House of Representatives

Explanatory Memorandum

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

Chapter 5 - Cost setting rules

Outline of chapter

5.1 The rules explained in this chapter deal with assets of subsidiary entities that join or leave a consolidated group. The costs for income tax purposes of the assets of an entity are reset upon its becoming a subsidiary member of a consolidated group. The costs are reset so that they reflect the cost to the group of acquiring the entity. When an entity ceases to be a subsidiary member of the group, the group is recognised as having a cost for the membership interests in the subsidiary. This cost is equal to the groups cost for the net assets of that entity.

5.2 This chapter explains the rules for:

•

a subsidiary entity joining an existing consolidated group (contained in Subdivision 705-A); and

•

subsidiary entities leaving a consolidated group (contained in Division 711).

5.3 The chapter also contains illustrative examples of applications of those rules.

5.4 The cost setting rules explained in this chapter are to be modified in the case of a MEC group. The modifications are to be contained in a later bill.

Context of reform

5.5 The treatment of assets of entities joining a consolidated group is based on the asset-based model discussed in A Platform for Consultation and recommended by A Tax System Redesigned .

5.6 This model dispenses entirely with income tax recognition of separate entities within a consolidated group. It treats a consolidated groups cost of acquiring a subsidiary entity as the cost to the group of acquiring the assets of that entity. A groups cost of acquiring an entity includes the liabilities of the entity that become liabilities of the group. This cost also includes the liabilities that the acquired entity owes to existing members of the acquiring consolidated group.

5.7 A consolidated groups cost for membership interests in a subsidiary member when it leaves a consolidated group is determined based on the cost to the group for the net assets of the subsidiary.

5.8 This treatment of the acquisition and disposal of subsidiary entities by a consolidated group prevents the double taxation of gains and duplication of losses arising within the group and allows for assets to be transferred between members of the group without requiring cost base adjustments to address value shifting.

Summary of new law

An entity joining an existing consolidated group

5.9 When an existing consolidated group completes the acquisition of an entity that is eligible to become a member of a consolidated group, the acquired entity becomes a subsidiary member of the consolidated group and the cost of acquiring the entity (allocable cost amount) is treated as the cost to the group of the entitys assets. The groups cost for each of the assets is worked out by allocating the allocable cost amount for the acquired entity among the entitys assets. The groups cost for each asset, worked out in this way, provides the basis for determining the cost of the asset to the group for CGT, trading stock and capital allowance purposes.

5.10 A consolidated groups allocable cost amount for a joining entity consists of the groups cost of acquiring the membership interests in the joining entity and the amount of liabilities of the joining entity at the joining time. The allocable cost amount also reflects certain retained earnings, distributions, losses and entitlements to future deductions of the joining entity.

5.11 The case of a single entity becoming a subsidiary member of a consolidated group provides the basic rules for determining the cost of the assets of a joining entity to a consolidated group. Other cases, including the initial formation of a consolidated group, will operate by modifying these rules.

Pre-CGT status

5.12 The pre-CGT status of assets is unaffected by the entities, holding those assets, joining or leaving a consolidated group. The pre-CGT status of membership interests in an entity joining a consolidated group is preserved by transferring it to the assets the entity brings to the group. The assets do not themselves acquire pre-CGT status but are attributed a factor that results in recognition of pre-CGT status for membership interests in an entity that leaves the group with those assets.

Entities leaving a consolidated group

5.13 Immediately before an entity leaves a consolidated group, the groups cost, for income tax purposes, of its membership interests in the leaving entity is set so that it reflects the cost to the group of the net assets of the leaving entity.

5.14 Where a leaving entity holds membership interests in one or more other subsidiary members of the group, those entities also will be ineligible to remain in the group. The rules for a single entity leaving are adapted to determine costs for membership interests in all such leaving entities and to provide each leaving entity with a cost for any membership interests it holds in other leaving entities.

Acquisition or disposal of an entity by a holding company is dealt with only as an acquisition or disposal of membership interests in the entity.

Detailed explanation of new law

A single entity joining an existing consolidated group

5.15 These rules for a single entity joining an existing consolidated group are the basic case of an entity joining a consolidated group. The rules for this case do not apply to:

•

group formation;

•

one consolidated group joining another consolidated group;

•

entities linked through membership interests joining a consolidated group in consequence of one of them joining; or

•

an entity joining an existing consolidated group where the entity is held by the head company through one or more non-resident entities.

[Schedule 1, item 2, section 705-15]

5.16 When an entity (the joining entity) becomes a subsidiary member of a consolidated group (the joined group) it is generally treated for income tax purposes as being a part of the head company.

5.17 The rules for a head company fall into 3 main parts:

•

allocation of the cost of acquiring a joining entity among the assets that the entity brings to the consolidated group (the groups costs for the assets of the joining entity - see paragraphs 5.18 to 5.53);

•

working out the cost of acquiring the joining entity (the allocable cost amount - see paragraphs 5.54 to 5.105);

•

preservation of unrealised losses relating to membership interests in a joining entity (see paragraphs 5.106 to 5.107); and

•

preservation of the pre-CGT status of membership interests in the joining entity (see paragraphs 5.108 to 5.113).

A groups cost for the assets of a joining entity

5.18 A joined groups cost of acquiring a joining entity is treated as the head companys cost of acquiring the assets of the joining entity. The head companys cost for each of the assets of the joining entity is set with effect from the time the entity becomes a subsidiary member of the group (the joining time). This overrides the groups inherited history of the joining entity insofar as that history would affect the head companys cost for each asset.

5.19 An asset, for the purposes of the cost setting rules, is anything of economic value which is brought into a consolidated group by an entity that becomes a subsidiary member of the group. This includes those assets which subsequently cease to be recognised as a consequence of the single entity rule whilst the asset is within the consolidated group.

5.20 The set cost for an asset (the tax cost setting amount) will be the relevant cost for all income tax purposes including for the purposes of the CGT, capital allowance and trading stock provisions.

5.21 The elements for setting a head companys cost for each asset are:

•

setting a cost for the retained cost base assets, by reference to their terminating value (see paragraphs 5.22 to 5.28);

•

setting a cost for the reset cost base assets (see paragraphs 5.29 to 5.53), taking account of special rules for:

-

goodwill (see paragraphs 5.34 to 5.36);

-

revenue assets (see paragraphs 5.37 to 5.41);

-

accelerated depreciation (see paragraphs 5.42 and 5.43);

-

over-depreciated assets (see paragraphs 5.44 to 5.52); and

-

order of application of restrictions and reductions (see paragraph 5.53).

Retained cost base assets

5.22 To simplify compliance, a head companys cost for certain assets (retained cost base assets) is set equal to the joining entitys cost for those assets.

5.23 A retained cost base asset is Australian currency or a right to receive a specified amount of Australian currency (other than a right that is a marketable security within the meaning of section 70B of the ITAA 1936) or an entitlement that is subject to a prepayment. However, assets that are Australian currency and that are trading stock or collectables of a joining entity are not retained cost base assets. [Schedule 1, item 2, subsection 705-25(5)]

5.24 The amount treated as a head companys cost for each retained cost base asset of a joining entity that is Australian currency or a right to receive Australian currency is the amount of Australian currency concerned. This will avoid the compliance costs that would arise in dealing with these assets if their cost was set at an amount that was different to their nominal value. [Schedule 1, item 2, subsection 705-25(2)]

5.25 If a retained cost base asset is a qualifying security within the meaning of Division 16E of Part III of the ITAA 1936, a head companys cost for it is the joining entitys terminating value for the security. This is an amount such that if the joining entity were to dispose of the security for that amount at the joining time, it would cause neither an amount to be added to the assessable income of, nor a deduction to be allowed to, the joining entity. [Schedule 1, item 2, subsection 705-25(3)]

5.26 If a retained cost base asset is an entitlement to a pre-paid service or other entitlement arising from a pre-paid amount, a head companys cost for it is the amount of the head companys entitlement to deductions in relation to the pre-paid amount arising because of the head companys inheritance of entitlements of the joining entity. [Schedule 1, item 2, subsection 705-25(4)]

5.27 If the total amount to be treated as a head companys cost for retained cost base assets of a joining entity exceeds the joined groups allocable cost amount for the joining entity, the head company of the consolidated group will make a capital gain equal to the excess. Rules to provide the CGT event under which the capital gain will arise will be included in a later bill.

Terminating value of an asset of a joining entity

5.28 The terminating valuesof assets of a joining entity are relevant for the head companys cost base for retained cost base assets that are qualifying securities within the meaning of Division 16E of Part III of the ITAA 1936 (see paragraph 5.25), revenue assets (paragraphs 5.38 and 5.39), accelerated depreciation assets (paragraph 5.42), and over-depreciated assets (paragraphs 5.47 and 5.48). A joining entitys terminating values for assets of different types are set out in Table 5.1. [Schedule 1, item 2, section 705-30]

Reset cost base assets

5.29 The allocable cost amount remaining after deducting an amount equal to a head companys set costs for the retained cost base assets of a joining entity is allocated among the reset cost base assets other than excluded assets. [Schedule 1, item 2, section 705-35]

5.30 A reset cost base asset is any asset that is not a retained cost base asset. An asset is an excluded asset if an amount has been deducted in respect of the asset when working out a head companys allocable cost amount for a joining entity. [Schedule 1, item 2, subsections 705-35(1) and (2)]

5.31 A head company is not attributed a cost for excluded assets (no allocable cost amount is allocated to them). This is because the allocable cost amount has already been reduced to take account of these assets (see paragraphs 5.96 to 5.102). [Schedule 1, item 2, subsection 705-35(2)]

5.32 An asset of the joining entity being a right to future tax deductions for a loss would be an excluded asset where an amount was subtracted for the loss in steps 5 or 6 in working out the allocable cost amount. Also, an asset being a right to a certain future tax deduction would be an excluded asset where an amount was subtracted for that deduction in step 2 or 7 in working out the allocable cost amount.

