Edited version of private ruling

Authorisation Number: 1011530286199

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Ruling

Subject: Application of subsections 23AH(3) and 23AH(4) of the ITAA 1936 and Subdivision 855-B of the ITAA 1997.

Question 1

Do subsections 23AH(3) and 23AH(4) of the Income Tax Assessment Act 1936 (ITAA 1936) apply in relation to the Loan made by Parent Co to Subsidiary Co?

Answer

No.

Question 2

Does Subdivision 855-A of the Income Tax Assessment Act 1997 (ITAA 1997) apply in relation to the Loan made by Parent Co to Subsidiary Co?

Answer

No.

This ruling applies for the following period:

1 January 2007 - 31 December 2007

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Parent Co is a wholly owned subsidiary of Company A, which in turn is owned by Head Co Ltd.

Parent Co was the 100% holding company of Subsidiary Co from the time of the incorporation of Subsidiary Co up until its disposal by Parent Co in 200Y. Parent Co had no other connection with Subsidiary Co other than lending funds to it in US dollars via an inter-company loan (Loan).

Subsidiary Co was incorporated in the USA. Subsidiary Co carried on business as an exploration and production company in the USA where it operated a number of interests. At all times prior to its disposal, Subsidiary Co derived no Australian income and it was a resident of and had its central management and control in, the USA.

Parent Co was incorporated in the USA and was a non-resident of Australia (for Australian income tax purposes) up until 200X, when it became a member of the Head Co Ltd Consolidated Group. Whilst a non-resident its central management and control was in the USA. It had no activity, representative or permanent establishment in Australia and did not carry on business in Australia.

When Parent Co joined the Head Co Ltd Consolidated Group it moved its place of central management and control from the USA to Australia and it became a resident of Australia for Australian income tax purposes. Since joining the Head Co Ltd Consolidated Group, Parent Co has had no presence in the USA. However, Subsidiary Co continued to carry on business solely in the USA and continued to obtain additional funds from Parent Co to fund its business up until its sale in 200Y.

On Parent Co becoming a resident of Australia, the first element of the cost base of the Loan, which was not taxable Australian property, was set to market value for CGT purposes pursuant to section 855-45 of the ITAA 1997. The tax cost of the Loan was then set at its tax cost setting amount in accordance with the income tax consolidation rules when Parent Co joined the Head Co Ltd Consolidated Group. The Loan was disposed of for CGT purposes at the time of the sale of Subsidiary Co by Parent Co through part of the Loan being forgiven prior to closing the sale and the outstanding (un-forgiven) balance of the Loan then remaining being repaid in full at closing.

The disposal of Subsidiary Co occurred while Parent Co was, and the present private ruling application was lodged while Parent Co continues to be, a member of the Head Co Ltd Consolidated Group. As such, pursuant to the single entity rule in section 701-1 of the ITAA 1997, the present private ruling application will be taken to have been lodged by, and applied for, Head Co Ltd as head company of the Head Co Ltd Consolidated Group.

Relevant legislative provisions

Income Tax Assessment Act 1936, subsection 6(1)

Income Tax Assessment Act 1936, section 23AH

Income Tax Assessment Act 1936, subsection 23AH(2)

Income Tax Assessment Act 1936, subsection 23AH(3)

Income Tax Assessment Act 1936, subsection 23AH(4)

Income Tax Assessment Act 1936, paragraph 23AH(3)(a)

Income Tax Assessment Act 1936, paragraph 23AH(4)(a)

Income Tax Assessment Act 1936, paragraph 23AH(4)(b)

Income Tax Assessment Act 1997, section 701-1

Income Tax Assessment Act 1997, Division 855

Income Tax Assessment Act 1997, Subdivision 855-A

Income Tax Assessment Act 1997, subsection 855-10(1)

Income Tax Assessment Act 1997, paragraph 855-10(1)(b)

Income Tax Assessment Act 1997, subsection 855-15

Income Tax Assessment Act 1997, subsection 855-35

Income Tax Assessment Act 1997, Subdivision 855-B

Income Tax Assessment Act 1997, section 855-45

Income Tax Assessment Act 1997, subsection 855-45(1)

Income Tax Assessment Act 1997, paragraph 855-45(1)(a)

Income Tax Assessment Act 1997, paragraph 855-45(1)(b)

Income Tax Assessment Act 1997, subsection 855-45(2)

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Application of section 23AH - residency

Section 23AH of the ITAA 1936 applies to companies that are residents of Australia for Australian income tax purposes.

