Edited version of private advice

Authorisation Number: 1052305853156

Date of advice: 10 October 2024

Ruling

Subject: Consolidation and Tainting of Share Capital

Question 1

Following the transfer of shares in ForeignCo to HoldCo:

(a)          will HoldCo meet the requirements under paragraph 703-15(2)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to be a head company of a consolidatable group?

(b)          will each of ForeignCo and SubCo meet the requirements under paragraph 703-15(2)(b) of the ITAA 1997 to be a subsidiary member of a consolidatable group?

Answer

Yes.

Question 2

If the answer to Question 1 is 'Yes' and HoldCo elects to form an income tax consolidated group comprising HoldCo as head company and ForeignCo and SubCo as subsidiary members, will section 701-1 of the ITAA 1997 apply to:

(a)           the transfer of a property from ForeignCo to SubCo?

(b)           the payment of a dividend to HoldCo?

(c)           a return of capital to HoldCo?

(d)           the assignment of a loan from ForeignCo to HoldCo?

Answer

Yes.

Question 3

If HoldCo contributes the receivable due under a loan from ForeignCo to SubCo in exchange for the issue of new ordinary shares in SubCo equal to the value of the loan, will the transfer of the value of the loan to SubCo's share capital account result in SubCo's share capital account being tainted within the meaning of Division 197 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

DDMMYYYY

The scheme commenced:

DDMMYYYY

Relevant facts and circumstances

HoldCo

1.            HoldCo was incorporated in Australia with 1 ordinary share (nil paid up and nil unpaid) issued to each of Shareholder A and Shareholder B (collectively the Shareholders, each a Shareholder).

2.            HoldCo will have its taxable income taxed at a corporate rate in Australia.

ForeignCo

3.            ForeignCo is a company incorporated in a particular foreign jurisdiction.

4.            ForeignCo's ordinary shares are held by the Shareholders. Each Shareholder holds more than a 10% interest in ForeignCo.

5.            The directors of XXXXX are:

a.             Shareholder A

b.             Director C (who is related to Shareholder A), and

c.             Director D (who is an independent third party).

6.            All assets held by ForeignCo are located in Australia.

7.            ForeignCo has lodged its income tax returns on the basis that it is a tax-resident of Australia. ForeignCo has its taxable income taxed at a corporate rate.

8.            While ForeignCo's registered office is the foreign jurisdiction, ForeignCo has not kept any operational office, nor carried on any business or operation, in that foreign jurisdiction. Its operation in that foreign jurisdiction is limited to preparing audited financial statements (for the purposes of maintaining its company registration in that foreign jurisdiction).

9.            The Shareholders are not 'residents of Australia' as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936), although they are each a holder of a 'permanent visa' within the meaning of subsection 30(1) of the Migration Act 1958.

10.            Director C and Director D are 'residents of Australia' as defined in subsection 6(1) of the ITAA 1936.

11.            According to minutes of board meetings:

a.             the board meetings were conducted in Australia

b.             the chairperson of the meetings was Director C

c.             Shareholder A was not present at some of the board meetings

d.             Shareholder A attended the other board meeting whilst physically present in Australia, and

e.             those board meetings centred around the financial performance of ForeignCo, the re-development of the Property, financing options available and consideration of the structure of ForeignCo.

12.            A Circulating Resolution of Directors in respect of a payment of dividends to ForeignCo's shareholders was signed by Director C and Director D whilst physically located in Australia and by Shareholder A whilst physically located in a foreign jurisdiction.

SubCo

13.            SubCo is an Australian-incorporated company and has nominal market value.

14.            ForeignCo is the sole shareholder of SubCo.

15.            SubCo is, and has been, a dormant company since its incorporation. Therefore, SubCo has no taxable income that would be taxable.

The Property

16.            ForeignCo is the sole registered proprietor of a property located in Australia (the Property).

17.            The Property is ForeignCo's main asset.

18.            The leasing of the Property, including managing tenants and lease negotiations, has been conducted in Australia.

