House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 12 Consolidation interactions

Outline of chapter

12.1 This chapter explains:

•

amendments to the income tax consolidation regime to ensure appropriate interactions with Division 230; and

•

how the existing law in relation to consolidation will apply to entities that are taken to hold or cease to hold a financial arrangement.

Context of amendments

12.2 Under the consolidation regime a group of eligible wholly-owned entities is treated as a single entity for income tax purposes. When an entity becomes a subsidiary member of a consolidated group or multiple entry consolidated group (MEC group), the membership interests held by the group in the joining entity are ignored and the entity's assets are treated for tax purposes as the assets of the head company. The tax costs of those assets are reset at an amount that reflects the group's cost of acquiring the joining entity.

12.3 This chapter outlines the operation of the consolidation regime if an entity that holds Division 230 financial arrangements joins or leaves a consolidated group or MEC group. To a large extent, the existing consolidation provisions will operate appropriately in these circumstances. However, modifications are required to:

•

enhance the interaction between the consolidation regime and Division 230; and

•

reduce compliance costs.

12.4 In this chapter, references to assets or liabilities being financial arrangements include assets or liabilities that form part of financial arrangements.

Summary of new law

12.5 There are four basic propositions outlined in this chapter.

12.6 First, where an entity joins a consolidated group or MEC group, the joining entity will apply Division 230 as if the joining time was the end of an income year.

12.7 Second, the head company will apply the consolidation rules and Division 230 (depending on whether it is required or has elected to apply Division 230) as if the head company had directly acquired assets or assumed liabilities that are, or form part of, financial arrangements from the joining entity. Certain amendments are made to this proposition to reduce compliance costs specifically related to Division 230 interactions.

12.8 Third, where an entity leaves a consolidated group or MEC group, the head company will apply Division 230 as if the leaving time was the end of an income year.

12.9 Finally, a leaving entity which applies Division 230 in relation to its financial arrangement gains and losses will apply the Division as if the leaving entity took the financial arrangements with it at the leaving time.

Comparison of key features of new law and current law

Detailed explanation of new law

12.10 This chapter outlines how the amendments and existing consolidation provisions will apply:

•

if a joining entity holds financial arrangements and Division 230 applies to work out gains or losses on those financial arrangements, in relation to:

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the joining entity; and

-

the head company at the joining time; or

•

if a leaving entity takes financial arrangements with it and Division 230 applies to work out gains or losses on those financial arrangements, in relation to:

-

the leaving entity; and

-

the head company at the leaving time.

12.11 This chapter will also outline other consolidation and Division 230 interaction amendments relating to:

•

the eligibility of MEC groups to make Division 230 elections; and

•

the Division 230 transitional measures.

Treatment of joining entities

12.12 Subsection 701-30(3) of the Income Tax Assessment Act 1997 (ITAA 1997) requires a joining entity to work out its taxable income for the period prior to the joining time as if the joining time were the end of an income year.

12.13 Therefore, a joining entity will apply Division 230 (depending on whether it is required or has elected to apply Division 230) as it ordinarily would on the basis that the joining time is the end of its income year.

12.14 There is no Subdivision 230-G balancing adjustment at the end of this income year as a consequence of the joining event because the joining entity is not taken by the consolidation rules to have transferred the financial arrangement or otherwise ceased to have it.

Example 12.1

Joining Co holds a financial arrangement whose gains or losses are worked out using the compounding accruals method. The effect of the compounding accruals method is that $333 must be included in the entity's assessable income in 2010-11, 2011-12, and 2012-13. The intervals to which this gain is being allocated exactly equate to Joining Co's income year, which starts on 1 July and ends on 30 June.

On 1 January 2011, Joining Co joins a consolidated group.

Therefore, Joining Co has an end of income year of 31 December 2010. Joining Co will be taken to have made a gain equal to so much of that part of the gain as is allocated to the income year 1 July 2010 to 31 December 2010 on a reasonable basis.

For example, a reasonable basis for calculating the part of the gain to be allocated to the 1 July 2010 to 31 December 2010 period may be to simply divide $333 by two. However, whether this is a reasonable basis to allocate the gain entirely depends on the facts and circumstances of the financial arrangement.

