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Ruling

Subject: Consolidations franking credits company losses

Question 1

At consolidation will the franking credits held by Subsidiary Company be available to Holding Company, as the head company of a consolidated group, under section 709-60 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the Commissioner cancel the franking credits transferred to Holding Company under section 177EB of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 3

Will the Commissioner allow the transfer of the tax losses from Holding Company to the consolidated group under subdivision 707-A of the ITAA 1997?

Answer

Yes.

Question 4

Can the tax losses transferred to the consolidated group be utilised by the head company under subdivision 707-B of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

01 June 2012

Relevant facts and circumstances

The current shareholders of Holding Company are two trusts (Trust A and Trust B). Both shareholders hold 1 share each. Its shareholding has not changed for some time nor will it change up until just after the joining time for the purposes of consolidation.

Holding Company has carry forward tax losses and a franking account balance.

Holding Company's current activities are provision of administration and other services. After consolidation it will include provision of services to Subsidiary Company.

Subsidiary Company's current shareholders are Trust A with thousands of ordinary shares and an individual with 1 ordinary share.

Subsidiary Company had previously ceased trading some years ago and do not have any carried forward tax losses. They have a franking account balance.

After consolidation Subsidiary Company will be commence a new business.

The scheme

Holding Company will acquire all the shares in Subsidiary Company.

Holding Company and Subsidiary Company will form a tax consolidated group after Holding Company has acquired all the shares in Subsidiary Company.

Holding Company will pay consideration to the shareholders of Subsidiary Company equal to the net asset value of the company.

Subsidiary Company will commence business operations requiring capital input.

Holding Company will raise the capital required via a share allotment to existing shareholders and on loan the amount raised from the share allotment to Subsidiary Company. This share issue will happen after consolidation.

Trust A will take up the allotment. At that point Trust A will own X shares and Trust B one share.

Trust A presently holds Y% of the shares in Subsidiary Company and Z% of the shares in Holding Company. After consolidation Trust A will own effectively Z% of the shareholding in Subsidiary Company by tracing of ownership.

After raising the capital and allotment of shares Trust A will own Y% of the shareholding in Subsidiary Company by tracing of ownership interests.

As a result of the above the person holding the majority interest in Subsidiary Company immediately before it became a subsidiary member of the group will be the same person holding a majority interest in the head company.

Holding Company as head of the consolidated group will receive franking credits from Subsidiary Company as a consequence of the formation of the consolidated group, from future profits derived from the exporting business.

Holding Company will receive income distributions from the Trust A which will have in place an interposed entity election. Holding Company has not previously received an income distribution from Trust A.

Trust A will make an interposed entity election in relation to Subsidiary Company and therefore be able to receive fully franked dividends from Holding Company.

In the event that Holding Company pays dividends to shareholders, Family Trust Distributions Tax will be payable on the portion of the dividends paid to Trust B and they will not receive the benefits of any franking credits.

The majority shareholding of Subsidiary Company by tracing of ownership interests will effectively remain to be held by Trust A. The beneficiaries of Trust A will remain unchanged as it has a family trust election in place.

Prior to Subsidiary Company forming the group it was not trading therefore had no income to pay franked dividends. It is intended that Subsidiary Company will derive profits from the new business.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 709-60

Income Tax Assessment Act 1936 Section 177EB

Income Tax Assessment Act 1936 Section 177EA

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1997 Subdivision 707-A

Income Tax Assessment Act 1997 Section 707-B

Income Tax Assessment Act 1997 Section 707-120

Income Tax Assessment Act 1997 Section 165-12

Income Tax Assessment Act 1997 Section 165-13

Income Tax Assessment Act 1997 Section 165-15

Income Tax Assessment Act 1997 Section 165-165

Income Tax Assessment Act 1997 Section 165-210

Income Tax Assessment Act 1997 Section 701-1

Reasons for decision

Question 1

Summary

The franking credit will transfer to Holding Company under section 709-60 of the ITAA 1997 upon consolidation.

Detailed reasoning

Under subsection 709-60(2) of the ITAA 1997 if a joining entity's franking account is in surplus just before the joining time then a debit equal to the franking surplus arises at the joining time in the joining entity's franking account and a credit equal to the franking surplus arises at the joining time in the franking account of the head company of the group.

Subsidiary Company has a franking credit surplus which will be transferred to Holding Company upon consolidation.

Question 2

Summary

The Commissioner will not utilise section 177EB of the ITAA 1936 to cancel the franking credits transferred to Holding Company under section 709-60 of the ITAA 1997.

Detailed reasoning

Section 177EB of the ITAA 1936 is a consolidation related integrity measure to prevent a head entity from acquiring a subsidiary to circumvent the franking credit trading scheme rules in section 177EA.

