Edited version of your private ruling

Authorisation Number: 1012483376581

Ruling

Subject: Acquisition of a consolidated group; tax cost setting for purchased debt ledgers

Question 1

For the purposes of section 705-25 of the Income Tax Assessment Act 1997 (ITAA 1997), which is the relevant retained cost base asset in respect of a purchased debt ledger (PDL): the PDL itself, or each of the underlying debts?

Answer

Each discrete debt within the purchased debt ledgers is the relevant retained cost base asset for the purposes of section 705-25 of the ITAA 1997.

Question 2

For subsection 705-27(3) of the ITAA 1997 to apply, is it necessary only that the tax cost setting amount of 2 or more of the joining entity's assets could be reduced by subsection 705-27(1) of the ITAA 1997?

Answer

Yes

Question 3

Does the rulee's chosen sequence comply with the requirements of subsection 705-27(3) of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

1 April 2010 to 31 March 2011

Relevant facts and circumstances

The rulee is a resident head company of a tax consolidated group.

The rulee acquired all of the issued capital of company A during the accounting period.

Company A was the head company of a tax consolidated group whose members included company B.

For a number of years B has been in the business of acquiring certain third party debts from other unrelated entities at a discount to face value. The debts that B acquires are primarily credit card receivables or other unsecured consumer debt where the borrower is in default. B acquires such debts en bloc from Australian lenders in the form of purchased debt ledgers (PDLs) at a steep discount to face value.

When the rulee acquired company A, company A's assets (as head company, of the tax consolidated group) included a number of PDLs (listed in the taxpayer's submission).

The debts are transferred to B by way of legal assignment (rather than being assigned only in equity).

All but one of the PDLs owned by B at the joining time consist of Australian dollar denominated debts. The exception is a PDL consisting of a foreign currency denominated debts and this is not a retained cost base asset.

Company A and company B joined the rulee's tax consolidated group during the substituted accounting period.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 705-A

Income Tax Assessment Act 1997 Section 705-25

Income Tax Assessment Act 1997 Section 705-27

Reasons for decision

Question 1

Summary

Each discrete debt within each PDL will be separate retained cost assets for the purposes of section 705-25 of the ITAA 1997.

Detailed reasoning

The meaning of asset for the purposes of Part 3-90 of the ITAA 1997 has been interpreted by the Commissioner in Taxation Ruling TR 2004/13 as follows:

4. The meaning of the word 'asset' is found within the commercial or business context that applies where a single entity joins an existing consolidated group (Subdivision 705-A of the ITAA 1997). Assets are recognised for the purposes of the consolidation tax cost setting rules on the basis that a head company of a consolidated group is acquiring a joining entity. All the assets of the joining entity therefore need to be identified. The total costs (both direct and indirect) of acquiring the joining entity are allocated to the underlying assets of the joining entity.

5. Accordingly, an asset for the purpose of the tax cost setting rules is anything recognised in commerce and business as having economic value to the joining entity at the joining time for which a purchaser of its membership interests would be willing to pay. The business or commercial assets of a joining entity would include the things that would be expected to be identified by a prudent vendor and purchaser as having value in the making of a sale agreement in respect of all the membership interests in an entity and its business. These assets would also come within the scope of a due diligence examination undertaken on behalf of a prudent purchaser of such an entity and business.

The debts company B acquires are primarily credit card receivables or other unsecured consumer debt where the borrower is in default. B acquires such debts en bloc from Australian lenders in the form of PDLs at a steep discount to face value. In all cases, the debts are transferred to B by way of legal assignment (rather than being assigned only in equity). All but one of the PDLs acquired by B consist of Australian dollar denominated debts.

Taxation Ruling TR 2005/10 sets out the Commissioner's view for assets of a joining entity that are retained cost base assets that consist of Australian currency or a right to receive a specified amount of such currency. The relevant paragraphs are stated below:

14. According to paragraphs 5.22 and 5.24 of the EM to the New Business Tax System (Consolidation) Bill (No 1) 2002, the policy objective for treating certain assets of a joining entity that come within the terms of paragraphs 705-25(a) and (b) of the ITAA 1997 as retained cost base assets is:

To simplify compliance, a head company's cost for certain assets (retained cost base assets) is set equal to the joining entity's cost for those assets...

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.

