House of Representatives

Explanatory Memorandum

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

Chapter 2 - Additional rules for MEC groups

Outline of chapter

2.1 This chapter explains amendments of a technical nature that will effectively treat MEC groups like consolidated groups. It also explains modifications that are required to the MEC cost setting rules so that they are aligned with certain other cost setting rules found within Part 3-90.

Context of reform

2.2 Subdivision 719-A contains the provisions that allow MEC groups to work out their income tax liabilities as though they are a single entity. Amendments in this bill link MEC groups with the consolidated group operational provisions.

2.3 Also, modifications have been made to the MEC cost setting rules found in Subdivision 719-C (contained in the September Consolidation Act) so that they are aligned with the cost setting rules found in Subdivision 705-C (where a consolidated group is acquired by another consolidated group). The provisions introduced in this bill build on the cost setting rules introduced in previous consolidation legislation.

2.4 Further, for clarification purposes, the interaction between Subdivisions 719-C and 705-D is explained when a MEC group acquires linked entities which comprise an eligible tier-1 company and its wholly-owned subsidiary(s).

Summary of new law

Operational rules for MEC groups

2.5 Subdivision 719-A provides that other than Division 703 (the membership rules for consolidated groups) and Division 719 (the MEC grouping rules) Part 3-90 has effect in relation to a MEC group in the same way in which it has effect in relation to a consolidated group. This rule is, however, subject to any modifications that are required where it is not practicable to use the operational rules for consolidated groups. This means that the rules relating to the tax treatment of consolidated groups will also apply, as far as practicable, to MEC groups. A similar rule applies to the transitional provisions found in the IT(TP) Act 1997.

Modifications to the cost setting rules for MEC groups

2.6 The modifications made to the cost setting rules in Subdivision 719-C ensure that:

•

where the acquiring group is a MEC group and the head company of the acquired group becomes an eligible tier-1 company of the acquiring group, the assets of the members of the acquired group do not have their tax cost reset at the acquisition time; and

•

where either:

-

the acquiring group is a MEC group but the head company of the acquired group does not become an eligible tier-1 company of the acquiring group; or

-

the acquired group is a MEC group and the acquiring group is a consolidated group;

the assets of the members of the acquired group have their tax cost reset at the acquisition time.

Detailed explanation of new law

Operational rules for MEC groups

2.7 Subdivision 719-A contains the provisions that allow MEC groups to work out their income tax liabilities as though they are a single entity. Without these provisions MEC groups cannot effectively operate so as to obtain the benefits of consolidation. This is because as it currently stands MEC groups have merely been defined in Division 719 of the ITAA 1997; there are no operational provisions.

2.8 Subdivision 719-A provides that other than Division 703 (the membership rules for consolidated groups) and Division 719 (the MEC grouping rules) Part 3-90 (consolidated groups) has effect in relation to a MEC group in the same way in which it has effect in relation to a consolidated group [Schedule 11, item 1, subsection 719-2(1)] . Further, where reference is made in Part 3-90 (other than Division 703 or 719) to a provision in Division 703 it applies as if it referred instead to that provision or the corresponding provision in Subdivision 719-B (as appropriate) [Schedule 11, item 1, subsection 719-2(3)] . For example, paragraph 709-80(1)(c) of the ITAA 1997 and the note accompanying paragraph 709-80(1)(e) makes reference to subsection 703-35(4). There is no mention of a MEC group equivalent. In brief, subsection 719-2(3) ensures that where such a reference is made it will be treated as if it referred to the corresponding provision in Subdivision 719-B (in this example it is section 719-30).

2.9 The abovementioned rule is, however, subject to any modifications that are required where it is not practicable to use the operational rules for consolidated groups [Schedule 11, item 1, subsection 719-2(2)] . This means that the rules relating to the tax treatment of consolidated groups will also apply, as far as practicable, to MEC groups.

