ATO Interpretative Decision

ATO ID 2004/388 (Withdrawn)

Income Tax

Consolidation - modified market value and a debt/equity swap
FOI status: may be released
Status of this decision: Decision Withdrawn 17 September 2004
CAUTION: This is an edited and summarised record of a Tax Office decision. This record is not published as a form of advice. It is being made available for your inspection to meet FOI requirements, because it may be used by an officer in making another decision.

This ATOID provides you with the following level of protection:

If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.

Issue

Does a debt/equity swap involving a debtor and a creditor, constitute an event under paragraph 707-325(4)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) for the purpose of the rule to prevent the inflation of the modified market value ('anti-inflation rule')?

Decision

Yes. A debt/equity swap involving a debtor and a creditor is considered to be an injection of capital as described in paragraph 707-325(4)(a) of the ITAA 1997.

Facts

The head company of a consolidatable group, company D (the debtor), borrowed funds from an unrelated third party, company C (the creditor).

Under a subsequent arrangement, company D issues shares to company C, in exchange for the discharge of the outstanding debt. The arrangement takes place after 8 December 2000 and less than four years prior to company D forming a consolidated group.

Reasons for Decision

The basic rule for working out the modified market value of an entity that becomes a member of a consolidated group is contained in subsection 707-325(1) of the ITAA 1997. It provides that the modified market value of an entity at the joining time is the market value of the entity at that time based on certain assumptions.

Subsection 707-325(2) of the ITAA 1997 provides that if:

•
there are one or more events described in subsection 707-325(4) of the ITAA 1997;
•
that occurred in the four years before the time an entity becomes a member of a consolidated group; and
•
the modified market value of the entity calculated under subsection 707-325(1) of the ITAA 1997 exceeds what it would have been if none of those events occurred,

then the modified market value worked out under subsection 707-325(1) of the ITAA 1997 is reduced by the amount worked out under subsection 707-325(3) of the ITAA 1997.

Subsection 707-325(4) of the ITAA 1997 contains the events that are referred to in subsection 707-325(2) of the ITAA 1997. Paragraph 707-325(4)(a) of the ITAA 1997 identifies one of the events as an injection of capital into the entity or an associate.

An injection of capital that occurred in the four years before the joining time can only be disregarded if it is made:

•
into a listed public company through a dividend reinvestment scheme (paragraph 707-325(5)(a) of the ITAA 1997);
•
in association with the acquisition of shares under an employee share scheme meeting certain conditions (paragraph 707-325(5)(b) of the ITAA 1997); or
•
on or before 8 December 2000 (section 707-329 of the Income Tax (Transitional Provisions) Act 1997).

The distinguishing features of a debt/equity swap involving a debtor and a creditor are such that the creditor releases the debtor from the obligation to repay the debt (or part of the debt) in exchange for the debtor issuing equity (usually shares) to the creditor. Under the arrangement, the creditor acquires membership interests in the entity in return for releasing the debtor from a debt of equivalent value.

The wealth of the debtor has increased by virtue of it no longer having an obligation to repay loan funds. As such, the debt/equity swap is considered an injection of capital captured by the anti-inflation rule.

As company D has issued shares to company C, an event of an injection of capital into the company has occurred. As the arrangement took place after 8 December 2000 and in the four years prior to company D forming a consolidated group, this injection constitutes an event for the purposes of the anti-inflation rule and is not disregarded.

A reduction in the modified market value of company D may be required under subsection 707-325(2) of the ITAA 1997.

Date of decision:  22 April 2004

Year of income:  30 June 2003

Legislative References:
Income Tax Assessment Act 1997
   Section 707-325
   subsection 707-325(1)
   subsection 707-325(2)
   subsection 707-325(3)
   subsection 707-325(4)
   paragraph 707-325(4)(a)
   subsection 707-325(5)
   paragraph 707-325(5)(a)
   paragraph 707-325(5)(b)

Income tax (Transitional Provisions) Act 1997
   section 707-329

Related ATO Interpretative Decisions
ATO ID 2004/387
ATO ID 2004/389

Keywords
Acquisition of shares
Consolidatable group
Consolidation
Consolidation - event
Consolidation - losses
Consolidation - reduction
Injection of capital
Modified market value

Business Line:  Consolidation Centre of Expertise

Date of publication:  7 May 2004

ISSN: 1445-2782

history
  Date: Version:
  22 April 2004 Original statement
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