House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 5 - Goods and services tax: interaction with consolidation regime

Outline of chapter

5.1 Schedule 6 to this bill amends the GST Act to ensure that certain supplies made in relation to the consolidation regime will not be taxable supplies.

Context of amendments

5.2 As a direct result of the consolidation regime, supplies for the purposes of the GST Act may be made both as a consequence of the statutory operation of the consolidation provisions and as a result of contractual arrangements that are entered into because of consolidation.

5.3 Some of the potential supplies that may occur as a direct result of the statutory operation of the consolidation law include:

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the transfer of tax attributes such as losses, franking credits, foreign tax credits, foreign dividend accounts and attribution account surpluses;

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the transfer of the ability to claim certain deductions and offsets such as capital allowance deductions;

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the transfer of the ability to make certain elections or declarations such as a foreign dividend account declaration; and

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the release from an obligation of joint and several liability as a result of being covered by a tax sharing agreement.

5.4 Under the current legislation, supplies resulting from the operation of the consolidation law may be taxable supplies for GST purposes in some circumstances. Even where the supply is not made for consideration, it may still be subject to GST under Division 72 of the GST Act as the supply is made between associates. The value of such supplies may be difficult to determine.

5.5 In a pre-consolidation environment, similar supplies made as a result of the operation of income tax provisions were not taxable supplies due to the operation of sections 110-5 and 110-10 of the GST Act.

5.6 In addition to statutory supplies, GST consequences may also arise in relation to agreements that directly relate to consolidation. One such type of agreement is a tax sharing agreement, as outlined in Division 721 of the ITAA 1997. Broadly speaking, a tax sharing agreement is one that allocates the group liability between the members of the group on a reasonable basis.

5.7 If an entity is party to a valid tax sharing agreement, that entity will be liable to the Commonwealth for the amount allocated under the agreement (known as the contribution amount) and will not be subject to an imposition of joint and several liability. Division 721 of the ITAA 1997 also allows for an entity to leave a consolidated group clear of the group liability if certain conditions are met, including the payment of the contribution amount to the head company of the group.

5.8 Both entering into a tax sharing agreement and leaving a group clear of the group liability may give rise to statutory supplies. These supplies will include the release from statutory obligations of joint and several liability or the obligation to pay a contribution amount should the head company default. However, entities may also make other supplies in relation to the agreement such as the entry into or the release from non-statutory obligations. The value of such supplies may be difficult to determine.

5.9 Under the consolidation regime, the head company is responsible for paying consolidated group liabilities to the Commonwealth. However, it is the activities and attributes of the subsidiary entities as well as the head company that result in the group liabilities. To reflect this, many consolidated groups will enter into agreements, commonly referred to as tax funding agreements, for subsidiaries to contribute to the group liability of the head company. Tax funding agreements may also provide for payments to be made to subsidiaries if those entities have caused an overall reduction in the group liability (e.g. if a subsidiary would have made a tax loss had it been taxed as a separate entity).

5.10 The entry into obligations under a tax funding agreement may give rise to taxable supplies for GST purposes, although this will depend to a large extent on the terms of the agreement. Prior to the introduction of the consolidation regime, GST would not have applied if a subsidiary entity paid its income tax liability directly to the Commonwealth. GST would also not have been applicable if another company made a payment to the subsidiary in respect of a transfer of its tax losses.

5.11 Both the statutory and non-statutory supplies that are made as a consequence of the consolidation regime may be made between consolidated entities that are also members of the same GST group. In these circumstances, any such supplies will not be subject to GST. However, there are a variety of reasons why the members of a consolidated group will not necessarily be members of the same GST group. The potential GST consequences of consolidation may present difficulties for entities in this situation.

5.12 Entities should be afforded similar GST treatment under the consolidation regime as the treatment they received in a pre-consolidation environment. If no amendments were made, GST may be a potential impediment for some entities that wish to enter the consolidation regime.

