House of Representatives

Explanatory Memorandum

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

Chapter 3 - MEC groups

Outline of chapter

3.1 This chapter explains rules that ensure the cost setting rules contained in the May Consolidation Act and the June Consolidation Bill apply in an appropriate manner to MEC groups.

3.2 The cost setting rules covered in this chapter are:

•

a single entity joining a MEC group (Division 701 and Subdivision 705-A of the May Consolidation Act);

•

the formation of a MEC group (Subdivision 705-B of the June Consolidation Bill), including the transitional cost setting rules contained in the amendments to the IT(TP) Act 1997 which were contained in the June Consolidation Bill; and

•

one or more entities leaving a MEC group (Divisions 701 and 711 of the May Consolidation Act).

3.3 This chapter also explains rules:

•

that reset the cost of membership interests in eligible tier-1 companies that are not held by other members of the MEC group (the pooling rules );

•

that ensure that the annual rate of use of a groups existing losses is adjusted as a result of a new eligible tier-1 company joining the group; and

•

that ensure the tax position of a MEC group does not change where a different company is appointed as the head company of the group.

3.4 The amendments explained in this chapter are contained in Schedules 6, 8 and 10 to this bill.

Context of reform

3.5 In general, the rules in Part 3-90 are to apply to a MEC group and its members in the same manner in which they apply to a consolidated group and its members. This general application rule will be contained in subsequent legislation. However, the general application rule will be subject to a number of specific modifications, such as those discussed in this Chapter, which take into account the special characteristics of a MEC group.

Cost setting rules

3.6 The treatment of assets of entities joining a MEC group is intended to mirror the treatment of assets of entities joining a consolidated group, the rules for which were contained in the May Consolidation Act and the June Consolidation Bill. Some modifications are required to those rules however to reflect the different nature of a MEC group. Unlike a consolidated group, a MEC group does not have a single Australian resident head company. Rather, a MEC group has 2 or more eligible tier-1 companies that are collectively akin to a head company of a consolidated group. The modifications contained in this chapter ensure that eligible tier-1 companies are treated in the same manner as the head company of a consolidated group from a cost setting perspective.

Pooling rules

3.7 The cost setting rules that apply when an entity joins or leaves a MEC group allow for assets to be transferred between members of the group without requiring cost base adjustments to address value shifting. The cost setting rules however are limited in their operation to membership interests held within the group. Without further measures, much of the benefits of forming a MEC group would disappear as entities who hold membership interests in eligible tier-1 companies would still be required to make value shifting adjustments when assets are transferred between members of the group. The pooling rules for eligible tier-1 companies in this chapter are designed to facilitate the tax free transfer of assets within a MEC group by removing the need to make value shifting adjustments at the eligible tier-1 company level.

Available fractions for MEC groups

3.8 A groups use of losses transferred to it by members on joining the group is restricted by the available fraction calculated for the losses. The available fraction is a proxy for determining the proportion of the groups income or gains generated by the joining loss entity.

3.9 In order to retain the integrity of an available fraction, it is essential that it be adjusted when capital is introduced into the group from outside. In that case, the groups income generating capacity is increased which reduces the proportion of the groups income that the original loss entity can be regarded as generating.

3.10 The inclusion of a new eligible tier-1 company in a group essentially amounts to an injection of capital into the group. That is, the new tier-1 company joins the group because of its relationship with the groups top company - the group has not paid cash or assets in order to acquire it. Therefore, a group will be required to adjust its available fractions when a new eligible tier-1 company joins.

Change in head company

3.11 Where the head company of a MEC group becomes ineligible to continue as the head company of the group, rules apply to allow the remaining eligible tier-1 companies to appoint a replacement head company. Whilst the MEC group will have a new head company as the taxpayer for the group, the tax position of the group should not be affected by the departure or change in membership status of the previous head company.

