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Will the Acquisition of the XYZ Securities result in XYZ failing the same owners test in section 165-12 of the Income Tax Assessment Act 1997 ("ITAA 1997")?

No

Does section 705-27 of the ITAA 1997 reduce the tax cost setting amount of XYZ LLC's ("LLC") retained cost base assets, comprising the New Notes and Accrued Interest Receivable on the New Notes, and thus reduce the capital gain under CGT event L3 upon LLC's entry into XYZ income tax consolidated group?

Yes

Are the New Notes and Accrued Interest Receivable between XYZ and LLC forgiven for the purposes of Division 245 of the ITAA 1997 upon LLC joining the XYZ income tax consolidated group?

Year ending 30 June 2017

XYZ is the head company of the XYZ income tax consolidated group ("XYZ Tax Group").

The XYZ Trust is a special purpose trust to raise funds for the XYZ group.

The XYZ Trust is a public unit trust that was settled with the issue of a single ordinary unit with a face value of $X held by XYZ.

As part of the establishment of the composite XYZ Trust financing structure, a limited liability company ("LLC"), was established in a foreign country. LLC is treated as transparent for the foreign country’s federal tax purposes.

On establishment of LLC, XYZ invested $X to subscribe for one class of common limited liability company interests in LLC ("LLC Common Share"). The LLC Common Share carries 100% of the voting and management rights in LLC.

The LLC Common Share gives XYZ the right to appoint the Board of Directors of LLC which has absolute discretion over any distribution made by LLC.

Post establishment of LLC, XYZ Trust used the $X proceeds from the issue of XYZ Securities to subscribe for X preference shares in LLC ("LLC Preference Shares").

The payment of dividends on both the LLC Common Share and LLC Preference Share is controlled by XYZ as the holder of the LLC Common Share.

Post issue of the LLC Preference Shares, the $X proceeds were used by LLC to subscribe for loan notes ("the Notes") issued by XYZ (Overseas).

At that point in time, XYZ (Overseas) was a non-resident of Australia for taxation purposes. lt was an indirect wholly owned subsidiary of XYZ. XYZ (Overseas) used the $X proceeds received as consideration for the issue of the Notes to retire existing debt.

The Notes that were issued by XYZ (Europe) to LLC were sold by LLC to XYZ in exchange for XYZ's newly issued notes ("New Notes").

The New Notes have an aggregate principal face value of $X and are interest bearing. The market value of the New Notes is greater than the accounting carrying value of the New Notes.

XYZ Australia then in turn contributed the Notes to its wholly owned Australian subsidiary XYZ Associates in return for equity. These subsequent transactions were within the XYZ Tax Group and thus ignored for Australian income taxation purposes. The Notes subsequently ceased to exist.

The treatment of LLC as a partnership for Australian income tax purposes has the effect that XYZ Trust and XYZ, as shareholders in the LLC, are treated as partners in the LLC partnership.

The proposed transaction would be implemented by the Trust Scheme. Pursuant to the transaction XYZ would acquire the remaining XYZ Securities ("Acquisition"). The proposed steps of the acquisition are as follows:

lncome Tax Assessment Act 1936 Division 36

Income Tax Assessment Act 1997 Section 104-510

Income Tax Assessment Act 1997 Section 105-510

Income Tax Assessment Act 1997 Division 165

Income Tax Assessment Act 1997 Division 166

Income Tax Assessment Act 1997 Section 166-5

Income Tax Assessment Act 1997 Section 165-12

Income Tax Assessment Act 1997 Section 166-145

Income Tax Assessment Act 1997 Section 165-155

Income Tax Assessment Act 1997 Section 166-175

Income Tax Assessment Act 1997 Section 166-220

Income Tax Assessment Act 1997 Section 166-225

Income Tax Assessment Act 1997 Section 166-270

Income Tax Assessment Act 1997 Section 166-272

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 Section 245-10

Income Tax Assessment Act 1997 Section 245-35

Income Tax Assessment Act 1997 Section 245-36

Income Tax Assessment Act 1997 Section 245-37

Income Tax Assessment Act 1997 Section 245-45

Income Tax Assessment Act 1997 Division 701

Income Tax Assessment Act 1997 Section 701-1

Income Tax Assessment Act 1997 Section 703-15

Income Tax Assessment Act 1997 Section 703-20

Income Tax Assessment Act 1997 Division 705

Income Tax Assessment Act 1997 Section 705-25

Income Tax Assessment Act 1997 Section 703-27

Income Tax Assessment Act 1997 Division 820

Income Tax Assessment Act 1997 Subsection 995-1

Reasons for decision Question 1

No. The Acquisition of the XYZ Securities will not result in XYZ failing the same owners test in section 165-12 of the ITAA 1997.