Summary of new law

5.13 This bill will amend the GST Act to ensure that certain supplies made as a result of the consolidation regime, specifically those made as a result of:

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the statutory operation of the consolidation provisions;

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entering into a tax sharing agreement;

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leaving a consolidated group clear of group liability; or

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entering into a tax funding agreement,

will not be taxable supplies.

Comparison of key features of new law and current law

Detailed explanation of new law

Supplies under operation of the consolidated group regime

5.14 Section 110-15 ensures that where a supply occurs because of the operation of the provisions of the consolidation law as set out in Part 3-90 of the ITAA 1997 and Part 3-90 of the IT(TP) Act 1997, that supply will not be a taxable supply for the purposes of the GST Act. These amendments should not be taken to imply that all transfers that occur as a result of the statutory operation of the consolidation regime would be taxable supplies apart from the operation of the new provision. Rather, they ensure that if such transfers could be taxable supplies, no GST consequences will result. [Schedule 6, item 1, subsections 110-15(1) and (3)]

5.15 The concept of 'the operation of these provisions' in subsection 110-15(1) is intended to be broad, as the consolidation provisions will operate in a variety of ways. The concept will include an operation of the consolidation provisions that results from an action undertaken by an entity. [Schedule 6, item 1, subsection 110-15(2)]

5.16 One such action is a choice that an entity may make under the provisions of the consolidation law [Schedule 6, item 1, paragraph 110-15(2)(a)]. These choices will include the choice to consolidate as either a consolidated group or a MEC group and various choices made under the transitional provisions. Other voluntary actions provided for under the consolidation law, such as entering into a tax sharing agreement, are also included [Schedule 6, item 1, paragraph 110-15(2)(b)].

Tax sharing agreements

5.17 Section 110-15 will apply to some of the supplies that may be made in relation to tax sharing agreements, such as the statutory release from joint and several liability or from liability in respect of contribution amounts when an entity leaves a group clear of the group liability. However, there may also be non-statutory supplies that are made in relation to tax sharing agreements. These supplies are dealt with in sections 110-20 and 110-25. It is envisaged that some supplies will be covered under more than one of these provisions.

Entering into the agreement

5.18 Section 110-20 deals with supplies, including the entry into non-statutory obligations, that may be made when entering into a tax sharing agreement. The section will have application if an entity makes a supply because it enters into a new agreement or becomes party to an existing agreement that meets the requirements for a tax sharing agreement as stipulated in subsections 721-25(1) and (2) of the ITAA 1997. The satisfaction of the requirements in those subsections is to be tested at the time the entity enters into or becomes party to the agreement. The agreement must relate to an existing or future group liability of the head company of a consolidated group (or a MEC group). [Schedule 6, item 1, subsection 110-20(1)]

5.19 A supply that is made by an entity because it enters into a tax sharing agreement will not be a taxable supply to the extent to which that supply relates to the fact that the agreement satisfies the requirements of subsections 721-25(1) and (2) of the ITAA 1997. If the agreement partially concerns meeting the requirements of subsections 721-25(1) and (2) and partially concerns other matters, the concessional treatment will only apply to that part of the supply that relates to meeting the requirements. [Schedule 6, item 1, subsections 110-20(2) and (3)]

5.20 Definitions of the terms consolidated group, group liability, head company and MEC group are inserted in the GST dictionary by reference to section 703-5, paragraph 721-10(1)(a), subsection 995-1(1) and section 719-5 of the ITAA 1997 respectively. [Schedule 6, items 2, 4 to 6, section 195-1]

Leaving the group clear of group liability

5.21 Section 110-25 deals with certain supplies, including non-statutory supplies, that may be made when an entity leaves a consolidated group. It provides that if:

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an entity, known as a TSA contributing member, has left a consolidated group (or a MEC group) clear of the group liability for the purposes of subsection 721-30(3) of the ITAA 1997; and

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a supply of a release of an obligation relating to a contribution amount in relation to a group liability of the head company is made to that exiting entity,

then that supply will not be a taxable supply. [Schedule 6, item 1, section 110-25]

