Edited version of private advice

Authorisation Number: 1052041010262

Date of advice: 4 October 2022

Ruling

Subject: Consolidation - debt and equity - sale and leaseback

Question 1

Did Trust A leave the X tax consolidated group as a result of the issue of the class B units to Company B?

Answer

No

Question 2

Did Trust A leave the X tax consolidated group when the redemption right attached to the class B units lapsed?

Answer

Yes

Question 3

Did CGT event L5 happen when Trust A left the X tax consolidated group causing its allocable cost amount for Trust A to be negative?

Answer

Yes

Question 4

Will the transaction be characterised for income tax purposes as a sale and leaseback such that lease payment made to Trust A will be deductible for the X tax consolidated group under section 8-1 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following periods:

Questions 1-3: Income year ending XXXX

Question 4: Income years ending XXXX to XXXX

Relevant facts and circumstances

1.    Company X is an Australian resident company and the head company of X tax consolidated group (X TCG). X TCG operates in a number of States and Territories in Australia and holds land and buildings for its operational purposes. Land and buildings are not considered to be trading stock or depreciable assets for X TCG.

2.    Company B is an Australian tax resident company.

3.    X TCG entered into a joint venture project with Company B with regard to a number of land and buildings (Portfolio Assets) that were held by X TCG in different States or Territories (the "Project").

The Joint Venture Project

4.    In order to facilitate the Project, X TCG established a new trust (Trust A) and acquired class X units issued by the trust for an amount equal to x% of the total market value of all the land and buildings (Portfolio Assets) to be acquired under the Project. The remaining consideration was provided by X TCG by way of a loan in the form of promissory notes to Trust A. Trust A used the cash and promissory notes received to acquire the entire Portfolio Assets from X TCG.

5.    The transfer of the Portfolio Assets was achieved in two batches. A number of land and buildings in the Portfolio Assets were transferred first to Trust A. Following the completion of the first stage transfer, Trust A issued class B units to Company B for an amount equal to (100 - x)% the total market value of the Portfolio Assets. Trust A used the cash received from the subscription to repay the loan owing to X TCG in full and used the promissory notes to acquire rest of the Portfolio Assets from X TCG.

6.    The sequencing of the transfer of Portfolio Assets was said to manage particular commercial outcomes.

7.    Subsequently, market value leases were entered into, respectively, between Trust A and X TCG in respect of use of each Portfolio Asset by X TCG for its business operation.

8.    It is expected that, following the conclusion of the operational use of the land and buildings by X TCG, the land may be used in a particular way by X TCG and Company B.

Trust A and Class B Units

9.    The constitution of Trust A provides that the holder of each class of units is entitled to Trust A's net income and distribution of any capital gain. On a winding up of Trust A, each class of units is entitled to their proportionate interest in Trust A. However, the unitholders are not entitled to any of the underlying Portfolio Assets held by the trust.

10.  It has always been the parties' intention that the investment by Company B into the project would be by way of a fresh issue of units by Trust A.

11.  The class B units issued to Company B would be automatically redeemed at the expiry of its issued term, unless and until certain conditions were satisfied before the expiry date, which includes the transfer of all the Portfolio Assets to Trust A.

12.  Upon acquiring class B units, Company B became a unitholder to Trust A and each X TCG and Company B appointed two members to the management committee of the trust (Committee). A resolution by the Committee requires approvals from all the Committee member. The Committee is responsible for making decisions in relation to all material matters in connection with Trust A, including the transfer of the second batch of the Portfolio Assets.

Sale and Leaseback

13.  A fundamental requirement for X TCG was to retain sufficient operational control over its operational sites transferred under the projects, such that their business operations are not adversely impacted, and maximum flexibility is retained over all future developments on the properties. To that end, X TCG entered into long term leases over the sites with Trust A following the transfer of all Portfolio Assets to Trust A.

Other matters

14.  All transactions and agreements were undertaken by the parties on arm's length terms.

15.  Any sale or lease (including lease periods) were executed at the market value supported by independent valuations.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 104-520

Income Tax Assessment Act 1997 Division 703

Income Tax Assessment Act 1997 Division 705

Income Tax Assessment Act 1997 Division 711

Income Tax Assessment Act 1997 Division 974

Reasons for decision

Question 1

Did Trust A leave the X tax consolidated group as a result of the issue of the class B units to Company B?

