Edited version of your written advice

Authorisation Number: 1051321514344

Date of advice: 21 December 2017

Ruling

Subject: Corporate restructure of the Australian MEC Group

Question 1

Can section 104-520 (CGT event L5) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to HeadCo (as provisional head company of the HeadCo MEC Group) with respect to NewCo when NewCo and its wholly-owned subsidiaries cease to be members of the HeadCo MEC Group?

Answer

No

Question 2

Will NewCo, Sub1 and Sub2 exit the MEC group clear from all group liabilities that relate to a period in which they were group members (including members of the HeadCo TCG) but fall due after their exit from the HeadCo MEC group?

Answer

Yes, provided that:

There is a valid tax sharing agreement(s) (TSA) covering those group liabilities,

● The exiting member pays its contribution amount to the head company (HeadCo) in respect of its share of those group liabilities in accordance with the valid TSA before it exits, and

● The contribution amount paid covers those group liabilities that were expected, or should have expected.

Question 3

Will the Commissioner make a determination under subsection 177F(1) of the Income Tax Assessment Act 1936 (ITAA 1936) to cancel the tax benefit (as described below) that would otherwise have arisen for HeadCo if the scheme (described below) had not been entered into or carried out?

Answer

No, in respect of the following scheme:

● The creation of new ET-1 company (NewCo) by ForeignCo,

● The section 719-40 choice and conversion to a MEC group being made by HeadCo,

● HeadCo to then transfer all the shares in subsidiary member Sub1 to NewCo. Other offshore entities/assets are to be transferred to NewCo (all the shares in ForeignSub1 and ForeignSub2 to be transferred by their respective foreign parent companies and other assets (as held by various other global group entities) to be transferred to one or more legal entities wholly-owned by NewCo), and

● ForeignCo to then sell 50% of the shares in NewCo to a third party joint venture partner for cash consideration with the potential counterfactual being:

● the (direct) disposal by HeadCo of 50% of the shares in Sub1 to the third party joint venture partner

and the subsection 177C(1) of the ITAA 1936 tax benefit being:

● the paragraph 177C(1)(a) assessable capital gain that otherwise might have arisen in the hands of HeadCo in respect of this disposal if the scheme had not been entered into or carried out.

This ruling applies for the following period:

Year ending 31 December 2017

Year ending 31 December 2018

The scheme commences on:

During the year ended 30 June 2018

Relevant facts and circumstances

An international corporate group conducting various operations, which has wholly-owned Australian subsidiary entities (HeadCo, Sub1 and Sub2) that are members of an Australian income tax consolidated group (TCG) with HeadCo as the head company of the Australian TCG, is being restructured so that legal entities and other assets belonging to one of the international business operations will be transferred under a newly incorporated Australian holding company (NewCo). 50% of NewCo will then be sold to a third party joint venture partner.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 177F(1)

Income Tax Assessment Act 1997 section 104-520

Income Tax Assessment Act 1997 section 721-35

Reasons for decision

Question 1

CGT Event L5 cannot happen in relation to the exit of NewCo from the MEC group because NewCo is an ET1 company and none of its membership interests are held by members of the MEC group.

Reasoning

CGT event L5, in section 104-520, happens where the following conditions are satisfied:

(a) an entity ceases to be a subsidiary member of a consolidated or MEC group; and

(b) in working out the group's allocable cost amount for the entity, there is a negative amount remaining after applying step 4 of the calculation in section 711-20.

Subsections 104-520(2) and 104-520(3) respectively provide that CGT event L5 happens to the head company of the consolidated group or MEC group at the time the entity ceases to be a subsidiary member of the group and the capital gain is equal to the amount remaining.

Will NewCo, an ET-1 company which is wholly-owned by ForeignCo (a non-resident company), cease to be a subsidiary member of the HeadCo MEC group? Yes.

For paragraph 104-520(1)(a) to be satisfied, an entity must cease to be a subsidiary member of a consolidated or MEC group.

Section 719-25 provides that all members of a MEC group, other than the head company, are subsidiary members of the group.

In this case, NewCo is not the head company of the MEC group; therefore it is a subsidiary member of the group. When ForeignCo, as a non-resident company, disposes of 50% of its interests in NewCo, NewCo ceases to be a subsidiary member of the MEC group, consequently paragraph 104-520(1)(a) will be satisfied.

Will HeadCo have to work out an allocable cost amount for NewCo, an ET-1 company that is wholly-owned by ForeignCo (a non-resident company)? No.

For paragraph 104-520(1)(b) to be satisfied, the consolidated group or MEC group must calculate an allocable cost amount, under section 711-20, for the entity ceasing to be a subsidiary member and there must be a negative amount remaining after applying step 4 of the calculation in section 711-20.

Division 711 applies to MEC groups by virtue of section 719-2. Subsection 711-5(1) provides that Division 711 has effect for head company and entity core purposes (subsections 701-1(2) and 701-1(3)), where an entity ceases to be a subsidiary member of a consolidated group.

The operation of Division 711 is modified for MEC groups by Subdivision 719-J. In particular, subsection 719-510(1) provides that the leaving entity, referred to in subsection 711-15(1), is a subsidiary member of the old group that is an ET-1 company. The leaving entity that is referred to in subsection 711-15(1) is an entity in whom membership interests are held by members of the old group.

The application of subsection 719-510(1) in conjunction with subsection 711-15(1), ensures that Division 711 will only apply to work out the MEC group's allocable cost amount, under section 711-20, for an ET-1 company that ceases to be a subsidiary member of the MEC group if some of the membership interests in the ET-1 company are held by members of the MEC group.

