Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)CHANGE OF TITLE - TAX LAW IMPROVEMENT BILL (No. 1) 1998 - SENATE - Explanatory Memorandum.
Chapter 2.15 - Roll-over for disposal of assets to, or the creation of assets in, a wholly-owned company
Overview
This segment covers the rules, dealt with in Division 122, that allow a roll-over when an entity transfers an asset, or the net assets of a business, to a company that it wholly owns. Division 122 also allows a roll-over where an entity creates certain assets in a wholly-owned company.
Part A summarises these rules.
Part B explains changes to the 1936 Act.
Part C explains why some provisions have not been rewritten.
A. Summary of the new law
Subdivision 122-A: Disposal or creation of assets by an individual to a wholly-owned company
Subdivision 122-A allows an optional roll-over where an individual or a trustee disposes of an asset or all the assets of a business to a company that is wholly owned by the person. The roll-over is also available where an individual or trustee creates certain rights in a wholly-owned company. [section 122-15 and subsection 122-25(1)]
Consideration for the disposal or creation
The consideration for the disposal or creation of rights must be:
- •
- non-redeemable shares in the company; or
- •
- non-redeemable shares together with the company undertaking to discharge liabilities in respect of the assets, where existing assets are transferred.
[subsections 122-20(1) & (2)]
The market value of the shares received must equal the market value of the assets transferred, less any liabilities undertaken by the company, or the market value of any assets created in the company. [subsection 122-20(3)]
If a single CGT asset is disposed of, roll-over is not available if it:
- •
- is a collectable or personal use asset;
- •
- is a decoration awarded for valour or brave conduct (except if the decoration was purchased);
- •
- is a precluded asset;
- •
- becomes trading stock of the company upon its disposal.
[subsection 122-25(2)]
If the asset to be rolled-over is a right, option or convertible note, the asset acquired by the company upon its exercise or conversion must not become trading stock upon its acquisition. [subsection 122-25(4)]
A precluded asset is:
- •
- a car, motorcycle or similar vehicle;
- •
- trading stock;
- •
- an interest in the copyright in a film referred to in section 118-30; or
- •
- a right to mine referred to in section 118-45.
[subsection 122-25(3)]
Disposal of all the assets of a business
The assets disposed of can include precluded assets but special rules apply to these assets. [subsection 122-25(2) and sections 122-50 and 122-60]
Status of company acquiring the asset or assets of a business
The company that acquires the assets cannot be one whose income is exempted under Division 50. [subsection 122-25(5)]
Where the transferor or the company are not Australian residents
If either the transferor or the company is not an Australian resident, the roll-over is confined to assets that have the necessary connection with Australia. [subsections 122-25(6) and (7)]
Liabilities in respect of transferred assets
There are special rules if the company undertakes to discharge liabilities in respect of transferred assets. [sections 122-35 and 122-37]
Effect of roll-over on the transferor where a single asset is transferred
Any capital gain or loss the transferor makes from the disposal is disregarded. [subsection 122-40(1)]
If the transferred asset was acquired by the transferor on or after 20 September 1985 (post-CGT), the cost base and reduced cost base of the shares acquired on the roll-over are essentially the cost base and reduced cost base of that asset, less any related liabilities that the company undertakes to discharge. [subsection 122-40(2)]
If the transferred asset was acquired by the transferor before 20 September 1985 (pre-CGT), the shares acquired on the roll-over are also taken to have been acquired before then. [subsection 122-40(3)]
Effect of roll-over on the transferor where all the assets of a business are transferred
The capital gain or loss from the disposal is disregarded. [section 122-45]
If all the transferred assets were acquired by the transferor post-CGT, the cost base and reduced cost base of the shares acquired on the roll-over are essentially the sum of:
- •
- the market values of any precluded assets; and
- •
- the cost bases and reduced cost bases respectively, of the other assets, less any liabilities the company undertakes to discharge in respect of them.
