House of Representatives

Explanatory Memorandum

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

Chapter 2 - Value shifting through debt forgiveness

Outline of Chapter

2.1 Schedule 2 to this Bill inserts new Division 139 into the ITAA 1997. Division 139 deals with CGT value shifting that occurs where, broadly, a debt owed by one commonly owned company to another is forgiven.

2.2 New Division 139 deals with these value shifts by requiring cost base and reduced cost base reductions to be made to equity acquired on or after 20 September 1985 (post-CGT) and, in certain circumstances, to post-CGT debt interests held directly or indirectly in the creditor company. In some cases, compensatory cost base and reduced cost base increases will be necessary for post-CGT equity interests held directly or indirectly in the debtor company.

Context of Reform

2.3 CGT value shifting describes transactions and other arrangements which shift value out of, and usually between, assets (including shares in companies). Value shifting is a problem because it distorts the calculation of capital gains and capital losses when assets are realised. Decreased value assets can be sold to bring forward losses whilst gains are deferred on increased value assets.

2.4 A particular type of value shifting is asset stripping , where the removal of asset value from an entity affects the value of interests in that entity. Asset stripping is currently dealt with by Division 138 of the ITAA1997.

2.5 Broadly, Division 138 of the ITAA 1997 applies to value shifts which occur between companies under common ownership, where the value shift occurs by the transfer or creation of an asset at undervalue . Undervalue can mean for less than the assets market value or, in some cases, for less than its cost base.

2.6 Where there has been a value shift, Division 138 of the ITAA 1997 may require a reduction in the cost base and reduced cost base of shares and loans (and indirect interests held in shares and loans) in the company transferring or creating the asset at undervalue. This Division also provides for increases to the cost base and reduced cost base of shares (and indirect interests in shares) in the company to which the value is shifted.

2.7 Division 138 of the ITAA 1997 does not apply to value shifting by way of debt forgiveness because this does not involve the transfer or creation of an asset. The commercial debt forgiveness (CDF) provisions (contained in the ITAA 1936) also generally do not require a compensating adjustment where the face value of the debt forgiven is equal to its market value.

2.8 Example 2.1 demonstrates value shifting by way of debt forgiveness.

Example 2.1

Holdco capitalises Subco with $200 post-CGT and receives 200 shares of the same class. Subco lends $100 back to Holdco. The loan is then forgiven and no consideration is given for the forgiveness. Assuming the market value of the loan is equal to its face value, Subco does not make a capital loss on the ending of the loan (because Subco is taken to have received market value capital proceeds). However, there has been a value shift of $100 from Subco to Holdco.

If Holdco immediately sold Subco, Holdco could realise a loss of $100 (as the market value of Subco would now be $100). This loss would be artificial as the company group has not suffered any economic loss from the arrangement.

2.9 The provisions contained in this Bill will address this deficiency in Division 138 of the ITAA 1997.

Interaction with the commercial debt forgiveness provisions

2.10 The existing CDF provisions do not adjust the tax attributes (such as its carry forward losses) of a debtor to the extent the cost base of the debtors asset has been reduced under the CGT provisions as a result of the forgiveness of a debt (refer to paragraph 245-85(1)(c) of the ITAA1936).

2.11 If adjustments required by new Division 139 were not excluded from this rule, the CDF adjustment could be inappropriately reduced on the forgiveness of a valuable debt. This would be the case where the debt being forgiven was between a subsidiary company (creditor) and its holding company (debtor) (as in example 2.1).

2.12 For example, if a debt with a face value of $100 and market value of $50 were forgiven, and no consideration was received for the forgiveness, Division 139 could cause a cost base reduction of $50 to interests held in the creditor subsidiary company (for example, the shares held by the debtor holding company). This would reflect the value shifted out of the creditor subsidiary company by the forgiveness.

2.13 The CDF provisions would usually apply to adjust the tax attributes of the debtor holding company (and related companies) in respect of the difference between the face value of the debt ($100) and its deemed market value ($50) at the time of the forgiveness.

