Senate

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 4 - Amendments to Subdivision 170-D

Outline of Chapter

4.1 Schedule 1 to this Bill amends Subdivision 170-D of the ITAA 1997. Subdivision 170-D defers recognition of a capital loss or deduction which would otherwise be realised on the transfer or creation of a CGT asset between companies in the same linked group or between a company in a linked group and a connected entity (or its associate).

4.2 The amendments introduced in this Bill refine Subdivision 170-D to ensure that it operates as intended.

Context of Reform

4.3 Subdivision 170-D was introduced to address the duplication of losses. This can arise if a 'loss asset' (an asset with an unrealised loss) is transferred or created between companies in the same wholly-owned or majority-owned company group (both a 'linked group') or between such a company and an entity connected with it. Under the previous law, duplication was facilitated by, among other things, the existence of compulsory loss asset roll-over within wholly-owned groups of companies and by rules that allowed companies to realise losses or deductions by 'internal' transactions.

4.4 Subdivision 170-D addresses loss duplication by ensuring that the transfer or creation of a loss asset by one company (the 'originating company') to, or in, another company in the linked group or a connected entity, does not allow a capital loss or deduction that can be immediately realised for taxation purposes. Broadly speaking, recognition of the capital loss or deduction is deferred until the asset, or a majority interest in it, is no longer held by the linked group and connected entities. If the asset, or majority interest in it, is reacquired by certain entities within a 4 year period, the capital loss or deduction may be subject to further deferral.

4.5 Following the introduction of Subdivision 170-D, it became evident that certain minor refinements could be made to the Subdivision that would enhance its operation. The amendments contained in this Bill make these refinements.

Summary of new law

4.6 The amendments proposed by Schedule 1 will ensure that Subdivision 170-D will:

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apply to defer a deduction to a non-resident company on the disposal of a CGT asset;

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clarify the operation of the 'double counting' rule in the linked group test;

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apply appropriately to dealings involving an interest in a CGT asset and clarify that 'asset' means 'CGT asset';

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modify the reacquisition rule so it works properly if an entity holding the asset, or a majority interest in the entity, is acquired; and

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provide relief from the operation of the reacquisition rule in circumstances where it would be reasonable to conclude that the majority underlying ownership of the originating company has changed from when the capital loss or deduction was deferred.

Disposal of a CGT asset leading to a deduction by a non-resident

4.7 Subdivision 170-D is amended so it will apply where:

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the originating company is a non-resident at the time of the disposal of the CGT asset; and

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the disposal would have resulted in the originating company (or partnership in which it is a partner) becoming entitled to a deduction.

[Schedule 1, items 57,58, subparagraph 170-255(1)(d)(v)]

4.8 Currently, the Subdivision does not apply to defer a deduction on the disposal of an asset held on revenue account by a non-resident company (alone or in partnership), although it may defer a capital loss on the disposal of a CGT asset. The amendment ensures consistent treatment for non-residents.

Clarify the operation of the double counting rule in the linked group and connected entity tests

4.9 In applying the linked group rules, the controlling stake and connected entity tests work on an associate-inclusive basis. Where an interest held by an entity would be double counted, and the interest is both direct and indirect, only the direct interest (of the entity or its associate) is to be counted. [Schedule 1, items 60 and 61, existing subsection 170-260(4) and paragraph 170-265(3)(a)]

4.10 These tests are amended to put beyond doubt that the meaning of the word 'interest' in respect of an entity in the double counting provisions is to be read as including the interests held by its associates. [Schedule 1, items 56 and 57, paragraphs 170-260(4)(a) and 170-265(3)(a)

References to CGT asset and application of the Subdivision to an interest in a CGT asset

4.11 For avoidance of doubt, amendments are made to ensure that 'asset' in this Subdivision 170-D means a 'CGT asset'. In addition, Subdivision 170-D does not currently apply consistently if an interest in a CGT asset, rather than the asset itself, is dealt with.