165-12 Same owner test

To satisfy the same owner test in section 165-12, the company must satisfy three conditions during the ownership test period - the period from the start of the loss year to the end of the income year.

Division 166 modification to the same owner test

Broadly, Division 166 modifies the way the rules in Division 166 apply to a widely held company by making it easier for the company to apply the rules. If the company has maintained the same owners as between certain points of time, it does not need to prove it has maintained the same owners throughout the periods in between. In certain cases, special concessional tracing rules deem entities to hold voting, dividend or capital stakes in the company so that the company does not have to trace through to the ultimate beneficial owners of the stakes.

Section 166-5 specifically provides the following modification:

XYZ is listed on the ASX and is a widely held company for the purpose of Division 166. XYZ does not choose, pursuant to section 166-15, for Subdivision 166-A not to apply. Therefore, Subdivision 166-A applies to XYZ and modifies the operation of Subdivision 165-A.

Subsections 166-5(2) and 166-5(3) contain the following modified rules ("Modified COT"):

Accordingly, a "corporate change" occurs for XYZ as there is an issue of shares in XYZ that results in an increase of more than 20% in the number of XYZ's shares on issue. In other words, XYZ is required to satisfy the Modified COT at each testing point described in the above section.

For the purposes of the Modified COT, "substantial continuity of ownership" is defined in section 166-145 as follows:

XYZ has only one class of shares that carry equal voting, dividend and capital distribution rights. XYZ will meet all three of the conditions in subsection 166-145 if the "voting power" condition is satisfied. Accordingly, the following analysis will only be in reference to the "voting power" condition in subsection 166-145(2).

(2) Applying the alternative test: if it is the case, or it is reasonable to assume, that there are persons (none of them companies or *trustees) who (between them) at a particular time control, or are able to control (whether directly, or indirectly through one or more interposed entities) the voting power in the company, those persons have more than 50% of the voting power in the company at that time.

Subdivision 166-E provides concessional tracing rules which make it easier for a widely held entity to satisfy the tests in section 166-145.

For all registered shareholdings carrying less than 10 % of voting power, the voting power is taken to be controlled by a single notional entity. The single notional entity is taken to be a person (other than a company), and is therefore regarded as an ultimate owner for the purpose of the alternative test.

In this case, based on the share ownership of XYZ and the rights attached to those shares, it is observable that there are significant direct voting stakes of less than 10% of the voting power in XYZ at each of the relevant testing points. Accordingly, subsection 166-225(2) should apply to XYZ in respect of those direct voting stakes.

Pursuant to the operation of subsection 166-255(2) in conjunction with subsection 165-150(2), the Modified COT is satisfied on the basis that the single notional entity is deemed to hold more than 50% of the voting power in XYZ at the relevant testing points.

However, this is subject to the integrity provision in section 166-270, which applies to stakes taken to be held oy a single notional entity under the tracing rule relating to direct stakes of less than 10%.

Given that the single notional entity has, at each of the testing points, greater than 50% of the voting power, section 166-270 will not cause the taxpayer to fail the Modified COT. The integrity provision in section 166-272 (Same Share Test) will have no impact on the outcome of the Modified COT for the taxpayer here. This outcome is consistent with paragraph 1.128 of the associated Explanatory Memorandum which states that the same share test does not apply in respect of stakes held by a single notional entity.

Accordingly, the Acquisition of XYZ Securities by XYZ will not result in XYZ failing the same owners test in section 165-12 of the ITAA 1997.

Yes. The capital gain under CGT event L3 upon LLC's entry into the XYZ income tax consolidated group will be reduced on the basis that all of the conditions in section 705-27 will be satisfied at the time of entry.