5.33 The amount set as a head companys cost for each reset cost base asset, other than excluded assets, of a joining entity is worked out in 3 steps:

•

step 1 - determine the joined groups allocable cost amount for the joining entity (discussed in paragraphs 5.54 to 5.105);

•

step 2 - the allocable cost amount is reduced by the total of the payments for the retained cost base assets. If the result of this step is zero (or would be a negative amount), then the amount treated as the head companys cost for each reset cost base asset is zero; and

•

step 3 - any remaining allocable cost amount is allocated to each of the joining entitys reset cost base assets in proportion to their market values. The amount allocated to each asset is the head companys cost for the asset for income tax purposes. If there are no reset cost base assets, the result of step 2 is instead treated as a capital loss of the head company. Rules to provide the CGT event under which the capital loss will be included in a later bill.

Example 5.1: Resetting costs for assets

On 1 July 2002, Head Co, the head company of a consolidated group, completed a staged acquisition of all of the membership interests in D Co. This causes D Co to join the consolidated group. At that time, D Cos assets are $100 cash (a retained cost base asset) and 2 reset cost base assets - Asset A (market value $300) and Asset B (market value $200).

The set costs for the assets brought into the group by D Co are worked out as follows:

First , the groups allocable cost amount for D Co is worked out. Suppose this is $500. (The difference between this cost ($500) and the market value of the assets ($600) would be accounted for by unrealised appreciation of the assets accruing to membership interests already held by Head Co before the completion of Head Cos acquisition of D Co.)

Secondly , Head Cos set cost for D Cos retained cost base asset (the $100 cash) is $100. The allocable cost amount ($500) is reduced by the set costs for the retained cost base assets ($100), leaving $400 for allocation to the reset cost base assets.

Finally , the $400 is allocated to the reset cost base assets in proportion to their market values. For Asset A, the amount allocated is $240 ($300 $500 $400). For Asset B, the amount allocated is $160 ($200 $500 $400).

Head Cos set costs for Asset A and Asset B are $240 and $160 respectively.

Goodwill

5.34 Any synergistic goodwill accruing to assets or businesses of a group, other than assets and businesses brought into the group by the joining entity, as a consequence of the groups ownership and control of the joining entity will be treated as a reset cost base asset of the joining entity. As for other reset cost base assets, this synergistic goodwill has an amount determined as its cost to the head company. This amount will determine the cost base of this goodwill for CGT purposes.

5.35 The market value of an entity can reflect its potential to add to the value of the existing assets of potential acquirers. Therefore, the market value of the whole of this goodwill can be taken as the amount of any excess of the market value of the joining entity at the joining time over the market value of the net identifiable assets of the joining entity at that time. It is, therefore, appropriate to treat all elements of this goodwill as reset cost base assets of the entity even though some of the added value may accrue to assets or businesses already owned by the joined group. [Schedule 1, item 2, subsection 705-35(3)]

Example 5.2: Goodwill

On 1 July 2002, Head Co, the head company of an existing consolidated group, acquired all of the membership interests in Z Co. This causes Z Co to join the consolidated group.

At that time, the market value of Z Cos net identifiable assets (excluding goodwill) is $1 million. However, the market value of Z Co is determined to be $1.5 million. At the time Z Co joins the consolidated group, goodwill with a market value of $500,000 is treated as one or more CGT assets of Z Co.

5.36 The treatment of goodwill when an entity leaves a consolidated group is discussed in paragraph 5.141.

Restriction on reset costs of revenue assets

5.37 The amount of the reset cost of a reset cost base asset may be restricted in certain circumstances. The restriction addresses the potential for unrealised capital losses to be converted to revenue losses when an entity joins a consolidated group. This can occur where assets still held by a joining entity have declined in value after the group it is joining purchased membership interests in it.

5.38 The restriction applies to reset cost base assets that, after the joining time, are effectively treated for income tax purposes on revenue account (e.g. trading stock and depreciating assets). [Schedule 1, item 2, subsection 705-40(2)]

5.39 The restriction applies where the reset cost worked out for the asset exceeds both the market value of the asset and the joining entitys terminating value for the asset (see paragraph 5.28). In these circumstances, the reset cost is reduced to the greater of those 2 amounts. [Schedule 1, item 2, subsection 705-40(1)]

5.40 The amount by which the reset cost is reduced is then allocated and added to each of the reset cost base assets whose reset cost has not been reduced under the restriction. The allocation is in proportion to the market values of those assets, except that the amount allocated to a revenue asset cannot cause its reset cost to exceed the limit specified in this section. [Schedule 1, item 2, subsection 705-40(3)]

Example 5.3: Capping reset costs for revenue assets

Headco, the head company of a consolidated group, purchased 90% of the membership interests in Ayco for $90 when Ayco had trading stock with a market value of $10 and land with a market value of $90. Subsequently the land declined in value and when Headco purchased the remaining membership interests, for $8, Ayco had trading stock with a market value of $20 and land with a market value of $60.

Upon the completion of the acquisition of Ayco, Ayco becomes a subsidiary member of Headcos consolidated group. Headcos allocable cost amount for Ayco is $98, comprised solely of the cost of acquiring the membership interests. If the allocable cost amount were allocated to the assets Ayco brings to the group in proportion to their market values, the reset costs for the assets would be:

Asset	Market Value ($)	Reset Cost ($)
Trading stock	20	25.50
Land	60	73.50
Total	80	98.00

However, the reset cost for trading stock cannot exceed the greater of its market value or Aycos terminating value for it. Supposing the market value is greater, this rule requires that the reset cost for the trading stock be reduced by $5.50. This amount can be added to the reset cost for the land. Headcos costs for the assets brought to the group by Ayco become $20 for the trading stock and $78 for the land.

5.41 If the reset costs for all of the reset cost base assets of a joining entity are reduced by the restriction, the head company of the joined group makes a capital loss equal to the total amount by which the allocable cost amount cannot be allocated. Rules to provide the CGT event under which the capital loss will arise will be included in a later bill.

Reduction in reset costs for accelerated depreciation assets

5.42 Retention by a head company of a joining entitys entitlement to accelerated depreciation for any of its depreciating assets is conditional upon the reset cost for the asset not being greater than the joining entitys terminating value (see paragraph 5.28).

5.43 In order to retain entitlement to accelerated depreciation for an asset, a head company can choose to reduce the reset cost for the asset to the joining entitys terminating value for that asset. Where this occurs, the excess reset cost amount is not allocated to other assets. [Schedule 1, item 2, section 705-45]

Over-depreciated assets and the intercorporate dividend rebate

5.44 In certain circumstances there may be a reduction to the amount of the reset cost that would otherwise apply to over-depreciated assets of a joining entity. An asset is over-depreciated at a particular time if there has been some depreciation (i.e. a reduction in its adjustable value) and its market value exceeds its adjustable value. The amount of over-depreciation of the asset is the excess of its market value over its adjustable value. [Schedule 1, item 2, subsection 705-50(6)]

5.45 The reduction applies to prevent an increase in the adjustable value of a depreciating asset where there has been tax deferral resulting from the over-depreciation of the asset. Without the reduction, the rules for consolidation would permit an increase in the adjustable value of an asset despite its over-depreciation resulting in tax deferral of indefinite duration.

5.46 The potential for indefinite deferral arises where a company held an asset that was over-depreciated and income sheltered from tax by over-depreciation was distributed as an unfranked dividend to a recipient that was entitled to the intercorporate dividend rebate. This can occur where such a company becomes a subsidiary member of a consolidated group and:

•

the asset is held continuously by the company until its joining time; and

•

the asset remains over-depreciated at the joining time.

This last condition is required because the over-depreciation of an asset continues to be a net shelter from income tax only so long as the asset continues to be over-depreciated. Over-depreciation of an asset can be diminished through time through deductions for depreciation that are lower than they would have been but for the earlier over-depreciation, or eliminated by a balancing adjustment on the disposal of the asset.

5.47 Consistent with the rationale outlined in paragraphs 5.45 and 5.46, a reduction in the payment for an asset applies where:

•

the reset cost for the asset (its cost for depreciation purposes) is more than its adjustable value to the joining entity at the joining time (the terminating value) [Schedule 1, item 2, paragraph 705-50(2)(a)] ;

•

the joining entity paid an unfranked or partly franked dividend during the period between when it acquired the asset and its joining time [Schedule 1, item 2, paragraph 705-50(2)(b)] ;

•

the dividends, to the extent they were unfranked, were paid out profits that were untaxed because of the over-depreciation of the asset, where the over-depreciation did not contribute to a tax loss that was deducted at step 5 in working out the allocable cost amount [Schedule 1, item 2, paragraph 705-50(3)(a)] ; and

•

an amount representing the unfranked dividend had not been paid, before the joining time, as a dividend to a recipient that was not entitled to the intercorporate dividend rebate [Schedule 1, item 2, paragraph 705-50(3)(b)] .

5.48 The amount of the reduction is the lesser of:

•

the amount of income that continues to be sheltered from tax; or

•

the amount by which the reset cost would, apart from this provision, exceed the joining entitys terminating value of the asset.

[Schedule 1, item 2, subsection 705-50(2)]

Example 5.4: Unfranked dividend and over-depreciated asset

T Co and U Co each contributed $50 to capitalise K Co. K Co applied the $100 to acquire a depreciating asset and generated cash flow income of $40. K Co claimed depreciation of $40 for income tax but its depreciation for financial reporting purposes was $10. After allowing for the deferred income tax liability of $9 (30% of ($40 - $10), K Co had an after-tax profit of $21 ($40 - $10 - $9). This enabled K Co, before 30 June 2001, to pay an unfranked dividend of $21 shared equally between T Co and U Co. K Co then became inactive and did not claim any further depreciation before 1 July 2002. On 1 July 2002 T Co formed a consolidated group and immediately afterwards it purchased U Cos stake in K Co for $50 (representing 50% of $100, that is, the market value of K Cos depreciating asset ($90) plus K Cos cash ($19) less K Cos deferred tax liability for its over-depreciated asset ($9)).

