Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 13 - Subsidiary company liquidations and capital gains tax
Overview
13.1 Schedule 13 of the Bill introduces new sections 160ZZOB and 160ZZOC which may operate to reduce a capital gain or loss otherwise realised on the cancellation of shares on dissolution of a company which is a wholly owned subsidiary of another company. The provisions will apply where consideration for the disposal of the shares is equal to the market value of assets distributed in specie to the shareholder company by the liquidator as part of a final distribution.
Summary of the amendments
13.2 The amendments contained in Schedule 13 have the effect that, in the context of a liquidator's final distribution, to the extent that an increase or decrease in the value of assets held by a company is reflected in the value of shares held by another company which owns 100% of the shares in the liquidating company, duplication of economic gains and losses relating to the assets will be minimised.
13.3 The amendments apply to share cancellations occurring after 7.30pm on 20 August 1996, which was the date on which the amendments were announced. [Part 2 of Schedule 13]
Background to the legislation
13.4 Section 160ZZO of part IIIA of the Income Tax Assessment Act 1936 (the Act) provides CGT rollover where an asset is transferred from a company to another wholly owned group company. Rollover will be available for the in specie distribution of an asset by the liquidator of a company to another company in a wholly owned company group. The rolled over asset retains its cost base (indexed or reduced) in the hands of the transferee company. If the asset is a loss asset, rollover will be compulsory by virtue of subsection 160ZZO(1AA).
13.5 Where an asset is transferred as part of a liquidator's final distribution and the shares in the transferor subsidiary are cancelled, the cancellation of the shares will be a disposal for CGT purposes (subsection 160M(3)). The consideration for the disposal for the purposes of subsection 160ZD(1) will be equal to the market value of the transferred asset or assets at the time of the transfer. Rollover is not available for the disposal of the shares on cancellation, as the shares will cease to exist. Therefore, any accrued gains relating to the asset and which are reflected in the value of the shares will be subject to CGT as consideration for the disposal of the shares, and again on subsequent disposal of the relevant asset by the transferee company. Similarly, a capital loss which is realised on the disposal of the shares may be duplicated on a subsequent disposal of the asset.
Explanation of the amendments
Prerequisites for the amendments to apply
13.6 The provisions apply where an asset is transferred from a company which is in the course of liquidation, to a holding company whose shares in the transferor were acquired in whole or in part on or after 20 September 1985. [New paragraph 160ZZOB(2)(e)]
13.7 The transfer of an asset would generally be taken to occur in the course of the liquidation of a company where the transfer is effected by a liquidator appointed pursuant to part 5.6 of the Corporations Law. However, new sections 160ZZOB and 160ZZOC are confined in their operation to the CGT consequences of a cancellation of shares on a final distribution by the liquidator. Specifically, the amendments will not affect the application of section 160ZL in relation to interim in specie asset distributions by a liquidator.
13.8 The transferee company must hold 100% of the shares in the liquidating subsidiary throughout the period commencing at the time of the first in specie asset distribution by the liquidator (whether an interim or final distribution, or part thereof) and the time at which the shares in the transferor company are cancelled [new paragraph 160ZZOB(2)(d)] . The in specie distribution must be consideration for the disposal of all of the shares in the transferor company owned in that period [new paragraphs 160ZZOB(2)(b) and (c)].
13.9 The consideration for the disposal of all of the shares in the transferee (being the market value of the transferred assets under section 160ZD) would be spread equally across all of the shares which are cancelled in the course of the liquidation. [New paragraph 160ZZOB(2)(c)]
13.10 In the case of a 'notional gain' asset the transferor and transferee companies must have elected that CGT rollover relief under section 160ZZO will apply in relation to the transfer of the asset [new subparagraph 160ZZOB(2)(a)(i)] . Where the transferred asset is a 'notional loss' asset, rollover will be compulsory under the operation of subsection 160ZZO(1AA) [new subparagraph 160ZZOB(2)(a)(ii)]
13.11 New subsections 160ZZOC(3) and (4) define the terms 'notional gain' and 'notional loss' in relation to transferred assets. A notional gain asset is an asset in relation to which a capital gain would be realised if the asset were disposed of for market value. Similarly, a notional loss asset is an asset in relation to which a capital loss would be realised if the asset were disposed of for market value.
13.12 The amendments will only apply where there is either an actual gain realised on the disposal of shares in the subsidiary company along with a notional gain accrued in relation to the transferred assets, or where an actual loss is realised on the disposal of the shares and a corresponding notional loss applies in relation to the transferred assets. [New paragraph 160ZZO(2)(f)]
13.13 Broadly, new sections 160ZZOB and 160ZZOC may operate to reduce a capital gain or loss which would otherwise be realised on the cancellation of the shares in the transferee company. The capital gain or loss would be determined by reference to the indexed or reduced cost base of the shares in the transferor company and the market value of assets transferred in a liquidator's final distribution. A gain or loss realised on disposal of the shares may be reduced to reflect the unrealised economic gain or loss on the transferred assets.
13.14 In relation to a share cancellation, the formulae contained in new subsections 160ZZOB(3) and (4) require that:
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- the overall actual gain or overall actual loss realised on the disposal of the post CGT shares in the subsidiary company be determined.
