Disclaimer
This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1051271138234

Date of advice: 24 August 2017

Ruling

Subject: Share capital tainting

Question 1

Will the assignment or forgiveness of the intercompany loans constitute an amount that is transferred to the Company B, or in the case of an assignment of the intercompany loan, an amount transferred to the share capital account of Company Z for the purposes of section 197-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the assignment or forgiveness of the intercompany loans cause a franking debit to arise in the franking account of Company A in accordance with subsection 709-75(2) of the ITAA 1997?

Answer

No.

Question 3

Will the assignment or forgiveness of the intercompany loans give rise to an amount of tax imposed under the New Business Tax System (Franking Deficits Tax) Act 2002?

Answer

No.

Relevant facts and circumstances

Limitation of scope

The Commissioner’s opinion on the effect of the assignment or forgiveness under the commercial debt forgiveness rules contained in Division 245 of the ITAA 1997 is neither sought nor provided.

Background

Company A is the head company of an income tax consolidated group (the group) with its wholly owned subsidiary entities, which include Company B, Company C, Company D and Company Z.

As part of the group’s operations, Company D (Creditor Company) provided a loan to Company B (Debtor Company) and Company C (Creditor Company) provided a loan to Company D (Debtor Company).

Company D will forgive the loan amount owed by Company B.

Company A will assign the loan amount Company D owed to Company C to Company Z (Assignee Company).

The accounting entries

Company A will account for the assignment or forgiveness of these loans as follows:

Creditor Company Assignee Company or

Debtor Company

The credit entry in the accounts of the Creditor Company recognises that it will cease to have an asset. It will therefore reduce its assets (i.e. the intercompany loan that was forgiven or assigned). This loss of value will be recognised as a debit to retained earnings and this debit will not be treated as an expense through the profit and loss, but rather affects the accumulated retained earnings balance (i.e. this will have a balance sheet impact).

The debit entry in the accounts of the Debtor Company will recognise that the debtor has ceased to have a liability (i.e. the intercompany loan that was forgiven). This decrease in its liabilities will be recognised as a credit to the retained earnings account and this credit will not be treated as an income amount through the profit and loss, but rather affects the accumulated retained earnings balance (i.e. this will have a balance sheet impact).

The debit entry in the accounts of the Assignee Company will recognise that Company Z will be assigned an asset (i.e. the intercompany loan that was assigned). This increase in its assets will be recognised as a credit to the retained earnings account and this credit will not be treated as an income amount through the profit and loss, but rather affects the accumulated retained earnings balance (i.e. this will have a balance sheet impact).

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 197.

Income Tax Assessment Act 1997 Subdivision 197-A.

Income Tax Assessment Act 1997 Subsection 197-5.

Income Tax Assessment Act 1997 Subsection 197-5(1).

Income Tax Assessment Act 1997 Subsection 197-5(2).

Income Tax Assessment Act 1997 Subsection 197-45(1).

Income Tax Assessment Act 1997 Section 205-45.

Income Tax Assessment Act 1997 Section 205-45(2).

Income Tax Assessment Act 1997 Section 205-45(3).

Income Tax Assessment Act 1997 Subsection 709-75(1).

Income Tax Assessment Act 1997 Subsection 709-75(2).

Income Tax Assessment Act 1997 Subsection 709-75(3).

Income Tax Assessment Act 1997 Section 975-300.

Income Tax Assessment Act 1997 Subsection 975-300(1).

Income Tax Assessment Act 1997 Subsection 975-300(2).

Income Tax (Transitional Provisions) Act 1997 Section 205-20.

Income Tax (Transitional Provisions) Act 1997 Subsection 205-20(2).

Income Tax (Transitional Provisions) Act 1997 Section 205-25.

New Business Tax System (Franking Deficits Tax) Act 2002 Section 3.

New Business Tax System (Franking Deficits Tax) Act 2002 Section 4.

Reasons for decision

In these reasons for decision, all legislation references are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless specified otherwise.

Question 1

Summary

The assignment or forgiveness of each intercompany loan will not constitute an amount that is transferred to the share capital account of the relevant debtor companies or in the case of an assignment of the intercompany loan, an amount that is transferred to the share capital account of Company Z for the purposes of section 197-5.

Detailed reasoning

Section 709-75 operates to debit the franking account of the head company of a consolidated group if a debit would otherwise arise in the franking account of a subsidiary member of the group. The consolidation single entity rule does not affect the operation of section 709-75.

Subsection 197-5(1) states:

Subsection 197-45(1) provides that where an amount is transferred to a company’s share capital account, a franking debit arises in the company’s franking account immediately before the end of the franking period in which the transfer happened.

The exclusions in subdivision 197-A (which are set out in sections 197-10 to 197-42) will not be relevant for the Company A group of companies.

Meaning of share capital account

The term ‘share capital’ is not defined in Australian income tax legislation. However, the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 3) Bill 2006 which introduced section 975-300 into the ITAA 1997 states:

A company’s share capital comprises amounts received by a company as consideration for the issue of shares.

