Senate

Revised Explanatory Memorandum

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

Chapter 4 - Technical amendments to consolidation

Outline of chapter

4.1 This chapter explains various additional rules of a minor or technical nature which are included in this bill. These amendments consist of modifications to various consolidation rules in the ITAA 1997 and related income tax legislation dealing with membership rules, utilisation of losses, cost setting, imputation and the removal of grouping provisions. The amendments explained in this chapter are contained in Schedules 1, 8 and 11 to this bill.

Context of reform

4.2 In response to submissions received during consultation, changes have been made to the consolidation membership rules to remove the exclusion relating to the membership of certain co-operatives. One of the underlying reasons why certain entities are excluded from the membership of a consolidatable or consolidated group is to ensure that the integrity of the regime is protected. These changes do not compromise this objective.

4.3 Amendments are also required to the transitional rules for losses to rectify a deficiency identified during consultations.

4.4 This bill also introduces amendments to various imputation provisions in the consolidation rules which are necessary to correct cross references to provisions in the proposed imputation rules to Part 3.6 of the ITAA 1997.

4.5 The amendments in this bill clarify how the final year, in which the loss transfer rules of Division 170 of the ITAA 1997 apply, is to be treated when a subsidiary becomes a member of a consolidated group. Submissions received following introduction of the Consolidation Bill on 16 May 2002indicate that the measure contained therein requires further clarification.

Summary of new law

4.6 The following is a summary of technical and other minor amendments contained in this bill:

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co-operative companies are no longer specifically excluded from being members of a consolidatable or consolidated group;

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amendments to the transitional rules for losses will maintain the intent of the 'value and loss donor' concession by allowing losses to be 'donated' by a company even where that company has a nil modified market value;

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amendments to various imputation provisions in the consolidation rules will correct cross references to provisions in the proposed imputation rules to Part 3.6 of the ITAA 1997; and

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technical amendments will clarify the application of the loss transfer rules in relation to the final year of a subsidiary before it joins a consolidated group.

Detailed explanation of new law

Membership rules

4.7 Subsection 703-20(2), item 4 in the table of the Consolidation Bill introduced on 16 May 2002 excluded from membership of a consolidatable or consolidated group a company if, assuming it applied at the time an amount of its assessable income as described in paragraph 120(1)(c) of the ITAA 1936, the company could deduct an amount because of that paragraph. In response to submissions received on this matter, this exclusion has now been removed. Removing this restriction will ensure that such companies are not disadvantaged by the repeal of the grouping provisions that are being replaced by the consolidation measure (without compromising the objects of single entity treatment). However, due to the operation of the single entity principle, access to the paragraph 120(1)(c) deduction as well as access to deductions for distributions made to shareholders may be lost if such a company becomes a member of a consolidated group. [Schedule 1, item 1, subsection 703-20(2), item 4 in the table]

Amendments to the transitional rules for losses

4.8 The 'available fraction' method set out in Subdivision 707-C of the ITAA 1997 sets a limit on the utilisation of losses transferred to a consolidated group by reference to the contribution to group income expected to be made by the entity that made the losses. The available fraction is basically the proportion the loss entity's market value bears to the value of the group at the time the entity joins the group.

4.9 The 'value and loss donor' concession in Subdivision 707-C of the IT(TP) Act 1997 recognises that, under the existing loss transfer rules in Division 170 of the ITAA 1997, a company can use its losses to shelter not just its own income but also the income of certain other company members of the same wholly-owned group. This concession therefore seeks to provide, on transition into consolidation, the same rate of utilisation of losses that would be achievable under the existing loss transfer rules. The concession is only available on a transitional basis because the loss transfer rules will be repealed as a result of the introduction of the consolidation regime.

4.10 The value and loss donor concession operates to allow value and losses to effectively be combined (i.e. by being 'donated') to achieve a higher available fraction (and therefore a faster rate of loss utilisation). However, the rules currently only allow a company (the first company) to donate losses to another company where the first company has also donated value to the other company. This means that a company that has a nil 'modified market value' (i.e. broadly market value determined on the basis of certain assumptions) is unable to donate its losses to another company. This outcome is inconsistent with the current loss transfer rules, which allow losses to be transferred by a company even if that company has no income of its own.