Section 705-27 provides a reduction in tax cost setting amount that exceeds the market value of certain retained cost base assets as follows:

(1) If:

The Explanatory Memorandum to Tax Laws Amendments (2010 Measures No 1) Bill 2010 provides the following explanation in relation to the interaction between section 705-27 and CGT event L3 in section 104-510:

5.291 A capital gain arises under CGT event L3 if the total tax cost setting amounts for all retained cost base assets exceed the joining entity's allowable cost amount (section 104-510). A capital loss cannot arise under CGT event L3.

5.292 Impaired debts qualify as retained cost base assets because they are a right to receive a specified amount of Australian currency. The tax cost setting amount of impaired debts is the face value of those debts at the joining time.

5.293 However, the face value of the debt is likely to be higher than the amount that could be recovered under the debt (that is, the market value of the debt). Therefore, the amount taken into account in working out the capital gain under CGT event L3 does not reflect the amount of the debt that is likely to be recovered. Consequently, the capital gain arising under CGT event L3 is overstated.

5.294 To overcome this concern, the tax cost setting amount of an asset of a joining entity will be reduced if:

5.295 Where an asset satisfies these conditions, the tax cost setting amount of the asset will be reduced by the amount of the capital gain arising under CGT event L3, but not below zero. [Schedule 5, item 132, subsection 705-27(1)]

5.296 As the tax cost setting amount of the asset is reduced, the capital gain arising under CGT event L3 will also be reduced by an equivalent amount (paragraph 104-510(1)(b)). The amount of the capital gain might be reduced to nil.

5.297 However, the amount of the reduction under subsection 705-27(1) is reduced if:

5.298 In these circumstances, the amount of the reduction under subsection 705-27(1) is reduced by the amount of the deduction (but not below zero). [Schedule 5, item 132, subsection 705-27(2)]

5.299 An asset is an intra-group asset if the requirements in subsection 701-58(1) are satisfied in relation to the asset. Those requirements are, broadly:

5.300 If the tax cost setting amount of two or more of a joining entity's assets could be reduced under subsections 705-27(1) and (2), a reduction is made sequentially to the tax cost setting amounts of each of those assets [Schedule 5, item 132, paragraph 705-27(3)(a)]

Whether the New Loan Notes and Accrued Interest Receivable of the LLC are retained cost base assets under paragraph 705-25(5)(b)

A retained cost base asset under paragraph 705-25(5)(b) is:

(b) A right to receive a specified amount of such Australian currency, other than a right that is a marketable security within the meaning of section ?OB of the Income Tax Assessment Act 1936;

The assets of LLC to be considered are the New Notes and Accrued Interest Receivable.

Under subsection 708(7) of the ITAA 1936, a marketable security means a "traditional security" that is covered by paragraph (a) of security in section 159GP(1) of the ITAA 1936:

Security means:

A "traditional security" is defined in section 26BB of the ITAA 1936 as follows:

Traditional security, in relation to a taxpayer, means a security held by the taxpayer that:

The term "eligible return" is defined in section 26BB to have the same meaning as in Division 16E. According to subsection 159GP(3) in Division 16E, a security has an eligible return if it is reasonably likely at the time of issue, having regard to the terms of the security that the sum of all payments under the security (other than "periodic interest”); will exceed the issue price of the security.

Under the New Note Deed Poll ("the Deed") the Issuer may, in its discretion, on any Interest Payment Date defer the payment of any amount of the interest until the next Interest Payment Date. Interest is cumulative and continues to accrue if there is optional deferral of interest.

Having regard to the terms of the Deed, the Commissioner is of the view that it is reasonably likely that the sum of all payments under the New Notes (other than "periodic interest") will exceed the issue price of the notes.

Section 705-25 states what the tax cost setting amount is for a retained cost base asset. In particular, subsection 705-25(2) provides that if the retained cost base asset is a right to receive a specified amount of such Australian currency other than a marketable security, its tax cost setting amount is equal to the amount of the Australian currency concerned.

The aggregate market value of the New Notes and Accrued Interest Receivable is less than the tax cost setting amount of the New Notes and the tax cost setting amount of the Accrued Interest Receivable pursuant to section 705-25.

The head company makes a capital gain under CGT event L3 (disregarding subsection 705-27(1)) as a result of the joining entity becoming a subsidiary member of the group

LLC (or XYZ and the XYZ Trust as partners of LLC) has not been entitled to a deduction for an income year ending on or before the joining because the market value of the asset being less than the specified amount. Accordingly, no adjustment needs to be made pursuant to subsection 705- 27(2).

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