2.14 Under the existing rules, the Division 139 adjustment of $50 would have to be subtracted from the potential CDF adjustment amount, reducing that amount to nil. No adjustment would therefore be made under the CDF measures to reflect the gain to the debtor holding company as a result of the forgiveness.

2.15 Therefore, the introduction of new Division 139 will require a consequential amendment to the CDF provisions to deal with this situation.

Example 2.2

Assume the same facts as in Example 2.1 except that the loan to Holdco had a market value of $60 at the time of its forgiveness. When the loan is forgiven and no consideration is given for the forgiveness, Subco will generally realise a capital loss of $40, being the difference between the reduced cost base of the loan (i.e. its face value) and its market value.

There has been a value shift of $60 from Subco to Holdco, to which new Division 139 would apply. Division 139 would require the cost base of the shares in Subco to be reduced by $60 so that it would now be $140.

In addition, under the amended CDF provisions there would be a net forgiven amount of $40 which would have to be used to reduce certain amounts in Holdco. Assuming Holdco and Lossco had no carry forward losses and Holdcos only asset was its shares in Subco, the cost base of the shares would be reduced to $100. If the shares in Subco were then sold, no loss would be realised.

The overall effect of both the amended CDF provisions and new Division 139 is that a loss of $40 is allowed to Subco reflecting the $40 economic loss made by the group.

2.16 In many cases, either the CDF provisions or new Division 139 (but not both) will require adjustments as a result of the forgiveness of a debt.

2.17 For example, where the market value of a debt which is forgiven is equal to its face value, the CDF provisions will not generally require an adjustment but new Division 139 will apply. Alternatively, where the market value of a debt forgiven is nil, new Division 139 will have no application (because there would be no value shift) but the CDF provisions may require an adjustment.

Summary of new law

2.18 New Division 139 will apply where:

•

a debt owed by one company to another is forgiven;

•

at the time of the forgiveness, the creditor and debtor companies are under common ownership; and

•

the debtor is not a 100% subsidiary of the creditor company.

2.19 Where this occurs, the usual case is that cost base and reduced cost base reductions will be required firstly to post-CGT equity interests held directly in the creditor company and, in some cases, also to post-CGT debt interests owned directly in the creditor company. Cost base and reduced cost base reductions may also be required to indirect interests in post-CGT equity and debt in the creditor company. In addition, compensatory cost base and reduced cost base increases may also be required to shares held in the debtor company (and to indirect interests in such shares).

2.20 The reductions to the cost base and reduced cost base of interests held directly in the creditor company are calculated using a formula approach to provide certainty. However, this approach is not used in certain cases if it gives an unreasonable outcome. Other adjustments are to be made on a reasonable basis having regard to various stated factors.

Detailed explanation of new law

2.21 New Division 139 will be inserted into the ITAA 1997 to deal with value shifts involving the forgiveness of debts. Division 139 will apply to a taxpayer where:

•

a company (the debtor company ) has an obligation to pay a debt to another company (the creditor company ); and

•

the taxpayer has a share in, a loan to, or an indirect interest in a share or loan in the creditor company, or a share in, or an indirect interest in a share in the debtor company.

[Subsection 139-10(1)]

2. 22 In addition, the conditions in one of the following scenarios must be satisfied.

Scenario 1

2.23 CGT event C2 (the trigger event ) must happen to the debt or part of the debt (the surrendered amount ) at a time (the forgiveness time ) on or after 22 February 1999 and the capital proceeds the creditor company receives or is entitled to receive from the trigger event are less than the market value of the surrendered amount at the forgiveness time. In addition, the debtor and creditor companies must be under common ownership at the forgiveness time. [Subsection 139-10(3)]

2.24 CGT event C2, contained in section 104-25 of the ITAA 1997, deals with the ending of the ownership of a CGT asset in certain circumstances. Those circumstances include the satisfaction or release of an asset. CGT event C2 would apply where a debt is forgiven. It would also apply where part of a debt is forgiven, as section 108-5 of the ITAA1997 provides that a CGT asset includes part of an asset.