13.15 The terms overall actual gain and overall actual loss are defined in new subsections 160ZZOC(6) and (7). An overall actual gain is taken to have arisen where the sum of actual gains realised on shares exceeds the sum of actual losses. Likewise an overall actual loss will be realised where the sum of actual losses exceeds the sum of actual gains.
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- the overall actual gain or loss on the disposal of the shares is reduced by an amount equal to a proportion of the overall notional gain or loss relating to the transferred assets. The overall notional gain or loss is apportioned to reflect the proportion of pre and post CGT shares held in the transferor company.
13.16 The terms notional gain and notional loss are defined by new subsections 160ZZOC(3) and (4) in relation to a transferred asset as being the gain or loss (as the case may be) that would be realised if the asset were disposed of at the time of transfer for an amount equal to its market value.
13.17 The difference between the sum of all notional gains and losses will be an overall notional gain or loss as defined in new subsections 160ZZOC(2) and (5) .
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- the amount which is determined using steps (1) and (2) above is divided by the number of post CGT shares in the transferor company to give a new deemed capital gain or loss realised on the disposal of each of the shares.
13.18 Holding company H owns all of the shares in subsidiary company S. The shares have a cost base of $100 and a market value of $1000. Company S owns one asset with a cost base of $100 and a market value of $1000. On final distribution of the assets of company S, the asset is transferred (distributed in specie) to company H, and an election is made under section 160ZZO that CGT rollover should apply in relation to the transfer. Ignoring indexation, the 'notional gain' on the transferred asset is $900 and the overall actual gain on the disposal of the shares is also $900. The overall actual gain is reduced by the notional gain to give a taxable capital gain of nil.
13.19 If the cost base of the transferred asset exceeds the cost base of the shares (ie the 'notional gain' is less than the overall actual gain that would otherwise be realised on the cancellation of the shares) the overall actual gain on the shares will only be reduced by the amount of the notional gain and not by the excess notional capital gain.
13.20 Holding company H owns 100% of the shares in subsidiary S. The shares have a cost base of $50 which reflects the market value of asset A at the time of their acquisition. The cost base of asset A is $100, its market value having decreased prior to the purchase of Company S by company H. Subsequently, the market value of asset A has increased to $1000. The notional capital gain attaching to asset A is $900. On cancellation of the shares in subsidiary S, an overall capital gain of $950 will be realised ($1000 less the $50 cost base). The amendment will operate to reduce this gain by the notional gain of $900 attaching to asset A leaving a total taxable capital gain on the share cancellation of $50.
13.21 The gain realised on cancellation of the shares can only be reduced to zero, and any accrued gains on transferred assets will be unaffected. For example, if the market value of a transferred asset is equal to the cost base of the cancelled shares, no adjustment will be made.
13.22 Holding company H owns shares in subsidiary S with a cost base of $1000. Asset A which has a cost base of $100 and a market value of $1000, is distributed in specie to holding company H and the shares are cancelled. Consideration for the disposal of the shares will be $1000 being the market value of the transferred asset. This is equal to the cost base of the shares and therefore no overall gain or loss is realised. A $900 capital gain would be realised on a subsequent disposal by company H of asset A.
Examples 4 and 5 - subsidiary holding both gain and loss assets
13.23 Holding company H owns shares in subsidiary company S with a cost base of $50 and a market value of $100. Company S has two assets, one of which has a cost base of $100 and a market value of $50 (a notional loss asset) and the other of which has a cost base of zero and a market value of $50 (giving a notional gain of $50). In specie distribution of the assets would crystallise an actual gain of $50 on the cancellation of the shares. There is no overall notional gain or loss on the assets, since the notional loss offsets the notional gain. Therefore there will be no reduction in the capital gain realised on the shares.
13.24 Company H owns shares in company S with a cost base of $100 and market value of $200. Company S has one asset with a cost base of $10 and market value of $100 (giving a $90 notional capital gain), and another asset with a cost base of $200 and market value of $100 (giving a $100 notional capital loss). On cancellation of the shares, an actual gain of $100 ($200 - $100) will be realised. Because the transferred assets carry a notional capital loss of $10, there will be no reduction in the $100 gain realised on the cancellation of the shares.
13.25 Holding company H owns shares in subsidiary S with a cost base of $100. Asset A is a pre CGT asset with a market value of $1000. The consideration for the disposal of the shares will be the market value of the asset, giving a realised capital gain of $900. No capital gain applies to the transferred asset, and therefore there is no notional capital gain available to reduce the gain on the shares. Instead the current rules will apply whereby the consideration for the disposal of the post CGT shares will be equal to the market value of the pre CGT asset. This reflects the underlying intention of the amendments viz, removal of the current 'double' CGT impost on economic gains and losses relating to post CGT shares and assets.
Example 7 - mixture of pre and post CGT assets
13.26 Holding company H holds post CGT shares in subsidiary company S with a cost base of $50. Company S owns a post CGT asset with a cost base of $50 and a market value of $100, and a pre CGT asset with a market value of $100. Under the existing law, the cancellation of the shares in company S would realise a capital gain of $150.
13.27 The new provisions will reduce this gain by the $50 notional gain attaching to the post CGT asset. There will be no