House of Representatives

Explanatory Memorandum

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

Chapter 2 - Interposed shelf head company

Outline of chapter

2.1 This chapter discusses modifications to the consolidation rules in the May Consolidation Act and the June Consolidation Bill dealing with membership. It also discusses changes that have been made to provisions in the ITAA 1997 as a consequence of these modifications.

Context of reform

2.2 In response to submissions received during consultation, this bill contains changes that amend the membership rules for consolidated groups (other than MEC groups) to ensure that, in limited circumstances, a consolidated group will not cease to exist even though the head company of the group is replaced by a new shelf head company. These changes will help to reduce unnecessary compliance costs for taxpayers, including those who wish to implement a Wallis Report recommendation that Australian banks should be able to interpose a non-operating holding company between the bank and its shareholders. These changes will also aid in protecting the integrity of the consolidation regime.

2.3 This bill also proposes changes to existing CGT rollover relief provisions that currently provide rollover relief for certain shareholders involved in a share exchange. These changes are necessary to maintain the integrity of the consolidation regime and were developed in consultation with external advisors.

Summary of new law

Interposed shelf head company

2.4 This bill amends the membership rules contained in the May Consolidation Act and the June Consolidation Bill to allow a consolidated group to continue to exist in limited circumstances where a company that is eligible to be a head company is interposed between the former head company of a consolidated group and its shareholders.

2.5 Related amendments included in this bill are made to existing CGT rollover relief provisions (in Subdivision 124-G of the ITAA 1997) to:

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prevent gains and losses from being realised by shareholders on the disposal, cancellation or redemption of their shares in the former head company of a consolidated group where those shares are exchanged for shares in a replacement head company; and

•

modify the requirements for rollover relief in certain circumstances.

Detailed explanation of new law

Interposed shelf head company

2.6 Generally, a consolidated group will cease to exist where the head company of the group no longer satisfies the conditions for being a head company. An exception to this rule now operates to ensure that a consolidated group will not cease to exist in limited circumstances despite an entity ceasing to be the head company of the group.

2.7 These changes will help to reduce unnecessary compliance costs. For example, by preserving a consolidated group in certain cases where nothing of substance has changed within the group, the group will be relieved of the burden of applying the consolidation cost setting rules (and obtaining the necessary market valuations). The changes will also aid in protecting the integrity of the consolidation regime. For example, the changes effectively prevent the cost bases of a groups assets from being reallocated between those assets where nothing of substance has changed within the group. Other integrity benefits of these changes are discussed in paragraphs 2.30 and 2.35.

In what circumstances will the deconsolidation exception apply?

2.8 A consolidated group will continue to exist if:

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An entity (the original company) ceases to be a head company of a consolidated group because, through a share exchange, another company (the interposed company) is interposed between the original company and its shareholders and that company becomes the owner of all of the shares in the original company; and

•

the interposed company makes an irrevocable choice that the consolidated group is to continue in existence.

[Schedule 2, item 10, section 703-65 and subsection 703-70(1)]

What are the conditions for making the choice for the group to continue in existence?

2.9 An interposed company can make an irrevocable choice that a consolidated group is to continue in existence at and after the time (the completion time) when, broadly, the last of the shareholders of the original company has disposed of its shares in the original company to the interposed company or had its shares redeemed or cancelled (as part of the share exchange) if:

•

immediately before the completion time, the original company is the head company of a consolidated group; and

•

immediately after the completion time, the interposed company is the head company of a consolidatable group consisting only of itself and the members of the group immediately before the completion time.

[Schedule 2, item 4, subsections 124-380(5) and (7)]

2.10 It is important that following the completion time the interposed company satisfies the conditions for being a head company. The single entity rule operates to treat subsidiary members of a consolidated group as parts of the head company. If the interposed company makes a choice that the consolidated group is to continue in existence, this requirement will ensure that the group continues to be taxed like an ordinary Australian resident company.

2.11 Before the interposed company can make a choice that the consolidated group is to continue in existence, the share exchange which results in the interposed company being interposed between the original company and its shareholders must also be in accordance with the conditions set out in Subdivision 124-G of the ITAA 1997. For example, the interposed company needs to be a shelf company. Also, the entities described as the interposed company and the original company in paragraph 2.8 must come within the existing meanings of those terms given by Subdivision 124-G. Broadly, the term original company means the existing resident company in which the shareholders originally held shares before the share exchange. The term interposed company broadly means a resident company that acquires all of the shares in a company whose shares are held by the original shareholders.