Pursuant to subsection 23AH(2) of the ITAA 1936, foreign income of a company that is a resident of Australia derived in carrying on a business at or through a permanent establishment (PE) in a listed or unlisted country is not assessable income and not exempt income for Australian tax purposes. Likewise, pursuant to subsections 23AH(3) and 23AH(4) of the ITAA 1936, foreign gains and losses made by a resident company will be disregarded for Australian income tax purposes if the company uses the asset wholly or mainly for the purposes of producing foreign income in carrying on a business at or through a PE of the company in a listed or unlisted country and the asset is not taxable Australian property.

Subsection 23AH(4) of the ITAA 1936 states:

Subject to this section, a capital loss from a CGT event happening to a CGT asset is disregarded for the purposes of Part 3-1 of the Income Tax Assessment Act 1997 if:

(a) the loss is made by a company that is a resident; and

(b) the company used the asset wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE of the company in a listed country or unlisted country; and

(c) had the loss been a gain, it would be disregarded under subsection (3).

Subsection 23AH(3) states:

Subject to this section, a capital gain from a CGT event happening to a CGT asset is disregarded for the purposes of Part 3-1 of the Income Tax Assessment Act 1997 if:

(a) the gain is made by a company that is a resident; and

(b) the company used the asset wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE of the company in a listed country or unlisted country; and

(c) the asset is not taxable Australian property.

As is clear from the above, it is a pre-condition to the application of subsections 23AH(3) and 23AH(4) of the ITAA 1936 that the company in question be a resident for Australian income tax purposes.

Residency of Parent Co

Paragraph (b) of the definition of 'resident' in subsection 6(1) of the ITAA 1936 provides three alternative tests for the determination of the residence of a company, namely, a company is a resident of Australia if it:

§ is incorporated in Australia,

§ carries on business in Australia and has its central management and control in Australia or

§ carries on business in Australia and has its voting power controlled by Australian residents.

The applicant has stated that Parent Co was incorporated in the USA and that prior to joining the Head Co Ltd Consolidated Group in December 200X:

§ its central management and control was in the USA,

§ it had no PE in Australia and

§ it did not carry on business in Australia.

Parent Co is considered therefore not to have been a resident of Australia prior to joining the Head Co Ltd Consolidated Group in 200X

Application of paragraphs 23AH(3)(b) and 23AH(4)(b) of the ITAA 1936 up to 2005

As Parent Co was not a resident for Australian tax purposes prior to joining the Head Co Ltd Consolidated Group, subsections 23AH(3) and 23AH(4) of the ITAA 1936 will not apply to Parent Co prior to it joining the Head Co Ltd Consolidated Group. As subsections 23AH(3) and 23AH(4) do not apply it is not necessary to consider whether Parent Co carried on a business at or through a PE for the purposes of paragraphs 23AH(3)(b) and 23AH(4)(b) of the ITAA 1936 up to 200X.

Application of paragraphs 23AH(3)(b) and 23AH(4)(b) of the ITAA 1936 post 2005

Parent Co is considered to be a resident for Australian tax purposes from the time of joining the Head Co Ltd Consolidated Group, that is, post December 200X, as from that time onwards it ceased to have any further presence in the USA and its central management and control shifted to Australia. Paragraphs 23AH(3)(a) and 23AH(4)(a) of the ITAA 1936 are therefore satisfied as from 200X Parent Co became a resident company for Australian tax purposes.

However, Subsidiary Co remained a non-resident of Australia and continued up until the time it was disposed of by Parent Co, to carry on business in the USA and to obtain additional funds from Parent Co whilst Parent Co was a resident of Australia.

For paragraphs 23AH(3)(b) and 23AH(4)(b) of the ITAA 1936 to be satisfied in the present case Parent Co will need to be considered to be '..carrying on a business at or through a PE of the company in a listed country'. The USA is a listed country. However, it is not considered that Subsidiary Co is a PE of Parent Co by virtue of Parent Co's sole ownership of Subsidiary Co and just simply lending money to it.

ATO Interpretative Decision ATO ID 2002/850 covers a situation where carrying on a business through a subsidiary company amounts to a PE, but only because employees of the subsidiary are doing things on behalf of the parent company. In the circumstances of ATO ID 2002/850, if mere ownership of the subsidiary amounted to a PE for the parent company, it would not have been necessary to consider whether the things done by the employees of the subsidiary amounted to a PE for the parent company. Outright ownership by a parent company is therefore considered in and of itself not enough to conclude that the parent is carrying on business at or through a PE (the subsidiary).

Furthermore, ATO Interpretative Decision ATO ID 2004/602 covers a situation where a subsidiary does not amount to a PE of the parent company because it is not doing things on behalf of the parent company. A subsidiary carrying on a business in its own right would therefore not amount to the parent company carrying on business at or through a PE.