T Co does not elect under the transitional measures to reset the cost for K Cos assets (under the transitional provisions, for which legislation is being prepared). T Cos allocable cost amount for K Co is $109, which is comprised its cost for membership interests ($100) and K Cos deferred tax liability for the depreciable asset ($9). This allocable cost amount is allocated $19 to K Cos cash (a retained cost base asset) and, in the first instance, $90 for the depreciating asset.

The reduction to the reset cost for the depreciating asset to limit tax deferral would be the lesser of:

•

the over-depreciation at K Cos joining (i.e. $30 ($90 - $60)); and

•

the unfranked part of the dividends paid by K Co which satisfy the conditions in paragraphs 705-45(2)(b) to (d) (i.e. $21),

but not with the effect of reducing the reset cost below K Cos terminating value for the asset (i.e. $60).

In this case, reset cost for the depreciating asset is reduced from $90 to $69.

As a transitional measure (for which legislation is being prepared), T Co can elect that an amount up to the $21 reduction be added back to the terminating value of this asset for the head company, for the purpose of determining the deemed payment for the purchase of membership interests in an entity that owns the asset when it leaves the consolidated group.

5.49 A reduction in the reset cost may also apply where an asset has been received by a joining entity subject to rollover and the transferor paid dividends that were sheltered from tax because of over-depreciation of the asset in its hands. [Schedule 1, item 2, subsection 705-50(4)]

5.50 A reduction may also apply in relation to an asset held by a joining entity where:

•

the asset had been an over-depreciated asset of another consolidated group that formed before 1 July 2004 (this date is to be specified in the transitional rules - legislation for the transitional rules will be included in a later Bill);

•

because of a choice made under the transitional rules, some or all of the original reduction for over-depreciation was added back for the purpose of working out the groups original cost for its membership interests when the joining entity left the other consolidated group;

•

the asset was held by the joining entity when it left the other consolidated group and was continuously held by the joining entity from the time it left the other consolidated group until the joining time; and

•

the asset was over-depreciated at the current joining time.

5.51 The amount of any reduction in this case is the lesser of:

•

the amount of the prior reduction that was added back when the joining entity left the original consolidated group; or

•

the amount of over-depreciation at the current joining time.

[Schedule 1, item 2, subsection 705-50(5)]

5.52 In the circumstances outlined in paragraph 5.51, the income originally sheltered from tax may not be taxed to the original consolidated group when it disposes of the entity holding the asset. This is because the group is able to elect, under transitional rules, to use a terminating value for the asset that disregards adjustments for sheltered income in determining the groups deemed payment for the membership interests in the leaving entity. Therefore, to limit the tax deferral, adjustments for income sheltered from tax may still be required when the joining entity joins the latter consolidated group.

Order of application of provisions

5.53 The resetting of the cost for a depreciating asset could be subject to more than one of:

•

the restriction on reset costs of revenue assets (see paragraphs 5.37 to 5.41;

•

the reduction in reset costs for accelerated depreciation assets (paragraphs 5.42 and 5.43); and

•

the adjustment for over-depreciated assets (paragraphs 5.44 to 5.52).

When this occurs, different sequences in applying these provisions can produce different outcomes. In all cases the outcome that is most favourable to the consolidated group is consistent with the policy objectives of the provisions. However, the sequence in applying the provisions that is most favourable to a consolidated group can vary according to the specific circumstances. For this reason, provision has been made that the head company can choose the sequence in which these provisions apply. If the head company does not make a choice, the provisions apply in the sequence in which they appear in the legislation. [Schedule 1, item 2, section 705-55]

What is a joined groups allocable cost amount for a joining entity?

5.54 A joined groups allocable cost amount for a joining entity determines the aggregate of the reset cost for assets of the joining entity to the joined group. The amount reflects the cost to the joined group of acquiring the joining entity (see discussion of the cost setting rules in Chapter 2). That cost consists of the groups cost of acquiring the membership interests in the joining entity and the liabilities of the joining entity at the joining time. Adjustments are made to reflect certain undistributed profits, distributions, deductions and losses of the joining entity.

5.55 A joined groups allocable cost amount for a joining entity is worked out in 7 steps which are discussed in paragraphs 5.56 to 5.105 [Schedule 1, item 2, section 705-60] . Where a consolidated group acquires the whole of the membership interests in an entity in a single transaction (a non-incremental acquisition), only steps 1, 2, 6 and 7 can apply. Steps 3, 4 and 5 make adjustments to the allocable cost amount for profits that accrue, distributions made and losses that accrue to membership interests that are continuously owned by the acquiring consolidated group prior to the joining time. Therefore, these steps only apply where the acquisition of membership interests in an entity by a consolidated group occurs over time (an incremental acquisition). Steps 3 to 5 can also apply where there is an interval of time between the formation of a wholly-owned group that is eligible to form a consolidated group and the time from which the head company chooses that the group be taxed as a consolidated group (deferred consolidation).

Step 1: Determine the cost of membership interests in the joining entity

5.56 The first step in determining a groups allocable cost amount for a joining entity is to add up the costs for all of the membership interests in a joining entity that are held by members of the group joined. The cost used for each membership interest is the amount that would be the cost (the relevant cost) for determining the CGT outcome if the membership interest were disposed of at the joining time. This amount reflects part of the groups cost of acquiring the joining entity.

5.57 If, at the joining time, the market value of a membership interest is greater than or equal to its cost base, the cost base is the relevant cost. Otherwise, the relevant cost is the greater of the market value of the interest or the reduced cost base of the interest. [Schedule 1, item 2, subsection 705-65(1)]

5.58 This single cost base will limit the circumstances where assets of a consolidated group will have a reduced cost base that is different from their cost base.

5.59 No amount is to be added for indexation when determining the cost base of pre-CGT membership interests. A joined groups pre-CGT status for membership interests is preserved within consolidation (see paragraphs 5.108 to 5.113). [Schedule 1, item 2, subsection 705-65(2)]

5.60 Where, at the joining time, there are outstanding cost base adjustments for membership interests, the cost base to be used when recognising a single cost for membership interests is the cost base after making those adjustments. The cost base adjustments may be required because of, for example, an earlier loss or asset transfer or a value shift. [Schedule 1, item 2, subsection 705-65(3)]

5.61 As these outstanding cost base adjustments are brought to account at the joining time, the adjustments will have no further application in relation to membership interests in the joining entity. [Schedule 1, item 2, subsection 705-65(4)]

5.62 Examples of provisions under which relevant cost base adjustments may be required at the joining time are set out in Table 5.2.

5.63 The reduced cost base of a membership interest should be increased by any reduction to this cost base previously made under subsection 110-55(7) for distributions of certain profit. This is done in order to prevent this adjustment being made twice, because the allocable cost amount is also reduced in step 4 for any distributions of profit in excess of profits accruing directly or indirectly to the head company (see paragraphs 5.86 and 5.87). [Schedule 1, item 2, subsection 705-65(5)]

5.64 An existing group members cost of acquiring a right or option (issued by a joining entity) to acquire membership interests in the joining entity is also counted as part of the groups cost of acquiring the membership interests of the joining entity. [Schedule 1, item 2, subsection 705-65(6)]

Step 2: Add liabilities of the joining entity

5.65 The second step in determining a groups allocable cost amount for a joining entity is to add amounts that are the joining entitys liabilities in accordance with accounting standards or statements of accounting concepts made by the Australian Accounting Standards Board. A joining entitys liabilities reflect part of the cost to the group of acquiring the joining entity, because:

•

liabilities the joining entity owed to third parties become liabilities of the consolidated group (which includes the joining entity); and

•

liabilities that the joining entity owed to existing members of the consolidated group cease to be assets of the group.

5.66 The amount is worked out by adding up all of a joining entitys liabilities at the joining time that, in accordance with accounting standards or statements of accounting concepts made by the Australian Accounting Standards Board, can or must be identified in the entitys statement of financial position. [Schedule 1, item 2, subsection 705-70(1)]

5.67 SAC 4: Definition and Recognition of the Elements of Financial Statements (March 1995) defines liabilities to be the future sacrifices of economic benefits that the entity is presently obliged to make to other entities as a result of past transactions or other past events. Aside from satisfying the definition of liability, recognition criteria must also be satisfied. In accordance with SAC 4, a liability should be recognised in the statement of financial position when and only when:

(a)

it is probable that the future sacrifice of economic benefits will be required; and

(b)

the amount of the liability can be measured reliably.

5.68 The accounting standards and statements of accounting concepts may not apply to all entities. However, if an entity joins a consolidated group then it is necessary to identify the relevant liabilities by reference to those liabilities that can or must be identified under the accounting standards or statements of accounting concepts. This requirement enables consistent rules to be applied in determining the allocable cost amount for all entities that join a consolidated group.

