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Treasury Laws Amendment (Income Tax Consolidation Integrity) Bill 2018

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2016-2017-2018

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

HOUSE OF REPRESENTATIVES

 

 

 

Treasury Laws Amendment (Income Tax consolidation integrity) Bill 2018

 

 

 

 

EXPLANATORY MEMORANDUM

 

 

 

(Circulated by authority of the

Minister for Revenue and Financial Services, Minister for Women and Minister Assisting the Prime Minister for the Public Service, the Hon Kelly O’Dwyer MP)



Table of contents

Glossary.............................................................................................................. 1

General outline and financial impact............................................................ 3

Chapter 1               Consolidation........................................................................ 5

Chapter 2               Statement of Compatibility with Human Rights............ 69

 



The following abbreviations and acronyms are used throughout this explanatory memorandum.

Abbreviation

Definition

AASB

Australian Accounting Standards Board

ADI

authorised deposit-taking institution

April 2013 Report

Board of Taxation Report on the on the Post-implementation review of certain aspects of the consolidation tax cost setting process , finalised in April 2013

Bill

Treasury Laws Amendment (Income Tax Consolidation Integrity) Bill 2018

Commissioner

Commissioner of Taxation

ITAA 1936

Income Tax Assessment Act 1936

ITAA 1997

Income Tax Assessment Act 1997

June 2012 Report

Board of Taxation Report on the Post-implementation review of certain aspects of the consolidation regime , finalised in June 2012

MEC group

multiple entry consolidated group

TOFA

Taxation of Financial Arrangements

 



Consolidation

Schedule 1 to this Bill amends the ITAA 1997 to improve the integrity and operation of the consolidation regime by implementing the following measures:

•        the deductible liabilities measure, which will remove a double benefit that can arise in respect of certain liabilities held by an entity that joins a consolidated group;

•        the deferred tax liabilities measure, which will simplify the operation of the entry and exit tax cost setting rules by ensuring that deferred tax liabilities are disregarded;

•        the securitised assets measure, which will remove anomalies that arise when an entity joins or leaves a consolidated group where the entity has securitised an asset;

•        the churning measure, which will switch off the entry tax cost setting rules for a joining entity where a capital gain or capital loss made by a foreign resident owner when it ceases to hold membership interests in the joining entity is disregarded in certain circumstances;

•        the TOFA measure, which will clarify the operation of the TOFA provisions when an intra-group asset or liability that is, or is part of, a Division 230 financial arrangement emerges from a consolidated group because a subsidiary member leaves the group; and

•        the value shifting measure, which will remove anomalies that arise when an entity leaves a consolidated group holding an asset that corresponds to a liability owed to it by the old group because the value of the asset taken into account for tax cost setting purposes is not always appropriate.

Date of effect The dates of effect of the various measures are, broadly, as follows:

•        the deductible liabilities measure applies from 1 July 2016;

•        the deferred tax liabilities measure applies from the date of introduction of the amending legislation;

•        the securitised assets measure applies to ADIs and financial entities from 13 May 2014, and to all other entities from 3 May 2016;

•        the churning measure and the value shifting measure apply from 14 May 2013; and

•        the TOFA measure applies from the commencement of the TOFA regime (generally from 1 July 2010).

Where appropriate, transitional rules ensure that taxpayers who have entered into arrangements prior to commencement are not disadvantaged, are not able to obtain windfall gains, or do not have to change a position they have taken under the current law.

Proposal announced These measures (except for the deferred tax liabilities measure and the securitised assets measure) were originally announced by the former Government in the 2013-14 Budget.

The application of the securitised assets measure to ADIs and financial entities was announced by the Government in the 2014-15 Budget.

In the 2016-17 Budget, as part of the Tax Integrity Package, the Government announced:

•        changes to the deductible liabilities measure to modify the approach for implementing the measure and to defer the start date for the measure until 1 July 2016;

•        the deferred tax liabilities measure; and

•        the extension of the securitised assets measure to all entities.

Financial impact These amendments are estimated to have the following revenue implications:

2017-18

2018-19

2019-20

2020-21

$475m

$200m

$235m

$260m

Human rights implications :  This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights — see Chapter 2.

Compliance cost impact Minimal.



Chapter 1          

Consolidation

Outline of chapter

1.1                   Schedule 1 to this Bill amends the ITAA 1997 to improve the integrity and operation of the consolidation regime by implementing the following measures:

•        the deductible liabilities measure, which will remove a double benefit that can arise in respect of certain liabilities held by an entity that joins a consolidated group;

•        the deferred tax liabilities measure, which will simplify the operation of the entry and exit tax cost setting rules by ensuring that deferred tax liabilities are disregarded;

•        the securitised assets measure, which will remove anomalies that arise when an entity joins or leaves a consolidated group where the entity has securitised an asset;

•        the churning measure, which will switch off the entry tax cost setting rules for a joining entity where a capital gain or capital loss made by a foreign resident owner when it ceases to hold membership interests in the joining entity is disregarded in certain circumstances;

•        the TOFA measure, which will clarify the operation of the TOFA provisions when an intra-group asset or liability that is, or is part of, a Division 230 financial arrangement emerges from a consolidated group because a subsidiary member leaves the group; and

•        the value shifting measure, which will remove anomalies that arise when an entity leaves a consolidated group holding an asset that corresponds to a liability owed to it by the old group because the value of the asset taken into account for tax cost setting purposes is not always appropriate.

1.2                   All legislative references in this Chapter are to the ITAA 1997 unless otherwise indicated.

Context of amendments

1.3                   The consolidation regime applies primarily to a wholly owned group of Australian resident entities that chooses to form a consolidated group for income tax purposes. A consolidated group generally consists of an Australian resident head company and all of its wholly owned resident subsidiaries.

1.4                   Specific rules also allow certain resident wholly owned subsidiaries of a foreign holding company to consolidate by forming a MEC group. Unless otherwise specified, references in this Chapter to a consolidated group include a MEC group.

1.5                   If a wholly owned group of entities chooses to form a consolidated group or MEC group, the group is treated as a single entity for income tax purposes.

1.6                   The consolidation regime was introduced in 2002. The Board of Taxation commenced a post implementation review of certain aspects of the consolidation regime in 2009. As a result of its review, the Board presented two reports:

•        the June 2012 Report; and

•        the April 2013 Report.

1.7                   Schedule 1 to this Bill implements recommendations made by the Board of Taxation in these Reports to improve the integrity and operation of the consolidation regime. It also implements other changes which are consistent with the Board's recommendations.

1.8                   In particular, the integrity and operation of the consolidation regime will be improved by implementing the following measures:

•        the deductible liabilities measure;

•        the deferred tax liabilities measure;

•        the securitised assets measure;

•        the churning measure;

•        the TOFA measure; and

•        the value shifting measure.

1.9                   These measures (except for the deferred tax liabilities measure and the securitised assets measure) were originally announced by the former Government in the 2013-14 Budget.

1.10               The application of the securitised assets measure to ADIs and financial entities was announced by the Government in the 2014-15 Budget.

1.11               In the 2016-17 Budget, as part of the Tax Integrity Package, the Government announced:

•        changes to the deductible liabilities measure to modify the approach for implementing the measure and to defer the start date for the measure until 1 July 2016;

•        the deferred tax liabilities measure; and

•        the extension of the securitised assets measure to all entities.

Summary of new law

1.12               Schedule 1 to this Bill amends the ITAA 1997 to improve the integrity and operation of the consolidation regime. In particular:

•        the deductible liabilities measure will remove a double benefit which can arise in respect of certain deductible liabilities held by an entity that joins a consolidated group by excluding the value of deductible liabilities from the entry allocable cost amount, with effect from 1 July 2016;

•        the deferred tax liabilities measure will simplify the operation of the entry and exit tax cost setting rules by ensuring that deferred tax liabilities are disregarded, with effect from the date of introduction of the amending legislation;

•        the securitised assets measure will remove anomalies that arise when an entity that has securitised assets joins or leaves a consolidated group by modifying the tax cost setting rules to disregard liabilities relating to the securitised assets, with effect from:

-                  for ADIs and financial entities 13 May 2014; and

-                  for all other entities 3 May 2016;

•        the churning measure will switch off the entry tax cost setting rules for a joining entity where a capital gain or capital loss made by a foreign resident owner when it ceases to hold membership interests in the joining entity is disregarded and there has been no change in the majority economic ownership of the joining entity for a period of at least 12 months before the joining time, with effect from 14 May 2013;

•        the TOFA measure will clarify the operation of the TOFA provisions by setting a tax value for an intra-group asset or liability that is, or is part of, a Division 230 financial arrangement when the asset or liability emerges from a consolidated group because a subsidiary member leaves the group, with effect from the commencement of the TOFA regime (generally from 1 July 2010); and

•        the value shifting measure will remove anomalies that arise when an entity leaves a consolidated group holding an asset that corresponds to a liability owed to it by the old group by ensuring that the amount taken into account under the exit tax cost setting rules for the asset is aligned with the tax cost setting amount for the corresponding asset of the leaving entity, with effect from 14 May 2013.

Comparison of key features of new law and current law

New law

Current law

The deductible liabilities measure will remove a double benefit which can arise in respect of certain deductible liabilities held by an entity that joins a consolidated group by excluding the amount of deductible liabilities from the entry allocable cost amount.

 

When an entity that holds a deductible liability becomes a member of a consolidated group, a double benefit arises because:

•        the liability increases the allocable cost amount for the joining entity ; and

•        the head company can claim a deduction in respect of the liability when the relevant expenditure is incurred.

The deferred tax liabilities measure will simplify the operation of the entry and exit tax cost setting rules by ensuring that deferred tax liabilities of a joining entity or leaving entity are disregarded.

For the purposes of working out the entry and exit tax cost setting amount, adjustments are made to take account of deferred tax liabilities of a joining entity or leaving entity.

The securitised assets measure will modify the entry and exit tax cost setting rules to remove anomalies that arise when an entity that has securitised assets joins or leaves a tax consolidated group by ensuring that the corresponding liability is disregarded.

If an entity that joins or leaves a tax consolidated group has securitised assets, a mismatch occurs under the entry and exit tax cost setting rules because the securitised asset and the corresponding liability are not recognised in the same way for tax consolidation purposes.

The churning measure will switch off the entry tax cost setting rules for a joining entity where a capital gain or capital loss made by a foreign resident owner when it ceases to hold membership interests in the joining entity is disregarded and there has been no change in the majority economic ownership of the joining entity for a period of at least 12 months before the joining time.

When an entity is acquired by a consolidated group from a foreign resident, the entry tax cost setting rules apply to reset the tax costs of the joining entity’s assets even where a capital gain or capital loss made by a foreign resident owner (as a consequence of the disposal of its membership interests in the joining entity) is disregarded.

The TOFA measure will set a tax value for an intra-group asset or liability that is, or is part of, a Division 230 financial arrangement when the asset or liability emerges from a consolidated group because a subsidiary member leaves the group. This will clarify the operation of the TOFA provisions to these financial arrangements.

The tax value for an intra-group asset or liability that is, or is part of, a Division 230 financial arrangement which emerges from a consolidated group because a subsidiary member leaves the group is unclear. As a result, the operation of the TOFA provisions to these financial arrangements is also unclear.

The value shifting measure will remove anomalies that arise when an entity leaves a consolidated group holding an asset that corresponds to a liability owed to it by the old group by ensuring that the amount taken into account under the exit tax cost setting rules for the asset is aligned with the tax cost setting amount for the corresponding asset of the leaving entity.

When an entity leaves a consolidated group holding an asset that corresponds to a liability owed to it by the old group, the amount taken into account under the exit tax cost setting rules for the asset is:

•        the market value of the asset; or

•        in limited circumstances, an amount that reflects the tax cost of the asset.

As a result, circumstances arise where economic gains made by the old group are sheltered from the appropriate tax consequences.

Detailed explanation of new law

1.13               Schedule 1 to this Bill implements some of the recommendations made by the Board of Taxation to improve the integrity and operation of the consolidation regime. In particular:

•        the deductible liabilities measure (Part 1 of Schedule 1) will remove a double benefit which can arise in respect of certain deductible liabilities held by an entity that joins a consolidated group by excluding the value of deductible liabilities from the entry allocable cost amount;

•        the deferred tax liabilities measure (Part 2 of Schedule 1) will simplify the operation of the entry and exit tax cost setting rules by ensuring that deferred tax liabilities are disregarded;

•        the securitised assets measure (Parts 3 and 4 of Schedule 1) will remove anomalies that arise when an entity that has securitised assets joins or leaves a tax consolidated group by modifying the tax cost setting rules to disregard liabilities relating to the securitised assets;

•        the churning measure (Part 5 of Schedule 1) will switch off the entry tax cost setting rules for a joining entity where a capital gain or capital loss made by a foreign resident owner when it ceases to hold membership interests in the joining entity is disregarded and there has been no change in the majority economic ownership of the joining entity for a period of at least 12 months before the joining time;

•        the TOFA measure (Part 6 of Schedule 1) will clarify the operation of the TOFA provisions by setting a tax value for an intra-group asset or liability that is, or is part of, a Division 230 financial arrangement when the asset or liability emerges from a consolidated group because a subsidiary member leaves the group; and

•        the value shifting measure (Part 7 of Schedule 1) will remove anomalies that arise when an entity leaves a consolidated group holding an asset that corresponds to a liability owed to it by the old group by ensuring that the amount taken into account under the exit tax cost setting rules for the asset is aligned with the tax cost setting amount for the corresponding asset of the leaving entity.

Part 1 — The deductible liabilities measure

1.14               The deductible liabilities measure in Part 1 of Schedule 1 to this Bill removes a double benefit which can arise in respect of certain deductible liabilities held by an entity that joins a consolidated group by excluding the amount of deductible liabilities from the entry allocable cost amount.

1.15               One of the objects of the consolidation regime (as set out in section 700-10) is to prevent double taxation and a double tax benefit from being realised by a consolidated group.

1.16               The Board of Taxation raised concerns that a consolidated group can obtain a double benefit in respect of deductible liabilities held by a joining entity that is acquired by the group (see Chapter 2 of the Board's April 2013 Report). That is, when an entity joins a consolidated group holding a deductible liability:

•        a benefit arises under the tax cost setting rules because the liability increases the allocable cost amount for the joining entity and therefore contributes to the tax cost that is set; and

•        a second benefit arises because the head company can claim a deduction for the liability when the relevant expenditure is incurred.