Accordingly, it is concluded that simple outright ownership of a subsidiary company (Subsidiary Co) by a parent company (Parent Co) coupled with the subsequent mere lending of funds to (mere financing of) the subsidiary would not be sufficient to conclude that the parent company lending the funds was carrying on a business at or through a PE at the place where the subsidiary was resident. Even though Subsidiary Co's business was financed by Parent Co, Parent Co did no more than advance funds to Subsidiary Co to enable Subsidiary Co to carry on its own business as an exploration and production company in the US where it operated a number of US business interests. From 200X onwards it cannot therefore be concluded that Parent Co was carrying on a business at or through a PE in the USA, a listed country through Subsidiary Co. As paragraphs 23AH(3)(b) and 23AH(4)(b) of the ITAA 1936 are not satisfied they (and ultimately subsections 23AH(3) and 23AH(4) of the ITAA 1936) will not apply to Parent Co from the time Parent Co joins the Head Co Ltd Consolidated Group in late 200X up until the time Parent Co sells Subsidiary Co in 200Y.

Question 2

As with section 23AH of the ITAA 1936 the residency status of a taxpayer is of fundamental importance in the context of Division 855 of the ITAA 1997, that is, when determining the CGT consequences of various transactions of foreign residents.

Division 855 of the ITAA 1997 applies in two distinct circumstances, namely, one, where a foreign resident makes a capital gain or capital loss when a CGT event happens to a CGT asset that is 'taxable Australian property' as defined in section 855-15 of the ITAA 1997 (Subdivision 855-A of the ITAA 1997) and two, when a foreign resident becomes an Australian resident (Subdivision 855-B of the ITAA 1997).

Application of Subdivision 855-A of the ITAA 1997

Subsection 855-10(1) of the ITAA 1997 states:

855-10(1)

Disregard a *capital gain or *capital loss from a *CGT event if:

(a) you are a foreign resident, or the trustee of a *foreign trust for CGT purposes, just before the CGT event happens; and

(b) the CGT event happens in relation to a *CGT asset that is not *taxable Australian property.

Section 855-35 of the ITAA 1997 is found in Division 855 of the ITAA 1997 and in particular, in Subdivision 855-A. Section 855-35 states:

855-35(1)

This section applies to a *CGT asset that is *taxable Australian property under item 3 of the table in section 855-15 because you have used it at any time in carrying on a *business through a permanent establishment (within the meaning of section 23AH of the Income Tax Assessment Act 1936) in Australia.

855-35(2)

The *capital gain or *capital loss you make from a *CGT event in relation to the asset is reduced if you used it in this way for only part of the period from when you *acquired it to when the CGT event happened.

855-35(3)

The gain or loss is reduced by this fraction:

Number of days the asset was not used

in the way described in subsection (1)

Number of days in that period

Application of Subdivision 855-A before Parent Co joins the Head Co Ltd Consolidated Group

For the reasons stated at question 1 above, Parent Co was a non-resident for Australian tax purposes up until 200X which is when Parent Co joined the Head Co Ltd Consolidated Group. Therefore Parent Co is a foreign resident for the purposes of paragraph 855-10(1)(a) of the ITAA 1997 prior to 200X.

However, it is considered that no relevant CGT event for Australian tax purposes has happened (i.e. the disposal of Subsidiary Co, the relevant CGT event, did not happen) during the period immediately before Parent Co joined the Head Co Ltd Consolidated Group. Subsections 855-10 (1) and 855-35(2) are therefore not satisfied prior to Parent Co joining the Head Co Ltd Consolidated Group as there is no relevant CGT event to which they can apply during this time.

Accordingly, Subdivision 855-A of the ITAA 1997 (and therefore subsection 855-35 of the ITAA 1997 which is found in Subdivision 855-A of the ITAA 1997) will not apply in respect of the Loan before Parent Co joins the Head Co Ltd Consolidated Group. It is therefore not necessary to consider whether Parent Co is carrying on a business through a permanent establishment by way of lending funds to Subsidiary Co pursuant to subsection 855-35(1) prior to it joining the Head Co Ltd Consolidated Group.

Application of Subdivision 855-A after Parent Co joins the Head Co Ltd Consolidated Group

Subdivision 855-A of the ITAA 1997 will not apply at any time from when Parent Co joined the consolidated group up until its disposal of Subsidiary Co because during this time, for the reasons stated at question 1 above, Parent Co is considered to be a resident -Subdivision 855-A of the ITAA 1997 applies to foreign residents only. Again, as Subdivision 855-A (and hence section 855-35) of the ITAA 1997 is not applicable it is not necessary to consider whether Head Co Ltd has carried on a business through a permanent establishment as a consequence of lending money to Subsidiary Co, for the purposes of section 855-35 of the ITAA 1997, from the time Parent Co joined the Head Co Ltd Consolidated Group until the time it disposed of Subsidiary Co.