15. This compliance simplification policy objective is achieved by the operation of subsection 703-25(2) of the ITAA 1997, whereby the tax cost setting amount for these retained cost base assets is 'the amount of Australian currency concerned.' This will not be the joining entity's cost for the asset where the joining entity acquired the asset at a discount or a premium to its nominal value. The reference at paragraph 5.22 of the EM to setting the cost of retained cost base assets 'equal to the joining entity's cost for those assets' must then, be taken to be only referring to the general case. For example, discounted securities (not being qualifying securities which receive a special tax neutral transfer value, nor marketable securities which are specifically excepted) that are retained cost base assets in terms of paragraph 705-25(b) will get a tax cost setting amount equivalent to their nominal value and not the discounted cost to the joining entity of acquiring them. See Example 1 at paragraphs 44 to 45.

Example 1 - factored debt

44. Just before joining a consolidated group, Subco (a factor company) acquired a book of mature unconditional and legally enforceable debts with a collective face value of $1 million, but which it bought for $700,000.

45. The debts are retained cost base assets and will each receive a tax cost setting amount equivalent to their nominal value in accordance with subsection 703-25(2) of the ITAA 1997.

The acquisition of the PDLs occurs by way of legal assignment, which would entitle B the full rights to the unpaid debts, including the right to collect each discrete debt within the PDL. Debts are a legal chose in action which comprises a bundle of proprietary rights. It is therefore the Commissioner's view that each discrete debt within each PDL will be separate retained cost asset for the purposes of section 705-25 of the ITAA 1997. Example 1 in TR 2005/10 supports this view that where a book of debts is acquired each debt will receive a tax cost setting amount (TCSA) equivalent to their nominal value. Further support for this view is contained in ATO ID 2007/40 where the Commissioner said that rights over the discrete debts can be retained cost base assets, irrespective of whether the vendor may buy back those rights in certain circumstances.

Question 2

Summary

Statutory interpretation allows the use of 'and' and 'in accordance with' in a manner which allows subsection 705-27(3) of the ITAA 1997 to be read in the wider sense. Therefore, the choice made under paragraph 705-27(3)(b) of the ITAA 1997 can be made where there is a reduction pursuant to subsection 705-27(1) of the ITAA 1997 and subsection 705-27(2) of the ITAA 1997 has been considered and may or may not apply.

If a joining entity has more than one retained cost base asset under paragraph 705-25(5)(b) of the ITAA 1997 whose market value is lower than its TCSA, the head company can choose the order in which each asset's TCSA is reduced by the CGT event L3 gain. The reduction is limited to each asset's TCSA.

Detailed reasoning

Subsection 705-27(1) of the ITAA 1997 acts to reduce the TCSA of retained cost base assets (covered by section 705-25(5)(b) of the ITAA 1997) where the head company makes a capital gain under CGT event L3 as a result of the joining entity becoming a subsidiary member of the group. The TCSA of the asset is reduced by the amount of the capital gain arising under CGT event L3, but not below zero.

To prevent duplication, where the asset is an intra group asset, subsection 705-27(2) of the ITAA 1997 provides for a reduction to the amount reduced under subsection 705-27(1) of the ITAA 1997 by the amount of the deduction (but not below zero) the joining entity was entitled to for an income year on or before the joining time.

Subsection 705-27(3) of the ITAA 1997 states:

If the *tax cost setting amount of 2 or more of the joining entity's assets could be reduced in accordance with subsections (1) and (2):

subsections (1) and (2) apply sequentially to each of those assets; and

the *head company may choose the sequence of assets to which subsections (1) and (2) apply; and

if the head company does not make such a choice - subsections (1) and (2) apply sequentially to each of those assets according to the time at which they were created, from earliest to latest.

The question of whether a head company can only choose the sequence of assets in which the reduction in the TCSA applies is dependent on whether subsection 705-27(2) of the ITAA 1997 is a relevant consideration, but not a pre-condition, to the choice being made pursuant to subsection 705-27(3) of the ITAA 1997.

When interpreting an Act, an interpretation which best achieves the policy or object of the Act is to be preferred: see section 15AB of the Act Interpretation Act 1901. Pearce and Geddes' Statutory Interpretation in Australia states:

[2.28] If it is obvious that a simple mistake in the form of a printing or drafting error has been made in the text of legislation, the courts will read the legislation in its correct form.

[...]

Although the golden rule is still relied on to correct printing and drafting errors, it may also be possible to achieve that result by resorting to the modern approach to interpretation, which permits the court to take account initially of underlying purpose and context.

[...]

[2.29] In the second group of cases the court has not decided that 'and' or 'or' was used in error. Instead, it has concluded, usually by reference to the context in which the word appears, that the cumulative effect of the provision should not be dictated by the presence of the word in question.

[..]

