Draft Taxation Ruling

TR 2000/D17

Income tax: use of a proxy for a company's adjusted unrealised loss at an alteration time under Subdivision 165-CD of the Income Tax Assessment Act 1997

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FOI status:

draft only - for comment

Preamble

What this Ruling is about

1. This Ruling is about the use of a proxy for the adjusted unrealised loss of a company (the loss company ). Calculation of an adjusted unrealised loss is a requirement of the inter-entity loss multiplication measure contained in Subdivision 165-CD of the Income Tax Assessment Act 1997. This measure is designed to prevent duplication of a company's losses on inter-entity interests in that company.

Note: This Ruling covers all companies who use the proxy methodology to determine if they have an adjusted unrealised loss. This includes companies that have no adjusted unrealised loss using the proxy method.

2. To determine if a loss company has an adjusted unrealised loss in respect of an alteration time there is a requirement to establish, broadly speaking, what losses the loss company would have made on a notional disposal of each of its assets at market value at the alteration time. The requirement to value assets individually can, in particular cases, add significantly to compliance (including valuation) costs.

3. This Ruling permits the use of a proxy for a loss company's adjusted unrealised loss in respect of an alteration time. The proxy is calculated having regard to:

•

a market valuation of the loss company's assets en globo; and

•

its alteration time asset tax base (broadly the total of certain costs of the loss company's assets).

4. An entity with a relevant equity or debt interest in a loss company immediately before an alteration time can - provided it has not received notification of the company's actual adjusted unrealised loss by the end of the period in which notices are required to be given - use the proxy adjusted unrealised loss to determine the need for, and the quantum of, reductions and adjustments required by sections 165-115ZA and 165-115ZB.

Note: In this Ruling, these reductions and other adjustments are referred to as inter-entity reductions.

5. If the proxy adjusted unrealised loss method is used by an entity at an initial alteration time, then, irrespective of whether that method yields an adjusted unrealised loss, later inter-entity reductions may be required if there is a later alteration time in respect of the loss company, or if a later event causes a capital loss, deduction or trading stock loss to arise in relation to the interest.

6. The Ruling contains advice for the purpose of subsection 165-115V(8). That provision expressly authorises the Commissioner to give advice about methods to be used in valuing assets for the purposes of Subdivision 165-CD including advice about the grouping of assets in appropriate cases. The Commissioner is given this authority specifically for the purpose of reducing the costs of complying with the Subdivision.

7. The Ruling also extends the time period generally for the provision of section 165-115ZC notices in respect of which penalties may apply, and specifically it extends the time period for the provision of unrealised loss information in notices. An entity will not now be required to provide a notice containing information required by subsection 165-115ZC(6) before the date one month after the date of finalisation of this Ruling. In respect of unrealised loss information, an entity will not be required to provide such information in a notice before the date six months after the date this Ruling is finalised. This Ruling also extends the two month period referred to in paragraph 165-115ZC(5)(b) for the loss company to be told that the controlling entity has given or proposes to give notices to associates. If this two month period would end before the date one month after the date this Ruling is finalised, the controlling entity has until the end of that one month period to advise the loss company.

8. The following outline summarises the effect of using a proxy adjusted unrealised loss if an alteration time (the initial alteration time) occurs in relation to a loss company.

1. Choosing to use the proxy adjusted unrealised loss at the initial alteration time

The loss company or its controller (whoever is obliged to give the section 165-115ZC notice) documents that in calculating the loss company's overall loss the proxy adjusted unrealised loss has been used. The necessary details are included in the notice (refer paragraphs 165-115ZC(6)(b) and (d)). The proxy adjusted unrealised loss is the difference between the loss company's assets valued on an en globo basis and the tax base of those assets. [Refer Part B of this Ruling - paragraphs 20 - 41].

2. Reductions at initial alteration time

An entity with a relevant equity or debt interest in the loss company immediately before the initial alteration time can choose to use the proxy adjusted unrealised loss included in the notice as the basis for making inter-entity reductions at the initial alteration time. Alternatively, if it has the relevant information, the entity may make reductions based on the loss company's actual adjusted unrealised loss (i.e., as calculated under section 165-115U). [Refer Part C of this Ruling - paragraphs 42 - 54].

3. Subsequent events happening to equity or debt interest (other than a later alteration time)

If the proxy adjusted unrealised loss method has been used at an initial alteration time in respect of an interest, later inter-entity reductions may be required for that interest if a subsequent event happens and a loss could arise in relation to it.

Such later reductions may be required if the proportional interest of the relevant equity or debt interest in the adjusted asset value (refer paragraph 57) of the loss company's assets at the time of the subsequent event is less than its proportional interest in the tax base of assets of the loss company at the initial alteration time.

Assuming that the proxy adjusted unrealised loss has been properly used in relation to an interest, later inter-entity reductions are not required to be made in respect of interests that were disposed of at the initial alteration time or have been disposed of subsequently unless roll-over has been chosen for the disposal and the transferor's reduced cost base becomes the acquisition cost for the transferee (e.g., under Subdivision 126-B). In this situation the company's loss can still be duplicated on disposal of the interest.

