flows from the single entity rule which treats subsidiary members as parts of the head company.

Adjusting the available fraction

8.51 Available fractions are adjusted to ensure they continue to approximate the proportion of the groups income that can be said to be generated by the relevant loss entity.

8.52 For example, a groups available fractions are adjusted whenever the group acquires another loss entity (or group) or the groups market value is increased as a result of a capital injection or a non-arms length transaction. A groups available fractions must also be adjusted if they total more than one. For the purpose of this explanation, the events giving rise to an adjustment are referred to as adjustment events. [Schedule 1, item 2, subsection 707-320(2)]

8.53 Table 8.1 identifies the adjustment events. The adjusted available fraction is worked out by multiplying the existing available fraction by the factor identified at the relevant item in the table. An adjustment event can never result in an increased available fraction.

Table 8.1: Available fraction adjustments
Item no. Adjustment event Factor
1 Previously transferred loss bundles are transferred to a new head company. The lesser of one and this fraction:

market value of the old group / market value of the new joined group

2 Previously transferred loss bundles are transferred to a new head company and, at the same time, the old group also transfers its group losses to the new head company.

the lesser of the available fraction for group losses and 1 / the total of available fractions for all bundles being transferred

3 Existing group with transferred losses acquires new loss bundles.

1 - the total of the available fractions for all the new loss bundles that have been transferred to the head company

4 There is an increase in the market value of the group as a result of an injection of capital or a non-arms length transaction.

market value of the group just before the event / (market value of the group just before the event + amount of the increase)

5 Available fractions total more than one.

1 / total of available fractions

Adjustment event 1 - previously transferred losses are transferred again

8.54 This event occurs when:

·
the head company of a consolidated group (the old group) joins another consolidated group (the new group);
·
the old group transfers losses to the new group; and
·
those losses had been previously transferred to the old group.

8.55 The available fraction for each bundle of previously transferred losses is adjusted by multiplying it by the factor at item 1 in Table 8.1, if the factor is less than one. If the factor is one or more, then each available fraction is multiplied by one and therefore remains unchanged. [Schedule 1, item 2, item 1 of the table in subsection 707-320(2)]

8.56 The market value of the old group is included in the numerator as if the group had continued to exist as a single entity. The market values of the old and new groups are worked out as at the time the old group joins the new group. The new group is the whole group including the old group. [Schedule 1, item 2, subsection 707-330(2)]

8.57 Unlike the formula for calculating an available fraction for a bundle of losses transferred for the first time, this factor does not use modified or adjusted market values. This is because the original available fractions were calculated to take account of the assumptions in paragraph 8.74 as well as any relevant capital injections and non-arms length transactions. Therefore, they can simply be adjusted to reflect the proportion that the old groups market value bears to the value of the new group at the transfer time.

Adjustment event 2 - previously transferred and group losses are both transferred

8.58 This event occurs when the old group transfers to the new group both previously transferred losses and its own group losses. First, an available fraction for the bundle of group losses is worked out using the formula for losses transferred for the first time. Second, the available fraction for each bundle of previously transferred losses is adjusted by multiplying it by the factor for adjustment event 1. [Schedule 1, item 2, subsection 707-320(1) and subsection 707-320(2), item 1 in the table]

8.59 Each of these available fractions (i.e. for group losses and previously transferred losses) is then adjusted by multiplying each by the factor at item 2 in Table 8.1. This factor caps the total of the available fractions for the joining group so their total does not exceed what would otherwise have been the available fraction for the group losses. This ensures the available fractions bear the correct proportion to each other. It also ensures they bear the correct proportion to the available fractions for any loss bundles already held by the acquiring group. [Schedule 1, item 2, item 2 of the table in subsection 707-320(2)]

Adjustment event 3 - when another loss entity joins the group

8.60 A groups available fractions are adjusted if the group acquires another loss entity or loss group. Each available fraction is adjusted by multiplying it by the factor at item 3 in Table 8.1. A head company may choose to cancel the transfer of all its incoming losses to avoid this adjustment. [Schedule 1, item 2, item 3 in the table in subsection 707-320(2)]

Adjustment event 4 - capital injections and non-arms length transactions

8.61 A groups available fractions are adjusted if the groups market value is increased as a result of capital injected into the group or a non-arms length transaction involving the group. This increase in the groups income generating capacity reduces the proportion of income that loss entities within the group can be regarded as generating. Therefore, each available fraction is adjusted by multiplying it by the factor at item 4 in Table 8.1 (see also the discussion in paragraphs 8.92 to 8.102). [Schedule 1, item 2, item 4 in the table in subsection 707-320(2)]

Adjustment event 5 - available fractions total more than one

8.62 If a groups available fractions total more than one, it would incorrectly indicate that the group can generate more income than it actually does. The factors for adjustment events 1, 2 and 3 have in-built mechanisms for ensuring that, in those cases, a groups available fractions cannot total more than one.

8.63 However, it may still be possible, for example, on formation or after a series of adjustments that a groups available fractions total more than one. If they do, they are proportionally reduced. Each available fraction is reduced by dividing it by the total available fractions (see item 5 in Table 8.1). This adjustment only applies after completion of the available fraction calculation and other relevant adjustments. [Schedule 1, item 2, item 5 in the table in subsection 707-320(2) and subsection 707-320(3)]

8.64 In determining whether available fractions total more than one, only take account of available fractions for bundles that still exist. A bundle ceases to exist if none of the losses in it (including those that are taken to be in it under the value and loss donor concession discussed in Chapter 9) can be used or otherwise reduced. [Schedule 1, item 2, subsections 707-315(3) and (4)]

Several adjustment events

8.65 A single loss transfer may trigger more than one adjustment event (e.g. an old group transfers losses to a new group and the new group has existing loss bundles). If this occurs, then the adjustment calculations are made in the same order as they appear in Table 8.1. The results of earlier calculations are used in making the calculations under a later item (see also Example 8.11). [Schedule 1, item 2, subsection 707-320(3)]

More about the available fraction calculation

Available fractions are rounded to 3 decimal places

8.66 Available fractions are calculated and then adjusted to 3 decimal places. The third decimal place is rounded up if the fourth decimal place is 5 or more. [Schedule 1, item 2, subsection 707-320(4)]

When will an available fraction be zero?

Numerator is zero

8.67 The available fraction works out as zero if the modified market value of the joining entity (i.e. the numerator) is nil. Such an entity is not in an income producing position and therefore the bundle of losses transferred by it does not have an available fraction. This means the group will not be able to use any of the losses transferred by that entity, unless value is added to the modified market value of the entity by another group member under the value donor concession discussed in Chapter 9.

Available fraction would otherwise be a negative amount

8.68 An available fraction will be zero if it would otherwise be a negative amount. This could occur in applying the factor for adjustment event 3 if the incoming available fractions totalled more than one. [Schedule 1, item 2, subsection 707-320(6)]

When will an available fraction be one?

8.69 The available fraction may work out as one if all of the groups losses and value are pooled in a single bundle under the value and loss donor concession. This can only occur where all of the group members and their losses are fully groupable (all losses transferable to every other member in the group) under the current loss transfer rules (see Chapter 9).

8.70 The available fraction is also one if the modified market value of the joining entity is a positive amount (the numerator) but the adjusted market value of the group joined (the denominator) is nil. This matches what occurs naturally if the numerator is greater than the denominator and the denominator is also a positive amount. It reflects the fact that any income generated by the group will be attributable to the loss entity and therefore the entitys losses can be used to offset that income without restriction. However, if a group with a nil value has more than one loss entity with a positive value, this rule will mean that each available fraction is more than one and so the groups available fractions will total more than one. In that case, each available fraction is proportionally reduced under item 5 of Table 8.1. [Schedule 1, item 2, subsections 707-320(2) and (5)]

Head company can choose to cancel transferred losses

8.71 A head company can choose to cancel the transfer of a loss. The choice is made on a loss by loss (as opposed to bundle by bundle) basis. [Schedule 1, item 2, subsection 707-145(1)]

8.72 A head company may choose to cancel a loss to:

·
avoid adjusting the available fractions for its existing loss bundles under adjustment event 3 (though it would need to cancel all its incoming losses to achieve this); or
·
achieve a better outcome under adjustment event 2 which caps available fractions when both group and previously transferred losses are transferred.

8.73 A choice to cancel the transfer of a loss cannot be changed. The effect of the cancellation is that the transfer is treated as if it had never occurred. Cancelled losses can never be used or transferred by any entity for a period after the loss entity has joined the group. [Schedule 1, item 2, subsections 707-145(2) and (3)]

Values used in calculating the available fraction

Modified market value of a single joining entity

8.74 The modified market value of a joining entity (relevant to working out the initial available fraction) is its market value, assuming:

·
it has no losses and the balance of its franking account is nil;
·
the subsidiary members of the group at the joining time are separate entities and not parts of the head company; and
·
its market value did not include an amount that is attributable (directly or indirectly) to a membership interest in any other group member (with one exception).

[Schedule 1, item 2, subsection 707-325(1)]

Assume no tax attributes

8.75 In working out the modified market value the market value of a joining entity is worked out as though it did not have losses or franking credits. The value is worked out as if these attributes did not exist because they do not enhance the joining entitys income generating capacity. This means, for example, that a loss entity with no assets other than its losses will have a nil available fraction which will prevent its losses being used by the group (unless the value donor concession discussed in Chapter 9 applies). [Schedule 1, item 2, paragraph 707-325(1)(a)]

Override the single entity rule

8.76 In working out that market value, a joining entity (whether the head company or other entity) is treated as a separate entity. This overrides the single entity rule which would otherwise treat subsidiary members as parts of the head company. [Schedule 1, item 2, paragraph 707-325(1)(b)]

Assume no interests in other group members

8.77 The modified market value of the joining entity is worked out on the assumption that its market value did not include any amounts directly or indirectly attributable to membership interests in other group members. Such amounts are reflected in the market value of those other group members. Ignoring them prevents double counting.

8.78 If the joining entity has a membership interest in another member of the group (e.g. shares in a member company) the market value is worked out as if the amount attributable to that interest were not included in its market value. However, if the joining entity has a membership interest in a non-member company the market value includes the amount attributable to that interest. But, if that non-member company itself has a membership interest in the head company of the group the value attributable to that interest, and included in the value of the joining entitys membership interest in the non-member, is excluded from the joining entitys market value (i.e. this would be an amount indirectly attributable to a membership interest in a member of the group). [Schedule 1, item 2, paragraph 707-325(1)(c)]

8.79 There is one exception. A joining entitys modified market value may include value contributed by a trust but the value is limited to the amount attributable to the joining entitys fixed entitlement to income or capital of the trust. The inclusion of this value recognises that outside consolidation the trusts income is sheltered from income tax by the joining entitys losses. In determining this amount, it is necessary to exclude value attributable (directly or indirectly) to membership interests in other group members, unless those other group members are themselves trusts in which a fixed entitlement is held. [Schedule 1, item 2, paragraph 707-325(1)(d)]

8.80 However, a joining entitys modified market value cannot include the value of a trust that:

·
itself transferred losses to the head company (because the value that trust will be counted in working out its own available fraction (though the head company could choose to cancel the transfer of losses by the trust in which case its value could be counted); or
·
is a corporate unit trust or a public trading trust (because these trusts are taxed like companies as opposed to receiving flow-through treatment and so, outside consolidation, their income cannot be sheltered from income tax by a beneficiarys losses).

[Schedule 1, item 2, subparagraphs 707-325(1)(c)(i) and (ii)

Example 8.9

modified market value

A consolidated group forms consisting of a head company, 4 subsidiary companies and a fixed trust. Loss Co (and A Co) are beneficiaries of the fixed trust - they each hold a fixed entitlement to 50% of the income and capital of the trust.The modified market value for Loss Co is worked out by determining its market value assuming it:

·
has no losses and the balance of its franking account is nil;
·
is a separate entity (and not just a part of the head company); and
·
has no value directly or indirectly attributable to membership interests in other group members, except for a fixed entitlement to income and capital of the trust:

-
Loss Cos interest in B Co is not taken into account;
-
However, Loss Cos fixed entitlement to income and capital of the trust (that is not attributable to the trusts interest in C Co) can be counted.

These assumptions do not exclude the taking into account of value attributable to membership interests Loss Co has in entities outside the group. Therefore, Loss Co may count the value of its interest in the foreign subsidiary.

Adjusted market value of the head company

8.81 The adjusted market value of the head company to which the losses are initially transferred (i.e. the transferee) is the head companys market value at the transfer time, ignoring any losses it has and assuming that its franking account balance is nil. The value of these attributes is ignored because they do not contribute to the groups earning capacity. [Schedule 1, item 2, subsection 707-320(1)]

8.82 This is essentially the market value of the whole group. That is, as a result of the single entity rule, the market value of the head company includes the value of subsidiary members of the group, including the loss entity. It also includes the value of interests held by group members in entities outside the group. Therefore, in Example 8.9 the value of the head company would include the value of interests held by the loss company in the foreign subsidiary.

Value of a joining entity that was a head company

8.83 When the head company of one group (the old group) joins another group (the new group) and transfers losses to that new group the modified market value of the old group at loss transfer time is the value used in working out the available fraction for the transferred losses. [Schedule 1, item 2, subsections 707-330(1) and (2)]

8.84 In other words, the single entity rule applies so that in working out the value of the ex-head company of the old group all of the subsidiary members of the old group at the loss transfer time are treated as a part of the ex-head company (and not as a separate member of the new group).

8.85 The losses transferred may be group losses (in which case the ex-head company must work out its modified market value) or previously transferred losses (in which case adjustment event 1 requires the market value of the old group, the transferor, to be determined).

8.86 If the losses are group losses, the single entity rule will also apply to the period the old group was in existence prior to the joining time. That is, the modified market value of the ex-head company is worked out as if each subsidiary member of the group had been a part of the ex-head company while it was a subsidiary member of the old group. This ensures that capital injected into (or non-arms length transactions involving) subsidiary members of the old group before it joins the new group are taken into account in working out the ex-head companys modified market value. [Schedule 1, item 2, subsections 707-330(1) and (3)]

Maintaining the integrity of the available fraction

8.87 The calculation of available fractions is a crucial component of the rules for loss utilisation by consolidated groups. As such, special rules are necessary to maintain the integrity of those calculations. These rules prevent the inflation of available fractions from certain events occurring prior to consolidation. In addition, adjustment event 4 in Table 8.1 ensures that available fractions are appropriately adjusted to reflect certain events occurring post-consolidation.

Pre-consolidation events that increase market value

8.88 An increase in the value of a loss entity is excluded from the entitys modified market value if the increase is as a result of either:

·
an injection of capital into the loss entity, its associate or, if the loss entity is a trust, an associate of its trustee; or
·
a non-arms length transaction that involved the loss entity, its associate or, if the loss entity is a trust, an associate of its trustee.

[Schedule 1, item 2, subsections 707-325(2) and (4)]

8.89 The amount excluded is the lesser of:

·
the difference between the loss entitys market value at the joining time and what would have been its market value if the injection or transaction had not occurred; and
·
the total increase in the entitys market value that occurred after each (capital injection or non-arms length transaction) event.

[Schedule 1, item 2, subsection 707-325(3)]

8.90 Framing the reduction in this way ensures that no reduction is required if the event has not actually resulted in an increased available fraction as at the joining time. It also ensures the reduction does not include the compounding effects of the increase in value. That is, if additional value has been built up as a result of profitably utilising the original increase, then the reduction is only the amount of the original increase.

8.91 These rules prevent a loss entity from inflating its market value before it joins a consolidated group in order to obtain a higher available fraction. They apply to events that occur in the 4 years before the loss entity joins the group [Schedule 1, item 2, paragraph 707-325(2)(a)] . However, they do not apply to events that occur before 9 December 2000 [Schedule 2, item 2, section 707-329 of the Income Tax (Transitional Provisions) Act 1997] .

Post-consolidation events that increase market value

8.92 A groups available fractions are adjusted if the groups market value is increased as a result of either:

·
an injection of capital into the group or an associate of the group; or
·
a non-arms length transaction that involved the group or an associate of the group.

[Schedule 1, item 2, subsection 707-320(2), item 4 in the table]

8.93 These events increase the income generating capacity of the group which reduces the proportion of income a loss entity can be regarded as generating. If these events occur, the groups available fractions are adjusted using the factor at item 4 in Table 8.1.

More about events that increase value

8.94 These events may affect the initial calculation of an available fraction if they happen to a joining entity pre-consolidation. They may also result in the available fraction being adjusted if the events happen to the group post-consolidation.

8.95 Pre-consolidation events only become relevant after an initial modified market value has been worked out for a joining entity. However, a joining entitys modified market value is worked out ignoring or excluding value attributable, directly or indirectly, to membership interests in other group members. To the extent value has already been ignored (because it was represented in the value of a group membership interest) it will not be considered again in assessing the effects of these events. [Schedule 1, item 2, paragraphs 707-325(1)(d) and (2)(b)]

8.96 Post-consolidation, the events are only relevant if they trigger an increase in the market value of the whole group. This can only occur in this context as a result of an injection of capital or non-arms length transaction involving entities external to the group.

8.97 The expression injection of capital is not defined and therefore takes its ordinary meaning. Capital is generally understood as the wealth of an entity, whether in money or property. The use of the word injection conveys that the capital or wealth has been introduced from outside the entity (or group) in the sense that it has not been obtained from the entitys (or groups) own resources. The simplest example of an injection of capital is the payment of cash to an entity as consideration for membership interests in the entity.

8.98 Non-arms length transaction is also not defined though it is specified that the transaction must involve an associate of the entity or group. These events are only relevant if they trigger an increase in the value of a joining entity or a group. There would be no increase in value for example, if the entity or group acquired an asset from an associate for which it paid full consideration.

8.99 Examples of transactions that may lead to an increase in value of an entity or group are:

·
transferring an asset to the entity or group for less than market value consideration;
·
forgiving a debt owed by the entity or group;
·
lending money to the entity or group on non-commercial terms; and
·
paying the entity or group an inflated price for goods or services.

Exception to rules regarding events that increase market value

8.100 The pre- and post-consolidation capital injection events do not apply to an injection of capital:

·
into a listed public company through a dividend reinvestment scheme, provided the entity to which shares are issued held a share in the listed public company before the capital injection; or
·
in association with an acquisition of shares under an employee share scheme if the scheme is one described in the rules dealing with membership of a consolidated group. (Minor holdings of shares in a company issued under certain employee share arrangements will not prevent the company being a subsidiary member of a consolidated group, see Chapter 3.)

[Schedule 1, item 2, subsection 707-325(5)]

8.101 The exceptions recognise that such schemes are unlikely to be exploited pre-consolidation to increase available fractions. Excluding these schemes from the rules will also reduce compliance costs for consolidated groups as market valuations will not need to be made as a result of operating these schemes after consolidation.

General anti-avoidance rule

8.102 In addition to the specific rules to prevent the inflation of an available fraction, the general anti-avoidance provisions of Part IVA of the ITAA 1936 may apply where values relevant to the calculation of an available fraction are manipulated as part of a scheme entered into with the sole or dominant purpose of increasing an available fraction (or otherwise increasing the rate of utilisation of losses by a consolidated group).

Examples of calculating and adjusting available fractions

Example 8.10

Example 1 of calculating and adjusting available fractions

The Cellar Door Sales group consolidates. At the initial transfer time, the groups market value is $10,000.Available fractions for the head companys loss bundles are:
head company: $5,000 / $10,000 = 0.5
A: $3,000 / $10,000 = 0.3
B: $2,000 / $10,000 = 0.2

Example 8.11 Cellar Door Sales is taken over by another consolidated group, All Over Australia Liquor Distributors.At this time, the Cellar Door Sales Groups modified market value is $13,000 (the same as its market value). Cellar Door Sales now has a group loss in addition to its previously transferred losses.The market value of the new group (All Over Australian Liquor Distributors and Cellar Door Sales is $35,000).

Example 2 of calculating and adjusting available fractions

Cellar Door Sales 1. Calculate an available fraction for the loss bundle containing the group loss:

$13,000 / $35,000 = 0.371

2. Adjust the available fractions for the previously transferred loss bundles:
head co: 0.5 ($13,000 / $35,000) = 0.186
A: 0.3 ($13,000 / $35,000) = 0.111
B: 0.2 ($13,000 / $35,000) = 0.074
0.371
3. Cap the available fractions:
Group loss 0.371 * (0.371 / 0.742) = 0.186
head co: 0.186 * (0.371 / 0.742) = 0.093
A: 0.111 * (0.371 / 0.742) = 0.056
B: 0.074 * (0.371 / 0.742) = 0.037
0.372
Note: 0.742 is the sum of the available fractions calculated under steps 1 and 2 (i.e. 0.371 + 0.186 + 0.111 + 0.074). All Over Australia Liquor Distributors Recalculate the available fractions for the loss bundles held by the head company of All Over Australia Liquor Distributors before the takeover:
C: 0.115 * (1 - / 0.372) = 0.072
D: 0.162 * (1 - / 0.372) = 0.102

Application and transitional provisions

8.103 The consolidation regime will apply from 1 July 2002.

8.104 Two transitional measures are included in the Income Tax (Transitional Provisions) Act 1997 that may affect a groups use of its transferred losses. Both apply to certain losses transferred to a group that consolidates during the transitional period (i.e. 1 July 2002 to 30 June 2004).

8.105 The first increases a loss entitys modified market value (and therefore its available fraction) by a portion of the modified market value of another group member with whom the entity could have grouped its losses under Division 170 of the ITAA 1997 (the value and loss donor rules). The second allows certain company COT losses to be used over 3 years instead of in accordance with their available fraction (the concessional loss method). Both are discussed in Chapter 9.

Consequential amendments

8.106 Consequential amendments have been made to subsection 995-1(1) to include references to new dictionary terms. [Schedule 5, items 3, 4 and 18]

Chapter 9 - Transitional concessions for losses

Outline of chapter

9.1 This chapter explains the transitional concessions available for transferred losses. These concessions will be included in Subdivision 707-C of the Income Tax (Transitional Provisions) Act 1997.

Context of reform

9.2 The available fraction method outlined in Chapter 8 sets a limit on the utilisation of losses transferred to a group by reference to the contribution to group income expected to be made by the entity that transferred the losses. A concession that increases the available fraction is provided in recognition that, under the existing group loss transfer rules, an entity can use its losses to shelter not just its own income but also the income of another member of the same wholly-owned group. Since the group loss transfer rules will be repealed as a result of the introduction of the consolidation regime, this concession is only available to groups that consolidate during the transitional period (i.e. 1 July 2002 to 30 June 2004).

9.3 The available fraction method departs from Recommendation 15.3 of A Tax System Redesigned. In recognition of this departure, an additional concessional method for the use of transferred losses has been developed to apply to certain losses transferred to a group that consolidates during the transitional period.

