Edited version of private advice

Authorisation Number: 1051684949492

Date of advice: 26 May 2020

Ruling

Subject: Whether an entity is a base rate entity during its non-membership period prior to joining a consolidated group

Question

Can a company (subsidiary member) that joins a tax consolidated group part-way through an income year be eligible for the reduced corporate tax rate of 27.5% under the base rate entity rules if the aggregate income of the tax consolidated group is in excess of the $50 million threshold criteria under section 23 of the Income Tax Rate Act 1986?

Answer

Yes

This ruling applies for the following period

1 July 2018 - 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

Company A is an Australian Proprietary Company limited by shares.

Company B is also an Australian proprietary company limited by shares, whose ultimate holding company is an overseas resident.

Company B acquired 100% of the shares in Company A part way through the 2019 financial year.

One day later, Company A and B were consolidated for tax purposes, with Company B being the head company.

As Company A was acquired part way through its 2019 financial year, it has to lodge a stub tax return covering a period less than 12 months.

Company A's turnover in the less than 12 months prior to joining the consolidated group was $25 million. During this time:

·        Company A was not connected to, or affiliated with, any other entities, and

·        no more than 80% of Company A's assessable income was base rate entity passive income (see subsection 23AA(a) of the Income Tax Rate Act 1986).

Relevant legislative provisions

Income Tax Rates Act 1986 section 23

Income Tax Rates Act 1986 section 23AA

Income Tax Assessment Act 1997 subsection 328-115(1)

Income Tax Assessment Act 1997 subsection 328-120(1)

Income Tax Assessment Act 1997 section 701-1

Income Tax Assessment Act 1997 subsection 701-1(2)

Income Tax Assessment Act 1997 subsection 701-1(3)

Income Tax Assessment Act 1997 subsection 701-30(3)

Income Tax Assessment Act 1997 section 716-850

Reasons for decision

The rates of tax payable by a company (other than a company in the capacity of a trustee) are set out in section 23 of the Income Tax Rates Act 1986. Relevantly, subsection 23(2) provides that the company tax rates are:

(a)   if the company is a base rate entity for a year of income - 27.5%; or

(b)   otherwise - 30%;

if subsections (3) to (5) and section 23A do not apply to the company.

Section 23AA of the Income Tax Rates Act 1986 provides that;

An entity is a base rate entity for a year of income if:

(a)   no more than 80% of its assessable income for the year of income is base rate entity passive income; and

(b)   its aggregated turnover (within the meaning of the Income Tax Assessment Act 1997) for the year of income, worked out as at the end of that year, is less than $50 million.

The aggregated turnover amount of $50 million referred to in subsection 23AA(b) of the Income Tax Rates Act 1986 became effective on 1 July 2018, and is applicable to the 2018-2019 year of income (in the 2018 year of income, the aggregated turnover threshold amount to be a base rate entity was $25 million).

'Aggregated turnover' is defined in subsection 328-115(1) of the Income Tax Assessment Act 1997 (ITAA 1997). It provides that:

Your aggregated turnover for an income year is the sum of the relevant annual turnovers (see subsection (2)) excluding any amounts covered by subsection (3).

Subsection 328-115(2) of the ITAA 1997 provides that the 'relevant annual turnovers' are:

(a) your *annual turnover for the income year; and

(b) the annual turnover for the income year of any entity (a relevant entity) that is *connected with you at any time during the income year; and

(c) the annual turnover for the income year of any entity (a relevant entity) that is an *affiliate of yours at any time during the income year.

'Annual turnover' is defined in subsection 328-120(1) of the ITAA 1997 as:

An entity's annual turnover for an income year is the total *ordinary income that the entity *derives in the income year in the ordinary course of carrying on a *business.

Where an entity joins a consolidated group part way through an income year, it is necessary to consider how it is impacted by the consolidation regime.

Subsection 701-1(1) of the ITAA 1997 contains the single entity rule, which provides:

If an entity is a ^*subsidiary member of a ^*consolidated group for any period, it and any other subsidiary member of the group are taken for the purposes covered by subsections (2) and (3) to be parts of the ^*head company of the group, rather than separate entities, during that period.

The purposes covered by subsections 701-1(2) and (3) of the ITAA 1997 are the head company core purposes and the entity core purposes, respectively. The entity core purposes relevantly include:

(a)   working out the amount of the entity's liability (if any) for income tax calculated by reference to any income year in which any of the period occurs or any later income year; and

It includes the note:

An assessment of the entity's liability calculated by reference to income tax for a period when it was not a subsidiary member of the group may be made, and that tax recovered from it, even while it is a subsidiary member.