Example 12.2

Joining Co holds a financial arrangement whose gains or losses are worked out using the fair value method.

On 1 July 2010, the fair value of the financial arrangement according to Joining Co's financial reports is $100.

On 1 January 2011, Joining Co joins a consolidated group. The market value of the financial arrangement at this time is $120.

Joining Co will apply the fair value method on the basis that 31 December 2010 is the end of its income year.

Joining Co makes a gain from this financial arrangement for the income year 1 July 2010 to 31 December 2010 of $20.

Subdivision 716-A of the ITAA 1997 does not apply even where a Division 230 spreading method is being used

12.15 Subdivision 716-A applies if an entity is a subsidiary member of a consolidated group for part of an income year and a provision of the income tax law spreads an amount of assessable income, or the amount of a deduction, over two or more income years by including part of the original amount in the same entity's assessable income, or by allowing the same entity to deduct part of the amount, for each of those income years.

12.16 Under Division 230, gains and losses from a financial arrangement are recognised over its life. If a Division 230 spreading method applies to the financial arrangement, the gain or loss that is recognised in each income year is determined at the end of that income year. If an entity joins a consolidated group part way through an income year, the entity applies the Division 230 spreading method to determine its taxable income at the joining time. Similarly, if an entity leaves a consolidated group part way through an income year, the head company applies the Division 230 spreading method to the financial arrangement up to the leaving time to determine its taxable income for that income year. The Division 230 spreading methods do not spread a pre-determined amount of assessable income, or the pre-determined amount of a deduction, between income years. Therefore, if an entity that holds a financial arrangement is a subsidiary member of a consolidated group for part of an income year, Subdivision 716-A does not apply to allocate the gain or loss on that financial arrangement in that income year between the head company and the subsidiary member.

Treatment of head companies at the joining time

12.17 A head company which commences to hold an asset or liability that is a financial arrangement will apply Division 230 as if the head company directly acquired the asset or liability. There are two implications of this:

•

the tax cost of any asset that is a financial arrangement that the head company is taken to have acquired is equal to the asset's tax cost setting amount; and

•

any election the head company has made in relation to its existing financial arrangements will apply to the financial arrangements it has taken to have acquired as a result of the joining entity becoming a member of the consolidated group.

[ Schedule 1, items 85 and 89, subsections 701-55(5A) and 715-375(2 )]

Setting the tax costs of assets

12.18 If a joining entity holds assets that are a financial arrangement, Division 705 of the ITAA 1997 will apply to set the tax costs of those assets at their tax cost setting amounts.

12.19 Where the asset is a reset cost base asset, section 705-40 of the ITAA 1997 may apply such that the asset's tax cost setting amount must not exceed the greater of the asset's market value, or the joining entity's terminating value for the asset. The section will apply where the asset that is a financial arrangement is a revenue asset (as defined in section 977-50 of the ITAA 1997).

12.20 Section 701-55 of the ITAA 1997 sets out how the tax cost setting amount is used as the basis for applying other provisions in the income tax law. For the purpose of applying Division 230, the use of the tax cost setting amount for assets that are financial arrangements varies depending on the method the head company is applying to work out its gains or losses under Division 230.

Where the head company is using the accrual/realisation method

12.21 In relation to assets that are financial arrangements on which gains or losses are being worked out using the compounding accruals or realisation method, the effect of the asset's tax cost being set is that Division 230 will apply as if the financial benefits provided to acquire the asset were equal to the asset's tax cost setting amount. [ Schedule 1, item 85, paragraph 701-55(5A)(a )]

12.22 Consequently, the financial benefits the head company is taken to have provided for the purposes of step 2(a) in the method statement in the table at subsection 230-445(1) includes the asset's tax cost setting amount (rather than its original cost). The asset's tax cost setting amount will also be relevant in determining whether an entity has a sufficiently certain gain or loss from the financial arrangement.

12.23 However, the tax cost resetting process will not necessarily cause a re-estimation to arise. A re-estimation arises in circumstances that materially affect the amount or value of financial benefits that were taken into account in working out the amount of a gain or loss. The reason no re-estimation arises is because the head company is required to apply Division 230 as though it had acquired the asset at the joining time for its tax cost setting amount. In other words, the gain or loss the head company makes from an asset that is a financial arrangement is worked out on the basis of the head company's tax cost setting amount for the asset.

