Draft Taxation Determination
TD 2009/D4
Income tax: consolidation: capital gains: does paragraph 40-880(5)(f) of the Income Tax Assessment Act 1997 prevent the deduction, under section 40-880 of that Act, of incidental costs described in subsection 110-35(2) of that Act that the head company of a consolidated group or MEC group incurs, in disposing of shares in a subsidiary member to a non-group entity, before the member leaves the group?
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Please note that the PDF version is the authorised version of this draft ruling.This document has been finalised by TD 2010/1.There is a Compendium for this document: TD 2010/1EC .
FOI status:
may be released
This publication provides you with the following level of protection:
This publication is a draft for public comment. It represents the Commissioner's preliminary view about the way in which a relevant taxation provision applies, or would apply to entities generally or to a class of entities in relation to a particular scheme or a class of schemes. You can rely on this publication (excluding appendixes) to provide you with protection from interest and penalties in the following way. If a statement turns out to be incorrect and you underpay your tax as a result, you will not have to pay a penalty. Nor will you have to pay interest on the underpayment provided you reasonably relied on the publication in good faith. However, even if you don't have to pay a penalty or interest, you will have to pay the correct amount of tax provided the time limits under the law allow it. |
Ruling
1. No. Paragraph 40-880(5)(f) of the Income Tax Assessment Act 1997 (ITAA 1997)[1] does not prevent the deduction, under section 40-880, of incidental costs described in subsection 110-35(2) that the head company of a consolidated group or MEC group incurs, in disposing of shares in a subsidiary member to a non-group entity, before the member leaves the group (that is, ceases to be a member of the group).
Application
2. This draft Determination does not apply to the extent (if any) that the incidental costs mentioned in paragraph 1 of this draft Determination are remuneration to a member of the group.
Example
3. H Co is the head company of a consolidated group of which another company, Sub Co, is a subsidiary member. H Co's shareholding in Sub Co consists of 2,000 shares, all of the same class. H Co incurs a liability to pay legal and accounting fees of $10,000 to entities outside the group in negotiating the sale of all of its shares in Sub Co to a non-group entity. The fees are incidental costs that are described in subsection 110-35(2).
4. The shares are later sold for $700,000 ($350 per share), and Sub Co leaves the group. Just before the leaving time, Sub Co has assets consisting of cash ($100,000) and land with a cost base of $500,000. At that time, it has accounting liabilities totalling $160,000 to entities outside the group.
5. The cost base and reduced cost base of each of H Co's shares in Sub Co is $220.[2] H Co makes capital gains totalling $260,000[3] on the sale of the shares.
6. As the legal and accounting fees do not form part of the cost base or reduced cost base of the shares, they are not taken into account in working out the amount of the capital gain on the sale of these shares. Further, the legal and accounting fees incurred do not fit the description of any amount that forms part of the calculation of a capital gain or capital loss from any other CGT event. Therefore paragraph 40-880(5)(f) does not apply to prevent the deduction of any amount in relation to the fees that would otherwise be available under section 40-880.
Date of effect
7. When the final Determination is issued, it is proposed to apply in cases where the incidental costs mentioned in paragraph 1 of this draft Determination are incurred on or after 6 June 2008. However, the Determination will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Determination (see paragraphs 75 to 77 of Taxation Ruling TR 2006/10).
Commissioner of Taxation
8 July 2009
Appendix 1 - Explanation
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This Appendix is provided as information to help you understand how the Commissioner's preliminary view has been reached. It does not form part of the proposed binding public ruling.
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Explanation
8. Paragraph 40-880(5)(f) prevents an amount of business capital expenditure from being deductible under section 40-880 to the extent the expenditure could be taken into account in working out the amount of a capital gain or capital loss from a CGT event.
9. In the context of this Determination, where CGT event A1[4] happens on the disposal of the shares in the subsidiary member, two factors - the head company's cost base (or reduced cost base) of the shares and the capital proceeds from their disposal - are taken into account in working out the amount of a capital gain or capital loss from that CGT event. The incidental costs incurred by the head company would be taken into account in working out the amount of a capital gain or capital loss from the CGT event if they formed part of the cost base (or reduced cost base) of the shares. However, the incidental costs would not reduce the capital proceeds.
10. The question of whether the incidental costs do form part of the cost base (or reduced cost base) of the shares is decided by examining how the cost base (or reduced cost base) is worked out under the consolidation tax cost setting rules when the subsidiary member leaves the group.
11. The object of the consolidation tax cost setting rules in Part 3-90 that apply when a subsidiary member leaves a consolidated group or MEC group, is to preserve the alignment between the head company's cost for its shares in entities and the entities' assets that is established by the tax cost setting process when entities join the group (that is, become members of the group).[5] Broadly the alignment is achieved by the cost of the shares reflecting the cost of the leaving subsidiary member's assets reduced by the amount of its liabilities.[6]
12. This has the result that the capital gain or capital loss on disposal of the shares in a subsidiary member reflects the gains or losses in respect of the underlying assets held by the member at the time it leaves the group. The legislation giving effect to this scheme is outlined in the following paragraphs.