1.17               To overcome these concerns, the Board initially recommended (Recommendation 2.1 of the Board's April 2013 Report) that, broadly, where a consolidated group obtains a double benefit because an acquired deductible liability is included in step 2 of the entry allocable cost amount, then:

•        in the case of a deductible liability that is a current liability for accounting purposes an equivalent amount should be included in the assessable income of the head company over the 12 month period following the joining time; and

•        in the case of a deductible liability that is a non-current liability for accounting purposes an equivalent amount should be included in the assessable income of the head company over the four year period following the joining time.

1.18               Exposure draft legislation to implement the Board’s recommendation was released in April 2015. In response, stakeholders raised concerns that the deductible liabilities measure would operate in circumstances where a double tax benefit may not necessarily arise in practice for example, where the allocable cost amount contributes to the tax costs of certain intangible assets (such as goodwill) held by a joining entity that are retained permanently by the group.

1.19               Stakeholders also raised concerns about the complexity of the recommended approach because it would require different treatment to deductible liabilities that are ‘acquired’ and those that are ‘owned’.

1.20               These concerns were raised with the Board and the approach for addressing the issue was reviewed. As a result of that review, the Board concluded that, in practice, the approach originally recommended could give rise to unfair tax outcomes in some circumstances. Therefore, although there is no perfect solution to address the integrity concerns, the Board concluded that a fairer approach would be to reduce the amount at step 2 of the entry tax cost setting amount by the amount of deductible liabilities.

1.21               This revised approach was announced as part of the 2016-17 Budget as a better targeted measure designed to prevent a consolidated group from obtaining a double taxation benefit when an entity joins a group. In addition, given the complexity of the issues involved and its impact on commercial arrangements, the start date of the measure was deferred until 1 July 2016.

1.22               The revised approach applies to accounting liabilities of a joining entity, irrespective of whether the joining entity becomes a member of the consolidated group because it is acquired by the group or because of the formation of a new group.

Deductible liabilities excluded from step 2

1.23               Step 2 of the entry allocable cost amount increases the amount of the allocable cost amount for a joining entity by, broadly, the amount of the joining entity’s accounting liabilities.

1.24               The operation of the consolidation tax cost setting rules will be modified so that, with the exception of those liabilities that are specifically referred to in subsection 705-70(1AC), an amount will not be added at step 2 for an accounting liability that is a deductible liability. [Schedule 1, item 1, subsection 705-70(1AB)]

1.25               An accounting liability is a deductible liability if, assuming that the head company had made a payment to discharge the accounting liability just after the joining time, that payment would result in an amount that reflects all or part of the accounting liability being a deduction to the head company of the group. [Schedule 1, item 1, paragraph 705-70(1AA)(b)]

1.26               For the purpose of working out the amount of an accounting liability that is a deductible liability, the head company must determine, based on the facts of the joining entity at the joining time, whether a deduction would arise in respect of all or part of the liability. The assumed discharge represents a deemed payment for the purposes of the relevant deduction provision. The amount of the deductible liability is so much of the liability which gives rise to the assumed discharge (even if there is no legal obligation to discharge the liability at that time).

1.27               Typical examples of accounting liabilities held by a joining entity at the joining time that are deductible liabilities are:

•        an accounting provision that is expensed, where the deduction for tax purposes is allowed at a later time (such as an accrued leave liability);

•        a derivative liability that is out of the money (and is not covered by TOFA); and

•        a foreign currency liability that is in a net forex loss position.

1.28               These accounting liabilities are often an estimate of a future expected expense or outgoing. Consequently, the amount of the liability that gives rise to the future deductible amount may be unclear.

1.29               If the head company makes an error in its tax cost setting amount calculations by, for example, treating an accounting liability as deductible liability where the deduction would not be allowable as a matter of law, the normal mechanisms for correcting errors in the tax cost setting amount calculations would need to be considered. That is, the tax cost setting amount calculations can be revised or the provisions in Subdivision 705-E can be applied where the other conditions in the error rules are satisfied to make adjustments to correct the error.

1.30               If the head company would be entitled to a deduction as a result of the discharge of an accounting liability (or a part of the accounting liability) just after the joining time, the amount that would be deductible is not added for that liability at step 2 of the entry allocable cost amount.

Example 1.1  

Head Co acquires all of the membership interests in Joining Co on 30 September 2018. At the joining time, Joining Co holds an accounting liability that is a provision for long service leave of $150,000. Under Joining Co’s long service leave policy employees accrue long service leave from the first day of their employment but are not entitled to take the leave until they have completed five years of employment.

Joining Co’s long service leave liability at the joining time is a mixture of long service leave entitlements for both:

•        employees entitled to take the leave because they have completed five years of employment; and

•        employees not entitled to take the leave because they have not yet completed five years of employment.

After the joining time, Head Co can deduct an amount for long service leave when it is paid to an individual to whom the leave relates (or, if the individual has died, to that individual’s dependant or legal personal representative) (section 26-10).

For the purpose of working out whether the accounting liability is a deductible liability, and the amount of that liability, Head Co must assume that, just after the joining time:

•        all of the conditions for making long service leave payments are met in relation to all employees;

•        all of the conditions for claiming a deduction are met; and

•        it makes a payment to discharge the full amount of the Joining Co’s long service leave liability (and there is an amount paid for the purposes of section 26-10).

In this regard, Head Co would need to make a payment of $150,000 to discharge the long service leave liability just after the joining time. As the requirements in section 26-10 would be taken to be satisfied, the amount of the deductible liability would be $150,000. Therefore, the amount of the long service leave liability ($150,000) is not added at step 2 of the entry allocable cost amount for Joining Co.

1.31               If the head company would be entitled to a deduction for part of an accounting liability, the net amount of the accounting liability that would be deductible is not added for that liability under step 2 of the entry allocable cost amount.

Example 1.2  

Head Co acquires all of the membership interests in Joining Co on 1 July 2018. At the joining time, Joining Co holds an accounting liability that is a foreign currency loan payable of AUD$100,000. The original loan amount was AUD$75,000. The original loan matures on 1 July 2020.

The foreign currency loan is recognised as an accounting liability on the balance sheet of Joining Co. At the joining time the net increase in respect of the foreign currency loan is AUD$25,000 and this increase is reflected in the balance sheet.

Head Co would be entitled to deduct an amount for the net foreign currency loss if the foreign currency loan obligation was discharged just after the joining time (under Division 775).

The amount of Joining Co's accounting liability that would be deductible to Head Co is AUD$25,000. Therefore, the amount of AUD$25,000 of the foreign currency loan is not added at step 2 of the entry allocable cost amount for Joining Co.

1.32               An accounting liability that is an unearned income liability is not typically a deductible liability because it is generally reasonable to conclude that the liability will not result in a future income tax deduction for the head company.

1.33               Where an accounting liability is not included at step 2 of the entry allocable cost amount, no adjustments are required in respect of that accounting liability under section 705-75 or section 705-80 these sections adjust the amount of an accounting liability that is included in step 2 in certain circumstances.

1.34               Similarly, where an entity joins a consolidated group by way of a group acquisition under Subdivision 705-C, the deductible liabilities of the acquired group (which is treated as the joining entity) are not included at step 2 of the joining group's entry allocable cost amount.

Certain deductible liabilities continue to be included at step 2

1.35               The existing tax cost setting rules will continue to apply to an amount in relation to an accounting liability that is a deductible liability to the extent that it is covered by subsection 705-70(1AC). Consequently:

•        an amount in respect of these liabilities will continue to be added at step 2 of the entry allocable cost amount; and

•        the adjustments to the step 2 amount that are made by sections 705-75 and 705-80, to the extent that they are relevant, will continue to apply to these liabilities.

[Schedule 1, items 1, 2 and 3, paragraph 705-70(1AA)(a), subsections 705-70(1AC), 705-75(1A) and 705-80(1A)]

1.36               The liabilities that are referred to in subsection 705-70(1AC) are, broadly:

•        accounting liabilities held by life insurance companies and that relate to life insurance policyholders;

•        accounting liabilities held by general insurance companies and private health insurers that relate to general insurance policyholders;

•        accounting liabilities that are financial arrangements covered by the TOFA rules; and

•        accounting liabilities that relate to certain retirement village contracts.

1.37               In this regard, in its April 2013 Report (at paragraphs 2.9 to 2.11), the Board of Taxation concluded that the tax cost setting changes to deductible liabilities should not apply to insurance policy liabilities or to TOFA liabilities.

1.38               The Board also noted that the treatment of retirement village contract liabilities should be considered during the implementation of its recommendations (see footnote 17 of the April 2013 Report).

Accounting liabilities held by life insurance companies

1.39               The Board of Taxation noted that the concerns relating to deductible liabilities did not appear to arise in relation to life insurance policy liabilities and recommended that the longstanding treatment of these liabilities should not disturbed by these amendments.

1.40               Therefore, if a life insurance company joins a consolidated group an amount in respect of a liability that is covered by section 713-520 will continue to be added at step 2 of the entry allocable cost amount. [Schedule 1, item 1, paragraph 705-70(1AA)(a) and subparagraph 705-70(1AC)(a)(i)]

1.41               Section 713-520 applies when a life insurance company joins a consolidated group to set a value for the following types of policy liabilities for consolidation purposes:

•        complying superannuation liabilities;

•        exempt life insurance policy liabilities;

•        liabilities under the net investment component of ordinary life insurance policies; and

•        liabilities under the net risk component of life insurance policies.

1.42               In addition, if a life insurance company joins a consolidated group, an amount in respect of a liability that relates to an asset that is a retained cost base asset because of section 713-515 will continue to be added at step 2 of the entry allocable cost amount. [Schedule 1, item 1, paragraph 705-70(1AA)(a) and paragraph 705-70(1AC)(b)]

1.43               In this regard, when a life insurance company joins a consolidated group, assets that are held to support policyholders are generally retained cost base assets (and therefore do not have their tax costs reset). The broad effect of this mechanism (together with section 713-520) is to ensure that the tax outcomes for these policyholder assets are not affected when a life insurance company joins a consolidated group.

1.44               To ensure that this mechanism remains undisturbed, an amount in respect of a liability that relates to an asset that is a retained cost base asset because of section 713-515 will continue to be added at step 2 of the entry allocable cost amount where the value of the liability is reflected in the value of the retained cost base assets.

1.45               A liability of a life insurance company may be both a policy liability covered by subparagraph 705-70(1AC)(a)(i) and a liability that relates to an asset that is a retained cost base asset covered by paragraph 705-70(1AC)(b). In these circumstances the liability is included at step 2 of the entry allocable cost amount only once. Therefore, paragraph 705-70(1AC)(b) will not apply to the liability to the extent that it is covered by subparagraph 705-70(1AC)(a)(i).

1.46               Consistent with the longstanding view set out in Taxation Determination TD 2005/17, the adjustments to the step 2 amount that are made by sections 705-75 and 705-80 do not apply to life insurance policyholder related liabilities. [Schedule 1, items 2 and 3, subsections 705-75(1A) and 705-80(1A)]

Accounting liabilities held by general insurance companies and private health insurers

1.47               The Board of Taxation noted that the concerns relating to deductible liabilities did not appear to arise in relation to general insurance policy liabilities and recommended that the longstanding treatment of these liabilities should not disturbed by these amendments.

1.48               Therefore, if a general insurance company (as defined in subsection 995-1(1)) or a private health insurer (within the meaning of the Private Health Insurance (Prudential Supervision) Act 2015 ) joins a consolidated group, an amount will continue to be added at step 2 of the entry allocable cost amount if it is:

•        the outstanding claims liability of the general insurance company or private health insurer under general insurance policies (as defined in subsection 995-1(1)); or

•        the unearned premium liability of the general insurance company or private health insurer under general insurance policies; or

•        the unexpired risk liability of the general insurance company or a private health insurer under general insurance policies.

[Schedule 1, item 1, paragraphs 705-70(1AA)(a) and 705-70(1AC)(c)]

1.49               For the purposes of step 2 of the entry allocable cost amount, the values of the outstanding claims liability, unearned premium liability and unexpired risk liability of a general insurance company are worked out in accordance with Accounting Standard AASB 1023 General Insurance Contracts .

1.50               In this regard, the outstanding claims liability of a general insurance company or private health insurer is essentially a provision for future claims. Accounting Standard AASB 1023 defines the outstanding claims liability to mean:

‘all unpaid claims and related claims handling expenses relating to claims incurred before the end of the reporting period’.

1.51               Under Accounting Standard AASB 1023, the outstanding claims liability includes indirect claims settlement costs.

1.52               The unearned premium liability of a general insurance company or private health insurer essentially represents premium income received by the general insurance company or private health insurer that is unearned.

1.53               Under the Liability Adequacy Test in Accounting Standard AASB 1023, a general insurance company or private health insurer must assess the adequacy of the unearned premium liability by considering current estimates of the present value of expected future cash flows relating to future claims arising from the rights and obligations under general insurance policies. The unexpired risk liability must be recognised if the unearned premium liability is deficient.

1.54               A new accounting standard (Accounting Standard AASB 17) is being introduced to establish principles for the recognition, measurement, presentation and disclosure of insurance contracts issued by a general insurance company or private health insurer. Accounting Standard AASB 17 will generally apply for annual reporting periods beginning on or after 1 January 2021. Accounting Standard AASB 17 uses different terminology to Accounting Standard AASB 1023. However, if a general insurance company or private health insurer is applying Accounting Standard AASB 17, paragraph 705-70(1AC)(c) applies to liabilities that are equivalent to the concepts of outstanding claims liability, unearned premium liability and unexpired risk liability in Accounting Standard AASB 1023.

1.55               When a general insurance company joins a consolidated group, section 713-710 (together with section 713-715) applies to specify the value of outstanding claims liabilities and the unearned premium reserve for the purposes of applying Division 321 to the consolidated group. Division 321 sets out a systematic treatment for these liabilities. For the purposes of Division 321, the accounting value of these liabilities is adjusted in certain circumstances (such as in relation to deferred acquisition costs and indirect claims settlement costs).