The concept of share capital is discussed in paragraphs 32, 34 and 50 of Taxation Ruling TR 2012/1: Income tax: retail premiums paid to shareholders where share entitlements are not taken up or are not available which state:

Transfer to a share capital account

Loans to be forgiven

Under the current proposed arrangement, the following accounting entries will be recorded in the accounts of Company B to reflect Company D forgiveness of the intercompany loan:

The debit entry in the accounts of Company B recognises that it will cease to be liable for the loan amount payable to Company D that will be forgiven.

The decrease in liabilities will be reflected as a credit to the retained earnings account of Company B. The credit entry will not be treated as an income amount through the profit and loss account, but instead will affect the retained earnings balance at the end of the financial period in which Company D forgives the loan amount owed by Company B.

Although retained earnings are recorded under shareholder’s equity in the balance sheet of Company B, the account remains entirely separate from other shareholder’s equity accounts such as the ‘share capital account’.

Loans to be assigned

The following accounting entries will be recorded in the accounts of the assignee company, Company Z:

The credit entry above in Company Z’s account will recognise that Company Z will be entitled to receive the intercompany loan that Company C will assign to Company Z.

The increase in the assets of Company Z will be reflected as a credit to the retained earnings / (accumulated losses) account. The credit entry will not be treated as an income amount through the profit and loss account, but instead will affect the retained earnings / (accumulated losses) balance at the end of the financial period in which Company C will assign the intercompany receivable to Company Z, due to the balance sheet impact of the accounting treatment.

Although retained earnings / (accumulated losses) are recorded under shareholder’s equity in the balance sheet of Company Z, the retained earnings / (accumulated losses) account remains entirely separate from other shareholder’s equity accounts such as the share capital account.

Conclusion

Based on the above accounting entries, the Commissioner accepts that no part of the forgiveness of the intercompany loan will cause, or result in, the transfer of an amount to the share capital account of Company B from another shareholders’ equity account of Company B, nor will the forgiveness cause, or result in, an increase in the Company B’s share capital account.

The Commissioner accepts that no part of the assignment of the intercompany loan will cause, or result in, the transfer of an amount of the share capital account of Company C from another shareholders’ equity account of Company C, nor will the assignment cause, or result in, an increase in Company Z’s share capital account.

Question 2

Summary

The assignment or forgiveness of the intercompany loans will not cause a franking debit to arise in the franking account of Company A in accordance with subsection 709-75(2).

Detailed reasoning

Section 709-75 operates to debit the franking account of the head company of a consolidated group if a debit would otherwise arise in the franking account of a subsidiary member of the group. The consolidation single entity rule does not affect the operation of section 709-75.

Subsection 197-45(1) provides that where an amount is transferred to a company’s share capital account, a franking debit arises in the company’s franking account immediately before the end of the franking period in which the transfer happened.

As set out in the Reasons for Decision for Question 1, the Commissioner accepts that there is no ‘transferred amount’ to the share capital account of each of Company B and Company Z.

The Commissioner also notes that Company D will record the following accounting entries to reflect the forgiveness of the loan:

The Commissioner also notes that Company C will record the following accounting entries to reflect the assignment of the loan:

Conclusion

The Commissioner accepts that there is no ‘transferred amount’ to Company B’s share capital account caused by, or as a result of Company D’s forgiveness of the loan.

As the share capital account of Company B, or the share capital account of Company D, will not otherwise be tainted by Company D’s forgiveness of the loan, the forgiveness will not cause, nor result in, a debit arising in the franking account of Company A under section 709-75.

The Commissioner also accepts that there is no ‘transferred amount’ to the share capital account of Company C caused by, or as a result of, Company A’s assignment of the intercompany loan.

As the share capital account of Company C or the share capital account of Company D would not otherwise be tainted by the assignment of the intercompany loans, the assignment will not cause, nor result in, a debit to the franking account of Company A under section 709-75.

Question 3

Summary

The assignment or forgiveness of the intercompany loans will not give rise to an amount of tax imposed under the New Business Tax System (Franking Deficits Tax) Act 2002.

Detailed reasoning

Franking deficit tax (FDT) is imposed by section 4 of the New Business Tax System (Franking Deficits Tax) Act 2002 (the FDT Act).

As set out in Section 3 of the FDT Act:

A liability to FDT arises where:

● An entity’s franking account is in deficit at the end of the income year (Subsection 205-45(2))

● An entity’s franking account is in deficit immediately before the entity ceases to be a franking entity (Subsection 205-45(3)), or

● A late balancing company elects to have its FDT liability determined on 30 June under section 205-0 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA 1997). The entity’s liability is therefore determined under sections 205-25 and 205-30 of the ITTPA 1997 (Subsection 205-20(2) of the ITTPA 1997).

The Commissioner confirms that the assignment of the intercompany loan or the forgiveness of the intercompany loan will not of itself give rise to an amount of tax imposed under the New Business Tax System (Franking Deficits Tax) Act 2002.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).