4. A later alteration time

A later alteration time for the loss company is another time when a holder of a relevant equity or debt interest immediately before an initial alteration time must examine whether later inter-entity reductions are required in relation to that interest. The same issues as discussed in 3 above are relevant, including the fact that no later reductions are required in respect of interests disposed of on which unrealised losses at the initial alteration time can no longer be duplicated. After this examination has been done, and necessary inter-entity reductions made, no further reductions will be required in respect of interests that were relevant equity or debt interests immediately before the initial alteration time.

In relation to the later alteration time itself, a new decision can be made whether to use the proxy adjusted unrealised loss in respect of assets of the loss company at that time, irrespective of whether a proxy adjusted unrealised loss was used for the initial alteration time assets.

However, if the proxy adjusted unrealised loss was used at the initial alteration time, in some cases this may limit the 'double-counting' relief otherwise available in relation to unrealised losses applicable to individual assets that have continued to be held since the initial alteration time. [Refer Part D of this Ruling - paragraphs 59 and60].

Ruling and explanation

Part A: background

Purpose of inter-entity loss multiplication measure

9. Subdivision 165-CD was introduced to give effect to Recommendation 6.9(b) of A Tax System Redesigned. That recommendation relates to the removal of inter-entity loss multiplication.

10. The Subdivision prevents losses on relevant equity or debt interests in a loss company if the loss duplicates a loss company's losses.

11. Broadly, a relevant equity or debt interest is one held by an entity with a 'controlling stake' (determined on an associate-inclusive basis) in the loss company if that entity :

•

has a 10% or more direct or indirect equity interest in that loss company; or

•

is owed a debt of at least $10,000 by the loss company or another entity with a relevant equity or debt interest in that loss company.

12. Losses continue to be available to individuals and certain entities representing individuals that hold interests (directly or indirectly) in loss companies. This is appropriate because individuals ultimately bear the burden of the losses made by those companies.

Operation of Subdivision 165-CD

13. Subdivision 165-CD applies in respect of an 'alteration time' that happens on or after 1.00pm by legal time in the ACT on 11 November 1999. A change of ownership or control of a loss company (among other things) triggers an alteration time.

14. Subdivision 165-CD operates by requiring inter-entity reductions in respect of relevant equity or debt interests in a company that has an 'overall loss' at an alteration time.

15. An overall loss is calculated having regard to a loss company's realised and unrealised losses. Unrealised losses that are taken into account include notional losses on individual capital assets, revenue assets and items of trading stock. The sum of these unrealised losses is referred to as the loss company's 'adjusted unrealised loss'.

16. Various concessions apply to reduce the compliance costs associated with the adjusted unrealised loss rules. For example:

•

a company with a net worth of $5 million or less (calculated having regard to assets owned by related entities) is taken not to have an adjusted unrealised loss;

•

assets acquired for less than $10,000 are not taken into account in working out the amount of the adjusted unrealised loss; and

•

in certain circumstances a company can choose to treat the tax written down value of plant as its market value.

17. Nevertheless, it is recognised that the requirement to value assets individually can, in particular cases, result in high compliance (including valuation) costs. It has been suggested that a compliance cost saving may result if a loss company were permitted to value all of its assets together using a generally accepted valuation methodology (eg a projected net cash flow or net profit basis).

18. Because an en globo asset market valuation does not permit loss assets to be individually identified, loss duplication may not be fully eliminated using only that valuation at that time. Thus, if a loss company does not maintain sufficient asset value following an alteration time, later inter-entity reductions may be necessary.

19. Example 1 in Part E of this Ruling demonstrates why later inter-entity reductions may be needed to prevent loss duplication.

Part B: use of proxy and its implications

Advice

20. The Commissioner advises, pursuant to subsection 165-115V(8), that a proxy may be used for a loss company's adjusted unrealised loss at an alteration time. The proxy adjusted unrealised loss must be calculated in accordance with this Ruling and included in the notice required to be given by the loss company or its controller under section 165-115ZC.

21. Holders of relevant equity or debt interests in the loss company immediately before the alteration time can rely on the proxy adjusted unrealised loss (included in the notice) to determine the need for, and quantum of inter-entity reductions. Alteration time inter-entity reductions must be made in accordance with Part C of this Ruling.

Note: References in this Ruling to a relevant equity or debt interest in a loss company immediately before an alteration time includes such interests in companies that used the proxy method to determine if they have an adjusted unrealised loss. This is relevant, for example, if use of the proxy results in the company not being a loss company.

Note: Most inter-entity reductions are to be made with effect from immediately before an initial alteration time. However, for ease of explanation, this Ruling refers to the reductions, the need for which is apparent following an initial alteration time, as 'alteration time inter-entity reductions and other reductions as 'later inter-entity reductions'.

22. If the loss company or its controller includes details of the proxy adjusted unrealised loss in the notice, an entity may, if it has access to the relevant information, calculate the actual adjusted unrealised loss of the loss company, and make inter-entity reductions on the basis of that amount. If the loss company or its controller has chosen to calculate a proxy adjusted unrealised loss, practically the entity may have little choice but to use that information.

23. If the loss company or its controller includes details of the loss company's actual adjusted unrealised loss in the notice, then an entity with a relevant equity or debt interest in that company, cannot use a proxy adjusted unrealised loss as the basis of making inter-entity reductions.