2.25 Where a debt is forgiven and the capital proceeds are less than the market value of the debt, there can be a value shift from the creditor to the debtor company. The amount of the value shift will be the difference between the market value of the debt and the amount of the capital proceeds. This is the amount of value shift that new Division 139 will address.

2.26 New Division 139 will only apply where the capital proceeds the creditor company receives or is entitled to receive from the CGT event are less than the market value of the surrendered amount at the forgiveness time. When determining the capital proceeds for the forgiveness of a debt, the market value substitution rules are ignored. [Section 139-20]

Scenario 2

2.27 There must be a substantial and permanent reduction in the value of the debt because of something done (the trigger event ) by the creditor company or by both companies at a time (the forgiveness time ) on or after 22 February 1999 and the money and market value of other property (if any) received or receivable by the creditor company for the reduction are less than the amount of the reduction. In addition, the debtor and creditor companies must be under common ownership at the forgiveness time. [Subsection 139-10(4)]

2.28 A substantial and permanent reduction is a reduction which is not insignificant compared to the market value of the debt and which, on an objective examination of the facts, is one not likely to be reversed. Whether a reduction is substantial and permanent must be determined by taking into account the facts of the particular case.

2.29 A substantial and permanent reduction in the value of a debt may occur where the rights attached to a debt are altered. For example, the debt may be converted to subordinate debt or the date for repayment of the debt may be significantly extended. In some instances, the value of the debt would be expected to fall substantially and permanently in these circumstances.

2.30 Where there is a reduction in the value of a debt and the amount received or receivable by the creditor company for the reduction is less than the amount of the reduction, there will be a value shift from the creditor to the debtor company. The amount of the value shift will be the difference between the amount of the reduction and the amount received or receivable by the creditor company for the reduction. This is the amount of value shift that new Division 139 will address.

Threshold issues

2.31 A debt for the purposes of new Division 139 has not been defined but will instead take its ordinary meaning. As mentioned at paragraph 2.24, a debt would include part of a debt.

2.32 New Division 139 will only apply where the debt is owed between companies which are under common ownership at the forgiveness time. Two companies will be under common ownership where they are members of the same wholly-owned group or where the companies are ultimately owned by the same individuals in the same proportions (refer to subsection 138-15(2) of the ITAA 1997).

2.33 However, new Division 139 will not apply where the debtor company is a 100% subsidiary of the creditor company [subsection 139-10(2)] . In this situation, there would be no potential for an artificial loss or reduced gain to result from the value shift.

Consequences of Division 139 applying

2.34 Where the relevant conditions are met, adjustments to the cost base and reduced cost base of shares and debts in the creditor company and indirect interests in those shares and debts may be required. Adjustments may also be required to the cost base and reduced cost base of shares, and indirect interests in shares, in the debtor company. The cost base and reduced cost base adjustment mechanisms will be based (broadly) on those contained in Subdivision 138-E of the ITAA 1997.

2.35 Reductions to cost bases and reduced cost bases of direct interests in the creditor company are to be made as at the forgiveness time. [Subsection 139-15(1)]

2.36 Adjustments to cost bases and reduced cost bases of indirect interests in the creditor company and to direct and indirect interests in the debtor company are to be made as at the time of a CGT event applying to those interests [subsection 139-15(2)] . This will mean that these adjustments to the cost base or reduced cost base would be made at the time of calculating any capital gain or capital loss from the CGT event.

Direct interests in shares in creditor company

2.37 Where new Division 139 applies, and all of the shares in the creditor company at the forgiveness time are post-CGT shares, their cost base and reduced cost base will be reduced under new subsection 139-25(1). Where there are pre-CGT shares, or more than one class of share in the creditor company, new section 139-30 may apply. (Refer to paragraphs 2.41 and 2.42.)