Example 12.3

Joining Co has an asset that is a financial arrangement whose gains are worked out using the realisation method. The market value of the financial arrangement is $100. This is the only asset or liability held by Joining Co.

Head Co acquires Joining Co for $80. The asset is a reset cost base asset.

Head Co subsequently sells the financial arrangement for its market value of $100. As a result, Head Co has a balancing adjustment under step 2(a) in the method statement in the table at subsection 230-445(1).

The financial benefits received by Head Co in relation to the disposal of the financial arrangement are $100, and the benefits taken to have been provided are $80 (as a result of the tax cost setting process).

As a result, Head Co is taken to have made a gain from the financial arrangement for the purposes of Division 230 equal to $20.

Example 12.4

Joining Co has a zero-coupon bond with the right to receive a financial benefit equal to $200 on 1 July 2021. Joining Co provided a financial benefit equal to $100 in relation to the acquisition of the bond on 1 July 2011.

Head Co acquires Joining Co on 1 July 2016 for $150 (representing the market value of the right to receive $200 in five years time). Head Co's allocable cost amount for Joining Co is therefore $150.

Given that the amount to be received on 1 July 2021 represents a right to receive a specified amount of Australian currency, the asset is a retained cost base asset and a qualifying security. Therefore, the tax cost setting amount of the asset is $150. As the tax cost setting amount exactly equals the allocable cost amount for Joining Co, CGT event L3 will not occur.

However, Head Co will take the tax cost setting amount of $150 into account when working out whether it has a sufficiently certain overall gain or loss under the accruals method. Given that the tax cost setting amount is $50 less than the amount of $200 due to be received on 1 July 2021, Head Co will make a $50 Division 230 gain from the arrangement. This gain will be spread in accordance with the rules in Division 230.

Where the head company has elected to use the hedging method

12.24 In relation to assets that are financial arrangements on which gains or losses are being worked out using the hedging method, the effect of the asset's tax cost being set is that Division 230 will apply as if the financial benefits provided to acquire the asset are equal to the asset's tax cost setting amount. [ Schedule 1, item 96, paragraph 701-55(5A)(a )]

12.25 However, this will not affect whether the hedge effectiveness test in section 230-365 is satisfied, even though the hedge effectiveness test is in part based on the value of the underlying asset. The tax cost resetting process only applies to reset the tax cost of the asset, and not its accounting value. Given that the hedge effectiveness test relies on the accounting standards to determine whether it is satisfied, the fact that the tax value of the hedged item is reset is not relevant.

Example 12.5

Joining Co has $1,000 worth of Australian currency and a hedging financial arrangement with a fair value of $50 and a hedged item worth $100. The hedging financial arrangement was initially entered into for a fair value of $0. In accordance with the hedging documentation, the fair value of the hedging financial arrangement represents a gain and will be included in the entity's assessable income when the hedged item is disposed of.

Head Co acquires the membership interests in Joining Co for $1,150 (being the $1,000 cash, the fair value $50 hedging financial arrangement, and the hedged item worth $100). Head Co's allocable cost amount for the joining entity is therefore $1,150.

The Australian currency is given a tax cost setting amount of $1,000. Similarly, the hedging financial arrangement has a tax cost setting amount of $50 and the hedged item has a tax cost setting amount of $100.

Head Co applies Division 230 on the basis that it acquired the financial arrangement for $50. If the Head Co chooses to apply hedging financial arrangement election in relation to the arrangement and it is eligible to do so, the method applies on the basis that the Head Co acquired the hedging financial arrangement for $50 and the hedged item for $100.

If the Head Co were to immediately dispose of the hedging financial arrangement after the joining time for its fair value of $50, it would make a $0 gain from the hedging financial arrangement.

Where the head company has elected to use the fair value, retranslation or financial reports method

12.26 If the gains or losses in relation to an asset that is a financial arrangement are calculated using the fair value, retranslation or financial reports method, the asset's tax cost setting amount is the asset's Division 230 starting value at the time of joining. [ Schedule 1, item 85, paragraph 701-55(5A)(b )]

12.27 Consequently, the financial benefits the head company has taken to have provided includes the asset's Division 230 starting value (rather than its original cost) for the purposes of step 2(a) in the method statement in the table at subsection 230-445(1).