16.  Division 711 of the Income Tax Assessment Act 1997 (ITAA 1997) sets out rules about determining the tax cost setting amount for membership interests where an entity leaves a consolidated group. Subsection 711-5(1) provides that the Division applies at the leaving time when an entity ceases to be a subsidiary member of a consolidated group.

17.  The term "subsidiary member" in relation to a consolidated group has the meaning given in section 703-15 of ITAA 1997. The specific requirements are set out in paragraph 703-15(2)(b) as follows:

•         the entity must be a company, trust or partnership;

•         the entity must comply with section 703-25 if it is a trust; and

•         the entity must be a wholly owned subsidiary of the head company of the group and, if there are interposed between them any entities, the set of requirements in section 703-45, section 701C-10 of the Income Tax (Transitional Provisions) Act 1997 or section 701C-15 of that Act must be met.

18.  The first two requirements are satisfied because Trust A is unit trust. Trust A will be a "resident unit trust" under section 102Q of the Income Tax Assessment Act 1936 (ITAA 1936) for the purposes of Division 6 of Part III, and a "resident trust for CGT purposes" as defined in section 995-1 of ITAA 1997. That is because:

•         the trust properties are situated in Australia;

•         the central management and control of the trust is in Australia;

•         the trust will carry a business in Australia; and

•         Australian residents held more than 50% of the beneficial interests in the income or property of the trust.

19.  Section 703-30 of ITAA 1997 provides that an entity is a "wholly-owned subsidiary" of another entity if all the membership interests in the first entity are beneficially owned by the second entity or by other wholly-owned subsidiaries of the second entity.

20.  A "membership interest" in a unit trust is the interest or right held by a unitholder in the trust that is not a debt interest (sections 960-130 & 960-135 of ITAA 1997).

21.  Trust A was wholly-owned subsidiary of X TCG whilst X TCG held all the units issued by the trust. However, following the investment by Company B, Trust A issued B units to Company B. The characterisation of B units, more specifically, whether B units were "membership interests" or debt interests, depends on the terms and conditions under which they were issued.

Application of Division 974

22.  Under section 974-15 of ITAA 1997, a scheme gives rise to a debt interest in an entity if the scheme satisfies the debt test contained in subsection 974-20(1), which provides:

(a)    the scheme is a *financing arrangement for the entity; and

(b)    the entity, or a *connected entity of the entity, receives, or will receive, a *financial benefit or benefits under the scheme; and

(c)    the entity has, or the entity and a connected entity of the entity each has, an *effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when:

(ii)    the financial benefit referred to in paragraph (b) is received if there is only one; or

(iii)   the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and

(d)    it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and

(e)    the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil.

26   The issue of B units was a financing arrangement within the meaning of subsection 974-130(1) as it was undertaken to raise finance for Trust A in relation to acquisition of the relevant Portfolio Assets.

27   B units would have been automatically redeemed at the expiry of the initial term after their issue, if the transfer of all Portfolio Assets have not completed by then. This would entitle Company Bto receive a refund of the entire subscription amount that was initially paid, plus any capital contribution available. Therefore, the value received by Company B from a redemption of B units would be at least equal to the value provided upon subscription.

28   In this respect of whether there is an effectively non-contingent obligation to provide the financial benefit, subsection 974-135(1) relevantly states that:

... ...

(1)     There is an effectively non-contingent obligation to take an action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation ... to take that action...

(2)     An obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a connected entity of that entity), other than the ability or willingness of that entity or connected entity to meet the obligation.

... ...

(4) The existence of the right of the holder of an interest that will or may convert into an equity interest in a company to convert the interest does not of itself make the issuer's obligation to repay the investment not non-contingent.

... ...

29   Both X TCG and Company B had a right to veto the subsequent transfer of stage two Portfolio Assets, which means, effectively, that Company B could choose to have its money back at the end of the initial term through exercising such right to block the transaction. It is also noted that exercise of such a right by Company B was completely at its own discretion and was not restricted nor could it be extinguished, unless and until the successful transfer of the entire Portfolio Assets.

30   Unless and until Company B voted favourably for the transfer of stage two Portfolio Assets, the risk that the deal might fall apart due to Company B would remain a real and significant risk to X TCG.

31   B units therefore represented an effectively non-contingent obligation to X TCG (unless and until the transfer of entire Portfolio Assets) for the purposes of Division 974. It follows that as the B units were debt interests, they were not membership interests in Trust A, and as such, Trust A would remain a wholly-owned subsidiary member of the X TCG immediately after the issue of B units.

32   Accordingly, Trust A did not leave the X tax consolidated group as a result of the issue of the class B units to Company B.