Summary of new law

Cost setting rules

3.12 The rules that deal with the cost of assets of subsidiary entities that join or leave a consolidated group (contained in Divisions 701, 705 and 711 of the May Consolidation Act) will generally have equivalent application to MEC groups. However, some modifications are required to ensure that those rules work appropriately in the MEC group context.

3.13 Broadly, the cost setting rules dealing with entities joining a group are modified so that each eligible tier-1 company is treated as if it were a part of the head company of the group, rather than a separate entity. This ensures, for example, that provisions in the cost setting rules that operate if the head company of the group holds membership interests in another entity will operate if one or more eligible tier-1 companies of the MEC group holds membership interests in the other entity. It also ensures that, when an eligible tier-1 company joins a MEC group, the cost of the assets of that company is not reset. This is because the rules that reset the cost of assets only apply when an entity joins a group as a subsidiary member.

3.14 Where an eligible tier-1 company leaves a MEC group, the rules in Divisions 701 and 711 that deal with entities leaving a group generally apply to reset the cost of membership interests in the leaving eligible tier-1 company that are held by other members of the MEC group. The cost of membership interests in the leaving eligible tier-1 company held by entities outside the MEC group is determined under special pooling rules (see paragraphs 3.50 to 3.71). No modifications to the leaving rules are required where a subsidiary that is not an eligible tier-1 company leaves the MEC group.

3.15 Certain modifications are also made to the transitional cost setting rules that were included in the June Consolidation Bill.

Pooling rules

3.16 The cost base of all membership interests in eligible tier-1 companies of a MEC group that are held by entities that are not members of the group are to be pooled just before the time either, or both, of the following events (for ease called trigger events ) happen in relation to one or more eligible tier-1 companies in the group:

•

the company ceases to be a member of the group;

•

a CGT event happens in relation to one or more membership interests in the company.

3.17 Pooling the cost bases of those membership interests is required to allow the cost base of the interests to be reset based on an allocation from the pool immediately before the trigger event. The resetting of the cost base from the pool facilitates the free transfer of assets within the group as it removes the need to make value shifting adjustments to the membership interests each time there is a transfer of value between MEC group members.

3.18 The method adopted for allocating a part of the total cost base pool to each membership interest in each eligible tier-1 company differs depending on whether or not a trigger event happens in relation to the eligible tier-1 company. For those companies in relation to which a trigger event happens, the percentage allocation from the pool for each membership interest will equal the market value of the membership interest as a proportion of the market value of the group. For the remaining eligible tier-1 companies, the reset cost base is determined by allocating the remainder of the pool equally across all the membership interests in each of those companies.

3.19 Similar rules also apply to reset, just before the time of a trigger event, the reduced cost base of the membership interests in eligible tier-1 companies as well as the cost of those membership interests which are held on revenue account.

Available fractions for MEC groups

3.20 A groups existing available fractions are adjusted if the group expands because a new eligible tier-1 company joins the group. (An available fraction is calculated for a bundle of losses transferred to a group from an entity on joining the group. It is used to limit the annual rate at which transferred losses can be recouped by a group.)

3.21 Also, any losses generated by the group that were held by the groups head company when the new eligible tier-1 company joined will be treated as transferred losses. An available fraction will be calculated for them. It will be used to limit their annual rate of use.

Change in head company

3.22 When the head company of a MEC group is replaced by a new head company, its income tax history will be transferred to the new head company of the group.

Detailed explanation of new law

Cost setting rules

An entity joining an existing MEC group

Joining cost setting rules generally apply

3.23 The cost setting rules for ordinary consolidated groups (i.e. non-MEC consolidated groups), contained in Division 701 and Subdivision 705-A of the May Consolidation Act, govern the treatment of an entitys assets when it joins an existing consolidated group. Broadly, the effect of these rules (i.e. joining rules) is that a consolidated groups cost of acquiring a subsidiary entity is treated as the cost to the group of acquiring the assets and liabilities of that entity.