5.69 An amount is not to be added as a liability if it arises because of a joining entitys ownership of an asset where, on disposal of the asset, the liability will transfer to the new owner. The amount of such a liability should be taken into account in working out the market value of the asset when allocating the allocable cost amount for the joining entity to the assets of the joining entity. An example of such a liability would be a liability to rehabilitate a mine site, where under legislation or license, the liability will transfer to the new owner on disposal of the mine. [Schedule 1, item 2, subsection 705-70(2)]

5.70 If some or all of a liability will be a deduction to the head company when the liability is discharged, the amount of the liability to be taken into account is reduced by the amount that will be a deduction multiplied by the general company tax rate. This is so that only the net cost to the group of the liability is taken into account as a cost of acquiring the entity. [Schedule 1, item 2, subsection 705-75(1)]

5.71 The amount taken into account for a liability of a joining entity which is a debt or other liability owed to the joined group is affected by the market value of the asset (reflecting the liability) owned by the joined group. If the market value is equal to or more than the groups cost base for the asset, the amount to be added is the groups cost base. If the market value is less than or equal to the groups reduced cost base, the amount to be added is the groups reduced cost base. If the market value falls between the groups cost base and reduced cost base, the amount to be added is the market value of the asset. [Schedule 1, item 2, subsection 705-75(2)]

5.72 If a liability of a joining entity is a pre-CGT asset of an existing member of a joined group, an amount is not added for indexation in determining the members cost base for the asset (see paragraph 5.59). Also, if any adjustments would be made, under existing provisions of the income tax law, to the members cost base or reduced cost base if the member were to dispose of its asset (the liability of the joining entity), those adjustments are made where the cost base or reduced cost base is taken into account for working out the groups step 2 amount for the liability. These rules correspond to rules for determining a groups cost base and reduced cost base for membership interests in a joining entity (see paragraphs 5.60 to 5.62) [Schedule 1, item 2, subsection 705-75(3)]

5.73 Where a liability, or a change in the amount of a liability, is taken into account, under generally accepted accounting principles, sooner than occurs for income tax and if the liability were taken into account at the earlier time for income tax this would cause the allocable cost amount to be different, the amount of the liability is adjusted for the purposes of step 2. The amount of the adjustment is the amount required to cause the allocable cost amount to be the amount that it would be if the liability were taken into account for income tax purposes at that earlier time. Examples of such liabilities are employees accrued entitlements to paid leave and liabilities that are designated in a foreign currency. [Schedule 1, item 2, subsection 705-80(1)]

Example 5.5: Increase in the amount of a liability recognised for accounting but not for income tax

M Co, the head company of a consolidated group, acquires 80% of the membership interests in N Co for $800 when N Cos only asset is the goodwill of a business which has a market value of $1,000. After operating for an income year, N Co breaks even on cash account but accrues a liability of $100 for employees accrued leave entitlements. Assuming a company tax rate of 30%, N Co recognises a deferred tax asset of $30 (30% of $100) in respect of the liability for employees leave entitlements. M Co then acquires the remaining 20% of the membership interests in N Co for $186 (20% (1,000 + 30 - 100)), the market value of N Cos goodwill still being $1,000. N Co then becomes a member of M Cos consolidated group.

If M Cos allocable cost amount for N Co were worked out disregarding the adjustment for differences in the time a liability is taken into account for general accounting purposes and for income tax, the allocable cost amount would be $1,056, comprised of $986 for the cost base of membership interests (step 1 in working out the allocable cost amount) and $70 for liabilities (the after-tax value of the liability for employees leave - step 2).

However, if the liability were taken into account for income tax at the same time as for general accounting, N Co would have a carry-forward tax loss of $100 at the joining time. M Cos allocable cost amount for N Co, worked out under this assumption, would be $1,000, comprised $986 for the cost base for membership interests (step 1), plus $100 for liabilities (the full amount of the liability for employees entitlements is added at step 2 as the deduction for income tax has already been claimed), less $80 for an owned loss (80% of $100 at step 5) and less a further $6 for an acquired loss (30% of ($100 - $80) at step 6).

Therefore, for working out the allocable cost amount, the amount for the liability for employees leave is reduced by $56. The allocable cost amount is, then, $1,000, made up of $986 for cost of membership interests (step 1) and $14 for liabilities of the joining entity (step 2).

The whole of the allocable cost amount is allocated to the goodwill. No amount is allocated to the deferred tax asset consisting of the entitlement to a deduction for the employees leave as it is an excluded asset - because an amount was deducted for the future tax deduction at step 2.

Example 5.6: Decrease in the amount of a liability recognised for accounting but not for income tax

S Co, the head company of a consolidated group, acquires 90% of the membership interests in T Co for $9 when T Co has assets with a market value of $100 and a foreign currency liability with an Australian currency value of $90. During the remainder of its income year, T Co has neither taxable income nor a tax loss and, due to a movement in the exchange rate, the Australian currency value of its foreign exchange liability decreases to $80. S Co then acquires the remaining membership interests in T Co for $1.70 (T Co has an asset with a market value of $100, a foreign exchange liability with an Australian currency value of $80 and an exposure to income tax of $3 - assuming a 30% company tax rate - on the decline in the Australian currency value of the foreign exchange liability) and T Co becomes a subsidiary member of S Cos consolidated group.

If S Cos allocable cost amount for T Co were worked out without regard to the adjustment for differences in the time at which the change in the value of the foreign exchange liability is taken into account for general accounting and for income tax, the allocable cost amount would be $93.70, comprised of:

•

$10.70 for cost base for membership interests (step 1 in working out allocable cost amount); plus

•

$83.00 for liabilities (step 2 - $80 for the foreign currency liability and $3 for the deferred tax liability).

Alternatively, if S Cos allocable cost amount for T Co were worked out assuming that changes in the foreign currency liability are taken into account for income tax at the same time as for general accounting, the allocable cost amount would be $100, comprised of:

•

$10.70 for cost base for membership interests (step 1); plus

•

$83.00 for liabilities ($80 for the foreign currency liability and $3 for income tax - step 2); plus

•

$6.30 for the portion of the frankable undistributed profits that accrued to S Cos continuously held membership interests in T Co (90% of $7 - step 3).

The allocable cost amount is $6.30 greater ($100 - $93.70) where the income tax treatment of the foreign currency liability is aligned with the general accounting treatment. Therefore, $6.30 is added to the amount of the liability for the purpose of working out S Cos allocable cost amount for T Co. The allocable cost amount is $100, comprised of:

•

$10.70 for cost base for membership interests (step 1 in working out allocable cost amount); and

•

$89.30 for liabilities (step 2 - $86.30 for the foreign currency liability and $3 for the deferred tax liability).

$6.30 of the $10 decline in the Australian currency value of the foreign exchange liability is added to the actual amount of the liability at the joining time because, if the liability had been realised just before the joining time, it would have caused an increase in the amount of frankable undistributed profits accruing to S Cos continuously held membership interests ($6.30 (90% $7)) added at step 3 - see paragraphs 5.80 and 5.85.

The outcome is that there is no change to the aggregate cost base for S Cos assets. This is appropriate as S Co has not realised any profits or losses for income tax purposes.

5.74 Where all of the historical information required for calculating the adjustment for differences in the time at which changes in the amounts of liabilities are taken into account for general accounting and income tax purposes is not available, the amount of the adjustment should be determined on the most reliable basis for estimation available. [Schedule 1, item 2, subsection 705- 80(2)]

5.75 Where there are employee shares in a joining entity that are disregarded in determining whether the joining entity is a wholly-owned subsidiary of the head company, those shares are treated as a liability of the joining entity at an amount equal to the market value of those shares at the joining time. [Schedule 1, item 2, subsection 705-85(1)]

5.76 The amount added at step 2 for disregarded employee shares will be reduced where the employee shares were issued after the joined group acquired membership interests in the joining entity. Part of these employee shares is not treated as liabilities because it represents part of the price paid by the head company for its interest in the assets of the joining entity which were subsequently paid to employees. The rule applies to the head companys contribution to the discount on the employee shares, that is, to the excess of the market value of the employee share interests over the consideration given for their acquisition by the employees. [Schedule 1, item 2, subsection 705-85(2)]

5.77 The amount of the reduction is determined by applying to the market value of each employee share at the time it was acquired by the employee the factor derived from the following formula:

where:

•

market value of head companys membership interests is the market value, just before the employee share interest was acquired by the employee, of any membership interests that the head company held, directly or indirectly in the joining entity, continuously from that time until the joining time.

•

market value of all membership interests is the market value of all membership interest in the joining entity just before the employee share interest was acquired.

Example 5.7: Employee shares

Headco, the head company of a consolidated group, owns 90%, by value, of the membership interests in Zedco when Zedco issues employee shares. The employees are not required to make any payment for the shares which have a value of $3 at their time of acquisition. Headco subsequently acquires the minority interests in Zedco apart from the employee shares. As the employee shares are not more than 1% of the ordinary shares in Zedco, Zedco becomes a subsidiary member of Headcos consolidated group (see paragraph 3.72).

Applying the formula for working out the factor gives:

90% * [($3-$0) / $3] = 0.9


The amount of the reduction for each share is $2.70 (0.9 $3).

If, at the joining time, the employee shares in Zedco have a market value of, say, $3.30, the amount to be added to the step 2 liability amount for each employee share would be $0.60 ($3.30 - $2.70).

5.78 Rights or options to acquire membership interests in a joining entity that were issued by the joining entity and are not held by a member of the joined group are treated as liabilities of the joining entity for the purpose of step 2 in working out the allocable cost amount. This is because the joined group will have to acquire these rights or options prior to them being exercised to preserve the entitlement of the joining entity to remain a subsidiary member of the consolidated group. The amount treated as a liability of the joining entity is the market value of the rights and options at the joining time. [Schedule 1, item 2, paragraph 705-85(3)(a)]

5.79 Specific provision is also made for treating debt interests covered by Subdivision 974-B as liabilities of a joining entity where those debt interests are regarded as equity interests for general accounting purposes. Specific provision is required because these debt interests are excluded from the definition of membership interests (see paragraph 3.68) but are not covered by the general definition of liabilities for step 2 in working out the allocable cost amount because they do not fall within the accounting definition of liabilities (see paragraphs 5.65 to 5.67). The amount to be included for these debt interests, at step 2 in working out the allocable cost amount, is their market value at the joining time. [Schedule 1, item 2, paragraph 705-85(3)(b)]

Step 3: Add undistributed, frankable profits accruing to the joined group

5.80 The third step in determining a groups allocable cost amount for a joining entity is to add the sum of fully franked dividends the head company would have received from the joining entity under specified hypothetical conditions. [Schedule 1, item 2, subsection 705-90(1)]

5.81 The hypothetical conditions are that:

•

the undistributed profits of the joining entity at the joining time (except profits that recouped losses that accrued to the joined group before the joining time) were distributed as dividends as they accrued;

•

the dividends were franked to the maximum extent that would be possible if income tax on the profits was paid as the profits accrued; and

•

entities interposed between the head company and the joining entity successively distributed any fully franked dividends they received immediately upon receiving them.