2.38 The method of doing the reduction where the trigger event is CGT event C2 is as follows:

•

divide the market value of the share just before the forgiveness time by the sum of the market values of all the post-CGT shares in the creditor company. The result is the share reduction factor [subsection 139-25(2)] ;

•

reduce the market value of the surrendered amount by the capital proceeds the creditor company receives or is entitled to receive from the trigger event;

•

multiply this result by the share reduction factor;

•

the result is the maximum reduction amount ;

•

reduce the cost base and reduced cost base of the share to the extent possible by the maximum reduction amount [subsection 139-25(3)] . The cost base and reduced cost base cannot be reduced below nil.

2.39 Example 2.3 demonstrates the operation of new section 139-25 where the trigger event is a CGT event C2.

Example 2.3

Using the facts from Example 2.1, assume that each of the 200 shares on issue in Subco has a market value of $2. Applying new section 139-25, the share reduction factor would be 0.005 (that is, 2/400). This would be multiplied by the value shift of $100 to give a cost base and reduced cost base reduction of $0.50 (the maximum reduction amount ). Therefore, the cost base and reduced cost base of each share in Subco would be reduced to $0.50.

2. 40 Where new Division 139 applies, and the trigger event is something done which causes a substantial and permanent reduction in the value of the debt, the cost base and reduced cost base of any post-CGT shares held in the creditor company at the forgiveness time will be reduced as follows:

•

calculate the share reduction factor as outlined in paragraph 2.38;

•

reduce the amount of the substantial and permanent reduction in the value of the debt by the money and market value of any other property (if any) received or receivable by the creditor company for the reduction;

•

multiply this result by the share reduction factor;

•

the result is the maximum reduction amount ;

•

reduce the cost base and reduced cost base of the share to the extent possible by the maximum reduction amount . The cost base and reduced cost base cannot be reduced below nil.

Different calculation in certain circumstances

2. 41 However, a reduction is not required under new section 139-25 where:

•

at the forgiveness time:

-

there were 2 or more classes of shares owned in the creditor company; or

-

the taxpayer or another entity owned a share in the creditor company that was acquired before 20September1985 (pre-CGT); and

•

it would be unreasonable to reduce the cost base and reduced cost base of the share by as much as would be required under new section 139-25.

[Subsection 139-30(1)]

2.42 In this situation, the cost base and reduced cost base of the post-CGT share are reduced by a reasonable amount having regard to the circumstances in which the share was acquired and the extent to which its market value was reduced by the trigger event. [Subsection 139-30(2)]

2.43 Example 2.4 demonstrates when new section 139-30 could apply.

Example 2.4

Holdco capitalises Subco with $100 pre-CGT and receives 100 shares. Subco lends the $100 back to Holdco, also pre-CGT. Subsequently, Holdco subscribes another $100 to Subco post-CGT and receives another 100 shares.The loan is then forgiven and no consideration is given by Holdco. Assuming the market value of the loan was still equal to its face value, there has been a value shift of $100 from Subco to Holdco.

It is also assumed that, immediately prior to the forgiveness, the shares in Subco are worth $2.50 each and that immediately afterwards they are worth $2 each.

If new section 139-25 applied to this situation, the share reduction factor would be 0.01 ($2.50/250). Therefore, the cost base and reduced cost base of each post CGT share would be reduced by $1 (0.01 * 100). However, this result would be unreasonable because the market value of the pre-CGT shares has also been reduced by the value shift.

Applying new section 139-30, the cost base of each post-CGT share would be reduced by $0.50, being the amount by which the market value of each share was reduced by the value shift.

Direct interests in loans to creditor company

2.44 New section 139-35 deals with the reduction in the cost base and reduced cost base of loans to the creditor company. Where there are pre-CGT shares in, or more than one loan to, the creditor company, new section 139-40 may apply. (Refer to paragraphs 2.52 to 2.54.) New section 139-35 will apply where:

•

a loan is owed to the creditor company at the forgiveness time;

•

the loan was acquired post-CGT; and

•

either:

-

the value of the loan was reduced by the trigger event; or

-

the loan was not an arms length loan.

