Edited version of private ruling

Authorisation Number: 1011606240450

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Ruling

Subject: Consolidations

Issue 1

Consolidation, and the rights to future income provisions

Question 1

Does section 716-405 of the Income Tax Assessment Act 1997 (ITAA 1997) provide Company A as head company of a tax consolidated group with a tax deduction for Work-in-Progress (WIP) and Disbursements during a year of income to the extent the relevant files have been billed in that year of income?

Advice/Answers

The deduction for the tax cost setting amount of an asset covered by section 716-410 of the ITAA 1997 must be spread over 10 years where the asset, being a contract, is not for a specified period or term.

Question 2

In applying section 705-35 of the ITAA 1997, are WIP and Disbursements reset cost base assets?

Advice/Answers

No. The WIP and disbursements are not reset cost base assets. Rather it is the contract with the client that is the relevant asset for cost setting purposes. The WIP recorded and disbursements incurred in respect of each client contract as at the joining time are factors relevant to determining the market value of the contract asset at that time.

All the client contracts held by the subsidiary as at the date the company qualifies as a subsidiary member of Company A's consolidatable group (the completion date) will be reset cost base assets if Company A chooses to form a consolidated group at the completion date.

Question 3

If the joining time is at a time later than the date of completion, does Company A use the market value of WIP and Disbursements at the completion date or at the date of consolidation for the purposes of applying section 705-35 of the ITAA 1997?.

Advice/Answers

For the client contracts that are reset cost base assets, the market value of the contracts as at the later time (if this is the joining time) must be used for the purpose of determining the tax cost setting amount under section 705-35 of the ITAA 1997.

Question 4

Does the ATO response to each question change if the date of consolidation is some date after the completion date?

Advice/Answers

No.

Relevant facts and circumstances

The following facts and the description of the scheme are based on information provided by the applicant. The following documents, or relevant parts of them, form part of and are to be read with these facts and the description of the scheme:

§ Private Ruling Application, including all attachments and sample contracts.

Prior to June 2010 you contracted to acquire 100% of the shares in another company.

As part of the due diligence process for the purchase you valued the work in progress (WIP).

Disbursements that are recoverable from clients were valued.

Any deviation from either of those figures will be adjusted for in the purchase price.

Both companies operate in the same environment.

You intend to form a consolidated group for taxation purposes with the acquired company.

The consolidation date is intended to be the date the contracts are completed and the share transfer takes place; alternatively you may elect to consolidate on 1 October 2010.

The applicant has stated in the ruling application that the WIP and disbursements balance is not expected to vary significantly between the completion date and 1 October 2010 but that there will be some variation.

Relevant legislative provisions

Income Tax Assessment Act 1997: Subsection 701-55(5c)

Income Tax Assessment Act 1997: Subsection 701-90(1)

Income Tax Assessment Act 1997: Subsection 701-90(2)

Income Tax Assessment Act 1997: Section 703-33

Income Tax Assessment Act 1997: Paragraph 705-25(5)(d)

Income Tax Assessment Act 1997: Section 705-35

Income Tax Assessment Act 1997: Section 705-60

Income Tax Assessment Act 1997: Section 716-405

Income Tax Assessment Act 1997: Section 716-410

Income Tax Assessment Act 1997: Division 230

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

These reasons for decision accompany the Notice of private ruling for Company A.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Reasons for decision

Issue 1

Question 1

Summary

Does section 716-405 of the ITAA 1997 provide Company A as head company of a tax consolidated group with a tax deduction for Work-in-Progress (WIP) and Disbursements during a year of income to the extent the relevant files have been billed in that year of income?

Advice/Answers

The deduction for the tax cost setting amount of an asset covered by section 716-410 of the ITAA 1997 must be spread over 10 years where the asset, being a contract, is not for a specified period or term.

Detailed reasoning

Section 716-405 of the ITAA 1997 applies if subsection 701-55(5C) of the ITAA 1997 applies. Subsection 701-55(5C) of the ITAA 1997 applies to an asset that meets the requirements of section 716-410 of the ITAA 1997.

Section 716-410 of the ITAA 1997 applies to rights to amounts that are expected to be included in assessable income after joining time. Section 716-410 states:

This section covers an asset at a time if:

(a) the asset is a valuable right covered by subsection 701-90(1); and

Note: Such a valuable right is treated as a separate asset for the purposes of this Part (see subsection 701-90(2))

(b) the asset is held by an entity just before the time (the joining time) it became a *subsidiary member of a *consolidated group; and

(c) it is reasonable to expect that an amount attributable to the asset will be included in the assessable income of the entity or any other entity after the joining time; and

(d) Division 230 does not apply in relation to the asset (disregarding section 230-455)

Each client file or contract held by the subsidiary as at the date of consolidation may be covered by section 716-410 of the ITAA 1997 if, in accordance with subsection 701-90(1) of the ITAA 1997, it is a valuable right (including a contingent right) to receive an amount for the performance of work or services or the provision of goods (other than trading stock); it is reasonable to expect that an amount attributable to the contract will be included in the assessable income of Company A after joining time and Division 230 of the ITAA 1997 does not apply to the contract.

