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Subject: Cost setting amount for depreciating assets.

Question 1

For depreciating assets acquired from B and previously subject to Division 58, is the amount deductible under Division 40 for the year ended 30 June 2012 limited by the application of subsection 705-47(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are the conditions for the exception provided in subsection 705-47(5) of the ITAA 1997 satisfied?

Answer

No.

This ruling applies for the following periods:

1 July 2011 to 30 June 2012

The scheme commences on:

22 August 2006

Relevant facts and circumstances

1. A, an Australian resident, is the head entity of the A consolidated group.

2. B, an Australian resident, was the head entity of the B consolidated group.

3. Prior to and after the formation of the B consolidated group, B held a number of privatised assets that were subject to the operation of Division 58 of the ITAA 1997.

4. At the commencement of the 2007 income tax year, A held a small interest in B.

5. During the 2007 income tax year, A acquired a majority interest in B.

6. By the end of the 2007 income tax year, A had acquired the remaining interests in B so that it owned 100% of B.

7. B became a wholly owned subsidiary of the A consolidated group.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Section 58-1

Income Tax Assessment Act 1997 Section 705-47

Income Tax Assessment Act 1997 Subsection 705-47(2)

Income Tax Assessment Act 1997 Subsection 705-47(3)

Income Tax Assessment Act 1997 Subsection 705-47(5)

Acts Interpretation Act 1901 Paragraph 15AB(1)(b)

Income Tax Assessment Act 1936 Paragraph 318(2)(d)

Reasons for decision

Question 1

For depreciating assets acquired from B and previously subject to Division 58, is the amount deductible under Division 40 for the year ended 30 June 2012 limited by the application of subsection 705-47(2) of the ITAA 1997?

Detailed reasoning

The Uniform Capital Allowances regime is contained in Division 40. The provision determining whether amounts can be deducted for depreciating assets is section 40-25 of the ITAA 1997. In accordance with section 40-25, a deduction is allowable for an amount equal to the decline in value for an income year of a depreciating asset that was held at any time during the year.

In the present case, assets which were held by B consolidated group and subsequently acquired and held by A are broadly considered depreciating assets for which a deduction is allowable under section 40-25 of the ITAA 1997.

Division 58 sets out special rules that apply in calculating deductions for the decline in value of depreciating assets and balancing adjustments for assets previously owned by, or purchased from, a tax-exempt entity.

ATO Interpretative Decision ATO ID 2007/74 provides that the effect of Division 58 of the ITAA 1997 is to limit the first element of the cost of a privatised asset. As tax exempt entities are not subject to balancing change events, the absence of Division 58 would potentially enable values to be shifted into depreciating assets and higher tax benefits to be claimed by the newly privatised business. Division 58 ensures that the depreciation deductions are capped until such time as the privatised asset is disposed of in an asset sale and a special balancing adjustment (SBA) occurs. Where the asset is disposed of in an entity sale, prior to the SBA occurring, the depreciation deductions remain capped.

The assets A acquired from B consolidated group have been subject to the special rules in Division 58 as they were privatised assets and had their cost, for the purposes of Division 40 of the ITAA 1997, limited by Division 58 at the time of their purchase.

Upon completion of the takeover, A had acquired 100% of the securities in B consolidated group.

Section 705-47 of the ITAA 1997 ensures the appropriate interaction between Division 58 and the consolidations provisions in the ITAA 1997. Section 705-47 also applies to limit the cost of a privatised asset held by a consolidated group which joins another consolidated group. Specifically, subsection 705-47(2) states:

Reduction of tax cost setting amount

705-47(2) the *tax cost setting amount for a *depreciating asset is reduced to the joining entity's terminating value for the asset if:

(a) at a time before the joining entity became a *subsidiary member of the joined group, the asset was *held by an entity (whether the joining entity or another entity) that, at that time, was:

(i) an *exempt Australian government agency; or

(ii) another entity whose *ordinary income and *statutory income were exempt from income tax; and

(b) any of the following provisions directly or indirectly affected the amount the joining entity could deduct for the asset:

(iii) Division 58 of this Act (as that Division applies to a transition time or acquisition time mentioned in that Division before, on or after 1 July 2001); and

(c) Apart from this section, the tax cost setting amount for the asset would exceed the joining entity's terminating value for the asset.