12.28 Gains or losses under the fair value, retranslation or reliance on financial reports methods will be worked out applying the principles set out in those methods.

What is the Division 230 starting value?

12.29 The Division 230 starting value of an asset that is a financial arrangement depends on which elective method is chosen in relation to the arrangement.

12.30 If the fair value method applies in relation to the arrangement, the Division 230 starting value is the value of that asset according to the relevant standards mentioned in section 230-230 that apply in relation to the arrangement. [ Schedule 1, item 96, paragraph (a) of the definition of ' Division 230 starting value' in subsection 995-1(1) of the ITAA 1997 ]

12.31 If the foreign exchange retranslation method applies in relation to the arrangement, the Division 230 starting value is the value of the asset according to the relevant standards mentioned in section 230-280 that apply in relation to the arrangement. [ Schedule 1, item 96, paragraph (b) of the definition of ' Division 230 starting value' in subsection 995-1(1) of the ITAA 1997 ]

12.32 If the reliance on financial reports method is chosen in relation to the arrangement, the Division 230 starting value is the value of the asset according to the relevant standards mentioned in section 230-420 that apply in relation to the arrangement. [ Schedule 1, item 96, paragraph (c) of the definition of ' Division 230 starting value' in subsection 995-1(1) of the ITAA 1997 ]

Example 12.6

Joining Co holds an asset that is a financial arrangement and joins Head Co's consolidated group. Head Co has chosen to apply the fair value method in relation to its financial arrangements.

The value of the asset according to the relevant standards mentioned in section 230-230 is $100. However, Head Co's tax cost setting amount for the asset is $80.

For the purposes of applying Division 230, the value of the financial benefits Head Co provided to acquire the financial benefit will be $100. In applying step 2(a) of the Division 230 balancing adjustment provisions, the financial benefits provided in relation to the acquisition of the financial arrangement is $100.

Under the fair value method, the value of the financial arrangement is also equal to $100.

What happens when there is a difference between an asset's tax cost setting amount and the Division 230 starting value

12.33 The sum of the tax cost setting amounts of the assets of a joining entity that are financial arrangements may differ from the sum of the Division 230 starting values for those assets.

12.34 If the sum of the Division 230 starting values exceeds the sum of the tax cost setting amounts, an amount equal to 25 per cent of that excess is included in the head company's assessable income for the income year in which the single entity rule commenced to apply, and each of the subsequent three income years. [ Schedule 1, item 87, subsections 701-61(1) to (3 )]

12.35 If the sum of the Division 230 starting values is less than the sum of the tax cost setting amounts, an amount equal to 25 per cent of that shortfall is allowed to the head company as a deduction for the income year in which the single entity rule commenced to apply, and each of the subsequent three income years. [ Schedule 1, item 87, subsections 701-61(1), 2) and (4 )]

12.36 The rationale for including these amounts in assessable income, or allowing a deduction for them, is that the head company has effectively obtained an increase or decrease in the value of the financial benefits it provided to acquire the financial arrangement. If a Subdivision 230-G balancing adjustment subsequently occurs in relation to the financial arrangement, the step 2(a) amount in the method statement at section 230-445 would be higher or lower, resulting in the head company having a higher or lower balancing adjustment that is included in assessable income or allowed as a deduction under step 3 in that method statement. Therefore, this difference is appropriately included in assessable income, or allowed as a deduction, under section 701-61.

Example 12.7

Following on from the facts in Example 12.6, the Division 230 starting value of $100 of the asset exceeds its tax cost setting amount of $80 by $20.

Therefore, Head Co will include $5 in its assessable income in the year in which it was taken to have acquired the financial arrangement from the Joining Co, and in each of the three subsequent income years.

Elections made by the head company apply to financial arrangements a head company is taken to have acquired

12.37 If a joining entity holds financial arrangements, Division 230 will apply as if the head company had directly acquired those financial arrangements.

What happens if the joining entity had made a Division 230 election?