The WIP recorded and disbursements incurred in respect of each client file held by the subsidiary as at the date of consolidation would be relevant for determining the market value of the asset as at that date, where the asset is a reset cost base asset.

Where the client contract is a reset cost base asset it will receive a tax cost setting amount as at the date of consolidation based on its market value as at that date.

The tax cost setting amount of the contract asset, to the extent it meets the definition in section 716-410 of the ITAA 1997 will be deductible under section 716-405 of the ITAA 1997.

The amount of the deduction under section 716-405 of the ITAA 1997 depends on whether the contract has a specified term or period. If the contract is for a specified period that is less than 10 years, then the deduction for the tax cost setting amount is spread over that period. If the contract has no specified period, then the deduction is spread over 10 years. However if the contract comes to an end before the end of its specified period or 10 years, the balance of the remaining tax cost setting amount may be claimed in the year in which the contract ends.

With regard to the client contracts held by the subsidiary as at the date of consolidation, these appear to have no specified or set period within which the contract is to be completed. Therefore the deduction for the tax cost setting amount, where the contract meets the requirements of section 716-410 of the ITAA 1997 must be spread over 10 years.

Question 2

Summary

In applying section 705-35 of the ITAA 1997, are WIP and Disbursements reset cost base assets?

Advice/Answers

No. The WIP and disbursements are not reset cost base assets. Rather it is the contract with the client that is the relevant asset for cost setting purposes. The WIP recorded and disbursements incurred in respect of each client contract as at the joining time are factors relevant to determining the market value of the contract asset at that time.

All the client contracts held by the subsidiary as at the date the company qualifies as a subsidiary member of the Company A consolidatable group (the completion date) will be reset cost base assets if Company A chooses to form a consolidated group at the completion date.

Detailed reasoning

Section 705-60 of the ITAA 1997 tells you how to work out the allocable cost amount (ACA) for a joining entity. It lists the seven steps that must be applied in this process.

Once the ACA for the joining entity has been determined it is reduced by the total of the tax cost setting amounts of the joining entity's retained cost base assets and then, in accordance with section 705-35 of the ITAA 1997, the balance of the ACA is allocated to each of the joining entity's reset cost base assets in proportion to their market values.

The definition of a retained cost base asset was amended by Schedule 5, Part 11 of Tax Laws Amendment (2010 Measures No 1) Act 2010 to include a right that is an asset covered by section 716-410 of the ITAA 1997 if at the time the right was created the head company was the head company of a consolidatable group and the joining entity was a subsidiary member of the consolidatable group.

The subsidiary will become a subsidiary member of the consolidatable group of which Company A is the head company on the day Company A is entitled to be registered as the shareholder of the subsidiary (refer to section 703-33 of the ITAA 1997). We would normally expect this date to be the date of completion or settlement.

If the choice to form a consolidated group is not made until some time (for example months) after the day on which the consolidatable group comes into existence, then the subsidiary may hold some client contracts which are retained cost base assets and some client contracts which are reset cost base assets at the time the group is formed.

In accordance with paragraph 705-25(5)(d) of the ITAA 1997, all the client contracts entered into by the subsidiary after the date on which the company qualifies as a subsidiary member of the Company A consolidatable group and which are covered by section 716-410 of the ITAA 1997 will be retained cost base assets. The terminating value of these contracts will be nil.

However all of the client contracts already held by the subsidiary as at the date the company qualifies as a subsidiary member of the Company A consolidatable group (the 'acquired' contracts) will be reset cost base assets at the time the group is formed, to the extent they have not matured into billed or billable amounts at this time. The reset cost base contracts will receive a tax cost setting amount based on their market value as at the date on which the group chooses to consolidate. As noted above the WIP recorded and client disbursements incurred in respect of these contracts as at the date of consolidation will be relevant in determining their market value as at this date.

Question 3

Summary

If the joining time is at a later date rather than the date of completion, does Company A use the market value of WIP and Disbursements at the completion date or at the date of consolidation for the purposes of applying section 705-35 of the ITAA 1997?

Advice/Answers

For the client contracts that are reset cost base assets, the market value of the contracts as at this later date (if this is the joining time) must be used for the purpose of determining the tax cost setting amount under section 705-35 of the ITAA 1997.

Detailed reasoning:

All the client contracts held by the subsidiary as at the date the company qualifies as a subsidiary member of the Company A consolidatable group (the completion date) will be reset cost base assets to the extent they have not matured into billed or billable amounts as at the possible later chosen date.

For the client contracts that are reset cost base assets, the WIP recorded and disbursements incurred in respect of each contract as at the later date will be relevant in determining their market value as at this date. It is the market value of the contracts as at the later date that must be used for the purpose of determining the tax cost setting amount under section 705-35 of the ITAA 1997.

Question 4

Summary

Does the ATO response to each question change if the date of consolidation is some date after the completion date?

Advice/Answers

No, our responses would not change.