In the present circumstances, B consolidated group acquired depreciating assets which were subject to Division 58. When B became a wholly owned subsidiary of A, the previously privatised assets held by B consolidated group subsequently became assets of A as the head company of the tax consolidated group.

At the time when B became members of the A tax consolidated group, the cost of the membership interests in the joining entities was allocated to the assets of those entities. Subsection 705-47(2) requires A to reduce the tax cost setting amount for depreciating assets acquired to the terminating value for assets held by the joining entities.

Given that the privatised assets acquired by A were subject to Division 58, the requirements in both paragraph 705-47(2)(a) and 705-47(b) of the ITAA 1997 are satisfied. Furthermore, the applicant provided that the tax cost setting amount would (without consideration of this section) be greater than B's terminating value of the assets. As a result, subsection 705-47(2) applies to reduce the tax cost setting amount for depreciating assets acquired.

Question 2

Are the conditions for the exception provided in subsection 705-47(5) of the ITAA 1997 satisfied?

Detailed reasoning

Exception from subsection 705-47(2) ITAA 1997

An exception from the application of subsection 705-47(2) of the ITAA 1997 is provided by subsections 705-47(3) to (5). The exceptions are;

Exception to reduction of tax cost setting amount

705-47(3) Subsection (2) does not apply if:

(a) just before the joining time, the joining entity was neither an *exempt Australian agency nor another entity whose *ordinary income and *statutory income were exempt from income tax; and

(b) a condition in subsection (4) or (5) is met in relation to the period (the pre-joining taxable period) between the last time for which the condition in paragraph (2)(a) is met and the joining time.

705-47(5) Another condition for subsection (2) not to apply is that:

(a) for at least some of the pre-joining taxable period, the asset was *held by the *head company of a *consolidated group (the earlier group) for the period (the earlier group period):

(i) starting when (and because) an entity that had previously held asset became a *subsidiary member of the earlier group or when the asset started to be held by that company because of an asset sale situation described in subsection 58-5(4) involving a *member of the earlier group as the purchaser mentioned in that subsection; and

(ii) ending when (and because) an entity ceased to be a subsidiary member of the earlier group or when the earlier group ceased to exist; and

(b) The company that was the head company of the earlier group just before the end of the earlier group period was not:

(i) an *associate of the head company of the joined group just before the joining time; or

(ii) the same company as the head company of the joined group; and

(c) the earlier group period was at least 24 months.

Paragraph 705-47(3)(a) of the ITAA 1997 is satisfied where the head company is not an exempt entity. In this case B (the old head entity) is not an exempt entity. Paragraph 705-47(3)(b) then requires the conditions of either of subsections 705-47(4) or (5) to be satisfied. In the present circumstances, the exception in subsection 705-47(4) does not apply as there was no balancing adjustment event for the assets during the pre-joining taxable period.

In order for subsection 705-47(5) of the ITAA 1997 to be satisfied, the head company of the earlier group just before the end of the earlier group period should not have been an associate of the head company of the joined group just before the joining time and the earlier company must have held the assets for at least 24 months. In the present circumstances, B held the privatised assets for more than 24 months, at a minimum, being the time of formation of the B tax consolidated group until when B joined the A tax consolidated group.

Is B an associate of A?

The term associate is defined in section 995-1 of the ITAA 1997 to have the meaning given by section 318 of the Income Tax Assessment Act 1936 (ITAA 1936). Paragraph 318(2)(d) of the ITAA 1936 defines associates of a company (primary entity) to include another entity (controlling entity) where:

(i) the primary entity is sufficiently influenced by;

(a) the controlling entity; or

(b) the controlling entity and another entity or entities; or

(ii) a majority voting interest in the primary entity is held by;

(a) the controlling entity…

The above definition provides that B will be an associate of A where it is sufficiently influenced by A or a majority voting interest is held by A in B.

An entity holds a majority voting interest in a company if the following shareholdings amount to 50% or more of the maximum number of votes that can be cast at a general meeting of the company:

§ the entity's direct shareholding in the company, and

§ the entity's indirect shareholding in the company (for example, through a subsidiary).

A's holding in B consolidated group (and voting power) increased progressively to over 50%. Later, it acquired 100% of the securities. For at least two months prior to B joining the A consolidated group, A held a majority voting interest. Therefore, on the basis of the definition provided above, B would be considered an associate of A.

Is B an associate of A 'just before the joining time'?