3.24 The joining rules for ordinary consolidated groups generally have equivalent application to MEC groups. However, those rules are modified by a general modifying rule so that they take account of the special characteristics of a MEC group. [Schedule 8, item 8, sections 719-155 and 719-160]

General modifying rule

3.25 The general modifying rule operates to treat each eligible tier-1 company of the MEC group as if it were a part of the head company of the group, rather than a separate entity. This treatment also extends to an eligible tier-1 company when it joins a MEC group. [Schedule 8, item 8, subsection 719-160(2)]

3.26 The rationale for the general modifying rule is that eligible tier-1 companies, representing the top level of the MEC group structure, are collectively equivalent to the head company of an ordinary consolidated group. This is the case even though, nominally, only one of the eligible tier-1 companies of a MEC group becomes the head company with the remaining eligible tier-1 companies called subsidiaries. The modifying rule is required because, unlike an ordinary consolidated group, the head company of a MEC group will not hold (directly or indirectly) all the membership interests in the subsidiary members of the group.

3.27 There are a number of important effects of the general modifying rule.

3.28 The rule ensures that provisions in the cost setting rules that operate if the head company of the group holds membership interests in another entity will operate if one or more eligible tier-1 companies of the MEC group holds membership interests in that other entity. [Schedule 8, item 8, subsection 719-160(2), note 1(a)]

3.29 A second effect of the modifying rule is that provisions in the cost setting rules that operate if the head company owns or controls another entity will operate if one or more eligible tier-1 companies own or control that other entity. [Schedule 8, item 8, subsection 719-160(2), note 1(b)]

3.30 A further effect of the general modifying rule is that references in the cost setting rules to an entity interposed between the head company and another entity will apply to an entity interposed between an eligible tier-1 company and the other entity. [Schedule 8, item 8, subsection 719-160(2), note 1(c)]

Example 3.1: Effect of the general modifying rule

Assume there is an existing MEC group comprising A Co, B Co, C Co (all eligible tier -1 companies) and D Co. E Co is the entity joining the MEC group. A Co is the head company of the MEC group for the income year in which E Co joins the group.

Without the general modifying rule applying to the joining rules, the membership interests in E Co would not be taken into account when applying those rules because A Co, the head company of the MEC group, does not hold any direct or indirect membership interests in the joining entity. Further, A Co would not directly exercise any control or ownership over the joining entity. Also, the joining rules would not treat D Co as an entity interposed between the head company and the joining entity. The general modifying rule ensures the correct treatment in each of these cases by treating B Co and C Co as part of the head company, A Co, for the purposes of the joining rules.

No cost resetting for assets of an eligible tier -1 company

3.31 Another important effect of the general modifying rule is that, when an eligible tier-1 company joins a MEC group, the cost of the assets of that joining eligible tier-1 company is not reset. This is because the joining rules only apply when an entity joins a group as a subsidiary member. The general modifying rule treats a joining eligible tier-1 company as a part of the head company of the MEC group, rather than as a subsidiary member. [Schedule 8, item 8, subsection 719-160(2), note 2]

3.32 Therefore, when an eligible tier-1 company joins an existing MEC group, the eligible tier-1 company will retain the existing tax cost of its assets. This treatment is akin to the treatment of the head company of a consolidated group. It ensures neutrality between electing that the eligible tier-1 company join a MEC group and electing that the company become the head company of a consolidated group. In the latter case, there would also be no resetting of the cost of the companys assets.

3.33 This treatment means that where a member of the MEC group holds membership interests in a joining eligible tier-1 company, the cost of those membership interests will effectively be disregarded, as there will not be any resetting of the cost of the assets of that eligible tier-1 company (i.e. the cost of the membership interests will not be aligned with the cost of the companys assets). Groups in this situation have the option of transferring those membership interests in the eligible tier-1 company held outside the group to a member of the MEC group so that the company joins the group as a subsidiary member rather than as an eligible tier-1 company. In this event the cost of the assets of the joining company could be reset.