19.            The Shareholders intend to undertake a development of the Property.

The Restructure

20.            In order to develop the Property, the Shareholders consider that it is first necessary to reorganise the ForeignCo group.

21.            The reorganisation of the ForeignCo group will involve the steps taken below in the following order:

Step 1: Interposition of HoldCo between ForeignCo and its shareholders

22.            The Shareholders will transfer all of their ForeignCo shares to HoldCo in exchange for the exact same whole number of ordinary shares (and the same proportion of ordinary shares) in HoldCo as they held in ForeignCo immediately prior to the transfer (the Exchange). The ordinary shares in HoldCo will have the same rights as the ordinary shares in ForeignCo.

23.            The ordinary shares in HoldCo will not be redeemable shares.

24.            The Shareholders will not receive any other consideration in relation to the Exchange.

25.            As a result of the Exchange, the Shareholders will acquire the entire issued share capital of HoldCo and ForeignCo will become a direct wholly-owned subsidiary of HoldCo.

26.            Within 2 months of the Exchange, HoldCo will choose that section 615-65 of the ITAA 1997 applies.

Step 2: Tax Consolidation Election

27.            HoldCo will elect to form an income tax consolidated group, comprising HoldCo as the head company and ForeignCo and SubCo as subsidiary members.

28.            HoldCo will specify a date on and from which the group is consolidated (Consolidation Date).

Step 3: Transfer of SubCo shares to HoldCo

29.            On or after the Consolidation Date, ForeignCo will transfer all its issued ordinary shares in SubCo to HoldCo for nominal consideration.

Step 4: Transfer of the Property to SubCo

30.            Ownership of the Property will be transferred from ForeignCo to SubCo for market value consideration, to be funded by a vendor loan (Loan) and the assumption by SubCo of other liabilities owed by ForeignCo. Consideration of these other liabilities do not fall within the scope of this Ruling.

31.            SubCo will thereafter conduct the development of the Property.

Step 5: ForeignCo to pay dividends and return capital to HoldCo and deregister

32.            In order to prepare ForeignCo for deregistration, ForeignCo will, amongst other things (e.g. pay existing creditors):

a.             declare a dividend to HoldCo to the maximum extent possible (which would include profits from the sale of the Property to SubCo)

b.             return contributed capital to HoldCo as its shareholder, and

c.             reduce the value of the Loan between ForeignCo and SubCo. This would be done in a two-step process: ForeignCo will assign the receivable due under the Loan to HoldCo, and then HoldCo will contribute the receivable due under the Loan to SubCo, in exchange for the issue of new ordinary shares in SubCo, such that the Loan is repaid in full.

33.            The dividend and return of capital, referred to in the preceding paragraph, will be satisfied by the distribution of cash and the receivable due under the Loan.

34.            The market value of the shares issued by SubCo to HoldCo in paragraph 31(c) will equal the face value of the Loan.

35.            ForeignCo will have no assets or liabilities at this stage.

36.            ForeignCo will then be deregistered.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 paragraph 6(1)(b)

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 section 197-5

Income Tax Assessment Act 1997 section 197-10

Income Tax Assessment Act 1997 subsection 197-15(1)

Income Tax Assessment Act 1997 subsection 197-15(2)

Income Tax Assessment Act 1997 section 197-42

Income Tax Assessment Act 1997 section 615-65

Income Tax Assessment Act 1997 section 701-1

Income Tax Assessment Act 1997 subsection 703-15(2)

Income Tax Assessment Act 1997 paragraph 703-15(2)(a)

Income Tax Assessment Act 1997 paragraph 703-15(2)(b)

Migration Act 1958 subsection 30(1)

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1

1.            Subsection 703-15(2) lists the requirements for an entity to be a head company or subsidiary member of a consolidatable group.