[section 122-50]
If any transferred assets, except precluded assets, were acquired by the transferor pre-CGT, some of the shares received for the transfer may be taken to have been acquired before then. [sections 122-55 and 122-60]
Effect of roll-over on the creator where an asset is created in a company
Any capital gain or loss the creator makes from the creation is disregarded. [subsection 122-65(1)]
The cost base and reduced cost base of the shares acquired as consideration are essentially the costs incurred in creating the asset in the company. [subsection 122-40(2)]
Effect of roll-over on the company where one or more assets is transferred
In the hands of the company, the cost base and reduced cost base of transferred assets that were acquired by the transferor post-CGT (except for precluded assets) are essentially their cost base and reduced cost base in the hands of the transferor at the time of the roll-over.
If the transferor acquired the assets pre-CGT (except for precluded assets), the company is also taken to have acquired them pre-CGT. [section 122-70]
Effect of roll-over on the company if an asset is created in the company
The company's cost base and reduced cost base for the created asset are essentially the costs the creator incurred in creating the asset in the company. [section 122-75]
Subdivision 122-B: Disposal or creation of assets by partners to a wholly-owned company
B. Discussion of changes
Division 122
Provide explicit rules for the transfer of the net assets of a business to a wholly-owned company.
The 1936 Act is expressed solely in terms of the transfer of a single asset to a company. On the incorporation of a business, the existing law would literally need to be applied separately to each asset of the business that is transferred to the company, rather than to the assets of the business as a whole. The additional rules in the rewritten law recognise normal commercial activity and will reduce compliance costs.
Section 122-20 What you receive for the trigger event
Section 122-130 What the partners receive for the trigger event
Make it explicit that shares must always form part of the consideration for the asset or assets disposed of to the company.
In the existing law it is not clear whether, as a limiting case, the whole of the consideration could consist of the company undertaking to discharge one or more liabilities.
Provide that a contingent tax liability is to be disregarded when deciding whether the shares received in consideration for the asset have a market value that is substantially the same as the market value of the transferred asset.
There is a separate requirement that the shares received for the transfer must have a market value that is substantially the same as the market value of the asset, less any liabilities the company assumes in connection with the transfer. It can be impossible to satisfy this requirement if there is a significant contingent tax liability, such as an unrealised capital gain or balancing adjustment, inherent in a transferred asset which affects its market value. To overcome this, the rewritten provision states that a contingent liability (for example, a contingent tax liability or accrued leave entitlements of employees) is to be ignored in comparing the market values of the asset and of the shares received in consideration for the asset.
Sections 122-25, 122-35, 122-37, 122-45, 122-50, 122-55 and 122-60
The existing roll-over provisions apply on an asset by asset basis. As explained above, the rewritten provisions will specifically provide for the roll-over of the net assets of a business to a wholly-owned company. There are changes that have been required as a result of this new approach. These changes are listed below.
Define the term precluded assets. [section 122-25]
The term precluded assets is used for assets which may form part of the assets of a business but for which non-roll-over treatment applies.
Provide a rule that any liabilities transferred to the company that are in respect of precluded assets must not exceed the market value of the precluded assets. [section 122-35]
The new rule parallels the existing law that applies to transfers of single assets to a wholly-owned company.
Provide that:
- •
- a liability incurred for the purposes of a business that does not relate to a specific asset or assets of the business will be taken to be a liability in respect of all assets of the business; and
- •
- a liability covering two or more assets will be allocated to the respective assets in proportion to their market values. [section 122-37]
The existing law does not address liabilities of a business being undertaken by a company, unless they are in respect of particular assets. In allowing the roll-over of the net assets of a business, it is appropriate that all liabilities incurred for the purposes of the business be taken into account.
State how roll-over applies in all circumstances in which an individual or a trustee transfers the net assets of a business to a company. [sections 122-45 to 122-60]
These sections each deal respectively with the three possible cases when the net assets of a business are disposed of to a wholly owned company. These are where:
- •
- all the assets of the business were acquired post-CGT; [section 124-50]
- •
- all the assets of the business were acquired pre-CGT; [section 122-55] and
- •
- some of the assets of the business were acquired post-CGT. [section 122-60]
Sections 122-35 & 122-130 What if the company undertakes to discharge a liability (disposal case)
These sections will specify the limits on the amount of liabilities the company can undertake to discharge as consideration for assets transferred to it.
For a post-CGT asset - allow the company to undertake to discharge liabilities up to an amount equal to the cost base of the asset.