24. Holders of relevant equity or debt interests in the loss company immediately before an alteration time who have relied on the proxy may be required, in limited circumstances, to make later inter-entity reductions in respect of those interests. Later inter-entity reductions must be made in accordance with Part D of this Ruling.

Calculating the proxy adjusted unrealised loss

25. The proxy for a loss company's adjusted unrealised loss (which can be 'nil') is the excess (if any) of (A) over (B) where:

•

A is the loss company's alteration time asset tax base determined in accordance with paragraph 30 of this Ruling; and

•

B is an en globo market valuation of all the loss company's CGT assets (including assets that cost $10,000 or less) at the alteration time.

Note: If the proxy adjusted unrealised loss is chosen and the methodology outlined in this Ruling followed in relation to interests in the loss company, the operative provisions in section 165-115U, section 165-115V and section 165-115W (which relate to the calculation of individual asset unrealised losses) do not apply to determine the loss company's actual adjusted unrealised loss at the alteration time for the purpose of making reductions in relation to those interests. Also, subsection 165-115R(6) and subsection 165-115S(6) (which relate to disregarding non-economic losses) do not apply, as individual asset loss data would be needed to make these exclusions.

en globo market valuation

26. An en globo market valuation must be made in accordance with a generally accepted valuation methodology (e.g., a discounted cash flow analysis using an appropriate discount factor).

27. TD 10 specifies that where the market value of an asset needs to be determined, taxpayers can choose to:

(i)

obtain a detailed valuation from a qualified valuer; or

(ii)

compute their own valuation based on reasonably objective and supportable data.

28. The same choice exists when making an en globo market valuation of all of a loss company's assets for the purposes of Subdivision 165-CD. The key requirement is that a generally accepted valuation methodology is used. Whether or not a qualified valuer is consulted is likely to depend on the complexity of the valuation involved, the likelihood that the company could be in an unrealised 'net loss' position, and the expense required to make the valuation.

29. If a loss company or its controller makes its own valuation for the purposes of Subdivision 165-CD, it must have objective data to support it.

Alteration time asset tax base

30. A company's alteration time asset tax base is determined by adding the following individual asset tax costs which represent the greatest 'loss' for tax purposes obtainable on the asset at the alteration time:

•

for an item of trading stock, its last trading stock valuation under Division 70 (or its cost if no such valuation has been made);

Note: This may refer to an adjusted Division 70 value because of the operation of Subdivision 165-CD in relation to it at an earlier alteration time in the year.

•

for an asset for which a net profit (loss) on realisation is assessable income (deductible), the greater of the asset's reduced cost base, cost or other amount having regard to the maximum 'loss' for tax purposes that could be claimed in respect of it (e.g., tax written down value for a depreciable asset, if greater than cost or reduced cost base, may be the highest amount); and

•

for each other asset, the asset's reduced cost base. An asset includes a monetary asset (such as cash) for this purpose.

Advice for purposes of all of Subdivision 165-CD

31. This Ruling should be considered as advice for the purpose of Subdivision 165-CD as a whole and the advice must be considered as a 'package'. If the proxy is used in relation to a particular interest in respect of an alteration time, it is not only the valuation approach as at the alteration time that must be adhered to, but also the obligation to make later inter-entity reductions if required in respect of that interest in accordance with Part D of this Ruling.

32. It is only if an entity makes full inter-entity reductions based on the actual unrealised loss at the alteration time (i.e., assuming it has the necessary information and amendment period restrictions are not exceeded) that ongoing requirements arising from use of the proxy adjusted unrealised loss can be disregarded.

33. If the ongoing requirements of using the proxy adjusted unrealised loss in relation to an interest are not followed by an entity in relation to that interest while it holds it, that entity could be required to make reductions based on the loss company's actual adjusted unrealised loss.

34. Importantly, however, if an entity legitimately chooses to use the proxy adjusted unrealised loss in relation to a particular interest (i.e., it has not received prior notification of the actual adjusted unrealised loss), and the requirements of this Ruling are fully followed while it holds the interest, the validity of its choice will not be affected by any decision (e.g., by another interest holder) to use the actual adjusted unrealised loss in relation to another interest.

35. For example, assume that an entity that has legitimately used a proxy adjusted unrealised loss in respect of an alteration time disposes of an equity interest, resulting in a change of control of the loss company. The new owner decides to determine the loss company's actual adjusted unrealised loss in respect of the earlier alteration times and make inter-entity reductions accordingly (assuming this can be done within amendment periods). The vendor, having appropriately used the proxy, is not required to recalculate its inter-entity reductions for the interest it disposed of.

Implications for Notices

36. The advice contained in this Ruling may be relied upon for the purposes of the notice requirements set out in section 165-115ZC, and in particular for specifying a loss company's adjusted unrealised loss (paragraph 165-115ZC(6)(d)).

37. For alteration times happening before the date this Ruling is finalised, no entity will be required to notify affected entities of the loss company's adjusted unrealised loss before the date six months after this Ruling is finalised. This is so whether the amount is calculated using either the actual adjusted unrealised loss amount calculated in accordance with Subdivision 165-CD, or a proxy for that amount determined in accordance with this Ruling. No penalties will be imposed under subsections 165-115ZC(4) or (5) if this information is notified within the extended time frame set out above (or within such further period as the Commissioner may, in special circumstances, allow).

