Edited version of your written advice

Authorisation Number: 1013059305448

Ruling

Subject: Application of subsection 705-70(1A) of the Income Tax Assessment Act 1997

Question 1

Does subsection 705-70(1A) of the ITAA 1997 apply to include the deferred tax liabilities related to JoinCo's assets acquired by HeadCo at the joining time, measured in the accounts of HeadCo and calculated using the accounting principles and policies of JoinCo, in Step 2 of the ACA calculation when JoinCo joins the HeadCo consolidated group?

Answer

Yes.

This ruling applies for the following periods:

Year ending 31 December 20XX

The scheme commences on:

1 January 20XX

Relevant facts and circumstances

1. HeadCo is the head company of a consolidated group for income tax purposes.

2. As part of a restructure, HeadCo acquired the remaining shares in JoinCo.

3. When JoinCo became a 100% subsidiary of HeadCo, JoinCo and its wholly owned subsidiaries joined the HeadCo consolidated group for income tax purposes.

4. JoinCo prepared audited financial statements for the period both before and after the joining time. The JoinCo audited financial statements were prepared for the accounting consolidated group consisting of JoinCo and its wholly owned subsidiaries. This group was the same as the JoinCo consolidated group for income tax purposes.

5. HeadCo prepared consolidated audited financial statements for the period both before and after its acquisition of the JoinCo group.

6. Relevantly, the JoinCo and HeadCo accounting consolidated groups used different methods under accounting standard AASB 112 'income taxes' to calculate deferred tax liabilities (DTLs). The JoinCo group applied a policy to determine the tax base of intangible assets based on their CGT cost base, while the HeadCo group used tax written down value.

7. At the conclusion of the ACA allocation and subsequent DTL calculations, the value of DTLs of JoinCo, were different in the HeadCo group.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 705-60

Income Tax Assessment Act 1997 subsection 705-70(1)

Income Tax Assessment Act 1997 subsection 705-70(1A)

Reasons for decision

Summary

As the amount of the DTL in the hands of HeadCo (measured by applying the same accounting standard, principles and policies as used by JoinCo) is different from the amount of the DTL in the hands of JoinCo, subsection 705-70(1A) of the ITAA 1997 provides that it is the amount of the DTL in the hands of HeadCo that is treated as the amount of the liability for Step 2 of the entry ACA calculation.

Detailed reasoning

The steps for working out a group's ACA for a joining entity are set out in the table in section 705-60 of the ITAA 1997.

Step 2 of this calculation, which ensures that the joining entity's liabilities at the joining time are reflected in the ACA as part of the acquiring group's cost of acquiring that entity is set out in further detail at section 705-70 of the ITAA 1997.

Subsection 705-70(1) of the ITAA 1997 provides that:

For the purposes of step 2 in the table in section 705-60, the step 2 amount is worked out by adding up the amounts of each thing (an accounting liability) that, in accordance with the joining entity's accounting principles for tax cost setting, is a liability of the joining entity at the joining time.

Adjustments may be made to this Step 2 amount in a number of circumstances.

Relevantly, subsection 705-70(1A) of the ITAA 1997 provides:

However, if, in accordance with the accounting principles, the amount of an accounting liability of the joining entity would be different when it became an accounting liability of the joined group, the different amount is treated as the amount of the liability.

Accounting liability & the accounting construct

The term 'accounting principles for tax cost setting' is defined in subsection 705-70(3) of the ITAA 1997 to be:

the accounting principles that the entity would use if it were to prepare its financial statements just before the joining time.

The term 'accounting principles' for the purpose of this definition is defined in subsection 995-1(1) of the ITAA 1997, where it states:

A matter is in accordance with accounting principles if it is in accordance with:

(a) accounting standards; or

(b) if there are no accounting standards applicable to the matter - authoritative pronouncements of the Australian Accounting Standards Board that apply to the preparation of financial statements.