Summary of new law

9.4 A loss entity joining a consolidated group may increase its modified market value (for the purpose of calculating its available fraction) by a portion of the modified market value of another entity to which it could have transferred losses under the existing group loss transfer rules. This is a transitional measure that only applies if both entities joined the group when it formed during the transitional period.

9.5 Further, in respect of company COT losses transferred to a group when it consolidates during the transitional period, and that were made in an income year ending on or before 21 September 1999, concessional treatment can be chosen. That is, instead of their utilisation being determined by reference to an available fraction, they may be used over 3 years.

Comparison of key features of new law and current law
New law Current law
A loss entity, in calculating its available fraction, may add to its modified market value the modified market value of another company to which it could have transferred losses under Division 170 of the ITAA 1997. It may also add certain losses from the other company to its own loss bundle. The rule in the new law reflects the fact that under the current law an entity may shelter its losses not just against its own income, but also against the income of another member of the same wholly-owned company group.
Concessional losses can be used by a head company over 3 years, subject to it having sufficient income against which those losses can be offset (and satisfying the relevant loss recoupment tests). The rate of loss usage is dictated entirely by the loss entitys income or ability to transfer the loss to another member of the same wholly-owned company group (and satisfying the relevant loss recoupment tests).

Detailed explanation of new law

9.6 The transitional concessions only apply to losses transferred by companies to the head company of a group when it first forms during the transitional period.

9.7 The first concession complements the available fraction method for using transferred losses. Broadly it allows the available fraction for a loss company to be increased where that company has losses that it could have transferred to one or more other group companies under the existing loss transfer rules in Division 170 of the ITAA 1997. The fraction is increased by one company (the value donor) donating value to the loss company (the real loss-maker). The value donor may also donate certain of its own losses to the real loss-maker so they can be used by the group in accordance with the real loss-makers increased available fraction.

9.8 The second concession is an alternative to the available fraction method. It allows certain company COT losses to be used over 3 years.

Available fraction method: donating value

9.9 A real loss-maker that joins a consolidated group before 1 July 2004 and transfers one or more tax or net capital losses (test losses) at that time may work out its modified market value as if it included some or all of the modified market value of the value donor. The value donors modified market value is reduced by the amount of its value that has been used for the real loss-maker. The value donated represents income or gains that under the existing loss transfer rules could be sheltered by the real loss-makers losses.

9.10 Only company losses may benefit from the concession as companies are the only entities that can currently transfer losses.

9.11 The conditions are:

·
both the real loss-maker and the value donor join the group when it first consolidates before 1 July 2004 [Schedule 2, item 2, paragraphs 707-325(1)(b) and (c)] ;
·
the real loss-maker has a test loss;
·
the real loss-maker could have transferred its test loss to the value donor under Subdivision 170-A or 170-B of the ITAA 1997 for an income year (generally the trial year);
·
the value donor (assuming it had made the test loss) could have transferred it to the head company under Subdivision 707-A; and
·
the head company chooses to increase the real loss-makers modified market value by a portion of the value donors modified market value.

9.12 The left side of Diagram 9.1 shows a single real loss-maker (RLM) with 3 value donors. The right side depicts the conditions to be satisfied in respect of each value donor.

Diagram 9.1

a single real loss-maker with 3 value donors

Condition: the real loss-maker has a test loss

9.13 The real loss-makers loss bundle must include at least one test loss. A test loss is a tax loss or a net capital loss that is not a concessional loss. The term test loss is not used in the law but is used in this explanatory memorandum as a tag to describe these types of losses. A concessional loss is one the head company has chosen to use in accordance with the second concession discussed in paragraphs 9.56 to 9.69. The value donor concession is not relevant to concessional losses because their use is not limited by their available fraction. Further, the value donor concession does not apply to foreign losses because they cannot be transferred under Division 170. [Schedule 2, item 2, paragraph 707-325(1)(d)]

Condition: the test loss could be transferred to the value donor

9.14 The real loss-maker must have been able to transfer the test loss to the value donor under Subdivision 170-A or 170-B for an income year which will generally be the trial year. [Schedule 2, item 2, paragraph 707-325(1)(f) and subsection 707-325(2)]

9.15 Some modifications are needed to ensure that concepts in Division 170 interact appropriately with this rule. They are discussed in paragraphs 9.44 to 9.54.

Condition: the value donor could transfer the test loss to the head company

9.16 This condition ensures that the value donor could have used the test loss if it had made it instead of the real loss-maker. That is, the value donor must have been able to transfer the test loss to the head company under Subdivision 707-A, assuming the value donor made the loss for the same income year the real loss-maker did. [Schedule 2, item 2, paragraph 707-325(1)(e)]

9.17 This condition replaces the conditions in subsections 170-40(2) and 170-140(2) of the ITAA 1997 which require the transferee (referred to in those provisions as the income company or the gain company) to have not been prevented from deducting or applying the transferred loss. The condition ensures that the value donor tests its ability to use or apply the test loss by reference to the general loss rules as modified for consolidation loss transfer purposes.

Condition: the head company chooses (to donate value)

9.18 The head company chooses to increase the modified market value of a real loss-maker by a percentage (not greater than 100%) of the value donors modified market value. The values are worked out as at the joining time (i.e. the initial transfer time). The choice must be made by the head company by the day it lodges its income tax return for the first income year for which it uses transferred losses applying the available fraction method. The choice cannot be amended or revoked. [Schedule 2, item 2, subsections 707-325(5) and (6)]

The amount of the increase

9.19 The percentage of value chosen is multiplied by the proportion of the real loss-makers total transferred losses (other than concessional and foreign losses) that meet the conditions for the concession in relation to the value donor. In working out the proportion, ignore any losses donated to the real loss-maker under the rules discussed in paragraphs 9.29 to 9.43.

9.20 The result is the amount by which the real loss-makers modified market value is increased for that value donor. The amount of the increase will be less than the value chosen if the real loss-maker has any losses that are not transferable to the value donor. [Schedule 2, item 2, subsections 707-325(3) and (4)]

9.21 A real loss-maker may have more than one value donor, either in relation to the same test loss or in relation to different test losses in its bundle. Separate increases are worked out for the real loss-maker in respect of each of its value donors. While a real loss-maker may receive a number of donations of value, it cannot in turn donate any value it has received. Any value received by a real loss-maker is solely for the purpose of working out an available fraction for its own loss bundle. [Schedule 2, item 2, subsection 707-325(1)]

9.22 On the other hand, a value donor may have more than one real loss-maker to which it donates value. As discussed in paragraph 9.18, the percentage of value chosen in respect of a single real loss-maker cannot exceed 100% [Schedule 2, item 2, subsection 707-325(5)] . Also, the total actual increases to modified market value for all of the value donors real loss-makers cannot exceed the value donors modified market value [Schedule 2, item 2, subsection 707-325(7)] . This means that value chosen in respect of a particular real loss-maker but not able to be actually donated to it (because the real loss-maker had non-transferable losses) is available for donation to the value donors other real loss-makers.

What is the value donors modified market value?

9.23 The value donors modified market value is worked out by applying the same rules that a joining entity uses as part of its available fraction calculation. This includes the rules that reduce modified market value in respect of certain pre-consolidation events (i.e. capital injections or non-arms length transactions). This ensures these integrity rules are not avoided by use of the value donor concession. [Schedule 1, item 2, section 707-325]

9.24 The modified market value used by the value donor in working out its own available fraction is generally its modified market value less the total value actually used in working out an available fraction for real loss-makers to which it donated value. This rule applies if the value donor has tax losses or net capital losses remaining in its bundle after the value and loss donation process is completed. If the value donor has foreign losses, then it uses the whole of its modified market value in working out an available fraction for them (see paragraphs 9.25 to 9.28). [Schedule 2, item 2, subsections 707-325(8) and (9)]

Foreign losses

9.25 The available fraction for a foreign loss in either the real loss-makers bundle or the value donors bundle is unaffected by the value donor rules. This is because foreign losses cannot be transferred under Division 170 of the ITAA 1997 and the value donor and loss donor concessions therefore do not apply. [Schedule 2, item 2, subsection 707-325(9)]

9.26 This means the available fraction for a real loss-makers foreign loss is the fraction that would have applied had value not been donated. Likewise, the available fraction for a value donors foreign loss is what it would have been if the value donor had not donated some or all of its value to the real loss-maker.

9.27 Therefore, a single loss bundle may have 2 relevant available fractions - one that applies to the bundles tax and net capital losses and one that applies to its foreign losses. Both fractions will need to be updated if any of the adjustment events discussed in Table 8.1 occur.

9.28 The available fraction adjustments take account of the proportion that a groups fractions bear to each other (e.g. the adjustment in item 5 in Table 8.1 where a groups fractions total more than one). For that reason, where either the real loss-maker or the value donor transfer foreign losses to the group, the group must keep 2 completely separate sets of fractions - one that reflects the application of the value donor rules and one that ignores their application.

Available fraction method: donating losses

9.29 If a real loss-makers modified market is increased under the value donor rules discussed in paragraphs 9.9 to 9.24, the head company may also treat one or more of the value donors losses as being included in the real loss-makers bundle. The losses donated represent losses that under the existing loss transfer rules could be used to shelter the real loss-makers income (i.e. value). This is essentially the reverse of donating value.

9.30 The conditions are:

·
the loss donor has also donated value to the real loss-maker [Schedule 2, item 2, paragraph 707-327(1)(a)] ;
·
the loss to be donated is a movable loss;
·
the loss donor could have transferred the loss to the real loss-maker under Subdivision 170-A or 170-B of the ITAA 1997 for an income year (generally the trial year):

-
also the loss donor could have transferred the loss under either Subdivision to any other value donor to the real loss-maker;

·
the real loss-maker could have transferred the loss to the head company under Subdivision 707-A:

-
also any other value donor of the real loss-maker could have transferred the loss to the head company; and

·
the head company chooses that the loss be included in the real loss-makers bundle.

9.31 The left side of Diagram 9.2 shows a single real loss-maker (RLM) with 3 value/loss donors. The right side depicts the conditions to be satisfied in respect of each loss donor, the real loss-maker and any other value donor to the real loss-maker.

Diagram 9.2

a single real loss-maker (RLM) with 3 value/loss donors

Condition: the loss must be a movable loss

9.32 The loss must have been transferred by the loss donor to the head company when the loss donor joined the group. The loss must be a tax loss or a net capital loss that is not a concessional loss. [Schedule 2, item 2, paragraphs 707-327(1)(b) and (c)]

9.33 A loss donor may have been a real loss-maker under a separate application of these rules. The test loss in respect of that other application of the rules cannot be later moved or donated. That is, it is not a movable loss. [Schedule 2, item 2, subsection 707-327(6)]

Condition: the loss could be transferred to the real loss-maker

9.34 The loss donor must have been able to transfer the loss to the real loss-maker under Subdivision 170-A or 170-B of the ITAA 1997 for an income year which will generally be the trial year. [Schedule 2, item 2, paragraph 707-327(1)(e) and subsections 707-327(2) and (3)]

9.35 Also the loss donor must have been able to transfer the loss under Subdivision 170-A or 170-B to each of the real loss-makers other value donors (if any). This ensures that all losses donated are only effectively sheltering income of entities to which those losses could have been transferred under the existing loss transfer rules. [Schedule 2, item 2, subsection 707-327(3)]

9.36 Some modifications are needed to ensure that concepts in Division 170 interact appropriately with these rules. They are discussed in paragraphs 9.44 to 9.54.

Condition: the real loss-maker could have transferred the loss to the head company

9.37 The real loss-maker must have been able to transfer the loss under Division 707-A to the head company. This ensures that the real loss-maker tests whether it could use or apply the loss by applying the general loss rules as modified for consolidation loss transfer purposes. [Schedule 2, item 2, paragraph 707-327(1)(d) and subsection 707-327(2)]

9.38 Also, each of the real loss-makers other value donors must have been able to transfer the loss to the head company. This, together with the rule discussed in paragraph 9.35, ensures that the loss donor has the same relationship with each of the other value donors to the real loss-maker that the loss donor has with the real loss-maker. [Schedule 2, item 2, paragraph 707-327(1)(d) and subsection 707-327(2)]

Condition: the head company chooses (to donate losses)

9.39 The head company chooses that the (loss donors) loss be included in the real loss-makers bundle. The loss is taken to be included at the initial transfer time, but only for the purpose of working out the amount of the loss that can be used by the group. For these purposes, the loss is also treated as not remaining in the loss donors own loss bundle. [Schedule 2, item 2, subsection 707-327(4)]

9.40 This means the groups use of the loss is governed by the real loss-makers (increased) available fraction (instead of the loss donors). It means the donated loss cannot be used by the real loss-maker as a test loss. It also does not affect the application of the COT or other recoupment tests in respect of the groups use of the loss.

9.41 The real loss-makers (increased) available fraction may change during the income year. Therefore, the loss is taken to be in the real loss-makers bundle for the purpose of applying the apportionment rules which are discussed in paragraphs 8.37 to 8.46. However, the inclusion of the value donors loss does not affect how the real loss-maker calculates it loss holding period for the purpose of those apportionment rules. [Schedule 1, item 2, section 707-335; Schedule 2, item 2, subsection 707-327(4)]

9.42 While any part of the loss is capable of utilisation or reduction, it is treated as remaining in the real loss-makers bundle, even if the real loss-makers own losses have been fully utilised. (Usually a loss bundle ceases to exist when all the real loss-makers losses have been used or reduced.) [Schedule 1, item 2, section 707-315; Schedule 2, item 2, subsection 707-327(4)]

9.43 The choice to donate losses must be made by the head company by the day it lodges its income tax return for the first income year for which it uses transferred losses by the available fraction method. The choice cannot be revoked. [Schedule 2, item 2, subsection 707-327(5)]

Value and loss donor rules: modifications to Division 170

9.44 For value to be donated, the real loss-maker must have been able to transfer its test loss to the value donor under Subdivision 170-A or 170-B for an income year which is usually the trial year. Similarly, for a loss to be donated, the loss donor (which must also be a value donor) must have been able to transfer its movable loss to the real loss-maker under either Subdivision for an income year which is usually the trial year.

9.45 In determining whether a loss could have been transferred, only some sections of Subdivisions 170-A and 170-B are relevant. These are mainly the sections which concern the conditions for transfer (i.e. sections 170-30, 170-35 and 170-40 for tax losses and sections 170-130, 170-135 and 170-140 for net capital losses). Other sections, for example those that concern the agreement to transfer, are not relevant.

Assumptions

9.46 In determining whether those losses can be transferred, the conditions in Subdivision 170-A or 170-B are applied as though:

·
neither the real loss-maker nor the relevant donor had become a subsidiary member of the group before, at or after the initial transfer time [Schedule 2, item 2, subsection 707-328(3)]:

-
this overcomes the fact that a subsidiary entity cannot use (and therefore cannot transfer under Division 170) its own losses after joining the group;

·
Subdivisions 170-A and 170-B had not been amended so they only apply to transfers involving an Australian branch of a foreign bank [Schedule 2, item 2, subsection 707-328(4)]:

-
this ensures the continued operation of the Subdivisions in applying the value and loss donor rules;

·
the real loss-maker and the relevant donor had sufficient income or gains against which the test loss and the movable loss can be offset (as appropriate) [Schedule 2, item 2, subsection 707-328(5)]:

-
this effectively overrides the fact that losses may only be transferred under Subdivision 170-A or 170-B to the extent that the transferee has income or gains against which the losses can be offset; and

·
if the relevant loss was actually made in the joining year, it is generally taken to be made for the trial year (this assumption is discussed in paragraphs 9.51 to 9.52) [Schedule 2, item 2, subsection 707-328(6)] .

Modifications to trial year

9.47 Division 170 generally applies when a company seeks to transfer a loss in a particular income year (i.e. the deduction year for a tax loss or the application year for a capital loss). In determining whether that condition is met in the value or loss donor context, the deduction or application year is replaced with a period that:

·
starts at the later of these times:

-
the start of the trial year; and
-
the start of the loss year; and

·
ends just after the time the company joined the group.

[Schedule 2, item 2, subsections 707-328(1) and (2)]

9.48 This period is essentially the trial year which generally starts 12 months before, and ends immediately after, the company joined the group. The use of the trial year ensures that a consistent test period is used in all provisions concerning loss transfers (for further information on the trial year see Chapter 6).

9.49 Because a trial year may not match a normal income year, some modifications are needed to ensure that the conditions in Subdivisions 170-A and 170-B can be applied. The first modification is made to ensure that the conditions in sections 170-30 and 170-130 can be met if the trial year were to commence before the loss year. These sections require that the real loss-maker and value donor both be members of the same wholly-owned group during the following income years when both companies were in existence:

·
the loss year or capital loss year;
·
the deduction or application year; and
·
any intervening year.

9.50 Under an actual application of Division 170 it would be impossible for the deduction or application year to commence before the loss year. However, when the trial year is used instead of the deduction or application year it is possible for the trial year to commence before a loss year where the loss is made in a joining year. Without any modification, this would mean that the real loss-maker and the value donor must be members of the same wholly-owned group for the whole of the trial year even if the trial year starts before the loss year. For that reason, the trial year is modified to ensure it does not commence before the start of a loss year.

9.51 A further modification ensures that subsections 170-35(2) and 170-140(3) apply correctly. They prohibit the transfer of a loss where the loss year and the deduction or application year are the same if the loss were calculated under:

·
the current year loss rules (in sections 165-70 or 165-114 of the ITAA 1997); or
·
the income injection rules (in sections 175-35 or 175-75 of the ITAA 1997).

9.52 Without a further modification it would be impossible for the loss year and the trial year to be exactly the same period if the loss was made for an income year ending at the joining time. This is because the loss year will end at the time the company joins the consolidated group, but the trial year ends just after. To ensure the 2 periods match, a loss made in an income year ending at the joining time is taken to be made in the trial year. [Schedule 2, item 2, subsection 707-328(6)]

Part year losses

9.53 A further rule ensures that non-membership period losses (which are losses that are referable to only a part of an income year) can be tested to determine if they can be transferred under Division 170. A non-membership period loss may be calculated where an entity joins a group as a subsidiary member during the subsidiarys income year, or an entity exits a group during the entitys income year. The test periods need to reflect the fact that the loss was effectively made for a shortened income year.

9.54 Similar issues arise in testing whether such a loss can be transferred to the head company under Subdivision 707-A. The rules developed for that purpose also apply here for Division 170 testing. A non-membership period loss is taken to be a loss made for an income year that matches the non-membership period (see paragraphs 6.90 to 6.92). [Schedule 2, item 2, section 707-405]

Value and loss donor rules: examples

9.55 A group may have several different donor combinations available to it. Different available fractions may be produced depending on which combination is used. This is shown in Examples 9.1 to 9.3. Each example is based on the facts set out in Example 9.1.

Example 9.1 A wholly-owned group consists of a head company, H Co, and 3 subsidiary companies. The group consolidates on 1 July 2002. At that time, the market value of the group is $10,000.

Value and loss donor rules

In the absence of the value donor concession, the groups available fractions are:
A B C Total
0.3 0.05 0.25 0.6
However, A Co and C Co each have a loss that is transferable to all other group members. B Co has a loss that is only transferable to A Co.One option is to transfer value and losses to A Co. Transferring value and losses to A Co

·
A Cos loss is transferable to H Co:

-
H Cos modified market value is added to A Cos modified market value.

·
A Cos loss is transferable to C Co:

-
C Cos modified market value can also be added to A Cos modified market value. Assume only 60% of C Cos value is added. This allows some value to remain with C Co for use in determining an available fraction for C Cos non-transferable loss; and
-
C Cos 2001 loss is moved to A Cos bundle.

·
A Cos loss is transferable to B Co:

-
B Co could move its value to A Co. However, B Co cannot transfer its loss to A Co, because B Cos loss is not transferable to C Co (one of A Cos other value donors).; and
-
B Co needs to retain its value for an available fraction for its loss. Therefore, neither value nor loss is transferred from B Co to A Co.

·
As a result of moving H Cos value and 60% of C Cos:

-
A Cos available fraction is:

[$3,000 + $4,000 + (60% * $2,500)] / $10,000 = 0.85;

-
C Cos available fraction for its bundle consisting of the $100 non-transferable loss is:

(40% * $2,500) / $10,000 = 0.1; and

-
B Cos available fraction remains at 0.05.

Therefore, the groups available fractions, and the losses to which they apply are:
A B C Total
0.85 0.05 0.1 1
2001 - $400 tax loss

2001 - $100 tax loss (from Cs bundle)

1999 - $200 net capital loss 2000 - $80 tax loss

Example 9.2: Transferring value and losses to B Co Another option is to transfer value and losses to B Co.

·
B Cos only loss is transferable to A Co:

-
A Cos modified market value is added to B Cos modified market value; and
-
A Cos loss is moved to B Cos bundle.

·
B Cos available fraction is:

($500 + $3,000) / $10,000 = 0.35.

Therefore, the groups available fractions, and the losses to which they apply are:
A B C Total
- 0.35 0.25 0.6
1999 - $200 net capital loss

2001 - $400 tax loss (from As bundle)

2000 - $80 tax loss

2001 - $100 tax loss

Example 9.3: Transferring value and losses to C Co Another option is to transfer value and losses to C Co.

·
C Cos 2001 loss is transferable to H Co:

-
a portion of H Cos modified market value is added to C Cos. The percentage of H Cos value chosen is multiplied by the proportion of C Cos total losses that are transferable to H Co:

(100% * $4,000) * (100 / 180) = $2,222;

·
C Cos 2001 loss is also transferable to A Co:

-
a portion of A Cos modified market value is added to C Cos:

(100% * $3,000) * (100 / 180) = $1,667; and

-
A Cos 2001 loss is moved to C Cos bundle; and

·
C Cos available fraction is:

($2,500 + $2,222 + $1,667) / $10,000 = 0.639.

Therefore, the groups available fractions, and the losses to which they apply are:
A B C Total
- 0.05 0.639 0.689
1999 - $200 net capital loss 2000 - $80 tax loss

2001 - $100 tax loss

2001 - $400 tax loss (from As bundle)

Concessional loss method

9.56 A concessional method is available for utilising certain company COT losses transferred during the transitional period. A transferred loss, in a particular loss bundle, may be used in accordance with the concessional method if:

·
the loss meets the conditions in paragraph 9.57; and
·
the head company has chosen to use the concessional method for all other losses in the bundle that also meet those conditions.

[Schedule 2, item 2, subsection 707-350(1)]

9.57 The conditions are that the loss:

·
was originally made outside the group by a company (the real loss-maker) for an income year ending on or before 21 September 1999;
·
is transferred by the real loss-maker to the head company of the group when the group first consolidates before 1 July 2004 (the initial transfer time);
·
is transferred because the COT was passed; and
·
has not been previously transferred to a group.