2. 45 Where these conditions are satisfied, any reductions to the cost base and reduced cost base of the loan must be calculated under section 139-35. However, reductions only occur where one of the following applies:

•

there are no post-CGT shares in the creditor company acquired before the forgiveness time;

•

the cost base or reduced cost base of one or more shares in the creditor company has been reduced to nil under section 139-25; and

•

the market value of all the post-CGT shares in the creditor company, just before the forgiveness time, is nil.

[Subsection 139-35(1)]

2.46 This section ensures that if the whole of the maximum reduction amount is not used to reduce the cost base and reduced cost base of shares under new section 139-25(i.e. the amount of cost base and reduced cost base is less than the maximum reduction amount ), then the excess will be used to reduce the cost base and reduced cost base of loans to the creditor company.

2.47 The first step in calculating any reduction required under new section 139-35 is to calculate the loan reduction factor . This is determined by dividing the market value of the loan just before the forgiveness time by the sum of the market values of all the loans (that were acquired post-CGT) to the creditor company just before the forgiveness time. [Subsection 139-35(2)]

2.48 Where there were no shares to which new section 139-25 could apply, or the market value of all the post-CGT shares in the creditor company just before the forgiveness time is nil, the cost base and reduced cost base of the loan are reduced in the same way as in new section 139-25 (discussed at paragraph 2.38) except that the loan reduction factor (rather than the share reduction factor ) is used. [Subsection 139-35(3)]

2.49 If new section 139-25 has operated to reduce the cost base of one or more shares in the creditor company to nil, and the maximum reduction amount exceeded the cost base of the share (i.e. before the reduction), the reduction in the cost base of the loan is determined as follows:

•

the excess for each share whose cost base has been reduced to nil is multiplied by the loan reduction factor [subsection 139-35(4)] ;

•

the sum of the amounts obtained is the reduction in the cost base of the loan [subsection 139-35(5)] .

2.50 If new section 139-25 has operated to reduce the reduced cost base of one or more shares in the creditor company to nil, and the maximum reduction amount exceeded the reduced cost base of the share (i.e. before the reduction), the reduction in the reduced cost base of the loan is determined as follows:

•

the excess for each share whose reduced cost base has been reduced to nil is multiplied by the loan reduction factor [subsection 139-35(6)] ;

•

the sum of the amounts obtained is the reduction in the reduced cost base of the loan [subsection 139-35(7)] .

2. 51 Example 2.5 demonstrates the operation of new section 139-35.

Example 2.5

Holdco capitalises Subco A with $100 post-CGT and receives 100 shares. Subco A then capitalises Subco B with $100. Subco A subsequently trades profitably. Subco A then lends $150 to Holdco and Subco B lends $70 to SubcoA. Subco A then forgives the debt to Holdco and no consideration is given for the forgiveness. At that time, the market value of each share in Subco A is assumed to be $2. Assuming the market value of the loan is equal to its face value, there is a value shift of $150 from Subco A to Holdco.

Under new section 139-25, the maximum reduction amount will be $1.50 ($150 * (2/200)). Since the cost base and reduced cost base of the shares in Subco A is $1, they will be reduced to nil. The excess amount of $0.50 per share will then be applied under new section 139-35.

The loan reduction factor will be one (70/70). New subsections 139-35(4) to 139-35(7) would then apply to reduce the cost base and reduced cost base of the loan from Subco B to Subco A by $50 (i.e. the excess amount of $0.50 per share * 100 shares).

Different calculation in certain circumstances

2. 52 However, the cost base or reduced cost base of a loan owned by a taxpayer is not reduced under new section 139-35 if:

•

at the forgiveness time:

-

there was a pre-CGT share held in the creditor company;

-

the taxpayer owned another loan to the creditor company; or

-

another loan to the creditor company was owned by a company that was a member of the same wholly-owned group or by an individual who was an ultimate owner of the creditor and debtor company; and

•

it would be unreasonable to reduce the loan by as much as would be required under section 139-35.