Subsection 701-30(2) of the ITAA 1997 has effect for the entity core purposes if:

(a) the entity is a ^*subsidiary member of the group for some but not all of an income year; and

(b) there are one or more periods in the income year (each of which is a non-membership period) during which the entity is not a subsidiary member of any ^*consolidated group.

Subsection 701-30(3) of the ITAA 1997 provides a method for working out the tax position of each non-membership period;

For every non-membership period, work out the entity's taxable income (if any) for the period, the income tax (if any) payable on that taxable income and the entity's loss (if any) (a non-membership period loss) of each ^*sort for the period. Work them out:

(a) as if the start and end of the period were the start and end of the income year; and

(b) ignoring the operation of this section in relation to each other non-membership period (if any); and

(c) so that each relevant item is either:

(i) allocated to only one of the non-membership periods or to a period that is all or part of the rest of the income year; or

(iii) apportioned among such periods (for example, by Subdivision 716-A (see note to this subsection)).

Division 716 of the ITAA 1997 deals with miscellaneous special rules regarding consolidation. Section 716-850 relevantly provides:

716-850(1)

Under some provisions of this Act, something that is relevant to working out:

(a) an entity's taxable income (if any); or

(b) the income tax (if any) payable on an entity' s taxable income; or

(c) an entity's loss (if any) of a particular ^*sort;

is determined on the basis of a comparison between an amount worked out for an income year, or an amount *derived from 2 or more such amounts, and another amount.

Note:

The other amount assumes an income year of 365 days.

716-850(2)

This section affects how such a provision (the threshold provision) operates for the purposes of subsection 701-30(3), which requires each thing covered by paragraph (1)(a), (b) or (c) of this section to be worked out for an entity for a non-membership period (under section 701-30) during an income year.

Note:

A non-membership period is a period (of less than an income year) when the entity is not a subsidiary member of any consolidated group.

716-850(3)

An amount that would otherwise be worked out for the non-membership period, for the purposes of the comparison under the threshold provision, is instead:

(a) to be worked out by reference to the period (the reference period) starting at the start of the income year and ending at the end of the non-membership period; and

(b) then to be grossed up by multiplying it by this fraction:

365 / Number of days in reference period

Section 716-850 was inserted by Act No 117 of 2002, applicable on or after 1 July 2002. Chapter 4 of the Explanatory Memorandum to Act No 117 of 2002 (New Business Tax System (Consolidation and Other Measures) Act (No. 1) 2002), provides the following relevant commentary about its purpose:

4.1 This chapter explains how amounts of income and deductions are divided between a head company and a subsidiary member that is only in the consolidated group for part of a year if the law attributes the income or deduction to a period rather than to a particular moment.

...

4.6 The amendments also annualise amounts that an entity needs to count for its own part-year assessment to see if it has met the thresholds that trigger particular income tax provisions.

...

Threshold rules

4.50 The income tax law contains a number of provisions that permit, or deny, particular treatments on the basis of whether some threshold is met. For example, a company can only claim a deduction for 125% of some R & D expenditure if its aggregate R & D amount for the year is more than $20,000 (e.g. see subsection 73B(14) of the ITAA 1936). Entities that only have partial years because of joining or leaving a consolidated group would obviously find it harder to meet such thresholds.

4.51 The amendments address that problem by annualising the amounts for those partial years. They do that by multiplying the amount from the start of the year to the end of the non-membership period by:

365 / days in that period

Company A became a subsidiary member of the Company B consolidated group part way through the 2019 income year. Due to the single entity rule in subsection 701-1(1) of the ITAA 1997, Company A is taken to be part of the head company of the group for the purposes covered by subsections 701-1(2) and (3) of the ITAA 1997.

The purposes covered by subsection 701-1(3) of the ITAA 1997 are the entity core purposes. Relevant to Company A is paragraph 701-1(3)(a) which states that an entity core purpose is:

working out the amount of the entity's liability (if any) for income tax calculated by reference to any income year in which any of the period occurs or any later income year; ...

Subsection 701-30(1) of the ITAA 1997 explains that the object of the section is to provide a method of working out how the entity core rules apply to the entity for periods in the income year when it is not part of the consolidated group. Subsection 701-30(2) sets out that the section has effect for the entity core purposes if:

(a)   the entity is a ^*subsidiary member of the group for some but not all of an income year; and

(b)   there are one or more periods in the income year (each of which is a non-membership period) during which the entity is not a subsidiary member of any ^*consolidated group.