1.56               Therefore, for the avoidance of doubt, subsection 705-70(1AD) clarifies that section 713-710 does not affect the amount of the liability that is included at step 2 of the entry allocable cost amount. [Schedule 1, item 1, subsection 705-70(1AD)]

1.57               To the extent that they are relevant, the adjustments to the step 2 amount that are made by sections 705-75 and 705-80 will continue to apply to the deductible liabilities of general insurance companies and private health insurers that are included at step 2 of the entry allocable cost amount. [Schedule 1, items 2 and 3, paragraphs 705-75(1A)(a) and 705-80(1A)(a)]

1.58               In this regard, Taxation Determinations TD 2004/77 and TD 2004/78 set out how these adjustments apply to accounting liabilities of general insurance companies.

Accounting liabilities that are financial arrangements covered by the TOFA rules

1.59               Section 715-375 applies to an accounting liability that is taxed under the TOFA rules that is, the section applies if:

•        an accounting liability of a joining entity can or must be recognised in the entity’s statement of financial position; and

•        the accounting liability is, or is a part of, a Division 230 financial arrangement of the head company at the joining time.

1.60               If an accounting liability of a joining entity is, or is a part of, a Division 230 financial arrangement, then to the extent that the liability is covered by section 715-375, the existing tax cost setting rules (other than the section 705-75 and section 705-80 adjustments) will continue to apply to those liabilities. [Schedule 1, items 1, 2 and 3, paragraph 705-70(1AA)(a), subparagraph 705-70(1AC)(a)(iii) and subsections 705-75(1A) and 705-80(1A)]

Liabilities relating to retirement village contracts

1.61               If a joining entity is a retirement village operator, then the existing tax cost setting rules will continue to apply to an amount in respect of an accounting liability of the joining entity to the extent that the liability arises under:

•        a retirement village residence contract held by a joining entity which is defined in paragraph 230-475(4)(a) to mean a contract that gives rise to a right to residential premises in a retirement village; or

•        a retirement village services contract held by a joining entity which is defined in paragraph 230-475(4)(a) to mean a contract under which a resident of a retirement village is provided with general or personal services in the retirement village.

[Schedule 1, items 1, 2 and 3, paragraphs 705-70(1AA)(a) and 705-70(1AC)(b), and subsections 705-75(1A) and 705-80(1A)]

Step 3 of the entry tax cost setting rules

1.62               Step 3 of the entry tax cost setting amount (section 705-90) increases the allocable cost amount for a joining entity to take account of the undistributed, taxed profits of a joining entity that accrue to the group before the joining time. The purpose of the step 3 amount is to prevent double taxation of those profits.

1.63               The step 3 amount is worked out by reference to the undistributed retained profits of the joining entity (subsection 705-90(2)). In this regard, the deductible liabilities of the joining entity may effectively reduce the amount of retained profits. Therefore, to the extent that deductible liabilities are excluded from step 2 of the allocable cost amount under new subsection 705-70(1AA), the allocable cost amount will be reduced twice by the same amount.

1.64               To the extent that an accounting liability that is a deductible liability is excluded from step 2 under new subsection 705-70(1AB), that liability is not to be taken into account for the purposes of working out the undistributed profits of the joining entity under subsection 705-90(2). [Schedule 1, item 5, subsection 705-90(2B)]

1.65               This will prevent the double counting of the same amount where step 3 of the allocable cost amount applies to a joining entity.

Example 1.3  

Head Co incorporates a new subsidiary Sub Co for $200 on 1 July 2018. During its first year of operations, it derives income of $600 (assessable) and incurs a provision for annual leave of $400.

At 30 June 2019, Sub Co has a liability for income tax of $180 (calculated as $600 of income x 30%).

Sub Co’s balance sheet at 30 June 2019 is as follows:

Assets

$

Liabilities and Equity

$

Cash at bank

800

Provision for annual leave

400

Deferred tax asset

120

Provision for income tax (unpaid)

180

 

 

Share capital

200

 

 

Retained earnings

140

Total assets

920

Total Liabilities and Equity

920

Head Co forms a tax consolidated group on 1 July 2019.

The step 3 amount is $420, consisting of:

•        the retained earnings $140; and

•        the subsection 705-90(2B) amount $280 (that is,

$400  x  70 per cent).

Therefore, the allocable cost amount for Sub Co is:

•        step 1 $200

•        step 2 $180

•        step 3 $420

•        Total $800.

Operation of the exit tax cost setting rules

1.66               Step 4 of the exit tax cost setting amount (section 711-45) reduces the old group’s allocable cost amount for a leaving entity by the amount of the accounting liabilities that the leaving entity takes with it.

1.67               When an accounting liability that a leaving entity takes with it was brought into a consolidated group by a joining entity (and was therefore taken into account under the entry tax cost setting rules), the step 4 amount needs to be worked out having regard to the treatment of the liability on entry.

1.68               In working out the step 4 amount for an accounting liability that is a deductible liability:

•        subsection 711-45(3) applies to reduce the step 4 amount of the liability by the value of the future tax deduction;

•        if the liability is taken into account for income tax purposes at a later time than it is for accounting purposes, subsection 711-45(5) applies to adjust the step 4 amount of the liability (sometimes to nil); and

•        if the liability was taken into account in working out the entry allocable cost amount, subsections 711-45(8) to (10) apply to adjust the step 4 amount of the liability so that, generally, it is equal to the entry amount.

1.69               The changes to prevent deductible liabilities (other than excluded liabilities) from being added to step 2 of the entry allocable cost amount generally apply to a joining entity that becomes a member of a consolidated group under an arrangement entered into on or after 1 July 2016. Therefore, following those changes, there are three categories of liabilities that need to be considered for the purposes of working out the exit step 4 amount:

•        deductible liabilities (other than liabilities that are specifically referred to in subsection 705-70(1AC)) of the leaving entity brought into a group by a joining entity after 1 July 2016 (post-July 2016 joining time deductible liabilities);

•        liabilities that are specifically referred to in subsection 705-70(1AC) brought into a group by a joining entity after 1 July 2016 (post-July 2016 joining time excluded deductible liabilities); and

•        deductible liabilities of the leaving entity brought into a group by a joining entity before 1 July 2016 (pre-July 2016 joining time deductible liabilities).

1.70               Section 711-45 will operate to produce the appropriate outcome for each category of deductible liabilities of the leaving entity, as outlined in Table 1.1. As a consequence, no changes are being made to the exit tax cost setting rules.

Table 1.1 : Deductible liabilities of a leaving entity

Category of deductible liabilities

Application of step 2 of entry allocable cost amount

Application of step 4 of exit allocable cost amount

Post-July 2016 joining time deductible liabilities

Not included 

(subsection 705-70(1AB))

Subsection 711-45(3) reduces step 4 amount

Subsection 711-45(5) adjusts step 4 amount (generally to nil)

Subsection 711-45(8) to (10) do not apply to the extent that the deductible liability is not added at step 2 of the entry allocable cost amount

Post-July 2016 joining time excluded deductible liabilities

Included

(subsection 705-70(1AC))

Subsection 711-45(3) may reduce the step 4 amount

Subsection 711-45(5) may adjust step 4 amount

Subsection 711-45(8) to (10) may apply to adjust the step 4 amount to the amount added at step 2 of the entry allocable cost amount

Pre-July 2016 joining time deductible liabilities (including excluded deductible liabilities)

Included

(section 705-70)

 

Subsection 711-45(3) reduces step 4 amount

Subsection 711-45(5) may adjust step 4 amount

Subsection 711-45(8) to (10) may apply to adjust the step 4 amount to the amount added at step 2 of the entry allocable cost amount

Consequential amendments

1.71               Section 705-80 adjusts the entry step 2 amount for a liability that is recognised for accounting purposes but is taken into account at a later time for income tax purposes. The section refers to accrued employee leave liabilities and foreign exchange gains and losses as examples of the types of liabilities affected by the adjustment.

1.72               As accrued employee leave liabilities and foreign exchange gains and losses are deductible liabilities that will not be added to the step 2 amount because of new subsection 705-70(1AB), a consequential amendment removes the examples from section 705-80. [Schedule 1, item 4, section 705-80]

Application

1.73               The deductible liabilities measure applies in relation to an entity that becomes a subsidiary member of the group under an arrangement that commences on or after 1 July 2016. [Schedule 1, item 6]

1.74               The time that an arrangement commences depends on the nature of the arrangement, as outlined in paragraph 1.265. [Schedule 1, item 31]

Part 2 — The deferred tax liabilities measure

1.75               The deferred tax liabilities measure in Part 2 of Schedule 1 to this Bill will simplify the operation of the entry and exit tax cost setting rules by disregarding deferred tax liabilities.

1.76               Deferred tax liabilities are an accounting concept that measures a future tax liability. In essence, they represent the amount of income tax payable by an entity in future periods on taxable temporary differences between accounting and tax. Deferred tax liabilities are a specific accounting liability recognised under Accounting Standard AASB 112 Income Taxes .

1.77               When an entity joins a consolidated group, the accounting liabilities (including any deferred tax liabilities) of the joining entity are recognised under step 2 of the entry tax cost setting rules. The step 2 amount is adjusted where the amount of the deferred tax liabilities of the joining entity may be different to the amount for the joined group (subsection 705-70(1A)).

1.78               Similarly, when an entity leaves a consolidated group, the accounting liabilities (including any deferred tax liabilities) of the leaving entity are recognised under step 4 of the exit tax cost setting rules. There is no specific exit tax cost setting rule to adjust the step 4 amount for any deferred tax liabilities of the leaving entity that corresponds to subsection 705-70(1A).

1.79               The Board of Taxation considered issues that arise with the recognition of deferred tax liabilities under the entry and exit tax cost setting rules in Chapter 3 of its April 2013 Report. The Board recommended that the adjustments relating to deferred tax liabilities in the entry and exit tax cost setting rules be removed (Recommendation 3.1 of the Board’s April 2013 Report). In this regard, at paragraph 3.19 of the Report, the Board concluded that:

‘this will reduce the circumstances in which tax outcomes will differ from commercial outcomes. It will also reduce the complexity of the consolidation regime and overcome integrity concerns that arise with the recognition of deferred tax liabilities.’

Deferred tax liabilities disregarded under entry tax cost setting rules

1.80               When an entity joins a tax consolidated group, the value of the joining entity's accounting liabilities increase the entry allocable cost amount (step 2 of the entry allocable cost amount worked out under section 705-70).

1.81               In working out the value of the joining entity's accounting liabilities, deferred tax liabilities will be disregarded. That is, an amount will not be added at step 2 of the entry allocable cost amount for an accounting liability that is a deferred tax liability of the joining entity account recognised and measured in accordance with the joining entity’s accounting principles for tax cost setting. [Schedule 1, item 7, subsection 705-70(1B)]

1.82               The joining entity’s accounting principles for tax cost setting are the accounting principles that the joining entity would use if it were to prepare its financial statements just before the joining time (subsection 705-70(3)). 

1.83               Currently, subsection 705-70(1A) can apply to adjust the value of the deferred tax liability of the joining entity where that amount would be different for the joined group. As a result of this amendment, the amount added at step 2 of the entry allocable cost amount will no longer be adjusted to reflect the difference in the amount of the deferred tax liability.

1.84               The removal of deferred tax liabilities and the repeal of subsection 705-70(1A) will reduce the uncertainty and complexity of modifications required at the entry step 2 amount and simplify the consolidation tax cost setting rules. This will also improve the integrity of the consolidation regime as it will remove existing arbitrage opportunities.

1.85               However, a deferred tax liability that is an accounting liability that relates to an asset mentioned in paragraph 713-515(1)(a) or (b) will continue to be recognised for tax cost setting purposes. [Schedule 1, item 7, subsection 705-70(1C)]

1.86               That is, a deferred tax liability will continue to be recognised for tax cost setting purposes if it is an accounting liability that relates to an asset that is a retained cost base asset of a life insurance company that joins a consolidated group because it is:

•        a complying superannuation asset or segregated exempt asset of the company; or

•        another asset of the company that is held by the company for the purpose of discharging its liabilities under the net investment component of ordinary life insurance policies (except policies that provide for participating benefits or discretionary benefits under life insurance business carried on in Australia).

1.87               In this regard, when a life insurance company joins a consolidated group, assets that are held to support policyholders are generally taken to be retained cost base assets (and therefore do not have their tax costs reset). The broad effect of this mechanism (together with section 713-520) is to ensure that the tax outcomes for these policyholder assets are not affected when a life insurance company joins a consolidated group.

1.88               Therefore, deferred tax liabilities will continue to be recognised for these purposes to ensure that the tax outcomes for life insurance policyholder assets are not affected when a life insurance company joins a consolidated group.

Deferred tax liabilities disregarded under exit tax cost setting rules

1.89               When an entity leaves a tax consolidated group, the value of the joining entity's accounting liabilities reduce the exit allocable cost amount (step 4 of the exit allocable cost amount worked out under section 711-45).

1.90               In working out the value of the leaving entity's accounting liabilities, deferred tax liabilities will be disregarded. That is, an amount will not be added at step 4 of the exit allocable cost amount for an accounting liability that is a deferred tax liability of the leaving entity recognised and measured in accordance with the leaving entity’s accounting principles for tax cost setting. [Schedule 1, item 8, subsection 711-45(1B)]

1.91               The leaving entity’s accounting principles for tax cost setting are the accounting principles that the consolidated group would use if it were to prepare its financial statements just before the leaving time (subsection 711-45(1A)). 

1.92               However, a deferred tax liability that is an accounting liability that relates to an asset mentioned in paragraph 713-575(2)(a) or (b) will continue to be recognised for tax cost setting purposes. [Schedule 1, item 7, subsection 711-45(1C)]

1.93               That is, a deferred tax liability will continue to be recognised for tax cost setting purposes if it is an accounting liability that relates to an asset that is a retained cost base asset of a life insurance company that leaves a consolidated group because it is:

•        a complying superannuation asset or segregated exempt asset of the head company; or

•        another asset of the head company that is held by the company for the purpose of discharging its liabilities under the net investment component of ordinary life insurance policies (except policies that provide for participating benefits or discretionary benefits under life insurance business carried on in Australia).

1.94               In this regard, when a life insurance company leaves a consolidated group, the terminating value of an asset that is held to support policyholders is generally taken to be, broadly, the market value of the asset. The broad effect of this treatment (together with section 713-580) is to ensure that the tax outcomes for these policyholder assets are not affected when a life insurance company leaves a consolidated group.