The general anti-avoidance provision in section 177EA of the ITAA 1936 is primarily directed at schemes involving franking credit trading and dividend streaming. Section 177EA is designed to secure the integrity of the underlying principles of the dividend imputation system. That is, to ensure that the benefits of imputation are restricted to the true economic owners of the shares in proportion to their interest in the corporate tax entity, and only to the extent that they are able to use those franking credits themselves. Section 177EA also backs-up the specific anti-streaming rules and associated provisions.

Section 177EB of the ITAA 1936 applies where there is a scheme to dispose of a membership interest in an entity (the joining entity) and as a result of that disposition, the joining entity becomes a subsidiary of a consolidated group and a franking credit arises in the account of the head entity. Where, having regard to the relevant circumstances of the scheme, it would be concluded that a person entered into or carried out the scheme for a purpose of enabling the head entity to access the credit, the Commissioner may disallow the credit.

Subsection 177EB(3) of the ITAA 1936 states that the section applies if:

(a) there is a scheme for a disposition of membership interests in an entity and

(b) as a result of the disposition the joining entity becomes a subsidiary member of a consolidated group; and

(c) a credit arises in the franking account of the head company of the group because of the joining entity becoming a subsidiary member of the group; and

(d) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the credit referred to in paragraph (c) to arise in the head company's franking account.

Subsection 177EB(4) of the ITAA 1936 states that it is not to be concluded for the purpose of paragraph (3)(d) that a person entered into or carried out a scheme for a purpose mentioned in that paragraph merely because the person acquired membership interests in the joining entity.

The relevant circumstances of a scheme are provided for in subsection 177EB(10) as

(a)  the extent and duration of the risks of loss, and the opportunities for profit or gain, from holding membership interests in the joining entity that are respectively borne by or accrue to the parties to the scheme, and whether there has been any change in those risks and opportunities for the head company or any other party to the scheme (for example, a change resulting from the making of any contract, the granting of any option or the entering into of any arrangement with respect to any membership interests in the joining entity);

(b) whether the head company, or a person holding membership interests in the head company, would, in the year of income in which the joining entity became a subsidiary member of the group or any later year of income, derive a greater benefit from franking credits than other persons who held membership interests in the joining entity immediately before it became a subsidiary member of the group;

(c) the extent (if any) to which the joining entity was able to pay a franked dividend or distribution immediately before it became a subsidiary member of the group;

(d) whether any consideration paid or given by or on behalf of, or received by or on behalf of, the head company in connection with the scheme (for example, the amount of any interest on a loan) was calculated by reference to the franking credit benefits to be received by the head company;

(e) the period for which the head company held membership interests in the joining entity;

 (f) any of the matters referred to in subparagraphs 177D(b)(i) to (viii).

The matters referred to in subparagraphs 177D(b)(i) to (viii) are as follows:

(i) the manner in which the scheme was entered into or carried out;

(ii) the form and substance of the scheme;

(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and

(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi);

Application to your circumstances

The consolidation allows Holding Company to access the franking credits of Subsidiary Company under section 709-60 of the ITAA 1997. After consolidation Holding Company will issue X shares to Trust A. This will alter the ownership of Holding Company which is currently owned by two shareholders holding one share each. This share issue will raise the funds required by Subsidiary Company to undertake their new business.

Subsection 177EB(3) of the ITAA 1936 applies as there is a scheme for a disposition of membership interests in Subsidiary Company and it will become a subsidiary member of a consolidated group. A credit will arise in the franking account of the head company under section 709-60 of the ITAA 1997 and it could be concluded that the scheme was entered into for a purpose of enabling the credit to arise in the account of Holding Company.

In looking at the matters in regard to subsections 177EB(10) and 177D(b) it is noted that Subsidiary Company has not been operating for some time and the franking credits arose prior to that time. The acquisition of the shares in Subsidiary Company by Holding Company will occur some years since the trading time.

However the scheme will, after the issue of further shares in Holding Company to Trust A, benefit essentially the same shareholders as those who were the shareholders in Subsidiary Company in regard to the imputation credits. Therefore the benefits of the franking credits are essentially restricted to the true economic owners of the shares in proportion to their interest in the original corporate tax entity after the scheme is put in place.

Therefore the Commissioner will not utilise section 177EB to cancel the franking credits transferred to Holding Company Pty Ltd.

Question 3

Summary

The losses from Holding Company can be transferred into the consolidated group under subdivision 707-A of the ITAA 1997.

Detailed reasoning

When an entity becomes a member of a consolidated group (whether as head company or as a subsidiary), its unused carry-forward losses are transferred to the head company if the losses satisfy modified versions of the usual tests for deducting and applying them (referred to as the 'general loss provisions', in Division 165 of the ITAA 1997).