3.34 Further consideration will be given to ensuring that the MEC group membership rules provide sufficient time for such a transfer to occur before the relevant company is treated as being a member of the MEC group. Consideration will also be given to ensuring that such transfers are treated appropriately under the joining rules (which, for example, ignore the effects of certain asset rollovers in some circumstances).

Trading stock of a joining eligible tier-1 company

3.35 Subsection 701-35(4) of the May Consolidation Act does not apply in relation to the trading stock of an eligible tier-1 company when it joins an existing MEC group. As the cost of an eligible tier-1 companys assets (including its trading stock) is not reset when it joins a MEC group, there is no need to set a tax neutral amount for the trading stock for the companys income year that effectively ends at the time it joins the group. [Schedule 8, item 8, section 719-165]

Pre-CGT factors for assets of a MEC group

3.36 The application of the general modifying rule to the joining rules means that pre-CGT factors are only worked out for assets held by subsidiaries of a MEC group other than eligible tier-1 companies.

Example 3.2: Eligible tier-1 company joining an existing MEC group

Assume that non-resident company X Co owns 100% of the membership interests in each of resident companies A Co and B Co. X Co also owns 50% of the membership interests in resident company C Co. A MEC group is initially formed on 1 July 2003 comprising A Co and B Co (both eligible tier-1 companies), with A Co the provisional head company of the group.

B Co subsequently acquires the remaining 50% of the membership interests in C Co. A Co, the provisional head company of the MEC group at the time of the acquisition, chooses for C Co to join the MEC group. C Co is an eligible tier-1 company of the MEC group.

For the purposes of the joining rules, the MEC joining entity, C Co (an eligible tier-1 company) is treated as part of the head company, A Co. This means that the assets held by C Co do not have their cost reset under the joining rules. The cost of the membership interests B Co holds in C Co at the MEC joining time is disregarded.

Formation of a MEC Group

3.37 Subdivision 705-B of the June Consolidation Bill contains the cost setting rules for the formation of an ordinary consolidated group (the formation rules). Under those rules, each entity that becomes a subsidiary member of a consolidated group at the formation time is generally treated in the same way as an entity joining an existing consolidated group.

3.38 The formation rules for ordinary consolidated groups generally have equivalent application to MEC groups. However, the general modifying rule, discussed at paragraphs 3.25 to 3.36, also applies to the formation rules. [Schedule 8, item 8, paragraph 719-160(3)(c)]

Example 3.3: Formation of a MEC group

Assume that non-resident company X Co owns 100% of the membership interests in resident companies A Co and B Co. A Co and B Co each own 50% of the membership interests in C Co.

On 1 July 2005, A Co and B Co choose to form a MEC group comprising A Co, B Co and C Co. A Co and B Co are eligible tier-1 companies of the MEC group. A Co is the head company of the group for the income year in which the group is formed.

For the purposes of the formation rules, B Co is treated as part of the head company, A Co. This means that the assets of A Co and B Co do not have their cost reset under the cost setting rules. In addition, the assets of C Co will have their cost reset under the formation rules as if a single head company held all the membership interests in C Co.

Other joining cases

3.39 Subsequent legislation will include any modifications necessary to ensure appropriate application to MEC groups in cases where:

•

one consolidated group is acquired by another consolidated group;

•

entities linked through membership interests join a consolidated group as a result of one of them joining; and

•

an entity joins an existing consolidated group where the entity is held by the group through one or more interposed entities outside the group.

An entity leaving a MEC group

3.40 Divisions 701 and 711 of the May Consolidation Act contain rules (leaving rules) that apply to reset the cost of the group-owned membership interests in a subsidiary member that leaves an ordinary consolidated group. Those leaving rules generally have equivalent application to an entity leaving a MEC group, subject to certain modifications. The modifications ensure that the rules take into account the special characteristics of a MEC group. [Schedule 8, item 8, sections 719-500 and 719-505 and subsection 719-510(1)]

3.41 The general modifying rule that applies when an entity joins a MEC group does not apply when an entity leaves a MEC group.