2.10 A note to this effect is also found in the dictionary definitions of 'consolidated group' and 'MEC group'. [Schedule 11, items 2 and 3, subsection 995-1(1), note 1 to definitions 'consolidated group' and 'MEC group']

2.11 A similar rule applies to the transitional provisions found in the IT(TP) Act 1997. Subdivision 719-A of the IT(TP) Act 1997 provides that other than Division 703 (the membership rules for consolidated groups) and Division 719 (the MEC grouping rules) Part 3-90 (consolidated groups) has effect in relation to a MEC group in the same way in which it has effect in relation to a consolidated group. This rule is, however, subject to any modifications that are required where it is not practicable to use the operational rules for consolidated groups. [Schedule 11, item 4, section 719-2]

2.12 One modification that is required is to ensure that section 703-30 of the IT(TP) Act 1997 (debt interests that are not membership interests) has effect in relation to a MEC group in the same way in which it has effect in relation to a consolidated group. [Schedule 11, item 4, section 719-5]

Nomenclature of 'consolidated group' and 'MEC group'

2.13 While the terms 'consolidated group' and 'MEC group' are defined in section 995-1 of the ITAA 1997 it is important to note that the practical effect of Subdivision 719-A is that when the term 'consolidated group' is used:

•

within Part 3-90 it will, except for Divisions 703 and 719, include MEC groups; and

•

outside Part 3-90 it will not include MEC groups. Therefore for a provision to apply to a MEC group it must specifically mention them.

[Schedule 11, items 2 and 3, subsection 995-1(1), note 2 to definitions 'consolidated group' and 'MEC group']

Modifications to the cost setting rules for MEC groups

2.14 Modifications have been made to the MEC cost setting rules found in Subdivision 719-C (contained in the September Consolidation Act) so that they are aligned with the cost setting rules found in Subdivision 705-C (where a consolidated group is acquired by another consolidated group). Thus, eligible tier-1 companies are treated in a similar manner as head companies of a consolidated group.

2.15 These modifications ensure that:

•

where the acquiring group is a MEC group and the head company of the acquired group becomes an eligible tier-1 company of the acquiring group, the assets of the members of the acquired group do not have their tax cost reset at the acquisition time; and

•

where either:

-

the acquiring group is a MEC group but the head company of the acquired group does not become an eligible tier-1 company of the acquiring group; or

-

the acquired group is a MEC group and the acquiring group is a consolidated group;

the assets of the members of the acquired group have their tax cost reset at the acquisition time. [Schedule 12, item 4, section 719-170]

The acquiring group is a MEC group and the head company of the acquired group becomes an eligible tier-1 company of the acquiring group

2.16 Where the acquiring group is a MEC group and the head company of the acquired group becomes an eligible tier-1 company of the acquiring group, the assets of the members of the acquired group do not have their tax cost reset at the acquisition time. Where the acquired group is a consolidated group this outcome is obtained under the law as it currently stands. However, modifications are required to sections 705-175 and 705-185 of the September Consolidation Act where the acquired group is a MEC group.

2.17 With regards to MEC groups, modifications are required because as it currently stands the application provision of Subdivision 705-C (i.e. subsection 705-175(1)) cannot be satisfied where more than one eligible tier-1 company joins a MEC group. This is because the criterion requiring that the acquisition be 'as a result of the acquisition of membership interests in the head company of the acquired group' cannot be satisfied. Without satisfying the criteria in subsection 705-175(1) the operative provisions of Subdivision 705-C cannot be utilised. This issue has been resolved by ensuring that where the entities of the acquired group, other than the head company, have been acquired they are treated as if they are the membership interests in the head company of the acquired group. [Schedule 12, item 4, subsection 719-170(2)]

2.18 A similarly worded modification is needed for subsection 705-185(1) to ensure that the subsidiary members (which includes non-head company eligible tier-1 companies) of the acquired group are treated as part of the head company of the acquired group. As a consequence of this, where all members of a MEC group, for example, are acquired at the same time by another MEC group and the head company of the acquired group becomes an eligible tier-1 company of the acquiring MEC group, the tax cost of the assets of the acquiring group will not be reset. [Schedule 12, item 4, subsection 719-170(2)]

Example 2.1: Top company of mec group 1 acquires all the members of MEC group 2

If Top Company 1 of MEC group 1 acquires all the eligible tier-1 companies of MEC group 2 at the same time, the head company of MEC group 1 can decide that, inter alia , the members of MEC group 2 can join MEC group 1. If this occurs, the members of MEC group 2 will not have their tax cost of their assets reset when they become members of MEC group 1.