Broadly, the tests are applied as though the 12 months prior to the joining time were the loss claim year (known as the trial year). The loss is transferred to the head company of the group if the joining entity could have utilised the loss in the trial year assuming it had sufficient income or gains of the relevant type.

Under subsection 707-120(1) of the ITAA 1997, the tax loss is transferred from the company to the head company of the consolidated group to the extent it could be utilised by the company for the trial year under the assumptions in that subsection. The trial year is defined in subsection 707-120(2) of the ITAA 1997 as the period ending just after the joining time and is the notional loss claim year for transfer testing purposes.

The words 'to the extent' in subsection 707-120(1) of the ITAA 1997 are interpreted to mean 'to the maximum extent'. This gives effect to an object of Subdivision 707-A of the ITAA 1997: that a loss is transferred to the head company of a consolidated group if the joining entity could have utilised the loss had it not joined the group. The company could utilise all of the tax loss if, instead of joining the consolidated group, it continued as a separate entity for income tax purposes provided it continued to satisfy the loss recoupment tests and derived sufficient income.

The assumption in paragraph 707-120(1)(b) of the ITAA 1997 is consistent with this interpretation. Paragraph 707-120(1)(b) of the ITAA 1997 assumes that utilisation of a loss for the trial year is not limited by the joining entity's income or gains for the trial year.

The continuity of ownership test (COT) would be satisfied if the same majority ownership of the joining entity was maintained from the start of the income year in which the loss was made until just after consolidation. Thus, the trial year captures ownership changes resulting from the choice to consolidate joining entities. The COT requires that the same owners, owning the same shares, satisfy the test for the whole of the period.

The control test is failed if a person starts to control the entity's voting power, during the period in which the continuity of ownership test is applied, for the purposes of gaining a benefit or advantage in relation to the application of the Tax Act.

If the continuity of ownership and the control tests are satisfied, the joining entity's losses are transferred to the head company. If either of the tests is not satisfied, the same business test would need to be satisfied before the joining entity's losses could be transferred at consolidation.

Application to your circumstances

Holding Company has carry forward tax losses dating back a number of years.

Holding Company has had the same shareholders from the beginning of the first loss year until the time just after the joining time for consolidation.

As the ownership is unchanged through each test period Holding Company would pass the continuity of ownership and the control tests and the losses can be transferred into the consolidated group under subdivision 707-A of the ITAA 1997.

Question 4

Summary

The losses transferred into the consolidated group cannot utilised as Holding Company does not satisfy the continuity of ownership test and control test nor the same business test.

Detailed reasoning

Before utilising a group loss or a transferred loss, the head company is required to apply the general loss recoupment provisions. This necessitates the head company passing the continuity of ownership and control tests or the same business test. For transferred losses, these recoupment tests are modified for the purposes of determining whether the company has maintained the same ownership. The two modifications are outlined in Subdivision 707-B of the ITAA 1997.

First, the loss year is modified so that it starts from when the loss was transferred to the head company. This ensures that things that happened to the head company before the transfer time are not taken into account in applying the continuity of ownership test. However, this is subject to the second modification.

The second modification is that in determining whether the head company can use a loss transferred to it from a company as a result of passing the continuity of ownership and control tests, pre-consolidation changes in ownership of the loss company are recognised.

If the loss has been transferred as a COT transfer, for the first time to the head company from a joining company, the test company is that joining company. If the test company meets the COT based on the assumptions in subsection 707-210(4) of the ITAA 1997, the head company is taken to have satisfied the COT. If the test company fail the COT, the head company is taken to have failed the COT at the first time the test company does not meet the relevant conditions in section 165-12.

The assumptions made for the purposes of applying the COT to the test company are that:

1. the test company is reinstated as the owner of the loss.

2. the loss year is the income year in which the test company made the loss

3. the test company is a wholly-owned subsidiary of the head company at all time from the date of the transfer

4. if the loss is transferred to another head company, the test company is a wholly-owned subsidiary of the new head company from the time of that later transfer.

Assumptions 3 and 4 effectively 'freeze' the ownership structure below the applicable head company as at the date of transfer, so that only ownership changes above the applicable head company after that time are relevant.

The head company can be the test company.

The COT test provides that the same owners must maintain more than 50% of the voting power, rights to dividends and rights to capital dividends. For the purposes of the COT, ownership rights attaching to a shareholder's share in a company are only taken into account if the shareholder owns exactly the same share throughout the ownership test period under section 165-165 of the ITAA 1997.

