Edited version of private ruling

Authorisation Number: 1011741555674

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: tax implications of proposed acquisition

Question 1

For the purpose of Company A undertaking the required income tax consolidation calculations, will the Step 1 amount determined under section 705-65 of the Income Tax Assessment Act 1997 (ITAA 1997) equal the market value of the membership interests in Company B at the joining time plus any non-deductible costs for the purposes of determining the Allocable Cost Amount (ACA) for Company B under Division 705 of the ITAA 1997?

Answer

Yes.

Question 2

Will the Commissioner make a determination under section 177F of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of the proposed amalgamation?

Answer

No.

Reasons for decision

Question 1

Summary

Under item 1 of subsection 705-65(1), if the market value of the membership interest is equal to or greater than its cost base, the step 1 amount is the cost base.

The total value of the consideration that Company A will pay for the membership interests in Company B will be equal to their market value.

The rules for calculation of the cost base of an asset are set out in section 110-25 of the ITAA 1997.

The first element consists of the total of:

§ the money you are paid or are required to pay in respect of acquiring the asset, and

§ the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out at the time of acquisition).

The second element is the incidental costs incurred. Where assets are acquired after 7.30pm on 13 May 1997, expenditure does not form part of the second element of the cost base to the extent that you have deducted or can deduct it.

If Company A incurs non-deductible incidental costs in connection with the acquisition of Company B, those costs will be added to the cost base. The market value of the membership interest will in that case be less than the cost base, and Item 1 of subsection 705-65(1) will not apply.

Under Item 3 of the table in subsection 705-65(1), if the market value of the membership interest is less than or equal to its reduced cost base, the step 1 amount is the reduced cost base.

All of the elements of the reduced cost base (except for the third element) are the same as those for the cost base. The reduced cost base does not include an amount to the extent that you have deducted or can deduct it.

Therefore:

§ any non-deductible costs will be included in the reduced cost base;

§ the market value of the membership interests will be less than or equal to its reduced cost base, and

§ Item 3 of the table in subsection 705-65(1) will apply.

Therefore, the Step 1 amount determined under section 705-65 will equal the market value of the membership interests in Company B at the joining time plus any non-deductible costs incurred by Company A.

Detailed reasoning

When a consolidated group is acquired by another consolidated group the core rules provide that the head company of the acquired group is treated as a single entity joining the acquiring consolidated group.

When an entity joins a consolidated group, the tax values of the assets of each joining subsidiary are aligned with the tax values of the membership interests in that subsidiary. In effect, the cost of acquiring the entity is allocated to its assets.

The steps for calculating the allocable cost amount are set out in section 705-60 of the ITAA 1997. Step 1 ensures that the ACA includes the cost of acquiring the membership interests. The amount is worked out under section 705-65.

Under item 1 of subsection 705-65(1), if the market value of the membership interest is equal to or greater than its cost base, the step 1 amount is the cost base.

In this case, the membership interests in Company B consist of shares held by Company Y and the shares held by Company X. It is noted that the Commissioner has assumed, as requested by the applicant, that the shares are properly classified as equity interests.

In order to acquire the Company B group, Company A will acquire all of the shares in Company B. The acquisition will be funded partly by way of payment of cash and partly by issue of scrip in Company A.

The total value of the consideration that Company A will pay for the membership interests in Company B will be equal to their market value. The market value will be determined by an independent market valuation commissioned by the Group.

The rules for calculation of the cost base of an asset are set out in section 110-25 of the ITAA 1997. In this case, the first and second elements are relevant.

The first element (as set out in subsection 110-25(2)) consists of the total of:

§ the money you are paid or are required to pay in respect of acquiring the asset, and

§ the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out at the time of acquisition).

In this case, the amount of money and value of assets that Company A will pay or provide in respect of the acquisition of the membership interests in Company B will be equal to the market value of those interests.