12.38 If a joining entity had made a Division 230 election in relation to its financial arrangements prior to the joining time, that election will not bind the head company. In other words, the entry history rule does not operate to require the head company to use the elections the joining entity made in relation to its financial arrangements. [ Schedule 1, items 90 and 91, item 3A in the table in subsection 715-660(1) and item 1A in the table in subsection 715-665(1 )]

What happens if the head company made a Division 230 election prior to the joining time?

12.39 If a head company had made a Division 230 election prior to the joining time, the head company applies Division 230 on the basis that the financial arrangements that it acquired from the joining entity were directly acquired from the joining entity. Therefore, the head company must apply any Division 230 election it had made to the financial arrangements acquired from the joining entity (assuming the gains or losses on those financial arrangements are still eligible to be worked out under those elective methods).

12.40 Further, the head company will continue to apply any Division 230 election it had made in relation to the financial arrangements it had prior to the joining time. The head company is not entitled to make a fresh election in relation to those financial arrangements because it has acquired additional financial arrangements from the joining entity.

What happens if the head company had not made a Division 230 election prior to joining time?

12.41 If no election has been made by the head company prior to joining time, the accruals/realisation method will apply to all of the head company's financial arrangements. This includes both the arrangements the head company had prior to the joining time, as well as the arrangements it acquired from the joining entity.

12.42 The head company will also be eligible to make a Division 230 election in relation to all of its financial arrangements after the joining time, unencumbered by any elections that may or may not have been made by the joining entity. [ Schedule 1, items 90 and 91, item 3A in the table in subsection 715-660(1) and item 1A in the table in subsection 715-665(1 )]

Example 12.8

Joining Co has 10 financial arrangements, and is applying the accruals/realisation method in relation to them.

Joining Co becomes a member of Head Co's consolidated group. Head Co has previously elected to apply the fair value method to its financial arrangements.

Head Co must apply the fair value method to Joining Co's financial arrangements (assuming it continues to be eligible to use the fair value method, and the fair value method applies in relation to the financial arrangements).

Financial arrangements consisting of liabilities

12.43 For liabilities that are or form part of financial arrangements that are to be subject to the accruals/realisation or hedging financial arrangement method, the entry history rule will apply to determine the value of any liabilities a head company assumes from a joining entity. Generally this will be the original value of the liability, taking into account such things as repayments of principal that may have been made in relation to the liability prior to the joining time.

12.44 For liabilities that are or form part of financial arrangements that are to be subject to the fair value, foreign exchange retranslation, or reliance on financial reports method, the head company will apply Division 230 as if the liability were assumed at the time of joining for an amount equal to the liability's Division 230 starting value (see above for a discussion on Division 230 starting value in the context of assets). [ Schedule 1, item 89, subsections 715-375(3) and (4 )]

Financial arrangements consisting of both an asset and a liability

12.45 Some financial arrangements may consist of both assets and liabilities. In this circumstance, the consolidation provisions may apply separately to these assets and liabilities, depending on the facts and circumstances of the particular financial arrangement (section 705-58 of the ITAA 1997). However, if a financial arrangement contains assets and liabilities that are linked, section 705-59 of the ITAA 1997 may apply to the financial arrangement.

Treatment of head companies at the leaving time

12.46 If a head company is applying one of the Division 230 spreading methods to gains and losses for a financial arrangement, the head company would apply Division 230 as it ordinarily would on the basis that the leaving time is the end of its income year. [ Schedule 1, item 1, subsections 230-170(3), 230-230(3), 230-280(4), 230-300(10) and 230-420(3 )]

Allocation of gains or losses where the head company ceases to have a hedging financial arrangement

12.47 If a leaving entity takes a financial arrangement with it that was subject to the hedging financial arrangement election and also takes the hedged item (or as a result of leaving the head company ceases to expect that it will have the hedged item), the gain or loss from the hedging financial arrangement the head company allocates to the income year in which leaving time occurs is the amount determined under subsection 230-360(1). [ Schedule 1, item 1, subsection 230-300(10 )]

12.48 The entire gain or loss is not allocated to the income year in which leaving occurs, notwithstanding item 2 in the table in section 230-305. [ Schedule 1, item 1, subsection 230-300(11 )]

12.49 However, where the leaving entity takes the hedged item but not the hedging financial arrangement with it, section 230-305 will apply to ensure that any gain or loss is allocated to the income year in which leaving occurs.