Furthermore, Taxation Ruling TR 2006/6 Income tax: consolidation: recognising and measuring the liabilities of a joining entity under subsection 705-70(1) of the Income Tax Assessment Act 1997 where the joining time occurs in a financial reporting period of the joining entity beginning on or after 1 January 2005 (TR 2006/6) provides guidance on recognising and measuring liabilities of a joining entity under subsection 705-70(1) of the ITAA 1997 where an entity joins a consolidated group during a financial reporting period of the joining entity beginning on or after 1 January 2005.

Paragraph 2 of TR 2006/6 explains that the term 'accounting liability' refers to a liability at the joining time that can or must be recognised in a statement of financial position (balance sheet) in accordance with the accounting standards or statements of accounting concepts issued by the Australian Accounting Standards Board (AASB).

ATO Interpretative Decision ATO ID 2008/164 Income Tax: Step 2 of entry: allocable cost amount - deferred tax liabilities (ATO ID 2008/164) provides guidance in relation to the application of section 705-70 of the ITAA 1997 in relation to DTLs. Relevantly, it states:

For an amount of an accounting liability to be counted under subsection 705-70(1) of the ITAA 1997, the liability must be an accounting liability of the joining entity at the joining time. Joining time in the context of subsection 705-70(1) is interpreted as if the single entity rule did not apply (paragraph 16 of Taxation Ruling TR 2004/14).

…

Where the amount of the deferred tax liability in the joined group under subsection 705-70(1A) of the ITAA 1997 - measured by applying the same accounting standards and authoritative pronouncements and using the same accounting policies used to measure the amount of the deferred tax liability in the joining entity under subsection 705-70(1) of the ITAA 1997 - is different from the amount calculated under subsection 705-70(1), then it is the amount calculated under subsection 705-70(1A) that is relevant in determining step 2 of the ACA. (emphasis added)

As such, where the amount of the DTL in the hands of the joined group (measured by applying the same accounting standard and principles as used by the joining entity) is different from the amount of the DTL in the hands of the joining entity, subsection 705-70(1A) of the ITAA 1997 provides that it is the amount of the DTL in the hands of the joined group that is treated as the amount of the liability for Step 2 of the entry ACA calculation.

Application to the facts

A DTL primarily arising as a result of the accounting and tax timing difference in a number of assets held by JoinCo was included at Step 2 of the ACA calculation upon JoinCo joining the HeadCo consolidated income tax group.

'AASB 112 - Income Taxes' (AASB 112) prescribes the accounting treatment for the recognition and measurement of income taxes, including the recognition and measurement of deferred tax assets and DTLs.

Paragraph 5 of AASB 112 defines DTLs as the amounts of income tax payable in future periods in respect of taxable differences.

JoinCo's DTL therefore constitutes an accounting liability that is correctly taken into account at Step 2 of the ACA process under subsection 705-70(1) of the ITAA 1997.

As explained above, the liabilities included in Step 2 are the amounts that would be recognised in the joining entity's notional financial statement at the joining time, determined in accordance with the entity's accounting principles for tax cost setting. If, however, the amount of the joining entity's liability would be different when it became an accounting liability of the joined group (in accordance with the joining entity's accounting standards, principles and policies), subsection 705-70(1A) of the ITAA 1997 provides that the amount of the liability to be included at Step 2 is the latter amount.

A DTL is an example of an accounting liability affected by this rule and determining this correct value may take several iterations of the ACA calculation.

The JoinCo and HeadCo accounting consolidated groups used different methods under accounting standard AASB 112 'income taxes' to calculate DTLs. The JoinCo group applied a policy to determine the tax base of intangible assets based on their CGT cost base, while the HeadCo group used tax written down value.

The DTL which would have been recognised in the HeadCo group at the joining time (to the extent it related to the assets of the JoinCo TCG) if those accounts were prepared using the JoinCo accounting principles and policies was different to the DTL that was calculated by the JoinCo group in relation to its DTLs at the joining time.

As such, as the amount of the DTL in the hands of HeadCo (measured by applying the same accounting standard, principles and policies as used by JoinCo) is different from the amount of the DTL in the hands of JoinCo, subsection 705-70(1A) of the ITAA 1997 provides that it is the amount of the DTL in the hands of HeadCo that is treated as the amount of the liability for Step 2 of the entry ACA calculation.