[Schedule 2, item 2, paragraphs 707-350(1)(a) to (d)]

9.58 A loss chosen for use in accordance with the concessional method is referred to in this explanatory memorandum as a concessional loss.

Concessional losses can be used over 3 years

9.59 Concessional losses may effectively be utilised by the head company over 3 years (subject to the general loss recoupment tests as modified by the rules discussed in Chapter 7). This limit on utilisation replaces that which would otherwise apply under the available fraction method.

9.60 The head company divides its total concessional losses of each sort in a bundle into 3 equal portions. In the first income year that ends after the losses were transferred, the head company can use a maximum of one portion of the losses. [Schedule 2, item 2, subsection 707-350(3), item 1 in the table]

Example 9.4 A group consolidates on 1 July 2002. A bundle of tax and net capital losses is transferred to the head company.The bundle contains 3 concessional tax losses - each worth $100. The maximum amount of tax losses that can be deducted from the bundle in the first year is $100 (one-third of $300).The bundle also contains a concessional net capital loss of $1,500. The maximum amount of the net capital loss that can be deducted from this bundle in the first year is $500 (one-third of $1,500).

9.61 The head company can use another portion in each of the following 2 income years. In addition, it can deduct the remaining amount of a portion that it was unable to use in a prior income year because it had insufficient income. [Schedule 2, item 2, subsection 707-350(3), items 2 and 3 in the table]

9.62 If, after the third income year, the group still has undeducted losses of this sort, then it may use them without restriction (i.e. the limit ceases to apply, though the general loss recoupment tests do apply). [Schedule 2, item 2, subsection 707-350(3), item 3 in the table]

Example 9.5 The Colossal Coal Mining Group consolidates on 1 July 2002.At that time, a $5,000 loss incurred in the 1998 income year is transferred to the groups head company because the COT was passed. The loss is therefore eligible for concessional treatment.The groups first income year after the eligible loss was transferred ends on 30 June 2003. But the group makes a $2,000 loss for that year (and so is not in a position to use any of its transferred losses).The second income year after the transfer of the eligible tax loss ends on 30 June 2004. The group has $2,000 assessable income for that year from which it deducts its $2,000 group loss from the previous year (because group losses must be used before concessional losses). The groups taxable income is nil so the group is still not in a position to use any of its transferred losses.The third income year after transfer of the eligible tax loss ends on 30 June 2005. The groups assessable income less deductions (other than prior year losses) is $10,000. The head company chooses to deduct its transferred loss using the concessional method. Because this is the third income year after the eligible loss was transferred, it may deduct the whole of the $5,000 loss.

9.63 Also, the calculation of the limit is not linked to how many of the losses of the particular sort in the bundle pass or fail the general loss recoupment tests.

Example 9.6 One of the 3 concessional tax losses in the bundle referred to in Example 9.4 fails the general loss tests so it cannot be deducted. The maximum amount of tax losses that can be deducted is still calculated by reference to the sum of the tax losses in the bundle. This means that the maximum amount of tax losses that can be deducted from the bundle is still $100 (drawn from the other 2 tax losses that have passed the general loss tests).

Order of use

9.64 Concessional losses of a sort are used after group losses of the same sort. Group losses are losses generated by a group after its formation. This overrides the normal rule that oldest losses are used first. [Schedule 2, item 2, subsection 707-350(2)]

9.65 Concessional losses of a sort must effectively be used before other (non-concessional) transferred losses of the same sort, allowing groups the earliest possible access to the concession. As part of achieving this, concessional losses are taken not to be transferred losses for the purposes of Subdivision 707-C. This ensures that the relevant income and gain categories are reduced by concessional losses before applying the available fraction (see paragraphs 8.21 to 8.36). [Schedule 2, item 2, subsection 707-350(4)]

Making the choice

9.66 The method is optional. A head company that wishes to use the concessional method must choose to do so by the day it lodges its income tax return for the income year in which it first uses any of its transferred losses. The choice, if made, must be made for all eligible losses in a particular bundle (regardless of their sort). [Schedule 2, item 2, paragraph 350(1)(e) and subsection 707-350(5)]

9.67 Regardless of when the choice is made, it will not have effect until the income year in which transferred losses are first used. It applies to that income year and to all later income years and is irrevocable. [Schedule 2, item 2, subsection 707-350(6)]

Further transfer of concessional losses

9.68 The use limit imposed by the concession does not prevent the whole of a concessional loss (or its unused amount) being transferred again (i.e. to another consolidated group) [Schedule 2, item 2, subsection 707-350(7)] . However, if concessional losses are transferred again, they lose their concessional status [Schedule 2, item 2, paragraph 707-350(1)(d)] .

9.69 For that reason, concessional losses can be said to retain a link to their loss bundle. That is, if transferred again they revert to being transferred losses subject to the available fraction limit attached to the bundle.

Application and transitional provisions

9.70 The measures discussed in this chapter will apply to certain losses transferred to a group that consolidates during the transitional period (i.e. 1 July 2002 to 30 June 2004).

Consequential amendments

9.71 Consequential amendments have been made to subsection 995-1(1) to include references to new dictionary terms. [Schedule 5, item 18]

Chapter 10 - Franking accounts in consolidated groups

Outline of chapter

10.1 Part 1 of Schedule 1 to this bill provides for the treatment of franking accounts in consolidated groups. Briefly, this Part deals with the treatment of the existing balance of franking accounts of subsidiary members upon entry into a consolidated group, and also with the operation of the head companys franking account during the period of consolidation.

10.2 The anti-avoidance measures in section 177EA of the ITAA 1936 are complemented by new provisions in section 177EB to accommodate consolidated groups. These measures are necessary to counter potential abuse of the consolidations imputation rules. At a later stage, further franking rules will be introduced which will deal with exempting companies and former exempting companies in the context of consolidation.

Context of reform

10.3 As part of the introduction of the consolidation regime, A Tax System Redesigned recommended that a consolidated group operate a single franking account at the head company level and that all the existing franking credits of members of the group be pooled.

10.4 The proposed franking account rules for consolidated groups provide for the pooling of franking credits. The provisions also set out special rules for the operation of the franking accounts of both the head company and of subsidiary members of a consolidated group during the period of consolidation.

Summary of new law

10.5 In essence, the franking account of a subsidiary member will be inoperative during the period in which it is a member of a consolidated group. At the time at which it joins a consolidated group, any surplus in its franking account is transferred to the head companys franking account. Conversely, if the subsidiarys franking account is in deficit immediately before this time, the subsidiary is liable to pay franking deficit tax.

10.6 Any franking credits or debits that would otherwise have arisen in the franking account of the subsidiary member (i.e. were it not a member of a consolidated group with an inoperative franking account) are attributed to the franking account of the head company.

10.7 The rules also deal with the franking of distributions made by a subsidiary member to entities because those entities hold certain shares known as disregarded ESAS shares (as discussed in Chapter 3) or non-share equity interests.

Comparison of key features of new law and current law
New law Current law
The franking accounts of subsidiary members of a consolidated group do not operate during the period of consolidation. Subsidiary members of wholly-owned groups operate an active franking account in their own right.
Franking credits and debits, which would otherwise arise in a subsidiary members franking account, are attributed to the head companys franking account. Franking credits and debits arise in the subsidiarys own franking account in accordance with its treatment as a separate taxpaying entity.
Franking deficit tax is payable by the entity at the end of the income year and upon entry, as a subsidiary member, to a consolidated group if its franking account is in deficit at that time. No franking deficit tax is payable by the entity during the period in which it is a subsidiary member of a consolidated group. Franking deficit tax is payable at the end of a franking year if the franking account is in deficit at that time.
A subsidiary member cannot frank distributions. Distributions made by subsidiary members in respect of ESAS shares or non-share equity interests are taken to be distributions by the head company. A subsidiary may frank frankable distributions to its members in accordance with the current imputation rules.
Anti-avoidance rules will apply to schemes involving, broadly speaking, the acquisition of a subsidiary entity for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a franking credit to arise in the head companys franking account. Existing anti-avoidance rules apply to schemes involving, broadly speaking, the disposition of shares for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a relevant taxpayer to obtain a franking credit benefit.

Detailed explanation of new law

10.8 The franking account rules in consolidation can be divided into 5 distinct issues:

·
treatment of any surplus or deficit in a subsidiarys franking account upon joining a consolidated group;
·
treatment of a subsidiarys franking account during consolidation;
·
treatment of the head companys franking account during consolidation;
·
treatment of distributions by a subsidiary member during consolidation; and
·
anti-avoidance rules for consolidated groups.

Treatment of franking surplus or deficit on entry into consolidation

10.9 When an entity becomes a subsidiary member of a consolidated group, it must determine its franking account balance at the time of entry. The joining entity must transfer any surplus in its franking account at the joining time (the time at which the joining entity becomes a member of a consolidated group) to the franking account of the head company. In this manner, franking credits are pooled in the franking account of the head company. The application of this rule is subject to the operation of section 177EB, which gives the Commissioner the power to deny, in certain circumstances, franking credits to the head company. [Schedule 1, item 2, section 709-60]

10.10 When any surplus is transferred to the head companys franking account, an equivalent debit arises in the joining entitys franking account. This creates a nil balance in the account of the joining entity. A corresponding credit arises in the head companys franking account. [Schedule 1, item 2, subsection 709-60(2)]

10.11 If the subsidiary has a deficit in its franking account just prior to entry into a consolidated group, it is liable to pay franking deficit tax. [Schedule 1, item 2, paragraph 709-60(3)(b)]

10.12 Furthermore, a credit equal to the franking deficit arises at the joining time in the joining entitys franking account. However, to prevent the inappropriate duplication of franking credits, no franking credit arises under section 160-115 because of the crystallisation of the franking deficit tax liability. [Schedule 1, item 2, subsection 709-60(3)]

Treatment of subsidiarys franking account during consolidation

10.13 During the period in which a subsidiary entity is a member of a consolidated group, its franking account is inoperative. This means that, in general, neither credits nor debits can arise in that account. [Schedule 1, item 2, section 709-65]

10.14 Initially, however, where a subsidiary member has a franking account surplus immediately before the joining time, a debit will arise at the joining time to create a nil balance in the franking account of the subsidiary member.

Treatment of head companys franking account during consolidation

General rule

10.15 The rules for franking accounts are intended to facilitate the operation of imputation rules in accordance with the single entity principle. That is, once a subsidiary entity has become a member of a consolidated group, the provisions of the tax law which concern imputation and franking accounts will operate as if the consolidated group is a single entity.

10.16 To this end, the imputation rules ensure that the head company is responsible for operating the single franking account and that events which would affect a subsidiary are instead attributed to the head company. Therefore, activities which would otherwise have caused a franking credit or debit to arise in the franking account of a subsidiary member will instead give rise to a franking credit or franking debit in the franking account of the head company (other than the special credit explained in paragraph 10.12). [Schedule 1, item 2, sections 709-70 and 709-75]

Example 10.1 While it is a member of a consolidated group, a subsidiary member receives a refund of income tax in relation to an assessment of income tax relating to a period prior to when the member joined the consolidated group. In the ordinary course and outside of consolidation, this would lead to a debit arising in the franking account of the subsidiary.However, given that the subsidiarys franking account does not operate during the period of consolidation, the debit will arise in the head companys franking account. This is the case even though the assessment relates to a pre-consolidation period.

10.17 Other credits and debits will arise in the head companys franking account in the ordinary course of its usual activities as a taxpayer and a franking entity. For example, the payment of income tax will generate franking credits in the head companys franking account and similarly, the franking of dividends will generate franking debits.

Other credits or debits as a result of consolidation

10.18 As mentioned in paragraph 10.10, any franking surplus in the subsidiary members franking account immediately before joining time will give rise to a franking credit in the head companys franking account at the time of consolidation.

Treatment of distributions made by a subsidiary during consolidation

10.19 The general rule in consolidated groups is that a subsidiary member cannot frank distributions to entities outside the group because its franking account is inoperative [Schedule 1, item 2, section 709-65] . Only the head company of the group may allocate franking credits to frankable distributions by a subsidiary member while it is a member of that group.

Distributions made to entities in respect of ESAS shares and non-share equity interests

10.20 Certain shares held in a subsidiary member are able to be disregarded when determining whether that subsidiary member is a 100% Australian subsidiary of the head company and therefore eligible to be a member of a consolidated group. These are ESAS shares.

10.21 For the purpose of distributions made by a subsidiary in relation to disregarded ESAS shares, a frankable distribution made by a subsidiary member will be treated as a frankable distribution by the head company to a shareholder of the head company for the purposes of the imputation rules. This means that the imputation and franking consequences flowing from those rules will apply in respect of the distributions made by the subsidiary. [Schedule 1, item 2, section 709-80]

10.22 Distributions made by a subsidiary member in relation to non-share equity interests will be treated as a frankable distribution by the head company for the purposes of the imputation rules. Consistent with the treatment of distributions made in respect of ESAS shares, the imputation and franking consequences flowing from the operation of the imputation rules will apply in respect of such distributions. [Schedule 1, item 2, section 709-85]

Anti-avoidance rules for consolidated groups

10.23 The anti-avoidance rules provided in section 177EA of the ITAA 1936 are complemented by special rules dealing with consolidated groups. These rules are necessary to counter potential abuse of the consolidation imputation rules. [Schedule 3, item 40, section 177EB]

10.24 Section 177EB allows the Commissioner to deny the transfer of franking credits from a subsidiary entity to a head company upon consolidation in circumstances where a scheme exists which results in a subsidiary entity becoming a member of a consolidated group and having regard to the relevant circumstances of the scheme, it would be concluded that the scheme was entered into or carried out for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a franking credit to arise in the head companys franking account. [Schedule 3, item 40, subsection 177EB(3) and (5)]

10.25 The expressions used in section 177EB have the same meanings as those in section 177EA (unless the contrary intention is specified). [Schedule 3, item 40, subsection 177EB(1)]

10.26 The relevant circumstances set out in subsection 177EB(10) have been modelled on the relevant circumstances contained in subsection 177EA(19). [Schedule 3, item 40, subsection 177EB(10)]

10.27 In a manner similar to section 177EA, section 177EB allows the Commissioner to make a determination that where section 177EB applies, no franking credit is to arise in the head entitys franking account because of the joining entity becoming a subsidiary member of a consolidated group. [Schedule 3, item 40, subsection 177EB(5)]

10.28 Taxpayers dissatisfied with such a determination are entitled to object against the determination in a manner set out in Part IVC of the TAA 1953. [Schedule 3, item 40, subsection 177EB(9)]

Application and transitional provisions

10.29 These provisions will come into effect on 1 July 2002, along with the other aspects of the consolidation measures.

Consequential amendments

10.30 Amendments consequential to the measures in this chapter will be included in subsequent legislation.

Chapter 11 - Liability for the payment of tax where a head company fails to pay on time

Outline of chapter

11.1 This chapter explains how the Commissioner may seek to recover an income tax-related liability of a consolidated group (which includes a MEC group) directly from subsidiary members if the head company fails to meet its group taxation obligations on time.

Context of reform

11.2 The Review of Business Taxation recommended that liability for group taxation debts be based on the common law concept of joint and several liability. This would mean that all members of the group would be liable at all times for the full amount of the income tax-related liability of the group (group liability) that arose during the period of membership.

11.3 A number of concerns with this approach were highlighted during consultation, particularly in relation to the imposition of full joint and several liability. These included that:

·
a subsidiary member could become technically insolvent without the knowledge of that member - this is of particular concern for company directors, who are prohibited from permitting a company to trade while insolvent;
·
creditors of a subsidiary member could be swamped by the group liability - this could occur where a subsidiary member was insolvent and then incurred an additional debt, being a group liability; and
·
the due diligence activities of a purchaser of a subsidiary member would become necessarily excessive - because of the possibility that a subsidiary member might be liable for a group liability, a prospective purchaser would have to scrutinise the entire group to ensure that its due diligence obligations are satisfied.

11.4 In foreign jurisdictions, similar concerns regarding the effect of an imposition of joint and several liability are mitigated via the application of an extensive regime of cross-guarantees and indemnities.

11.5 However, in response to these concerns and to maintain legislative and administrative integrity, a modified model was proposed. This model differs from the Review of Business Taxation model in 3 key respects:

·
the head company of a consolidated group will be solely liable, in the first instance, for a group liability;
·
where that head company fails to meet the group liability by the time the liability becomes due and payable, the Commissioner may be able to recover a part or the whole of the unpaid amount directly from those entities (other than the head company) that were members of the group at any time during the period in which the group liability accrued (the contributing members); and
·
where a contributing member might be subject to recovery action by the Commissioner, it might nevertheless be able to exit a group free from a liability arising during a period in which it was a group member but which had not become due and payable at the time of exit, provided certain conditions are met.

Summary of new law

Effect of the single entity principle on group income tax-related liabilities

11.6 In respect of group liabilities, subsidiary members of a consolidated group are treated as divisions or parts of the head company. The head company is therefore liable, in the first instance, for group liabilities.

11.7 It is important to note that each member of the consolidated group remains separately liable for its tax-related liabilities that do not fall within the scope of the consolidation regime, including pre-consolidation income tax-related liabilities.

What happens where the head company does not pay the liability by the due and payable date?

11.8 Where the head company fails to satisfy a group liability by the time that it becomes due and payable, each contributing member then becomes jointly and severally liable with the head company, and each other contributing member, for the amount outstanding at this time, unless:

·
that member is prohibited under an Australian law from entering into arrangements that would subject it to joint and several liability; or
·
the group liability was covered by a valid tax sharing agreement that allocates the liability between the members of the group on a reasonable basis.

11.9 Where a liability to the Commonwealth is imposed on a contributing member (either a joint and several liability or an allocated liability under a valid tax sharing agreement), that liability is due and payable by the contributing member 14 days after the Commissioner notifies that member of that liability. In either case, the head company remains liable for the full amount of the unpaid group liability and these rules do not operate to change the time at which that amount was due and payable.

Consequences of ceasing to be a member of a consolidated group

11.10 Where an entity no longer meets the requirements for group membership and thus exits the group, that entity will normally continue to be subject to those liabilities that accrued during the period in which it was a contributing member.

11.11 However, a contributing member may be able to exit a group free from a group liability that arose during a period in which it was a group member but which had not become due and payable at the time of exit if:

·
the exited member had, prior to exit, paid to the head company any amounts that might become due under a valid tax sharing agreement in respect of that liability; and
·
the exit of the contributing member did not take place as part of an arrangement, a purpose of which was to prejudice the Commissioners ability to recover the liability from members of the group.

Comparison of key features of new law and current law
New law Current law
The head company of a consolidated group is solely liable, in the first instance, for the groups liabilities. Where the head company does not fully satisfy a group liability by its due and payable time, the other members of the group are then liable to the Commonwealth either:

·
jointly and severally for the full amount of the group liability; or
·
for an identifiable portion of the group liability under a valid tax sharing agreement.

This amount becomes due and payable by a member 14 days after notification of the liability by the Commissioner.

Each entity in a consolidated group is individually liable for its own income tax-related liabilities.

Determination of a contributing members liability under these rules.

11.12 Diagram 11.1 depicts the process for determining the extent to which a particular contributing member is liable in respect of an unpaid group liability.

process for determining the extent to which a particular contributing member is liable in respect of an unpaid group liability

Detailed explanation of new law

11.13 The head company of a consolidated group is solely liable, in the first instance, for group liabilities. This is because, as an implication of the single entity rule, an income tax-related liability of a consolidated group is, in fact, an income tax-related liability of the head company.

11.14 In circumstances where the head company fails to satisfy a group liability by its due and payable time, these rules enable the Commissioner to recover part or all of the unpaid amount from those members that were members of the group in the period the liability accrued by either:

·
apportioning the group liability between the members on the basis of a tax sharing agreement; or
·
making all members jointly and severally liable for the full amount of the group liability.

[Schedule 1, item 2, section 721-5]

11.15 It is expected that the Commissioner would usually be exercising this ability to recover directly from members of the group other than the head company where other avenues with respect to the head company have been unsuccessful. For example, where the groups liability is in dispute, the Commissioner would generally stay recovery action in respect of the liability until the dispute is resolved.

11.16 In circumstances where the Commissioner seeks to recover amounts directly from contributing members, the head company remains responsible for the group liability and these rules do not operate to change the time at which that liability was due and payable.

What is a group liability?

11.17 Section 250-10 of Schedule 1 to the TAA 1953 provides a list of tax-related liabilities. For groups consolidating for income tax purposes, a similar list is provided, identifying the tax-related liabilities of a head company of a consolidated group that are properly considered as related to the income tax obligations of the group and therefore within the scope of the consolidation regime. [Schedule 1, item 2, subsection 721-10(2)]

11.18 Each member of the consolidated group remains separately liable for its tax-related liabilities that do not fall within the scope of the consolidation regime, including pre-consolidation income tax-related liabilities.

11.19 When a group is created during a liability period (e.g. part way through an instalment quarter) a subsidiary member is individually liable for its tax related debts accrued before that time. However it is not appropriate for the member entity to be also liable for any individual income tax-related liabilities of the head company that accrued before the creation of the group. A special rule is necessary to ensure that subsidiary members only become jointly and severally liable for that part of the group liability that is reasonably attributable to that part of the liability period after the group is created. [Schedule 1, item 2, section 721-20]

11.20 There is no apportionment of a group liability where members enter or exit the group during the period when the group liability arises. Those members can potentially become subject to group liabilities under the rules of Division 721.

What is a contributing member?

11.21 A subsidiary member of a consolidated group may only be liable for any outstanding group liabilities if it is properly considered a contributing member. A contributing member is defined as an entity that was a subsidiary member of the consolidated group at any time during the period to which the relevant group liability relates [Schedule 1, item 2, paragraph 721-10(1)(b)] . In relation to an instalment quarter, for example, an entity that leaves a group one day into that quarter is still a contributing member in relation to that quarter. Similarly, an entity that is a member of the group for part of an income year is a contributing member in respect of the balance due on assessment for that income year.

Liability under the joint and several liability rule

11.22 Where an amount of a group liability remains unpaid after its due and payable time, each contributing member will then be jointly and severally liable for that group liability unless:

·
the contributing member is an entity that is specifically excluded because the nature of that entity is such that it is not able to be made subject to an imposition of a joint and several liability because of an Australian law [Schedule 1, item 2, paragraph 721-15(1)(b) and subsection 721-15(2)] ; or
·
the group liability is covered by a valid tax sharing agreement between the head company and one or more contributing members [Schedule 1, item 2, subsection 721-15(3)] .