In order for subsection 705-47(5)(b) of the ITAA 1997 to be satisfied, the head company of the earlier group just before the end of the earlier group period should not have been an associate of the head company of the joined group just before the joining time. Subsection 705-47(5)(a) specifies that the earlier group period:

§ starts when (and because) an entity that had previously held the asset became a subsidiary member of the earlier consolidated group; and

§ ends when the earlier group ceased to exist.

Subsection 703-5(2) of the ITAA 1997 provides that the consolidated group ceases to exist when the head company of the group ceases:

§ to be a head company; or

§ becomes a member of a MEC group.

B consolidated group (the earlier group) ceased to exist at the time (the joining time) when B became a subsidiary member of the A consolidated group. At the joining time, B ceased to be the head company of the B consolidated group. On this basis, the earlier group period ends when B is no longer eligible to be the head company of a consolidated group.

The term 'just before the joining time' is not defined for the purposes of the ITAA 1997.

The common, ordinary definition of 'just' can be found in the Macquarie Dictionary as '9. within a brief preceding time, or but a moment before.' For the purposes of sub-paragraph 705-47(5)(b)(i), just before the joining time refers to the time immediately before or for a brief period before the joining time. The joining time, at which B became a member of the A tax consolidated group is at the date when 100% of B securities were acquired.

You have argued that 'just before' can be said to be the point of time just prior to the commencement of the takeover process. In the alternative you argue that just before the joining time refers to the time when the lodgment of the 'Bidders Statement' with ASIC occurs.

In addition, you argue that the words 'just before' as they appear in subsection 705-47(5) import an element of temporal flexibility. You refer to the case of Handbury Holdings Pty Ltd v Federal Commissioner of Taxation (2008) 74 ATR 560 (Handbury Holdings).

In Handbury Holdings, Kenny J rejected suggestions that the phrases 'just before the leaving time' and 'at the leaving time' refer to different distinct concepts. Both these phrases are found in subsection 711-5(3) of the ITAA 1997 in relation to the recognition of a head company's cost for membership interests in a subsidiary member ceasing to be a member of the consolidated group. In this context, Kenny J accepted (for the purposes of section 711-45(1)) that 'a liability of the leaving entity at the leaving time means a liability of the leaving entity just before it ceases to be a subsidiary member of the consolidated group' (at paragraph 68).

Handbury Holdings can be distinguished from the present circumstances as Kenny J considered the intended meaning of 'just before' as opposed to 'at' in the context of preserving the relevant alignment of a head company's cost of membership interests (subsection 711-5(2)).

In the present circumstances, the Commissioner has been asked to consider the phrase 'just before' as it relates to paragraph 705-47(5)(b)(i) and the facts. The Court in Handbury Holdings considered the calculation of liabilities at particular points in time being no more than a number of days apart. In the present circumstances, you have argued that 'just before the joining time' should be construed as a period being a number of months (not days) before B joined the A consolidated group.

Paragraph 705-47(5)(b) specifies that the head company of the earlier group just before the end of the earlier group period is not an associate of the head company of the joined group just before the joining time. The period 'just before the end of the earlier group period' must align with 'just before the joining time'. Taking on a purposive construction of Division 705 of the ITAA 1997 and having regard to the objectives in section 705-47 of the ITAA 1997, the words 'just before the joining time' cannot be construed as points in time months before the joining time actually occurred. The Commissioner considers 'just before the joining time' cannot be said to be the point of time just prior to the commencement of the takeover process.

The alternative argument that just before the joining time refers to the time when the lodgment of the 'Bidders Statement' with ASIC occurs also cannot be accepted. The phrase 'just before the joining time' does not extend as far as three to four months prior to B joining the A consolidated group and does not comprise the takeover process in its entirety.

It must therefore be concluded that A, as the head company of the joined consolidated group, and B, as the head company of the joining group, do not meet the conditions for exception from the application of subsection 705-47(2) of the ITAA 1997 provided by paragraph 705-47(5)(b) of the ITAA 1997, in that A and B were both associates just before the joining time.

Given that the exception from the application of subsection 705-47(2) has not been satisfied, the tax cost setting amount for depreciating assets is reduced to B's terminating value of its assets. Therefore, when determining the deduction allowable under section 40-25 for an amount equal to the decline in value for the year ended 30 June 2012, A must calculate the amount with reference to the capped amount calculated under Division 58.