13. Under subsection 701-1(1) (the 'single entity rule' or SER), an entity that is a subsidiary member of a consolidated group or MEC group for a period is taken to be part of the head company of the group for that period for the 'head company core purposes' and 'entity core purposes' set out respectively in subsections 701-1(2) and (3).
14. One effect of the SER is that the existence of shares in the subsidiary member is disregarded for the head company's core purposes[7] during the period it is a member of the consolidated group or MEC group. The tax costs of the shares in a subsidiary member are set under subsection 701-15(3) just before the member leaves the group.
15. Subsection 701-15(3) sets the tax cost of each share to its 'tax cost setting amount'. This amount, worked out under section 701-60 and Division 711, is arrived at (broadly) by reducing the sum of the costs[8] of the leaving subsidiary member's assets by the amount of the liabilities of the member and allocating the result amongst the shares (and any other membership interests).
16. Subsection 701-55(5) then applies so that if the capital gains tax provisions[9] are to apply to the shares, they operate as if the head company's cost base or reduced cost base of each share in the subsidiary member just before it leaves the group is its tax cost setting amount. The cost base or reduced cost base of the shares thus determined is used to work out the amount of any capital gain or capital loss to the head company on disposal of the shares.
17. In this context, none of the actual elements of what, but for the SER, would have been the cost base or reduced cost base of the head company's shares in the leaving subsidiary member if they were recognised before the tax cost setting process, have a role to play in working out the amount of any capital gain or capital loss of the head company on disposal of the shares. The cost base and reduced cost base of the shares just before the subsidiary member leaves the group are determined strictly according to the provisions mentioned in paragraphs 15 and 16 of this draft Determination.
18. Therefore, the incidental costs mentioned in paragraph 1 of this draft Determination, which the head company incurred before the subsidiary member left the group, in disposing of the shares in the subsidiary member to a non-group entity, are not included in the head company's cost base or reduced cost base of the shares. Further, the incidental costs do not fit the description of any amount that forms part of the calculation of a capital gain or capital loss from any other CGT event.
19. As a result, paragraph 40-880(5)(f) does not prevent to any extent the deduction, under section 40-880, of incidental costs described in subsection 110-35(2) that the head company of a consolidated group or MEC group incurs, in disposing of shares in a subsidiary member to a non-group entity, before the member leaves the group.
20. However, it does not follow that the incidental costs are deductible under section 40-880: that will depend on the facts of each case and whether the other requirements under that section are met.
Appendix 2 - Your comments
21. You are invited to comment on this draft Determination. Please forward your comments to the contact officer by the due date.
22. A compendium of comments is also prepared for the consideration of the relevant Rulings Panel or relevant tax officers. An edited version (names and identifying information removed) of the compendium of comments will also be prepared to:
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- provide responses to persons providing comments; and
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- publish on the Tax Office website at www.ato.gov.au
Please advise if you do not want your comments included in the edited version of the compendium.
| Due date: | 7 August 2009 |
| Contact officer details have been removed following publication of the final ruling. | |
Footnotes
All legislative references are to the ITAA 1997 unless otherwise indicated.
That is, ($100,000 + $500,000 - $160,000) / 2,000. See sections 701-15 and 701-60, Division 711 and subsection 701-55(5).
That is, 2,000 x ($350 - $220). See section 104-10.
Section 104-10.
Subsection 711-5(2).
Subsection 711-5(3).
Paragraph 2.9 of the Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No. 1) 2002.
More precisely, the head company's 'terminating values' for the assets as defined in section 711-30.
That is, Parts 3-1 or 3-3.
Not previously issued as a draft
References
ATO references:
NO 2009/2327
Related Rulings/Determinations:
TR 2006/10
Subject References:
blackhole expenditure
capital expenditure
capital gains tax
CGT cost base
consolidation
cost setting rules
leaving entity
membership interest in an entity
single entity rule
tax cost setting rules
Legislative References:
ITAA 1997
ITAA 1997 40-880
ITAA 1997 40-880(5)(f)
ITAA 1997 Pt 3-1
ITAA 1997 Pt 3-3
ITAA 1997 104-10
ITAA 1997 110-35(2)
ITAA 1997 Pt 3-90
ITAA 1997 701-1(1)
ITAA 1997 701-1(2)
ITAA 1997 701-1(3)
ITAA 1997 701-15
ITAA 1997 701-15(3)
ITAA 1997 701-55(5)
ITAA 1997 701-60
ITAA 1997 Div 711
ITAA 1997 711-5(2)
ITAA 1997 711-5(3)
ITAA 1997 711-30
Other References:
Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No. 1) 2002