1.95               Therefore, deferred tax liabilities will continue to be recognised for these purposes to ensure that the tax outcomes for life insurance policyholder assets are not affected when a life insurance company leaves a consolidated group.

Application

1.96               The deferred tax liabilities measure applies in relation to an accounting liability of entity that becomes a subsidiary member of a consolidated group under an arrangement that commences on or after the start of the day on which this Bill is introduced into the House of Representatives. [Schedule 1, subitem 9(1)]

1.97               In addition, the deferred tax liabilities measure applies in relation to an accounting liability of entity that ceases to be a subsidiary member of a consolidated group under an arrangement that commences on or after the start of the day on which this Bill is introduced into the House of Representatives. [Schedule 1, subitem 9(2)]

1.98               The time that an arrangement commences depends on the nature of the arrangement, as outlined in paragraph 1.265. [Schedule 1, item 31]

Parts 3 and 4 — The securitised assets measure

1.99               The securitised assets measure in Parts 3 and 4 of Schedule 1 to this Bill removes anomalies that arise when an entity that has securitised assets joins or leaves a tax consolidated group by modifying the tax cost setting rules so that liabilities relating to the securitised assets are disregarded, with effect from:

•        for ADIs and financial entities 13 May 2014; and

•        for all other entities 3 May 2016.

1.100           The Board of Taxation considered issues that arise where an asset is not recognised for tax consolidation purposes but a related accounting liability is recognised (or vice versa) in Chapter 5 of its April 2013 Report. In practice, the main scenario where this issue arises is when an entity joins or leaves a tax consolidated group holding assets that are subject to a securitisation arrangement.

1.101           In this regard, at paragraphs 5.13 to 5.15 of its April 2013 Report, the Board stated that:

For example, in the case of a mortgage loan securitisation arrangement, where a financial institution's interest in mortgages is equitably assigned:

•        the consideration received for the assignment is recognised as an accounting liability and therefore is taken into account under the entry and exit tax cost setting rules; and

•        the mortgage loan asset (being the assigned mortgage loan), which is recognised as an asset for accounting purposes, may not be recognised as an asset for tax purposes and therefore may have no tax cost allocated to it under the entry or exit tax cost setting rules.

As a result, in the case of a securitised asset held by an entity that joins a consolidated group, a mismatch that is beneficial to the group may arise because the accounting liability increases the entry tax cost setting amount but no tax cost is allocated to the securitised asset (the value of the accounting liability is instead allocated to other reset cost base assets held by the joining entity).

However, in the case of a securitised asset held by an entity that leaves a consolidated group, a mismatch that is detrimental to the group may arise because the accounting liability reduces the exit tax cost setting amount, so that the tax cost allocated to the leaving entity's shares is understated (with the result that the group makes a higher capital gain on the disposal of those shares).

1.102           In September 2012, the Board released a Discussion Paper on the Post Implementation Review of Certain Aspects of the Consolidation Tax Cost Setting Process . In that Discussion Paper, the Board included an example of a securitisation arrangement involving the securitisation of residential mortgages (see Example 5.1 of the Discussion Paper).

1.103           Securitisation is a financing arrangement that typically involves the interest held by an ADI or financial entity in certain financial assets (such as residential mortgages) being equitably assigned to a special purpose vehicle.

1.104           Typically, the special purpose vehicle raises the funds to purchase the assets from the ADI or financial entity by issuing debt securities to investors.

1.105           The ADI or financial entity holds the residual income rights in the special purpose vehicle and gets a return equal to, broadly, the difference between the payments due on the notes and the amounts receivable on the assets, net of fees, associated with the securitisation arrangement. This has the advantage of allowing the ADI or financial entity to diversify its funding.

1.106           While securitisation arrangements are common in the financial industry, such arrangements can also be entered into as a means of financing by entities that are not ADIs or financial entities in some circumstances.

1.107           A problem arises under the consolidation tax cost setting rules when an entity that holds securitised assets joins or leaves a consolidated group. In certain circumstances, the relevant Australian accounting standard issued by the AASB requires an entity to continue to recognise the underlying securitised assets on its balance sheet despite the equitable assignment of those assets to the special purpose vehicle for valuable consideration (see Accounting Standard AASB 139 Financial Instruments: Recognition and Measurement ). In addition, the entity is required to recognise an accounting liability for the consideration received from the special purpose vehicle.

1.108           In these circumstances a mismatch can arise because the consolidation tax cost setting rules recognise the value of the associated accounting liability, but the underlying securitised assets may not be recognised as assets. This is because the assets do not have economic value in the hands of the joining entity as a result of being equitably assigned to the special purpose vehicle.

1.109           As a result of this mismatch, when an entity that has securitised assets joins a tax consolidated group, the value of the accounting liability is allocated to other assets held by the joining entity. This outcome arises because the underlying securitised assets have no or little value. As a result:

•        the tax costs of those other assets are overstated; and

•        to the extent that there are insufficient assets to absorb the increased tax value, the head company may realise an artificial capital loss.

1.110           When an entity that has securitised assets leaves a tax consolidated group, the accounting liability reduces the tax value that is allocated to the membership interests held by the group in the leaving entity. As a result, the group will make a higher capital gain on the disposal of the membership interests in the leaving entity because:

•        the tax costs of membership interests are understated; and

•        to the extent that the accounting liabilities exceed the value of the leaving entity's assets, the tax costs of the membership interests will be nil and the head company will make a capital gain equal to the amount of the excess.

1.111           To overcome this anomaly, an accounting liability arising from the transfer or equitable assignment of the securitised assets will effectively be disregarded for entry and exit tax cost setting purposes. This outcome is consistent with Recommendation 5.1 of the Board's April 2013 Report.

1.112           These changes apply from the 2014 Budget time where a member of the relevant group is an ADI or a financial entity.

1.113           The changes apply to all groups from the 2016 Budget time. That is, from the 2016 Budget time, the requirement that a member of the relevant group is an ADI or a financial entity will no longer apply.

1.114           Securitisation arrangements typically involve ancillary agreements, such as agreements that relate to swap arrangements, liquidity facilities and other standby facilities. Any accounting liabilities arising from ancillary agreements do not arise from the transfer or equitable assignment of the underlying securitised assets and therefore are not securitisation liabilities covered by these amendments.

Securitisation liabilities disregarded under entry tax cost setting rules

1.115           When an entity joins a tax consolidated group, the value of the joining entity's accounting liabilities increase the entry allocable cost amount (step 2 of the entry allocable cost amount worked out under section 705-70). However, no amount is added at step 2 for the liability if the accounting liability is a securitisation liability (as defined in section 705-76). [Schedule 1, item 10, subsection 705-70(4)]

1.116           An accounting liability is a securitisation liability if:

•        the liability:

-                  arose from the transfer or equitable assignment of one or more assets (the underlying securitised assets) by the joining entity to another entity before the joining time; and

-                  is a liability of the joining entity at the joining time according to the accounting principles that the joining entity would use if it were to prepare financial statements just before the joining time;

•        the other entity was established for the purpose of securitising assets this will be determined by applying ordinary commercial principles;

•        the underlying securitised assets were securitised in accordance with that purpose before the joining time; and

•        at the joining time, the market value of the joining entity's interest in the underlying securitised assets is nil (so that the interest in underlying securitised assets is not recognised as an asset for tax consolidation purposes), or is substantially less than the amount of the securitisation liability this requirement ensures that, regardless of what the entity recognised, at law there is a mismatch between the value of the joining entity's interest in the securitised assets recognised for tax consolidation purposes and the value of the securitisation liability.

[Schedule 1, item 11, section 705-76]

1.117           The underlying securitised assets will be transferred or equitably assigned for these purposes if those assets are taken to be transferred or equitably assigned for the purposes of the relevant Australian accounting standards. This ensures that the full range of circumstances that can give rise to the current anomaly in the law are covered by these amendments.

1.118           In addition, if the joining entity was a member of another tax consolidated group (the old group) prior to the joining time, the single entity rule (section 701-1) applied to the joining entity when it was a member of the old group. However, that rule has no effect for the purpose of determining whether the joining entity transferred or equitably assigned the underlying securitised assets to another entity before the joining time. In this regard:

•        the single entity rule applies to the old group only for the purpose of determining the old group's income tax liability or loss for an income year; and

•        the single entity rule does not affect the joined group's ability to determine whether, in fact, a transfer or assignment took place while the joining entity was a member of the old group.

1.119           If an entity becomes a member of a tax consolidated group under an arrangement that commenced between the 2014 Budget time and the 2016 Budget time, an accounting liability of the joining entity will be a securitisation liability only if, at the joining time, a member of the joined group is an ADI or a financial entity (as defined in subsection 995-1(1)). [Schedule 1, item 11, paragraph 705-76(a)]

1.120           In this regard, when the measure was announced as part of the 2014 Budget, it was restricted to circumstances where a member of the joined tax consolidated group is an ADI or a financial entity because securitisation arrangements are primarily undertaken by these types of entities.

1.121           However, securitisation arrangements are also entered into as a means of financing by entities that are not ADIs or financial entities in some circumstances. Therefore, as part of the 2016 Budget, the scope of the measure was extended so that it applies to all securitisation arrangements.

1.122           Consequently, from the 2016 Budget time, paragraph 705-76(a) will be removed so that an accounting liability of a joining entity will be a securitisation liability if the requirements in paragraphs 705-76(b) to (g) are satisfied, regardless of whether a member of the joined tax consolidated group is an ADI or a financial entity. [Schedule 1, item 16]

Securitisation liabilities disregarded under exit tax cost setting rules

1.123           When an entity leaves a tax consolidated group, the value of the joining entity's accounting liabilities decrease the exit allocable cost amount (step 4 of the exit allocable cost amount worked out under section 711-45). However, no amount is added at step 4 for the liability if the accounting liability is a securitisation liability (as defined in section 711-46). [Schedule 1, item 12, subsection 711-45(11)]

1.124           An accounting liability is a securitisation liability if:

•        the liability:

-                  arose from the transfer or equitable assignment of one or more assets (the underlying securitised assets) by the member of the old group to another entity before the leaving time; and

-                  is a liability of the leaving entity at the leaving time according to the accounting principles that the leaving entity would use if it were to prepare financial statements just before the leaving time;

•        the other entity was established for the purpose of securitising assets this will be determined by applying ordinary commercial principles;

•        the underlying securitised assets were securitised in accordance with that purpose before the leaving time; and

•        at the leaving time, the market value of the leaving entity's interest in the underlying securitised assets is nil (so that the interest in the underlying securitised asset is not recognised as an asset for tax consolidation purposes), or is substantially less than the amount of the securitisation liability this requirement ensures that, regardless of what the entity recognised, at law there is a mismatch between the value of the leaving entity's interest in the securitised assets recognised for tax consolidation purposes and the value of the securitisation liability.

[Schedule 1, item 13, section 711-46]

1.125           The underlying securitised assets will be transferred or equitably assigned for these purposes if those assets are taken to be transferred or equitably assigned for the purposes of the relevant Australian accounting standards. This ensures that the full range of circumstances that can give rise to the current anomaly in the law are covered by these amendments.

1.126           If an entity leaves a tax consolidated group under an arrangement that commenced between the 2014 Budget time and the 2016 Budget time, an accounting liability of the leaving entity will be a securitisation liability only if, at the leaving time, a member of the old group is an ADI or a financial entity (as defined in subsection 995-1(1)). [Schedule 1, item 13, paragraph 711-46(a)]

1.127           Consistent with the joining case, from the 2016 Budget time, paragraph 711-46(a) will be removed so that an accounting liability of a leaving entity will be a securitisation liability if the requirements in paragraphs 711-46(b) to (g) are satisfied, regardless of whether a member of the tax consolidated group is an ADI or a financial entity. [Schedule 1, item 17]

Application to tax consolidated ADI groups

1.128           If a member of a tax consolidated group is an ADI or a financial entity (a tax consolidated ADI group), the securitised assets measure applies in relation to an entity that joins or leaves the group under an arrangement that commences after the 2014 Budget time. The 2014 Budget time is 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 2014 (the time of announcement of the measure). [Schedule 1, subitems 14(1) and (7), and 15(1) and (6)]

1.129           The time that an arrangement commences depends on the nature of the arrangement, as outlined in paragraph 1.265. [Schedule 1, item 31]

1.130           Under the transitional rules, the securitised assets measure also applies in relation to an entity that:

•        became a member of a tax consolidated ADI group under an arrangement that commenced before the 2014 Budget time in certain circumstances; or

•        ceased to be a member of a tax consolidated ADI group under an arrangement that commenced before the 2014 Budget time in certain circumstances.

[Schedule 1, subitems 14(2) to (7) and 15(2) to (6)]

1.131           The transitional rules are consistent with observations made by the Board of Taxation directed at ensuring equitable outcomes for tax consolidated groups affected by anomalies that arise under the current law in relation to securitised assets and have been developed in consultation with key stakeholders to ensure that taxpayers are not disadvantaged by the amendments. However, the transitional rules are also designed to prevent taxpayers from obtaining unexpected windfall gains.

Transitional rules Entity that became a member of a tax consolidated ADI group under a pre-2014 Budget time arrangement

1.132           Under the joining case transitional rules, the securitised assets measure applies in relation to an entity that became a member of a tax consolidated ADI group under an arrangement that commenced before the 2014 Budget time in certain circumstances. [Schedule 1, subitems 14(2) to (7)]

1.133           The joining case transitional rules ensure that the position taken by the head company of a tax consolidated ADI group under the entry tax cost setting rules in relation to an arrangement entered into before the 2014 Budget time is maintained.

1.134           In addition, the joining case transitional rules ensure that the current law will apply to an arrangement entered into before the 2014 Budget time where the head company of the group first works out the entry allocable cost amount for a joining entity between the 2014 Budget time and the commencement of this measure.

1.135           The outcome that arises under the joining case transitional rules depends on whether or not, under the entry tax cost setting rules, the head company recognised:

•        the securitisation liability held by the joining entity; or

•        the securitised asset held by the joining entity.

Securitisation liability recognised under the entry tax cost setting rules

1.136           Where, under an arrangement that was entered into before the 2014 Budget time, the head company of a tax consolidated ADI group recognised the full securitisation liability held by the joining entity under the entry tax cost setting rules, the joining case transitional rules confirm this position.

