NSW 9 th Annual Tax Forum

NSW 9th Annual Tax Forum “Tax consolidation update – still grappling with these rules?” Written by: Wayne Plummer Partner pwc Presented by: Wayne Pl...
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NSW 9th Annual Tax Forum “Tax consolidation update – still grappling with these rules?”

Written by: Wayne Plummer Partner pwc

Presented by: Wayne Plummer Partner pwc

NSW Division 2-3 June 2016 Sofitel Wentworth, Sydney

© Wayne Plummer 2015 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.

Wayne Plummer

Tax consolidation update – still grappling with these rules?

CONTENTS 1

Tax consolidation law in danger of stagnating ........................................................................... 3

2

Worth the wait? .............................................................................................................................. 4

3

2.1

Federal Budget (2016/17) - Overview....................................................................................... 5

2.2

Deductible liabilities .................................................................................................................. 6

2.3

Don’t forget the other changes announced in May 2013 ........................................................ 10

2.4

Where does that leave ‘share’ v. ‘asset’ acquisition distortions?............................................ 13

2.5

Some circumstances warranting particular care ..................................................................... 14

So much still to do ....................................................................................................................... 15 3.1

Previously identified by the BoT, but still to be fixed .............................................................. 15

3.2

Issues arising out of the 2012 tax consolidation changes ...................................................... 16

3.3

Other areas warranting attention ............................................................................................ 17

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1 Tax consolidation law in danger of stagnating The pond that is our tax consolidation regime is suffering the effects of stagnation. Only a few years ago, it was a boiling sea of major reviews and significant legislative change. And then, ‘nothing’ … We have now been waiting over three years to see legislation introduced for the last significant announced changes to the consolidation rules (those changes relating to “deductible liabilities”, “securitised assets” and “antichurning where companies are transferred from non-residents”). The recent Federal Budget was at least the cause of a ripple with further announcements on those previous announcements. I will take a look at where these changes currently sit and what they should look like when eventually introduced. We were, of course, promised a broad review of the Tax Consolidation Regime to be undertaken in 2015. Various preliminary discussions were held. Lists compiled. And then, ‘nothing’ …. Not that we should cast stones toward the resourced-constrained Treasury tax team. The Tax Consolidation regime has suffered the same fate under successive Governments as the broader Australian tax system … band aid fixes and political adjustments, with no meaningful reviews or reform. I will also take the opportunity to repeat the long list of outstanding announcements, identified issues and areas for improvement of the tax consolidation rules. We can but remain hopeful that, once we get past the Federal Election, the elected Government will re-prioritise the broad tax consolidation review so that we may, once again, see this fundamental plank of our income tax system refreshed and flowing with outcomes in line with clear policy objectives.

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2 Worth the wait? The 2016/17 Federal Budget was handed down on 3 May 2016 and contained updates on three long outstanding measures. These measures were part of a package announced in May 2013 and, in the absence of legislation, taxpayers have been grappling with the potential impact of these rules to transactions over the last three years. The unfortunate timeline is set out below:

Date

Event

14 May 2013

Board of Tax Report: Post Implementation Review of Certain aspects of the Consolidation Tax Cost Setting Process (dated April 2013), including recommendations on: • Deductible liabilities - new assessable income • Removal of deferred tax liabilities • Securitised assets • CGT rollovers

14 May 2013

2013/14 Federal Budget announced the following changes: • Deductible liabilities of joining entities – new assessable income • Anti-churning - entities transferred from non-residents under the same ownership will not reset the tax cost of those entities (unless within 12 months of group acquisition) • Intra-group assets excluded from TARP calculations • Assets subject to an intra-group liability • Reset intra-group TOFA liabilities on exit

13 May 2014

2014/15 Federal Budget confirming the 2013/14 proposals will be implemented with effect from 14 May 2013 and adding a new change to remove unintended outcomes on entry and exit for securitised assets. The Government also confirmed that it would not be proceeding with changes to the MEC rules as a result of the tripartite review, but noted that MEC issues would be considered as part of the broader tax consolidations review planned for 2015.