11.23 When the group initially comes into existence, the group liability for which the head company is liable may be partly attributable to a time prior to that point in time when the group is first formed. This part of the group liability is not subject to joint and several liability. [Schedule 1, item 2, section 721-20]

Entities not able to enter into joint and several liability arrangements

11.24 There are some entities upon whom other Australian laws apply to prohibit them from entering into arrangements that may subject them to the imposition of a joint and several liability. These entities are specifically excluded from the operation of the joint and several liability rule where they are contributing members of a consolidated group. They would, however, be likely to be covered by a tax sharing agreement where their activities had contributed toward the accrual of the group liability. [Schedule 1, item 2, paragraph 721-15(1)(b) and subsection 721-15(2)]

Application of the statutory right of contribution in section 265-45 of Schedule 1 to the TAA 1953

11.25 Where a joint and several liability is imposed upon a contributing member and the member pays an amount in respect of that liability, that member holds a statutory right of contribution against the head company and other contributing members upon whom a joint and several liability is imposed, in accordance with section 265-45 of Schedule 1 to the TAA 1953. [Schedule 1, item 2, subsection 721-15(1)]

11.26 This statutory right operates irrespective of any application of a common law right of contribution and indemnity, or any contractual arrangements regarding the same, that arise from the nature of the liability as a joint and several one.

Liability under a tax sharing agreement

11.27 Contributing members will not be subject to an imposition of joint and several liability where the group liability is covered by a valid tax sharing agreement [Schedule 1, item 2, subsection 721-15(3)] . In these circumstances, each contributing member covered by the tax sharing agreement (TSA contributing member) is liable to the Commonwealth for the amount determined under that tax sharing agreement, whether or not the TSA contributing member had paid a contribution amount to the head company under the terms of the agreement [Schedule 1, item 2, subsection 721-30(2)] .

11.28 For a group liability to be covered by a tax sharing agreement:

·
the agreement between the head company and the TSA contributing members must exist immediately prior to the time when the head companys liability is due and payable [Schedule 1, item 2, paragraph 721-25(1)(a)] ;
·
the agreement must provide a mechanism for determining that part of the amount of the relevant group liability that is to be allocated to the TSA contributing members (the contribution amount) [Schedule 1, item 2, paragraph 721-25(1)(b)] ;
·
that allocation of contribution amounts between the head company and TSA contributing members must be a reasonable allocation of the group liability [Schedule 1, item 2, paragraph 721-25(1)(c)] ;
·
the agreement must not have been entered into as part of an arrangement, for which a purpose was to prejudice the Commissioners ability to recover some or all of the unpaid amount of the group liability from group members (e.g. by allocating a contrived portion of the group liability to an entity which had not conducted any income-producing activities in the period when the liability arose and which had little or no assets) [Schedule 1, item 2, subsection 721-25(2)] ; and
·
the agreement must comply with any other requirements set out in the regulations [Schedule 1, item 2, paragraph 721-25(1)(d)] .

11.29 To provide additional assurance to the business community, the Commissioner will publish guidelines as to what he considers to be a reasonable allocation of a group liability under a tax sharing agreement.

11.30 Where the Commissioner has issued a notice to the head company requiring that a copy of the tax sharing agreement in the approved form be provided to him within 14 days, a tax sharing agreement will be considered to have never applied to that group liability if a copy of that agreement is not provided to the Commissioner within the time required. The Commissioner may defer the time for lodgement under section 388-5 of Schedule 1 to the TAA 1953 where it is appropriate to do so. The consequence is that the contributing members will be liable under the joint and several rule provided for in new subsection 721-15(1), as the exception to that rule for group liabilities covered by a tax sharing agreement in new subsection 721-15(3) is taken to have never applied. [Schedule 1, item 2, subsection 721-25(3)]

Where a TSA contributing member can exit the group clear of a future liability being allocated under a tax sharing agreement

11.31 To provide additional certainty to a purchaser of a contributing member, certain TSA contributing members may exit a consolidated group clear of a particular group liability [Schedule 1, item 2, subsection 721-30(3)] where it:

·
ceased its membership of the group prior to the time at which the group liability became due and payable by the head company [Schedule 1, item 2, paragraph 721-35(a)] ;
·
paid to the head company the allocated amount (or a reasonable estimate of that amount) in respect of its contribution to the group liability prior to ceasing membership of the group [Schedule 1, item 2, paragraph 721-35(c)] ; and
·
did not cease membership of the group as part of an arrangement to prejudice the recovery of some or all of the unpaid group liability (e.g. the deliberate transfer of part or all of an entity as part of an arrangement for the purpose of putting most of the assets of the group out of the consolidated group would be regarded as prejudicial to the recovery of the liability) [Schedule 1, item 2, paragraph 721-35(b)] .

11.32 The exiting member is not able to exit clear of liability for a group liability that had become due and payable by the head company before the time of that members exit. For these liabilities, the normal tax sharing agreement liability rule applies. That is, the TSA contributing member is liable for the amount determined under the tax sharing agreement.

Common rules applying to the liability of a contributing member

11.33 The liability of a contributing member, or a TSA contributing member, arises just after the head company has failed to fully discharge that group liability by its due and payable time. [Schedule 1, item 2, subsections 721-15(4) and 721-30(4)]

11.34 However, that liability will not become due and payable by the contributing member, or TSA contributing member, until 14 days after the Commissioner issues a notice to that member advising of their liability [Schedule 1, item 2, subsections 721-15(5) and 721-30(5)] . To maintain flexibility for the Commissioner and taxpayers alike, there is no legislative requirement for the notice to be issued within a certain period.

Application of these rules to contributing members, or TSA contributing members, that are trusts or partnerships

11.35 The consolidation rules apply such that partnerships and some trusts may be members of a consolidated group. Where a contributing member, or a TSA contributing member, is a partnership or a trust the liabilities imposed under these rules are instead imposed on:

·
if the contributing member, or TSA contributing member, is a partnership - the partners of the partnership (as described in section 444-5 of Schedule 1 to the TAA 1953); and
·
if the contributing member, or TSA contributing member, is a trust - the trustees of the trust (as described in section 254 of the ITAA 1936) [Schedule 1, item 2, subsections 721-15(6) and 721-30(6)] .

Application and transitional provisions

11.36 These rules apply from the commencement of the consolidation regime, on 1 July 2002.

Chapter 12 - Pay as you go instalments

Outline of chapter

12.1 This chapter explains the consequential amendments that will be made to the PAYG instalments legislation to ensure the efficient collection of income tax payable by entities that are members of consolidated groups at some point during an income year.

12.2 Unless otherwise noted, the sections referred to in this chapter are sections of Schedule 1 to the TAA 1953.

Context of amendments

12.3 As discussed in Chapter 2 of this explanatory memorandum, the income tax liability single entity rule of the consolidation legislation will provide that an entity, that is a subsidiary member of a consolidated group, will be treated as a part of the head company of that group for the purpose of working out that subsidiary members and the head companys liability to pay income tax. This treatment necessitates changes to the liability of both the subsidiary member and the head company to pay PAYG instalments.

12.4 Amendments are needed to the existing PAYG instalments legislation to ensure that the liability to pay PAYG instalments reflects the assessment liabilities of the members of a mature consolidated group and to make appropriate transitional arrangements for the period prior to a head company of a consolidated group being given an instalment rate worked out from its first assessment as the head company of that consolidated group.

Summary of new law

Rules that will apply to a mature consolidated group (i.e. one where the head company has been given an instalment rate worked out from its first assessment as the head company of that group)

12.5 Generally, the only member of a mature consolidated group liable to pay PAYG instalments will be the head company. The PAYG instalments provisions will apply to a head company of a consolidated group in much the same way as they do to any other company. Head companies will be liable to pay quarterly instalments and will pay using either:

·
the GDP-adjusted notional tax method if the instalment income of the head company in its most recently assessed income year is $1 million or less and it does not choose to pay using the instalment income method; or
·
the instalment income method if the instalment income of the head company in its most recently assessed income year is more than $1 million or it has chosen to use that method.

12.6 When the head company of a consolidated group works out its instalment income for an instalment quarter, it will need to work it out on the basis that each subsidiary member of the group is a part of the head company. That is, the head company will work out its instalment income as if it derives the income or gains arising from transactions carried out by the members of the group.

12.7 Further, the head company will work out its instalment income on the basis that it has the attributes of its subsidiary members. For example, if a subsidiary member of a consolidated group is a partner in a partnership, or a beneficiary of a trust, the head company will be treated as being the partner or beneficiary where that partnership or trust is not itself a member of the group.

12.8 The head company will not be required to include ordinary income arising from intra-group transactions in its instalment income as it will not be assessed on those amounts. This results from treating the subsidiary members of a consolidated group as parts of the head company which, in turn, brings into play the principle that an entity cannot derive income from itself.

12.9 An entity that becomes a subsidiary member of a consolidated group will be liable to pay a PAYG instalment for the instalment quarter (or income year if it is an annual payer) in which it joins the group. However, it will not be liable to pay an instalment for any subsequent quarter (or year) unless it later leaves the group.

12.10 If, at the time the subsidiary member joins the group, it pays its instalments using the instalment income method, its instalment income for the joining quarter will be the ordinary income it derives before joining the group. Any income derived after joining will be treated as if it is derived by, and assessable to, the head company under the income tax liability single entity rule. As it will not be assessable income of the subsidiary member, it will not be instalment income of the subsidiary member.

12.11 If, at the time the subsidiary member joins the group, it pays its instalments using the GDP-adjusted notional tax method, the entity will, for the joining quarter, pay the amount notified by the Commissioner. However, the subsidiary member may choose to vary the amount on the basis of its estimate of its expected tax liability for the income year.

12.12 An entity will become liable to pay PAYG instalments immediately on leaving a consolidated group. The entity will be required to:

·
pay quarterly instalments;
·
use the instalment income method; and
·
use the most recent instalment rate given to the head company before the end of the instalment quarter in which the entity leaves the group.

The entity will continue to pay on the instalment income basis until the first instalment quarter of the first income year that starts after it has been assessed in its own right. It can then determine whether it is eligible to pay instalments annually or quarterly and if it is a GDP-adjusted notional tax payer or instalment income payer under the existing PAYG instalments provisions.

12.13 The Commissioner will have a power to give a head company of a consolidated group a new instalment rate or instalment amount in certain circumstances when there is a change in the membership of a mature consolidated group.

Rules that apply before a head company has been given an instalment rate worked out from its first assessment as a head company

12.14 There are special rules that will apply during the transitional period until the Commissioner gives a head company of a consolidated group an instalment rate that is worked out from its first assessment as the head company of that group.

12.15 In this transitional period, each member of the consolidated group will remain liable to pay instalments as if it were not a member of a consolidated group. This will be so even though each subsidiary member will be treated as a part of the head company of the group for the purposes of determining its income tax liability on assessment.

12.16 When the head company of the group is assessed, it will be entitled to a credit for its own instalments and the instalments payable by each subsidiary member of the group. The amount of the credit arising from a subsidiary members instalments will take account of so much of the subsidiary members instalments and variation credits as are reasonably attributable to:

·
the period during which that subsidiary member is a subsidiary member of the group; and
·
the part of the instalment quarter (or income year) for which the instalment is payable by that subsidiary member that falls within the head companys income year.

12.17 There will also be special rules to deal with variations made by members of the group in this transitional period. Under these rules, a head company of a consolidated group may be liable to a variation penalty in relation to a variation made by a subsidiary member of the group.

Comparison of key features of new law and current law
New law Current law
The head company of a consolidated group will be liable to pay PAYG instalments to meet its tax liabilities on the basis that the subsidiary members of the group are a part of the head company. Each entity is liable to pay PAYG instalments to meet its tax liability.
The head company of a consolidated group will pay instalments quarterly.

Head companies will pay using the GDP-adjusted notional tax method if their instalment income in their most recently assessed income year is $1 million or less unless they choose to pay using the instalment income method. All other head companies will pay using the instalment income method.

Entities that are members of company groups (as defined by reference to a 50% control test) pay instalments quarterly.

Companies pay using the GDP-adjusted notional tax method if their instalment income in their most recently assessed income year is $1 million or less unless they choose to pay using the instalment income method. All other companies pay using the instalment income method.

A quarterly instalment payable by a head company will be due on or before 21 days after the end of the instalment quarter. A quarterly instalment payable by an entity that is a deferred BAS payer is due on or before 28 days after the end of the instalment quarter, or on 28 February for an instalment quarter of which the last month includes all or part of December.

A quarterly instalment payable by an entity that is not a deferred BAS payer is due on or before 21 days after the end of the instalment quarter.

When the head company of a consolidated group works out its instalment income, it will ignore income from intra-group transactions.

The head company will work out its instalment income as if it derives the income or gains arising from the transactions carried out by the subsidiary members of the group as well as its own.

Generally, the instalment income of all entities, regardless of whether they are members of a company group, includes intra-group transactions.
An entity that becomes a subsidiary member of a consolidated group will cease to be liable to pay PAYG instalments as from the instalment quarter (or income year) that is subsequent to the quarter (or year) in which it joins the group. Joining a group of companies does not alter the entitys liability to pay PAYG instalments.
An entity that leaves a consolidated group will become liable to pay PAYG instalments for the instalment quarter in which it leaves the group and subsequent quarters. It will be an instalment income payer and will work out its instalments using the head companys instalment rate until the Commissioner gives it an instalment rate from its first assessment in its own right. Leaving a group of companies does not alter the entitys liability to pay PAYG instalments.
The Commissioner will have a power to give a head company of a consolidated group a new instalment rate or instalment amount in certain circumstances when the membership of a group changes. No equivalent.
Special rules will apply in the transitional period for a group (that is until a head company is given an instalment rate worked out from the head companys first assessment as a head company of that group). All members of the consolidated group will continue to be liable to pay PAYG instalments as if they were not members of a consolidated group until that rate is given. No equivalent.

Detailed explanation of new law

12.18 Two new Subdivisions will be inserted into Division 45. [Schedule 4, item 1, Subdivisions 45-Q and 45-R]

12.19 The first new Subdivision will ensure that the single entity rule applies to the members of a consolidated group for the purposes of PAYG instalments. However, this will not occur until the Commissioner has given the head company an instalment rate worked out from the head companys first assessment as a head company. This Subdivision will also contain rules that modify the usual operation of Division 45 insofar as it applies to entities that are members of a consolidated group and deal with changes in the membership of a group. [Schedule 4, item 1, Subdivision 45-Q]

12.20 The second new Subdivision will set out rules that apply to members of consolidated groups during the transitional period commencing when a consolidated group is formed and ending just before the start of the instalment quarter in which the head company of a consolidated group is given an instalment rate worked out from its first assessment as a head company of that group. [Schedule 4, item 1, Subdivision 45-R]

General rules for mature consolidated groups

Application of Subdivision 45-Q to a head company of a consolidated group

12.21 The general rules for consolidated groups will not apply until a head company of a consolidated group has been assessed as a head company for the first time and has been given an instalment rate that is worked out from that assessment. That is, Subdivision 45-Q will start to apply to a head company of a consolidated group for the period that commences on the first day of the instalment quarter of a head company during which the head company is given its initial head company instalment rate. [Schedule 4, item 1, paragraph 45-705(a)]

12.22 The initial head company instalment rate of a head company of a consolidated group is the instalment rate, given to the head company by the Commissioner, worked out on the basis of the head companys first base assessment as a head company. [Schedule 5, item 12, subsection 995-1(1) of the ITAA 1997]

12.23 Subdivision 45-Q will continue to apply to a head company of a consolidated group until the end of the instalment quarter in which the head company ceases to be the head company of the group. [Schedule 4, item 1, paragraph 45-705(b)]

12.24 When Subdivision 45-Q applies to the head company of a consolidated group, the group is referred to in this chapter as a mature group.

Single entity rule

12.25 The single entity rule will be included in the PAYG instalments provisions and will apply for the purposes of that regime. This is necessary as the single entity rule discussed in Chapter 2 does not apply for PAYG instalments purposes. Consequently, while an entity is a subsidiary member of a consolidated group it, and any other subsidiary member of the group, will be taken to be parts of the head company of the group, rather than separate entities, during that period. However, the single entity rule in the PAYG instalments provisions will only start to apply from the start of the instalment quarter during which the Commissioner gives the head company of a consolidated group its initial head company instalment rate. It will continue to apply while Subdivision 45-Q applies to that head company. [Schedule 4, item 1, section 45-710]

12.26 There are several effects of applying the single entity rule for the purposes of PAYG instalments.

12.27 The main effect is to ensure that, while Subdivision 45-Q applies to the head company of a consolidated group, the head company of the group will bear the liability to pay PAYG instalments. Once the single entity rule starts to apply to a particular head company, an entity that is a subsidiary member of that consolidated group at the end of a particular instalment quarter will not be liable to pay an instalment for that quarter. This is necessary because the PAYG instalments provisions do not apply to an entity that is taken to be a part of a head company (see existing section 45-10). However, special rules will apply when:

·
an entity joins a mature consolidated group during an instalment quarter (see paragraphs 12.36 to 12.41); and
·
Subdivision 45-Q begins to apply to the head company of a consolidated group in a particular quarter of the head companys income year and a subsidiary member has an instalment quarter, or income year, that ends before the instalment quarter, or income year, of the head company (see paragraphs 12.67 to 12.69).

12.28 The single entity rules that will apply for PAYG instalments purposes and for income tax liability purposes will also affect how an entity works out its instalment income. This is because:

·
the instalment income of an entity for an instalment period is the ordinary income derived by the entity in that period, to the extent to which that ordinary income is assessable income of the income year that includes that period (see the existing definition of instalment income in section 45-120); and
·
the assessable income of an entity will be determined having regard to the single entity rule that applies for income tax liability purposes.

12.29 Therefore, the instalment income of a head company of a consolidated group for a particular instalment quarter will be the ordinary income that the head company derives in the quarter worked out on the basis that the subsidiary members are parts of the head company. This may mean that the instalment income of the head company is not simply the total of the ordinary income of all the members of the group.

12.30 Further, when the head company is working out whether a particular amount of ordinary income will be its assessable income of the income year that covers a particular instalment quarter, it will do so having regard to the single entity rule that applies for income tax liability purposes.

12.31 The head company will work out its instalment income on the basis that it has the attributes of its subsidiary members. For example, if a subsidiary member of a consolidated group is a partner in a partnership, or beneficiary of a trust, the head company will be treated as being the partner or beneficiary where that partnership or trust is not itself a subsidiary member of the group.

12.32 The single entity rule that applies for income tax liability purposes will also affect how entities that are not head companies work out their instalment income for a particular period. For example, an entity that becomes a subsidiary member of a consolidated group during a particular period will not have any instalment income from the date it joins the group until it leaves the group without immediately becoming a subsidiary member of another mature group. This is because any income it derives during that period will be assessable to the head company of the group and, therefore, will not be instalment income of the entity.

12.33 An entity that ceases to be a subsidiary member of a mature consolidated group, without immediately becoming a subsidiary member of another mature group, may have instalment income in relation to a period, or periods, after it leaves the group.

Head companies will pay quarterly instalments

12.34 Members of company groups (determined on a 50% ownership/control test) cannot choose to be annual payers under the existing law. Consistently with this, the law will state that the head company of a consolidated group cannot choose to pay annual instalments while Subdivision 45-Q applies to the head company. [Schedule 4, item 1, section 45-720]

Quarterly instalments are due within 21 days

12.35 The quarterly instalments that are payable by a head company of a mature consolidated group will be due on or before 21 days after the end of the instalment quarter. This will be so even if the head company is a deferred BAS payer that is not due to pay its other BAS amounts until 28 days after the end of the quarter. This provision does not affect the due date for paying those other BAS amounts. [Schedule 4, item 1, section 45-715]

Entity becomes a subsidiary member

12.36 The PAYG instalments single entity rule will remove an entitys liability to pay an instalment for an instalment quarter or income year when an entity becomes a subsidiary member of a mature consolidated group during that quarter, or year, if the entity would otherwise be liable to pay an instalment for that instalment period. However, the entity should still be liable to pay an instalment for the quarter, or year, in which it joins the group. This is because the entity will still be liable to pay income tax for the part of the income year during which it is not a subsidiary member of a consolidated group.

12.37 Accordingly, an entity that becomes a subsidiary member of a consolidated group will be liable to pay a PAYG instalment for the instalment quarter (or income year if it is an annual payer) in which it becomes such a member if:

·
Subdivision 45-Q applies to the head company of the consolidated group at any time during that quarter (or year);
·
the entity would have been liable to pay a PAYG instalment had it not become a subsidiary member of that consolidated group; and
·
the entity joins that consolidated group on a day other than the first day of:

-
an instalment quarter in the case of a quarterly payer; or
-
an income year in the case of an annual payer.

[Schedule 4, item 1, subsection 45-755(1)]

12.38 Special rules apply if the joining entity would have been a quarterly payer that pays 4 instalments annually on the basis of GDP-adjusted notional tax and it varies its instalment for the joining quarter and that quarter is not the fourth quarter of the income year for which the entity is liable to pay an instalment. In that case, the joining entity must work out its instalment for the quarter on the assumption that it were the fourth quarter of the income year for which it is liable to pay an instalment. That is, it works out its instalment by subtracting from its estimated benchmark tax the sum of its previous instalments for the income year, if any, and adding back the amount of any variation credit it claimed for a previous quarter of the income year. [Schedule 4, item 1, subsections 45-755(2) and (3)]

12.39 The same assumption applies for working out the acceptable amount of the instalment for the joining quarter when working out a variation penalty in relation to that instalment. [Schedule 4, item 1, subsections 45-755(2) and (4)]

12.40 The entry rule discussed in paragraph 12.37 will apply to an entity that is not a member of a mature consolidated group before entering a mature group or an entity that is, before joining the mature group, the subsidiary member of a consolidated group that is not yet mature. It will also apply to an entity that is the head company of a consolidated group immediately prior to becoming a subsidiary member of another mature group.

12.41 Where an entity becomes a subsidiary member of a consolidated group that is not yet a mature consolidated group the rule in paragraph 12.37 does not apply. All members of a group that is not yet a mature consolidated group are liable to pay instalments under the transitional rules discussed in paragraphs 12.62 to 12.99. Consequently, an entity that becomes a member of such a group will remain liable to pay PAYG instalments for the transitional period if it was already liable to do so.

Entity ceases to be a subsidiary member

12.42 A special rule will provide:

·
that an entity that leaves a mature consolidated group (the exiting entity) becomes liable to pay PAYG instalments; and
·
the basis on which it is liable to pay PAYG instalments.

12.43 It is appropriate for an entity that ceases to be a subsidiary member of a mature consolidated group to become liable to pay PAYG instalments. However, it would not be appropriate for that entity to revert to the instalment rate or payment method that applied prior to it joining the group. Primarily, this is because the instalment rate or GDP-adjusted notional tax amount worked out from an old assessment may no longer be appropriate to the entitys tax attributes on leaving the group and its expected income tax liability for the income year in which it leaves.