HoldCo will meet the requirements under paragraph 703-15(2)(a)

2.            Under paragraph 703-15(2)(a), to be a head company of a consolidatable group, the entity must:

a.             be a company that has all or some of its taxable income (if any) taxed at a rate equal to the general corporate tax rate

b.             be an Australian resident (but not a prescribed dual resident), and

c.             not be a wholly-owned subsidiary member of a consolidated group or a group that is eligible to consolidate.

3.            A company is an Australian resident if it is incorporated in Australia (paragraph 6(1)(b) of the ITAA 1936).

4.            HoldCo is incorporated in Australia. Therefore, it is an Australian-resident company which has its taxable income taxed at a corporate tax rate.

5.            HoldCo will not be a wholly-owned subsidiary member of a consolidated or consolidatable group.

6.            Therefore, HoldCo will meet the requirements under paragraph 703-15(2)(a) to be a head company of a consolidatable group.

SubCo will meet the requirements under paragraph 703-15(2)(b)

7.            To be a subsidiary member of a consolidatable group, an entity must satisfy the requirements set out in item 2 of the table in subsection 703-15(2). Relevantly, the entity must be:

a.             a company, trust or partnership

b.             if it is a company, an Australian resident (but not a prescribed dual resident) that has all or some of its taxable income (if any) taxed at a rate equal to the general corporate tax rate, and

c.             a wholly-owned subsidiary of the head company of the group.

8.            A company is an Australian resident if it is incorporated in Australia or, if its not incorporated in Australia, carries on a business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are residents of Australia (paragraph 6(1)(b) of the ITAA 1936).

9.            SubCo is incorporated in Australia and has no taxable income that would be taxable. SubCo will be wholly-owned by HoldCo.

10.         Consequently, SubCo meets the income tax treatment and Australian residence requirements, and will meet the ownership requirement, under paragraph 703-15(2)(b) to be a subsidiary member of a consolidatable group.

ForeignCo will meet the requirements under paragraph 703-15(2)(b)

11.            As stated above, for a company that is not incorporated in Australia, the company is an Australian resident if it carries on a business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are residents of Australia (paragraph 6(1)(b) of the ITAA 1936).

12.            ForeignCo is not incorporated in Australia. Its voting power is controlled by the Shareholders who are not residents of Australia. Therefore, to be an Australian resident, ForeignCo must carry on a business in Australia and have its central management and control in Australia.

13.            Identifying who exercises central management and control is a question of fact. It cannot be determined solely by identifying who has the legal power or authority to control and direct the company. The crucial question is who controls and directs the company's operations in reality (Taxation Ruling TR 2018/5 Income tax: central management and control test of residency, which sets out the Commissioner's view on how to apply the central management and control test of company residency following Bywater Investments Limited & Ors v Commissioner of Taxation; Hua Wang Bank Berhad v Commissioner of Taxation [2016] HCA 45).

14.            Central management and control refers to the control and direction of a company's operations. The key element in the control and direction of a company's operations is the making of high-level decisions that set the company's general policies, and determine the direction of its operations and the type of transactions it will enter (paragraph 11 of TR 2018/5).

15.            Normally, a company's central management and control will be exercised where those making its high-level decisions make their decisions, execute their duties and comply with the standards under the applicable laws (Practical Compliance Guideline PCG 2018/9 Central management and control test of residency: identifying where a company's central management and control is located).

16.            While ForeignCo's registered office is in the foreign jurisdiction, ForeignCo has not kept any operational office, nor carried on any business or operation, in that jurisdiction. Its operation in the foreign jurisdiction is limited to preparing audited financial statements (for the purposes of maintaining its company registration in that jurisdiction).

17.            The directors of ForeignCo are Shareholder A (a foreign resident and a holder of a 'permanent visa' within the meaning of subsection 30(1) of the Migration Act 1958), Director C (an Australian resident) and Director D (an Australian resident).

18.            Minutes of board meetings demonstrate that:

a.             the board meetings took place in Australia

b.             were chaired by Director C, and

c.             were attended by Director C and Director D in Australia.