April 2015

Release of Exposure Draft Legislation – Tax and Superannuation Laws Amendment (2015 Measures No.4) Bill 2015: Consolidation (the “ED”) covering deductible liabilities, antichurning for entities transferred from non-residents, assets impaired by an intra-group liability on exit, resetting of intra-group TOFA liabilities on exit, and securitised assets

3 May 2016

2016/17 Federal Budget announcing significant changes to the deductible liabilities measures, a broadening of the securitised assets measures and confirming the removal of deferred tax liabilities from entry/exit calculations.

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2.1 Federal Budget (2016/17) - Overview Deductible liabilities In a welcome amendment, it was announced in the 2016/17 Federal Budget that the proposed deductible liability rules will be significantly modified. Head companies of consolidated groups will no longer be required to bring to account assessable income amounts corresponding to the deductible liabilities of a joining entity. Instead, when calculating the allocable cost amount (ACA) of the joining entity, deductible liabilities will be excluded. As a result, the assets of the acquired entity will have a lower tax cost base which may reduce future tax depreciation deductions. The Budget announcement promises the new rules will be much simpler than those previously proposed. This is promising, but may mean that the new rules will apply in a broader range of circumstances, with limited or no carve outs for group formations or certain group restructures. Rather than the retrospective application (from 14 May 2013) under the previous announcement, the new deductible liabilities rules will now only apply from 1 July 2016.

Deferred tax liabilities The current treatment of deferred tax liabilities (DTLs) on entry to, and exit from, a consolidated group gives rise to the need for to complex calculations and uncertain outcomes. This 2016/17 Budget included an announcement that, for transactions commencing after the date the amending legislation is introduced into Parliament, DTLs will be excluded from the ACA entry and exit calculations. This change will reduce the complexity involved in the joining and leaving process.

Securitised assets The 2014-15 Federal Budget included proposed amendments applicable to accounting liabilities in respect of securitised assets. As the relevant liability exists for accounting purposes, but the corresponding asset is not recognised for tax purposes, an unintended result could arise when an entity joins or leaves a consolidated or MEC group. The original proposal, which is to apply to arrangements commencing on or after 7.30pm (AEST) 13 May 2014, only applies where a member of the group is an authorised deposit taking institution (ADI) or a financial entity. The 2016-17 Federal Budget extends this ‘securitisation measure’ to non-financial institutions for arrangements commencing on or after 7.30 pm (AEST) 3 May 2016.

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2.2 Deductible liabilities Summary

Date of effect

Future deductible liabilities (e.g. employee leave entitlements) of a joining

1 July 2016

entity will be excluded from the ‘step 2’ amount in the joining ACA calculation.

The ‘deductible liabilities’ measure is the most highly anticipated of the outstanding amendments. For the last three years taxpayers who entered into affected transactions have had to deal with the significant uncertainty associated with an announcement that lacked detail; together with restrictions on the ability to recognise the proposed amendments for financial reporting purposes as they were not substantially enacted. The deductible liabilities measures are intended to remove a perceived double benefit (or a double detriment) which can arise in respect of certain deductible liabilities held by a joining entity that is acquired by a consolidated group. The perceived double benefits are: a)

The increase in ACA amount (step 2) attributable to these liabilities (and corresponding increase in the tax cost of assets); and

b)

The future deduction for the joined group claimed when these liabilities are paid.

The 2015 Exposure Draft In April 2015, Treasury released an Exposure Draft for the outstanding measures. The Exposure Draft set out rules under which future deductible liabilities (e.g. employee leave entitlements) of a joining entity would result in the head company of the joined group including a corresponding amount in its assessable income over a 12 month period (for current liabilities) or a 48 month period (for non-current liabilities). A similar mechanism was to apply to create deductions where a joining entity held liabilities that had been reduced by unrealised foreign exchange gains that would give rise to future assessable income. The Exposure Draft contained a number of exclusions: (a) certain insurance company liabilities (b) TOFA liabilities (c) retirement village liabilities (d) where there is a joining and exit in the same income year and the deductible liabilities leave the group (e) where the deductible liability is characterised as an "owned" liability (f) liabilities that are not taken up at step 2 of an ACA calculation. For excluded liability types (a)-(d) - the step 2 amount was reduced by 30%. For excluded liability type (e) - the step 2 amount was reduced to nil. For excluded liability type (f) - there was no corresponding ACA calculation.