[Schedule 1, item 2, subsections 705-90(2) and (3)]

5.82 Whether a loss accrued prior to the joining time is identified by drawing a parallel between the loss and a profit that accrued to the joined group. [Schedule 1, item 2, subsections 705-90(4) and (5)]

5.83 Effectively, a loss that accrued to a joined group is so much of a tax loss, net capital loss or overall foreign loss of a joining entity that, as it accrued, accrued to membership interests held by members of the joined group. The membership interests held by members of the existing group may be either actual membership interests in the joining entity or indirect interests in the joining entity held through holding membership interests in other entities. The membership interests are only those that are held continuously by members of the joined group from when the loss accrued until the joining time.

5.84 The purpose of this step is, consistent with the imputation system, to prevent double taxation by allowing a consolidated group a cost for retained taxed or taxable profits that accrued to membership interests when the membership interests were held by the consolidated group (as can occur where there is an incremental acquisition of an entity). The groups allocable cost amount is spread across all of the joining entitys assets at the joining time, including assets that represent earnings whilst the group has held membership interests that have been retained in the entity. Therefore, not to add an amount for these retained earnings in the allocable cost amount would result in double taxation upon the disposal of those assets. The step is not intended to prevent the double taxation of profits derived under the classical system of company taxation that existed before the imputation system was introduced.

Example 5.8: Undistributed frankable profits

On 1 July 1998, Head Co subscribed $6 for 60% of the membership interests in X Co. On 1 July 2002, Head Co forms a consolidated group and acquires the remaining 40% of the membership interests in X Co for $32. At that time, X Co has taxed retained profits of $70, and one reset cost base asset with a cost base and market value of $80.

In the absence of any adjustment, Head Cos allocable cost amount for X Co would be $38, being the cost base of Head Cos membership interests in X Co ($6 + $32). The reset cost for the asset brought into the group by X Co would be $38. If this asset were subsequently sold for its market value ($80), a capital gain of $42 would be realised. The taxation of the capital gain would represent double taxation of the 60% of the $70 retained profits of X Co that accrued to Head Cos continuously held membership interests.

The adjustment under this step would increase the groups allocable cost amount in relation to X Co by $42 to $80. This would become the cost for tax purposes for the reset cost base asset brought into the group by X Co.

5.85 Historical records that would facilitate precise identification of the income tax payable on profits of a joining entity that were earned during a particular period may not be available to the group joined. Therefore, provision is made that the head company can use the most reliable basis for estimation that is available. Similar provision is made for estimation of the amount of a loss or a profit that accrued to a joined group during a period. [Schedule 1, item 2, subsection 705-90(6)]

Step 4: Subtract pre-joining time distributions of profits that were earned before the membership interests were acquired or which recouped a loss

5.86 The fourth step in determining a groups allocable cost amount for a joining entity is to subtract distributions to the head company (directly, or indirectly by distribution to an entity in which the head company has a direct or indirect membership interest) by the joining entity out of certain profits. The profits are profits that either:

•

did not accrue to membership interests continuously held by members of the joined group until the joining time; or

•

recouped a loss that accrued to membership interests continuously held by members of the joined group until the joining time.

[Schedule 1, item 2, section 705-95]

5.87 The purpose of this step is to prevent the reset costs for a joining entitys assets reflecting an amount paid for the membership interests in the entity that was later (but before it became a member of the joined group):

•

recovered through distributions; or

•

lost and, following the recoupment of the loss, the profit that recouped the loss was distributed.

Example 5.9: Cost of membership interests recovered through distributions

On 29 September 2002, Head Co, the head company of a consolidated group, acquired 70% of the membership interests in F Co for $420. At that time, F Co had assets with a market value of $600, including undistributed taxed profits of $100. On 30 September 2002, F Co paid a fully franked dividend of $100, of which Head Co received $70. Following the distribution, the assets of F Co have a market value of $500.

On 1 October 2002, Head Co purchased the remaining 30% of membership interests in F Co for $150 and F Co becomes a subsidiary member of Head Cos consolidated group. In the absence of any other adjustments, the groups allocable cost amount for F Co would be $570 (reflecting the cost to Head Co of acquiring the membership interest in F Co). This would then be allocated to F Cos assets, which have a market value of only $500. An immediate disposal of all of those assets would result in a capital loss of $70, despite Head Co having suffered no economic loss.

The step 4 adjustment makes the required reduction in the allocable cost amount for F Co. Step 4 in working out the allocable cost amount will subtract the $70 dividend paid by F Co to Head Co on 30 September 2002. It does so because the $70 was a distribution of profits that were earned before Head Co acquired the membership interests in respect of which the dividend was paid.

Example 5.10: Dividend out of profits that recoup a loss that accrued to membership interests continuously held by the joined group

On 1 July 2002, Top Co, the head entity of a consolidated group, acquired 60% of the membership interests in Subco for $60. At that time, Subco had assets with a market value of $100. In the year ended 30 June 2003, Subco made a loss of $30. In the year ended 30 June 2004, Subco made a profit of $30. Subco distributed this profit as an unfranked dividend on 1 July 2004 and Top Co receives $18 of the dividend.

On 2 July 2004, Top Co purchased the remaining 40% of the membership interests in Subco for $28 (reflecting a market value for Subcos assets of $70) and Subco became a subsidiary member of Top Cos consolidated group. Top Cos allocable cost amount for Subco is $70, consisting of $88 for the cost of membership interests (step 1 in working out the allocable cost amount) less $18 for a dividend paid to Top Co out of profits that recouped a loss that accrued to membership interests continuously held by Top Co (step 4).

In the absence of the adjustment for distributions out of profits that recoup owned losses, the Top Cos allocable cost amount for Subco would be $88, which would reinstate Top Cos share of the loss in an unrealised form when treated as Top Cos cost for Subcos assets.

Step 5: Subtract losses accruing to continuously held membership interests

5.88 The fifth step in determining a groups allocable cost amount for a joining entity is to subtract the carry forward tax losses and net capital losses of the joining entity to the extent that those losses accrued to membership interests that were directly or indirectly owned by the head company and were continuously held by the head company until the joining time (a groups owned component of the losses of a joining entity). [Schedule 1, item 2, subsection 705-100(1)]

5.89 Determination of whether a loss accrued to a membership interest that was continuously held by the head company (i.e. the joined group) is discussed at paragraphs 5.82 and 5.83.

Example 5.11: An owned loss

Jayco, the head company of a consolidated group, acquired 90% of the membership interests in Kayco on 28 February 2003. In April 2003, Kayco disposed of an asset and realised a capital loss of $30 on the disposal. That $30 became Kaycos carry-forward net capital loss for the year ended 30 June 2003.

On 1 July 2004, Jayco purchased the remaining 10% of the membership interests in Kayco and Kayco became a subsidiary member of Jaycos consolidated group. In considering whether Kaycos net capital loss should be deducted in working out the allocable cost amount, it was determined that $10 of the loss in value of the asset on which the capital loss was realised occurred after Jayco acquired a 90% stake in Kayco. Therefore, $9 of the loss is required to be deducted (at step 5) in working out the allocable cost amount.

5.90 A carry-forward loss is only subtracted at step 5 in working out the allocable cost amount to the extent that the loss does not have the effect of reducing the amount that is added at step 3 . A loss will have the effect of reducing the amount at step 3 if the loss:

•

reduces the amount of undistributed profits (other than profits that recouped certain losses) of a joining entity at its joining time that accrued to members of the joined group in respect of their continuously held membership interests; and

•

those undistributed profits could have been fully franked as they accrued.

Example 5.12: An owned loss that reduces the undistributed profits added at step 3

Subco was formed with a paid up capital of $100. Of this, $90 was contributed by Holdco in exchange for 90% of the membership interests. Minco subscribed $10 for the remaining 10% of the membership interests.

Holdco is the head company of a consolidated group.

In its first year of operation, Subco had a profit before tax of $10. Subco subsequently paid income tax of $3 but did not distribute any of the profit as a dividend. In the next year, Subco made a tax loss of $7.

Immediately upon the completion of this second year, Holdco purchased Mincos interest in Subco for $10.21 and Subco became a subsidiary member of Holdcos consolidated group. The price Holdco paid for Mincos interest reflected an expectation that Holdco would be able to utilise Mincos share of Subcos carry-forward tax loss - the value attributed to the deduction being $0.21 (see below).

Holdcos allocable cost amount for Subco is $100, comprised $100.21 for its cost base for membership interests (the step 1 amount) less $0.21 (($7 - $6.30) 30% - the company income tax rate) for the acquired component of Subcos carry-forward tax loss (the step 6 amount). Nothing is deducted for the owned part of the loss (at step 5) ($6.30 being 90% $7) because this element reduces the amount that would otherwise be added for owned frankable undistributed profits (at step 3).

5.91 Without this step, a consolidated group could get a double benefit for the owned component of a joining entitys losses. The group could get the benefit of deducting the losses when working out its future taxable income. In addition, allocable cost amount properly attributable to assets that had been lost would be allocated to the assets remaining after the losses.