2.12 A choice for the consolidated group to continue in existence must be made by the interposed company within 2 months after the completion time, or within such further time as the Commissioner allows. [Schedule 2, item 4, subsection 124-380(7)]

2.13 Under subsections 103-25(1) and (2) of the ITAA 1997, a choice made under the CGT provisions contained in the ITAA 1997 must generally be made by the day a taxpayer lodges its income tax return for the income year in which the relevant CGT event happened and the manner in which a taxpayer prepares its income tax return is sufficient evidence of the making of such a choice. Amendments are made to paragraph 103-25(1)(a) to ensure that the choice by the interposed company for the consolidated group to continue in existence is an exception to this rule. [Schedule 2, item 1, paragraph 103-25(3)(a)]

2.14 Once made, a choice by the interposed company to preserve the consolidated group results in consequences for:

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the consolidated group (see paragraphs 2.15 to 2.25) [Schedule 2, item 10, section 703-65] ;

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the original company when it ceases to be a subsidiary member of the group (see paragraphs 2.26 to 2.28) [Schedule 2, item 10, section 703-65] ; and

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the shareholders of the original company (see paragraphs 2.29 to 2.42).

What are the consequences of the choice for the consolidated group?

2.15 If the interposed company makes a choice for the consolidated group to continue in existence, the interposed company will become the head company of the consolidated group at the completion time and the original company will cease to be the head company and immediately become a subsidiary member of the group at that time. [Schedule 2, item 10, subsection 703-70(2)]

2.16 Additionally, everything that happened in relation to the original company before the completion time will be taken to have happened instead in relation to the interposed company, just as if, at all times before the completion time:

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the interposed company had been the original company; and

•

the original company had been the interposed company.

[Schedule 2, item 10, paragraphs 703-75(1)(a),(c) and (d)]

For brevity, this rule will be referred to in the explanatory memorandum as the substitution rule.

2.17 The substitution rule also ensures that things that happened to the original company prior to the completion time because of the single entity rule, the entry history rule, the transfer of history rule (see paragraph 3.118 in Chapter 3) or a previous application of the substitution rule will be taken to have happened to the interposed company [Schedule 2, item 10, subsection 703-75(2)]. The single entity rule and the entry history rule were contained in the May Consolidation Act. The single entity rule treats subsidiary members of a consolidated group (or MEC group) as part of the head company of the group and allows such groups to be treated as single entities for income tax purposes. The entry history rule allows the head company to inherit the income tax history of subsidiary members once they become subsidiary members of the group.

2.18 The substitution rule ensures that any income tax history of the interposed company that relates to periods prior to the completion time is effectively ignored. [Schedule 2, item 10, paragraph 703-75(1)(b)]

2.19 The substitution rule will apply for the following purposes:

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for the head company core purposes in relation to an income year ending after the completion time. The head company core purposes were contained in the May Consolidation Act. They relate to the purposes of a head company working out its income tax liability or loss for any period during which it is the head company of a consolidated group (or MEC group) or any later income year; and

•

for the purposes of determining the respective balances of the franking accounts of the original company and the interposed company at and after the completion time.

[Schedule 2, item 10, paragraphs 703-75(3)(a) and (c)]

2.20 The substitution rule also applies for the entity core purposes in relation to an income year ending after the completion time [Schedule 2, item 10, paragraph 703-75(3)(b)] . However, this will be subject to the exit history rule and any provision which the exit history rule is subject to [Schedule 2, item 10, subsection 703-75(4)] . The exit history rule was contained in the May Consolidation Act. It allows an entity to inherit certain income tax history on ceasing to be a subsidiary member of a consolidated group (or MEC group) .

2.21 In general, for the income year that ends after the completion time, the head company of the consolidated group will be the interposed company. That is, generally, in respect of the income year that includes the completion time, the interposed company will be the head company of the consolidated group up until the completion time because of the substitution rule and afterwards because of the rule in paragraph 2.15.

2.22 Also, all of the tax attributes (e.g. losses and franking credits) of the original company will instead become those of the interposed company. This will include, for example, tax attributes generated by the consolidated group and tax attributes transferred to the original company from subsidiary members at the joining time or the group formation time.

2.23 Consolidation provisions that ordinarily apply when an entity becomes a subsidiary member of a consolidated group (hereafter referred to as the joining rules) will not apply when the original company becomes a subsidiary member of the group at the completion time (subject to any specific exceptions to this rule) [Schedule 2, item 10, subsection 703-70(3)] . This rule aims to prevent unintended consequences such as double counting of tax attributes that may otherwise occur. In the absence of such a rule it may be arguable, for example that losses of the original company are transferred to the interposed company under the joining rules. The transfer of the losses of the original company under the joining rules would be in addition to the effective transfer of those losses that would occur under the substitution rule.

2.24 The rule in paragraph 2.23 does not affect the application of the single entity rule. [Schedule 2, item 10, subsection 703-70(4)]

2.25 The substitution rule in conjunction with the rule in paragraph 2.23 that prevents the joining rules from applying when the original company becomes a subsidiary member of the consolidated group will also ensure that the consolidated groups existing asset cost bases will be retained following the change in the head company of the group.