Complex rules were proposed to calculate the extent to which a deductible liability was ‘owned’. The Exposure Draft treatment of deductible liabilities went far beyond the stated objective of avoiding double deductions/double income and represented an impediment to transactions involving companies that carry material deductible liabilities (such as leave provisions).

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Many submissions were lodged during the public consultation period by taxpayers, tax agents, and professional bodies. Treasury and the Government clearly accepted the main premises of these submissions and have now proposed a more simple and better targeted measure.

The 2016/17 Budget Announcement The Treasurer released the following statement on Budget night: The Government will modify how the 2013-14 Budget measure Closing loopholes in the consolidation regime — deductible liabilities of a joining entity addresses the double counting of deductible liabilities under the consolidation regime. The modifications mean that a consolidated group that acquires a subsidiary with deductible liabilities will no longer include those liabilities in the consolidation entry tax cost setting process, thus removing a double tax benefit. This measure also defers the start date from 14 May 2013 to 1 July 2016. The elimination of the double tax benefit will result in increased revenue. However, modifying the 201314 Budget measure results in a cost to revenue of $270.0 million over the forward estimates period, reflecting both the deferred start date and a timing difference for when the double tax benefit is removed under the modified approach. Whereas the 2013-14 Budget measure required the consolidated group to recognise an additional income amount over the first four years after acquiring an entity with deductible liabilities, the modified approach of denying an increase in the consolidated entry cost setting process will result in lower depreciation allowances over a longer period of time and hence a delay to the revenue gain from eliminating the double tax benefit. Over time (and after accounting for the deferred start date), the revenue gain from the two approaches will be broadly the same and hence the cost over the forward estimates period from the modification largely reflects a timing difference only. This measure removes inequitable consequences for taxpayers identified during consultation on the 2013-14 Budget measure. If introduced as originally announced, the measure would have applied even where no double tax benefit arose in practice. It will also provide a less complex approach than the original 2013-14 Budget measure. The deferred start date will address difficulties caused by the implementation delay for taxpayers who have undertaken commercial transactions based on the current law.

What will the revised measures look like? The principal aspect of the proposed deductible liabilities measure could be as simple as an amendment to sub-section 705-75(1), as follows:

If some or all of an accounting liability will result in a deduction to the *head company, the amount to be added for the accounting liability under subsection 705-70(1) is reduced by the following amount: [Deduction

×

*Corporate tax rate]

-

Double-counting adjustment

where: double-counting adjustment means the amount of any reduction that has already occurred in the accounting liability under subsection 705-70(1) to take account of the future availability of the deduction.

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What is a ‘deductible liability’? As noted above, an ACA adjustment for a future deductible liability has been part of the tax consolidation rules since 2002. It has not been considered necessary to have any further legislative clarification of the types of liabilities that attract the subsection 705-75(1) adjustment. However, the 2015 Exposure Draft legislation contained an additional definition of the liabilities that triggered the former proposals, as follows: “(b) because the joining entity became a member of the group at that time, an amount … that is all or part of the joining liability would result in a deduction to the *head company of the group if, just after the joining time, the *head company of the group had made a payment to discharge the joining liability”

A few comments on the application of the wording currently used in sub-section 705-75(1) and the wording that had been proposed in the 2015 Exposure Draft: 

While the sub-section 705-75(1) provision has application where any part of a liability of a joining company will give rise to a future deduction, the ACA adjustment is only based on that future deduction (rather than on the total amount of the liability). This seems appropriate.



The 2015 Exposure Draft test had the potential to generate unintended outcomes based on the contrived nature of the test – ie. to determine tax deductibility based on a hypothetical [single] payment to discharge the [entire] liability immediately following the joining time. While the ‘entry history’ rule imputed the history of the joining entity business for the purpose of making this determination, it still left room for an uncertain characterisation in many circumstances.