Company A is a subsidiary member of the Company B consolidated group for some but not all of the 2019 income year, and there is a period in that income year during which Company A is not a subsidiary member of any consolidated group. Company A therefore has a non-membership period. Accordingly, section 701-30 of the ITAA 1997 has effect for Company A in relation to its core purpose under subsection 701-1(3).

Subsection 701-30(3) of the ITAA 1997 outlines how to calculate the tax position of each non-membership period. It provides:

For every non-membership period, work out the entity's taxable income (if any) for the period, the income tax (if any) payable on that taxable income and the entity's loss (if any) (a non-membership period loss) of each ^* sort for the period. Work them out:

(a) as if the start and end of the period were the start and end of the income year; and

(b) ignoring the operation of this section in relation to each other non-membership period (if any); and

(c) so that each relevant item is either:

(i) allocated to only one of the non-membership periods or to a period that is all or part of the rest of the income year; or

(ii) apportioned among such periods (for example, by Subdivision 716-A (see note to this subsection)).

The note to this subsection relevantly states that other provisions of this Part are to be applied in working out the taxable income or loss, including section 716-850 of the ITAA 1997, which applies to gross up threshold amounts for periods of less than 365 days in certain circumstances.

Subsection 716-850(1) states:

716-850(1)

Under some provisions of this Act, something that is relevant to working out:

(a) an entity's taxable income (if any); or

(b) the income tax (if any) payable on an entity ' s taxable income; or

(c) an entity ' s loss (if any) of a particular ^* sort;

is determined on the basis of a comparison between an amount worked out for an income year, or an amount *derived from 2 or more such amounts, and another amount.

Note:

The other amount assumes an income year of 365 days.

Company A's aggregated turnover is something that is relevant to working out the income tax (if any) payable on its taxable income, based on a comparison between an amount worked out for an income year, and another amount (the $50 million threshold in the definition of base rate entity in section 23AA of the Income Tax Rates Act 1986). Accordingly, subsection 716-850(1)(b) of the ITAA 1997 applies to Company A.

Subsection 716-850(2) of the ITAA 1997 explains how the section affects such a provision:

716-850(2)

This section affects how such a provision (the threshold provision) operates for the purposes of subsection 701-30(3), which requires each thing covered by paragraph (1)(a), (b) or (c) of this section to be worked out for an entity for a non-membership period (under section 701-30) during an income year.

Note:

A non-membership period is a period (of less than an income year) when the entity is not a subsidiary member of any consolidated group.

Subsection 716-850(3) further demonstrates how the calculation is made:

716-850(3)

An amount that would otherwise be worked out for the non-membership period, for the purposes of the comparison under the threshold provision, is instead:

(a) to be worked out by reference to the period (the reference period) starting at the start of the income year and ending at the end of the non-membership period; and

(b) then to be grossed up by multiplying it by this fraction:

365/ Number of days in reference period

Accordingly, the amount of aggregated turnover that would otherwise be worked out for Company A's non-membership period for the purposes of comparison is grossed up according to subsection 716-850(3) of the ITAA 1997.

The reference period referred to in paragraph 716-850(3)(a) of the ITAA 1997 runs from the start of its 2019 income year, and ends at the end of its non-membership period. Company A's reference period is therefore a certain number of days.

As Company A was not connected to, or affiliated with, any other entities in its non-membership period, there are no other entities to consider in determining the amount of its aggregated turnover for its non-membership period.

The calculation of Company A's grossed up aggregated turnover for the 2019 income year is therefore:

$25 million x 365/(the relevant number of days) = less than $50 million

Company A's aggregated turnover for its non-membership period for the purpose of determining if it is a base rate entity under section 23AA of the Income Tax Rates Act 1986, is less than $50 million.

According to section 23AA of the Income Tax Rate Act 1986, Company A is a base rate entity for the 2019 year of income as:

·        no more than 80% of its assessable income for the 2019 year of income is base rate entity passive income, and

·        its aggregated turnover (within the meaning of the ITAA 1997) is less than $50m for the 2019 year of income.

The aggregated turnover of Company B's consolidated group has no impact on whether Company A will be eligible for the reduced corporate tax rate of 27.5% under section 23AA of the Income Tax Rates Act 1986 during Company A's non-membership period.