What are the consequences for the original company if it ceases to be a subsidiary member of the consolidated group following the completion time?

2.26 As mentioned in paragraph 2.15, if the interposed company makes a choice for the consolidated group to continue in existence, the original company will become a subsidiary member of the group at the completion time. If the original company ceases to be a subsidiary member of the group following that time, any provision that would ordinarily apply to an entity when it ceases to be a subsidiary member will also apply to the original company.

2.27 However, the following modifications will apply when the original company ceases to be a subsidiary member of the consolidated group:

•

section 701-30 is modified so that in applying that section to the original company for the income year that includes the completion time, any non-membership period that starts before the completion time is to be ignored [Schedule 2, item 10, section 703-80] . This modification is necessary to avoid unintended tax consequences, such as double taxation that may otherwise arise (as a consequence of the substitution rule). Section 701-30 was contained in the May Consolidation Act and it, broadly, provides a method for working out an entitys tax position for a period when it is not a subsidiary member of any consolidated group. Its application can also affect the entitys tax position in later income years;and

•

the substitution rule will apply subject to the exit history rule and any exceptions to the exit history rule (see paragraph 2.20) [Schedule 2, item 10, subsection 703-75(4)] . This will ensure that when the original company ceases to be a subsidiary member of the consolidated group it will take with it only the income tax history that relates to the assets, liabilities and businesses that leave with the company.

2.28 One implication of the substitution rule operating in conjunction with the modification to section 701-30 (see paragraph 2.27) is that the only tax payable by the original company for the income year that includes the completion time arises because of the application of section 701-30 to non-membership periods in the income year that end after the completion time. Under the substitution rule, the interposed company inherits the original companys tax position for the part of the income year that ends before the completion time, with the consequences that the original companys taxable income, income tax payable, and losses of any sort for that part are each nil.

What are the consequences for a shareholder of the original company when a choice is made for the group to continue in existence?

2.29 There are consequences for a shareholder of the original company when the interposed company makes a choice for the consolidated group to continue in existence (see paragraphs 2.32 to 2.37). There are additional consequences where the shares in the original company are trading stock (see paragraphs 2.38 to 2.40) or revenue assets (see paragraph 2.41 to 2.42) of the shareholder immediately before the time that the share exchange takes place.

2.30 The effect of these implications (discussed in paragraphs 2.32 to 2.42) is to defer tax recognition of gains or losses on the disposal, cancellation or redemption of shares in the original company until the replacement shares in the interposed company are disposed of. These rules are aimed at preventing unintended consequences, in particular loss or gain duplication.

2.31 Compulsory deferral of losses or gains (on the disposal, cancellation or redemption of shares in the original company) is appropriate given that the rules that give rise to those outcomes will only be invoked in circumstances where nothing of substance would have changed for the shareholders of the original company as a consequence of the share exchange.

Consequences for shareholders of the original company

2.32 Where the interposed company makes a choice for the consolidated group to continue in existence, the shareholders of the original company will be taken to have chosen to obtain rollover relief on the disposal, cancellation or redemption of their shares in the original company which are exchanged for replacement shares in the interposed company if:

•

immediately before the completion time, the original company is the head company of a consolidated group; and

•

immediately after the completion time the interposed company is the head company of the group.

[Schedule 2, item 2, subsection 124-360(2), and item 3, subsection 124-370(1A)]

2.33 The share exchange which results in the interposed company being interposed between the original company and its shareholders must have also been in accordance with the conditions set out in Subdivision 124-G of the ITAA 1997 for the rule in paragraph 2.32 to apply.

2.34 Under the existing rules in Subdivision 124-G, shareholders may choose to defer capital gains or losses on the disposal, cancellation or redemption of their shares in the original company where those shares are exchanged for replacement shares in the interposed company provided that:

•

the interposed company makes an election that the consequences set out in section 124-385 of the ITAA 1997 apply; and

•

the share exchange is in accordance with the conditions set out in Subdivision 124-G.

2.35 As discussed, the existing rules in Subdivision 124-G are modified in the circumstances set out in paragraphs 2.32 and 2.33 so that rollover will now be compulsory in those circumstances. This is necessary to prevent gain or loss duplication.

2.36 Another difference between the existing rules in Subdivision 124-G and the rules in paragraphs 2.32 and 2.33 is that in respect of the latter rules, rollover is dependant on the interposed company making an election that the consolidated group continue in existence (rather than a choice that the consequences set out in section 124-385 apply). The consequences set out in section 124-385 are irrelevant in a consolidation context given that within a consolidated group intra-group membership interests are not recognised. Broadly, section 124-385 determines the number, if any, of the interposed companys shares in the original company that are pre-CGT assets and sets the interposed companys cost base for its newly acquired shares in the original company that are not pre-CGT assets. The consequences set out in section 124-385 are equivalent in substance to a choice that the consolidated group continue in existence.