The subsection 705-75(1) requirement that the liability ‘will’ result in a deduction to the head company seems to require a high level of probability as to that outcome (or perhaps as far as ‘no probability of a contrary outcome’). In this regard, there are typically two elements of contingency: (i) whether an amount ‘will’ be paid in the future in respect of (or normally in reduction of) the relevant liability; and (ii) whether the payment of that amount “will” give rise to a tax deduction. It might be suggested that the appropriate policy outcome may be achieved if the ‘will’ requirement is aimed at the future tax deductible nature of the payment, rather than whether a payment itself ‘will’ be made. This policy objective should be able to be achieved through a less contrived test than that proposed in the 2015 Exposure Draft.

Consider, for example, a liability for onerous contracts. On one argument, an onerous contract liability may be excluded from step 2 under subsection 705-70(2) on the basis it arises because of the joining entity’s ownership of an asset (being the relevant contract). However, if the onerous contract liability is not otherwise excluded, question how it might be treated under either the subsection 705-75(1) test or the 2015 Exposure Draft test? The often broad estimate of future loss that supports an onerous contract liability makes it very difficult to predict the extent and nature of any future payments that might relate to this liability. This might render the subsection 705-75(1) test difficult to apply. In relation to the 2015 Exposure Draft test, the same uncertainty makes it difficult to determine the nature of a payment that might be made to discharge the liability. On one view, a hypothetical payment to discharge an onerous contract liability might be a payment of compensation for breach or other termination of the contract. Circumstances are easily conceivable where such a payment might be treated as a non-deductible capital payment.

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Any exceptions? The announcement states that the revised measures will be “less complex” than the previous proposals. This may mean the Government is less inclined to provide the same list of exceptions that was the case under the 2015 Exposure Draft legislation. The reasons that warranted the previous exclusion of certain insurance company liabilities and retirement village liabilities would seem to equally warrant exclusions from the revised measures (ie. these liabilities should revert to being reduced by only 30% for the purposes of step 2 of an ACA calculation). Given that the TOFA liabilities of a joining entity would normally be reset at joining time, it is questionable what circumstances would arise where they would give rise to a future tax deduction; in which case a specific exclusion may not be necessary. The previous exclusion proposed where an entity joins and leaves a consolidated group within an income year should not be needed as the impact of the revised deductible liabilities measures is an adjustment to calculated ACA and therefore an adjustment to the reset cost base of the assets of the joining entity. If that entity then leaves the group the exit ACA calculation will appropriately reflect the adjusted cost base of the assets that leave the group. Liabilities that are not taken up at step 2 of an ACA calculation should not give rise to any adjustment even if they might give rise to future tax deductions. These include: i.

liabilities of a head company on formation;

ii.

liabilities that transfer with an asset - excluded by s705-70(2); or

iii.

liabilities of an entity that joins a group without a reset of assets - eg. Division 615 interposition of a company above a tax consolidated group; or Subdivision 124-M rollover with application of the ‘restructure’ provisions.

Much of the complexity of the 2015 Exposure Draft provisions arose from the mechanism to exclude from the rules, deductible liabilities to the extent they were ‘owned’ by the acquiring group prior to the joining time. This rationalisation of this ‘owned’ v. ‘acquired’ adjustment was that the value of the future tax deductions for an ‘owned’ liability were not reflected in any purchase price paid for the joining entity (and therefore not reflected in step 1 of the corresponding ACA calculation). In the context of the new deductible liabilities proposal (to reduce the cost base of assets, rather than trigger assessable income), there is likely to be fewer anomalous outcomes that warrant the additional complexity (and necessary arbitrary mechanics) of an ‘owned’ liability exclusion. It is also noted that the proposed removal of deductible liabilities from step 2 of a joining ACA generally mirrors the treatment of these same liabilities in step 4 of an exit ACA calculation; again likely to result in fewer anomalous outcomes where entities exit one group and join another; or exit one group and then form a new consolidated group.