38. Notices containing other relevant information (e.g., realised losses and other matters referred to in subsection 165-115ZC(6)) must still be provided within the period specified in the legislation (i.e., 6 months after the alteration time or by 31 December 2000 if the alteration time happens before 30 June 2000), unless the period ends before the time one month after this Ruling is finalised, in which case an extension without risk of penalty is allowed until the end of that one month period. An extension is also given where the two month period specified in paragraph 165-115ZC(5)(b) (for a controlling entity to advise the loss company that it has given, or proposes to give, notices) ends before one month after the date of finalisation of this Ruling. Such advice does not now have to be provided until the end of one month after the Ruling's finalisation date.

Note: If this notice has not been given within the prescribed time, no penalties may attach, but both the loss company and its controlling entity must then provide notices containing the information they are required to give (as discussed in the following paragraphs) but, as indicated above, not before the end of the one month after this Ruling is finalised.

39. It is noted generally that the Commissioner may allow an extension of time for the provision of a notice in particular cases, but will do so only in special circumstances.

40. It is emphasised that subsection 165-115ZC(7) ensures that an entity (whether a loss company or its controlling entity) is required to provide only information, including information about unrealised losses, that it knows or could reasonably be expected to know and can readily obtain. Entities holding relevant equity or debt interests are ultimately accountable for making inter-entity reductions required by Subdivision 165-CD.

41. If unrealised loss information is not contained in the original notice, the provider must specify this in the original notice. This will alert affected entities that amendments may later be required if they dispose of interests at a loss (and offset that loss against a gain) before the unrealised loss information is received which means that all or part of the loss is not actually available.

Part C: alteration time inter-entity reductions

Are reductions necessary?

42. If the proxy adjusted unrealised loss is nil or positive (i.e., the total market value of the loss company's assets at least equals the alteration time asset tax base of those assets), then the loss company is taken to have no adjusted unrealised loss for that alteration time.

43. Entities relying on the proxy adjusted unrealised loss (rather than the actual adjusted unrealised loss) of the loss company will not have to make inter-entity reductions in respect of an unrealised loss at this time.

Note: Inter-entity reductions may be required to be made at this time in respect of realised losses of the loss company.

44. If the amount obtained by using the proxy is negative, the loss company is treated as having an adjusted unrealised loss equal to that amount. This amount must be included in the notice required by section 165-115ZC (refer paragraphs 165-115ZC(6)(b) amount of overall loss and (d) adjusted unrealised loss).

Note: Alternatively, if the amount is negative, it may be decided not to use the proxy adjusted unrealised loss and instead to value individual assets and calculate the loss company's actual adjusted unrealised loss i.e., by individual asset valuations in accordance with sections 165-115U, 165-115V and 165-115W.

What alteration time inter-entity reductions are necessary?

45. For entities relying on the proxy adjusted unrealised loss, alteration time inter entity reductions must be made to relevant debt or equity interests in the loss company as follows.

46. If the 'formula method' in subsection 165-115ZB(3) can be used for making the inter-entity reductions, then the proxy adjusted unrealised loss will form part of the loss company's overall loss for that purpose.

47. If the 'non-formula method' in subsection 165-115ZB(6) is used, then the adjustment amounts relating to the proxy adjusted unrealised loss must be worked out in a reasonable way having regard to the object of the Subdivision i.e., to prevent loss duplication (refer paragraph 165-115ZB(6)(a) and section 165-115J). Regard should also be had to the other factors set out in paragraphs 165-115ZB(6)(b) to (f) to the extent they can reasonably be applied given the fact that aggregated data is used in calculating the proxy adjusted unrealised loss.

Double counting and related matters

48. The double counting rules in subsections 165-115U(1) and 165-115W(1) (which prevent double counting of unrealised losses on particular assets owned at more than one alteration time) cannot generally apply because they require individual asset valuation data which is not available where a proxy adjusted unrealised loss is, or has been, used.

49. However, if a proxy adjusted unrealised loss was used at the previous alteration time, but both at an earlier alteration time and at the current alteration time a proxy is not used it will generally be appropriate to allow a notional loss on an asset at the earlier time to reduce a notional loss in respect of that asset at the current alteration time.

50. Also, if it can be shown that unrealised losses in respect of the same assets would be counted more than once, it will not be necessary to count an amount a second or further time.

Refer to Example 2 in Part E of this Ruling.

51. Section 165-115T (which reduces a realised loss to the extent it reflected a previously counted unrealised loss) cannot generally apply to the extent that a realised loss at an alteration time relates to an asset held at the last alteration time and a proxy adjusted unrealised loss was used at that time.

52. Again, this is because individual data would be required to determine the appropriate reduction.

53. However, if a proxy adjusted unrealised loss was used at the previous alteration time, but there was an earlier alteration time where a proxy adjusted unrealised loss was not used, it will generally be appropriate to allow the notional loss on an asset at the earlier time to reduce the realised loss on that asset at the current alteration time.

54. Also, if it can be shown that unrealised losses in respect of the same assets would be counted as realised losses, it will not be necessary to count an amount a second or further time. Refer to Example 3 in Part E of this Ruling.