[Subsection 139-40(1)]

2.53 Where these conditions are met, the cost base and reduced cost base are reduced by a reasonable amount having regard to the circumstances in which the loan was acquired and the extent to which its market value was reduced by the trigger event. [Subsection 139-40(2)]

2.54 New section 139-40 could apply where all of the shares in a company were acquired pre-CGT and there was a post-CGT loan owed to the creditor company. In this case, if new section 139-35 were to apply, the whole of the maximum reduction amount would be applied to reduce the cost base of the loan. Under new section 139-40, any reduction in the market value of the loan can be taken into account in determining the reduction in the cost base and reduced cost base of the loan.

2.55 Example 2.6 demonstrates when new section 139-40 could apply.

Example 2.6

Modifying the facts in Example 2.5, assume the shares held by Holdco in Subco A were all acquired pre-CGT. Further, assume that the market value of the loan from Subco B to Subco A was not affected by the value shift.

In this situation, new section 139-25 would not operate to adjust the cost base and reduced cost base of shares in Subco A. If new section 139-35 applied, the full amount of the value shift of $150 would be offset against the cost base and reduced cost base of the loan from Subco B to Subco A. The cost base and reduced cost base would be reduced to nil, regardless of the fact that the value shift did not affect the market value of the loan.

Under new section 139-40, no adjustment would be required to the cost base and reduced cost base of the loan because the market value of the loan was not altered by the value shift.

Indirect interests in creditor company

2. 56 Under new section 139-45 the cost base and reduced cost base of a CGT asset must be reduced if:

•

because of owning the asset, a taxpayer has an indirect interest in a share in, or loan to, the creditor company;

•

the asset was owned at the forgiveness time;

•

a CGT event happens in relation to the asset;

•

the asset was acquired post-CGT; and

•

new Division 139 has applied to reduce the cost base or reduced cost base of one or more shares in, or loans to, the creditor company.

[Subsection 139-45(1)]

2.57 The amount of the reduction is such amount as is reasonable having regard to the reduction in the value of the CGT asset as a result of the trigger event and, in the case of cost base reductions, inflation measured by reference to the All Groups CPI Number. [Subsection 139-45(2)]

2.58 In regard to a taxpayer having an indirect interest in a share in, or loan to, the creditor company , the words indirect interest do not require an interest in a strict legal or technical sense. There is a relevant interest if it would be reasonable to conclude, by tracing the effect of the value shift through an interposed entity or interposed entities, that the CGT asset could be affected by a shift in value out of a share in, or loan to, the creditor company.

2.59 Example 2.7 demonstrates when new section 139-45 could apply.

Example 2.7

Holdco capitalises Subco A with $200 post-CGT. Subco A then capitalises Subco B and Subco B capitalises Subco C with $200 each. Subco C subsequently lends $50 to Subco A. The debt is then forgiven and no consideration is given for the forgiveness. Assuming the debt is worth its face value, there has been a value shift of $50 from Subco C to Subco A.

The effect of the value shift on Subco As shares in Subco B would be accounted for under new section 139-45 as Subco A has an indirect interest in the creditor company (Subco C). Assuming an adjustment has been done under new section 139-25 and the market value of Subco As shares in Subco B has decreased by the amount of the value shift, then the cost base and reduced cost base of Subco As shares in Subco B would be reduced by $50 (ignoring inflation) if a CGT event happens to the shares.

The effect of the value shift on Holdcos shares in Subco A would have to be determined under both new sections 139-45 and 139-50.There would be no adjustment to Holdcos shares in Subco A if the market value of the shares has not been affected by the value shift from Subco C to Subco A.

2.60 When calculating the reduction in the cost base of a CGT asset under new section 139-45, regard is to be had to inflation. An adjustment for inflation is necessary because the adjustment to the cost base is only made when a CGT event happens to the asset (refer to new subsection 139-15(2)). If an adjustment were not made for inflation, indexation would be available on the full amount of the cost base from the forgiveness time. By having regard to inflation, it achieves an analogous result to reducing the cost base of the asset at the forgiveness time.