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Start date The 2016/17 Federal Budget announcement simply referred to a deferral of the start date for these measures to 1 July 2016. However, given the previous proposal had a start date based on the ‘commencement of an arrangement’, it is likely this will also be the basis for the revised measures, ie. ‘arrangements commencing on or after 1 July 2016’. The commencement of an arrangement for these purposes is likely to adopt the definition used elsewhere in the Act, as follows: Arrangement type

Time of commencement of the arrangement

On-market takeover bid

The day on which the bid is announced

Off-market takeover bid

The day on which the bidder’s statement is lodged with the ASIC

Scheme of arrangement

The day on which a company applies to the court for the scheme meeting

Other arrangement

The day on which a decision to enter into the arrangement was made

Adjustment for future assessable foreign exchange gains on liabilities It would still seem appropriate to implement the mechanism in the Exposure Draft legislation that increased step 2 liabilities by the amount of any inherent foreign exchange gain in relation to a liability (ie. a future assessable amount relating to a step 2 liability).

2.3 Don’t forget the other changes announced in May 2013 Anti-churning Summary

Date of effect

This measure will prevent the tax cost of the assets of an Australian entity from being “reset” where the Australian entity (which is held by a

Broadly applies in relation to an entity that joins a

non-resident) is transferred to a tax consolidated group in Australia, there has been no change in ultimate ownership of the entity and no

consolidated or MEC group under an arrangement that

tax recognised as a result of the non-resident capital gains tax (CGT)

commenced on or after 14

rules.

May 2013

Under this proposal, where membership interests in an entity are transferred by a non-resident to a consolidated or MEC group where the interests are not taxable Australian property (TAP) under the non-resident capital gains tax (CGT) rules, the tax cost setting rules will only apply in respect of the entity's assets if: 

there has been a change in the underlying majority beneficial ownership of the transferred entity, or



if there has not been such a change, the membership interests in the entity were acquired by the foreign entity/group in the preceding 12 months.

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Effectively this amendment will ensure that non-residents are not able to achieve an uplift in the tax cost of assets of Australian entities that they have held for longer than 12 months by transferring the entity to a consolidated or MEC group owned by the non-resident in circumstances where the nonresident transferor does not realise a taxable Australian capital gain in respect of the transfer transaction. In these circumstances, the tax cost of the assets will instead be retained. Key points to note:



In effect this measure creates a "quasi-stick" option. In particular not only does it mean that there is no tax cost uplift of the assets of the transferred entity, but it also means that tax costs will not be reset downwards in cases where the value of the Australian entity has declined since its assets were acquired.



Tax cost resetting will continue to be available for entity transfers from within the foreign owned group where the transferred entity is an indirect real property interest (ie TAP). It would seem, but is not entirely clear, this would be the case in the event that Subdiv 126-B CGT rollover were obtained in relation to the transferred entity (although note that any cost resetting would have regard to the historical rolled-over cost base of the membership interests).



The Board disagreed with submissions that the general anti-avoidance rules in Part IVA should be relied on as a primary measure to target the ability of non-residents to uplift the tax cost of their Australian assets by transferring entities to Australian consolidated or MEC groups that they own, without realising a capital gain on disposal.



Multinationals that acquire an Australian entity or group at the non-resident level as part of a global acquisition will have a 12 month period to rationalise the holding of the Australian assets and facilitate the transfer of the newly acquired entity into a consolidated or MEC group of the non-resident transferor and be able to reset the tax costs of the assets of the entity that has been recently transferred.



It is unclear how this measure may apply in cases where membership interests are not all held by a non-resident, ie in cases where some membership interests in the transferred entity are already held by members of the consolidated group. It would seem that if the non-resident holds a majority interest in the entity, no tax cost setting relief would be provided in spite of the original holding by the consolidated group.

Value shifting measure Summary

Date of effect

Consolidated groups will not be able to access double deductions by shifting the value of assets between entities, i.e. when an encumbered asset, whose market value has been reduced due to the intra-group creation of rights over the encumbered asset, is sold by a consolidated group.

Broadly applies in relation to an entity that exits a consolidated or MEC group under an arrangement that commenced on or after 14 May 2013

The double benefit that this measure is intended to address arises as follows: 

Where a consolidated group sells an encumbered asset that is subject to rights belonging to another member of the group, the group would make a reduced taxable capital gain on sale of

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the asset. The reduction would typically be equivalent to the market value of the rights which the group retains. 

At the same time, the group might have argued that it obtained a market value cost base in the rights it retains, in both the situation where it sells the encumbered asset directly, or sells an entity which holds the encumbered asset. Under the proposed measure, the group will instead obtain a cost base that reflects the notional cost of creating this asset.