4.12 Schedule 1 therefore amends subparagraphs 170-255(1)(b)(ii) and (iii), paragraph 170-275(1)(c), subsection 170-280(1) and paragraph 170-280(3)(c) to ensure these outcomes. [Schedule 1, items 56, 59, 62, 64, 65 and 65A, subparagraphs 170-255(1)(b)(ii) and (iii), paragraphs 170-275(1)(c), subsection 170-280(1) and 170-280(3)]

Modifying the reacquisition rule

4.13 Currently, if a deferred capital loss or deduction was recognised by an originating company because of the occurrence of a new event in respect of a CGT asset (as described in section 170-275), that recognition may be undone if within 4 years after the happening of the new event, the asset, or a greater than 50% interest in it is acquired by:

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the originating company;

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an entity which is a connected entity, or an associate of the connected entity, of the originating company; or

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a company that is a member of the same linked group as the originating company.

4.14 Section 170-280 is amended so that these events are now called 'further events'. [Schedule 1, item 64, subsection 170-280(1)]

4.15 The reacquisition rules are modified to include new further events which may give rise to a deferral of a capital loss or deduction. This is because the current law focuses on reacquisition of the asset by a company in the linked group or connected entity, and does not deal with other cases where the asset may be effectively reacquired. [Schedule 1, item 64]

4.16 A capital loss or deduction which has been made is also to be deferred if the following additional further events happen:

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a company that owns the asset or a greater than 50% interest in it becomes a member of the same linked group as the originating company [Schedule 1, item 64, paragraph 170-280(1)(b)] ;

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the originating company becomes a member of a linked group a member of which owns the asset or a greater than 50% interest in it [Schedule 1, item 64, paragraph 170-280(1)(c)] ; or

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an entity that owns the asset or a greater than 50% interest in it becomes:

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a connected entity of the originating company; or

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an associate of such a connected entity.

[Schedule 1, item 64, paragraph 170-280(1)(d)]

4.17 The purpose of these amendments is to deny the previous recognition of a capital loss or deduction if the asset is effectively reacquired indirectly.

Example 4.1

Subco and Smallco are owned by Holdco. On 1 December 1999 Subco transfers a loss asset to Smallco. As Subco and Smallco are part of the same linked group, the capital loss that would otherwise have been made on transfer of the asset is deferred.

On 1 June 2000 Holdco sells Smallco to an entity unconnected to the linked group. At this time Subco recognises the deferred capital loss.

Two years later, on 1 June 2002, Smallco, while still holding the asset, is sold back to Holdco. This is a further event, therefore, the capital loss which has been claimed is taken not to have been made.

Relief from the reacquisition rule if change in underlying ownership of the originating company

4.18 Subdivision 170-D focuses on the originating company and on entities that are part of the same linked group as the originating company or entities connected with the originating company and its associates.

4.19 In limited cases, the originating company may have been sold to a different group of underlying owners such that it would be inappropriate to apply the reacquisition rule if the asset, or a majority interest in it, were acquired by the originating company and related companies and entities.

4.20 A relieving provisionis proposed to be inserted into the reacquisition rule contained in section 170-280. If within 4 years after the new event happens the CGT asset involved is transferred to the originating company and the originating company has information from which it would be reasonable to conclude that the ultimate owners who now have the majority underlying interest in the asset are not the same as the ultimate owners who had a majority underlying interest at the time of the deferral event, then, the further event is considered not to have happened. [Schedule 1, item 64, subsection 170-280(1A)]

Example 4.2

Subco and Smallco are owned by Holdco. On 1 December 1999 Subco transfers a loss asset to Smallco. As Subco and Smallco are part of the same linked group the capital loss, which Subco makes on transfer of the asset, is deferred.

On 1 June 2000 Holdco sells Subco to an entity outside the linked group and not connected with the linked group. At this time Subco is able to recognise the deferred loss.

Two years later, on 1 June 2002, Smallco sells the asset to Subco. Subco is able to establish that there has been a change in underlying ownership and therefore the further event is considered not to have occurred and the capital loss claimed is not denied.

Application and transitional provisions

4.21 The amendments made by Schedule 1 apply to deferral events happening on or after 21 October 1999. This was the application date for Division 170-D when it was introduced. These amendments make a number of corrections and clarifications to achieve what was intended by that measure. [Schedule 1 , subitem 68(6)]

Consequential amendments

4.22 There are no consequential amendments relating to this measure.