In this instance NewCo, the ET-1 company that ceases to be a subsidiary member of the MEC group, is wholly-owned by ForeignCo, a non-resident company. ForeignCo fails to meet the residency requirements set out in the table in subsection 719-10(2) and is therefore, not a member of the MEC group.

Division 711 would not apply in respect of NewCo when it ceases to be a subsidiary member of the MEC group as none of the members of the MEC group holds membership interests in NewCo, an ET-1 company. ForeignCo's interests in NewCo are ‘pooled interests’ (section 719-560).

The head company of the MEC group, HeadCo, will not be required to work out an allocable cost amount for NewCo, therefore paragraph 104-520(1)(b) will not be satisfied.

As paragraph 104-520(1)(b) will not be satisfied, CGT event L5 cannot happen to HeadCo with respect to NewCo, an ET-1 company of the MEC group, when NewCo and its wholly-owned subsidiaries, cease to be subsidiary members of the MEC group.

Question 2

Summary

NewCo, Sub1 and Sub2 will exit the MEC group clear from all group liabilities that related to a period in which they were group members provided the conditions of section 721-35 are met.

Reasoning

Special conversion event does not give rise to an exit of Sub1 and Sub2 from the old consolidated group

The HeadCo consolidated group will convert to a MEC group with HeadCo remaining as head company. However, Part 3-90 (other than Subdivision 719-BA) does not apply to an entity ceasing to be a member of a consolidated group or MEC group if there is a group conversion as described in section 719-120 including where a MEC group being created from a consolidated group (subsection 719-130(3)).

A MEC group is created from the consolidated group, Sub1 and Sub2 are subsidiaries which take part in the conversion of the (former) consolidated group to a MEC group. Therefore, there is no ‘leaving time’ under section 721-35 for Sub1 and Sub2 – a section 721-35 clear exit payment cannot arise merely upon the conversion event.

Sale of 50% of NewCo gives rise to an exit from the MEC group and consideration of the clear exit provision

Group liabilities – head companies and subsidiaries

In a tax consolidated group or MEC group, the primary liability for taxation sits with the head entity of the group (paragraph 11 of PS LA 2013/5).

In this case, the head entity is HeadCo.

Joint and several liability

If the head entity fails to pay a group taxation liability by the due date for payment, each member of the group becomes jointly and severally liable for that group taxation liability unless there is a valid tax sharing agreement in place (paragraph 12 of PS LA 2013/5).

Tax sharing agreements

Where an entity is, for income tax purposes, part of a consolidated group then the head entity of the group should enter into a tax sharing agreement with each member of the group. This ensures that if a subsidiary entity is sold later on and a tax liability exists for the group for a period when the subsidiary was a member of the group, the subsidiary entity will only be liable for income tax in proportion stated in the tax sharing agreement.

Validity of the tax sharing agreement

There are specific conditions that must be satisfied in order for a group tax liability to be covered by a tax sharing agreement (section 721-25). These conditions are:

● the agreement must be entered into before the head entity’s due time under section 721-25,

● the agreement must be between the head entity and at least one subsidiary,

● an amount must be allocated to each member who is a party to the agreement,

● the contributions for each member under the agreement must be reasonably allocated among the head entity and the subsidiary entities,

● the agreement must comply with any applicable regulations, and

● the agreement must not have been entered into as part of an arrangement for which a purpose was to prejudice the Commissioner’s ability to recover some or all of the unpaid group liability (subsection 721-25(2)).

When a tax sharing agreement contributing member has left the group clear of the group liability

For the agreement to apply to a contributing member leaving the group clear of the group liability, certain conditions must be satisfied (section 721-35). These conditions are:

● the member was a party to a valid agreement covering the group liability,

● the member ceased to be a member of the group on or before the date the group liability became due and payable by the head company,

● the member did not leave the group as part of an arrangement that had a purpose of prejudicing the recovery of some or all of the amount of that group liability (or of the same kind) by the Commissioner, and

● before ceasing to be a member of the group, the member paid to the head company an amount equal to the contribution amount or, if the contribution amount could not be determined at the time, a reasonable estimate of that amount.

Payment contribution amount

In order to leave a group clear of a group liability, the member is required to pay the head company either (section 721-35):

● an amount equal to the contribution amount,

● a reasonable estimate of that amount (if the contribution amount could not be determined at the time).

For an estimate to be reasonable it must (PS LA 2013/5):

● be reasonable in the circumstances at the time the member leaves the group

● relate to and be based on the relevant TSA, and

● take into account expected future events such as extraordinary or abnormal transactions, ATO audit or pending court cases, to the extent that there is knowledge of such future events at the time the member leaves the group.

Time of payment

The tax sharing agreement member must have paid the head company the contribution amount before the leaving time (paragraph 721-35(c)).

Conclusion

NewCo, Sub1 and Sub2 will exit the MEC group clear from all group liabilities that relate to a period in which they were group members but fall due after their exit from the HeadCo MEC Group provided that:

● there is a valid tax sharing agreement covering the relevant group liabilities,

● NewCo, Sub1 and Sub2 have paid their contribution amounts to HeadCo in respect of their respective share of the relevant group liability in accordance with the valid tax sharing agreement before they exit, and

● the contribution amounts paid cover the relevant group liabilities that were expected or should have been expected.

Question 3

Summary

Having regard to the facts and circumstances described in the application, the Commissioner considers that Part IVA does not apply to the scheme as described. Accordingly, the Commissioner cannot make a determination under subsection 177F(1) of the ITAA 1936 to cancel the potential tax benefit described in the ruling.