12.44 Consequently, an entity will become liable to pay PAYG instalments if it:

·
ceases to be a subsidiary member of a consolidated group during an instalment quarter and Subdivision 45-Q applies to the head company of the group at any time during that quarter; and
·
does not immediately become a subsidiary member of another consolidated group the head company of which is a head company to which Subdivision 45-Q applies.

[Schedule 4, item 1, subsection 45-760(1)] and paragraph 45-760(2)(a)

12.45 The exiting entity will become liable to pay instalments because the PAYG instalments provisions will apply as if the Commissioner gave that entity an instalment rate during the instalment quarter in which it ceased to be a member of the group. It will be liable to pay an instalment for the quarter in which it leaves the group and subsequent quarters because the giving of an instalment rate to an entity triggers that entitys liability to pay instalments under the existing law - see section 45-15. [Schedule 4, item 1, paragraph 45-760(2)(a)]

12.46 Further, the entity will be treated as if it has been given the same instalment rate as the instalment rate most recently given to the head company of the mature consolidated group that it leaves. That will include an instalment rate given to the head company after the entity has left but before the end of the instalment quarter in which it leaves. It will continue using that instalment rate until the Commissioner gives it an instalment rate worked out from an assessment for the income year that includes the day the entity ceased to be a member of the consolidated group. [Schedule 4, item 1, paragraph 45-760(2)(a)]

12.47 The exiting entity will, at the end of the quarter in which it exits the group, be a quarterly payer that pays instalments using the instalment income method. Generally, it will remain liable to pay its instalments on this basis until the end of the last instalment quarter of the income year in which the Commissioner gives it an instalment rate worked out from the assessment of the income year in which it left the group. This means that the entity will not be entitled to pay instalments using any other method until the income year that starts after its first assessment for a post-consolidation period. However, if the Commissioner gives the exiting entity an instalment rate worked out from its first assessment for the income year that includes the day the entity ceased to be a member of the consolidated group, during the first instalment quarter of an income year, it will stop being required to be an instalment income payer under this rule. That will occur immediately before the end of that quarter and the entity will be required to determine the method it uses to work out its instalments under the existing law. [Schedule 4, item 1, paragraph 45-760(2)(b)] and subsection 45-760(3)]

12.48 The exit rule discussed in paragraphs 12.44 to 12.47 will apply to an entity that ceases to be a subsidiary member of a mature consolidated group, for example, because:

·
it ceases to be a 100% subsidiary of the head company of the group; or
·
the group is deconsolidated because the head company of the group ceases to be eligible to be a head company for a reason other than the head company becoming a subsidiary member of another mature consolidated group.

It does not apply to an entity that ceases to be a head company of a consolidated group. Subdivision 45-Q continues to apply to the head company until the end of the quarter in which the deconsolidation occurs and the entity that was the head company continues to be liable to pay instalments.

Commissioners power to work out a higher or lower instalment rate or instalment amount

12.49 Currently, the Commissioner is required to work out the instalment rate and/or GDP-adjusted notional tax amount that is given to an entity having regard to that entitys most recent assessment for its most recent income year.

12.50 Changes in the composition of a mature consolidated group could significantly alter the head companys expected tax liability for a year. This could also mean that the instalment rate or GDP-adjusted notional tax amount worked out from a head companys most recent assessment is not an appropriate basis from which to work out the head companys instalments.

12.51 For example, the head company of one consolidated group - the take-over head company - may acquire the head company of another consolidated group - the target head company. Further, the most recently assessed tax liabilities of the 2 head companies may be quite similar but their instalment rates may be very different. For instance, the take-over head companys rate might be relatively low because its instalment income for its most recent assessment is large, while the target head companys rate might be high because its instalment income for its most recent assessment is quite small. (Broadly, an entitys instalment rate is worked out by dividing its tax for its most recent year, with some adjustments, by its instalment income for that year.)

12.52 In a case like that outlined in the previous paragraph, the instalments payable by the take-over head company would probably fall short of the take-over head companys expected tax liability. Applying its relatively low instalment rate to the relatively small additional instalment income that it derives as a result of acquiring the target head companys group, would result in instalments falling short of its increased tax liability.

12.53 In the converse of the situation discussed in paragraph 12.51, that is, a high instalment rate head company acquiring a low instalment rate head company, the instalments payable by the take-over head company could far exceed its expected tax liability.

12.54 The Commissioner does not currently have any power to calculate a higher, or lower, instalment rate or GDP-adjusted notional tax amount for an entity if the Commissioner believes the instalments payable using a head companys latest instalment rate or amount will be too high or low. Under the changed arrangements flowing from the consolidations regime, such a power will be necessary to address the increased chance of consolidated groups significantly over or under-paying their instalments as a result of material changes in the membership of a consolidated group.

12.55 Consequently, the Commissioner will be given a subjective power to work out a higher, or lower, instalment rate or GDP-adjusted notional tax amount to ensure that the objects of the PAYG instalments regime are given effect. The Commissioner will be able to exercise this power if:

·
there has been a change in the membership of a mature consolidated group because one or more entities become, or cease to be, subsidiary members of the group; and
·
having regard to the statutory object of the PAYG instalments regime (which includes ensuring the efficient collection of income tax by minimising the amount payable, or refundable, on assessment), the Commissioner is of the opinion that it would be reasonable to work out a higher, or lower, instalment rate or GDP-adjusted notional tax amount.

[Schedule 4, item 1, subsections 45-775(1) and (2)]

12.56 The higher, or lower, instalment rate or amount that the Commissioner works out will be the rate or amount that, in the opinion of the Commissioner, is reasonable. In working out whether a rate or amount is reasonable, the Commissioner must have regard to the change in membership of the group and the object of the PAYG instalments regime. [Schedule 4, item 1, subsection 45-775(3)]

12.57 The Commissioner will be able to exercise this power at any time during an income year. This will be so even if the head company of a consolidated group varies its instalment rate or estimates its benchmark tax for the year prior to the membership change, or after that change but before the Commissioner has exercised the power in respect of that change in the group.

12.58 Any higher, or lower, rate or amount will be relevant for working out the GIC to which the head company may be liable in respect of a variation. This is consistent with the existing law. Currently, an instalment rate or GDP-adjusted notional tax amount worked out from an assessment that occurs after an entity has varied is taken into account in working out any variation penalty.

12.59 Whether or not the head company of a consolidated group is given a higher, or lower, instalment rate or GDP-adjusted notional tax amount, the head company will be entitled to vary its rate or amount under the existing law.

12.60 The Commissioners decisions made in the exercise of the power will be reviewable in the normal way under the Administrative Decisions (Judicial Review) Act 1977.

12.61 It is expected that the Commissioner will exercise this power only when the membership change alters the head companys anticipated tax liability in a material way. In many situations, the entry of a new subsidiary member to the group or the exit of an existing subsidiary member will be appropriately addressed by applying the groups existing instalment rate to its increased, or decreased, instalment income.

Transitional period rules

12.62 The rules discussed in paragraphs 12.21 to 12.61 will only apply once the Commissioner gives a head company of a consolidated group its initial head company instalment rate. Special rules will apply in the transitional period from a groups date of consolidation until the start of the instalment quarter of a head company of a consolidated group in which it is given its initial head company instalment rate by the Commissioner.

12.63 It is anticipated that the transitional period will affect the first 2 income years of a consolidated group. This can be seen from the definition of consolidation transitional year which will be, for a member of a group, an income year of that member:

·
during all or part of which the head companys choice to consolidate has effect; and
·
which is either the year in which the Commissioner gives the head company its initial head company instalment rate or the year that ends immediately before that year.

[Schedule 5, item 8, subsection 995-1(1) of the ITAA 1997]

Liability for instalments

12.64 As explained in paragraph 12.25, the single entity rule will only start to apply to a consolidated group for PAYG instalments purposes from the start of the instalment quarter in which the head company of that group is given its initial head company instalment rate. This means that, prior to the giving of the initial head company instalment rate, the members of a consolidated group will continue to be liable to pay PAYG instalments as if they were not members of a consolidated group. No special rules are needed to ensure an entity is liable to pay an instalment because of the way Subdivision 45-Q will operate.

12.65 However, a rule is needed to ensure that an instalment payable by such a member in the transitional period is worked out in an appropriate way. This is because, under the existing law, an entitys instalment income for a period is so much of the ordinary income it derives in that period as will be assessable income of the income year that includes that period. If a subsidiary member were to apply this definition in a quarter in which it is a member of the group for the whole quarter, it would not have any instalment income because its ordinary income will be assessable to the head company.

12.66 Consequently, when an entity that is a member of a consolidated group works out its instalment income for a particular instalment quarter or income year, or part of that quarter or year, it will ignore the fact that its ordinary income will not be included in its assessable income. That is, it will ignore the operation of the single entity rule that applies for income tax liability purposes. For example, it will include in its instalment income, an amount derived from an intra-group transaction even though such income is not assessable to it or to the head company. This will not produce an incorrect result as the entitys instalment rate, being worked out from an assessment for an income year when the entity was not a member a consolidated group, will also take account of intra-group transactions that occurred in that income year. [Schedule 4, item 1, section 45-855]

Special liability rule for group members with different instalment periods

12.67 The single entity rule for PAYG instalments will start to apply to a consolidated group from the start of the instalment quarter of the head company of a consolidated group in which the head company is given its initial head company instalment rate. This will mean that the single entity rule will start to apply to a particular subsidiary member of a consolidated group part way through its instalment quarter or income year in some cases where that member has a different income year from the head company and is, therefore, liable to pay instalments in respect of different periods from the head company. Without a special rule, no entitys instalment would take account of instalment income derived in the period from the start of the subsidiary members instalment quarter, or year, to the day on which Subdivision 45-Q started to apply to the head company of the group.

12.68 Therefore, although this is not expected to happen very often, a subsidiary member will be liable to pay an instalment for the instalment quarter (or income year if it is an annual payer) in which the single entity rule starts to apply to the head company of the consolidated group if:

·
the subsidiary member would, but for the operation of the Subdivision 45-Q, be liable to pay an instalment for the instalment quarter, or income year, during which Subdivision 45-Q starts to apply to the head company of the group; and
·
that subsidiary members instalment quarter or income year ends before the end of the instalment quarter or income year of the head company during which Subdivision 45-Q starts to apply to the head company.

[Schedule 4, item 1, subsections 45-860(1) and (2)]

12.69 Once the subsidiary member is liable to pay an instalment for the instalment quarter, or income year, in which Subdivision 45-Q starts to apply to the head company of the group, the subsidiary member will work out its instalment for that quarter or year using certain assumptions. First, it will only need to work out its instalment income for the period from the start of its quarter or year to the day on which Subdivision 45-Q starts to apply to the head company of the group. Second, consistent with section 45-855, it will disregard the operation of the income tax liability single entity rule for that period. That is, its instalment income will be the ordinary income it derives in that period, regardless of the fact that that income will not be included in its assessable income. [Schedule 4, item 1, subsection 45-860(3)]

Example 12.1: Member having a different instalment period Company A, the head company of a consolidatable group, chooses to consolidate the group as from 1 July 2002. It is a 30 June balancing entity, but one subsidiary member, Company SM5, has a substituted accounting period ending on 30 April.The Commissioner gives Company A its initial head company instalment rate (worked out from its 2002-2003 assessment) on 20 March 2004. Therefore, Subdivision 45-Q starts to apply to Company A on 1 January 2004.Prior to the day on which Subdivision 45-Q starts to apply to Company A, both Company A and SM5 are quarterly instalment payers that use the instalment income method.SM5 will be liable to pay an instalment for its instalment quarter ending 31 January 2004. However, that instalment will be payable for the period from 1 November to 31 December 2003 and will be worked out from the ordinary income SM5 derives in that period. The income earned by SM5 from 1 January 2004 will be taken into account by Company A in working out its instalment for the quarter ending 31 March 2004.

Credits for instalments on assessment

12.70 Under the existing law, the PAYG instalments that are payable by an entity for an income year are credited against that entitys assessment for that year under section 45-30. However, the credit for instalments payable by a subsidiary member of a consolidated group for a consolidation transitional year for that entity are allocated between:

·
a head companys assessment in respect of a period when the subsidiary member was a member of a consolidated group; and
·
any separate assessment of the subsidiary member for its consolidation transitional year in respect of a period when it was not a member of a consolidated group.

[Schedule 4, item 1, section 45-865]

12.71 A head company of a consolidated group will be entitled to a credit for instalments payable by an entity that is a subsidiary member of that group at any time during the head companys consolidation transitional year. This credit will be in addition to the credit to which the head company is entitled for its own instalments under section 45-30. For example, if a group consists of the head company and 3 subsidiary members, the head company will be entitled to a credit for instalments payable by each of those 3 subsidiary members. [Schedule 4, item 1, subsection 45-865(1)]

12.72 A head company will be entitled to credits after the Commissioner:

·
makes an assessment of the income tax the head company is liable to pay for a consolidation transitional year for the head company; or
·
determines that the head company is not liable to pay tax on its taxable income or that it has no taxable income for that year.

This is consistent with existing section 45-30. [Schedule 4, item 1, subsection 45-865(1)]

12.73 The amount of the credit to which a head company is entitled in respect of a particular subsidiary member is worked out by:

·
totalling each instalment payable by that subsidiary member; and
·
subtracting any variation credits claimed by it,

to the extent to which those instalments and variation credits are reasonably attributable to that head companys assessment for a consolidation transitional year. [Schedule 4, item 1, subsection 45-865(2)]

12.74 To determine how much of an entitys instalment is reasonably attributable to a head companys assessment, it will be necessary to work out how much of the instalment quarter (or income year) for which the instalment is payable falls within:

·
the head companys consolidation transitional year; and
·
the period during which the entity is a subsidiary member of the consolidated group.

[Schedule 4, item 1, paragraph 45-865(2)(a)]

12.75 For a variation credit, the attribution must also be made taking account of the factors identified in the previous paragraph. However, it is necessary to examine more than just the instalment quarter for which the credit is claimed in making that attribution. For an instalment income payer, the period to be considered is the previous instalment quarters of the income year. For a GDP-adjusted notional tax payer, the period is the quarter for which the variation credit is claimed and the preceding quarters of the income year. The difference in approach arises because of differences in the way variation credits are worked out by instalment payers using these different methods. [Schedule 4, item 1, paragraph 45-865(2)(b)]

12.76 It should be noted that section 45-865 may also apply in allocating the instalment payable by an entity for a particular instalment period between 2 or more head companies, if that entity was a member of more than one consolidated group during that period.

12.77 Once part of a subsidiary members instalment or variation credit has been taken into account in working out the credit to which a head company is entitled on assessment, that amount cannot be taken into account in working out the subsidiary members credit under section 45-30 for any income year. [Schedule 4, item 4, subsection 45-30(4)]

Example 12.2: Head companys credit for instalments of a subsidiary member HC is a 30 June balancing entity that chooses to consolidate on 1 July 2002. On 1 December 2002, HC acquires a new subsidiary member, SM5, which is a 30 April balancing entity. For PAYG instalments purposes, SM5 is a quarterly payer that pays on the basis of instalment income and has been given an instalment rate of 10% by the Commissioner. It pays the following instalments after becoming a member of the group:

Quarter ending Instalment payable Variation credit claimed
31 January 2003

(Q3 of its 2002-2003)

$10,000

(10% of $100,000)

N/A
30 April 2003

(Q4 of its 2002-2003)

$6,400

(8% of $80,000)

$6,000

(2% of $300,000)

31 July 2003

(Q1 of its 2003-2004)

$10,000

(10% of $100,000)

N/A
Note: The variation credit for the 30 April 2003 quarter assumes that SM5 derived $100,000 in each of its previous instalment quarters.
Some part of SM5s instalments may be credited to HCs assessment for HCs 2002-2003 income year (i.e. the year ending 30 June 2003) as that is a consolidation transitional year for HC. SM5s quarter ending 31 January 2003 This instalment will need to be apportioned because SM5 was not a member of the consolidated group for the whole of this quarter.The part of the instalment that is reasonably attributable to the HCs 2002-2003 income year can be determined by apportioning the instalment on a time basis. For the period during which SM5 is a subsidiary member of the consolidated group - the period 1 December 2002 to 31 January 2003 - the amount reasonably attributable to HCs 2002-2003 assessment on that basis is 62/92 of $10,000, which is $6,739. SM5s quarter ending 30 April 2003 All of the instalment of $6,000 payable by SM5 for this quarter will be taken into account for HCs assessment credit because SM5 was a member of the group for the entire instalment quarter and all of the quarter falls within HCs 2002-2003 income year.Some part of the variation credit SM5 claimed for this quarter will have to be taken into account to work out the credit to which HC is entitled. This is because some of the variation credit is reasonably attributable to the head company assessment as SM5 was a member of the consolidated group for part of the earlier instalment quarters of its consolidation transitional year.The part of the 31 January 2003 variation credit that is reasonably attributable to HCs 2002-2003 income year can be determined by apportioning the credit on a time basis. For the period during which SM5 is a subsidiary member of the consolidated group - the period 1 December 2002 to 31 January 2003 - the amount reasonably attributable to HCs 2002-2003 assessment on that basis is 62/276 of $6,000, which is $1,347. SM5s quarter ending 31 July 2003 This instalment will need to be apportioned because part of the period for which the instalment is payable falls outside HCs 2002-2003 income year.The part of the instalment payable for the quarter ending on 31 July 2003 that is reasonably attributable to the head companys 2002-2003 income year can be determined by apportioning the instalment on a time basis. For the part of the instalment quarter that falls into HCs 2002-2003 income year - the period 1 May to 30 June 2003 - the amount reasonably attributable to HCs assessment on that basis is 61/92 of $10,000, which is $6,630.The balance of SM5s instalment ($3,370) will be credited to HCs 2003-2004 assessment if SM5 continues to be a subsidiary member of the consolidated group for the rest of its instalment quarter ending 31 July 2003. HCs 2002-2003 assessment credit HC will be entitled to a credit of $18,422 against its 2002-2003 assessment for the instalments payable by SM5. That amount is the sum of $6,739, $6,400 and $6,630 for the instalments payable by SM5, minus $1,347 for SM5s variation credit.

How to deal with variations during the transitional period

12.78 The existing PAYG instalments regime penalises an entity that varies an instalment rate or amount and, as a result, pays too little towards its assessed tax. The variation penalty rules take account of both the total instalments payable for the year and the timing of those instalments. They are based on the GIC and entities are allowed a 15% margin for error.

12.79 Special rules will apply for working out whether a head company of a consolidated group is liable to the GIC for a consolidation transitional year. The rules will ensure that both the total instalments payable for the year and the timing of those instalments are taken into account and will allow a 15% margin for error.

Head company liable for the GIC

12.80 A head company of a consolidated group will be liable to pay the GIC for an instalment quarter of a consolidation transitional year if:

·
any member of the consolidated group has varied its instalment for:

-
that quarter; or
-
if the members instalment quarters differ from the head companys - the last instalment quarter of the member that finishes before the end of that particular quarter of the head company (called the equivalent quarter); and

·
the sum of the instalments payable by the members of the group for the quarter (and any equivalent quarters of the members) reduced by any variation credits claimed by those members is less than 85% of one-quarter of the head companys benchmark tax for that consolidation transitional year.

[Schedule 4, item 1, subsections 45-870(1) and (4)]

12.81 To work out the amount of the instalments payable, or variation credits claimed, by a subsidiary member during a particular quarter, only so much of those amounts as is reasonably attributable to a period in the head companys consolidation transitional year during which it was a subsidiary member will be taken into account. [Schedule 4, item 1, subsection 45-870(3)]

Amount on which GIC is imposed

12.82 A method statement will prescribe how to work out the amount on which the GIC is imposed for a particular instalment quarter of the head company. [Schedule 4, item 1, subsection 45-870(2)]

12.83 As with determining if a head company is liable to the GIC, it will be necessary to:

·
take account of only so much of an instalment or variation credit as is reasonably attributable to a period in the head companys consolidation transitional year during which the entity was a subsidiary member; and
·
if the subsidiary members instalment quarters differ from the head companys - take account of the instalments payable, or variation credits claimed, for an equivalent instalment quarter of the member.

[Schedule 4, item 1, subsections 45-870(2) to (4)]

12.84 The existing variation penalty provisions of the PAYG instalments regime ensure that the amount on which the penalty is imposed for a particular instalment does not exceed the lesser of the amount that would have been payable for that instalment had the entity:

·
not varied; or
·
worked out its instalment using its benchmark instalment rate (in the case of instalment income payers) or benchmark tax (in the case of GDP-adjusted notional tax payers).

12.85 The amount on which a head company will be liable to pay the GIC will be worked out similarly for a consolidation transitional year. In these circumstances, the amount on which the GIC is imposed for a particular instalment quarter of a head companys consolidation transitional year will be determined by reference to the lesser of:

·
the sum of all the instalments that would have been payable by the members of the group had no member varied; and
·
the amount that would have been payable by the head company if it had been required to pay one quarter of its benchmark tax as its instalment for that quarter.

[Schedule 4, item 1, subsection 45-870(2), steps 1 and 2 of the method statement]

12.86 The lesser of those 2 amounts will be reduced by the sum of the instalments actually payable by all the members of the group reduced by any variation credits claimed by them. If the result is positive, the GIC is imposed on that amount. [Schedule 4, item 1, subsection 45-870(2), steps 3 and 4 of the method statement]

12.87 As with the existing variation penalty rules:

·
the GIC is payable for each day in the period that starts on the due date for the particular instalment of a head companys consolidation transitional year and ends on the due date for payment of that head companys assessed tax [Schedule 4, item 1, subsection 45-875(1)] ;
·
the Commissioner must notify the head company in writing of the GIC that is payable [Schedule 4, item 1, subsection 45-875(2)] ;
·
the GIC is payable within 14 days of that notice [Schedule 4, item 1, subsection 45-875(2)] ;
·
if the GIC is not paid in full within 14 days, any shortfall will itself be subjected to GIC for late payment [Schedule 4, item 1, subsection 45-875(3)] ; and
·
the Commissioner may remit the GIC in whole or part, if the Commissioner is satisfied that there are special circumstances that make it fair and reasonable to do so [Schedule 4, item 1, subsection 45-875(4)] .