Part D: later inter-entity reductions to interests that were part of a relevant equity or debt interest at an alteration time

Are later inter-entity reductions necessary?

55. If the proxy adjusted unrealised loss was used at an initial alteration time to determine the need for, and quantum of, inter-entity reductions in relation to relevant equity or debt interests in the loss company, later reductions may be required. These later reductions are to prevent duplicate recognition of unrealised losses on the loss company's assets that existed at the alteration time. If later inter-entity reductions are required they are generally made with effect immediately prior to the initial alteration time.

56. Later inter-entity reductions are never required in respect of an interest that formed part of a relevant equity or debt interest at an initial alteration time if a tax deduction or loss (reflecting any unrealised losses of the loss company at that time) can no longer be obtained on it.

Note: Assuming that the proxy adjusted unrealised loss has been properly used in relation to an interest, later inter-entity reductions are not required to be made in respect of interests that were disposed of at the initial alteration time or have been disposed of subsequently unless roll-over has been chosen for the disposal and the transferor's reduced cost base becomes the acquisition cost for the transferee (e.g., under Subdivision 126-B). In this situation the company's loss can still be duplicated on disposal of the interest.

57. In other cases reductions may be required, but only if:

(a)

either

•

a CGT event or something else (e.g., an item ceases to be trading stock) happens to the interest that could result in the owner 'making a loss' on the interest; specifically:

-

making a capital loss (or making such a loss but for Subdivision 170-D) including one that is disregarded because of a CGT roll-over;

-

becoming entitled to a deduction (or becoming so entitled but for Subdivision 170-D); or

-

making a trading stock loss at a time when the owner realises, or otherwise has to account for the trading stock for tax purposes (assuming that the methodology in subsection 165-115A(1D) notionally applies at that time); or

•

another (i.e., later) alteration time happens in respect of the loss company; and

(b)

the relevant equity or debt interest's proportional interest in the loss company's adjusted asset value at the time of the CGT event, other happening or later alteration time is less than its proportional interest in the initial alteration time asset tax base.

Note: The fact that the adjusted asset value is less than the initial alteration time asset tax base suggests that further reductions may be required. Whether they are required will depend on inter-entity reductions already made at the initial alteration time, and whether further reductions are reasonably needed to prevent loss duplication.

In this context, later inter-entity reductions for interests held on capital account will also take account of reductions to the reduced cost bases of the interests made under other provisions where it can be shown that these other reductions have effectively prevented loss duplication.

For example, if it can be shown that an amount of value of an asset was taken into account in an en globo market valuation, and a later distribution of this value was treated for tax purposes as a non-dividend amount (e.g., a return of capital (CGT Event G1)) such that the reduced cost base of interests in the distributing company were reduced, no later inter-entity reduction to reduced cost base would be required to the extent that loss duplication has already been prevented.

58. The adjusted asset value of a loss company at a later time is calculated as follows:

en globo market valuation of the loss company's assets at that time

Less/(plus)

Net increase /(decrease) in the loss company's liabilities between the initial alteration time and the later time.

Note: changes in liabilities are taken into account for these purposes (but not in relation to the calculation of the proxy adjusted unrealised loss) because what is required to be measured is essentially the net asset values, and changes in net asset values, of the loss company that may be relevant in determining whether losses that duplicate unrealised losses of the loss company can be obtained on interests in it.

Without regard to changes in liabilities, an increase in the market value of assets may (inappropriately) be taken to have increased the value of shares and other interests in the company (e.g., if the increase in asset value is matched by an increase in borrowing), and a decrease in the market value of assets may (inappropriately) be taken to have decreased the value of interests (e.g., if liabilities have been repaid).

Later inter-entity reductions may be required at a later alteration time

59. When a later alteration time (being the next alteration time after the initial alteration time) happens it will be necessary for the loss company to assess whether it has an adjusted unrealised loss in respect of that later alteration time. Valuation information (which may be asset by asset or an en globo valuation) that is accessed or obtained for the purpose of calculating the loss company's actual or proxy adjusted unrealised loss in respect of the later alteration time, must also be used in determining whether any later inter-entity reductions should be made in relation to the initial alteration time.

60. In other words, this valuation information, together with details of the loss company's liabilities and any changes therein from the initial alteration time, will facilitate the making of any later inter-entity reductions necessary to prevent loss duplication in relation to the initial alteration time. A consequence of making later reductions for the initial alteration time is that no more reductions will then be required in respect of unrealised losses for that alteration time.

What later reductions are required?

61. Where later inter-entity reductions to interests that were part of a relevant equity or debt interest at an alteration time need to be considered, they will only be necessary to the extent that:

•

the proportional interest of the relevant equity or debt interest in the adjusted asset value of the loss company at the later time is less than its proportional interest in the alteration time asset tax base; and

•

the difference exceeds inter-entity reductions made previously to the interest in relation to the alteration time.

Refer to Example 4 in Part E of this Ruling.

Note: if there was no adjusted unrealised loss at the alteration time (i.e., the proxy was nil or positive), the full amount of any deficiency at the time of the CGT event or happening, or at a later alteration time, will be relevant in determining what inter-entity reductions are required.

62. The proportionality requirement ensures that later injections of equity or debt cannot inappropriately impact on amounts of inter-entity reductions to be made.