TOFA measure Summary

Date of effect

Clarifying the operation of the TOFA provisions when an intra-group asset or liability emerges from a consolidated group because a subsidiary leaves the group. Under this measure, only net gains and losses on certain intra-group liabilities and assets that are subject to the TOFA regime will be recognised for tax purposes upon exit of a

Applies from the commencement of the TOFA regime (in most cases, income years commencing on or after 1 July 2010)

member from a consolidated group.

The amendments ensure that only net gains and losses are recognised for tax purposes for certain intra-group liabilities and assets that are subject to the taxation of financial arrangements (TOFA) regime, upon exit of a member from a consolidated group. These provisions deal with a deficiency in the application of the entry history rule to intra-group liabilities (ie. no history is inherited in respect of intra-group liabilities owed to or by a subsidiary member when it leaves a consolidated group, as nothing “happens” in respect of the liability while the subsidiary member was a group member). This amendment will, for example, prevent a lender from being assessed on a return of the principal of a loan and prevent a borrower from claiming a deduction for repayment of that principal. In particular, to make the tax treatment of intra-group assets and liabilities consistent with the economic substance of transactions: 

the entity that holds the liability will be deemed to have received, as consideration for assuming that liability, a financial benefit equal to the liability's market value at the leaving time, so that any deduction obtained under the TOFA regime will reflect the entity's economic loss (if any), and



the entity that holds the asset takes into account the asset's market value tax cost setting amount in working out the TOFA gain or loss from the asset, so that the entity is assessed on their economic gain (if any).

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2.4 Where does that leave ‘share’ v. ‘asset’ acquisition distortions? The revised deductible liability measures will go a long way to reducing the tax distortion to the questions of ‘share’ v. ‘asset’ acquisition. The current state of play is summarised below: Share acquisition

Direct business acquisition

(i)

Consumables deduction

(v)

Consumables deduction

(ii)

WIP deduction

(vi)

WIP deduction

(iii)

Retained cost base for all other RTFI

(vii)

CGT cost base for all other RTFI contracts

(viii)

Potential blackhole deduction for assets not recognised under tax laws

(broader definition of RTFI) (iv)

Deemed goodwill for assets not recognised under tax laws

(v)

deduction for revenue assets (although potential for cost to be utilised under a ‘net income’ approach) (vi)

Reset TOFA liabilities

(vii)

Deductible liabilities – excluded from ACA resulting in a reduced cost of assets

(viii)

Deferred tax liabilities - excluded from ACA calculations resulting in a reduced cost of assets

(ix)

Tax liabilities (apart from income tax liabilities where a clear exit is obtained) will remain with the company.

(x)

(ix)

“Business Acquisition” approach - no

Tax attributes (such as losses and franking credits) only remain with the entity if it was a stand-alone company or a head company

potential for cost to be utilised under a ‘net income’ approach) (x)

Reset TOFA liabilities

(xi)

Deductible liabilities – no reduction in asset cost and future liability deduction, although note Ausnet decision (2015))

(xii)

Deferred tax liabilities – no reduction in asset cost

(xiii)

No tax liabilities are inherited by the purchaser.

(xiv)

Tax depreciation – must use the same method as was used prior to joining; and must reset the effective life except for an asset using prime cost which has not been reset upwards. 200% DV accelerated rate is available based on the joining date.

(xii)

Potential adverse impact of CGT Event L5

No tax attributes (losses or franking credits) ae inherited by the purchaser.

(xv)

Tax depreciation – can use a different depreciation method. The rate on remaining useful life of assets or Commissioner’s rates. 200% DV accelerated rate is available based on acquisition date.

of a consolidated group. If losses remain with the entity, they will be subject to joining tests and available fraction. (xi)

“Business Acquisition” approach - no deduction for revenue assets (although

(xvi)

Equivalent CGT Event L5 would normally manifest as a CGT Event L1 gain (or balancing charge in relation to plant); The equivalent CGT Event L3 gain is likely deferred under a direct asset acquisition.