However subsection 165-12(7) of the ITAA 1997 provides that where a condition in subsection 165-12(2), 165-12(3) or 165-12(4) has not been satisfied, those conditions will be taken to have been satisfied if:

(a) they would have been satisfied except for the operation for section 165-165; and

(b) the company has information from which it would be reasonable to conclude that less than 50% of the tax loss has been reflected in deductions, capital losses, or reduced assessable income, that occurred, or could occur in future, because of the happening of any CGT event in relation to any direct equity interests or indirect equity interests in the company during the ownership test period.

In your circumstances Holding Company is the test company and the head company. The ownership test period to determine whether the loss can be utilised based on satisfaction of the COT test is from the beginning of the loss year to the year in which the loss is recouped. At the beginning of the loss year Trust A and Trust B held one share each. This represents a holding of 50% each but between them 100% interest in the company. After consolidation additional shares will be issued to Trust A. The share issue will result in Trust A owning X shares and Trust B owning one share.

Holding Company would have satisfied the requirements of paragraphs 165-12(2), 165-12(3) and 165-12(4) except for the operation of section 165-165 of the ITAA 1997. Based on the information provided and the scheme outlined, the company would have information to conclude that less than 50% of the tax loss would be reflected in deductions, capital losses or reduced assessable income that occurred or could occur in the future because of the happening of a CGT event in relation to the direct equity interests or indirect equity interests in the company during the ownership test period. Therefore the saving rule under 165-12(7) would apply.

However to pass the COT test the company must satisfy section 165-15 which requires the same people must control the voting power otherwise the company must satisfy the same business test. For the purposes of this provision a company cannot deduct the tax loss if:

(a) for some or all of the part of the *ownership test period that started at the end of the *loss year, a person controlled, or was able to control, the voting power in the company (whether directly, or indirectly through one or more interposed entities); and

(b) for some or all of the *loss year, that person did not control, and was not able to control, that voting power (directly, or indirectly in that way); and

(c) that person began to control, or became able to control, that voting power (directly, or indirectly in that way) for the purpose of:

(i) getting some benefit or advantage in relation to how this Act applies; or

(ii) getting such a benefit or advantage for someone else;

or for purposes including that purpose.

In Holding Company's situation paragraph 165-15(1) applies to exclude the losses from being able to be claimed. Trust A while only having a 50% control of the voting power at the time of the losses were incurred, would have Y% of the voting power after the issue of the additional shares. Therefore Holding Company must satisfy the Same Business Test (SBT) to be able to claim the losses from the previous years.

Same business test

Section 165-13 of the ITAA 1997 requires the company to satisfy the SBT to deduct the tax loss if it fails to meet a condition in the COT test. Section 165-210 states that a company satisfies the SBT if:

· it carried on at all times during the same business test period the same overall business that it carried on immediately before the test time

· it did not carry on any business (meaning a particular undertaking or enterprise) other than a business of a kind carried on before the test time as part of the overall business

· it only derived income from transactions of a kind that it entered into in the course of the overall business before the test time, and

· the anti-avoidance provisions in subsection 165-210(3) do not apply.

Subsection 165-13(2) defines the test time which is generally when the ownership (or control) test was first failed. The test period is the income year in which the loss is to be recouped.

The single entity rule in section 701-1(1) requires that the subsidiary members of a consolidated group are taken to be parts of the head company for the purposes of the SBT. Taxation Ruling TR 2007/2 states that the same principles set out in Ruling TR 1999/9 in respect of the application of the SBT to a single company will apply to the head company of a consolidated group.

TR 2007/2 requires that when determining the one overall business carried on by the head company for SBT purposes, it is necessary to have regard to the activities of the subsidiary members of the group. Applying the principles in Ruling TR 1999/9, the ruling says that the business of the head company is to be identified by examining all of the activities, enterprises or undertakings carried on:

· at the appropriate test time by all those entities that were members of the consolidated group at that time; and

· by all entities during that part of the same business test period when they were members of the consolidated group.

When applying the new business test and new transactions test to the head company, regard must be had to the enterprises, undertakings and transactions that were carried on or entered into before the test time by entities while they were members of the consolidated group.

These activities are then compared with the enterprises, undertakings and transactions carried on or entered into by all entities while they are members of the consolidated group during the same business test period. This comparison determines whether the enterprises, undertakings and transactions before the test time and during the same business test period are different in kind.

The business of Holding Company is administration. Subsidiary Company ceased trading some years ago and at the time of consolidation will still be inactive. After consolidation the share issue in Holding Company will raise the capital for Subsidiary Company to commence in a new business.

In your circumstances the test time for the purposes of the SBT is when the control test is failed. This happens on the issue of the new shares in Holding Company which occurs after consolidation.

Therefore when considering the business of the group as a whole the SBT will not be passed as there is a new business commencing some time after the test time that was not in existence just prior to the test time.

The prior years tax losses transferred to the consolidate group under subdivision 707-A of the ITAA 1997 are unavailable for utilisation in future years.