1.137           Consequently, the securitisation liability is not removed from the entry allocable cost amount for a joining entity under an arrangement that was entered into before the 2014 Budget time if the Commissioner considers that it is reasonable to conclude that:

•        the circumstances in section 705-76 existed that is, broadly:

-                  at the joining time, a member of the joined group is an ADI or financial entity;

-                  the joining entity was holding an accounting liability that is a securitisation liability; and

-                  the market value of the joining entity's interest in the underlying securitised asset was nil, or was substantially less than the amount of the securitisation liability;

•        the head company of the group worked out the group's allocable cost amount for the joining entity before the 2014 Budget time; and

•        for the purpose of working out the step 2 amount, the head company added the full amount for the securitisation liability.

[Schedule 1, subitem 14(3)]

1.138           If the Commissioner is not satisfied that the circumstances in subitem 14(3) exist, the joining case transitional rules apply to ensure that the securitisation liability is not included in the entry allocable cost amount for the joining entity . [Schedule 1, subitem 14(2)]

Securitised asset recognised under the entry tax cost setting rules

1.139           In some cases, under an arrangement that was entered into before the 2014 Budget time, the head company of a tax consolidated ADI group that recognised a securitisation liability for the purpose of working out the step 2 amount for a joining entity may have worked out a tax cost setting amount for the interest in the securitised asset in order to eliminate or reduce the mismatch that would otherwise arise.

1.140           As the interest in the securitised asset is not recognised as an asset under the tax consolidation regime, the joining case transitional rules apply to reduce the tax consolidated ADI group's allocable cost amount for the joining entity by the tax cost setting amount allocated to the interest in the underlying securitised assets. [Schedule 1, subitems 14(4) and (5)]  

1.141           This transitional rule applies only if the Commissioner considers that it is reasonable to conclude that, before the 2014 Budget time, the head company of the group worked out a tax cost setting amount for that interest. [Schedule 1, subitems 14(4) and (5)]

1.142           The purpose of this transitional rule is to prevent affected tax consolidated ADI groups from obtaining an unintended benefit by revising the tax cost setting calculations for a joining entity and allocating the value of the securitisation liability to the tax cost setting amounts of other assets.

1.143           However, the transitional rule minimises compliance costs for affected tax consolidated ADI groups as it ensures that the tax cost setting amounts for assets other than the interest in the securitised asset remain the same.

Securitisation liability not recognised under the entry tax cost setting rules

1.144           In some cases, under an arrangement that was entered into before the 2014 Budget time, the head company of a tax consolidated ADI group may not have recognised a securitisation liability under the entry allocable cost amount for a joining entity in order to eliminate or reduce the mismatch that would otherwise arise.

1.145           The joining case transitional rules apply to protect affected tax consolidated ADI groups that took this position. In addition, these tax consolidated ADI groups are prevented from obtaining an unintended benefit by revising the tax cost setting calculations for a joining entity to change the position that they took that is, these groups are unable to revise the tax cost setting calculations for a joining entity by recognising a securitisation liability under the entry allocable cost amount for the joining entity. [Schedule 1, subitems 14(2) and (3)]

No position taken prior to the 2014 Budget time

1.146           The joining case transitional rules ensure that the current law will apply to an arrangement entered into before the 2014 Budget time where the head company of the tax consolidated ADI group first works out the entry allocable cost amount for a joining entity between the 2014 Budget time and the commencement of this measure. This will protect taxpayers that relied on the current law when they entered into a commercial transaction before the 2014 Budget time.

1.147           Consequently, the amendments will not apply where an entity entered into an arrangement before the 2014 Budget time and the Commissioner considers that it is reasonable to conclude that:

•        the circumstances in section 705-76 existed that is, broadly:

-                  at the joining time, a member of the joined group is an ADI or financial entity;

-                  the joining entity was holding an accounting liability that is a securitisation liability; and

-                  the market value of the joining entity's interest in the underlying securitised asset was nil, or was substantially less than the amount of the securitisation liability; and

•        the head company of the group first worked out the group's allocable cost amount for the joining entity:

-                  after the 2014 Budget time; and

-                  before the date of commencement of Part 3 to Schedule 1 of this Bill.

[Schedule 1, subitem 14(6)]

1.148           If the Commissioner is not satisfied that the circumstances in subitem 14(6) exist, the joining case transitional rules apply to ensure that the securitisation liability is not included in the entry allocable cost amount for the joining entity. [Schedule 1, subitem 14(2)]

Transitional rules Entity that ceased to be a member of a tax consolidated ADI group under a pre-2014 Budget time arrangement

1.149           Under the leaving case transitional rules, the securitised assets measure applies in relation to an entity that ceased to be a member of a tax consolidated ADI group under an arrangement that commenced before the 2014 Budget time in certain circumstances. [Schedule 1, subitems 15(2) to (6)]

1.150           The leaving case transitional rules ensure that the position taken by the head company of a tax consolidated ADI group under the exit tax cost setting rules in relation to an arrangement entered into before the 2014 Budget time is maintained.

1.151           However, under these transitional rules, the securitised assets measure will apply to disregard a securitisation liability when working out the exit allocable cost amount for a leaving entity if the head company:

•        entered into an arrangement before the 2014 Budget time; and

•        has not taken a position in relation to the treatment of the securitisation liability prior to that time.

1.152           Therefore, the outcome that arises under the leaving case transitional rules depends on whether or not, under the exit tax cost setting rules, the head company of the old group recognised:

•        the securitisation liability that leaves the old group with a leaving entity; or

•        the securitised asset that leaves the old group with a leaving entity.

Securitisation liability recognised under the exit tax cost setting rules

1.153           Where, under an arrangement that was entered into before the 2014 Budget time, the head company of a tax consolidated ADI group recognised a securitisation liability held by the leaving entity under the exit tax cost setting rules, the leaving case transitional rules confirm this position.

1.154           Consequently, the securitisation liability is not removed from the exit allocable cost amount for a leaving entity under an arrangement that was entered into before the 2014 Budget time if the Commissioner considers that it is reasonable to conclude that:

•        the circumstances in section 711-46 existed that is, broadly:

-                  just before the leaving time, a member of the old group is an ADI or financial entity;

-                  the leaving entity was holding an accounting liability that is a securitisation liability; and

-                  the market value of the leaving entity's interest in the underlying securitised asset was nil, or was substantially less than the amount of the securitisation liability;

•        the head company of the group worked out the old group's allocable cost amount for the leaving entity before the 2014 Budget time; and

•        for the purpose of working out the step 4 amount, the head company added an amount for the securitisation liability.

[Schedule 1, subitem 15(3)]

1.155           If the Commissioner is not satisfied that the circumstances in subitem 15(3) exist, the leaving case transitional rules apply to ensure that the securitisation liability is not included in the exit allocable cost amount for the leaving entity. [Schedule 1, subitem 15(2)]

Securitised asset recognised under the exit tax cost setting rules

1.156           In some cases, under an arrangement that was entered into before the 2014 Budget time, the head company of a tax consolidated ADI group that recognised a securitisation liability under the exit allocable cost amount for a leaving entity may have also recognised the tax cost setting amount for the interest in the securitised asset in order to eliminate or reduce the mismatch that would otherwise arise.

1.157           In these circumstances, the leaving case transitional rules apply so that the old group's allocable cost amount for the leaving entity is increased by the amount included for the interest in the securitised asset at step 1 of the exit allocable cost amount. [Schedule 1, subitems 15(4) and (5)]

1.158           However, the transitional rule applies only if the Commissioner considers that it is reasonable to conclude that, before the 2014 Budget time, the head company of the old group worked out a tax cost setting amount for the leaving entity's interest in the underlying securitised assets and included an amount at step 1. [Schedule 1, subitems 15(4) and (5)]

1.159           As a result of this transitional rule, the tax cost setting amounts for the membership interests held by the old group in the leaving entity will remain unchanged. Therefore, affected tax consolidated ADI groups will not incur additional compliance costs that would be required to recalculate the tax cost setting amounts for those membership interests if the interest in the securitised asset ceased to be recognised as an asset for the purposes of applying step 1 of the exit allocable cost amount.

No position taken prior to the 2014 Budget time

1.160           The leaving case transitional rules ensure that the securitisation measure will apply to an arrangement entered into before the 2014 Budget time where the head company of the old tax consolidated ADI group first works out the entry allocable cost amount for a leaving entity after the 2014 Budget time. [Schedule 1, subitem 15(2)]

1.161           This will ensure that affected tax consolidated ADI groups are protected from adverse outcomes that arise under the existing law.

Transitional rules When is the allocable cost amount worked out?

1.162           The joining case and leaving case transitional rules are largely intended to ensure that affected tax consolidated ADI groups do not have to change what they actually did under the current law. Therefore, some of the transitional rules apply based on way that a tax consolidated ADI group worked out the allocable cost amount for a joining entity or a leaving entity.

1.163           When an entity joins a tax consolidated ADI group, the tax costs of each asset of the joining entity is set at the joining time at an amount equal to the asset's tax cost setting amount (subsection 701-10(4)).

1.164           Similarly, when an entity leaves a tax consolidated ADI group, the tax costs of each membership interest held by old group in the leaving entity is set at the leaving time at an amount equal to the interest's tax cost setting amount (subsection 701-15(3)).

1.165           Subsections 701-10(4) and 701-15(3) set the tax costs of assets and membership interests at a particular time. However, the application of the transitional rules depends on the time when the head company of a tax consolidated ADI group actually calculated the tax cost setting amounts.

1.166           The head company of a tax consolidated ADI group may calculate multiple draft permutations of an allocable cost amount. Although these calculations may be based on the entry and exit allocable cost amount rules, they are merely draft calculations.

1.167           Only the amount used to determine the tax costs of the joining entity's assets, or to calculate the tax costs of the old group's membership interests in the leaving entity, constitute the allocable cost amount. None of the other draft calculations constitute an allocable cost amount and therefore are insufficient alone to evidence the time at which a tax consolidated ADI group has ‘worked out’ its allocable cost amount.

1.168           To determine if an allocable cost amount is ‘worked out’ before a particular time, for the purpose of applying the transitional rules, the Commissioner will assess each situation according to the facts of each case. However, it is expected that the Commissioner will have regard to the following factors:

•        information supplied by the affected tax consolidated ADI group the group may need to supply the Commissioner with electronic copies of its allocable cost amount calculations, with an electronic timestamp showing the time of the calculation;

•        information available in the affected tax consolidated ADI group's income tax return it is expected that the Commissioner will cross-check an allocable cost amount calculation with, for example, capital allowance deductions, or a net capital gain or loss, claimed in the group's income tax return to determine the authenticity of their allocable cost amount calculation; and

•        any other information that the Commissioner considers to be relevant.

Application to all tax consolidated groups

1.169           The securitised assets measure was originally announced as part of the 2014 Budget. At that time, the measure was restricted to circumstances where a member of the joined tax consolidated group is an ADI or a financial entity because securitisation arrangements are primarily undertaken by these types of entities.

1.170           However, securitisation arrangements are also entered into as a means of financing by entities that are not ADIs or financial entities in some circumstances. Therefore, as part of the Tax Integrity Package announced in the 2016-17 Budget, the scope of the measure was extended so that it applies to all securitisation arrangements.

1.171           Therefore, the requirement that a member of the relevant group is an ADI or a financial entity will no longer apply to an arrangement that commences after the 2016 Budget time. The 2016 Budget time is 7.30 pm, by legal time in the Australian Capital Territory, on 3 May 2016 (the time of announcement of the measure). [Schedule 1, items 18 and 19]

1.172           The time that an arrangement commences depends on the nature of the arrangement, as outlined in paragraph 1.265. [Schedule 1, item 31]

Part 5 — The churning measure

1.173           The churning measure in Part 5 of Schedule 1 to this Bill switches off the entry tax cost setting rules for a joining entity where a capital gain or capital loss made by a foreign resident owner when it ceases to hold membership interests in the joining entity is disregarded and there has been no change in the majority economic ownership of the joining entity for a period of at least 12 months before the joining time.

1.174           The churning measure is consistent with Recommendation 5.6 of the Board of Taxation's June 2012 Report.

When do the modifications to the tax cost setting rules apply?

1.175           The operation of the tax cost setting rules will be modified when:

•        an entity (the joining entity) becomes a subsidiary member of a consolidated group;

•        another entity (the disposing entity) ceased to hold membership interests in the joining entity during the period (the test period) that:

-                  started 12 months before the joining time; and

-                  ended immediately after the joining time;

•        a CGT event happened because the disposing entity ceased to hold the membership interests;

•        a capital gain or capital loss of the disposing entity from the CGT event was disregarded because of the operation of Division 855 (or, in the event where the amount of the capital gain or loss is nil, would have been disregarded if there had been an amount of the capital gain or loss);

•        the tax costs of the joining entity's assets would ordinarily be set at their tax cost setting amounts because the joining entity becomes a subsidiary member of the group that is, section 701-10 would ordinarily apply to the joining entity's assets;

•        it is reasonable to conclude that, throughout the test period, an entity (the control entity) and its associates had a total participation interest in the joining entity of 50 per cent or more; and

•        if the control entity is not the disposing entity, it is reasonable to conclude that the control entity and its associates had a total participation interest in the disposing entity of 50 per cent or more at the time the CGT event happened.

[Schedule 1, item 20, subsection 716-440(1)]

1.176           For the purposes of determining whether paragraph 716-440(1)(b) is satisfied, the reference to membership interests in the joining entity is taken to include membership interests in another entity (the higher level entity) if:

•        the higher level entity holds membership interests in the joining entity (whether directly or indirectly through one or more interposed entities) at any time during the test period;

•        the higher level entity becomes a subsidiary member of the consolidated group at the joining time;

•        the requirement in paragraph 716-440(1)(b) is not satisfied (disregarding subsection 716-440(5)); and

•        the requirement in paragraph 716-440(1)(b) would be satisfied if the reference in paragraph 716-440(1)(b) to membership interests in the joining entity included a reference to membership interests in the higher level entity.