This outcome is achieved by first, applying section 719-160 (the MEC group general modifying rule) so that an entity becoming an eligible tier-1 company of MEC group 1 (i.e. Company C) will be treated as if it were a part of the head company of MEC group 1 (i.e. Company A). And second, by applying section 705-185 so that the subsidiary members of MEC group 2 (including any non head company eligible tier-1 companies - see section 719-25 of the ITAA 1997) are treated as if they were part of the head company of MEC group 2.

When the members of MEC group 2 join MEC group 1 the rules for setting the head company's cost of membership interests in subsidiary entities when they leave MEC group 2 (i.e. Division 711 of the ITAA 1997) will not be triggered. This is pursuant to subsection 705-180(1) of the September Consolidation Act. Further, the tax cost of the acquired group's assets will not be reset due to the application of section 719-160 which, in brief, ensures that where a MEC joining entity is an eligible tier-1 company, the assets of the entity do not have their tax cost reset at the MEC joining time.

The acquiring groups is a MEC group but the head company of the acquired group does not become an eligible tier-1 company of the acquiring group

2.19 Where the acquiring group is a MEC group and the head company of the acquired group does not become an eligible tier-1 company of the acquiring group the assets of the members of the acquired group have their tax cost reset at the acquisition time. This is achieved by applying sections 705-175 and 705-185 for the purposes of the MEC cost setting rules, discussed in paragraphs 2.17 and 2.18.

Example 2.2: A subsidiary member of a MEC group acquires the members of another MEC group

Where a subsidiary member of MEC group 1 acquires all the members of MEC group 2, the members of MEC group 2 will become non-eligible tier-1 company subsidiary members of MEC group 1 (i.e. there will not be any members becoming eligible tier-1 companies of MEC group 1). Where this occurs, the members of MEC group 1 will have the tax cost of their assets reset at the acquisition time.

Because the criteria in subsection 705-175(1) have been satisfied section 705-185 can be utilised so that the subsidiary members of MEC group 2 are treated as if they were part of the head company (of MEC group 2). Thus Subdivision 705-A can apply (subject to any modifications contained in Subdivision 705-C) to reset the tax cost of the assets of the acquired entity (i.e. the head company of MEC group 2, which is becoming a subsidiary member of MEC group 1).

The MEC group general modifying rule in section 719-160 does not have any relevant operation here because the MEC joining entity is not an eligible tier-1 company.

The acquired group is a MEC group and the acquiring group is a consolidated group

2.20 Where the acquired group is a MEC group and the acquiring group is a consolidated group the assets of the members of the acquired group have their tax cost reset at the acqiuisition time. This is achieved by applying modified sections 705-175 and 705-185 for the purposes of the MEC cost setting rules, discussed in paragraphs 2.17 and 2.18.

Example 2.3 A subsidiary member of a consolidated group acquires all eligible tier-1 companies of a MEC group

Where a subsidiary member of a consolidated group acquires all the eligible tier-1 companies of a MEC group (i.e. companies A, B and C) the members of the acquired group will become subsidiary members of the consolidated group.

The MEC group general modifying rule does not apply because this rule does not apply when an entity leaves a MEC group. The general modifying rule only applies where an entity becomes a subsidiary member of a MEC group (see section 719-155 of the September Consolidation Act).

Because the criteria in subsection 705-175(1) have been satisfied section 705-185 can be utilised so that the subsidiary members of the MEC group are treated as if they were part of the head company (of the MEC group). Thus Subdivision 705-A can apply (subject to any modifications in Subdivision 705-C) to reset the tax cost of the assets of the acquired entity.

Other amendments made to Subdivision 719-C

2.21 Necessary consequential amendments have also been made to sections 719-155, 719-160 and 719-165, but these are purely structural in nature so as to provide a better framework to the Subdivision. [Schedule 12, items 1, 2 and 3, subsection 719-155(1), section 719-155, subsection 719-160(1) and section 719-165]

Subdivision 705-D - application to MEC groups

2.22 For clarification purposes only, Subdivision 705-D will apply (as modified by section 719-160) where the linked entities comprise an eligible tier-1 company and its wholly-owned subsidiary(s) join a MEC group. In such a situation the eligible tier-1 company's tax cost of its assets will not be reset at the joining time. This is pursuant to the MEC group general modifying rule. However, the linked subsidiary members will have the tax cost of their assets reset at the joining time pursuant to Subdivision 705-A (subject to any modifications in Subdivision 705-D).