Edited version of your private ruling

Authorisation Number: 1012500719820

Ruling

Subject: Application of the continuing majority-owned entity test in section 701A-1 of the Income Tax (Transitional Provisions) Act 1997

Question 1

Will section 701A-5 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA) not apply in respect of trading stock brought into the Company B income tax consolidated group by the relevant subsidiary members when the income tax consolidated group was formed, on the basis that none of the relevant subsidiary members are a 'continuing majority-owned entity' as defined in section 701A-1 of the ITTPA?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 2011

The scheme commenced on:

Income year ended 30 June 2011

Relevant facts and circumstances

Company A

1. Company A was an Australian resident company listed on the Australian Securities Exchange (ASX).

2. Company A and its wholly-owned subsidiaries elected to form an income tax consolidated group on 1 July 2002 (Company A consolidated group).

Company B

3. Company B is the Australian incorporated holding company of the Company B group.

4. Company B and its Australian wholly-owned subsidiaries became subsidiary members of the Company A consolidated group either when it was formed on 1 July 2002 or later upon joining.

Demerger from Company A and formation of Company B consolidated group

5. Company A carried out a demerger of all the shares in Company B.

6. As a result of the demerger, Company B and its Australian wholly-owned subsidiaries exited the Company A consolidated group.

7. Shortly after the demerger, Company B and its subsidiaries formed a new income tax consolidated group (Company B consolidated group).

Trading stock brought into the Company B consolidated group

8. At the time the Company B consolidated group was formed (the formation time), trading stock was held by Company C, Company D and Company E (the relevant subsidiary members):

Relevant subsidiary members

9. Company C is the only relevant subsidiary member that was also a subsidiary member of the Company A consolidated group when the Company A consolidated group was formed on 1 July 2002.

10. Company D was a new company incorporated after the Company A consolidated group was formed.

11. Company E was acquired by the Company A consolidated group from unrelated third parties after the Company A consolidated group was formed.

12. None of the relevant subsidiary members had any preference shares or other special shares on issue during the period 27 June 2002 to the formation time (the test period).

Ownership of Company A

13. The ordinary shares in Company A were listed on the ASX for a significant period of time prior to the formation of the Company A consolidated group on 1 July 2002.

14. Company A had a widely distributed shareholder base during the test period.

15. Company A did not have any preference shares, or other shares carrying special rights, on issue during the test period apart from a de minimis number of partly paid shares which had been issued under certain employee share plans.

16. The ASX-listed ordinary shares in Company A have been regularly traded since 1 July 2002. There has been an annual average turnover of greater than 100% for the period from 1 July 2002 to the formation time based on number of shares.

17. Over the test period, there were changes in the issued share capital of Company A resulting from ordinary capital management activities (e.g. share buy-backs and fresh share issuances to obtain funding). However, the changes to the number of issued Company A ordinary shares during the test period were proportionally small, changing less than 5% in any year between 2002 and the formation time.

Shareholder analysis

18. A specialist provider of shareholder analysis services was engaged by the applicant to undertake comparative analyses of the change in beneficial owners of shares in Company A and Company B during the test period.

19. The comparative analyses found that more than 50% of the beneficial owners of Company A's shares did not beneficially own any shares in Company B during two different testing times (both of which were within the test period).

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 705

Income Tax (Transitional Provisions) Act 1997 Section 701A-1

Income Tax (Transitional Provisions) Act 1997 Section 701A-5

Reasons for decision

When an entity joins a consolidated group, its trading stock is generally treated as a 'reset cost base asset' under Division 705 of the Income Tax Assessment Act 1997 (ITAA 1997) (see subsections 705-35(1) and 705-25(5) of the ITAA 1997).

However, section 701A-5 of the ITTPA modifies the operation of Division 705 of the ITAA 1997 in relation to each asset of a 'continuing majority-owned entity' that is trading stock just before the entity becomes a subsidiary member of the entity's 'designated group'.

Subsection 701A-5(3) of the ITTPA sets out the relevant modification for trading stock:

For the head company core purposes when the continuing majority-owned entity becomes a subsidiary member of a designated group, the asset is a retained cost base asset whose tax cost setting amount is equal to the value applicable in accordance with paragraph (2)(b).

Continuing majority-owned entity

Section 701A-1 of the ITTPA states, so far as relevant:

Continuing majority-owned entity and designated group

701A-1(1)  

If:

(a) an entity becomes a subsidiary member of a consolidated group at any time on or after 1 July 2002; and

(b) a person or persons continued to be the majority owners (see subsection (2)) of the entity from the start of 27 June 2002 until the entity became a subsidiary member of the group;

the entity is a continuing majority-owned entity and the group is the entity's designated group.

Majority owners of an entity

701A-1(2)  

A person or persons are the majority owners of an entity if they beneficially own, directly or indirectly through one or more interposed entities, membership interests in the entity whose market value is more than 50% of the market value of all of the membership interests in the entity.

Taxation Determination TD 2004/88 provides that in determining whether there has been a change in the majority ownership of joining entities, for the purpose of applying the continuing majority-owned entity test in section 701A-1 of the ITTPA, it will be necessary to trace through all interposed entities to the ultimate beneficial owners of the entity.

Accordingly, it will be necessary to ascertain the ultimate beneficial owners of each entity that becomes a subsidiary member of a consolidated group. That is, the continuing majority-owned entity test under section 701A-1 of the ITTPA is applied at the individual entity level since it requires an examination of the individual entity's ultimate beneficial ownership starting from 27 June 2002 until becoming a subsidiary member of a consolidated group.

The relevant subsidiary members (being the 3 entities identified in paragraph 9 of the 'Relevant facts and circumstances' above) each became a subsidiary member of the Company B income tax consolidated group when the group was formed, satisfying paragraph 701A-1(1)(a) of the ITTPA.

The outcome of the analyses stated at paragraphs 18 and 19 of the 'Relevant facts and circumstances' demonstrates that each relevant subsidiary member was not a 'continuing majority-owned entity' (as defined in section 701A-1 of the ITTPA) at the formation time.

Given this outcome, and the fact that the ordinary shares in Company A have been regularly traded since they were listed on the ASX (a significant period of time prior to the formation of the Company A consolidated group on 1 July 2002), until the Company B income tax consolidated group was formed, it is reasonable to infer that each relevant subsidiary member was not a 'continuing majority-owned entity' (as defined in section 701A-1 of the ITTPA) at the formation time.

On the basis of the factual information adduced by the applicant, and the inferences that can be drawn from it, the Commissioner accepts that each relevant subsidiary member was not a 'continuing majority-owned entity' as defined in section 701A-1 of the ITTPA when the Company B income tax consolidated group was formed. Paragraph 701A-1(1)(b) of the ITTPA is not satisfied.

Accordingly, section 701A-5 of the ITTPA will not apply in respect of trading stock brought into the Company B consolidated group by the relevant subsidiary members when the Company B consolidated group was formed.