Example 12.3: Head companys liability to GIC on shortfall in quarterly instalment Companies A, B, C and D are members of a consolidated group of which Company A is the head company. The group was consolidated on 1 July 2002 and each entity is a member of the group for all of the head companys consolidation transitional year.Companies A, B and C are quarterly payers who pay using the instalment income method. Company D is a quarterly payer who pays on the basis of GDP-adjusted notional tax.In quarter 3, Company C varies its instalment rate under section 45-205. Company D varies its instalment by estimating its benchmark tax under paragraph 45-112(1)(b). In quarter 4, Companies C and D again work out their instalments based on those variations.The following table summarises the position of the group for the consolidation transitional year:

Company Instalment rate/GDP-adjusted notional tax amount Amount of instalment and/or credit for quarter 1 Amount of instalment and/or credit for quarter 2 Amount of instalment and/or credit for quarter 3 Amount of instalment and/or credit for quarter 4
Co. A (head company) 15% $15,000

($100,000 * 15%)

$15,000

($100,000 * 15%)

$15,000

($100,000 * 15%)

$15,000

($100,000 * 15%)

Co. B

(subsidiary member)

10% $100,000

($1,000,000 * 10%)

$100,000

($1,000,000 * 10%)

$80,000

($800,000 * 10%)

$80,000

($800,000 * 10%)

Co. C

(subsidiary member)

8% $160,000

($2,000,000 * 8%)

$160,000

($2,000,000 * 8%)

$90,000

($1,500,000 * 6%)

$80,000 credit

($4,000,000 2%)

$90,000

($1,500,000 * 6%)

Co. D

(subsidiary member)

$100,000 $25,000

(25% * $100,000)

$25,000

(50% * $100,000 less instalment for quarter 1)

$5,000 credit

(75% * $60,000 less instalments for quarters 1 and 2)

$15,000

(100% * $60,000 less instalments for quarters 1 and 2 plus credit for quarter 3)

Company As benchmark tax for the consolidation transitional year is $1,100,000. Head companys liability to the GIC for quarter 3 As both Companies C and D varied in quarter 3, Company A is liable to pay the GIC if the sum of instalments payable by the members of the group for quarter 3, reduced by credits claimed by those members for that quarter, is less than 17/80 of its benchmark tax for the consolidation transitional year.The sum of instalments payable by the members of the group for quarter 3 is $185,000. This is reduced to $100,000 by the credits totalling $85,000 claimed by Companies C and D. 17/80 of Company As benchmark tax of $1,100,000 is $233,750. As the amount of $100,000 is less than $233,750, Company A is liable to GIC for quarter 3.The amount on which the GIC is payable will be worked out using the method statement in subsection 45-870(2) as follows:

Step 1:
¼ of $1,100,000 = $275,000.
Step 2:
$15,000 + $80,000 + $120,000 + $25,000 = $240,000.
Step 3:
($15,000 + $80,000 + $90,000 + $0) - ($80,000 + $5,000) = $100,000.
Step 4:
$240,000* - $100,00 = $140,000.

*
The result of step 2 is less than the result of step 1.

The GIC is payable on the amount of $140,000 for quarter 3, for the period from the due date for the quarter 3 instalment to the due date for payment of Company As assessed tax. Head companys liability to the GIC for quarter 4 As both Companies C and D varied in quarter, 4, Company A is liable to pay the GIC if the sum of instalments payable by the members of the group for quarter 4, reduced by credits claimed by those members for that quarter, is less than 17/80 of its benchmark tax for the consolidation transitional year.The sum of instalments payable by the members of the group for quarter 4 is $200,000. This is not reduced because no variation credits were claimed by Companies C and D in that quarter. 17/80 of Company As benchmark tax of $1,100,000 is $233,750. As the amount of $200,000 is less than $233,750, Company A is liable to GIC for quarter 4.The amount on which the GIC is payable will be worked out using the method statement in subsection 45-870(2) as follows:

Step 1:
¼ of $1,100,000 = $275,000.
Step 2:
$15,000 + $80,000 + $120,000 + $25,000 = $240,000.
Step 3:
$15,000 + $80,000 + $90,000 + $15,000 = $200,000.
Step 4:
$240,000* - $200,00 = $40,000.

*
The result of step 2 is less than the result of step 1.

The GIC is payable on the amount of $40,000 for quarter 4, for the period from the due date for the quarter 4 instalment to the due date for payment of Company As assessed tax.

Subsidiary members liable for GIC

12.88 A subsidiary member of a consolidated group may also be subject to variation penalties in respect of its variations if it is assessed as a separate entity in relation to its consolidation transitional year. These penalties will be raised under the existing PAYG instalments provisions as modified by the rules discussed in paragraphs 12.89 to 12.99.

Instalment income payers

12.89 For instalment income method payers that vary, a GIC penalty is payable if the varied instalment rate chosen by the entity is less than 85% of its benchmark instalment rate - see subsection 45-230(1). In general terms, the GIC is imposed on an amount worked out by multiplying the entitys instalment income for the variation quarter by the lower of the entitys benchmark instalment rate and the most recent instalment rate given to the entity by the Commissioner by the end of the variation quarter - see subsection 45-230(2). But variation credits also need to be taken into account to work out the amount on which the GIC is imposed.

12.90 To the extent to which an entity is assessed on the income of the part of its consolidation transitional year when it was not a subsidiary member of a consolidated group, the entity may be liable to the GIC in respect of a varied instalment rate. This liability will arise under the existing law without the need for any modification - that is, it will be liable to the GIC penalty if its varied instalment rate is less than 85% of its benchmark instalment rate.

12.91 However, the amount on which the GIC is imposed will be worked out under the existing law as modified by a new subsection. That new subsection will ensure that only so much of the instalment income of the variation quarter as is reasonably attributable to the part of that quarter when the entity was not a subsidiary member of the consolidated group is taken into account. It will also apply in relation to the instalment income of any earlier instalment quarters in respect of which a variation credit is claimed. [Schedule 4, item 9, subsection 45-230(2A)]

GDP-adjusted notional tax payers

12.92 For GDP-adjusted notional tax payers that vary, a GIC penalty is payable if the entitys estimated benchmark tax is less than 85% of its benchmark tax - see existing subsection 45-232(1).

12.93 The amount on which the GIC is imposed is worked out by reducing the acceptable amount of the instalment by the actual amount of the instalment. The actual amount of an instalment is defined as the amount actually payable by the entity, or if the entity claimed a variation credit in a particular quarter, that credit expressed as a negative amount. Broadly, the acceptable amount of an instalment for a quarter is the lesser of the amount that would be payable if the instalment was worked out using the lesser of the Commissioners notified GDP-adjusted notional tax amount or the entitys benchmark tax - see existing subsections 45-232(2) and (3).

12.94 To the extent to which an entity is assessed for the part of a consolidation transitional year when it was not a subsidiary member of a consolidated group, the entity may be liable to the GIC in respect of its estimate of its benchmark tax.

12.95 Several modifications to existing section 45-232 will operate in working out whether an entity is liable to pay the GIC and the amount on which it will be imposed. [Schedule 4, item 10, subsection 45-232(7)]

12.96 The first modification applies where a provision of section 45-232 refers to an entitys benchmark tax. Instead of using the entitys actual benchmark tax in applying such a provision, the amount used will be the amount worked out by converting the entitys actual benchmark tax to an annual figure. This modification applies to determine whether an entity is liable to pay the variation penalty. It is necessary because the existing law assumes that the entitys assessment relates to a full years tax liability and when an entity varies for a consolidation transitional year it must still estimate its benchmark tax as if it were not a member of a consolidated group. This is so even though its actual tax liability will only relate to the period when the entity is not a member of a consolidated group. [Schedule 4, item 10, subsection 45-232(8)]

12.97 The second modification applies where a provision refers to the acceptable amount of an instalment for a particular quarter for the entity and is relevant to determining the amount of the variation penalty. In these cases, the amount used is so much of the acceptable amount worked out under the existing law as is reasonably attributable to the part of that quarter or earlier quarters when the entity was not a subsidiary member of the consolidated group. [Schedule 4, item 10, subsection 45-232(9)]

12.98 The third modification applies where a provision refers to the actual amount of an instalment for a particular quarter for the entity and is also relevant to determining the amount of the variation penalty. In these cases, the amount used is so much of the actual amount worked out under the existing law as is reasonably attributable to the part of that quarter or earlier quarters when the entity was not a subsidiary member of the consolidated group. [Schedule 4, item 10, subsection 45-232(10)]

12.99 The second and third modifications discussed in paragraphs 12.97 and 12.98 are necessary to ensure that the amount of the penalty is appropriate to the period when the entity was not a member of the consolidated group. Otherwise the amount would be too high.

Application and transitional provisions

12.100 No special application provisions have been prepared for the consequential amendments to the PAYG instalments regime. As with other provisions of this bill, the rules dealing with PAYG instalments will apply from 1 July 2002.

12.101 The way the members of a particular consolidated group will move from paying separate instalments to a single instalment for the group payable by the head company has been described in paragraphs 12.62 to 12.99. It should be noted that the provisions discussed in those paragraphs will apply whenever a new consolidated group is formed.

Consequential amendments

12.102 The amendments described in this chapter are the main consequential changes that need to be made to the PAYG instalments regime so that it can operate consistently with the single entity rule of the consolidations regime and with the object of the PAYG instalments regime. However, there are other consequential amendments to be made to the TAA 1953 and the dictionary to the ITAA 1997. They are discussed in Tables 12.1 and 12.2 respectively.

Table 12.1: Consequential amendments to the TAA 1953
Schedule 4, item no. Provision amended Explanation
2 8AAB(5) Subsection 8AAB(5) contains an index of provisions of Acts other than the ITAA 1936 that impose a liability to the GIC. Items 17E to 17H of the table to that subsection list provisions of the PAYG instalments regime that impose GIC.

The table will be amended to insert references to sections 45-870 and 45-875 which will impose GIC in relation to a consolidation transitional year for a head company of a consolidated group. [Schedule 4, item 2]

3 Note 1 to 45-15 Note 1 to section 45-15 states that an instalment rate that the Commissioner gives an entity under subsection 45-15(1) is worked out under section 45-320.

This note will be amended to reflect the fact that the Commissioner will have a power to work out an instalment rate for the head company of a consolidated group in a different way under section 45-775 when the composition of a group changes. [Schedule 4, item 3]

5, 6 45-61(2) Section 45-61 sets out the due date for the payment of quarterly instalments.

A new note will be inserted to refer to section 45-715 which states when a head company of a consolidated group must pay its quarterly instalments. The existing note will be numbered as note 1. [Schedule 4, items 5 and 6]

7 45-120(1) Subsection 45-120(1) defines instalment income.

A new note will be added explaining that the definition of instalment income will be affected by sections 45-855 and 45-860 for a member of a consolidated group in the transitional period after the formation of the group but before the head company of the group is given its initial head company instalment rate. [Schedule 4, item 7]

8 45-140(1) Subsection 45-140(1) states who may pay annual instalments.

A new note will be added to explain that a head company of a consolidated group cannot be an annual payer because of section 45-720. [Schedule 4, item 8]

11 45-320(1) Subsection 45-320(1) states how the Commissioner must work out an instalment rate for an entity.

This subsection will be amended to reflect the fact that the Commissioner will have a power to work out an instalment rate for the head company of a consolidated group in a different way under section 45-775 when the composition of a group changes. [Schedule 4, item 11]

12 45-330(2A) Section 45-330 states how an entitys adjusted taxable income is worked out. An entitys notional tax is worked out from its adjusted taxable income and an entitys notional tax is used to work out its instalment rate.

The adjusted taxable income of an entity is generally worked out by subtracting from its assessable income for its base year (which is, in general terms, the most recent income year that has been assessed):

·
any net capital gain included in assessable income;
·
all deductions other than tax losses; and
·
any tax losses carried forward to the next income year.

This calculation will be modified for an entity that is, or has been, a head company of a consolidated group. This is because, under the primary consolidations rules, there is a limit on the amount of tax losses a head company can deduct, at least insofar as those tax losses are losses transferred to the head company under Subdivision 707-A of the ITAA 1997.

To ensure that the adjusted taxable income is correctly calculated, the calculation will take account of the lesser of any tax loss deducted in the base year and the amount of any tax loss that is carried forward to the next year. [Schedule 4, item 12]

This rule will effectively operate when the tax loss to be carried forward to the next income year exceeds the amount of tax losses that can reasonably be expected to be deducted in that year. That would occur when rules of the consolidations regime limit the amount of losses that an entity can deduct. For example, the available fraction, limits the amount of losses transferred under Subdivision 707-A that an entity can deduct.

13 45-405(1) Subsection 45-405(1) states how the Commissioner must work out the GDP-adjusted notional tax amount for an entity.

This subsection will be amended to reflect the fact that the Commissioner will have the power to work out a GDP-adjusted notional tax amount for the head company of a consolidated group in a different way under proposed section 45-775 when the composition of a group changes. [Schedule 4, item 13]

Table 12.2: Consequential amendments to the ITAA 1997
Schedule 5, item no. Provision amended Explanation
8 995-1(1) A new defined term, consolidation transitional year, will be inserted into the dictionary for the ITAA 1997 as the dictionary also applies for the purposes of Schedule 1 to the TAA 1953. The consolidation transitional year for a member of a consolidated group is an income year of that member that satisfies both of the following:

·
the consolidation of the group has effect for all or part of that income year; and
·
either:

-
the year is the income year during which the head company of the consolidated group is given its initial head company instalment rate; or
-
the year is the income year that ends before the year in which the head company is given its initial head company instalment rate.

[Schedule 5, item 8]

12 995-1(1) A new defined term, initial head company instalment rate,will be inserted into the dictionary for the ITAA 1997 as the dictionary also applies for the purposes of Schedule 1 to the TAA 1953. The initial head company instalment rate of a head company of a consolidated group means the instalment rate given to the head company of that group by the Commissioner that is the first rate worked out from the head companys first assessment as the head company of that group. [Schedule 5, item 12]

Chapter 13 Removal of grouping provisions

Outline of chapter

13.1 This chapter discusses the amendments to the existing grouping provisions of the ITAA 1997 and the ITAA 1936 applicable to wholly-owned groups. The modification or removal of these grouping provisions is consequent upon the introduction of a consolidation regime for wholly-owned groups.

Context of reform

13.2 As part of the introduction of the consolidation regime, A Tax System Redesigned recommended that all existing grouping provisions of the ITAA 1936 and the ITAA 1997 be repealed. The current provisions in effect treat - for some limited purposes - wholly-owned groups as if they were consolidated by allowing tax concessions within wholly-owned groups. The intention of the measures contained in this bill is to allow wholly-owned groups to elect to be taxed in one of 2 ways - as a single consolidated taxpaying entity or on an individual entity basis for each member of the group. The existing hybrid and less than comprehensive arrangements as represented by the grouping provisions will be replaced by the consolidation regime. Groups who choose not to consolidate will be governed by loss integrity and anti-value shifting measures in relation to intra-group transactions.

13.3 In accordance with this policy intent, the removal of the various grouping provisions was to correspond with the general introduction of the consolidation regime. In order to accommodate the position of some small and medium sized businesses, the removal of these grouping rules will be delayed for 12 months to ensure that these groups will not be disadvantaged while they are preparing to make the election to enter consolidation. Groups who are nevertheless ready to consolidate from 1 July 2002 may do so.

13.4 Further, the fixed termination date for grouping will be modified in the case of some groups with SAPs to avoid imposing significant additional compliance costs on those SAP groups.

Summary of new law

13.5 Broadly, the existing grouping provisions will be phased out commensurate with the transition to a consolidation regime. In the case of loss transfers and capital gains tax rollover relief concessions applicable to wholly-owned groups, concessions will be limited to certain loss transfers or CGT events. Accordingly in those cases, the existing provisions will be replaced by new rules.

13.6 The termination date for the current grouping provisions for consolidated groups will depend on whether:

·
a choice is made to consolidate in the first year of consolidation (i.e. that commencing on 1 July 2002), or in the second year (generally, that commencing on 1 July 2003);
·
the head company of a consolidated group chooses to consolidate on the first day of its income year commencing on or after 1 July 2003; and whether
·
a group chooses to consolidate at all.

13.7 The measures contained in this bill deal with the removal and phasing out of:

·
the loss transfer provisions currently applying to wholly-owned groups (although loss transfers will be retained for Australian branches of foreign banks in some cases); and
·
CGT asset rollovers for wholly-owned groups.

13.8 Subsequent legislation on grouping will deal with:

·
the intercorporate dividend rebate under sections 46 and 46A of the ITAA 1936;
·
transfers of excess foreign tax credits within wholly-owned groups;
·
grouping rules contained in the Thin Capitalisation legislation that applies to a taxpayers first income year commencing on or after 1 July 2001; and
·
the rate of loss utilisation permitted in the retained loss transfers for Australian branches of foreign banks.

Comparison of key features of new law and current law
New law Current law
Consolidated groups need not transfer losses within the group as losses are automatically pooled. Company groups that do not choose to consolidate may not transfer losses within the group. Wholly-owned company groups are able to transfer losses within the group.
Loss transfers will continue to apply in certain cases to transfers involving Australian branches of foreign banks. Loss transfer provisions for wholly-owned company groups also apply to Australian branches of foreign banks that are part of a wholly-owned company group.
CGT rollover relief will be unnecessary within a consolidated group as there will not be income tax consequences from asset movements within the group. CGT rollover relief for asset transfers within a wholly-owned group will therefore cease. Wholly-owned groups are entitled to CGT rollover relief for asset transfers within the same wholly-owned group.

Detailed explanation of new law

General

13.9 The consolidation provisions will come into effect on 1 July 2002. The current grouping provisions will, in general, continue to apply until 1 July 2003 in conjunction with the new consolidation regime for a period of 12 months. Nevertheless, the grouping provisions will cease if the date of consolidation occurs before 1 July 2003. Special provisions relating to SAP groups that consolidate are discussed in paragraph 13.12.

Grouping provisions as referred to in this discussion are:

·
loss transfer provisions in Divisions 170-A to 170-C of the ITAA 1997; and
·
CGT rollover for asset transfers between companies in the same wholly-owned group in Division 126-B of the ITAA 1997.

Extension of grouping in parallel with consolidation

13.10 Although the grouping provisions will continue to operate until 1 July 2003 where a wholly-owned group does not make a choice to consolidate in that period, a choice to consolidate in the first year has the effect that grouping benefits cease for the entity concerned in that first year. Accordingly, the parallel period allows groups to consider whether they will consolidate but without being penalised by losing concessions. If however, a group decides to consolidate in the first year, access to grouping ceases in that first year.

13.11 In particular, where a choice to consolidate is made in the first year of consolidation and which occurs during the parallel period up until 1 July 2003, grouping concessions will cease for all members of the group as of the date of consolidation.

Example 13.1 The head company of Group A is an ordinary balancer and chooses to consolidate on 1 September 2002. Grouping entitlements cease on the date of consolidation for all members of that group.

Example 13.2 The head company of Group B has a SAP of 1 April 2002 to 31 March 2003. The group consolidates on 1 December 2002. Grouping entitlements cease on the date of consolidation for all members of that group as this date falls before 1 July 2003.

Extension of grouping for SAPs

13.12 Wholly-owned SAP groups that wish to consolidate in the year after the parallel period may be faced with high additional compliance costs by the fixed start date of 1 July 2003 in comparison with ordinary balancing groups. To reduce these potential compliance costs, which would otherwise be incurred because of the truncation of a SAP, certain SAP taxpayers will be permitted to use the existing grouping provisions (in their current form) beyond 1 July 2003 (depending on whether a choice is made in the first year of consolidation). This extended access will be permitted where certain conditions are complied with in relation to each particular provision.

13.13 These conditions are designed to ensure that groups have extended, but not unlimited access to the existing grouping benefits. In particular, those companies which have already been a member of a consolidated group will cease to have access to grouping provisions after an initial entry into the consolidation regime.

13.14 The general and specific conditions in each provision apply both to consolidated groups and MEC groups. Except where otherwise stated, a reference to a consolidated group should also be taken to refer to a MEC group.

13.15 Extended access to the concessions allowed under these grouping provisions until the date of consolidation applies to any company within a consolidated or MEC group.

Example 13.3 Head Co has a SAP of 1 April to 31 March. It avails itself of the parallel grouping period and chooses to consolidate on 1 July 2003. Grouping ceases for all members of this group on 1 July 2003.

Example 13.4 Head Co has a SAP of 1 April to 31 March. It consolidates on 1 September 2003. Grouping also ceases for all members of this group on 1 July 2003.

Example 13.5 Head Co, with the same SAP as Examples 13.3 and 13.4, consolidates on 1 April 2004. Grouping ceases for all members of the group on 31 March 2004, as Head Co has complied with the conditions for extension of grouping beyond 1 July 2003 and has consolidated on the first day of its next income year commencing after 30 June 2003.

13.16 Tables 13.1 and 13.2 summarise termination dates for the current grouping provisions.

Table 13.1: Ordinary balancing head company
Consolidation date of head company 1 July 2002 Any date after 1 July 2002 but before 1 July 2003 1 July 2003 Any date after 1 July 2003 Does not consolidate
Grouping no longer applies as of (all members) Date of consolidation Date of consolidation Date of consolidation 1 July 2003 1 July 2003
Table 13.2: SAP head company
Consolidation date of head company Any date from 1 July 2002 to 30 June 2003 First day of SAP income year commencing after 30 June 2003 Any other date before or after first day of SAP income year commencing after 30 June 2003 Group does not consolidate
Grouping no longer applies as of (all members) Date of consolidation Date of consolidation 1 July 2003 1 July 2003

Specific provisions

Loss transfers

Retention of loss transfers for foreign banks

13.17 Broadly, company groups that do not choose to consolidate may not transfer losses.

13.18 However, as an exception, loss transfers will be retained for transfers involving an Australian branch of a foreign bank (as defined under Part IIIB of the ITAA 1936) where the resident wholly-owned subsidiaries of the foreign bank form a consolidated group or a MEC group (should they be eligible to do so). [Schedule 3, item 27, subsection 170-5(2A), item 28, subsection 170-30(3), item 31, subsection 170-105(2A) and item 32, subsection 170-130(3)]

13.19 Where the foreign banks resident 100% subsidiaries are not eligible to be members of a consolidated group, Division 170 will continue to operate as it does now in respect of loss transfers between an Australian branch of the foreign bank and the subsidiaries. [Schedule 3, item 28, subsection 170-30(4), item 3 in the table, item 32, subsection 170-130(4), item 3 in the table]

13.20 Division 170 will generally also operate as it does now for losses made after consolidation by an Australian branch of a foreign bank or by a head company of a consolidated group or a MEC group where the branch and the head company are members of the same wholly-owned group. [Schedule 3, item 28, subsection 170-30(4) items 1 and 2 in the table, item 32, subsection 170-130(4), items 1 and 2 in the table]

13.21 Modifications to Division 170 will be required for the transfer of losses made by a foreign bank branch after the formation of a MEC group if an additional tier-1 company joins the MEC group after the loss is made but before it is transferred. Modifications will also be required to impose limits on the transfer of certain pre-consolidation losses between the Australian branch of the foreign bank and the head company of a consolidated group or a MEC group. These modifications are necessary in order to ensure that the ability for foreign banks to transfer losses is not extended beyond what is available under the current law. These modifications are to be included in a later bill.