5.92 This step also prevents a benefit from an owned loss being reinstated through a higher cost for remaining assets where the loss is not permitted to be transferred to the head company or is cancelled by the head company (see Chapter 6).

Step 6: Subtract an amount for certain losses transferred to the head company

5.93 The sixth step in determining a joined groups allocable cost amount for a joining entity is to subtract an amount for the groups acquired losses of the joining entity that are transferred to the head company and not cancelled. The amount subtracted for these losses is the amount of the losses multiplied by the company tax rate. [Schedule 1, item 2, section 705-110]

5.94 The groups acquired losses of the joining entity are those tax losses, net capital losses and overall foreign losses of the joining entity at the joining time that did not accrue to membership interests that were continuously held by members of the joined group from when the loss accrued until the joining time.

5.95 Consistent with the treatment of acquired deductions of a joining entity (see paragraph 5.96), this adjustment reflects the amount by which the loss would reduce the head companys tax liability when the loss is deducted if the company tax rate is unchanged from its rate at the joining time.

Example 5.13: An acquired loss

Trader Co subscribed $100 for all of the membership interests in a new company, Z Co. Z Co used the $100 to acquire 2 assets for $60 and $40 respectively. Trader Co and Z Co do not form a consolidated group.

Subsequently, Z Co disposed of its second asset for $0, realising a net capital loss of $40 ($0 - $40).

On 1 July 2004, Head Co, the head company of a consolidated group, acquires all of the membership interests in Z Co for $72. The price paid for Z Co reflects the unchanged market value ($60) of the asset Z Co acquired for $60 and an amount ($12) for Z Cos net capital loss, which is able to be transferred to Head Co.

Head Cos allocable cost amount for Z Co is $60, comprised $72 at step 1 for the cost of membership interests less $12 (30% of $40) at step 6 for the acquired loss multiplied by the company tax rate.

The whole of the allocable cost amount is allocated to the asset with a market value of $60 and none to the deferred tax asset for the net capital loss. Nothing is allocated to the deferred tax asset because it is an excluded asset (see paragraphs 5.31 to 5.32).

Step 7: Subtract an amount for certain deductions to which the head company is entitled

5.96 The seventh step in determining a groups allocable cost amount for a joining entity is to deduct an amount for certain deductions inherited by the head company for expenditure incurred by the joining entity prior to the joining time. The amount deducted is calculated in accordance with the following formula:

owned deductions + (acquired deductions * general company tax rate)


where:

•

owned deductions are deductions for expenditure incurred by the joining entity that, at the time the expenditure was incurred, was in respect of membership interests that were directly or indirectly owned by the head company continuously until the joining time; and

•

acquired deductions are deductions for expenditure incurred by the joining entity that are not owned deductions.

[Schedule 1, item 2, subsection 705-115(1)]

5.97 The deductions referred to are deductions for expenditure inherited from the joining entity because of section 701-5 that when incurred would not have been included in or would not reduce the cost of an asset of the joining entity. These are unclaimed deductions for expenditure incurred prior to the joining time where the expenditure is not allowed in full as a tax deduction when incurred. For example, the deduction for the expenditure is spread over a number of income years. [Schedule 1, item 2, paragraph 705-115(2)(a)]

5.98 Examples of the deductions for expenditure that could be included in this step are:

•

expenditure allocated to a software development pool (sections 40-450 to 40-460);

•

capital expenditure associated with certain projects and certain business related costs (Subdivision 40-I);

•

borrowing expenses (section 25-25); and

•

certain gifts where the deduction is spread over 5 years. Cultural gifts (section 30-248), environmental gifts (section 30-249B) and heritage gifts (section 30-249E).

5.99 There would be circumstances where the above expenditure would have been included in, or would have reduced, the cost for tax purposes of an asset of the joining entity.

5.100 Where the expenditure has contributed to the cost of an asset it should not be included in this step. Examples of deductible expenditure that does contribute to the cost of an asset are:

•

Expenditure deductible under Subdivision H of Division 3 of Part III of the ITAA 1936 (deductibility of certain advance expenditure) would be included in the cost of an asset of the joining entity being a right to future services.

•

Expenditure incurred on capital works (Division 43 of the ITAA 1997) in respect of buildings acquired after 13 May 1997, subject to certain transitional provisions, would reduce the cost of a CGT asset as the Division 43 deduction is claimed.

•

Expenditure acquiring a depreciating asset reduces the adjustable value of the asset as the depreciation deductions are claimed.

5.101 Section 110-40 applies to CGT assets acquired before 7.30pm on 13 May 1997. To ensure that deductions in regard to certain expenditure will not reduce the allocable cost amount at this step, it is necessary to exclude from subsection 705-115(2) a deduction to which section 110-40 applies. [Schedule 1, item 2, paragraph 705-115(2)(b)]

5.102 A reduction should not be made at this step to the extent that the expenditure that gave rise to the deduction reduced the amount of the undistributed profit that is added at step 3 (paragraphs 5.80 to 5.85). Expenditure will have the effect of reducing the amount at step 3 if the expenditure:

•

reduces the amount of undistributed profits (other than profits that recouped certain losses) of a joining entity at its joining time that accrued to members of the joined group in respect of their continuously held membership interests; and

•

these profits could have been fully franked as they accrued.

See Example 5.12 which is about how losses should not be subtracted at step 5 to the extent that the loss does not have the effect of reducing the amount that is added at step 3. [Schedule 1, item 2, paragraph 705-115(2)(c)]

When is a membership interest continuously held?

5.103 Steps 3 to 5 in the calculation of the allocable cost amount require that profits and losses of a joining entity be worked out for the period that each membership interest in the joining entity was continuously held. Generally this would be the period that:

•

starts when the head company starts to hold directly or indirectly membership interests in the joining entity which the head company continues to hold until the joining time; and

•

ends at the joining time.

[Schedule 1, item 2, section 705-105]

5.104 However, a membership interest will be taken not to have been held continuously if, before the joining time, the cost base or the reduced cost base of the membership interest was taken by a provision of the income tax law to be the market value at a particular time. Where this occurs the membership interest is taken not to have been held by the head company prior to the time the cost base was taken to be its market value.

Example 5.14: Continuity of holding a membership interest

At 1 July 1997, Head Co owns 50% of the membership interests in each of L Co and M Co. On 1 July 1998, L Co acquires 60% of the membership interests in P Co. On 1 July 1999, L Co transfers its interest in P Co to M Co. There is no rollover relief available in relation to the disposal. On 1 July 2002, Head Co acquires the remaining membership interests in L Co and M Co, and chooses to form a consolidated group. On 1 July 2003, M Co acquires the remaining 40% of the membership interests in P Co which causes P Co to join the consolidated group.

Head Co first began to hold an indirect interest in P Co (the joining entity) on 1 July 1998. However, the continuity of holding in relation to this interest is broken when L Co transfers its interest in P Co to M Co without rollover. The period during which this membership interest will be taken to have been held continuously will start on 1 July 1999 (i.e. when M Co first held membership interests in P Co which were then held continuously until the joining time).

5.105 Table 5.3 contains examples of provisions within the income tax law that set the cost base and reduced cost base of membership interests in an entity to market value at a particular time. If 2 or more of the provisions apply, the interest is taken to have been acquired at the latest of the times specified.

Preservation of unrealised losses relating to membership interests in a joining entity

5.106 Some or all of a groups membership interests in a joining entity may have become subject to Subdivision 165-CC of the ITAA 1997. The effect of this is that the group would be able to take losses on disposal of these interests into account only if it satisfies the SBT. To preserve this effect when the joining entity becomes part of the head company, the application of Subdivision 165-CC is transferred to the assets the joining entity brings into the consolidated group. It applies to each of these CGT assets in the proportion:

(market value of membership interests subject to Subdivision 165-CC just before the joining time) / (market value of all membership interests just before the joining time)


[Schedule 1, item 2, subsections 705-120(1) to (3)]

5.107 If any of the assets of a joining entity were subject to Subdivision 165-CC, apart from the effect explained in paragraph 5.107, they are not subject to Subdivision 165-CC as assets of the consolidated group [Schedule 1, item 2, subsection 705-120(4)] . The continued application of Subdivision 165-CC to these assets is not required because resetting their cost based on the groups cost for membership interests itself fulfils the purpose of preventing the duplication of a loss realised by the vendors of membership interests in the joining entity.

Preservation of pre-CGT status of membership interests in a joining entity

5.108 The pre-CGT status of membership interests in a joining entity are an attribute of the assets of the group being joined (as opposed to being an attribute of the assets of the joining entity). Therefore, unlike the pre-CGT status of the assets of a joining entity that is preserved by the entry history rule, this status would be lost without a special rule to preserve it. This reflects that within a consolidated group intra-group membership interests are disregarded as the groups cost for membership interests is stored in its cost for assets.

5.109 Pre-CGT status for membership interests is preserved:

•

where the head company of a joined group directly holds membership interests in the joining entity that are pre-CGT assets; and

•

where any of the subsidiary members of the joined group have a pre-CGT factor for membership interests that they hold in the joining entity.

5.110 The pre-CGT status of those interests is preserved by attaching a pre-CGT factor to the assets of the joining entity at the joining time, other than those that are current assets in accordance with the accounting standards [Schedule 1, item 2, subsections 705-125(1) and (2)] . The term current asset is defined in AASB: 1010 Recoverable Amount of Non-Current Assets (December 1999) in paragraph 9.1 as meaning an asset that:

(a)

is expected to be realised in, or is held for sale or consumption in, the normal course of the entitys operating cycle;

(b)

is held primarily for trading purposes or for the short-term and is expected to be realised within twelve months of the reporting date; or

(c)

is cash or a cash-equivalent asset which is not restricted in its use beyond twelve months or the length of the operating cycle, whichever is greater.

