Taxation Determination

TD 2004/61

Income tax: consolidation tax cost setting rules: step 3 of the allocable cost amount: should tax losses or net capital losses transferred to a joining entity be taken into account when determining whether an amount should be excluded at paragraph 705-90(6)(b) of the Income Tax Assessment Act 1997?

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FOI status:

may be released

1. No. Losses transferred to a joining entity (income company) by another member of a wholly-owned group (loss company) prior to the joining entity becoming a member of a consolidated group are not treated as losses of the joining entity accruing to the group for the purposes of paragraph 705-90(6)(b) of the Income Tax Assessment Act 1997 (ITAA 1997). Instead, adjustments may be made at step 1 and/or step 2 of the allocable cost amount (ACA) for the loss company if it also joins the consolidated group (see subsection 705-65(3) and 705-75(3) respectively). Adjustments may also be made at steps 1 and/or step 2 for the income company (see paragraphs 5.60, 5.72 and Table 5.2 of the Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No. 1) 2002).

Example

Cost setting process for the income company

2. On 30 June 2001 Beta Co is acquired by HCo for $166,000. Beta Co has a franking account balance at that time of $34,000.

3. Beta Co's financial position at 1 July 2001 is shown in Table 1.

4. In the year ended 30 June 2002 Beta Co derives assessable income of $50,000, and is allowed a tax deduction for tax losses of $50,000 transferred from Alpha Co, a member of the same wholly-owned group. Beta Co makes a subvention payment of $15,000 in respect of the loss transfer.

5. Beta's Co's financial position at 1 July 2002 is shown in Table 2.

6. HCo decides to form a consolidated group from 1 July 2002. At the joining time the market value of Beta Co is $201,000.

7. Beta Co's ACA would be as follows:

8. When determining the step 1 amount certain adjustments are required to the cost base (CB) and reduced cost base (RCB) of each membership interests. In Table 3 the CB, RCB and market value for each share are equal and the shares have been grouped for convenience. In Table 3 the CB and RCB used in working out the step 1 amount under subsection 705-65(1) are increased to the extent the market value of each membership interest increased as a result of the loss transfer under subsection 705-65(3). These are the adjustments that would have occurred under Subdivision 170-C had the membership interests been disposed of prior to the joining time. In this case there was no increase in market value of Beta Co's membership interests as a result of the loss transfer because of the subvention payment made [see subsection 170-215(4)].

9. Once the relevant adjustments (if any) are made to the CB and RCB of each membership interest, they are then compared against the relevant market value of the membership interest at the joining time. The final step 1 amount is the sum of the following amounts for each membership interest. If the market value is:

•

Equal to or greater than its CB = use its CB;

•

Less than CB but greater than RCB = use its market value; or

•

Less than or equal to RCB = use its RCB.

10. As the market value of each membership interest is greater than both the CB and RCB, the CB is used as the step 1 amount [refer table in subsection 705-65(1)]. The step 3 amount under section 705-90 is $35,000. The amount of owned profits counted at step 3 is capped under subsection 705-90(3) and must not exceed $79,333. However, the owned profits at the joining time are only $35,000, so the paragraph 705-90(6)(a) amount is $35,000. Nothing is subtracted from this amount under paragraph 705-90(6)(b) as transferred losses are not taken into account under that provision.

11. The tax cost setting amount (TCSA) for the retained cost base assets (cash) is $201,000. As the TCSA amount for retained cost bases assets equals the ACA there neither a shortfall nor an excess of ACA.

Cost setting process for the loss company

12. On 30 June 2001 Alpha Co is incorporated as a wholly-owned subsidiary of HCo, with an initial capitalisation of $100,000 (100 shares at $1,000 each). For the year ended 30 June 2002, Alpha Co made a tax loss of $50,000, which it transferred to Beta Co, receiving a subvention payment of $15,000. At the joining time Alpha Co had no unused losses for income tax purposes and Alpha Co's net accounting and economic loss for the year was $35,000. HCo forms a consolidated group on 1 July 2002. The market value of Alpha Co at the joining time was $65,000.

13. Alpha Co's financial position at 1 July 2002 is shown in Table 4.

14. Alpha Co's ACA would be as follows:

15. The step 1 amount of the CB or RCB is reduced for adjustments that would have occurred under Subdivision 170-C had the membership interests been disposed of just prior to the joining time, under subsection 705-65(3). In Table 7, the CB, RCB and market value for each share are equal and the shares have been grouped for convenience. The CB and RCB is reduced by the amount of the economic loss, net of the subvention payment. After this adjustment the CB is $65,000 ($100,000 - ($50,000 - $15,000). This is the same for the RCB.

16. Once the relevant adjustments are made to the CB and RCB of each membership interest, they are then compared against the relevant market value of the membership interest at the joining time. In this case the CB, RCB and market value for each share are equal.

17. The tax cost setting amount for the retained cost base assets (cash) is $65,000. There is no shortfall or excess of ACA.

Date of effect

18. This Determination applies to years commencing both before and after its date of issue. However, it does not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of the Determination (see paragraphs 21 and 22 of Taxation Ruling TR 92/20).

Commissioner of Taxation
27 October 2004

Previously issued as Draft TD 2004/D38

References

ATO references:
NO 2004/9764

Related Rulings/Determinations:

TR 92/20

Subject References:
ACA
allocable cost amount
consolidation
cost base
cost setting
deferred tax assets
income company
loss company
losses
market value
profits
recouped losses
reduced cost base
retained profits
step 1
step 2
step 3
tax losses
undistributed profits
untaxed profits
wholly-owned group
wholly-owned subsidiary

Legislative References:
TAA 1953 Pt IVAAA
ITAA 1997 Subdiv 170-C
ITAA 1997 170-215(4)
ITAA 1997 705-65(1)
ITAA 1997 705-65(3)
ITAA 1997 705-75(3)
ITAA 1997 705-90
ITAA 1997 705-90(2)
ITAA 1997 705-90(3)
ITAA 1997 705-90(6)(a)
ITAA 1997 705-90(6)(b)

Other References:
Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No. 1) 2002