[Schedule 1, item 20, subsection 716-440(4) and(5)]

1.177           This ensures that the modifications to the operation of the tax cost setting rules will apply to all joining entities in cases where:

•        a consolidated group is acquired by another consolidated group that is, Subdivision 705-C cases; and

•        multiple entities that are linked by membership interests are acquired by a consolidated group that is, Subdivision 705-D cases.

1.178           Paragraph 716-440(1)(d) is satisfied if a capital gain or capital loss of the disposing entity from a CGT event was disregarded because of the operation of Division 855. This requirement can be satisfied even if, under a double tax agreement, Australia does not have a right to tax the capital gain of the disposing entity.

1.179           Paragraph 716-440(1)(f) is satisfied if it is reasonable to conclude that, throughout the test period, an entity (the control entity), together with its associates, had a total participation interest in the joining entity of 50 per cent or more. Broadly, this test ensures that the churning measure will apply in respect of a joining entity only where that joining entity has been majority owned (directly or indirectly) by the control entity for a period of at least 12 months ending immediately after the joining time.

1.180           Paragraph 716-440(1)(g) is satisfied if, where the control entity is not the disposing entity, it is reasonable to conclude that the control entity, together with its associates, had a total participation interest in the disposing entity of 50 per cent or more at the time of the CGT event which gave rise to the capital gain or capital loss that was disregarded because of Division 855. This test requires the control entity and the disposing entity to be the same or to be related at the time of the CGT event.

1.181           Where a capital gain is disregarded, this ensures that the churning measure applies only where the entity that ultimately benefits from the application of Division 855 would also ultimately benefit from the uplift in the tax cost of the joining entity's assets at the joining time if the churning measure did not apply.

1.182           An entity's total participation interest in another entity, as defined in section 960-180, at a particular time is the sum of:

•        the entity's direct participation interest in the other entity at that time; and

•        the entity's indirect participation interest in the other entity at that time.

1.183           An entity's direct participation interest is the total interest that an entity directly holds in another entity and is worked out under section 960-190.

1.184           An entity's indirect participation interest is the participation interest held by an entity in another entity through intermediate entities and is worked out in the way set out in section 960-185.

1.185           For the purposes of working out the total participation interest of the control entity and its associates in another entity under paragraphs 716-440(1)(f) and (g), if a particular direct participation interest or a particular indirect participation interest would be taken into account more than once because the entity holding it is an associate of the control entity, the particular direct participation interest or particular indirect participation interest held in the other entity should be taken into account only once. [Schedule 1, item 20, subsection 716-440(2)]

Tax cost setting rules do not apply

1.186           If the modifications apply to the head company of a consolidated group, the tax cost setting rules do not apply to reset the tax costs of the joining entity's assets. That is, the following provisions do not apply:

•        section 701-10 which is about the cost to the head company of the joining entity's assets;

•        subsection 701-35(4) which is about setting the value of trading stock at a tax neutral amount; and

•        subsection 701-35(5) which is about setting the value of registered emissions units at a tax neutral amount.

[Schedule 1, item 20, subsection 716-440(3)]

1.187           The consequence of switching off these tax cost setting rules is that, broadly, the tax costs of the joining entity's assets are retained.

Example 1.4  

On 1 July 2018, FP Co (a foreign resident company) beneficially owns all of the membership interests in Target Co and Head Co respectively. Head Co, in turn, beneficially owns all of the membership interests in Acquirer Co.

Target Co, Head Co and Acquirer Co are all Australian resident companies.

Head Co and Acquirer Co are members of a consolidated group (the Head Co consolidated group).

On 1 September 2019, FP Co disposed of all of its membership interests in Target Co to Acquirer Co. As a result, CGT event A1 happened and FP Co makes a capital gain which is disregarded under Division 855 of the ITAA 1997. 

Upon Acquirer Co becoming the beneficial owner of all of the membership interests in Target Co, Target Co became a subsidiary member of the Head Co consolidated group. 

The churning conditions in subsection 716-440(1) are satisfied in this example. That is:

•        paragraph 716-440(1)(a) is satisfied as Target Co became a subsidiary member of a consolidated group (the Head Co consolidated group) at a time (1 September 2019);

•        paragraph 716-440(1)(b) is satisfied as FP Co ceased to hold membership interests in Target Co on 1 September 2019, which is during the test period the test period is a period of 12 months ending just after the joining time (1 September 2019);

•        paragraphs 716-440(1)(c) and (d) are satisfied as CGT event A1 happened as a result of FP Co ceasing to hold membership interests in Target Co and the resulting capital gain was disregarded under Division 855;

•        paragraph 716-440(1)(e) is satisfied because, if the churning measure did not apply, the tax cost of Target Co's assets would be reset under the consolidation entry tax cost setting rules;

•        paragraph 716-440(1)(f) is satisfied as, throughout the test period, FP Co (the control entity) maintained a total participation interest of at least 50 per cent in Target Co that is, FP Co maintained a total participation interest of 100 per cent in Target Co throughout the test period, taking the following factors into account:

-       at the beginning of the test period, FP Co had a direct participation interest, and consequently a total participation interest, of 100 per cent in Target Co; and

-       at the end of the test period, FP Co had an indirect participation interest; and consequently a total participation interest, of 100 per cent in Target Co (FP's indirect participation interest in Target Co represents the total interest held in Target Co by FP through intermediary entities Head Co and Acquirer Co); and

•        paragraph 716-440(1)(g) is not relevant in this example as FP Co is the disposing entity.

All of the relevant churning conditions in subsection 716-440(1) are satisfied in this example. Therefore, subsection 716-440(1) applies, with the effect that the existing tax values of Target Co's assets are inherited by Head Co when Target Co joins the Head Co consolidated group.

Example 1.5  

On 1 July 2019, the Head Co consolidated group consists of two Australian resident companies, Head Co and Acquirer Co. Acquirer Co beneficially owns all of the membership interests in Foreign Co (a foreign resident company) who, in turn, beneficially owns all of the membership interests in Target Co (an Australian resident company).

Target Co is not a subsidiary member of the Head Co consolidated group as it does not qualify as a transitional foreign held subsidiary under Division 701C of the Income Tax (Transitional Provisions) Act 1997

On 1 December 2020, Foreign Co disposes of all of its membership interests in Target Co to Acquirer Co. As a result, CGT event A1 happens and Foreign Co makes a capital gain which is disregarded under Division 855 of the ITAA 1997. 

At the time Acquirer Co became the beneficial owner of all of the membership interests in Target Co, Target Co became a subsidiary member of the Head Co consolidated group. 

The churning conditions in subsection 716-440(1) are satisfied in this example. That is:

•        paragraph 716-440(1)(a) is satisfied as Target Co became a subsidiary member of a consolidated group (the Head Co consolidated group) at a time (1 December 2020);

•        paragraph 716-440(1)(b) is satisfied as Foreign Co ceased to hold membership interests in Target Co on 1 December 2020, which is during the test period the test period is a period of 12 months ending just after the joining time of 1 December 2020;

•        paragraphs 716-440(1)(c) and (d) are satisfied as CGT event A1 happened as a result of Foreign Co ceasing to hold membership interests in Target Co and the resulting capital gain was disregarded under Division 855;

•        paragraph 716-440(1)(e) is satisfied as, if the churning measure did not apply, the tax cost of Target Co's assets would be reset under the consolidation entry tax cost setting rules;

•        paragraph 716-440(1)(f) is satisfied as, throughout the test period, Head Co (a control entity) maintained a total participation interest of at least 50 per cent in Target Co that is, Head Co's maintained a total participation interest of 100 per cent in Target Co throughout the test period, taking the following factors into account:

-       at the beginning of the test period, Head Co had an indirect participation interest, and consequently a total participation interest, of 100 per cent in Target Co Head Co's indirect participation interest in Target Co represents the total interest held in Target Co by Head Co through intermediary entities Acquirer Co and Foreign Co; and 

-       at the end of the test period Head Co had an indirect participation interest, and consequently a total participation interest, of 100 per cent in Target Co Head Co's indirect participation interest in Target Co represents the total interest held in Target Co by Head Co through intermediary entity Acquirer Co; and

•        paragraph 716-440(1)(g) is satisfied as Head Co (a control entity) had a total participation interest in Foreign Co (the disposing entity) of at least 50 per cent at the time of the CGT event which gave rise to the disregarded capital gain this is because Head Co had an indirect participation interest in Foreign Co of 100 per cent at this time.

All of the relevant churning conditions in subsection 716-440(1) are satisfied in this example. Therefore, subsection 716-440(1) applies, with the effect that the existing tax values of Target Co's assets are inherited by Head Co when Target Co joins the Head Co consolidated group.

Example 1.6  

On 1 July 2018, the Head Co consolidated group consists of two Australian resident companies, Head Co and Acquirer Co. Acquirer Co beneficially owns 70 per cent of the membership interests in Target Co. The remaining 30 per cent of the membership in Target Co are beneficially owned by X Co, a foreign resident entity which is unrelated to the two members of the consolidated group.

On 1 June 2020, X Co disposes of its membership interests in Target Co to Acquirer Co. As a result CGT event A1 happens and X Co makes a capital gain which is disregarded under Division 855.

At the time Acquirer Co became the beneficial owner of all of the membership interests in Target Co, Target Co became a subsidiary member of the Head Co consolidated group. 

The churning conditions in paragraph 716-440(1)(a) to (f) are satisfied in this example. That is:

•        paragraph 716-440(1)(a) is satisfied as Target Co became a subsidiary member of a consolidated group (the Head Co consolidated group) at a time (1 June 2020);

•        paragraph 716-440(1)(b) is satisfied as X Co ceased to hold membership interests in Target Co on 1 June 2020, which is during the test period the test period is a period of 12 months ending just after the joining time of 1 June 2020;

•        paragraphs 716-440(1)(c) and (d) are satisfied as CGT event A1 happened as a result of X Co ceasing to hold membership interests in Target Co and the resulting capital gain was disregarded under Division 855;

•        paragraph 716-440(1)(e) is satisfied because, if the churning measure did not apply, the tax cost of Target Co's assets would be reset under the consolidation entry tax cost setting rules; and

•        paragraph 716-440(1)(f) is satisfied as, throughout the test period, Head Co (a control entity) maintained a total participation interest of at least 50 per cent in Target Co that is, Head Co maintained a total participation interest of at least 70 per cent in Target Co throughout the test period (which exceeds the minimum 50 per cent requirement in paragraph 716-440(1)(f)), taking the following factors into account:

-       at the beginning of the test period, Head Co has an indirect participation interest, and consequently a total participation interest, of 70 per cent in Target Co Head Co's indirect participation interest in Target Co represents the total interest held in Target Co by Head Co through Acquirer Co; and

-       at the end of the test period, Head Co had an indirect participation interest, and consequently a total participation interest, of 100 per cent in Target Co Head Co's indirect participation interest in Target Co at that time represents the total interest held in Target Co by Head Co through Acquirer Co.

However, the conditions in paragraph 716-440(1)(g) are not met because, at the time of the CGT event which gave rise to the disregarded capital gain, Head Co (a control entity) had a total participation interest of nil in X Co. Therefore, the minimum requirement of 50 per cent is not satisfied.

As all of the relevant churning conditions in subsection 716-440(1) are not satisfied, the churning measure does not apply in the circumstances set out in this example. Therefore, the consolidation entry tax cost setting rules will apply to reset the tax cost of Target Co's assets when it joins the Head Co consolidated group.

Application

1.188           The churning measure generally applies in relation to an entity that joins a consolidated group under an arrangement that commences on or after the 2013 Budget time. The 2013 Budget time is 7.30 pm, by legal time in the Australian Capital Territory, on 14 May 2013 (the date of announcement of the measure by the former Government). [Schedule 1, subitem 21(1)]

1.189           However, as a transitional rule, the extension of the control test to cover participation interests of associates applies only to an arrangement that commences on or after the start of the day on which this Bill is introduced into the House of Representatives. [Schedule 1, subitems 21(2) and (3)]

1.190           This transitional rule reflects the fact that the scope of the measure was broadened after the 2015 Exposure Draft legislation was released to make the control test an associate inclusive test. This extension is necessary to ensure the integrity of the measure. However, the transitional rule will ensure that taxpayers are not inadvertently affected by the measure because they were unaware of the change to make the control test an associate inclusive test.

1.191           The time that an arrangement commences depends on the nature of the arrangement, as outlined in paragraph 1.265. [Schedule 1, item 31]

Part 6 — The TOFA measure

1.192           The TOFA measure in Part 6 of Schedule 1 to this Bill clarifies the operation of the TOFA provisions by setting a tax value for an intra-group asset or liability that is, or is part of, a Division 230 financial arrangement when the asset or liability emerges from a consolidated group because a subsidiary member leaves the group.

1.193           This will, for example, ensure that:

•        a lender is not assessed on a return of the principal of a loan; and

•        a borrower cannot claim deduction for the repayment of that principal.

1.194           The broad objective of the TOFA measure is to make the tax treatment of intra-group TOFA financial arrangements consistent with the economic substance of the transactions.

1.195           Similar rules currently exist for TOFA financial arrangements that are not intra-group financial arrangements (sections 715-375 and 715-378).

Setting a tax cost for intra-group liabilities that are Division 230 financial arrangements

1.196           New section 715-379 sets a tax cost for an intra-group liability that is, or is part of, a Division 230 financial arrangement. This is necessary for the operation of the TOFA provisions so that the entity that holds the Division 230 financial arrangement after the leaving time can determine gains and losses relating to the arrangement.

1.197           The tax cost for an accounting liability that is, or is part of, a Division 230 financial arrangement is set for an entity (the leaving entity) that ceases to be a member of a consolidated group at a time (the leaving time) if:

•        a thing (the accounting liability) is, in accordance with accounting standards or statements of accounting concepts made by the AASB, a liability of the leaving entity just before the leaving time that can or must be recognised in its statement of financial position;

•        because the single entity rule (subsection 701-1(1)) ceases to apply to the leaving entity at the leaving time:

-                  the accounting liability becomes a liability of the leaving entity; and

-                  an asset (the corresponding asset) that consists of the liability becomes an asset of the head company; and

•        the corresponding asset's tax cost is set under section 701-20.