5.111 This allows a proportion of the membership interests in an entity that leaves a consolidated group to be treated as pre-CGT assets by reference to the pre-CGT factors of assets in the leaving entity (see paragraphs 5.146 to 5.152). The entity that leaves will not necessarily be the same entity whose membership interests were pre-CGT assets of the joined group.

5.112 The pre-CGT factor that applies to each asset, that is not a current asset, is obtained by adding:

•

the market values of the pre-CGT membership interests in the joining entity that are held directly by the head company; and

•

the products of market values of the membership interests in the joining entity that are held by subsidiary members of the joined group and their respective pre-CGT factors,

and dividing this sum by the sum of the market values of all the assets of the joining entity at the joining time that are not current assets. However, if the amount calculated in this way would be more than one, the pre-CGT factor is one. [Schedule 1, item 2, subsection 705-125(3)]

5.113 The pre-CGT factor only attaches to assets that existed at the joining time and is lost if the asset is disposed of directly (rather than indirectly by way of disposing of an entity which takes the asset with it). The factor is not attached to any replacement asset.

What happens when an entity leaves a consolidated group?

5.114 Division 711 contains the rules for setting the head companys cost of membership interests in subsidiary entities when they leave a consolidated group. Entities may leave a consolidated group where the group continues to exist and where the group ceases to exist. The situations where the group ceases to exist are discussed in paragraphs 5.14 to 5.15. This Division does not apply when the consolidated group joins another consolidated group. Proposed law dealing with the case of a consolidated group joining another consolidated group will be contained in a later bill.

Membership interests in the leaving entity

5.115 Where a subsidiary member (the leaving entity) leaves a consolidated group (the old group) the head company recognises, just before the time the entity leaves, the membership interests in the leaving entity. These membership interests would not be recognised whilst the entity was a member of the group. The cost for the membership interests is set at a cost equal to the head companys cost for the net assets that the leaving entity takes with it. This preserves the alignment between the costs for membership interests in the entity and its assets. The time at which the leaving entity leaves the old group is called the leaving time. [Schedule 1, item 2, section 701-15]

5.116 The recognition of the membership interests in the leaving entity does not apply to membership interests held by someone other than a member of the old group (i.e. the holder of an employee share).

5.117 Matters relating to the head companys recognition of the membership interests in the leaving entity are:

•

the setting of the cost of membership interests when a single entity leaves (see paragraphs 5.118 to 5.141);

-

steps in working out the old groups allocable cost amount (see paragraphs 5.118 to 5.135);

-

more than one class of membership interests (see paragraphs 5.136 to 5.138);

-

head companys terminating value for an asset (see paragraph 5.139);

-

where there is a capital loss on disposal of membership interests (see paragraph 5.140); and

-

treatment of goodwill (see paragraph 5.141).

•

where a group of entities leave at the same time (see paragraphs 5.142 and 5.143);

•

membership interests potentially subject to Subdivision 165-CC (see paragraphs 5.144 to 5.146); and

•

pre-CGT status for membership interests (see paragraphs 5.147 to 5.153).

The setting of the cost of membership interests when a single entity leaves

5.118 The cost of the membership interests in the leaving entity is determined by working out the old groups allocable cost amount for the leaving entity. The old groups allocable cost amount for the leaving entity reflects the cost of the net assets that the leaving entity takes with it as well as certain adjustments and is determined in 6 steps. [Schedule 1, item 2, section 711-20]

Step 1: Terminating values of assets

5.119 The first step in determining the old groups allocable cost amount for a leaving entity is to add up the head companys terminating values (see paragraph 5.139) of all the assets that the head company holds at the leaving time because the leaving entity is taken to be part of the head company. [Schedule 1, item 2, subsection 711-25(1)]

Step 2: Certain deductions inherited from the head company

5.120 The second step in determining the old groups allocable cost amount is to add an amount for deductions that the leaving entity inherits from the head company. The amount to be added is calculated in accordance with the following formula:

owned deductions + (acquired deductions * general company tax rate)


where:

•

owned deductions are for expenditure inherited from the head company because of section 701-40 that when incurred would not have been included in or would not reduce the cost of an asset of the head company or a joining entity. These are unclaimed deductions for expenditure incurred prior to the leaving time where the expenditure is allowed as a tax deduction over more than one year of income; and

•

acquired deductions are deductions that were acquired deductions of the head company under subsection 705-115(1) (see paragraph 5.96).

5.121 For examples of the deductions that are covered by this step refer to paragraphs 5.98 to 5.101 dealing with deductions inherited by the head company when an entity joins a consolidated group. [Schedule 1, item 2, section 711-35]

Step 3: Liabilities owed by members of the old group

5.122 The third step in determining the old groups allocable cost amount is to add the amount relating to any liabilities actually owed by members of the old group to the leaving entity at the leaving time. The amount is the market value of all those assets of the leaving entity at that time. This element of the allocable cost amount is separately identified because, whilst an entity is a member of a consolidated group, liabilities it is owed by other members of the group are not recognised for income tax purposes. [Schedule 1, item 2, subsection 711-40(1)]

5.123 However, a group could gain an unwarranted advantage where the creation of an asset in a leaving entity before its leaving time would have been a CGT event but is a disregarded transaction because of the single entity rule. This can arise where the asset created in the joining entity is a liability of a continuing member of the group. To prevent an unwarranted advantage arising from this source, specific provision is made that, instead of the market value of the leaving entitys asset, the amount that would have been a groups allowed cost in relation to the disregarded CGT event is added at step 3 in working out the groups cost base for its membership interests in the leaving entity. [Schedule 1, item 2, subsection 711-40(2) and (3)]

Example 5.15: Intra group dealing prior to the leaving time

Within a consolidated group, land with a market value of $10 million is leased to a group entity, Lefco, for 99 years for a rental of $1 per year. The group had a cost base for this land of $2 million.

With this lease as Lefcos only asset, the group sells all of its membership interests in Lefco.

The head companys cost for the groups membership interests in Lefco is set at $2 million, because that is the cost that would be allowed to the group for the CGT event constituted by the terms of the lease of the land to Lefco.

Step 4: Liabilities of the leaving entity

5.124 The fourth step in determining the old groups allocable cost amount is to subtract the amount of the leaving entitys liabilities. The amount is worked out by adding up all of a leaving entitys liabilities at the leaving time that, in accordance with accounting standards or statements of accounting concepts made by the Australian Accounting Standards Board, can or must be identified in the entitys statement of financial position. [Schedule 1, item 2, subsection 711-45(1)]

5.125 An amount is not to be added as a liability if it arises because of a leaving entitys ownership of an asset where, on disposal of the asset, the liability will transfer to the new owner. [Schedule 1, item 2, subsection 711-45(2)]

5.126 If some or all of the liability will be a deduction to the leaving entity when the liability is discharged, the amount of the liability to be taken into account is reduced by the amount that will be a deduction multiplied by the general company tax rate. [Schedule 1, item 2, subsection 711-45(3)]

5.127 Where a liability of a leaving entity is owed to a member of the old group then the amount of any such liability instead equals its market value. [Schedule 1, item 2, subsection 711-45(4)]

5.128 Where a liability, or a change in the amount of a liability, is taken into account under generally accepted accounting principles, sooner than occurs for income tax then the amount of any such liability is instead the payment that would be necessary to discharge the liability just before the leaving time without giving rise to a taxable gain nor an allowable deduction to the head company. Refer to paragraph 5.73 for the discussion of how these rules apply to a joining entity. [Schedule 1, item 2, subsection 711-45(5)]

5.129 The step 4 amount is increased by the market value of any employee share interests disregarded under section 703-35. [Schedule 1, item 2, subsection 711-45(6)]

5.130 A further amount is included at step 4 equal to the market value of any debt interests in the leaving entity that are equity for accounting purposes. A specific provision is required to have these debt interests taken into account as liabilities because they are not recognised as liabilities for accounting purposes. [Schedule 1, item 2 subsection 711-45(7)].

Step 5: Ensuring Subdivision 165-CC is not avoided

5.131 The fifth step in determining the old groups allocable cost amount is to subtract the amount determined under subsection 711-50 which applies where there are unrealised net losses and Subdivision 165-CC applies. This step ensures that the head company is not able to avoid the denial of certain losses by disposing of assets via an entity leaving a consolidated group rather than disposing of the assets directly. [Schedule 1, item 2, section 711-50]

5.132 Section 711-50 applies where:

•

one or more of the assets of the leaving entity are assets to which Subdivision 165-CC would apply if there were a loss on their disposal; and

•

Subdivision 165-CC applies to the asset because the asset was an asset of the group when a changeover time occurred in relation to the head company,

the amount included at step 5 in determining the old groups allocable cost amount for the leaving entity is equal to the sum of the denied amounts. [Schedule 1, item 2, subsections 711-50(1) and (2)]

5.133 Any reduction in net asset values as a consequence of the application of section 711-50 will be taken into account as capital losses, deductions or trading stock losses for the purposes of the future application of section 165-115BB to the head company. Taking any reduction in net asset value into account as losses or deductions for the purposes of section 165-115BB has the effect of reducing the head entitys residual unrealised net loss so that the amount by which future losses or deductions of the head company can be denied under this section is correspondingly reduced. [Schedule 1, item 2, subsection 711-50(3)]

Step 6: The old groups allocable cost amount

5.134 If the resulting old groups allocable cost amount after steps 1 to 5 would be negative, it is instead taken to be nil, and the head company is taken to have made a capital gain equal to the negative amount [Schedule 1, item 2, step 6 in the table in subsection 711-20(1)] . Consequential amendments to provide for a capital gain are not included in the accompanying legislation.