Extended access to existing loss transfer rules

13.22 Generally, the loss transfer provisions in their current form will cease to apply according to the guidelines discussed in paragraphs 13.10 to 13.15. The loss transfer provisions are:

·
Subdivision 170-A of the ITAA 1997 (transfer of tax losses within a wholly-owned group);
·
Subdivision 170-B (transfer of net capital losses within a wholly-owned group); and
·
Subdivision 170-C (provisions which apply to transfers under Subdivisions 170-A and 170-B).

13.23 Nevertheless, members of wholly-owned SAP groups will retain access to the loss transfer provisions in their current form - up to the date of consolidation and after the parallel period - if the following basic conditions are satisfied:

·
the company must become a member of a consolidated group on the day that the group comes into existence;
·
the head company of the group must make an election to consolidate on the first day of its next income year commencing after 30 June 2003;
·
the date of consolidation must be before 1 July 2004; and
·
the company must not have been a member of a consolidated group before the date of consolidation.

[Schedule 3, items 37 and 38]

13.24 In general, apportionment of a loss or of an income year based on 1 July 2003 will occur in some scenarios (such as those where a group does not consolidate, or where a group does not consolidate on the first day of its income year). Essentially, the loss itself or the income year for which it is sought to be transferred will be apportioned. This will occur on the basis of:

·
the portion of the loss year which occurs before the consolidation date; and
·
the portion of the income companys income year which occurs before the consolidation date.

[Schedule 3, item 39]

Example 13.6 The head company of Group A is an ordinary balancer and chooses to consolidate on 1 September 2002. The apportioning date for this group is 1 September 2002.

Example 13.7 The head company of Group B has a SAP of 1 April 2002 to 31 March 2003. The group consolidates on 1 December 2002. The apportioning date for this group is 1 December 2002.

Example 13.8 Head Co has a SAP of 1 April to 31 March. It avails itself of the parallel grouping period and chooses to consolidate on 1 July 2003. The apportioning date for this group is 1 July 2003.

CGT asset rollover

Retention of CGT rollover for certain asset transfers

13.25 Broadly, CGT rollover relief for asset transfers within wholly-owned groups will cease with the introduction of consolidation. Nevertheless, as recommended in A Tax System Redesigned, CGT asset rollover relief will be retained for wholly-owned groups where assets are transferred between:

·
non-resident companies; or
·
a non-resident company and the head company of a consolidated group.

[Schedule 3, item 21, subsection 126-50(5), items 1 and 2 in the table, item 22, subsection 126-50(6)]

13.26 Rollover relief will also be retained where an asset is transferred between a non-resident and a resident company that is not a member of a consolidatable group. [Schedule 3, item 21, subsection 126-50(5) and item 22, subsection 126-50(6)]

13.27 Additional restrictions apply to the circumstances in which rollover relief will be available. If the originating company in the transaction is a foreign resident, and the asset has already been rolled over to that foreign resident by an Australian resident under a previous application of new Subdivision 126-B, subsequent rollover under new Subdivision 126-B is not permitted. This restriction is necessary to prevent the removal of CGT rollover relief in relation to resident companies from being undermined. If however, the asset is merely re-transferred by the foreign resident back to the Australian resident company, rollover relief will be available for the subsequent re-transfer of the asset to the Australian resident. [Schedule 3, item 22, subsections 126-50(7) and (8)]

13.28 Rollover relief is however allowed where an asset is transferred from the head company of a MEC group to its foreign resident parent, then transferred subsequently back to the head company of the same MEC group, but not to the same head company. Where there has been a change in the head company of the MEC group since the time of the first transfer to the foreign resident parent, rollover relief will therefore be permitted under the new provisions. [Schedule 3, item 22, subsection 126-50(9)]

J1 events and the break-up of a consolidated group

13.29 A consequential amendment has been made to the circumstances in which a J1 event occurs under section 104-175 of the ITAA 1997. If the recipient company following a rollover under new Subdivision 126-B ceases to be a subsidiary member of a consolidated group at the break-up time, CGT event J1 does not occur. This is because the cost base provided to the group for its membership interests in the leaving entity under Division 711 of new Part 3-90 is the same as would have been provided if the group had disposed of the assets of the leaving entity directly. [Schedule 3, item 18, section 104-182 and item 19]

Extended access to existing CGT rollover

13.30 CGT asset rollover relief currently available under Subdivision 126-B of the ITAA 1997 will cease to apply to transfers of assets between resident companies in a wholly-owned group according to the guidelines discussed in paragraphs 13.10 to 13.15. [Schedule 3, item 23]

13.31 Nevertheless, members of wholly-owned SAP groups will retain access to the CGT rollover relief provisions in their current form - up to the date of consolidation and after the parallel period - if the following basic conditions are satisfied:

·
the originating company involved in the CGT trigger event must become a member of a consolidated group on the day that the group comes into existence;
·
the head company of the group must make a choice to consolidate on the first day of its next income year commencing after 30 June 2003;
·
the date of consolidation must be before 1 July 2004; and
·
the company seeking entitlement to the grouping concession must not have been a member of a consolidated group before the date of consolidation.

[Schedule 3, item 23]

Example 13.9 Head Co has a SAP of 1 April to 31 March. It consolidates on 1 September 2003. Rollover relief is not available to the members of this group in relation to a CGT trigger event occurring after 30 June 2003.

Example 13.10 Head Co, with the same SAP as Example 13.9, consolidates on 1 April 2004. Rollover relief ceases to apply to members of this group in relation to a CGT trigger event after 31 March 2004, as the Head Co has complied with the conditions for extension of grouping beyond 1 July 2003 and has consolidated on the first day of its next income year commencing after 30 June 2003.

Application and transitional provisions

13.32 In general, these amendments remove the grouping provisions in the existing law for wholly-owned groups from any date of consolidation before 1 July 2003. For certain wholly-owned groups with SAPs which consolidate after 1 July 2003, the grouping provisions in the existing law will instead cease to apply from the start of a groups first SAP income year commencing after 1 July 2003. For SAP groups that do not consolidate, or consolidate on any other date, grouping provisions will cease on 1 July 2003.

Consequential amendments

13.33 Amendments consequential to the removal or modification of the various grouping provisions will be included in later legislation.

Chapter 14 - Regulation impact statement

Policy objective

Background

14.1 The consolidation measure in this bill, which deals with the consolidated income tax treatment of wholly-owned groups as single entities, is part of the Governments broad ranging reforms which will give Australia a New Business Tax System. The reforms are based on the recommendations of the Review of Business Taxation, instituted by the Government to consider reform of Australias business tax system.

14.2 Currently, the income tax system treats each company in a wholly-owned group as a separate entity (subject to certain grouping provisions). Taxing member entities separately means that each entity must separately account for all intra-group transactions as well as debt and equity interests. For business, this imposes extra compliance costs and sometimes stands in the way of the most efficient business structures. From the communitys perspective, the existing grouping provisions for wholly-owned groups provide opportunities for tax avoidance through artificial arrangements.

14.3 This bill is part of the legislative program implementing the New Business Tax System. Other bills have been introduced and passed already.

14.4 Broadly, the New Business Tax System will enhance Australias competitiveness through lower company and capital gains tax rates, and reduced compliance costs.

14.5 Consolidation is expected to address both efficiency and integrity problems existing in the taxation of wholly-owned entity groups, many of which arise from this inconsistent treatment. These include:

·
compliance and general tax costs;
·
double taxation where gains are taxed when realised and then taxed again on the disposal of equity;
·
tax avoidance through intra-group dealings;
·
loss cascading by the creation of multiple tax losses from the one economic loss; and
·
value shifting to create artificial losses where there is no actual economic loss.

The objectives of measures in this bill

14.6 The object of consolidation is to improve efficiency and reduce compliance costs by providing a business environment in which some highly complex business structures are no longer seen as necessary.

14.7 The consolidation regime is expected to:

·
assist in the simplification of the tax system;
·
reduce both compliance costs and ATO administration costs associated with the existing tax treatment of company groups;
·
improve the efficiency of business restructuring; and
·
strengthen the integrity of the income tax system.

Implementation options

14.8 These problems will be addressed by ceasing to recognise multiple layers of ownership within a wholly-owned group and by treating the group as a single entity for income tax purposes.

14.9 It is intended that the benefits to be achieved by consolidation as described above should therefore encourage wholly-owned groups to adopt the new regime. Wholly-owned groups that choose to remain outside consolidation will lose entitlement to the existing grouping rules which currently provide some of the benefits intended to be replaced by consolidation.

14.10 The major measures in this bill arise directly from recommendations of the Review of Business Taxation. Those recommendations were the subject of extensive consultation. The implementation options for these measures can be found in A Platform for Consultation and A Tax System Redesigned. Table 14.1 shows where the measures (or the principles underlying them) are discussed in those publications.

Table 14.1: Options for implementing measures in this bill arising directly from the recommendations
Measure A Platform for Consultation A Tax System Redesigned
Consolidation Chapters 25 to 27, pp. 529-590. Recommendations 15.1 to 15.5, pp. 517-529.

14.11 These implementation options discussed in A Platform for Consultation and A Tax System Redesigned have only been subsequently modified where required to reflect changed circumstances. Table 14.2 lists variations from the recommendations of the original review. Most of these variations were exposed in the December 2000 and February 2002 exposure drafts.

Table 14.2: Other options following from the original recommendations
Approach reflected in this bill Reason for the approach
Discretionary trusts and hybrid trusts are allowed to be members of a consolidated group if they are effectively wholly-owned by the head company. This new test avoids introducing unnecessary complexity into the regime.
The rate at which transferred losses can be used by a group is restricted to approximate the rate at which the losses would have been used had the entity transferring the losses not joined the group. The new method by which this is achieved departs from Recommendation 15.3 of A Tax System Redesigned. This new method was developed in consultation with interested taxpayers and their advisers after earlier consultations concluded that the method contained in Recommendation 15.3 of A Tax System Redesigned would be inequitable in certain circumstances.
A concessional method for the use of transferred losses has been developed to apply to certain losses transferred to a group that consolidates during the transitional period. This change was necessary in recognition of the departure from Recommendation 15.3 of A Tax System Redesigned.
Group income tax liability is to be borne initially by the head company. Where the head company fails to satisfy the liability on time, The Commissioner can recover the liability directly from the subsidiary members of the group as allocated under a tax sharing agreement. This is a departure from Recommendation 15.1 of A Tax System Redesigned. The ability of the Commissioner to recover an unpaid amount in accordance with an allocation under a tax sharing agreement was developed in response to concerns raised by interested taxpayers and their advisers regarding the significant impact an imposition of joint and several liability would have on typical commercial practices.

Assessment of impacts

14.12 The potential compliance, administrative and economic impacts of the measure in this bill has been carefully considered, both by the Review of Business Taxation and by the business sector. The Review of Business Taxation focused on the economy as a whole in assessing the impacts of its recommendations and concluded that there would be net gains to business, government and the community generally from business tax reform.

Impact group identification

14.13 The measure in this bill specifically impacts on those taxpayers identified in Table 14.3.

Table 14.3: Taxpayers affected by the measures in this bill
Measure Affected taxpayers
Consolidated groups to be taxed as a single entity. Estimates based on ASIC and ATO data indicated that there may be between 11,300 and 33,472 head companies and up to 101,870 subsidiaries eligible to be members of consolidated groups. These figures do not include trusts which can also be subsidiary members. Businesses in all sectors of the economy will be affected but the greatest impact is expected to be on large corporate groups.
Repeal of grouping provisions. Companies in wholly-owned groups that choose not to be taxed as a consolidated group.

Analysis of costs / benefits

Compliance costs

14.14 As is standard with new measures, groups affected will need to incur up-front costs in determining whether entry into the consolidation regime is in their best interest and, if so, either familiarising themselves with the new law or having advisers familiarise themselves with the new law. Costs will also be incurred in updating reporting software and intra-group accounting systems as well as in notifying the ATO of the decision to consolidate.

14.15 Due to the magnitude of the consolidation measure, for large corporate groups, especially head companies, the start-up costs may be significant. For example, upon consolidation the market values of all assets held by group members needs to be determined, resulting in some new cost bases assigned (to each asset). However, these costs are alleviated by a transitional measure under which the group can elect, prior to 1 July 2003, to bring assets into the group at their existing cost bases.

14.16 However, overall the measure in this bill is expected to result in significantly reduced ongoing compliance costs for wholly-owned groups because the consolidation regime will improve the equity and integrity of the current business tax system.

14.17 Currently, each legal entity in a wholly-owned group is treated as a separate entity for tax purposes. However, AASB Accounting Standard 1024 requires financial reporting on an economic entity where a parent entity controls a subsidiary. By treating a wholly-owned group of entities as a single taxpayer, the taxation treatment of such groups is more consistent with their accounting treatment, resulting in cost savings. For example, transactions such as the sale of stock and payments of interest between group members are at present recognised for taxation purposes. Under the consolidation measure, these intra-group transactions will be ignored for taxation purposes, thereby more closely aligning the taxation and accounting treatment of entities.

14.18 As each legal entity in the group is currently treated as a separate entity for tax purposes, each must lodge a separate tax return resulting in an assessment, prepare a BAS for income tax, pay a separate PAYG instalment and separately comply with other administrative requirements. In a consolidated group only the head entity is recognised for income tax purposes, and is the only entity which must comply with the above requirements. This will result in compliance cost savings, especially for groups comprising numerous entities. There will also be cash flow benefits accruing to the group as a result of the aggregation of PAYG obligations.

14.19 Within a consolidated group, tax attributes such as losses, franking credits and foreign tax credits will be pooled by the head entity. The need for the head company to operate a single record for each attribute, rather than separate records for each attribute of each entity, will result in compliance cost savings for groups that choose to consolidate.

14.20 Company groups must currently deal with a large amount of complex legislation aimed at preventing loss duplication, value shifting, the avoidance or deferral of capital gains and other practices involving transactions within groups. The consolidation measure will result in significant compliance cost savings because existing integrity measures will not apply to intra-group transactions, which are ignored within a consolidated group.

14.21 Further, the consolidation measure will improve the integrity of the taxation system by removing the potential for taxpayers to receive unwarranted benefits in the form of duplicated losses. The tax system will also become more equitable as the consolidation regime will prevent gains being subject to double taxation - where the gain is taxed when realised and then taxed again on the disposal of the equity. To an extent, the consolidation measure will affect the amount of tax paid by entities that choose to consolidate as opposed to those that do not.

Administration costs

14.22 Although there will be initial administrative costs associated with the introduction of the consolidation measure, it is expected to produce administrative savings on an ongoing basis. For example, the ATO will expend less because it will be dealing with far fewer income tax entities than was previously the case.

Government revenue

14.23 The consolidation measure is expected to cost approximately $1 billion over the forward estimate period. This cost largely relates to the transitional concessions that will allow groups to use their losses faster than is allowed under the current law.

Strengthen integrity of the tax system

14.24 The consolidation measure will address integrity problems in the current taxation of wholly-owned groups, including:

·
double taxation;
·
loss cascading;
·
value shifting; and
·
tax avoidance through intra-group dealings.

Economic benefits

14.25 The consolidation measure, as part of the New Business Tax System, will provide Australia with an internationally competitive business tax system that will create an environment for achieving higher economic growth, more jobs and improved savings. Further economic benefits of this measure is explained in more detail in the publications of the Review of Business Taxation, particularly A Platform for Consultation and A Tax System Redesigned.

14.26 The consolidation measure in particular will provide economic benefits in the form of a simplified income tax system and a significant reduction in compliance and administrative costs associated with the current tax treatment of corporate groups. The consolidation regime will also have a positive effect on the Australian economy because it will improve the integrity, equity and efficiency of the Australian income tax system.

Other issues - consultation

14.27 The consultation process began with the release of the Governments Tax Reform Document: Tax Reform: not a new tax, a new tax system in August 1998. The Government established the Review of Business Taxation in that month. Since then, the Review of Business Taxation has published 4 documents about business tax reform, a subject of which was consolidation. In particular, A Platform for Consultation and A Tax System Redesigned canvassed options, discussed issues and sought public input.

14.28 In December 2000 an exposure draft was released which contained the general principles of consolidation. In February 2002 a further streamlined exposure draft was released taking into account submissions on the earlier exposure draft. The accompanying explanatory material to the February 2002 exposure draft provided a comprehensive overview of the regime as a whole. It discussed proposed legislative amendments not included in the exposure draft at that time.

14.29 The Government has consulted extensively in implementing this measure. Significant contribution was made to the regimes development via submissions and workshops and by ongoing consultative groups. For example, the consolidation measure has been the subject of ongoing discussion with a focus group comprised of large corporate group representatives and tax advisers. The measure has also been presented to the Commissioners Small Business Advisory Group.

14.30 The number of submissions received in response to the exposure drafts was 36 for the December 2000 exposure draft and 34 for the February 2002 exposure draft. Issues raised have been published on the ATOs Tax Reform website and are updated as developments occur. Whilst the majority of submission comments have been adopted, a small minority could not be accommodated. This was either because the submission did not accord with the underlying policy intent of the consolidation regime or was not a practically viable option for the regime.

14.31 For example, the suggestion that 5%, rather than 1%, of all membership interests be allowed to be held by employees ran contrary to the principle that the consolidation regime would only apply to entities that are substantively wholly-owned by the head company of the consolidated group. Another example is the suggestion that a wholly-owned group of entities be able to enter and exit the consolidation regime on an annual basis. Such a proposal would negate the intended ongoing compliance cost savings of the regime, and would be extremely difficult for the ATO to administer.

Conclusion and recommended option

14.32 The measure contained in this bill is expected to support a more efficient, innovative and internationally competitive Australian business sector, to reduce compliance costs and to establish a simpler and more structurally sound business tax system.

