Senate

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

General outline and financial impact

Consolidated groups

The consolidation measure represents a significant change to the taxation of corporate groups. Due to its magnitude, the measure is being enacted progressively via a series of bills. Schedule 1 of the Consolidation Bill introduced on 16 May 2002 contained most of the key elements of the measure. Those key elements are supplemented by the amendments to the consolidation measure contained in this bill which include:

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transitional cost setting rules for the first years of the measure;

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modifications to the general cost setting rules where an existing group forms a consolidated group;

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the treatment of attribution accounts held in relation to interests in foreign entities;

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the transfer and pooling of foreign tax credits; and

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a number of technical amendments and refinements to the Consolidation Bill introduced on 16 May 2002 to address issues raised through consultation.

Date of effect: The consolidation measure will allow wholly-owned entity groups to choose to consolidate under this regime from 1 July 2002. The existing grouping provisions will continue to operate in parallel with the consolidation regime until 1 July 2003, subject to special rules applying to consolidated groups with a head company that has a SAP. In general, such SAP groups will retain access to grouping provisions until the date of consolidation, provided that the head company chooses to consolidate from the first day of their next income year, commencing after 1 July 2003.

Proposal announced: The proposals were announced in Treasurer's Press Release No. 58 of 21 September 1999. The consolidation elements in this bill were foreshadowed in Minister for Revenue and Assistant Treasurer's Press Release No. C59/02 of 16 May 2002.

Financial impact: The consolidation measure is expected to cost approximately $1 billion over the forward estimate period as follows:

Further explanation of this impact was provided in the explanatory memorandum to the Consolidation Bill introduced on 16 May 2002.

Compliance cost impact: The amendments in this bill are integral to the consolidation measure which is expected to reduce ongoing compliance costs by ensuring that:

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intra-group transactions are ignored for taxation purposes, so that taxation and accounting treatments are more closely aligned;

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administrative requirements, such as multiple tax returns and multiple franking account, losses, foreign tax credit and PAYG obligations are reduced; and

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integrity measures aimed at preventing loss duplication, value shifting or the avoidance or deferral of capital gains within groups do not apply within a consolidated group.

The consolidation regime will necessitate some initial up-front costs for groups as they familiarise themselves with the new law, update software and notify the ATO of a choice to consolidate. Large corporate groups may incur greater start-up costs in determining the market values of group assets. These costs will be alleviated by a transitional measure under which the group can elect (prior to 1 July 2003) to bring assets into the group at their existing cost bases. Groups that form after the transitional period may use the market value guidelines developed by the ATO to minimise compliance costs.

Summary of regulation impact statement

Regulation impact on business

Impact: Medium to high.

Main points:

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The consolidation provisions included in this bill supplement those contained in the Consolidation Bill introduced on 16 May 2002. Further provisions are scheduled for introduction later this year.

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The impacts of the consolidation measure, which will allow wholly-owned entity groups to choose to consolidate from 1 July 2002, were fully explained in Chapter 14 of the explanatory memorandum to the Consolidation Bill introduced on 16 May 2002.

Imputation treatment of exempting entities

This bill also provides consequential amendments to the provisions currently referred to in the taxation laws as the 'exempting and former exempting company provisions'. The Imputation Bill introduced into Parliament core rules for the new simplified imputation system. As a result of the introduction of that bill, certain consequential amendments are required to other areas of the imputation system not covered by those rules, including the exempting and former exempting company provisions. This bill makes those amendments.

Date of effect: Broadly speaking, the measure applies from 1 July 2002.

Proposal announced: The amendments are consequential to the Government's decision to implement the simplified dividend imputation proposal. This proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 as a component of the unified entity regime. On 14 May 2002, the Minister for Revenue and Assistant Treasurer announced in Press Release No. C57/02, the Government's program for delivering the next stage of business tax reform measures. In that press release, the Minister confirmed that the simplified imputation system will commence on 1 July 2002.

Financial impact: The new imputation system will have no revenue impact.

Compliance cost impact: The new imputation system is designed to reduce compliance costs incurred by business by providing for simpler processes and increased flexibility.

General value shifting regime

This bill introduces a general value shifting regime (GVSR). The regime applies mainly to interests in companies and trusts that are not consolidated, but meet control or common ownership tests. The GVSR replaces the share value shifting and asset stripping rules currently in the income tax law.

Entities dealing at arm's length or on market value terms are generally excluded from the GVSR.

This bill also makes amendments to the loss integrity measure to allow the optional use of global asset valuations for calculating unrealised gains and unrealised losses in Subdivisions 165-CC and 165-CD.

A special value shifting rule is introduced into Subdivision 165-CD to maintain its integrity where global valuations are used.

Date of effect: The GVSR applies to value shifts that happen on or after 1 July 2002, unless they happen under an arrangement or scheme entered into before 27 June 2002.

The loss integrity change to allow global asset valuation applies to calculations for changeover times and alteration times from 11 November 1999. The global valuation approach is optional and will not disadvantage taxpayers in terms of the current law. A transitional rule will ensure that the new value shifting rule in Subdivision 165-CD cannot disadvantage taxpayers in respect of alteration times that happen before Royal Assent.

Proposal announced: The GVSR proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 (Attachment K), with further details announced in Treasurer's Press Release No. 16 of 22 March 2001. The proposal in this bill was further foreshadowed in the Minister for Revenue and Assistant Treasurer's Press Release No. C57/02 of 14 May 2002.

The loss integrity change to allow global asset valuation has not been previously announced.

Financial impact: The gain to revenue for the GVSR is estimated to be:

The loss integrity change to allow global asset valuation is not expected to have any significant impact on revenue.