5.135 In order to work out the cost of each membership interest in the leaving entity it is necessary to divide the old groups allocable cost amount for the leaving entity by the number of membership interests in the leaving entity. [Schedule 1, item 2, paragraph 711-15(1)(c)]

More than one class of membership interests in the leaving entity

5.136 If there is more than one class of membership interests in the leaving entity, membership interests of different classes may have different market values. In such instances, the cost of membership interests of different classes will also be proportional to the market values of the membership interests. [Schedule 1, item 2, paragraph 711-15(1)(b)]

5.137 Where the head company holds rights or options to membership interests in the leaving entity issued by the leaving entity these rights or options will be treated as if they are a different class of membership interest. [Schedule 1, item 2, subsection 711-15(2)]

5.138 The cost of each membership interest is calculated by:

•

first allocating the groups cost for the net assets of the leaving entity among the different classes in proportion to the aggregate of the market values of each class; and

•

then dividing the cost for the net assets allocated to each class by the number of membership interests in the class.

[Schedule 1, item 2, paragraph 711-15(1)(c)]

Head companys terminating value for an asset

5.139 The head companys terminating value for an asset is the amount that would need to be received for the asset to result in no tax consequences for the consolidated group as a result of the assets leaving the group via a disposal of membership interest. Consequently, there are generally no tax liability outcomes for a head company from the exit, as such, of an entity - as distinct from disposals of membership interests in an exited entity. The exception, where a tax liability could arise, is where the rules dealing with transactions between entities that separate when an entity leaves a consolidated group (see paragraphs 2.75 to 2.77). Table 5.4 provides guidance on determining the head companys terminating value of assets. [Schedule 1, item 2, section 711-30]

Where there is a capital loss on disposal of membership interests

5.140 If it is necessary to work out whether the head company makes a capital loss as a result of a CGT event that happens after the leaving time in relation to any of the membership interests, the amount of the cost of the membership interest is instead worked out as if the terminating value of any CGT asset (that is not trading stock, a qualifying security or a depreciable asset) is instead equal to its reduced cost base just before the leaving time. [Schedule 1, item 2, subsection 711-20(2)]

Treatment of goodwill

5.141 For the purpose of working out the cost of membership interest in the leaving entity, goodwill will be an asset of a leaving entity where it can be demonstrated that goodwill is leaving the group or is lost to the group as a result of the leaving entity ceasing to be a member of the group. This could occur, for example, because the goodwill is linked to assets of the leaving entity, or because of the entity leaving, some synergy is lost to the group. [Schedule 1, item 2, subsection 711-25(2)]

Where a group of entities leave at the same time

5.142 Where, at the leaving time, the leaving entity holds membership interests in other subsidiary members of the consolidated group, then those other subsidiary members will also cease to be members of the group at the leaving time. In these situations, the cost of the membership interests in each of the leaving subsidiaries must be worked out on a bottom-up basis. This ensures that the assets of an entity (the first entity) that are membership interests in another leaving member of the group are first given a cost, which will then be used to determine the terminating value of that asset in working out the cost of membership interests in the first entity. [Schedule 1, item 2, section 711-55]

Example 5.16: Multiple leaving entities

On 30 June 2003, M Co (the leaving entity) leaves a consolidated group (the old group). M Co, before the leaving time, owned all the shares in B Co and C Co. B Co owned all the shares in D Co and E Co. The companies were all members of the consolidated group.

The leaving entity and all those companies ceased to be members of the consolidated group at the leaving time.

In order to work out the cost of the membership interests in the leaving entities it is necessary to first work out the cost of the membership interests in companies C, D and E.

Next, work out the cost of the membership interests in B Co, taking into account the cost just worked out for its assets consisting of shares in companies D and E.

Finally, work out the cost of the membership interests in the leaving entity, taking into account the cost worked out for the membership interests for companies B and C.

5.143 Consideration is being given to the rules required to prevent loss duplication where a group of entities leave at the same time.

Membership interests potentially subject to Subdivision 165-CC

5.144 Where some or all of a groups membership interests in a joining entity are potentially subject to Subdivision 165-CC at its joining time, a proportion of each of the CGT assets of the joining entity that are brought into the group is subsequently treated as being potentially subject to Subdivision 165-CC (see paragraphs 5.106 and 5.107). If any of these assets become assets of a leaving entity, a proportion of each of the groups membership interests in the leaving entity are made potentially subject to Subdivision 165-CC. The proportion is the proportion of the groups cost for membership interests in the leaving entity that is referable to the proportions of any assets of the leaving entity that were made potentially subject to Subdivision 165-CC upon the entry of an entity into the group. [Schedule 1, item 2 section 711-60]

5.145 However, if these assets are also potentially subject to Subdivision 165-CC because there was a changeover time in relation to the head company, they are not taken into account in determining the proportions of the assets of the leaving entity made potentially subject to Subdivision 165-CC. These assets are dealt with in step 5 of working out the old groups allocable cost amount.

5.146 Assets and membership interests are potentially, rather than actually, subject to Subdivision 165-CC because Subdivision 165-CC only applies where a loss is made in respect of an asset or membership interest.

Pre-CGT status for membership interests

5.147 Where, just before the leaving time, any of the assets held by the head company that the leaving entity takes with it had a pre-CGT factor (discussed in paragraphs 5.108 to 5.113), a number of the membership interests in the leaving entity held by members of the group will be treated as not being subject to CGT. [Schedule 1, item 2, section 711-65]

5.148 The number of membership interests that will be treated in this way is determined by multiplying the leaving entitys pre-CGT proportion by the number of membership interests in the leaving entity held by members of the consolidated group. The result of this calculation is rounded down to the nearest whole number (if not already a whole number) or to zero if the result is more than zero but less than one. [Schedule 1, item 2, subsection 711-65(4)]

5.149 The leaving entitys pre-CGT proportion is calculated by dividing the aggregate of the market values of the pre-CGT factor components of the assets of the entity by the aggregate market value of the whole of its assets. For this purpose, the market value of the pre-CGT component of an asset is the market value of the asset multiplied by its pre-CGT factor. [Schedule 1, item 2, subsection 711-65(5)]

5.150 The design of the rules for preserving pre-CGT membership interests takes into account that a group has a discretion regarding the amount of the liabilities that an entity will have when leaving. If the rules had embodied an assumption that a leaving entity would have a specific amount of liabilities that is greater than zero, a group would be able to increase the proportion of the membership interests of a leaving entity that are pre-CGT assets by reducing the amount of liabilities of the leaving entity below the assumed amount. The rules have adopted the simplest design that would prevent manipulation, i.e. that a leaving entity does not have any liabilities. Therefore, groups will maximise the retention of pre-CGT status for equity by not attaching liabilities to leaving entities that have assets with pre-CGT factors.

5.151 The number of membership interests in the leaving entity held by members of the group that are treated as not being subject to CGT has effect regardless of when the membership interests were actually acquired. [Schedule 1, item 2, subsection 711-65(2)]

5.152 If there are 2 or more classes of membership interests in the leaving entity, the rules discussed in paragraphs 5.136 and 5.138 operate separately in relation to each class as if the interests in that class were all of the interests in the leaving entity. [Schedule 1, item 2, subsection 711-65(6)]

5.153 Where 2 or more entities cease to be subsidiary members of the old group at the same time the number of membership interests that are deemed to be pre-CGT assets is worked out on a bottom-up basis, like that for working out the costs for membership interests (see paragraph 5.142). Membership interests in a leaving entity (the first entity) that are determined to be pre-CGT assets are assigned a pre-CGT factor of one for the purpose of working out the numbers of pre-CGT membership interests in leaving entities that hold membership interests in the first entity - and so on. Where more than one entity holds membership interests in the first entity, the head company can choose which (up to the number permitted by the formula) of the membership interests in the first entity shall be pre-CGT assets. [Schedule 1, item 2, section 711-70]

What happens when the group ceases to exist?

5.154 A consolidated group will cease to exist where:

•

all the membership interests in the head company are acquired by another consolidated group (see paragraphs 5.155 and 5.156); or

•

the head company otherwise ceases to be eligible to continue to be a head company (see paragraph 5.157).

Where the group joins another consolidated group

5.155 A leaving entity may cease to be a member of an existing consolidated group because the head company of the existing consolidated group becomes a wholly-owned subsidiary of:

•

the head company of another existing consolidated group (which will result from its acquisition by one or more members of that group); or

•

a company eligible to be a head company. This can occur through a change in ownership of some or all of the membership interests in the head company or as a result of the existing owner of the head company becoming a company eligible to be a head company that immediately forms a consolidated group.

5.156 When the group joins another consolidated group the relevant rules for the treatment of the assets of the consolidated group are those that apply when a consolidated group joins an existing consolidated group (proposed law dealing with the case of a consolidated group joining another consolidated group will be contained in a later bill). The rules about leaving a consolidated group will not apply. [Schedule 1, item 2, subsection 711-5(1)]

Where a head company ceases to be eligible to remain as head company (other than because it joins another consolidated group)

5.157 Upon a change in the status of a head company that renders the head company ineligible to remain as the head company of a consolidated group, the head company ceases to be eligible to hold the assets of its subsidiary members in the capacity of the head company of a consolidated group. Where this occurs each of the subsidiary members of the group will be treated as leaving entities.

Application and transitional provisions

5.158 The consolidation regime will apply from 1 July 2002.

5.159 Under rules to be introduced in a later bill a company may elect on formation of a consolidated group to adopt the transitional option of using a joining entitys terminating value as its cost for the assets that are brought into the group by the subsidiary members.

Consequential amendments

5.160 Consequential amendments have been made to subsection 995-1(1) to include references to new dictionary terms. [Schedule 5, items 2, 20, 21, 23, 25 and 33]