19.         Shareholder A was not present at some of the board meetings, and attended the other board meeting whilst physically present in Australia.

20.            Those board meetings centred around the financial performance of ForeignCo, the re-development of the Property, financing options available and consideration of the structure of ForeignCo, being key strategic decisions that set the direction of ForeignCo's operations, particularly given that ForeignCo's primary business is its investment in the Property.

21.            The leasing of the Property, including managing tenants and lease negotiations, has also been conducted in Australia.

22.            On balance, the facts demonstrate that ForeignCo's central management and control is in Australia.

23.            ForeignCo's sole activity is the leasing and development of the Property, which is located in Australia. Therefore, ForeignCo is an Australian-resident company which carries on a business in Australia, has its taxable income taxed at a corporate tax rate and will be wholly-owned by HoldCo.

24.            ForeignCo is not a prescribed dual resident (as defined in subsection 6(1) of the ITAA 1936) because, while it is a resident of Australia, it is not a resident of another country where:

a.             it is treated as resident solely of the other country by one of Australia's double taxation agreements, or

b.             it qualifies as resident of Australia because it has its central management and control in Australia, but it also has its central management and control in the other country.

25.            Consequently, ForeignCo will meet the requirements under paragraph 703-15(2)(b) to be a subsidiary member of a consolidatable group.

Question 2

26.            Under the single entity rule in section 701-1, if an entity is a subsidiary member of a consolidated group, it is taken to be part of the head company for both head company core purposes (i.e. working out the head company's tax liability or loss) and entity core purposes (i.e. working out the entity's tax liability or loss).

27.            Consequently, the single entity rule has the effect that:

a.             the actions and transactions of the subsidiary members are treated as having been undertaken by the head company

b.             the assets a subsidiary member of the group owns are taken to be owned by the head company (with the exception of intra-group assets) while the subsidiary remains a member of the consolidated group

c.             assets where the rights and obligations are between members of a consolidated group (intra-group assets) are not recognised for income tax purposes during the period they are held within the group whether or not the asset, as a matter of law, was created before or during the period of consolidation, and

d.             dealings that are solely between members of the same consolidated group (intra-group dealings) will not result in ordinary or statutory income or a deduction to the group's head company (Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997).

28.            Therefore, if HoldCo elects to form an income tax consolidated group comprising HoldCo as head company and ForeignCo and SubCo as subsidiary members, then the transfer of the Property from ForeignCo to SubCo, the payment of a dividend by ForeignCo to HoldCo, a return of capital by ForeignCo to HoldCo, and the assignment of the Loan from ForeignCo to HoldCo, will be treated as intra-group dealings and section 701-1 will apply.

Question 3

29.            Division 197 will apply to an amount (the transferred amount) that is transferred to a company's share capital account from another of the company's accounts, resulting in the company's share capital account becoming tainted, unless one of the exclusions set out in sections 197-10 to 197-42 apply (section 197-5).

30.            Under subsection 197-15(1), Division 197 does not apply to the transferred amount if the transfer is a result of:

a.             a person discharging, releasing or otherwise extinguishing the whole or a part of a debt that the company owes to the person in return for the company issuing shares in the company to the person, and

b.             the transfer is a credit to the share capital account that is made because of the issue of the shares in return for the discharge, release or extinguishment of the debt.

31.            Subsection 197-15(2) provides that the exclusion in subsection 197-15(1) does not apply to so much of the transferred amount that exceeds the lesser of:

a.             the market value of the shares issued by the company, and

b.             so much of the debt as is discharged, released or extinguished in return for the shares.

32.            Under the restructure, HoldCo will contribute the receivable due under the Loan to SubCo in exchange for the issue of new ordinary shares in SubCo equal to the face value of the Loan.

33.            As the market value of the shares issued by SubCo to HoldCo will equal the value of the Loan, the exclusion in subsection 197-15(1) will apply and SubCo's share capital account will not be tainted within the meaning of Division 197.