12.50 Where the leaving entity takes the hedging financial arrangement with it but not the hedged item, the head company includes any gain or loss on that hedging financial arrangement in accordance with the determination under subsection 230-360(1).

Example 12.9

Head Co has $1,000 cash and a hedging financial arrangement with a fair value of $50 and a hedged item worth $100. The hedging financial arrangement was initially entered into for a fair value of $0. In accordance with the hedging documentation, the fair value of the hedging financial arrangement represents a gain and will be included in the entity's assessable income when the hedged item is disposed of.

On 30 June an entity leaves the consolidated group taking with it $500 in cash as well as the hedging financial arrangement and the hedged item. The cost base of the membership interests the head company holds in the leaving entity would be $600 (being $500 for the terminating value of the cash, $100 for the hedged item and $0 for the hedging financial arrangement). The membership interests in the leaving entity are sold for $650, taking into account the hedging financial arrangement with a fair value of $50. In effect, the $50 fair value gain on the financial arrangement is brought to tax for the head company in the form of a $50 capital gain from the sale of the membership interests in the leaving entity.

Subsections 230-300(10) and (11) ensure that the single gain is only brought to account once for the head company. Therefore, no Division 230 gain will arise in respect of the arrangement.

Setting the tax cost of the head company's membership interests in the leaving entity

12.51 Under subsection 701-15(3) of the ITAA 1997, if an entity ceases to be a subsidiary member of a consolidated group, the membership interests that the head company holds in that entity has a tax cost that is set just before the leaving time at the interest's tax cost setting amount. The tax cost setting amount for these membership interests is set at an amount based on the old group's allocable cost amount in the leaving entity and the market value of the membership interests.

12.52 In working out the old group's allocable cost amount for the leaving entity, the head company must work out the terminating values of all the assets held by the leaving entity (subsection 711-25(1) of the ITAA 1997).

12.53 If an asset of the head company is a financial arrangement, the head company's terminating value for the asset is equal to the amount of consideration that the head company would need to receive, if it were to dispose of the asset just before the leaving time without an amount being assessable income of, or deductible to, the head company under Division 230. [ Schedule 1, item 88, subsection 705-30(3B )]

12.54 In other words, the terminating value is the amount of consideration the head company would need to receive if:

•

where the hedging financial arrangement election does not apply in relation to the asset - a Subdivision 230-G balancing adjustment occurred just before leaving time in order for the result in step 3 in the method statement in subsection 230-445(1) to be nil; or

•

where the hedging financial arrangement election does apply in relation to the asset - the amount of consideration the head company would need to receive if it had disposed of the asset just before the leaving time that would result in no gain or loss arising in respect of the disposal under the hedging financial arrangement election in the income year in which leaving occurs or any subsequent income year.

Example 12.10

Head Co has an asset that is a financial arrangement. Leaving Co is leaving the consolidated group and is taking the financial arrangement with it. Therefore, the terminating value of the asset must be worked out for the purposes of determining the old group's allocable cost amount.

Head Co provided $100 to acquire the arrangement. It also received $20 under the arrangement by way of repayment of principal.

Therefore, the terminating value of the asset is the amount of consideration that Head Co would need to receive if it were to dispose of the asset just before the leaving time without a balancing adjustment arising under section 230-445 - that is, $80. In this regard, applying the method statement in subsection 230-445(1):

•

the step 1(a) amounts would be $20 (being amounts received under the arrangement) and $80 (being the amount needed to be received in relation to the disposal of the arrangement so that there is no balancing adjustment); and

•

the step 2(a) amount would be $100 (being the financial benefits provided in relation to the acquisition of the arrangement).

Example 12.11

Head Co has an asset that is a hedging financial arrangement that is a forward currency contract to which the hedging financial arrangement election applies. In accordance with a determination in subsection 230-360(1), Head Co includes any gain on the financial arrangement in the income year in which the hedged item is disposed of.

Head Co provided $0 to acquire the arrangement, and the current fair value of the arrangement is $50. However, in accordance with the determination, the $50 gain on the hedging financial arrangement will only be included in Head Co's assessable income when the hedged item is disposed of.

