House of Representatives

Explanatory Memorandum

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

Chapter 11 - Liability for the payment of tax where a head company fails to pay on time

Outline of chapter

11.1 This chapter explains how the Commissioner may seek to recover an income tax-related liability of a consolidated group (which includes a MEC group) directly from subsidiary members if the head company fails to meet its group taxation obligations on time.

Context of reform

11.2 The Review of Business Taxation recommended that liability for group taxation debts be based on the common law concept of joint and several liability. This would mean that all members of the group would be liable at all times for the full amount of the income tax-related liability of the group (group liability) that arose during the period of membership.

11.3 A number of concerns with this approach were highlighted during consultation, particularly in relation to the imposition of full joint and several liability. These included that:

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a subsidiary member could become technically insolvent without the knowledge of that member - this is of particular concern for company directors, who are prohibited from permitting a company to trade while insolvent;

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creditors of a subsidiary member could be swamped by the group liability - this could occur where a subsidiary member was insolvent and then incurred an additional debt, being a group liability; and

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the due diligence activities of a purchaser of a subsidiary member would become necessarily excessive - because of the possibility that a subsidiary member might be liable for a group liability, a prospective purchaser would have to scrutinise the entire group to ensure that its due diligence obligations are satisfied.

11.4 In foreign jurisdictions, similar concerns regarding the effect of an imposition of joint and several liability are mitigated via the application of an extensive regime of cross-guarantees and indemnities.

11.5 However, in response to these concerns and to maintain legislative and administrative integrity, a modified model was proposed. This model differs from the Review of Business Taxation model in 3 key respects:

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the head company of a consolidated group will be solely liable, in the first instance, for a group liability;

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where that head company fails to meet the group liability by the time the liability becomes due and payable, the Commissioner may be able to recover a part or the whole of the unpaid amount directly from those entities (other than the head company) that were members of the group at any time during the period in which the group liability accrued (the contributing members); and

•

where a contributing member might be subject to recovery action by the Commissioner, it might nevertheless be able to exit a group free from a liability arising during a period in which it was a group member but which had not become due and payable at the time of exit, provided certain conditions are met.

Summary of new law

Effect of the single entity principle on group income tax-related liabilities

11.6 In respect of group liabilities, subsidiary members of a consolidated group are treated as divisions or parts of the head company. The head company is therefore liable, in the first instance, for group liabilities.

11.7 It is important to note that each member of the consolidated group remains separately liable for its tax-related liabilities that do not fall within the scope of the consolidation regime, including pre-consolidation income tax-related liabilities.

What happens where the head company does not pay the liability by the due and payable date?

11.8 Where the head company fails to satisfy a group liability by the time that it becomes due and payable, each contributing member then becomes jointly and severally liable with the head company, and each other contributing member, for the amount outstanding at this time, unless:

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that member is prohibited under an Australian law from entering into arrangements that would subject it to joint and several liability; or

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the group liability was covered by a valid tax sharing agreement that allocates the liability between the members of the group on a reasonable basis.

11.9 Where a liability to the Commonwealth is imposed on a contributing member (either a joint and several liability or an allocated liability under a valid tax sharing agreement), that liability is due and payable by the contributing member 14 days after the Commissioner notifies that member of that liability. In either case, the head company remains liable for the full amount of the unpaid group liability and these rules do not operate to change the time at which that amount was due and payable.

Consequences of ceasing to be a member of a consolidated group

11.10 Where an entity no longer meets the requirements for group membership and thus exits the group, that entity will normally continue to be subject to those liabilities that accrued during the period in which it was a contributing member.

11.11 However, a contributing member may be able to exit a group free from a group liability that arose during a period in which it was a group member but which had not become due and payable at the time of exit if:

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the exited member had, prior to exit, paid to the head company any amounts that might become due under a valid tax sharing agreement in respect of that liability; and

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the exit of the contributing member did not take place as part of an arrangement, a purpose of which was to prejudice the Commissioners ability to recover the liability from members of the group.

Determination of a contributing members liability under these rules.

11.12 Diagram 11.1 depicts the process for determining the extent to which a particular contributing member is liable in respect of an unpaid group liability.

Detailed explanation of new law

11.13 The head company of a consolidated group is solely liable, in the first instance, for group liabilities. This is because, as an implication of the single entity rule, an income tax-related liability of a consolidated group is, in fact, an income tax-related liability of the head company.

11.14 In circumstances where the head company fails to satisfy a group liability by its due and payable time, these rules enable the Commissioner to recover part or all of the unpaid amount from those members that were members of the group in the period the liability accrued by either:

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apportioning the group liability between the members on the basis of a tax sharing agreement; or

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making all members jointly and severally liable for the full amount of the group liability.