[2.30] In Re The Licensing Ordinance 1968 13FLR 143 at 147 Blackburn J spoke of cases

...in which there was a list of items, the items being joined by 'and' and the list being governed or affected by words which showed the list was a list of alternatives. In such a case, the word 'and', which is used to join the items on the list, is truly cumulative, it links the members of a class and its function is to indicate that the whole class is to be considered together. Governing the words which enumerate the members of the class are other words which categorise the class as a whole, as a class of alternatives...the word 'and' inside the class does not have dispersive or alternative force; its force is wholly cumulative, it is the words outside the class which give the dispersive effect.

[...]

Re Peat Resources of Australia Pty Ltd; Ex Parte Pollock (2004) 181 FLT 454 illustrates the reasoning that may be employed to give the word 'and' disjunctive or dispersive effect. The Full Supreme Court of Western Australia had to decide whether an Australian Securities and Investments Commission authority purporting to 'authorise the National Bank of Australia and the Receivers ... to make an application... in relation to... Companies in Receivership.' required an application to be made by the bank and the receivers jointly. Malcolm CJ concluded that, as the interests of the bank and the receivers would not necessarily coincide, the ASIC authority should be interpreted as authorising them to apply separately or together (at 466-7). In reaching this conclusion Malcolm CJ considered the cases referred to in both this and the preceding paragraph, and observed that 'the purposive approach' to interpretation in a statute includes reading 'and' for 'or' and vice versa of the purpose of the legislation suggests such an interpretation (at 460).

It is not obvious from reading subsection 705-27(3) of the ITAA 1997 that a printing or drafting error has occurred. Whether the use of the word 'and' could be read disjunctively can be discerned from the use of the words 'in accordance with' and the context in which they both appear in section 705-27 of the ITAA 1997.

Pearce and Geddes' Statutory Interpretation in Australia [12.12] states:

In some contexts, 'in accordance with' will by synonymous with 'by': Chan v Credon Pty Ltd (1989) 168 CLR 242 at 249; 89 ALR 522 at 526. However, this will not necessarily be so. Context may give it a different meaning.

In Mount Barker Properties Ltd v District Council of Mount Barker (2001) 80 SASR 449 at 461; LGERA 190 at 204 Debelle J said that the verb 'accord' means to be in harmony or in correspondence or to be consistent with another thing.

Reading the words 'in accordance with' as 'consistent with' in subsection 705-27(3) of the ITAA 1997 could lead to an interpretation that subsection 705-27(2) of the ITAA 1997 has been considered and may or may not apply. Malcolm CJ concluded in Re Peat Resources above that, as the interests of the bank and the receivers would not necessarily coincide, the ASIC authority should be interpreted as authorising them to apply separately or together. In reaching this conclusion Malcolm CJ observed that 'the purposive approach' to interpretation in a statute includes reading 'and' for 'or' and vice versa of the purpose of the legislation suggests such an interpretation.

A similar purposive approach is considered to apply to interpret section 705-27 of the ITAA 1997 to give a wider interpretation, that is, subsection 705-27(3) of the ITAA 1997 is interpreted to apply where subsection 705-27(1) of the ITAA 1997 applies alone and where subsections 705-27(1) and (2) of the ITAA 1997 apply together. There is no indication in the Explanatory Memorandum or elsewhere that subsection 705-27(3) of the ITAA 1997 applies only in the narrow sense, such that it only applies where both subsections 705-27(1) and (2) of the ITAA 1997 apply.

Question 3

Summary

The rulee's chosen sequence of retained cost base assets comply with the requirements of subsection 705-27(3) of the ITAA 1997.

Detailed reasoning

If a joining entity has more than one retained cost base asset whose market value is lower than its TCSA, the head company can choose the order in which each asset's TCSA is reduced by the amount of capital gain made under CGT event L3. The reduction is limited to each asset's TCSA.

Where this choice has been made by the head company, and a sequence has been chosen in accordance with paragraph 705-27(3)(b) of the ITAA 1997, it is the applicant's view that, when working through the sequence, one retained cost base asset's TCSA to be reduced to nil (until all the capital gain made under CGT event L3 has been extinguished) before the next asset's TCSA can be reduced.

The application lists the rulee's chosen sequence, and includes the reasons for choosing this sequence. The sequence is listed for ease of reference to the PDLs, while the relevant assets are the underlying debts which comprise each PDL. However, the applicant notes that it is not entirely clear whether these PDLs are retained cost base assets or whether any of the underlying debts were outstanding at the joining time. The remaining PDLs are then listed in a chosen sequence.

It is the Commissioner's view that where the underlying debt within a PDL is determined to be a retained cost base asset, the sequence chosen by the rulee complies with the requirements in subsection 705-27(3) of the ITAA 1997.

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