The second element of the cost base (as set out in subsection 110-25(3)) is the incidental costs incurred. Incidental costs are defined in section 110-35 as including remuneration for the services of a valuer, accountant or legal adviser; costs of transfer; stamp duty or other similar duty. However, under subsection 110-45(1B), where assets are acquired after 7.30pm on 13 May 1997, expenditure does not form part of the second element of the cost base to the extent that you have deducted or can deduct it.

If Company A incurs non-deductible incidental costs in connection with the acquisition of

Company B, those costs will be added to the cost base. The market value of the membership interest will in that case be less than the cost base, and Item 1 of subsection 705-65(1) will not apply.

Under Item 3 of the table in subsection 705-65(1), if the market value of the membership interest is less than or equal to its reduced cost base, the step 1 amount is the reduced cost base.

Subsection 110-55(2) provides that all of the elements of the reduced cost base (except for the third element) are the same as those for the cost base. Subsection 110-55(4) provides that the reduced cost base does not include an amount to the extent that you have deducted or can deduct it.

Therefore:

§ any non-deductible costs will be included in the reduced cost base;

§ the market value of the membership interests will be less than or equal to its reduced cost base, and

§ Item 3 of the table in subsection 705-65(1) will apply.

Therefore, the Step 1 amount determined under section 705-65 will equal the market value of the membership interests in Company B at the joining time plus any non-deductible costs incurred by Company A.

It is noted that:

§ the market value of any scrip issued by Company A as payment for the membership interests in Company B will need to be ascertained for the purpose of calculating the total consideration for the membership interests.

§ the market value substitution rule in section 112-20 of the ITAA 1997 will only apply if the amount paid for the acquisition is more than its market value (subsection 112-20(2). The applicant has advised that that will not occur in this case.

§ in relation to the possible application of subdivision 126-B, we agree that rollover relief will not be available if the membership interests in Company B do not represent TAP. On that basis, there will be no modification to the cost base under section 122-145 of the ITAA 1997.

§ guidelines for the calculation of market value are set out in the Consolidations manual. Provided that the guidelines are followed, the Commissioner will accept the market valuation of the assets of Company B obtained by the Group.

Question 2

Summary

The Commissioner will not make a determination under section 177F of the ITAA 1936 in respect of the proposed amalgamation.

Detailed reasoning

Part IVA of the ITAA 1936 applies to a scheme, or any part of a scheme, entered into or carried out by a person for the dominant purpose of enabling a taxpayer to obtain a tax benefit in connection with the scheme. If Part IVA applies to a scheme, the Commissioner can make a determination under section 177F of the ITAA 1936 to cancel the tax benefit obtained under the scheme.

1. The Scheme

The relevant scheme is the proposed amalgamation of the group, which will be carried out as follows:

1. Company A purchases all of the shares held by Company X in Company B for a combination of cash and scrip equal to the market value of the shares;

2. Company A purchases all of the shares held by Company Y in Company B for cash consideration equal to the market value of the shares;

3. The cash payments will be funded via loans.

2. The tax benefit

The Commissioner considers that a tax benefit would be available to Company A in carrying out the proposed amalgamation, which would be represented by resetting the cost base of Company B's assets when the consolidated group of Company B joins the consolidated group with Company A as head entity.

3. The applicable purpose test

In deciding whether Part IVA applies to a scheme, it is necessary to consider whether, having regard to each of the factors set out in paragraph 177D(b) of the ITAA 1936, it would be concluded that the person, or one of the persons, who entered into the scheme or any part of it, did so for the purpose of enabling a relevant taxpayer to obtain a tax benefit in connection with the scheme.

In this case:

§ the scheme does not contain the elements of artificiality or unnecessary complexity;

§ the commercial drivers sufficiently explain the entry into the proposed amalgamation; and

§ the timing of the scheme was dictated by commercial events.

Having regard to the eight factors set out in paragraph 177D(b) of the ITAA 1936, the Commissioner has concluded that the scheme is not being entered into or carried out for the dominant purpose of enabling Company A to obtain a tax benefit.