[Schedule 1, item 2, section 721-5]

11.15 It is expected that the Commissioner would usually be exercising this ability to recover directly from members of the group other than the head company where other avenues with respect to the head company have been unsuccessful. For example, where the groups liability is in dispute, the Commissioner would generally stay recovery action in respect of the liability until the dispute is resolved.

11.16 In circumstances where the Commissioner seeks to recover amounts directly from contributing members, the head company remains responsible for the group liability and these rules do not operate to change the time at which that liability was due and payable.

What is a group liability?

11.17 Section 250-10 of Schedule 1 to the TAA 1953 provides a list of tax-related liabilities. For groups consolidating for income tax purposes, a similar list is provided, identifying the tax-related liabilities of a head company of a consolidated group that are properly considered as related to the income tax obligations of the group and therefore within the scope of the consolidation regime. [Schedule 1, item 2, subsection 721-10(2)]

11.18 Each member of the consolidated group remains separately liable for its tax-related liabilities that do not fall within the scope of the consolidation regime, including pre-consolidation income tax-related liabilities.

11.19 When a group is created during a liability period (e.g. part way through an instalment quarter) a subsidiary member is individually liable for its tax related debts accrued before that time. However it is not appropriate for the member entity to be also liable for any individual income tax-related liabilities of the head company that accrued before the creation of the group. A special rule is necessary to ensure that subsidiary members only become jointly and severally liable for that part of the group liability that is reasonably attributable to that part of the liability period after the group is created. [Schedule 1, item 2, section 721-20]

11.20 There is no apportionment of a group liability where members enter or exit the group during the period when the group liability arises. Those members can potentially become subject to group liabilities under the rules of Division 721.

What is a contributing member?

11.21 A subsidiary member of a consolidated group may only be liable for any outstanding group liabilities if it is properly considered a contributing member. A contributing member is defined as an entity that was a subsidiary member of the consolidated group at any time during the period to which the relevant group liability relates [Schedule 1, item 2, paragraph 721-10(1)(b)] . In relation to an instalment quarter, for example, an entity that leaves a group one day into that quarter is still a contributing member in relation to that quarter. Similarly, an entity that is a member of the group for part of an income year is a contributing member in respect of the balance due on assessment for that income year.

Liability under the joint and several liability rule

11.22 Where an amount of a group liability remains unpaid after its due and payable time, each contributing member will then be jointly and severally liable for that group liability unless:

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the contributing member is an entity that is specifically excluded because the nature of that entity is such that it is not able to be made subject to an imposition of a joint and several liability because of an Australian law [Schedule 1, item 2, paragraph 721-15(1)(b) and subsection 721-15(2)] ; or

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the group liability is covered by a valid tax sharing agreement between the head company and one or more contributing members [Schedule 1, item 2, subsection 721-15(3)] .

11.23 When the group initially comes into existence, the group liability for which the head company is liable may be partly attributable to a time prior to that point in time when the group is first formed. This part of the group liability is not subject to joint and several liability. [Schedule 1, item 2, section 721-20]

Entities not able to enter into joint and several liability arrangements

11.24 There are some entities upon whom other Australian laws apply to prohibit them from entering into arrangements that may subject them to the imposition of a joint and several liability. These entities are specifically excluded from the operation of the joint and several liability rule where they are contributing members of a consolidated group. They would, however, be likely to be covered by a tax sharing agreement where their activities had contributed toward the accrual of the group liability. [Schedule 1, item 2, paragraph 721-15(1)(b) and subsection 721-15(2)]

Application of the statutory right of contribution in section 265-45 of Schedule 1 to the TAA 1953

11.25 Where a joint and several liability is imposed upon a contributing member and the member pays an amount in respect of that liability, that member holds a statutory right of contribution against the head company and other contributing members upon whom a joint and several liability is imposed, in accordance with section 265-45 of Schedule 1 to the TAA 1953. [Schedule 1, item 2, subsection 721-15(1)]

11.26 This statutory right operates irrespective of any application of a common law right of contribution and indemnity, or any contractual arrangements regarding the same, that arise from the nature of the liability as a joint and several one.

Liability under a tax sharing agreement

11.27 Contributing members will not be subject to an imposition of joint and several liability where the group liability is covered by a valid tax sharing agreement [Schedule 1, item 2, subsection 721-15(3)] . In these circumstances, each contributing member covered by the tax sharing agreement (TSA contributing member) is liable to the Commonwealth for the amount determined under that tax sharing agreement, whether or not the TSA contributing member had paid a contribution amount to the head company under the terms of the agreement [Schedule 1, item 2, subsection 721-30(2)] .