2.37 As discussed, there are also consequences for shareholders of the original company if they are taken to have obtained the rollover under the rule in paragraph 2.32 and immediately before the time when their shares in the original company were disposed of, cancelled or redeemed some or all of those shares were their trading stock or revenue assets. [Schedule 2, item 7, subsection 124-390(1)]

Additional consequences for shareholders of the original company where those shares are shareholders trading stock

2.38 A shareholder of the original company is required to include an amount in its assessable income in respect of the disposal, redemption or cancellation of each of its shares (if any) in the original company that were its trading stock immediately before the time of the disposal, redemption or cancellation of those shares. The amount to be included in assessable income is equal to the amount set out in Table 2.1.

[Schedule 2, item 7, subsection 124-390(2)]

2.39 A shareholder of the original company whose shares in the original company were its trading stock immediately before the time of the disposal, redemption or cancellation (of those shares) will be taken to have paid an amount for each of its replacement shares in the interposed company equal to the amount worked out under the following formula:

total amounts included in assessable income of the shareholder of the original company for its shares in the original company (worked out using Table 2.1) / number of the replacement shares issued in the interposed company to the shareholder for those shares that were shareholder's trading stock


[Schedule 2, item 7, subsection 124-390(3)]

2.40 The amount worked out by applying the formula in paragraph 2.39 becomes the shareholders cost of each of its replacement shares in the interposed company.

Additional consequences for shareholders of the original company where those shares are shareholders revenue assets

2.41 Similarly, a shareholder of the original company is required to include an amount in its assessable income in respect of the disposal, redemption or cancellation of each of its shares (if any) in the original company that were its revenue assets immediately before the time of the disposal, redemption or cancellation of those shares. For each share, the amount to be included in assessable income is broadly equal to the cost of that share immediately before the completion time. [Schedule 2, item 7, subsection 124-390(4)]

2.42 A shareholder of the original company whose shares in the original company were its trading stock immediately before the time of the disposal, redemption or cancellation of those shares will be taken to have paid an amount for each of its replacement shares in the interposed company. The amount will be equal to the result obtained by applying the following formula:

[Schedule 2, item 7, subsection 124-390(5)]

Application and transitional provisions

2.43 These amendments will take effect on 1 July 2002, along with other aspects of the consolidation measures.

Consequential amendments

2.44 There are various consequential amendments to Subdivision 124-G of the ITAA 1997 in relation to the measure discussed in this chapter.

2.45 The consequential amendments will update references to certain provisions currently contained in Subdivision 124-G. They will also ensure that the existing requirements for rollover under that Subdivision on an exchange of shares in the original company for shares in the interposed company are retained where the following conditions do not apply:

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immediately before the completion time, the original company is the head company of a consolidated group; and

•

immediately after the completion time, the interposed company is the head company of a consolidatable group consisting of itself and the members of the group immediately before the completion time.

2.46 For example, one of the existing requirements for rollover under Subdivision 124-G is that the interposed company makes a choice, generally within 2 months after the completion time, that section 124-385 of the ITAA 1997 apply. Consequential amendments will ensure that this requirement remains in the circumstances set out in paragraph 2.45 (although this election is now irrevocable), along with the consequences set out in section 124-385 for the interposed company once the interposed company makes that election. [Schedule 2, item 4, subsections 124-380(6) and (7); item 5, and item 6, subsection 124-385(1A)]

2.47 Further, consequential amendments will update paragraph 103-25(3)(a) of the ITAA 1997 to continue to ensure that a choice made by the interposed company that section 124-385 apply is an exception to the general rule in subsections 103-25(1) and (2) of the ITAA 1997 regarding the timing of and method of making a choice under the CGT provisions in the ITAA 1997 (see paragraph 2.13). [Schedule 2, item 1, paragraph 103-25(3)(a)]

2.48 Shareholders of the original company will continue to be provided with a choice to obtain rollover under Subdivision 124-G where the pre-conditions for rollover are satisfied and the circumstances set out in paragraph 2.45 apply.

2.49 Aside from the above, consequential amendments are made to Division 703 (contained in the May Consolidation Act and the June Consolidation Bill). Amendments are made to subsection 703-60(3) to repeal the link note at the end of that section [Schedule 2, item 9, subsection 703-60(3)] . Further, consequential amendments are made to subsection 703-5(2) to add a note to explain that a consolidated group does not cease to exist in some cases where a shelf company is interposed between the head company and its former shareholders. [Schedule 2, item 8, subsection 703-5(2)]