(xvii)

Transaction costs incurred pre or postacquisition are likely to form part of the tax cost of the assets

on exit (where liabilities exceed the tax cost base of assets) or L3 on re-consolidation (where the available ACA is less than the retained cost base assets). (xiii)

Transaction costs incurred post-acquisition may be deductible under s40-880 (ie. over 5 years).

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2.5 Some circumstances warranting particular care The exclusion of deductible liabilities and deferred tax liabilities from ACA calculations could see significant reductions in the ACA of joining entities with very different outcomes dependent on type of industries and joining entity circumstances.

Service industries with significant intangible asset value Service industries are typically characterised by high employee costs (including high levels of future deductible employee leave liabilities); by low levels of tangible assets (such as tax depreciable plant and equipment); and, where successful, high levels of (non-tax depreciable) intangible assets. The protection of future deductions for employee leave payments is a welcome outcome for joining entities in these industries. And the reduction of ACA amounts to allocate across assets will have limited adverse implications.

Service industries with significant cash and receivables Some joining entities from a service industry may not yet have generated significant intangible asset values; but may have high levels of service receivables, as well as cash balances, on their balance sheets. The exclusion of employee liabilities and deferred tax liabilities from ACA calculations may result in a total ACA amount which is less than the level of retained cost base assets (such as cash and receivables). To this extent, the joining will give rise to a taxable gain under CGT Event L3 1.

Capital intensive industries A joining company in a capital intensive industry with a balance sheet consisting predominantly of tax depreciable plant and equipment will be more likely to see a reduction in the tax cost (and therefore future tax depreciation deductions) of that plant and equipment, as a consequence of the exclusion of employee liabilities and deferred tax liabilities from ACA calculations.

1

Although a CGT Event L3 gain can be reduced (by election of the joined group) where the market value of receivables is less than the face value of those receivables: section 705-27

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3 So much still to do 3.1 Previously identified by the BoT, but still to be fixed The previous Government released two Board of Taxation reports on 14 May 2013 2. The reports contained approximately 25 recommendations and the previous Government released, at the time, a statement indicating an intention to move to implementing many of the recommended changes. Some of these recommendations were later “scrapped” by the then Government in the Assistant Treasurer’s 14 December 2013 Press Release. Others will be addressed by the proposals subject to the announcements in respective 2013/14, 2014/15 and 2016/17 Federal Budgets. Of those Board of Taxation recommendations that remain outstanding (listed below) it was thought that most would be wrapped into the planned 2015 Tax Consolidations Review (but now very much ‘up in the air’): 1. A more systematic approach to addressing and resolving tax consolidation issues 2. Clarification of membership rules for trusts and trustees 3. Rules to deal with the application of the single entity rule and the “emergence” of intragroup assets and liabilities 4. Consistent rules to ensure the continuance of a tax consolidated group on the interposition of a new holding company 5. Straddle contracts involving intra-group assets 6. Measures to encourage SMEs to adopt tax consolidation At Appendix C of the Board's 2012 Report, the following issues are identified as outside the scope of the Board's review but which "would be desirable for these issues to be resolved as soon as practicable": 1. various issues relating to MEC groups including: 

the treatment of transfers up and transfers down of eligible tier-1 companies



MEC pooling rules relating to functional currency



interaction between MEC groups and loss rules including issues relating to the available fraction



deemed failure of the continuity of ownership test for MEC groups where there is no actual change in majority beneficial ownership, and



interaction with the thin capitalisation rules

2. access to the Subdivision 126-B CGT roll-over by a foreign resident with more than one wholly-owned entry point company in Australia that has not formed a MEC group 3. application of CGT event L5 to subsidiary members that are deregistered



2

Post Implementation Review into Certain Aspects of the Consolidation Regime; and Post-Implementation Review of Certain Aspects of the Consolidation Tax Cost Setting Process.

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Wayne Plummer

Tax consolidation update – still grappling with these rules?