11.28 For a group liability to be covered by a tax sharing agreement:

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the agreement between the head company and the TSA contributing members must exist immediately prior to the time when the head companys liability is due and payable [Schedule 1, item 2, paragraph 721-25(1)(a)] ;

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the agreement must provide a mechanism for determining that part of the amount of the relevant group liability that is to be allocated to the TSA contributing members (the contribution amount) [Schedule 1, item 2, paragraph 721-25(1)(b)] ;

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that allocation of contribution amounts between the head company and TSA contributing members must be a reasonable allocation of the group liability [Schedule 1, item 2, paragraph 721-25(1)(c)] ;

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the agreement must not have been entered into as part of an arrangement, for which a purpose was to prejudice the Commissioners ability to recover some or all of the unpaid amount of the group liability from group members (e.g. by allocating a contrived portion of the group liability to an entity which had not conducted any income-producing activities in the period when the liability arose and which had little or no assets) [Schedule 1, item 2, subsection 721-25(2)] ; and

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the agreement must comply with any other requirements set out in the regulations [Schedule 1, item 2, paragraph 721-25(1)(d)] .

11.29 To provide additional assurance to the business community, the Commissioner will publish guidelines as to what he considers to be a reasonable allocation of a group liability under a tax sharing agreement.

11.30 Where the Commissioner has issued a notice to the head company requiring that a copy of the tax sharing agreement in the approved form be provided to him within 14 days, a tax sharing agreement will be considered to have never applied to that group liability if a copy of that agreement is not provided to the Commissioner within the time required. The Commissioner may defer the time for lodgement under section 388-5 of Schedule 1 to the TAA 1953 where it is appropriate to do so. The consequence is that the contributing members will be liable under the joint and several rule provided for in new subsection 721-15(1), as the exception to that rule for group liabilities covered by a tax sharing agreement in new subsection 721-15(3) is taken to have never applied. [Schedule 1, item 2, subsection 721-25(3)]

Where a TSA contributing member can exit the group clear of a future liability being allocated under a tax sharing agreement

11.31 To provide additional certainty to a purchaser of a contributing member, certain TSA contributing members may exit a consolidated group clear of a particular group liability [Schedule 1, item 2, subsection 721-30(3)] where it:

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ceased its membership of the group prior to the time at which the group liability became due and payable by the head company [Schedule 1, item 2, paragraph 721-35(a)] ;

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paid to the head company the allocated amount (or a reasonable estimate of that amount) in respect of its contribution to the group liability prior to ceasing membership of the group [Schedule 1, item 2, paragraph 721-35(c)] ; and

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did not cease membership of the group as part of an arrangement to prejudice the recovery of some or all of the unpaid group liability (e.g. the deliberate transfer of part or all of an entity as part of an arrangement for the purpose of putting most of the assets of the group out of the consolidated group would be regarded as prejudicial to the recovery of the liability) [Schedule 1, item 2, paragraph 721-35(b)] .

11.32 The exiting member is not able to exit clear of liability for a group liability that had become due and payable by the head company before the time of that members exit. For these liabilities, the normal tax sharing agreement liability rule applies. That is, the TSA contributing member is liable for the amount determined under the tax sharing agreement.

Common rules applying to the liability of a contributing member

11.33 The liability of a contributing member, or a TSA contributing member, arises just after the head company has failed to fully discharge that group liability by its due and payable time. [Schedule 1, item 2, subsections 721-15(4) and 721-30(4)]

11.34 However, that liability will not become due and payable by the contributing member, or TSA contributing member, until 14 days after the Commissioner issues a notice to that member advising of their liability [Schedule 1, item 2, subsections 721-15(5) and 721-30(5)] . To maintain flexibility for the Commissioner and taxpayers alike, there is no legislative requirement for the notice to be issued within a certain period.

Application of these rules to contributing members, or TSA contributing members, that are trusts or partnerships

11.35 The consolidation rules apply such that partnerships and some trusts may be members of a consolidated group. Where a contributing member, or a TSA contributing member, is a partnership or a trust the liabilities imposed under these rules are instead imposed on:

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if the contributing member, or TSA contributing member, is a partnership - the partners of the partnership (as described in section 444-5 of Schedule 1 to the TAA 1953); and

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if the contributing member, or TSA contributing member, is a trust - the trustees of the trust (as described in section 254 of the ITAA 1936) [Schedule 1, item 2, subsections 721-15(6) and 721-30(6)] .

Application and transitional provisions

11.36 These rules apply from the commencement of the consolidation regime, on 1 July 2002.