Index

Schedule 1: Main consolidation provisions

Bill reference Paragraph number
Item 2, section 701-1 2.12, 2.23
Item 2, subsection 701-1(2) 2.13
Item 2, subsection 701-1(3) 2.13
Item 2, section 701-5 2.31
Item 2, section 701-5 6.111
Item 2, definition of 'sort of a loss' in subsection 701-5(4) 6.16, 6.102
Item 2, section 701-10 2.49
Item 2, section 701-10(5) 2.50
Item 2, subsection 701-10(6) 2.51
Item 2, subsection 701-10(7) 2.52
Item 2, section 701-15 2.62, 5.115
Item 2, section 701-20 and item 3 in the table in section 701-60 2.64
Item 2, section 701-25 2.66
Item 2, section 701-30 2.83
Item 2, subsection 701-30(3) 2.86
Item 2, subsections 701-30(3) and (4) 2.84
Item 2, subsections 701-30(3), (5) and (6) 2.85
Item 2, subsection 701-30(7) 2.86
Item 2, section 701-35 2.60, 6.26, Example 6.7
Item 2, subsection 701-35(4) 2.59
Item 2, section 701-40 2.38
Item 2, subsection 701-40(1) 2.39
Item 2, subsection 701-40(2) 2.40
Item 2, subsection 701-40(3) 2.44
Item 2, section 701-45 2.67
Item 2, section 701-50 2.63
Item 2, section 701-55 Table 2.1
Item 2, subsection 701-55(2) 2.53
Item 2, subsection 701-55(3) 2.54
Item 2, subsection 701-55(4) 2.55
Item 2, subsection 701-55(5) 2.56
Item 2, subsection 701-55(6) 2.57
Item 2, section 701-60, item 3 in the table 2.64, 2.67
Item 2, section 701-65 2.15
Item 2, section 701-70 2.70
Item 2, section 701-75 2.75
Item 2, section 701-80 2.79
Item 2, section 701-85 2.81
Item 2, section 701-90 6.7
Item 2, paragraph 703-5(1)(a) 3.10
Item 2, paragraph 703-5(1)(b) 3.13
Item 2, subsection 703-5(2) 3.97
Item 2, paragraph 703-5(2)(a) 3.17, 3.18
Item 2, paragraph 703-5(2)(b) 3.19
Item 2, subsection 703-5(3) 3.11, 3.17
Item 2, subsection 703-10(1) 3.22
Item 2, subsection 703-10(2) 3.24
Item 2, subsection 703-15(1) 3.12, 3.15, 3.23
Item 2, subsection 703-15(2) 3.27, 3.48
Item 2, subsection 703-15(2), item 1 in the table 3.25
Item 2, subsection 703-15(2), item 2 in the table 3.47
Item 2, subsection 703-15(2), column 3 of item 2 in the table 3.59, 3.62, Table 3.2
Item 2, subsection 703-20(1) 3.37
Item 2, subsection 703-20(2), item 5 in the table 3.38
Item 2, section 703-25 Table 3.2
Item 2, subsection 703-30(1) 3.64
Item 2, subsection 703-30(2) 3.65
Item 2, subsection 703-35(1) 3.73
Item 2, subsections 703-35(2) and (3) 3.72
Item 2, subsection 703-35(4) 3.74
Item 2, subsection 703-35(5) 3.75
Item 2, subsection 703-35(6) 3.76
Item 2, subsection 703-40(1) 3.79
Item 2, subsection 703-40(2) 3.78
Item 2, subsection 703-45(1) 3.85
Item 2, subsections 703-45(1) and (2) 3.81
Item 2, subsection 703-45(3) 3.87
Item 2, subsection 703-45(4) 3.88
Item 2, subsections 703-50(1) and (4) 3.91
Item 2, subsection 703-50(2) 3.94
Item 2, subsections 703-50(2) and (4) 3.93
Item 2, subsection 703-50(3) 3.92
Item 2, subsections 703-50(5) and (6) 3.95
Item 2, subsection 703-50(7) 3.96
Item 2, subsection 703-55(1) 3.13
Item 2, subsection 703-55(2) 3.14
Item 2, subsection 703-60(1), items 1 and 2 in the table 3.98
Item 2, subsection 703-60(1), item 3 in the table 3.99
Item 2, subsection 703-60(2) 3.100
Item 2, subsection 703-60(3) 3.101
Subdivision 705A 2.49
Item 2, subsection 705-15 5.15
Item 2, subsection 705-25(2) 5.24
Item 2, subsection 705-25(3) 5.25
Item 2, subsection 705-25(4) 5.26
Item 2, subsection 705-25(5) 5.23
Item 2, section 705-30 5.28
Item 2, section 705-35 5.29
Item 2, subsections 705-35(1) and (2) 5.30
Item 2, subsection 705-35(2) 2.52, 5.31
Item 2, subsection 705-35(3) 5.35
Item 2, subsection 705-40(1) 5.39
Item 2, subsection 705-40(2) 5.38
Item 2, subsection 705-40(3) 5.40
Item 2, section 705-45 5.43
Item 2, subsection 705-50(2) 5.48
Item 2, paragraph 705-50(2)(a) 5.47
Item 2, paragraph 705-50(2)(b) 5.47
Item 2, paragraph 705-50(3)(a) 5.47
Item 2, paragraph 705-50(3)(b) 5.47
Item 2, subsection 705-50(4) 5.49
Item 2, subsection 705-50(5) 5.51
Item 2, subsection 705-50(6) 5.44
Item 2, section 705-55 5.53
Item 2, section 705-60 5.55
Item 2, subsection 705-65(1) 5.57
Item 2, subsection 705-65(2) 5.59
Item 2, subsection 705-65(3) 5.60
Item 2, subsection 705-65(4) 5.61
Item 2, subsection 705-65(5) 5.63
Item 2, subsection 705-65(6) 5.64
Item 2, subsection 705-70(1) 5.66
Item 2, subsection 705-70(2) 5.69
Item 2, subsection 705-75(1) 5.70
Item 2, subsection 705-75(2) 5.71
Item 2, subsection 705-75(3) 5.72
Item 2, subsection 705-80(1) 5.73
Item 2, subsection 705-80(2) 5.74
Item 2, subsection 705-85(1) 5.75
Item 2, subsection 705-85(2) 5.76
Item 2, paragraph 705-85(3)(a) 5.78
Item 2, paragraph 705-85(3)(b) 5.79
Item 2, subsection 705-90(1) 5.80
Item 2, subsections 705-90(2) and (3) 5.81
Item 2, subsections 705-90(4) and (5) 5.82
Item 2, subsection 705-90(6) 5.85
Item 2, section 705-95 5.86
Item 2, subsection 705-100(1) 5.88
Item 2, section 705-105 5.103
Item 2, section 705-110 5.93
Item 2, subsection 705-115(1) 5.96
Item 2, paragraph 705-115(2)(a) 5.97
Item 2, section 705-115(2)(b) 5.101
Item 2, paragraph 705-115(2)(c) 5.102
Item 2, subsections 705-120(1) to (3) 5.106
Item 2, subsection 705-120(4) 5.107
Item 2, subsections 705-125(1) and (2) 5.110
Item 2, subsection 705-125(3) 5.112
Item 2, Subdivision 707-A 6.11
Item 2, Subdivision 707-B 8.14
Item 2, subsection 707-105(1) 6.14
Item 2, subsection 707-105(2) 6.15
Item 2, subsection 707-110(1) 6.14
Item 2, definition of 'utilises a loss' in subsection 707-110(2) 6.25
Item 2, subsection 707-115(1) 6.16
Item 2, paragraph 707-115(1)(b) 6.26
Item 2, subsection 707-115(2) 6.24
Item 2, section 707-120 6.27
Item 2, subsection 707-120(1) 6.29
Item 2, subsection 707-120(1) Table 6.2
Item 2, subsection 707-120(1) Table 6.1
Item 2, subsections 707-120(1) and (2) 6.55
Item 2, subsection 707-120(3) 6.57
Item 2, subsection 707-120(4) 6.30
Item 2, subsections 707-125(1) to (3) Table 6.1
Item 2, subsections 707-125(1) and (4) Table 6.2
Item 2, subparagraph 707-125(4)(a)(ii) and subsection 707-125(5) 7.37
Item 2, subsection 707-125(6) 7.38
Item 2, subsections 707-130(1) to (3) 6.88
Item 2, subsection 707-130(4) 6.89
Item 2, subsection 707-135(1) 6.76
Item 2, subsection 707-135(2) 6.78
Item 2, subsection 707-140(1) 6.95, 6.98, 7.40
Item 2, paragraph 707-140(1)(b) 6.111
Item 2, s ubsection 707-140(2) 6.99, 8.14
Item 2, subsection 707-140(3) 6.100
Item 2, section 707-145 6.108, 6.113
Item 2, subsection 707-145(1) 8.71
Item 2, subsections 707-145(2) and (3) 8.73
Item 2, section 707-150 2.86, 6.112, 6.113
Item 2, subsection 707-150(1) 6.108
Item 2, section 707-205 7.9, 7.40
Item 2, section 707-210 7.7
Item 2, subsection 707-210(1) 7.15
Item 2, subsections 707-210(1) and (2) 7.12
Item 2, subsections 707-210(1) and (3) 7.26
Item 2, paragraph 707-210(1)(b) 7.16
Item 2, subsection 707-210(3) 7.29
Item 2, paragraph 707-210(4)(a) 7.19
Item 2, paragraph 707-210(4)(b) 7.20
Item 2, paragraph 707-210(4)(c) 7.21
Item 2, paragraph 707-210(4)(d) 7.25
Item 2, subsection 707-210(5) 7.34
Item 2, subsections 707-210(5) and (6) 7.14
Item 2, subsection 707-210(6) 7.35
Item 2, subsection 707-210(7) 7.30
Item 2, section 707-305 8.3
Item 2, subsection 707-305(2) 8.6
Item 2, section 707-310 8.14, 8.17, 8.22
Item 2, sections 707-310 8.7
Item 2, subsections 707-310(1) and (2) 8.31
Item 2, paragraph 707-310(3)(a) 8.26
Item 2, paragraph 707-310(3)(b) 8.6, 8.14
Item 2, paragraph 707-310(3)(b), column 2 of the table 8.27
Item 2, subsections 707-310(4) and (5) 8.32
Item 2, section 707-315 9.42
Item 2, subsections 707-315(1) and (2) 8.9
Item 2, subsections 707-315(3) and (4) 8.11, 8.64
Item 2, section 707-320 8.7, 8.47
Item 2, subsection 707-320(1) 8.58
Item 2, subsection 707-320(1) 8.49, 8.81
Item 2, subsection 707-320(2) 8.52
Item 2, subsection 707-320(2), item 1 in the table 8.55, 8.58
Item 2, subsections 707-320(2) and (5) 8.70
Item 2, item 2 in the table in subsection 707-320(2) 8.59
Item 2, item 3 in the table in subsection 707-320(2) 8.60
Item 2, item 4 in the table in subsection 707-320(2) 8.61, 8.92
Item 2, item 5 in the table in subsection 707-320(2) 8.63
Item 2, subsection 707-320(3) 8.63, 8.65
Item 2, subsection 707-320(4) 8.66
Item 2, subsection 707-320(6) 8.68
Item 2, section 707-325 9.23
Item 2, subsection 707-325(1) 8.74
Item 2, paragraph 707-325(1)(a) 8.75
Item 2, paragraph 707-325(1)(b) 8.76
Item 2, paragraph 707-325(1)(c) 8.78
Item 2, subparagraphs 707-325(1)(c)(i) and (ii) 8.80
Item 2, paragraph 707-325(1)(d) 8.79
Item 2, paragraphs 707-325(1)(d) and (2)(b) 8.95
Item 2, subsections 707-325(2) and (4) 8.88
Item 2, paragraph 707-325(2)(a) 8.91
Item 2, subsection 707-325(3) 8.89
Item 2, subsection 707-325(5) 8.100
Item 2, subsections 707-330(1) and (2) 8.83
Item 2, subsections 707-330(1) and (3) 8.86
Item 2, subsection 707-330(2) 8.56
Item 2, section 707-335 8.37, 9.41
Item 2, paragraph 707-335(1)(a) 8.39
Item 2, paragraph 707-335(1)(b) 8.43
Item 2, subsection 707-335(2) 8.45
Item 2, subsection 707-335(3) 8.46
Item 2, section 707-340 8.36
Item 2, section 707-345 8.13
Item 2, section 707-400 6.58, 8.14
Item 2, section 707-405 6.26, 6.92
Item 2, section 709-60 10.9
Item 2, subsection 709-60(2) 10.10
Item 2, subsection 709-60(3) 10.12
Item 2, paragraph 709-60(3)(b) 10.11
Item 2, section 709-65 10.13, 10.19
Item 2, sections 709-70 and 709-75 10.16
Item 2, section 709-80 10.21
Item 2, section 709-85 10.22
Item 2, subsection 711-5(1) 5.156
Item 2, paragraph 711-15(1)(b) 5.136
Item 2, paragraph 711-15(1)(c) 5.135, 5.138
Item 2, subsection 711-15(2) 5.137
Item 2, section 711-20 5.118
Item 2, step 6 in the table in subsection 711-20(1) 5.134
Item 2, subsection 711-20(2) 5.140
Item 2, subsection 711-25(1) 5.119
Item 2, subsection 711-25(2) 5.141
Item 2, section 711-30 5.139
Item 2, section 711-35 5.121
Item 2, subsection 711-40(1) 5.122
Item 2, subsection 711-40(2) and (3) 5.123
Item 2, subsection 711-45(1) 5.124
Item 2, subsection 711-45(2) 5.125
Item 2, subsection 711-45(3) 5.126
Item 2, subsection 711-45(4) 5.127
Item 2, subsection 711-45(5) 5.128
Item 2, subsection 711-45(6) 5.129
Item 2 subsection 711-45(7) 5.130
Item 2, section 711-50 5.131
Item 2, subsections 711-50(1) and (2) 5.132
Item 2, subsection 711-50(3) 5.133
Item 2, section 711-55 5.142
Item 2 section 711-60 5.144
Item 2, section 711-65 5.147
Item 2, subsection 711-65(2) 5.151
Item 2, subsection 711-65(4) 5.148
Item 2, subsection 711-65(5) 5.149
Item 2, subsection 711-65(6) 5.152
Item 2, section 711-70 5.153
Item 2, subsection 719-5(1) 4.14
Item 2, subsection 719-5(2) 4.33
Item 2, subsections 719-5(2) to (4) 4.29
Item 2, subsection 719-5(3) 4.35
Item 2, paragraphs 719-5(4)(a) to (c) and subsection 719-5(5) 4.36
Item 2, paragraphs 719-5(4)(c) and (d) 4.40
Item 2, subsection 719-5(5) 4.36
Item 2, paragraphs 719-5(6)(a) to (c) and (e) 4.38
Item 2, paragraphs 719-5(6)(a) to (d) 4.37
Item 2, subsection 719-5(7) 4.72
Item 2, paragraph 719-5(7)(b) 4.81
Item 2, paragraph 719-5(7)(c) 4.83
Item 2, subsection 719-10(1) 4.42
Item 2, subsection 719-10(1), columns 1 and 2 and paragraph (a) in column 3 in the table 4.43
Item 2, subsection 719-10(1), paragraph (b) in column 3 in the table 4.44
Item 2, subsections 719-10(2) and (3) 4.45
Item 2, subsection 719-10(4) 4.50
Item 2, subsection 719-10(5) 4.51
Item 2, subsection 719-10(6) 4.53
Item 2, subsection 719-10(7) 4.74
Item 2, paragraph 719-10(7)(a) 4.75
Item 2, paragraph 719-10(7)(b) 4.76
Item 2, paragraphs 719-10(8)(a) to (c) and (e) 4.80
Item 2, paragraphs 719-10(8)(a) to (d) 4.78
Item 2, subsections 719-15(1) and (2) 4.66
Item 2, paragraph 719-15(3)(a) 4.67
Item 2, paragraph 719-15(3)(b) 4.68
Item 2, paragraph 719-15(3)(c) 4.66
Item 2, subsection 719-15(4) 4.69
Item 2, subsection 719-20(1), column 4 of item 1 in the table 4.59
Item 2, paragraph 719-20(1)(a) and item 1 in the table 4.57
Item 2, paragraph 719-20(1)(b) and item 2 in the table 4.62
Item 2, subsection 719-20(2) 4.64
Item 2, section 719-25 4.30
Item 2, sections 719-30 and 719-35 4.55
Item 2, subsection 719-40(1) 4.17
Item 2, paragraphs 719-40(1)(a) to (c) 4.18
Item 2, paragraph 719-40(1)(d) 4.26
Item 2, paragraphs 719-40(1)(e) and (f) 4.23
Item 2, paragraphs 719-40(1)(e) and 719-40(2)(a) 4.20
Item 2, paragraph 719-40(2)(b) 4.21
Item 2, section 719-45 4.71
Item 2, subsections 719-50(1) and (2) 4.110
Item 2, paragraph 719-50(1)(c) 4.111
Item 2, paragraphs 719-50(3)(a) to (c) and (e) 4.114
Item 2, paragraphs 719-50(3)(a) to (d) 4.113
Item 2, paragraphs 719-50(4)(a) to (c) and (e) 4.118
Item 2, paragraphs 719-50(4)(a) to (d) 4.117
Item 2, subsection 719-55(1) 4.110
Item 2, subsections 719-55(2) and (3) 4.119
Item 2, subsections 719-60(1) and (4) 4.99
Item 2, subsection 719-60(2) 4.100
Item 2, subsection 719-60(3) 4.102, 4.103.
Item 2, subsections 719-60(3) and (4) 4.105
Item 2, subsections 719-60(5) and (6) 4.101
Item 2, subsection 719-65(1) 4.88
Item 2, subsections 719-65(2) and (3) 4.90, 4.92
Item 2, section 719-70 4.94, 4.95
Item 2, subsections 719-75(1) and (2) 4.106
Item 2, subsection 719-75(3) 4.107
Item 2, subsection 719-80(1), column 3 in the table 4.120
Item 2, subsection 719-80(1), item 3 in the table 4.122
Item 2, subsection 719-80(1), items 1 and 2 in the table 4.121
Item 2, paragraphs 719-80(2)(a) and (b) 4.124
Item 2, paragraph 719-80(2)(c) 4.120
Item 2, section 721-5 11.14
Item 2, paragraph 721-10(1)(b) 11.21
Item 2, subsection 721-10(2) 11.17
Item 2, subsection 721-15(1) 11.25
Item 2, paragraph 721-15(1)(b) and subsection 721-15(2) 11.22, 11.24
Item 2, subsection 721-15(3) 11.22, 11.27
Item 2, subsection 721-15(4) 11.33
Item 2, subsection 721-15(5) 11.34
Item 2, subsection 721-15(6) 11.35
Item 2, section 721-20 11.19, 11.23
Item 2, paragraph 721-25(1)(a) 11.28
Item 2, paragraph 721-25(1)(b) 11.28
Item 2, paragraph 721-25(1)(c) 11.28
Item 2, paragraph 721-25(1)(d) 11.28
Item 2, subsection 721-25(2) 11.28
Item 2, subsection 721-25(3) 11.30
Item 2, subsection 721-30(2) 11.27
Item 2, subsection 721-30(3) 11.31
Item 2, subsection 721-30(4) 11.33
Item 2, subsection 721-30(5) 11.34
Item 2, subsection 721-30(6) 11.35
Item 2, paragraph 721-35(a) 11.31
Item 2, paragraph 721-35(b) 11.31
Item 2, paragraph 721-35(c) 11.31

Schedule 2: Transitional provisions relating to main consolidation provisions

Bill reference Paragraph number
Item 2, section 703-30 3.69, 3.104
Item 2, subsection 707-325(1) 9.21
Item 2, paragraphs 707-325(1)(b) and (c) 9.11
Item 2, paragraph 707-325(1)(d) 9.13
Item 2, paragraph 707-325(1)(e) 9.16
Item 2, paragraph 707-325(1)(f) and subsection 707-325(2) 9.14
Item 2, subsections 707-325(3) and (4) 9.20
Item 2, subsection 707-325(5) 9.22
Item 2, subsections 707-325(5) and (6) 9.18
Item 2, subsection 707-325(7) 9.22
Item 2, subsections 707-325(8) and (9) 9.24
Item 2, subsection 707-325(9) 9.25
Item 2, paragraph 707-327(1)(a) 9.30
Item 2, paragraphs 707-327(1)(b) and (c) 9.32
Item 2, paragraph 707-327(1)(d) and subsection 707-327(2) 9.37, 9.38
Item 2, paragraph 707-327(1)(e) and subsections 707-327(2) and (3) 9.34
Item 2, subsection 707-327(3) 9.35
Item 2, subsection 707-327(4) 9.39, 9.41, 9.42
Item 2, subsection 707-327(5) 9.43
Item 2, subsection 707-327(6) 9.33
Item 2, subsections 707-328(1) and (2) 9.47
Item 2, subsection 707-328(3) 9.46
Item 2, subsection 707-328(4) 9.46
Item 2, subsection 707-328(5) 9.46
Item 2, subsection 707-328(6) 9.46, 9.52
Item 2, section 707-329 of the Income Tax (Transitional Provisions) Act 1997 8.91
Item 2, paragraph 707-350(1)(d) 9.68
Item 2, paragraph 707-350(1)(e) and subsection 707-350(5) 9.67
Item 2, paragraphs 707-350(1)(a) to (d) 9.57
Item 2, subsection 707-350(1) 9.56
Item 2, subsection 707-350(2) 9.64
Item 2, subsection 707-350(2) of the Income Tax (Transitional Provisions) Act 1997 8.27
Item 2, subsection 707-350(3), item 1 in the table 9.60
Item 2, subsection 707-350(3), items 2 and 3 in the table 9.61
Item 2, subsection 707-350(3), item 3 in the table 9.62
Item 2, subsection 707-350(4) 9.65
Item 2, subsection 707-350(6) 9.67
Item 2, subsection 707-350(7) 9.68
Item 2, section 707-405 9.54

Schedule 3: Consequential amendments relating to main consolidation provisions

Bill reference Paragraph number
Item 1 2.90
Items 3 to 16 3.26, 3.104
Item 18, section 104-182 13.29
Item 19 13.29
Item 21, subsection 126-50(5), items 1 and 2 in the table 13.25
Item 21, subsection 126-50(5) 13.26
Item 22, subsection 126-50(6) 13.25, 13.26
Item 22, subsections 126-50(7) and (8) 13.27
Item 22, subsection 126-50(9) 13.28
Item 23 13.30, 13.31
Item 27, subsection 170-5(2A) 13.18
Item 28, subsection 170-30(3) 13.18
Item 28, subsection 170-30(4) items 1 and 2 in the table 13.20
Item 28, subsection 170-30(4), item 3 in the table 13.19
Item 31, subsection 170-105(2A) 13.18
Item 32, subsection 170-130(3) 13.18
Item 32, subsection 170-130(4), items 1 and 2 in the table 13.20
Item 32, subsection 170-130(4), item 3 in the table 13.19
Items 37 and 38 13.23
Item 39 13.24
Item 40, section 177EB 10.23
Item 40, subsection 177EB(1) 10.25
Item 40, subsection 177EB(3) and (5) 10.24
Item 40, subsection 177EB(5) 10.27
Item 40, subsection 177EB(9) 10.28
Item 40, subsection 177EB(10) 10.26

Schedule 4: Amendments about Pay as you go instalments

Bill reference Paragraph number
Item 1, Subdivision 45-Q 12.18, 12.19
Item 1, Subdivision 45-R 12.18, 12.20
Item 1, paragraph 45-705(a) 12.21
Item 1, paragraph 45-705(b) 12.23
Item 1, section 45-710 12.25
Item 1, section 45-715 12.35
Item 1, section 45-720 12.34
Item 1, subsection 45-755(1) 12.37
Item 1, subsections 45-755(2) and (3) 12.38
Item 1, subsections 45-755(2) and (4) 12.39
Item 1, subsection 45-760(1) and paragraph 45-760(2)(a) 12.44
Item 1, paragraph 45-760(2)(a) 12.45, 12.46
Item 1, paragraph 45-760(2)(b) and subsection 45-760(3) 12.47
Item 1, subsections 45-775(1) and (2) 12.55
Item 1, subsection 45-775(3) 12.56
Item 1, section 45-855 12.66
Item 1, subsection 45-860(3) 12.69
Item 1, subsections 45-860(1) and (2) 12.68
Item 1, section 45-865 12.70
Item 1, subsection 45-865(1) 12.71, 12.72
Item 1, subsection 45-865(2) 12.73
Item 1, paragraph 45-865(2)(a) 12.74
Item 1, paragraph 45-865(2)(b) 12.75
Item 1, subsections 45-870(1) and (4) 12.80
Item 1, subsection 45-870(2) 12.82
Item 1, subsection 45-870(2), steps 1 and 2 of the method statement 12.85
Item 1, subsection 45-870(2) steps 3 and 4 of the method statement 12.86
Item 1, subsections 45-870(2) to (4) 12.83
Item 1, subsection 45-870(3) 12.81
Item 1, subsection 45-875(1) 12.87
Item 1, subsection 45-875(2) 12.87
Item 1, subsection 45-875(3) 12.87
Item 1, subsection 45-875(4) 12.87
Item 2 Table 12.1
Item 3 Table 12.1
Item 4, subsection 45-30(4) 12.77
Items 5 and 6 Table 12.1
Item 7 Table 12.1
Item 8 Table 12.1
Item 9, subsection 45-230(2A) 12.91
Item 10, subsection 45-232(7) 12.95
Item 10, subsection 45-232(8) 12.96
Item 10, subsection 45-232(9) 12.97
Item 10, subsection 45-232(10) 12.98
Item 11 Table 12.1
Item 12 Table 12.1
Item 13 Table 12.1

Schedule 5: Amendments of Dictionary

Bill reference Paragraph number
Items 1, 6, 7, 11, 14 to 17, 29 and 39 3.104
Items 2, 20, 21, 23, 25 and 33 5.160
Items 3, 4 and 18 8.106
Item 5, subsection 995-1(1) of the ITAA 1997 4.101
Items 5, 9, 11, 13, 22, 24, 28, 29, 35 and 36 4.126
Item 8 Table 12.2
Item 8, subsection 995-1(1) of the ITAA 1997 12.63
Item 9, subsection 995-1(1) of the ITAA 1997 4.66
Items 10, 19, 26, 27, 32, 34, 37 and 38 6.115
Items 10, 19, 27, 30, 31 and 32 2.91
Item 11 3.26
Item 11, subsection 995-1(1) of the ITAA 1997 4.106, 4.107
Item 12 Table 12.2
Item 12, subsection 995-1(1) of the ITAA 1997 12.22
Item 13, subsection 995-1(1) of the ITAA 1997 4.14
Item 18 9.71
Item 22, subsection 995-1(1) of the ITAA 1997 4.42
Item 24, subsection 995-1(1) of the ITAA 1997 4.99, 4.100, 4.102
Item 28, subsection 995-1(1) of the ITAA 1997 4.17
Item 29, subsection 995-1(1) of the ITAA 1997 4.30
Item 35, subsection 995-1(1) of the ITAA 1997 4.62
Item 36, subsection 995-1(1) of the ITAA 1997 4.57
Item 41, subsection 960-130(1) Table 3.3
Item 41, subsection 960-130(2) 3.67
Item 41, subsection 960-130(3) 3.68
Item 41, section 960-135 3.66


This refers to:

·
the COT for companies;
·
the substantial COT for listed public companies and their 100% owned subsidiaries; and
·
the 50% stake tests for trusts.


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