Head Co's terminating value of the hedging financial arrangement is the amount of consideration it would need to receive if it had disposed of the arrangement just before the leaving time that would result in no gain or loss arising in respect of the disposal under the hedging financial arrangement election in the income year in which leaving occurs or any subsequent income year.

In this case, Head Co's terminating value for the hedging financial arrangement would be $0.

Exit history rule not to apply in relation to certain amounts

12.55 If a head company includes amounts in its assessable income, or is entitled to a deduction, as a result of an election for the portfolio treatment of fees, discounts or premiums under section 230-160, the amounts of assessable income or allowable deductions will continue to attach to the head company. That is, the exit history rule does not apply to transfer these amounts to the leaving entity. [ Schedule 1, item 89, subsections 715-380(1) and (2 )]

12.56 In addition, if a head company includes amounts in its assessable income, or is entitled to a deduction, over a four-year period under section 701-61 and an entity leaves the consolidated group before the end of the four-year period, the amounts of assessable income or allowable deductions will continue to attach to the head company. That is, the exit history rule does not apply to transfer these amounts to the leaving entity. [ Schedule 1, item 89, subsections 715-380(3) and (4 )]

12.57 Finally, if a head company includes amounts in its assessable income, or is entitled to a deduction, over a four-year period as a result of a transitional balancing adjustment election under item 121 of Schedule 1 to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 the amounts of assessable income or allowable deductions will continue to attach to the head company. That is, the exit history rule does not apply to transfer these amounts to the leaving entity. [ Schedule 1, item 99, section 715-380 of the Income Tax (Transitional Provisions) Act 1997 ]

Treatment of leaving entities

12.58 A leaving entity which commences to hold an asset or liability that is a financial arrangement after the single entity rule ceases to apply will apply Division 230 as if the leaving entity takes the financial arrangements with it. As a result:

•

the tax cost of an asset that is a financial arrangement that the leaving entity takes with it will be the asset's terminating value;

•

the value of a liability that is a financial arrangement that the leaving entity takes with it will be the value of the liability just before the leaving time; and

•

the leaving entity will inherit any election the head company made to apply Division 230.

Tax cost of the leaving entity's assets

12.59 The exit history rule (section 701-40 of the ITAA 1997) will apply to set the tax cost of an asset that is a financial arrangement that a leaving entity takes with it at the asset's terminating value. The leaving entity's terminating value for the asset is the same as the head company's terminating value.

12.60 The leaving entity's tax cost of the asset is not reset to the Division 230 starting value.

Example 12.12

In Example 12.10, Head Co's terminating value for the asset was worked out to be $80.

Similarly, for the leaving entity the tax cost of the asset will also be $80. If a Subdivision 230-G balancing adjustment subsequently occurs in relation to the asset, the amount provided in relation to the acquisition of the asset for the purposes of step 2(a) in the method statement in subsection 230-445(1) will be $80.

Value of liabilities assumed by the leaving entity

12.61 The exit history rule in section 701-40 of the ITAA 1997 will apply to set the value of any liability that is a financial arrangement that a leaving entity takes with it. As a result, anything that happened in relation to the liability is taken to have happened to the liability as if it had been a liability of the leaving entity.

Liabilities and assets that are hedging financial arrangements that the leaving entity takes with it

12.62 Where a leaving entity takes with it an asset or a liability that is a hedging financial arrangement, and the hedged item, the head company will apply the hedging financial arrangement election as if the leaving time is an end of income year. Furthermore, where this occurs the head company will not be taken to have ceased to have the hedged item under item 2 in the table in subsection 230-305(1). Instead, the head company makes a gain or loss on the hedging financial arrangement equal to the gain or loss the head company would have made under the hedging financial arrangement Subdivision had item 2 in the table in subsection 230-305(1) not been triggered. The tax cost of the asset and the value of the liability are therefore provided by the exit history rule in accordance with the discussion above.

Leaving entity may make fresh elections in relation to the elective methods

12.63 An entity that leaves a consolidated group or MEC group can make a fresh election under Division 230 in relation to the elective methods (but cannot override an election to apply Division 230). This is achieved under sections 715-700 and 715-705 of the ITAA 1997. [ Schedule 1, items 90 and 91, item 3A in the table in subsection 715-660(1) and item 1A in the table in subsection 715-665(1 )]

12.64 Hence, provided the requirements of the relevant provisions are met, a leaving entity may be able to make a fresh election that will apply from the leaving time or, if the election relates to an income year, the income year in which the leaving time occurs.