Where a later disposal of the asset results in a capital loss, the existing law permits the company to undertake to discharge liabilities up to an amount equal to the reduced cost base of the asset only. The amount of liabilities the company undertakes to discharge affects the cost base of the shares received in consideration for the transfer of the asset to the company. It is not practicable to have the amount of the cost base of those shares conditional upon the outcome of an event which may not occur before a CGT event happens to those shares.
Section 122-40 Disposal of a CGT asset
This section will set out the roll-over consequences for the transferor of a single asset.
Allow indexation of the cost base of the shares received in consideration of the transfer of the asset where a CGT event happens in relation to them within 12 months of the roll-over event, but at least 12 months after the transferred asset was acquired by the transferor.
The existing law denies indexation if the shares are disposed of within 12 months of the transferor acquiring them. This is inconsistent with the general design of the roll-over provisions, which transfer the CGT attributes of the asset rolled-over to the shares acquired on the roll-over.
Sections 122-65 & 122-195 Creation of asset
These sections will set out the roll-over consequences for the creation of an asset.
Broadly, the cost base and indexed cost base of the shares received as consideration are set equal to the costs incurred in creating the asset.
The existing law does not deal explicitly with the case where an asset is created in a company.
Sections 122-70 & 122-200 Consequences for the company (disposal case)
The company will be able to index the cost base of the transferred asset provided a CGT event does not affect the asset within 12 months of its acquisition by the transferor or, in the case of partners, acquisition of their interests in it.
The existing law allows indexation only if the transferred asset is retained for 12 months by the company acquiring it.
Sections 122-75 & 122-205 Consequences for the company (creation case)
Broadly, the company's cost base and indexed cost base for the created asset are set equal to the costs incurred in creating the asset.
The existing law does not deal explicitly with the case where an asset is created in a company.
Section 122-130 What the partners receive for the asset
Provide that each partner must only receive shares that have a market value equal to the partners interest in the asset transferred to, or created in, the company less any liabilities in respect of that interest that the company undertakes to discharge.
The 1936 Act also requires that each partner own shares in the company in the same proportion as that partners interest in the transferred asset. The two conditions are incompatible unless the liabilities of partners undertaken by the company are in proportion to the market value of each partners interest.
Section 122-135 Other requirements to be satisfied
Provide that relief is not available where an asset or assets are transferred to a company whose income is exempt from income tax.
The 1936 Act has a gap in that this requirement, which is specifically stated in the provisions for individuals or trustees transferring an asset to a company, is not contained in the equivalent partnership roll-over provision.
Section 122-140 What if the company undertakes to discharge a liability (disposal case)
This section will limit the amount of liabilities a company can undertake to discharge as consideration for the transfer of an asset or the assets of a business.
Provide a new rule that any liabilities undertaken by the company that are in respect of precluded assets must not exceed the market value of the precluded assets.
As in the case of section 122-35, this new rule parallels the existing law that applies to transfers of single assets to a wholly owned company.
Section 122-145 Rules for working out a liability in respect of an asset
This section provides new rules for determining the amount that can be taken to be a liability in respect of an asset.
Provide that:
- •
- a liability incurred for the purposes of a business, that does not relate to a specific asset or assets of the business, will be taken to be a liability in respect of all of the assets of the business; and
- •
- a liability covering two or more assets, will be allocated to the respective assets proportionately to their market values.
As in the case of corresponding section 122-37, it is appropriate that all liabilities incurred for the purposes of the business be taken into account in allowing the roll-over of its net assets.
Section 122-155 Disposal of post-CGT or pre-CGT interests
This section states the roll-over consequences where a partners interests in a transferred asset were all acquired pre-CGT or were all acquired post-CGT.
Allow indexation of the cost base of the shares acquired for the transfer where a CGT event concerning them happens within 12 months of the roll-over, but at least 12 months after the partner acquired an interest in the transferred asset.
The existing law does not allow indexation if the replacement shares are disposed of within 12 months of the partner acquiring them. This is inconsistent with the general design of the roll-over provisions, which transfers the CGT attributes of the original asset to the replacement asset.