2.61 Having regard to inflation effectively means that the reduction amount is indexed for inflation over the period from the forgiveness time until the CGT event happens to the asset. However, as a consequence of the amendments contained in Schedule 11 of this Bill, indexation of the reduction amount will only be required up to 30 September 1999 (when indexation is frozen).

Direct and indirect interests in debtor company

2.62 New section 139-50 requires that the cost base and reduced cost base of a CGT asset must be increased if:

•

the asset is a share in the debtor company or an asset that gives the taxpayer an indirect interest in a share in that company;

•

the asset was owned at the forgiveness time;

•

a CGT event happens in relation to the asset;

•

the asset was acquired post-CGT; and

•

new Division 139 has applied to reduce the cost base or reduced cost base of one or more shares in, or loans to, the creditor company.

[Subsection 139-50(1)]

2.63 The amount of the increase is such amount as is reasonable having regard to the increase in the value of the CGT asset as a result of the trigger event, the amount of any relevant reductions under new Division 139 and, in the case of cost base increases, inflation measured by reference to the All Groups CPI Number. [Subsection 139-50(2)] However, as mentioned in paragraph 2.61, indexation of the increased amount will only be required up to 30 September 1999.

2.64 As discussed at paragraph 2.58, the words indirect interest do not require an interest in a strict legal or technical sense. In this context, there is a relevant interest if it would be reasonable to conclude, by tracing the effect of the value shift through an interposed entity or interposed entities, that the CGT asset could be affected by a shift in value into a share in the debtor company.

2.65 Example 2.8 demonstrates when new section 139-50 may apply.

Example 2.8

Holdco capitalises Subco A with $100 post-CGT. Subco A in turn capitalises Subco B and Subco C with $50 each. Subco C subsequently lends $50 to Subco B. Subco C then forgives the loan and no consideration is given for the forgiveness. There has been a value shift of $50 from Subco C to Subco B (assuming the market value of the loan was equal to its face value).

The effect of the value shift on Subco As shares in Subco B would be accounted for under new section 139-50 as Subco A has a direct interest in the debtor company (Subco B). Assuming an adjustment has been done under new section 139-25 and the market value of Subco As shares in Subco B has increased by the amount of the value shift, then the cost base and reduced cost base of Subco As shares in Subco B would be increased by $50 (ignoring inflation).

The effect of the value shift on Holdcos shares in Subco A would have to be determined under both new sections 139-45 and 139-50. There would be no adjustment to Holdcos shares in Subco A if the market value of the shares has not been affected by the value shift from Subco C to Subco B.

Application and transitional provisions

2. 66 The amendments contained in this Bill will apply to trigger events that occur on or after 22 February 1999. [Item 5 of Schedule 2]

Consequential amendments

2.67 Item 1 of Schedule 2 to this Bill amends the note to subsection 116-30(1) of the ITAA 1997. Subsection 116-30(1) contains a market value substitution rule where no proceeds are received from a CGT event. As mentioned at paragraph 2.26, new section 139-20 of this Bill provides that in working out the capital proceeds from a CGT event covered by new Division 139, the market value substitution rule is to be ignored. Therefore, the note to subsection 116-30(1) will now provide that the market value substitution rule is ignored where section 138-30 or new section 139-20 apply.

2.68 Item 2 of Schedule 2 adds a note after section 138-15 of the ITAA1997. Section 138-15 is contained in Division 138 of the ITAA1997, which deals with value shifting between commonly owned companies. As new Division 139 now also deals with value shifting (involving the forgiveness of debts), the note will draw attention to newDivision 139 by providing that it also deals with cost base adjustments to interests in companies under common ownership.

2.69 Item 4 of Schedule 2 repeals paragraph 245-85(1)(c) of the CDF provisions (contained in the ITAA 1936) and inserts new paragraph 245-85(1)(c). The new paragraph will ensure that any cost base reductions made under Division 139 will not affect the application of the CDF provisions (also refer to paragraphs 2.10 to 2.15).