Question 2

Did Trust A leave the X tax consolidated group when the redemption right attached to the class B units lapsed?

33   As previously discussed, Trust A would leave the X TCG when they ceased to be wholly-owned subsidiaries of the group, which was when X TCG ceased to own all the membership interests in Trust A.

34   B units were issued with an initial term and would be automatically redeemed for at least their original subscription price on the expiry date, unless all the Portfolio Assets have been transferred to Trust A.

35   On the day after the Portfolio Asset was acquired by Trust A, B units ceased to have a fixed term or expiry date, which means they could not expire or be redeemed and the redemption right, therefore, lapsed. In other words, Trust A was released from an effectively non-contingent obligation to pay a financial benefit at least equal to the subscription price to Company B. B units then ceased to be debt interests as a result of paragraph 974-55(1)(e), but instead, became "membership interests" under sections 960-130 & 960-135 of ITAA 1997.

36   As Company B became a holder of membership interests in Trust A, Trust A ceased to be a "wholly-owned subsidiary" of X TCG. Trust A therefore exited the group at the time the redemption right of B units lapsed.

Question 3

Did CGT event L5 happen when Trust A left the X TCG causing its allocable cost amount for Trust A to be negative?

37   Section 104-520 of ITAA 1997 provides that CGT event L5 happens when:

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

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

38   As discussed previously, Trust A ceased to be a subsidiary member of X TCG when Trust A exited the X TCG - that was when the redemption right attached to B units lapsed due to the entire Portfolio Assets being transferred to Trust A.

39   Section 711-20 of ITAA 1997 provides the method statement on how to determine the tax consolidated group's allocable cost amount for the leaving entity. The Note to section 711-20 provides that if the result after applying step 4 is negative the head company is taken to have made a capital gain (as a result of CGT event L5) equal to the amount.

40   The amount remaining after step 4 was negative such that the conditions in section 104-520 are satisfied and CGT event L5 should happen when Trust A left the X TCG.

41   Therefore, CGT event L5 happened when Trust A ceased to be a subsidiary member of X TCG.

Question 4

Will the transaction be characterised for income tax purposes as a sale and leaseback such that lease payments made to Trust A will be deductible for the Company X tax consolidated group under section 8-1?

42   Tax Ruling TR 2006/13 Income tax: sale and leasebacks (TR 2006/13) describes a "sale and leaseback arrangement" in paragraph 4 as follows:

A sale and leaseback arrangement is typically a two party arrangement under which the owner of an asset (referred to in the Ruling as the lessee) disposes of the asset, usually by way of sale of the asset (or by disposing of rights to or including rights to the asset), but continues to use it as lessee (or bailee) under a lease (or bailment or licence) from the acquirer (referred to in the Ruling as the lessor).

43   The Commissioner may have concerns about arrangements that should be characterised as something other than a sale and leaseback. Paragraph 80 of TR 2006/13 sets out factors which would indicate, in some circumstances, that the legal characterisation of a transaction was not that of sale and leaseback arrangement. These factors would include:

(a)  the intention of the parties as determined from the documentation and surrounding circumstances that indicate the transaction is not a genuine sale and leaseback;

(b)  the lessor has no right to obtain possession of the asset on default by the lessee;

(c)   all the risks and benefits of ownership of the asset are with the lessee after the termination of the term of the lease (this could occur where the lessee was entitled to any excess of the sale price of the asset over the residual value);

(d)  the lease is for a period that is likely to exhaust or exceed the remaining useful life of the asset;

(e)  the lessee has a right or option to purchase the asset upon expiration of the term of the lease for less than the market value of the asset; or

(f)    the sale price of the asset to the lessor is substantially in excess of the market value of the asset.

44.  Having considered those factors above, the Commissioner considers the leases between the X TCG and Trust A are genuine sale and leaseback arrangements.

45.  Therefore, the usual tax treatment of a sale and leaseback arrangement should apply. As the Commissioner noted in paragraph 14 of TR 2016/13:

The lease back of the asset ordinarily requires specified periodic payments by the lessee to the lessor. The lessee will incur and deduct them, and the lessor will derive them as

income, on the same basis as for any lease of a similar asset on similar terms where there is no related sale of the asset to the lessor.

46.  Given the transaction is a genuine sale and leaseback arrangement, the periodic lease payment by X TCG under the lease is necessarily incurred in carrying on its business for the purpose of gaining or producing the assessable income, and therefore, should be deductible under section 8-1 of ITAA 1997.