Where all of a partners interest in an asset was acquired post-CGT, the cost base of the partners shares received for the transfer of the asset will be equal to the cost base of the partners interest when the asset was transferred, less any related liabilities undertaken by the company.
The 1936 Act allots to the partners any liabilities the company undertakes in relation to a partnership asset, in proportion to their respective interests in the asset. The rewritten law allows for the possibility that partners shares in the liabilities may not be proportionate to their respective interests in the asset.
Section 122-160 Disposal of both post-CGT and pre-CGT interests
This section will state the roll-over consequences where an asset is transferred in which a partner has some interests that were acquired post-CGT and some acquired pre-CGT.
1. Change
Allow indexation of the cost base of the shares received in consideration of the transfer of the asset to the company where a CGT event happens to them within 12 months of the roll-over, but at least 12 months after the partner acquired an interest in the transferred asset.
This change corresponds to the first change under section 122-155. It applies to shares that are in respect of the partners interests that were acquired post-CGT.
Provide that, where some of a partners interests were acquired post-CGT, the cost base of the partners shares received for the transfer will be equal to the cost base when the asset was transferred, of the partners interests that were acquired post-CGT less any liabilities in respect of those interests that are undertaken by the company.
This change corresponds to the second change under section 122-155. It applies to liabilities relating to interests acquired post-CGT.
Provide that the maximum number of shares in a company that a partner could elect to have treated as shares acquired pre-CGT under the 1936 Act, will be taken to have been acquired before then without the requirement to make an election.
The 1936 Act is framed in a way that sets a maximum number of shares based on the partners proportionate interests and allows the election up to that limit. However, it is always in the partners interest to elect that the number of shares received for the transfer of the asset that are taken to be acquired pre-CGT is the maximum that is permitted.
Section 122-170 Capital gain or loss disregarded
Section 122-175 Other consequences
Section 122-180 All interests acquired on or after 20 September 1985
Section 122-185 All interests acquired before 20 September 1985
Section 122-190 Interests acquired before and after 20 September 1985
The existing roll-over provisions apply on an asset by asset basis. The rewritten provisions will specifically provide rules for when partners transfer the net assets of a business to a wholly-owned company. The changes referred to below are required to take account of these proposed rules and to ensure that they operate on the same basis as the roll-over rules for transfers of single assets to a company wholly-owned by the partners.
State how the roll-over applies in all circumstances in which partners transfer the net assets of a business to a company.
The new rules in these sections correspond to the changes made by sections 122-45 to 122-60.
C. Provisions of the old law that have not been rewritten
Some provisions of the existing law are redundant and have not been rewritten.
They are summarised in the following table:
| Provision | Subject | Reason for omission |
|---|---|---|
| Paragraph 160ZZN(2)(d) | Form of election. | Formal elections are not generally required under self assessment. |
| Paragraph 160ZZN(4)(c) (in part) | Trust must be the same trust. | Not required. A different trust is a different entity (ref. section 960-100 of the 1997 Act). |
| Paragraph 160ZZN(4)(d) | Form of election. | Formal elections are not generally required under self assessment. |
| Subparagraph 160ZZNA(2)(d)(ii) | Partner must hold shares in same proportion. | Incompatible with another rule (ref. section 122-130). |
| Paragraph 160ZZNA(2)(g) | Trust must be the same trust. | Not required. A different trust is a different entity (ref. section 960-100 of the 1997 Act). |
| Subsection 160ZZNA(4) | Identification of partners interests in assets as being pre- or post-20September1985 eligible asset interests. | The form of the rewritten provisions does not require this express identification. |
| Subsection 160ZZNA(6) | Identification of an asset as being a post-20September1985 eligible asset. | The form of the rewritten provisions does not require this express identification. |
| Paragraph 160ZZNA(10)(c) | Identification of a consideration share as being a post-20September1985 replacement share. | The form of the rewritten provisions does not require this express identification. |
| Subsection 160ZZNA(13) | Form of election. | Formal elections are not generally required under self assessment. |
| Subsection 160ZZNA(14) | Specification that a reference to an acquisition of an interest in an asset by a partner is to include a reference to an acquisition of an interest acquired when the partner was a partner in a predecessor of the present partnership. | The form of the rewritten provisions does not require this express specification. |