4.11 Amendments to the IT(TP) Act 1997 will ensure that the intent of the transitional concession is maintained by allowing losses to be donated by a company even where it has a nil modified market value. To achieve this, the amendments will provide for the conditions for donating a loss to be met where there is an effective donation of nil value. [Schedule 8, items 1 to 10]

Imputation - updating of simplified imputation references

4.12 The Consolidation Bill introduced on 16 May 2002 contained franking rules relating to the operation of franking accounts of head companies and subsidiary members of consolidated groups. The operation of those rules is based on the rules introduced in the Imputation Bill. The Consolidation Bill also refers to provisions in the Imputation Bill. As a result of the re-numbering of the provisions in the Imputation Bill, it is necessary to correct certain section references made to it by the Consolidation Bill. These corrections are as follows:

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paragraph 709-60(3)(c) of the Consolidation Bill refers to item 6 in the table in section 160-115. Owing to the renumbering of the imputation provisions, the cross-reference is to be changed to item 5 of the table in section 205-15;

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subsection 709-70(2) of the Consolidation Bill refers to section 160-115. The cross-reference is to be changed to section 205-15; and

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subsection 709-75(2) of the Consolidation Bill refers to section 160-130. The cross-reference is to be changed to section 205-30.

Removal of loss transfer provisions

4.13 Part 3 of Schedule 3 to the ConsolidationBill introduced on 16 May 2002 contains application provisions for the removal of the current loss transfer rules contained in Division 170 of the ITAA 1997. In general, the existing rules are to be phased out commensurate with the introduction of the consolidation regime. Specific rules have been devised to set the maximum limits for transfer of a loss in the final year before Division 170 (in its form prior to the enactment of the Consolidation Bill ceases to apply to wholly-owned company groups.

4.14 The maximum limits for this final year are determined by applying the existing rules in Division 170. Those limits are then further apportioned under Part 3 of Schedule 3, depending on the date of consolidation or whether a choice to consolidate is made at all.

4.15 In some cases, a subsidiary will join a consolidated group part way through its regular income year or accounting period. This will result in a truncated income year at the time of consolidation. Given that in such cases, the 'final year' before current Division 170 ceases to apply will be shortened to less than a normal period of 365 days, this shortening will be taken into account for the purposes of working out the maximum limit under Part 3.

4.16 Accordingly, for the purposes of the fractional figure obtained under subitems 39(4) and 39(6) of Part 3, the denominator will in appropriate cases equal the number of days in the subsidiary company's income year that have actually elapsed at the time it joins a consolidated group. This is the intended result in certain cases, in recognition of the fact that, for example, certain subsidiaries may not have the same accounting period for income tax purposes as their head company, or may be constrained by the consolidation date of that head company. [Schedule 11, item 1, subitem 39(9)]

4.17 Therefore, if the final income year (for the purposes of use of loss transfer rules) is truncated when the subsidiary company first becomes a member of a consolidated group, that final year is treated as consisting of only the period up to consolidation time. [Schedule 11, item 1, subitem 39(9)]

4.18 This was the intended outcome of the application of the original provisions contained in the Consolidation Bill introduced on 16 May 2002. It was suggested after introduction of that Consolidation Bill, however, that this intention was not manifest. The provision in question has therefore been amended to clarify and affirm the original intention.

Example 4.1

Subsidiary A is a December balancer. Its head company chooses to consolidate on 1 July 2002. At that time, only 6 months of A's normal income year has elapsed. The denominator for the purposes of working out A's 'final year' figure in item 39 should in this case equal 181 days. Under item 38, the 'apportioning day' is 1 July 2002. Therefore, the fractional figure obtained by application of item 39 will equal 1 and will therefore not reduce the figure obtained by working out the limits as usual under Division 170.

Application and transitional provisions

4.19 These amendments will take effect immediately after the commencement of the Consolidation Bill introduced on 16 May 2002.