[Schedule 1, item 24, paragraph 715-379(1)(a), subparagraphs 715-379(1)(b)(i), (c)(i) and (d)(i), and paragraph 715-379(1)(e)]

1.198           In these circumstances, for the purposes of Division 230 and Schedule 1 to the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 , the leaving entity is taken to have started to have the accounting liability at the leaving time for receiving a payment equal to the tax cost setting amount of the corresponding asset. [Schedule 1, item 24, paragraph 715-379(2)(a)]

1.199           Similarly, the tax cost for an accounting liability that is, or is part of, a Division 230 financial arrangement is set for the head company of a consolidated group when an entity (the leaving entity) ceases to be a member of a consolidated group at a time (the leaving time) if:

•        a thing (the accounting liability) is, in accordance with accounting standards or statements of accounting concepts made by the AASB, a liability of the head company of the group at the leaving time that can or must be recognised in its statement of financial position;

•        because the single entity rule (subsection 701-1(1)) ceases to apply to the leaving entity at the leaving time:

-                  the accounting liability becomes a liability of the head company; and

-                  an asset (the corresponding asset) that consists of the liability becomes an asset of the leaving entity; and

•        the corresponding asset's tax cost is set under section 701-45.

[Schedule 1, item 24, paragraph 715-379(1)(a), subparagraphs 715-379(1)(b)(ii), (c)(ii) and (d)(ii), and paragraph 715-379(1)(e)]

1.200           In these circumstances, for the purposes of Division 230 and Schedule 1 to the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 , the head company is taken to have started to have the accounting liability at the leaving time for receiving a payment equal to the tax cost setting amount of the corresponding asset. [Schedule 1, item 24, paragraph 715-379(2)(b)]

1.201           The tax cost setting amount of the corresponding asset is worked out under sections 701-60 and 701-60A the operation of these sections is outlined in the explanation relating to the value shifting amendments in Part 7 of Schedule 1 to this Bill.

Application of Division 230 to intra-group financial arrangements when an entity leaves a consolidated group

1.202           Under TOFA provisions, a taxpayer has a financial arrangement if, broadly, the taxpayer has a right to receive or an obligation to provide financial benefits under an arrangement (section 230-45).

1.203           Section 230-60 deems a taxpayer to have a right to receive or an obligation to provide a financial benefit under an arrangement if the financial benefit plays an integral role in determining whether there is a gain or loss from the arrangement or the amount of such a gain or loss.

1.204           New section 715-379A ensures that section 230-60 operates appropriately when an entity starts to have an asset or liability that is, or is part of, a Division 230 financial arrangement which emerges from a consolidated group when an entity leaves the group. This ensures that the TOFA provisions apply after the leaving time to gains and losses on the financial arrangement.

1.205           An entity (the leaving entity) that ceases to be a member of a consolidated group at a time (the leaving time) will be taken to have an obligation to provide or a right to receive a financial benefit under an arrangement in relation to an asset or liability if:

•        because the single entity rule (subsection 701-1(1)) ceases to apply to the leaving entity after the leaving time, the asset or liability emerges from the group and becomes an asset or liability of the leaving entity;

•        in the case of an asset, subsection 701-55(5A) applies in relation to the asset at the leaving time because of section 701-45 that is, the tax cost of the asset is set at the leaving time;

•        in the case of a liability, subsection 715-379(2) applies in relation to the liability at the leaving time that is, the tax cost of the liability is set at the leaving time; and

•        the asset or liability is, or is part of, a Division 230 financial arrangement.

[Schedule 1, item 24, paragraph 715-379A(1)(a), subparagraph 715-379A(1)(b)(i), and paragraphs 715-379A(1)(c) and (e)]

1.206           In these circumstances, in the case of an asset that is, or is part of, a Division 230 financial arrangement held by the leaving entity after the leaving time, for the purpose of section 230-60, the leaving entity is taken to have acquired the asset (as mentioned in subsection 701-55(5A)) at the leaving time in return for it starting to have an obligation to provide the payment mentioned in that subsection. [Schedule 1, item 24, paragraph 715-379A(2)(a)]

1.207           In this regard, the payment mentioned in subsection 701-55(5A) is the tax cost setting amount for the asset (paragraph 701-55(5A)(a)). Paragraph 701-55(5A)(b) has no operation in this context as that paragraph applies only when an entity becomes a member of a consolidated group.

1.208           If a liability is, or is part of, a Division 230 financial arrangement held by the leaving entity after the leaving time, then, for the purposes of section 230-60, the leaving entity is taken to have started to have the liability at the leaving time in return for it starting to have a right to receive the payment mentioned in subsection 715-379(2). [Schedule 1, item 24, paragraph 715-379A(2)(b)]

1.209           The tax cost setting amount of the corresponding asset is worked out under sections 701-60 and 701-60A the operation of these sections is outlined in the explanation relating to the value shifting amendments in Part 7 of Schedule 1 to this Bill.

1.210           Similarly, the head company of a consolidated group will be taken to have an obligation to provide or a right to receive a financial benefit under an arrangement in relation to an asset or liability where an entity (the leaving entity) ceases to be a member of a consolidated group at a time (the leaving time) if:

•        because the single entity rule (subsection 701-1(1)) ceases to apply to the leaving entity after the leaving time, the asset or liability emerges from the group and becomes an asset or liability of the head company;

•        in the case of an asset, subsection 701-55(5A) applies in relation to the asset at the leaving time because of section 701-20 that is, the tax cost of the asset is set at the leaving time;

•        in the case of a liability, subsection 715-379(2) applies in relation to the liability at the leaving time that is, the tax cost of the liability is set at the leaving time; and

•        the asset or liability is, or is part of, a Division 230 financial arrangement.

[Schedule 1, item 24, paragraph 715-379A(1)(a), subparagraph 715-379A(1)(b)(ii), and paragraphs 715-379A(1)(c) and (e)]

1.211           In these circumstances, in the case of an asset that is, or is part of, a Division 230 financial arrangement, held by the head company after the leaving time, for the purpose of section 230-60, the head company is taken to have acquired the asset (as mentioned in subsection 701-55(5A)) at the leaving time in return for it starting to have an obligation to provide the payment mentioned in that subsection. [Schedule 1, item 24, paragraph 715-379A(3)(a)]

1.212           If a liability that is, or is part of, a Division 230 financial arrangement held by the head company after the leaving time, then, for the purpose of section 230-60, the head company is taken to have started to have the liability at the leaving time in return for it starting to have a right to receive the payment mentioned in subsection 715-379(2). [Schedule 1, item 24, paragraph 715-379A(3)(b)]

1.213           In this regard, the payment mentioned in subsection 701-55(5A) is the tax cost setting amount for the asset (paragraph 701-55(5A)(a)). Paragraph 701-55(5A)(b) has no operation in this context as it applies only when an entity becomes a member of a consolidated group.

1.214           The tax cost setting amount of the corresponding asset is worked out under sections 701-60 and 701-60A the operation of these sections is outlined in the explanation relating to the value shifting amendments in Part 7 of Schedule 1 to this Bill.

Example 1.7  

Head Co is the head company of a consolidated group and is subject to the TOFA provisions in Division 230. Company A and Company B are subsidiary members of the group.

On 1 July 2018, Company A enters into an Australian dollar denominated loan arrangement with Company B. Under the arrangement, Company B lends an amount of $100,000 to Company A on interest free terms. The term of the loan is 4 years.

On 1 December 2018, Company A repays $20,000 of the loan.

On 1 July 2019, another entity (which is not a member of a consolidated group) acquires all of the membership interests in Company A. As a result, Company A leaves the consolidated group.

At the leaving time, the market value of the corresponding loan asset held by Company B is $80,000.

Prior to the leaving time, the intra-group loan arrangement between Company A and Company B was not recognised for income tax purposes (due to the operation of the single entity rule).

At the leaving time, the single entity rule ceases to apply to the loan arrangement. Therefore, Division 230 starts to apply to the loan arrangement. As a result, for the purposes of applying Division 230:

•        Head Co is taken to have acquired the loan asset at the leaving time in return for it starting to have an obligation to provide a payment of $80,000 (section 701-20, item 3 of the table in section 701-60, paragraphs 701-55(5A)(a) and 715-379A(3)(a)); and

•        Company A is taken to have the loan liability at the leaving time in return for it starting to have a right to receive the payment of $80,000 (paragraphs 715-379(2)(a) and 715-379A(2)(b)).

Therefore, for the purposes of working out any gain or loss on the loan arrangement under Division 230:

•        Head Co will take into account the payment of $80,000; and

•        Company A will take into account the receipt of $80,000.

Example 1.8  

Head Co is the head company of a consolidated group and is subject to the TOFA provisions in Division 230. Company A and Company B are subsidiary members of the group.

On 1 July 2018, Company A enters into a cash-settlable swap transaction with Company B for nil consideration. The term of the swap is 4 years.

On 1 July 2018, another entity (which is not a member of a consolidated group) acquires all of the membership interests in Company A. As a result, Company A leaves the consolidated group.

At the leaving time, both the swap asset held by Company A and the corresponding swap liability held by Company B have a fair value of $100.

Prior to the leaving time, the intra-group swap arrangement between Company A and Company B was not recognised for income tax purposes (due to the operation of the single entity rule).

At the leaving time, the single entity rule ceases to apply to the swap arrangement. Therefore, Division 230 starts to apply to the swap arrangement. As a result, for the purposes of applying Division 230:

•        Company A is taken to have acquired the swap asset at the leaving time in return for it starting to have an obligation to provide a payment of nil (section 701-45, item 3A of the table in section 701-60, paragraphs 701-55(5A)(a) and 715-379A(2)(a)); and

•        Head Co is taken to have the swap liability at the leaving time in return for it starting to have a right to receive the payment of $0 (paragraphs 715-379(2)(b) and 715-379A(3)(b)).

Therefore, for the purposes of working out any gain or loss on the swap arrangement under Division 230:

•        Company A will take into account the payment of $0; and

•        Head Co will take into account the receipt of $0.

Consequential amendments

1.215           Consequential amendments are made to clarify the headings to sections 715-375 and 715-378. [Schedule 1, items 22 and 23, sections 715-375 and 715-378]

Application

1.216           The TOFA measure applies in the same way as Part 2 of Schedule 1 to the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 applies that is, from the commencement of the TOFA regime (generally from 1 July 2010). [Schedule 1, subitem 25(1)]

1.217           However, as a transitional rule, the Commissioner is prevented from amending an assessment of an entity for an income year in a particular way if:

•        the entity lodged its income tax return for the income year before the 2013 Budget time that is, before 7.30 pm, by legal time in the Australian Capital Territory, on 14 May 2013 (the date of announcement of the measure);

•        the Commissioner could not amend the assessment in that way if these amendments were disregarded; and

•        the entity has not requested the Commissioner to amend the assessment in that way.

[Schedule 1, subitems 25(2) and (3)]

1.218           This transitional rule ensures that taxpayers who took a position under the current law will not be disadvantaged by the amendments. However, it also prevents taxpayers from obtaining a windfall gain by amending prior year assessments in a way that takes advantage of a deficiency in the law.

Part 7 — The value shifting measure

1.219           The value shifting measure in Part 7 of Schedule 1 to this Bill removes anomalies that arise when an entity leaves a consolidated group holding an asset that corresponds to a liability owed to it by the old group by ensuring that the amount taken into account under the exit tax cost setting rules for the asset is aligned with the tax cost setting amount for the corresponding asset of the leaving entity.

1.220           Step 3 of the exit tax cost setting rules (section 711-40) increases the old group's allocable cost amount by the value of intra-group liabilities owed to the leaving entity.

1.221           Generally, the step 3 amount is the market value of the corresponding asset of the leaving entity (subsection 711-40(1)). However, this amount is reduced if, ignoring the single entity rule, a member of the group would have made a capital gain or capital loss when the liability arose. In these circumstances, the step 3 amount is, broadly, what would have been the cost base of the asset if that cost is less than the market value (subsections 711-40(2) and (3)).

1.222           When a leaving entity holds an asset that consists of a liability owed to it by a member of the old group, the asset's tax cost is set at the leaving time, for the entity’s income tax purposes, at the asset's tax cost setting amount (section 701-45). The tax cost setting amount is the market value of the asset (table item 3 in section 701-60).

1.223           The value shifting problem arises because:

•        subsections 711-40(2) and (3) do not appropriately identify all of the circumstances in which the step 3 amount should be less than the market value of the corresponding asset; and

•        in some cases, the tax cost setting amount for the corresponding asset should be less than the market value of that asset.

1.224           To overcome the value shifting problem:

•        the exit tax cost setting rules will be modified so that the step 3 amount included for an intra-group liability owed to the leaving entity by the old group is equal to the tax cost setting amount for the corresponding asset; and

•        the tax cost setting amount for the corresponding asset is set at:

-                  in the case of an asset that corresponds to a debt owed to the leaving entity by the old group the market value of the asset;

-                  otherwise an amount that reflects the cost of the asset.

Modification to step 3 of the exit tax cost setting rules

1.225           Under the exit tax cost setting rules that apply when an entity leaves a consolidated group, step 3 increases the old group's allocable cost amount when an intra-group liability is owed to the leaving entity by the old group.

1.226           The amendments modify section 711-40 so that the amount that is included at step 3 of the exit tax cost setting rules in relation to an intra-group liability that is owed to the leaving entity by the old group is the tax cost setting amount for the corresponding asset. [Schedule 1, item 28, section 711-40]

Modification to the tax cost setting amount

1.227           If an entity leaves a consolidated group holding an asset that consists of a liability owed to it by a member of the old group, the asset's tax cost is set at the leaving time at the asset's tax cost setting amount (section 701-45).

1.228           The asset's tax cost setting amount is set out in the Table 1.2 and depends on whether the asset is a right to recover an intra-group liability that:

•        is a debt owed to the leaving entity that is, broadly, because money has been borrowed, or credit obtained, by a member of the old group from the leaving entity;

•        arose in the old group or was acquired by the group and is not a debt owed to the leaving entity; or

•        was brought into the group by a joining entity and is not a debt owed to the leaving entity.

