House of Representatives

Explanatory Memorandum

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

Chapter 2 Consolidation

Outline of chapter

2.1 Schedule 2 to this Bill amends the consolidation provisions in the Income Tax (Transitional Provisions) Act 1997 to ensure that the integrity provision that requires certain roll-overs to be ignored for tax cost setting purposes does not apply to a consolidated group or multiple entry consolidated group (MEC group) that forms after a demerger, provided certain conditions are satisfied. These amendments also clarify the operation of the integrity provision.

Context of amendments

2.2 When a group consolidates, the tax cost of a joining entity's assets are generally reset under Division 705 of the Income Tax Assessment Act 1997 (ITAA 1997). However, as a transitional measure, the head company of the consolidated group could choose to retain the existing tax cost of assets held by some or all of the joining entities, provided certain requirements were satisfied (section 701-15 of the Income Tax (Transitional Provisions) Act 1997 ).

2.3 As the head company could apply the transitional measure on an entity by entity basis, opportunities arose for the tax cost of a joining entity's assets to be artificially increased by moving them between entities within the group prior to the group consolidating and claiming roll-over relief under Subdivision 126-B (capital gains tax (CGT) roll-over relief) or section 40-340 (balancing adjustment roll-over relief) of the ITAA 1997.

2.4 To prevent a head company from artificially increasing the tax cost of assets, section 701-35 of the Income Tax (Transitional Provisions) Act 1997 requires a head company to ignore the effect of a roll-over under Subdivision 126-B or section 40-340 of the ITAA 1997 undertaken after 16 May 2002 and before the date the transitional group came into existence (which was generally 1 July 2004). Where section 701-35 applies, a head company is required to set the tax cost of a joining entity's assets as if the CGT event had not occurred.

2.5 The demerger provisions (Division 125 of the ITAA 1997) facilitate the demerging of entities by ensuring that tax considerations are not an impediment to restructuring a business. Prior to a demerger group undertaking a demerger, assets may be transferred between members of the group. Where this occurs, the affected entities may claim roll-over relief under Subdivision 126-B or section 40-340 of the ITAA 1997.

2.6 If this restructuring occurred after 16 May 2002 and a former member of the demerger group with a rolled-over asset subsequently became a member of a consolidation transitional group, the integrity rule in section 701-35 of the Income Tax (Transitional Provisions) Act 1997 may apply to take away the benefits of the roll-over for consolidation tax cost setting purposes. It is inappropriate for the integrity rule to apply in these circumstances because the assets are transferred to facilitate the demerger rather than to artificially increase the tax cost of assets for consolidation purposes.

Summary of new law

2.7 The integrity provision that requires certain roll-overs to be ignored for consolidation tax cost setting purposes will not apply to a consolidated group or MEC group that forms after a demerger, provided that the company that received the rolled-over asset does not join the same consolidated group or MEC group as the company that transferred the asset.

2.8 These amendments also clarify the operation of the integrity provision.

Comparison of key features of new law and current law

Detailed explanation of new law

2.9 In broad terms, section 701-35 of the Income Tax (Transitional Provisions) Act 1997 will not apply where roll-over relief is claimed in respect of a restructure that happens to facilitate a demerger. That is, section 701-35 will not apply where:

•

the act, transaction or event that gave rise to the CGT event for which there was a roll-over under Subdivision 126-B or section 40-340 of the ITAA 1997 happened before the demerger and in connection with the demerger;

•

either the originating company or the recipient company ceased to be a member of the 'demerger group' (as defined in section 125-65 of the ITAA 1997) because of the demerger; and

•

the recipient company and the originating company do not both join the same consolidation transitional group.

[Schedule 2, item 6, subsection 701-35(2A) of the Income Tax (Transitional Provisions) Act 1997]

2.10 Section 701-35 is intended to test whether the cost base or reduced cost base of an asset is different as a consequence of an act, transaction or event that gave rise to a CGT event that occurred prior to consolidation. In these circumstances, the effect of the act, transaction or event in relation to the CGT event is unwound for consolidation tax cost setting purposes.

2.11 These amendments modify the wording of section 701-35 to ensure that it operates as intended. [Schedule 2, items 1 to 5 and 7, subsections 701-35(1) and (3) of the Income Tax (Transitional Provisions) Act 1997]

Application and transitional provisions

2.12 These amendments will apply from 1 July 2002, the commencement date of the consolidation regime. The amendments remove an unintended consequence and will be advantageous to taxpayers. [Schedule 2, item 8]