4. allowing the modified tax cost setting rules in Subdivision 705-C to apply in additional cases where a consolidated group is acquired 5. clarification of whether the foreign hybrid tax cost setting rules contained in Division 830 apply before or after the cost setting rules in Division 705 6. extending the principle in the tax law that allows inconsistent elections to be cancelled or ignored when an entity joins a consolidated group 7. clarification of how the consolidation rules apply to intangible economic assets (that is, nonCGT assets such as customer relationships, know-how and similar assets) 8. disclosure of Division 7A amounts on income tax returns 9. interactions with the new managed investment trust regime 10. practical issues that arise when a public trading trust or a corporate unit trust becomes the head company of a consolidated group 11. clarification of the treatment of amounts paid under earn out arrangements in the entry allocable cost amount calculation 12. interactions with FOREX and TOFA provisions, and 13. treatment of intra-group transactions that straddle the time an entity joins or leaves a consolidated group.

3.2 Issues arising out of the 2012 tax consolidation changes The ‘Prospective Rules’ were introduced by TLAB (2012 Measures No.2) with effect for joining times (or transactions commencing) from 31 March 2011. They included a number of significant shifts in the treatment of assets of a joining entity; for some of which we are only now realising the full impact. The key changes included: a) b)

A specific deduction for ACA allocated to work-in-progress A much broader definition of RTFI assets and deemed retained cost base treatment

c) d) e)

A narrowing of the assets to which ACA is allocated A resulting greater allocation of ACA to goodwill (with consequences for later disposals/exits) A “business acquisition approach” to determine the characterisation of tax cost setting amounts

Areas of uncertainty in relation to these rules that warrant ATO guidance or legislative clarification, include: 1. Clarification of the scope of the term ‘work in progress’ 2. Clarification of the latest (broad) definition of ‘right to future income’ and, in particular, whether it extends to: • • • • •

In the money (non-TOFA) derivatives Contracts for the supply of trading stock Valuable lease, rental or license agreements Contracts to generate an interest return In the money foreign currency receivables

© Wayne Plummer 2016

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Wayne Plummer

Tax consolidation update – still grappling with these rules?

3. Guidance on the allocation of value (and therefore ACA) on entry calculations that is otherwise attributable to non-CGT assets or various customer intangibles (ie. spread across other assets or specifically attributed to the value of goodwill). 4. Guidance on the allocation of goodwill cost base in disposal or exit calculations (where that goodwill cost base has been increased as a result of assets excluded from ACA entry calculations, such as RTFI assets, non-CGT assets etc.). 5. Guidance in relation to the application of the ‘business acquisition approach’ to the characterisation of the reset cost of non-RTFI contractual assets.

3.3 Other areas warranting attention In addition to the above, the author’s “shopping list” of suggestions and other items that should warrant the attention of any broad Tax Consolidations Review, would include: 1.

Do away with tax sharing agreements – ie. the default should be tax sharing/clear exit, unless otherwise agreed

2.

Liabilities – clearer rules to determine when to take up gross v. net liabilities in entry and exit ACA calculations (including broaden s705-70(2) and s711-45(2)).

3.

Liabilities – rules to better define liabilities to the exclusion of “accounting creations”

4.

Service receivables – dealing with the difficulty establishing cost base for Div 711 exit calculations (or perhaps clarification via s118-20)

5.

Broaden the circumstances in which Subdiv 705-C applies – including acquisition of a group by a single entity, offshore acquisitions via buy-back/cancellations.

6.

MEC – review the appropriateness of the deemed COT failure rules

7.

MEC – address the draconian impact on group losses of the establishment of a new ET1 company

8.

MEC – amend the rules dealing with the “transfer-up” of a subsidiary to become an ET1 (that, per the ATO interpretation, gives rise to a CGT Event A1 without any cost base)

9.

Reconsider the retained cost base treatment of RTFI assets on the basis this measure was an over-reaction and is inconsistent with an underlying policy to broadly replicate the outcomes of a business acquisition

10.

Consider the provision of a broad “stick election” for all transactions where the step 1 ACA amount is based on historic costs (ie. has not arisen from a third party acquisition of shares at market value) such as is the case for various roll-over transactions; reconsolidation of a group following IPO, demerger or formation of a joint venture.

As these various lists indicate, there is much still to be done and not much that will be “easy”. Many of the items that remain on the “to do” lists are there for a reason; because there has been no easily identified resolution. The tax consolidation rules warrant the previously promised broad-based review with appropriate resourcing, coordination and breadth of views. It is far too important a component of our income tax regime to be left to stagnate ….

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