[Schedule 1, items 26 and 27, table item 3A in sections 701-60 and 701-60A]

Table 1.2 : Tax cost setting amount for an asset that is a right to recover an intra-group liability

Nature of asset

Tax cost setting amount

Right to recover an intra-group liability that is a debt owed to the leaving entity

Market value of the asset at the leaving time

Right to recover a liability that is not a debt owed to the leaving entity where:

•        at the time the liability arose, the entity to whom the liability was owed and the entity owing the liability were both members of the old group; or

•        after the time the liability arose, a member of the old group acquired the corresponding asset

Nil

Right to recover a liability that is not a debt owed to the leaving entity where:

•        at the time the liability arose, the entity to whom the liability was owed and the entity owing the liability were not both members of the old group; and

•        the tax cost of the corresponding asset was set under section 701-10 at the time an entity became a subsidiary member of the old group (whether or not the asset became an intra-group asset at the joining time or at a later time)

The lesser of:

•        the tax cost setting amount for the asset;

•        if the head company was entitled to a deduction in respect of the asset for an income year ending on or before the leaving time the tax cost setting amount for the asset reduced by the amount of the deduction; and

•        the market value of the asset at the leaving time

[Schedule 1, item 27, subsections 701-60A(2), (3) and (4)]

1.229           If the asset is a right to recover a liability that is not a debt owed to the leaving entity and, at the time the liability arose, the entity to whom the liability was owed and the entity owing the liability were both members of the old group, the tax cost setting amount of the asset is nil. As a result, any incidental costs incurred by a consolidated group on the creation of the intra-group asset will not be prevented from being deducted as business capital expenditure under section 40-880.

1.230           If the asset is a right to recover a liability that is not a debt owed to the leaving entity and, after the time the liability arose, a member of the old group acquired the corresponding asset, the tax cost setting amount of the asset is also nil. As a result, the cost incurred by a consolidated group to acquire the intra-group asset may also be deductible as business capital expenditure under section 40-880.

1.231           If the asset is a right to recover a liability that is not a debt owed to the leaving entity and, after the time the liability arose, the asset's tax cost was set because it was held by an entity that became a subsidiary member of the old group, the tax cost setting amount of the asset the lesser of:

•        the tax cost setting amount for the asset that is, the cost to the old group of acquiring the asset;

•        the tax cost setting amount for the asset, reduced to the extent of any deduction claimed in respect of the asset for an income year ending at or before the leaving time; or

•        the market value of the asset at the leaving time.

Example 1.9  

In 2005, a company granted a right over one of its assets to a subsidiary member of its wholly owned group. The market value of the right at that time was $5,000.

In 2006, the company formed a consolidated group (Group A). As a result, the subsidiary member became a member of Group A. The tax cost setting amount for the right was set at $5,000 (reflecting the market value of the right at that time). However, this tax cost setting amount was disregarded due to the operation of section 701-58.

During the time that the right was held by Group A, the value of the right increased. As a result, there was a corresponding decrease in the value of the asset over which the right was created. This decrease in the value of the asset was not recognised for tax purposes.

In 2018, Group A sold the subsidiary member to Group B (another consolidated group) for $1 million. The right was the subsidiary member's only asset.

Under the current law, the step 3 amount is the market value of the right that is $1 million. In this regard, subsection 711-40(3) does not apply to reduce the step 3 amount because the right was created before the formation of the consolidated group. Therefore, Group A will not make a capital gain on the disposal of the subsidiary member.

The amendments change this outcome so that the step 3 amount is $5,000 that is, the lesser of:

•        the tax cost setting amount for the right that was disregarded at the joining time ($5,000); and

•        the market value of the right ($1 million).

Therefore, Group A will make a capital gain on the disposal of the subsidiary member which reflects the economic gain made by the group (being the difference between the amount the group receives on the disposal of the right ($1 million) and the cost of acquiring the right ($5,000)).

The tax cost setting amount of the right for the leaving subsidiary member will be $5,000. However, under the entry tax cost setting rules, the tax cost of the right will be reset at its market value ($1 million) when the subsidiary becomes a member of Group B.

Modification to step 4 of the exit tax cost setting rules

1.232           Step 4 of the exit tax cost setting rules (section 711-45) reduces the old group's allocable cost amount by the value of liabilities that the leaving entity takes with it. In the case of intra-group liabilities owed by the leaving entity to a member of the old group, the step 4 amount is the market value of the corresponding asset (subsection 711-45(4)).

1.233           To improve the structure of the current law, the amendments modify the step 4 amount in relation to an intra-group liability that is owed to the old group by the leaving entity so that it refers to the tax cost setting amount for the corresponding asset (rather than the market value of the corresponding asset). [Schedule 1, item 29, subsection 711-45(4)]

1.234           In this regard, when the head company of a consolidated group holds an asset that consists of a liability owed to it by the leaving entity, the asset's tax cost is set at the leaving time at the asset's tax cost setting amount (section 701-20). The tax cost setting amount for the asset is the market value of the asset (table item 3 in section 701-60). [Schedule 1, item 26, table item 3 in section 701-60]

1.235           The amendment to subsection 711-45(4) does not change the outcomes that arise under the current law but make it clear that there is alignment between:

•        the amount that is included at step 4 of the exit tax cost setting rules for intra-group liabilities owed by the leaving entity to the old group; and

•        the tax cost of the corresponding asset of the old group.

Application

1.236           The value shifting measure applies if an entity ceases to be a subsidiary member of a consolidated group under an arrangement that commences on or after the 2013 Budget time that is, at or after 7.30 pm, by legal time in the Australian Capital Territory, on 14 May 2013 (the date of announcement of the measure by the former Government). [Schedule 1, subitems 30(1) and (5)]

1.237           In this regard, the time that an arrangement commences depends on the nature of the arrangement, as outlined in paragraph 1.265. [Schedule 1, item 31]

1.238           The changes to section 701-61A in the value shifting measure amendments to determine the tax cost setting amount of an asset are relevant for the operation of the TOFA measure.

1.239           Therefore, as the TOFA measure applies from the commencement of the TOFA regime (generally from 1 July 2010), the changes to section 701-61A also apply from the commencement of the TOFA regime (as outlined in the paragraphs 1.216 to 1.218). [Schedule 1, subitems 30(2), (3) and (4)]

Application and transitional provisions

1.240           The dates of effect of the various measures are, broadly, as follows:

•        the deductible liabilities measure applies from 1 July 2016;

•        the deferred tax liabilities measure applies from the date of introduction of the amending legislation;

•        the securitised assets measure generally applies to ADIs and financial entities from 13 May 2014, and to all other entities from 3 May 2016;

•        the churning measure and the value shifting measure apply from 14 May 2013; and

•        the TOFA measure applies from the commencement of the TOFA regime.

1.241           Where appropriate, transitional rules ensure that taxpayers who have entered into arrangements prior to commencement are not disadvantaged, are not able to obtain windfall gains, or do not have to change a position they have taken under the current law.

1.242           In some cases these measures apply from a date prior to the introduction of the amendments. This is necessary to:

•        prevent taxpayers from structuring their affairs to obtain unintended tax benefits or to obtain windfall gains; and

•        protect a significant amount of revenue that otherwise would be at risk.

1.243           The application of the amendments for each measure and the associated transitional rules are explained in more detail below and at the end of the detailed explanation of the new law for each Part.

1.244           The measures will generally commence on the first 1 January, 1 April, 1 July or 1 October to occur after the day that this Bill receives Royal Assent. [Section 2]

Part 1 The deductible liabilities measure

1.245           The amendments in Part 1 (the deductible liabilities measure), apply in relation to an entity that becomes a subsidiary member of a consolidated group under an arrangement that commences on or after 1 July 2016. [Schedule 1, item 6]

1.246           The application of the deductible liabilities measure from 1 July 2016 is necessary to prevent corporate groups that elect to consolidate from obtaining an unintended tax advantage over other corporate entities. The measure will also protect a significant amount of revenue that otherwise would be at risk.

Part 2 The deferred tax liabilities measure

1.247           The amendments in Part 2 (the deferred tax liabilities measure) apply in relation to an accounting liability of entity that becomes a subsidiary member of a consolidated group under an arrangement that commences on or after the start of the day on which this Bill is introduced into the House of Representatives. [Schedule 1, subitem 9(1)]

1.248           In addition, the deferred tax liabilities measure applies in relation to an accounting liability of entity that ceases to be a subsidiary member of a consolidated group under an arrangement that commences on or after the start of the day on which this Bill is introduced into the House of Representatives. [Schedule 1, subitem 9(2)]

1.249           The deferred tax liabilities measure was recommended by the Board of Taxation and will reduce compliance costs that arise when an entity joins or leaves a consolidated group.

Parts 3 and 4 The securitised assets measure

1.250           The amendments in Part 3 (the securitised assets measure) apply in relation to an ADI or financial entity that joins or leaves a consolidated group under an arrangement that commences either before or after the 2014 Budget time that is, 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 2014 (the time of announcement of this measure). [Schedule 1, items 14 and 15]

1.251           Transitional rules ensure that taxpayers are not disadvantaged, are not able to obtain windfall gains, or do not have to change a position they have taken under the current law.

1.252           The amendments in Part 4 extend the scope of the securitised assets measure so that it applies to all entities that join or leave a consolidated group. These amendments apply in relation to an entity that joins or leaves a consolidated group under an arrangement that commences after the 2016 Budget time that is, 7.30 pm, by legal time in the Australian Capital Territory, on 3 May 2016 (the time of announcement of the extension of this measure). [Schedule 1, items 18 and 19]

1.253           The application of the securitised assets measure to arrangements entered into before the date of announcement in some circumstances, together with the transitional rules, are consistent with observations made by the Board of Taxation directed at ensuring equitable outcomes for consolidated groups affected by anomalies that arise under the current law in relation to securitised assets.

1.254           In this regard, the measure is necessary to prevent consolidated groups from structuring their affairs to obtain unintended tax benefits and windfall gains. The measure will also ensure that significant unintended tax liabilities do not arise when an entity that is a party to a securitisation arrangement leaves a consolidated group.

Part 5 — T he churning measure

1.255           The amendments in Part 5 (the churning measure) generally apply to arrangements that commence on or after the 2013 Budget time that is, 7.30 pm, by legal time in the Australian Capital Territory, on 14 May 2013 (the date of announcement of the measure by the former Government). [Schedule 1, item 21]

1.256           However, as a transitional rule, the extension of the control test to cover participation interests of associates applies only to an arrangement that commences on or after the start of the day on which this Bill is introduced into the House of Representatives. [Schedule 1, subitems 21(2) and (3)]

1.257           The application of the churning measure from the date of announcement is necessary to prevent foreign resident taxpayers from structuring their affairs to obtain unintended tax benefits and will protect a significant amount of revenue that otherwise would be at risk.

1.258           The transitional rule reflects the fact that the scope of the measure was broadened after the 2015 Exposure Draft legislation was released to make the control test an associate inclusive test. This extension is necessary to ensure the integrity of the measure. However, the transitional rule will ensure that taxpayers are not inadvertently affected by the measure because they were unaware of the change to make the control test an associate inclusive test.

Part 6 The TOFA measure

1.259           The amendments in Part 6 (the TOFA measure) apply in the same way as Part 2 of Schedule 1 to the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 applies that is, from the commencement of the TOFA regime. [Schedule 1, item 25]

1.260           The TOFA regime generally commenced from the start of the 2010-11 income year.

1.261           Transitional rules prevent the Commissioner from amending an assessment of an entity for an income year that is issued prior to the 2013 Budget time to ensure that taxpayers are not disadvantaged by the amendments and cannot obtain a windfall gain.

1.262           The application of this measure from the commencement of the TOFA regime is necessary to provide certainty to taxpayers and prevent consolidated groups from structuring their affairs to obtain unintended tax benefits and windfall gains. The measure will also protect a significant amount of revenue that otherwise would be at risk.

Part 7 The value shifting measure

1.263           The amendments in Part 7 (the value shifting measure) apply to arrangements that commence on or after the 2013 Budget time. [Schedule 1, item 30]

1.264           The application of this measure from the date of announcement is necessary to prevent consolidated groups from structuring their affairs to obtain unintended tax benefits and will protect a significant amount of revenue that otherwise would be at risk.

Part 8 Commencement of an arrangement

1.265           The time that an arrangement commences depends on the nature of the arrangement, as outlined Table 1.3.

Table 1.3 : Commencement of an arrangement

Type of arrangement

Time that the arrangement commences

Off-market takeover bid

The day on which the bidder lodged with the Australian Securities and Investments Commission a notice stating that the bidder's statement and offer document have been sent to the target that is, step 4 of the table in subsection 633(1) of the Corporations Act 2001 is completed

On-market takeover bid

The day on which the bidder announces a bid to the relevant financial market that is, step 2 of the table in subsection 635(1) of the Corporations Act 2001 is completed

Scheme of arrangement

The day on which a company applies for a court order (under subsection 411(1) of the Corporations Act 2001 ) for a meeting of the company's members, or one or more classes of the company's members, about the arrangement

Other arrangement

The day on which the decision to enter into the arrangement (including an initial public offering) was made

[Schedule 1, item 31]

 

 



Chapter 2          

Statement of Compatibility with Human Rights

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Treasury Laws Amendment (Income Tax Consolidation Integrity) Bill 2018

2.1                   This Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 .

Overview

2.2                   Schedule 1 to this Bill amends the ITAA 1997 to improve the integrity and operation of the consolidation regime by implementing the following measures:

•        the deductible liabilities measure, which will remove a double benefit that can arise in respect of certain liabilities held by an entity that joins a consolidated group;

•        the deferred tax liabilities measure, which will simplify the operation of the entry and exit tax cost setting rules by ensuring that deferred tax liabilities are disregarded;

•        the securitised assets measure, which will remove anomalies that arise when an entity joins or leaves a consolidated group where the entity has securitised an asset;

•        the churning measure, which will switch off the entry tax cost setting rules for a joining entity where a capital gain or capital loss made by a foreign resident owner when it ceases to hold membership interests in the joining entity is disregarded in certain circumstances;

•        the TOFA measure, which will clarify the operation of the TOFA provisions when an intra-group asset or liability that is, or is part of, a Division 230 financial arrangement emerges from a consolidated group because a subsidiary member leaves the group; and

•        the value shifting measure, which will remove anomalies that arise when an entity leaves a consolidated group holding an asset that corresponds to a liability owed to it by the old group because the value of the asset taken into account for tax cost setting purposes is not always appropriate.

Human rights implications

2.3                   This Bill does not engage any of the applicable rights or freedoms.

Conclusion

2.4                   This Bill is compatible with human rights as it does not raise any human rights issues.