12.65 If the entity makes such a fresh election, the leaving entity does not need to satisfy the requirement that the entity started to have the financial arrangement in the income year in which the election is made or in a later income year. [ Schedule 1, item 89, section 715-385 ]

12.66 But for section 715-385, under the exit history rule the leaving entity would be taken to have started to have the financial arrangement in the income year in which the head company started to have it. Therefore, if the leaving entity were to make a fresh election under sections 715-700 and 715-705 of the ITAA 1997, the elective methods could not apply in relation to the financial arrangements the leaving entity took with it because the leaving entity will be taken to have started to have those arrangements in an income year prior to the income year in which the election was made.

Leaving entity inherits head company's election to apply Division 230

12.67 If the head company of a consolidated group or MEC group elects to apply Division 230, the exit history rule will apply such that any leaving entity that was a subsidiary member of the consolidated group when the head company made that election will be taken to have been made by the leaving entity.

Consolidated groups and the elective requirements to rely on financial reports

12.68 An entity will satisfy a requirement that it prepare a financial report (such as for the purposes of making an election under the elective Subdivisions) if:

•

a financial report is prepared by another entity and that other entity is a connected entity of the entity; and

•

the report is a consolidated financial report that deals with both the entity and connected entity's affairs; and

•

the report properly reflects the entity's affairs.

[ Schedule 1, item 1, section 230-525 ]

12.69 If a top company of a MEC group prepares consolidated financial reports that deals with the affairs of the head company and the top company, and that report properly reflects the affairs of the head company, the requirement that the head company prepare a financial report are satisfied. This is because a top company is a connected entity of the head company because both are members of the same wholly-owned group.

12.70 A report may properly reflect the affairs of the head company even where many of the financial arrangements the head company has are not actually reflected in the financial reports of the top company. This may occur where the top company and the head company are members of the same accounting consolidated group and most of the arrangements the head company has is with the top company.

12.71 Financial arrangements the head company holds with entities outside of an accounting consolidated group will need to be properly reflected in the top company's consolidated financial reports.

Interactions with the Division 230 transitional measures

Application of Subdivision 716-A to transitional balancing adjustment amounts

12.72 Subitem 104(2) provides for a transitional balancing adjustment for financial arrangements that are in existence at the time Division 230 commences. Subitem 104(14) provides that a transitional balancing adjustment is to be spread evenly over four income years where an entity has made the transitional balancing adjustment election.

12.73 Given that this amount is spread over two or more income years by including part of the original amount in the same entity's assessable income, or allowing part of the original amount as a deduction to the same entity, Subdivision 716-A of the ITAA 1997 may apply in relation to these transitional balancing adjustment amounts.

Example 12.13

Joining Co has made a transitional balancing adjustment election which would include $250 in that entity's assessable income every income year from 2010-11 to 2013-14.

On 1 January 2011 Joining Co joins a consolidated group.

Subdivision 716-A of the ITAA 1997 applies in relation to the $250 to be included in the entity's assessable income over the current income year. For the purposes of section 716-15 of the ITAA 1997, the spreading period is the period from 1 July 2010 to 30 June 2011, or 365 days. Joining Co's non-membership period is 1 July 2010 to 31 December 2010, or 184 days. Joining Co is a subsidiary member of the consolidated group for the remaining 181 days of the spreading period.

Joining Co's assessable income for the non-membership period includes:

$250 x 184/365 = $126.03.

Head Co's assessable income for the 2010-11 income year includes:

$250 x 181/365 = $123.97.

Exit history rule and the transitional balancing adjustment election

12.74 If a head company makes an election under subitem 104(2) relating to financial arrangements, the exit history rule will apply such that any leaving entity that was a subsidiary member of the consolidated group when the head company made that election will be taken to have been made by the leaving entity. Where this occurs, in order to reduce compliance costs, any transitional balancing adjustment amount will remain with the head company. [ Schedule 1, item 99, section 715-380 of the Income Tax (Transitional Provisions) Act 1997 ]