5.22 Definitions of the terms contribution amount and TSA contributing member are inserted in the GST dictionary by reference to paragraphs 721-25(1)(b) and 721-25(1)(a) of the ITAA 1997 respectively. [Schedule 6, items 3 and 10, section 195-1]

Tax funding agreements

5.23 Section 110-30 provides that a supply made because an entity enters into a new agreement or becomes party to an existing agreement that:

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is in writing [Schedule 6, item 1, paragraph 110-30(1)(a)];

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deals with the distribution of economic burdens and benefits that directly relate to consolidated group tax-related liabilities of a head company amongst members (and former members) of the group [Schedule 6, item 1, paragraph 110-30(1)(b)]; and

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complies with any requirements that may be set out in the regulations to the GST Act [Schedule 6, item 1, paragraph 110-30(1)(d)],

will not be a taxable supply to the extent to which the supply relates to the fact that the agreement deals with the 'distribution' outlined in paragraph 110-30(1)(b). If the supply is an input taxed supply, section 110-30 will not alter that treatment. [Schedule 6, item 1, subsections 110-30(2) and (4)]

5.24 The agreement may be made prior to the formation of a consolidated or MEC group. In this circumstance, the agreement must be made in contemplation that the parties to the agreement will become members of such a group. [Schedule 6, item 1, paragraph 110-30(1)(c)]

5.25 The concept of 'distribution of economic burdens and benefits directly related to tax-related liabilities' as set out in paragraph 110-30(1)(b) is intended to encompass a range of arrangements put in place to allocate the income tax liabilities of the head company across the group. The most common form of distribution would involve subsidiaries making contributions to assist the head company with payment of the liabilities of the group [Schedule 6, item 1, paragraph 110-30(3)(a)]. Another potential type of distribution is where payments are made to subsidiaries in recognition that their activities or attributes have caused an overall reduction in the consolidated group tax-related liabilities of the head company [Schedule 6, item 1, paragraph 110-30(3)(b)].

Example 5.1

Alexander Co. is the head company of the Conquest consolidated group. The subsidiary members of that group are Caesar Co. and Napoleon Co. During the 2005-2006 income year, Napoleon Co. is involved in the disastrous Waterloo Project that results in that company making substantial losses that have the effect of reducing the overall income tax liability for the Conquest consolidated group. Alexander Co., Caesar Co. and Napoleon Co. have entered into an agreement that makes provision for Alexander Co. to make a payment to Napoleon Co. in respect of the effect of these losses on the tax-related liabilities of the head company. This aspect of the agreement will meet the criteria for dealing with the distribution described in paragraph 110-30(1)(b) of the GST Act.

5.26 The distribution can also take into account distributions made to or from former members of the group, as far as they concern the consolidated group tax-related liabilities of the head company.

Example 5.2

During the 2006-2007 income year, 100% of the membership interests in Caesar Co. are bought in a hostile takeover by Brutus Ltd. After Caesar Co. has left the Conquest consolidated group, an amended assessment is raised in respect of Caesar Co.'s activities when it was a member of the group. The agreement provides that Caesar Co. pay an amount to Alexander Co. in respect of the amended assessment. This aspect of the agreement will meet the criteria for dealing with the distribution described in paragraph 110-30(1)(b) of the GST Act.

5.27 Definitions of the terms member of a consolidated group and tax-related liabilities are inserted in the GST dictionary by reference to section 703-15 of the ITAA 1997 and section 255-1 in Schedule 1 to the TAA 1953 respectively [Schedule 6, items 7 and 9, section 195-1]. The note at the end of the definition of a taxable supply is amended to include references to sections 110-15, 110-20, 110-25 and 110-30 [Schedule 6, item 8, section 195-1].

Application and transitional provisions

5.28 The amendments apply, and are taken to have applied, in relation to net amounts for tax periods starting or that started on or after 1 July 2002, which is the commencement date for the consolidation regime. [Schedule 6, item 11]