Ruling Compendium

There is a concern that the approach in paragraph 4 is not legally binding on the Commissioner and that taxpayers are therefore unable to rely on the statement.

The issue would be more appropriately addressed by way of a legislative amendment to protect the tax positions adopted by taxpayers in the past once the Tax Office's views have been finalised.

Paragraph 4 of the Determination provides that the Tax Office would not disturb the relevant assessment which does not include what would otherwise be the assessable capital gain on the disposal of the membership interests that represents a duplication of the gain made by the head company on the disposal of the asset. Without this approach, the consolidation rules may result in tax being paid twice in respect of the same economic gain. The Tax Office has adopted this approach to produce a sensible tax outcome which, in its view, is consistent with the scheme of the Act.

Insofar as the comment relates to legislative design issues, these are outside the scope of the Determination and are matters more appropriate for Treasury to consider. To that end, the Tax Office has provided Treasury with a copy of these comments.

(i)

Change paragraph 4 of the draft Determination to allow taxpayers to apply subsection 104-10(4) of the ITAA 1997 to the capital gain or loss made on the disposal of the membership interests in a manner that reduces the capital proceeds by that part of the capital gain made on the disposal of the CGT asset that is the subject of the straddle contract.

(ii)

Subsection 6-25(1) of the ITAA 1997 refers to an 'amount' being included in your assessable income twice. It is possible to interpret 'amount' to include an amount attributable to the same economic gain. Where two amounts are included in section 102-5 of the ITAA 1997, it is possible for the ATO to apply subsection 6-25(1) in the limited scenario of a straddle exit-sell case.

(iii)

It is arguable that the contractual rights that the leaving entity acquired on entering into the sale contract have a cost base equal to the market value of the land under subsection 110-25(2)(b) of the ITAA 1997. This is because the leaving entity will have agreed to give property (the land) in respect of the acquisition of the right to receive the purchase price. Subsection 110-25(2)(b) is wide enough to encapsulate the value of property that the person is 'required to give' at a future time.

(iv)

Change the time of CGT event A1 to when the change of ownership occurs (discussed below)

Adjust capital proceeds: There is nothing within Division 116 of the ITAA 1997, nor subsection 104-10(4), that allows the head company to calculate its capital proceeds from the disposal of the membership interests in the leaving entity by ignoring the part of the capital gain that has already been taken into account on the sale of the CGT asset.

Subsection 6-25(1): The gain duplication that arises in an exit-sell case does not result from two income tax provisions including the same amount in the head company's assessable income. The requirements in subsection 6-25(1) therefore would not be met.

Market value cost base for straddle contract: In calculating the cost base of a CGT asset that is contractual rights, the Tax Office thinks the better view of subsection 110-25(2)(b) of the ITAA 1997 is that the property given by the vendor to acquire the asset is the contractual rights created in the purchaser to have the CGT asset transferred at the contract price (that is not the CGT asset itself). The market value of the rights created would generally be nil.

Changing the time of the CGT event: see below.

This interpretation would result in the same economic gain being assessed once in an exit-sell case. It would also avoid any practical issues for the head company of the old group in terms of monitoring whether the sale has been completed and other relevant events that occur after the member has left the consolidated group.

The ATO should acknowledge this alternative position in the Determination and also provide that such an interpretation is reasonably tenable (even if not the preferred ATO view).

The Tax Office does not consider the consolidation rules operate to ignore the contractual basis of the asset's disposal. The rules therefore do not change the timing of the CGT event (see paragraph 42 of the Determination).

The announced legislative changes, which seek to change the time of the CGT event to the time the change of ownership happens, lend further support to the view that the existing law cannot be interpreted in the way suggested. [Further details on the announced measure are available in the (former) Assistant Treasurer's Press Release No. 050 of 2007 and the Treasurer's and Assistant Treasurer's Joint Press Release No. 053 of 2008 ].

The Tax Office acknowledges that the exit-sell position in the Determination raises practical issues for the head company in obtaining information from the subsidiary member that is relevant to calculating its capital gain or loss. However external advisors (for the head company) have indicated that contracts for the sale of a subsidiary include indemnities for tax and other tax related clauses. The exchange of information to enable the head company to comply with its tax obligations could be incorporated into such contracts.

If, in Example 5, there was another asset (not being sold under a straddle contract) which had a tax cost of $2m and a market value of $100,000 at the leaving time, this would result in a capital loss on the disposal of the membership interests of $400,000.

The result is inequitable as it duplicates the capital gain on the asset's disposal by virtue of a reduced capital loss on the shares in S Co.

Paragraph 4 of the Determination applies specifically to taxpayers whose circumstances fall within the terms of the ruling. Whether a similar approach could be adopted in a different set of circumstances would need to be considered on a case by case basis.

The positions in TD 2005/D27 have some attraction from a pragmatic point of view but the logic leading to the positions is unclear.

CGT event A1 should be taken to happen at the contract time with any resulting capital gain or loss ignored under the single entity rule (being a CGT event that happens at the time the two entities are members of the same tax consolidated group.)

Example

B Co and C Co are subsidiary members of the same tax consolidated group and B Co owns land with a market value of $3.5m and a cost base of $2m. If B Co contracts to sell the asset to C Co and C Co leaves the consolidated group before the contract settles, there should be no consequences under CGT event A1 as it happens at the time the two entities are members of the same group.

Further consideration would be required on identifying the assets of C Co at its leaving time and whether an appropriate gain or loss is calculated on the group's membership interests in C Co. Based on draft TD 2008/D10, the CGT asset being acquired would not be an asset of C Co with the possibility of double tax if C Co is required to recognise a liability at step 4 of the allocable cost amount (ACA) calculations on exit.

However, the example highlights a number of interaction issues which the Tax Office thinks would benefit from further consultation with stakeholders. As a result, the types of intra-group dealings in CGT assets to which the final 3 Determinations do not apply now also include contracts where the purchaser and seller were members of the same consolidated group at either contract or settlement. These scenarios will be considered as part of the Tax Office's broader review of intra-group transactions.

Similarly, Examples 3 and 4 no longer include dollar amounts or commentary on cost base impacts and incidental costs of disposal after exit. Again, it is not clear why these changes were made.

Examples 3 and 4 were modified so that they address only the issue that is the subject of the Determination. Related issues, such as the cost base impacts for the CGT asset being acquired under the contract, will be clarified in the Consolidation Reference Manual.

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a tax consolidated group acquiring the leaving entity, and

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a multiple entry consolidated (MEC) group acquiring the leaving entity as a new eligible tier-1 (ET-1) company.

The Tax Office considers that the principles in the Determination, together with the existing examples, make clear which tax entity makes the capital gain or loss on the disposal of a CGT asset in an exit-sell case (that is the head company of the old consolidated group).

The implications of tax funding agreements are outside the scope of the Determination.

Example 5 is similar to an example where the leaving entity joins a MEC group as an eligible ET-1 company. In this case, the ET-1 company does not perform a Division 705 calculation in relation to its CGT assets. The announcement would therefore result in a capital gain to the old group on a disposal of the leaving entity, and a capital gain to the new group on settlement of the straddle contract.

We request that the ATO liaise with Treasury to ensure that Example 5 does not result in double tax under the amended legislation.

The Tax Office understands that Treasury intends to consult with relevant stakeholders on the legislative design of this measure. There will be an opportunity to raise this issue, and any others, directly with Treasury as part of these discussions.

The Tax Office has provided the comments to Treasury for their consideration.

To further assist taxpayers, worked examples setting out the income tax consequences for straddle contacts will be included in the Consolidation Reference Manual.