Note: a share split or consolidation or similar restructure would not affect the proportionality test provided it did not involve a change in the overall proportions of rights held by various interest holders.

Example

63. Assume there were 100 shares of the same class in a loss company immediately before an alteration time and because of an issue of 100 shares there were 200 shares (also of the same class) at a later time. A shareholding of 50 shares immediately before the alteration time would represent a 50% proportion of the company's assets immediately before the alteration time but only 25% at the later time.

Refer also to Examples 5 and 6 in Part E of this Ruling.

64. Any inter-entity reductions are effectively to be made under sections 165-115ZA and 165-115ZB in relation to the initial alteration time. All interests held at a later alteration time must be considered for reduction. It is also necessary to consider the interests subject to the CGT event or other happening, as well as other interests in the company upstream of these interests other than those in respect of which unrealised losses of the loss company at the alteration time could no longer be duplicated. An affected upstream interest is one whose market value would reasonably be expected to reflect, at least to some extent, the loss on the realised interest, and in respect of which a duplicate loss could still be obtained. As noted previously, interests acquired since the alteration time will not be affected unless they are acquired under a roll-over that preserves the reduced cost base and loss potential.

65. Inter-entity reductions must be reasonable in the circumstances. Similar considerations to those discussed in Part C of this Ruling are applicable.

Part E: examples

Example 1

66. Assume the following wholly-owned group structure.

67. After 19 September 1985, A Co capitalised B Co and D Co each with $100m. B Co, in turn, capitalised C Co with $100m. C Co then acquired Asset 1 and Asset 2. The assets have the cost base/reduced cost base and market value profile shown in the diagram.

68. Assume that A Co transfers its shares in B Co to D Co for market value consideration ($101m) This transaction would cause an alteration time to occur for C Co (and for B Co, but assume that B Co has no losses).

Note: that the alteration time occurs regardless of whether or not intra-group roll-over is elected.

69. Assuming that C Co had no realised losses, it would have an overall loss of $98m being its actual adjusted unrealised loss. This amount would form the basis of reductions to the reduced cost base of B Co's shares in C Co, and A Co's shares in B Co (i.e., the reduced cost bases would be reduced to $2m at each level).

70. However, using the proxy adjusted unrealised loss referred to in this Ruling, C Co would have no overall loss and there would be no alteration time reduction required because the en globo value of C Co's assets ($101m) exceeds their total reduced cost bases ($100m).

71. C Co subsequently sells the 'gain' asset and distributes the after-tax gain to B Co. As a consequence C Co's assets are worth $2m, although the total reduced cost bases of the shares that B Co has in C Co is $100m. Any loss later made on B Co's shares in C Co could duplicate the $98m loss on C Co's 'loss asset'.

72. No loss could be accessed on realisation of B Co's interest in C Co if the actual adjusted unrealised loss had been used at the initial alteration time because the reduced cost bases would have been reduced to $2m. But using the proxy adjusted unrealised loss the reduced cost bases of the interest would remain at $100m, allowing at least one level of duplication to occur on realisation. Thus, use of the proxy is made conditional on consideration of the adjusted asset value of C Co if there is a realisation of any loss by B Co on its interests in C Co.

Example 2

73. On 20 January 2000 A Co transfers a majority shareholding in Mining Co to B Co (the initial alteration time). Mining Co's alteration time asset tax base is as follows:

An en globo market valuation of $10.5m is made of the assets at the initial alteration time.

Individual market valuations of the four mine assets held by Mining Co are also obtained at this time.

74. The proxy is used to determine Mining Co's adjusted unrealised loss of $3.5m at the initial alteration time (i.e., en globo market valuation ($10.5m) less than the alteration time tax base of assets held at that time ($14m)).

75. Following the initial alteration time there are reductions in the market value of trading stock and mine assets that lead to a reduction in the aggregate value of assets of Mining Co.

76. On 6 September 2000 B Co sells shares in Mining Co causing a later alteration time to occur. The proxy is not used to determine Mining Co's adjusted unrealised loss at the later alteration time. For the purpose of determining the appropriate reductions, the relevant asset values for the mine assets are as follows:

77. Mining Co can apply the previously counted notional capital losses to reduce the notional capital losses for Asset 2 (to nil), and Assets 3 and 4 (each to $0.6m).

Example 3

78. On 14 March 2000 Loss Co has an alteration time (the initial alteration time) and the proxy is used to determine its adjusted unrealised loss of $6m. A small group of assets identified by their functional use in one branch of the business (the group assets) are individually valued at that time:

79. On 1 November 2000, Asset 1 is sold for $3m, realising a $7m capital loss. On 15 November 2000, a later alteration time occurs.

80. Loss Co can reduce the realised loss on Asset 1 by the amount of the notional capital loss on Asset 1 that was included in the adjusted unrealised loss at the initial alteration time i.e., by $4.5m to $2.5m.

Example 4

81. XYZ Co is wholly-owned by ABC Co immediately before 12 December 1999. ABC Co acquired all its shares in 1998 for $63m, and holds them on capital account.

82. XYZ Co, which has no realised losses, has the following asset profile as at 12 December 1999.

En globo market valuation of assets (using discounted cash flow analysis) = $60m.