While Subdivision 855-A of the ITAA 1997 does not apply to Head Co Ltd, for completeness we provide the following discussion in relation to the application of Subdivision 855-B of the ITAA 1997.

Subdivision 855-B of the ITAA 1997

Subdivision 855-B will apply when section 855-45 of the ITAA 1997 is satisfied. Section 855-45 of the ITAA 1997 states:

855-45(1)

If you become an Australian resident, there are rules relevant to each *CGT asset that you owned just before you became an Australian resident, except an asset:

(a) that is *taxable Australian property; or

(b) that you *acquired before 20 September 1985.

Note:

This section has effect subject to section 768-950 (individuals who become Australian residents and are temporary residents immediately after they become Australian residents).

855-45(2)

The first element of the *cost base and *reduced cost base of the asset (at the time you become an Australian resident) is its *market value at that time.

855-45(3)

Also, Parts 3-1 and 3-3 apply to the asset as if you had *acquired it at the time you became an Australian resident.

855-45(4)

This section does not apply to an *ESS interest if:

(a) Subdivision 83-C (about employee share schemes) applies to the interest; and

(b) the *ESS deferred taxing point for the interest has not yet occurred.

When does Parent Co become a resident?

As discussed at question 1 above, Parent Co became an Australian resident for Australian tax purposes at the time of joining the Head Co Ltd Consolidated Group. The first element of subsection 855-45(1) which provides 'If you become an Australia resident…' is therefore satisfied from the time Parent Co joins the Head Co Ltd Consolidated Group, that is, 200X, as this is the time Parent Co becomes an Australian resident . Subdivision 855-B will therefore apply at the time Parent Co becomes a resident in 200X provided that all the other requirements of Subdivision 855-B are satisfied.

Did Parent Co own a CGT asset prior to joining the Head Co Ltd Consolidated Group?

Parent Co owned a relevant CGT asset prior to joining the Head Co Ltd Consolidated Group, namely, the debt owed to it by Subsidiary Co, that is, the Loan. For the purposes of subsection 855-45(1) of the ITAA 1997, if this debt is considered to be taxable Australian property, then subsection 855-45 of the ITAA 1997 (and Subdivision 855-B of the ITAA 1997) will not apply. Taxable Australian property is defined in section 855-15 of the ITAA 1997. It is considered that items 1, 2, 4 and 5 of subsection 855-15 of the ITAA 1997 will not apply in these circumstances.

Taxable Australian property - does item 3 of section 855-15 of the ITAA 1997 apply?

Item three of section 855-15 of the ITAA 1997 provides that the following type of CGT asset is taxable Australian property:

A *CGT asset that:

(a) you have used at any time in carrying on a *business through a permanent establishment (within the meaning of section 23AH of the Income Tax Assessment Act 1936) in Australia; and

(b) is not covered by item 1, 2 or 5 of this table

With reference to the introductory words of the opening paragraph of subsection 855-45(1) it is submitted that '..just before..' the time of joining the Head Co Ltd Consolidated Group the Loan asset is not an asset that was used at any time '…in carrying on a *business through a permanent establishment (within the meaning of section 23AH of the Income Tax Assessment Act 1936) in Australia;…'. At no time immediately/just before Parent Co joined the Head Co Ltd Consolidated Group did Parent Co carry on business in Australia or derive income in Australia. If any business was carried on by Parent Co through Subsidiary Co before Parent Co joined the Head Co Ltd Consolidated Group, it is submitted that this was carried on in the USA and not through any PE in Australia.

Accordingly, it is concluded that paragraph 855-45(1)(a) of the ITAA 1997 is not satisfied (as none of the items in section 855-15 of the ITAA 1997 are relevant in the circumstances) and that the Loan is considered not to be taxable Australian property for the purposes of paragraph section 855-45(1)(a) of the ITAA 1997.

Paragraph 855-45(1)(b) of the ITAA 1997 is also not satisfied as the Loan, a CGT asset, was acquired post September 1985.

Accordingly, as none of the exceptions in either paragraphs 855-45(1)(a) or (b) of the ITAA 1997 apply, the '…rules relevant to each *CGT asset that you owned just before you became an Australian resident…' referred to in the beginning of subsection 855-45(1) of the ITAA 1997 will apply.

Importantly, subsection 855-45(2) of the ITAA 1997 will apply. Subsection 855-45(2) of the ITAA 1997 requires that the first element of the cost base and reduced cost base of the Loan at the time Parent Co becomes an Australian resident will be its market value at the time of becoming an Australian resident. The applicant has stated that it has applied this rule and valued the asset accordingly.

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