Compliance cost impact: A small to moderate increase in compliance costs for the GVSR is expected for most taxpayers affected by the measure, at least initially. In general, the de minimis rules and safe-harbours will assist in keeping compliance costs down.

In some instances the low value transaction exclusions and safe-harbours in the new law will mean a reduction in compliance costs for some taxpayers as compared with the existing law. Also, those entities that consolidate will not be subject to the GVSR.

In particular cases, the loss integrity changes to allow global asset valuation are expected to result in a significant reduction in compliance costs.

Summary of regulation impact statement

Regulation impact on business

Impact: The GVSR implements a generalised regime to replace the current value shifting rules which are deficient in many respects. The GVSR will apply to a wider range of entities, as well as to a wider range of transactions. In some instances the exclusions for low value transactions and safe-harbours will mean that taxpayers affected by the current rules will not be affected by the GVSR.

The loss integrity change to allow global asset valuation is expected to have a significant impact in reducing compliance costs in particular cases as the savings in valuation costs if assets are valued together rather than individually. The special value shifting rule required to preserve the integrity of Subdivision 165-CD may result in a small increase in compliance costs. This is because of the need to identify the removal of value from the company by particular means (e.g. certain distributions or transfers of assets to associates at undervalue). The net reduction in compliance costs is expected to be significant. The global valuation approach will also assist cost setting under the consolidation rules where affected entities have been subject to the loss integrity measures.

Main points:

General value shifting regime

There are taxpayers not subject to the current value shifting rules that will be subject to the GVSR:

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Controllers and associates that hold equity or loan interests in controlled trusts will be subject to the direct value shifting rules - however the 'interests' of mere objects in discretionary trusts are not subject to value shifting adjustments.

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Controllers and associates that hold equity or loan interests in controlled companies or trusts that are not covered by the asset stripping rules in the current law.

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Common owners that hold interests in closely-held companies or trusts that satisfy common ownership tests with other closely held companies or trusts.

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In some cases involving closely-held entities, persons with interests in entities who do not form part of a control or common ownership framework that actively participate in a value shifting scheme.

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Taxpayers who create rights over assets at less than market value in favour of their associates, and then sell the assets (or replacement assets) at reduced values for losses.

Taxpayers affected by the rules will need to make appropriate adjustments to account for the effect of value shifting transactions on the values of their assets to ensure that inappropriate gains and losses do not arise on the realisation of those assets. There may be some changes in the behaviour of entities subject to the GVSR who may choose to deal at arm's length, at market value, or within safe-harbours provided, to avoid the need to make adjustments.

Some taxpayers affected by the current value shifting rules will not be subject to the GVSR:

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Interest holders affected by an indirect value shift that can satisfy the CGT small business taxpayer $5 million net asset test or that are eligible to participate in the STS.

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Entities with interests in consolidated group members whose values for tax purposes are reconstructed under consolidation rules.

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No adjustments will be required for interest holders affected by small value shifts.

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On a practical level, many of the new rules are loss-focused and adjustments will only be required if an interest is realised at a loss.

Loss integrity

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A choice will be available to use global asset valuations for calculating unrealised losses in Subdivision 165-CD. This will enable compliance costs, especially valuation costs, to be lowered in circumstances where individual asset valuations are difficult or costly to perform. The approach will be optional and individual asset valuations may continue to be done if required.

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The choice will be available for alteration times happening from 11 November 1999, thereby allowing maximum compliance cost savings vis--vis the individual asset approach contained in the current law.

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A specific value shifting rule will, on an ongoing basis, preserve the integrity of Subdivision 165-CD even though some unrealised gain in value may be included in a global asset valuation at an alteration time. There will be some compliance costs involved in determining whether an adjustment is required if an interest in the company is later sold at a loss. However, in net terms, the reduction in valuation is expected to exceed by a considerable margin, in most cases, any additional costs of the value shifting rule.

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The value shifting rule will have a transitional application for alteration times that happen before this bill receives Royal Assent. Broadly, there will be no requirement specifically to examine whether value has been removed from the company after the alteration time. Any method by which a reasonable conclusion may be drawn that the later realised loss on the interest does not, or could not, duplicate an unrealised loss on an asset at the alteration time, will be sufficient to avoid an adjustment.

Demerger relief

Schedule 16 to this bill inserts into the ITAA 1997 and the ITAA 1936:

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a CGT roll-over and a dividend exemption for owners in the head entity of a demerger group; and

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a CGT exemption for the members of a demerger group,

where a demerger group divests itself of at least 80% of its interests in a demerger subsidiary to the interest owners of the head entity.

Date of effect: 1 July 2002.

Proposal announced: Treasurer's Press Release No. 16 of 22 March 2001. Further details were announced in Minister for Revenue and Assistant Treasurer's Press Release No. C40/02 of 6 May 2002.

Financial impact: Unquantifiable. Details of the financial impacts are included in the table (under Revenue costs) in the regulation impact statement which appears in Chapter 16.

Compliance cost impact: Details of the compliance cost impacts are included in the regulation impact statement which appears in Chapter 16.

Amendments to this measure are required to deal with its interaction with other tax regimes and to address issues raised during consultation. These amendments are planned to be introduced at the earliest opportunity.

Summary of regulation impact statement

Regulation impact on business

Impact: Low to medium.

Main points:

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The initial and ongoing compliance costs that may be incurred depend on the structure of the demerger group.

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The measure has the support of industry who have been consulted on the detail of the measure.

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The net benefit of this measure is to remove the taxation impediments to business reorganisations by way of a demerger and to ensure that the taxation consequences for owners does not unnecessarily drive the choice of structure in which business should operate.