83. ABC Co sold 60% of its shares in XYZ Co to Acquirer Co on 12 December 1999 for $36m triggering a change in ownership of XYZ Co and an initial alteration time. An amount of $3m can be treated as a proxy for the company's adjusted unrealised loss at that time, and inter-entity reductions made on that basis. On the facts available, the reduced cost base of ABC Co's entire 100% share holding would prima facie be reduced by $3m from $63m to $60m, and corresponding reductions would be needed for relevant equity or debt interests (if any) upstream of this holding that could duplicate the loss. No capital loss would be obtained on the disposal of the 60% interest (sale proceeds $36m and reduced cost base $36m ($37.8m less inter-entity reduction $1.8m)).

84. Consider the following independent scenarios, firstly where a further disposal of interests by ABC Co in XYZ Co does not cause another alteration time, and secondly where a disposal by Acquirer Co (which acquired ABC Co's original 60% interest) causes an alteration time.

Sale of further 10% equity in XYZ Co by ABC Co - no later alteration time

85. In June 2000, a further parcel of shares held by ABC Co representing 10% of the equity in XYZ Co (and 25% of ABC Co's remaining holding in XYZ Co) is sold. This sale does not cause another alteration time for XYZ Co to happen.

86. Because the holding sold by ABC Co was a relevant equity interest in XYZ Co immediately before the initial alteration time, if the interest is disposed of at a loss, it would be necessary to examine whether further inter-entity reductions are required in respect of it in relation to the initial alteration time..

87. If the 10% interest of ABC Co in XYZ Co were in fact sold at a small loss (e.g., because it is a minority interest), and if it can be concluded that the adjusted asset value is at least $60m (unchanged from the position on 12 December 1999) then no later inter-entity reduction in respect of the initial alteration time would be required in respect of the interest. The $0.3m reduction already made at the initial alteration time is sufficient to prevent any unrealised loss at the initial alteration time being duplicated at the time the CGT event happens to the interest. Any loss arising on the disposed of the interest would not be duplicating an unrealised loss of XYZ Co at the initial alteration time.

88. However, if the adjusted asset value has fallen to $50m (10% = $5m), it may be necessary to make later reductions (with effect from 12 December 1999) to the interest that was sold based on the difference between $1.3m (i.e., 10% x ($63m less $50m)) and the $0.3m already factored into reductions i.e., $1m. On the facts available, it would prima facie be necessary to reduce the reduced cost base of the shares sold by ABC Co by a further $1m, or if this does not produce a reasonable outcome the reduction would be based on the extent to which the total $10m decrease in asset value is reflected in the value of the disposed of interest.

Note: comparing the alteration time asset tax base with the adjusted asset value of the loss company at the disposal time can mean that loss in value on assets acquired after the alteration time may be factored into the equation. This is a consequence of using the proxy rather than the actual adjusted unrealised loss.

89. It may also be necessary to reduce reasonably the reduced cost base or other tax value of any other interest in XYZ Co that was upstream of ABC Co's interest provided it was also part of a relevant equity or debt interest in XYZ Co immediately before the initial alteration time. It would not be necessary to make inter-entity reductions for upstream interests whose tax value could not reflect an unrealised loss of XYZ Co at the alteration time, nor would it be necessary at this point to make reductions for the 30% interest that ABC Co still holds in XYZ Co. No further inter-entity reductions would be required in respect of the original 60% interest sold by ABC Co to Acquirer Co because the unrealised losses of XYZ Co as at the initial alteration time could no longer be duplicated on the interest.

Acquirer Co sells its 60% interest in XYZ Co - a second alteration time for XYZ Co

90. Assume that instead of a disposal of 10% of XYZ Co by ABC Co, Acquirer Co sells its 60% interest thereby triggering a later (i.e., the next) alteration time in relation to XYZ Co. Assume also that the later alteration time asset tax base was $40m and that an en globo market valuation of the company's assets was $30m. XYZ Co also had an external liability of $5m, which arose after the initial change of ownership on 12 December 1999, and was therefore an increase (from nil) in liabilities of XYZ Co.

91. The later alteration time calls for an examination of whether any later inter-entity reductions are needed for relevant equity or debt interests immediately before the initial alteration time i.e., the 40 % equity interest in XYZ Co retained by ABC Co. (No inter-entity reductions would be required in respect of the 60% shareholding previously sold by ABC Co to Acquired Co because the unrealised losses at the initial alteration time could no longer be duplicated on a disposal of those interests).

92. The adjusted asset value at the second alteration time is $25m ($30m - $5m). The initial alteration time asset tax base was $63m. Thus, a deficiency of $35m ($38m less the 12 December 1999 amount of $3m already factored into reductions) may require inter-entity reductions to that extent to prevent loss duplication on interests in XYZ Co. Reductions would only be made in respect of interests that can still duplicate the initial alteration time unrealised losses and only to that extent. No further inter-entity reductions will then be required in respect of the initial alteration time.

93. Assuming that the entire 40% interest retained by ABC Co could reflect a proportional share of the unrealised losses of XYZ Co at the initial alteration time, proportional reduced cost base reductions of $14m (40% of $35m) would prima facie be expected with effect from the initial alteration time in relation to those interests.

94. It is important to note that the adjusted unrealised loss of XYZ Co must then be determined in respect of the later alteration time itself as this will be relevant for relevant equity or debt interests immediately before that time. Assuming that ABC Co is not an associate of Acquirer Co, only Acquirer Co will have a relevant equity interest in XYZ Co immediately before the later alteration time because ABC Co no longer has, or is taken to have, a controlling stake in XYZ Co.

95. Assuming the proxy methodology is used again, XYZ Co's asset tax base is $40m in relation to the later alteration time and the en globo market valuation is $30m. This gives a proxy adjusted unrealised loss amount of $10m. This amount may be reduced to prevent double counting if there is individual asset loss data for both the initial and later alteration times.

96. Otherwise, there would prima facie be a proportional reduced cost base inter-entity reduction of $6m (i.e., 60% x $10m) required in respect of the 60% equity interest disposed of by Acquirer Co. Corresponding reductions would be needed for interests (if any) upstream of these interests.

Note: If it could be shown that any part of the reduction in en globo asset valuation between the first and second alteration times (i.e., $60m less $30m = $30m) is due to transfers of value to shareholders which have required reduced cost base reductions (e.g., for non-dividend amounts, or under the value shifting provisions)) and the interests are held on capital account, further inter-entity reductions would not be needed to that extent to prevent loss duplication.

Example 5 (proportional change in equity interests)

97. This example illustrates what happens when the proportional interest of a relevant equity interest in the assets of a loss company changes after an alteration time.

98. Assume a shareholder owns all of the issued shares in a company (100 shares) and it holds them on capital account. The total reduced cost base of the shares is $5m.

99. An alteration time happens for the company and it uses the proxy to ascertain that it had an adjusted unrealised loss of $2m (en globo asset market valuation $3m and alteration time asset tax base $5m).

100. As the shares are part of a relevant equity interest in relation to the alteration time, their total reduced cost base is reduced to $3m.

101. Later, asset value of $1m is removed from the company (e.g., by the payment of dividends, and there are no cost base or reduced cost base adjustments), but an additional 50 shares are issued contemporaneously to make up the deficiency (total extra capital contributed $1m).

102. A disposal then occurs of 10% of the equity that existed immediately before the alteration time. Assume this does not cause another alteration time to happen.

103. A capital loss of $100,000 [reduced cost base $300,000 less capital proceeds $200,000] would be made in respect of the disposal (subject to any adjustment required by this Ruling).

104. Although total asset market values have remained unchanged ($3m) since the alteration time, there has been a decline in the proportional asset value attributable to the disposed of interest i.e., $300,000 reduced to $200,000 (10% x 2/3 x $3m). Thus the reduced cost base of the disposed of interest would be reduced by $100,000 and no capital loss would be made.

Example 6 (proportional change in debt interests)

105. If, instead of the above, the original financing of the company had been $1m equity and $4m related party loans, and the further $1m funding also by way of loans, then if the original debt is disposed of (assuming it was a relevant debt interest immediately before the alteration time, and held on capital account), the following reductions would be required:

•

At the alteration time:

-

reduced cost base of equity reduced by $1m to nil

-

reduced cost base of original loan reduced by $1m to $3m (assuming that reduction is reasonable)

•

In respect of the disposal of the loans (with effect from the alteration time)

-

reduced cost base of original loan reduced by a further $1.4m to $1.6m [$4m/$5m x $ 2m = $1.6m; $3m less $1.6m = $1.4m]

Date of effect

106. This Ruling applies both before and after its date of issue.

Detailed contents list

107. Below is a detailed contents list for this draft Ruling:

Your comments

108. If you wish to comment on this draft Ruling, please send your comments promptly by 2 February 2001 to:

Commissioner of Taxation
20 December 2000

Not previously issued in draft form

References

ATO references:
NO T2000/020987

Related Rulings/Determinations:

TR 2000/D17W

Subject References:
asset tax base
inter-entity loss multiplication
inter-entity reductions
loss duplication
adjusted unrealised loss
en globo asset market valuation
market value
overall loss
alteration time
advice
proxy
relevant equity interest
relevant debt interest
CGT event

Legislative References:
ITAA 1997 Division 70
ITAA 1997 Subdivision 126-B
ITAA 1997 Subdivision 165-CD
ITAA 1997 165-115A(1D)
ITAA 1997 165-115R
ITAA 1997 165-115S
ITAA 1997 165-115T
ITAA 1997 165-115U
ITAA 1997 165-115U(1)
ITAA 1997 165-115V
ITAA 1997 165-115V(8)
ITAA 1997 165-115W
ITAA 1997 165-115W(1)
ITAA 1997 165-115ZA
ITAA 1997 165-115ZB
ITAA 1997 165-115ZB(3)
ITAA 1997 165-115ZB(6)
ITAA 1997 165-115ZB(6)(a)
ITAA 1997 165-115ZB(6)(b)
ITAA 1997 165-115ZC
ITAA 1997 165-115ZC(4)
ITAA 1997 165-115ZC(5)
ITAA 1997 165-115ZC(6)
ITAA 1997 165-115ZC(6)(a)
ITAA 1997 165-115ZC(6)(b)
ITAA 1997 165-115ZC(6)(d)