3.42 Where an entity that is not an eligible tier-1 company leaves a MEC group, the leaving rules apply without modification.

3.43 Where an eligible tier-1 company that is wholly-owned by entities outside the MEC group (e.g. by a non-resident entity or entities) leaves a MEC group, the leaving rules will effectively have no application. In these cases, the cost of the membership interests in the leaving eligible tier-1 company is set by special pooling rules in Subdivision 719-K of this bill (see paragraphs 3.50 to 3.71).

3.44 When an eligible tier-1 company that is partly owned by members of the MEC group leaves the group, a cost for each membership interest in the company held by other members of that MEC group is determined in broadly the same way as a cost for membership interests in a leaving subsidiary is determined under the leaving rules.

3.45 However, the leaving rules are modified to ensure they operate appropriately where the leaving entity is an eligible tier-1 company. A modification is necessary because, unlike when a subsidiary member leaves an ordinary consolidated group, all of the membership interests in a leaving eligible tier-1 company will not be held by members of the MEC group. This is because, by definition, some of the membership interests in an eligible tier-1 company must be held by entities outside the MEC group (e.g. non-resident entities).

3.46 The leaving rules are modified so that where an eligible tier-1 company leaves a MEC group, the ACA worked out in accordance with Division 711 of the May Consolidation Act is allocated to both:

•

membership interests, in one or more classes, in the leaving entity that are held by entities that remain members of the MEC group after the eligible tier-1 company leaves the group; and

•

membership interests, in one or more classes, in the leaving entity that are pooled interests in the leaving eligible tier-1 company. [Schedule 8, item 8, subsection 719-510(2)]

3.47 A pooled interest in an eligible tier-1 company of a MEC group is broadly a membership interest that is held by an entity that is not a member of the MEC group (see paragraphs 3.55 to 3.57). [Schedule 8, item 8, section 719-560] .

3.48 It is necessary to allocate the ACA for a leaving eligible tier-1 company to all membership interests in the company, including the pooled membership interests, in order to correctly apportion the ACA to those interests that members of the MEC group hold in the eligible tier-1 company. If the ACA for the leaving eligible tier-1 company was only allocated across the membership interests that members of the group held at the leaving time, the cost of those interests would be reset at an incorrect, and disproportionately high, amount.

3.49 However, it is important to note that the allocation of part of the leaving entitys ACA to the pooled interests in the leaving eligible tier-1 company is only necessary in order to work out the cost for the membership interests in that leaving entity that are held by members of the MEC group. This process does not set the cost for the pooled interests. The cost of pooled interests in a leaving eligible tier-1 company is set by the pooling rules discussed in paragraphs 3.50 to 3.71. [Schedule 8, item 8, note to subsection 719-510(2)]

Example 3.4: Eligible tier-1 company that is partly owned by group members leaves a MEC group

X Co, a non-resident company, owns all 100 membership interests in resident company A Co and 50 of the 100 membership interests in resident company B Co. A Co owns the other 50 membership interests in B Co. There is only one class of membership interests in B Co. A MEC group comprising A Co and B Co was formed on 1 July 2003.

On 1 July 2005, X Co sells its membership interests in B Co to an unrelated party causing B Co to leave the MEC group.

To determine the tax cost setting amount for A Cos membership interests in B Co, first work out the groups allocable cost amount for B Co in accordance with section 711-20. Assume that this amount is $100. Then divide that amount by the total number of membership interests in B Co (including those held by X Co).

$100 / 100 membership interests = $1 / membership interest


The tax cost setting amount for each of A Cos 50 membership interests in B Co is $1.

The cost of X Cos membership interests in B Co is set by the pooling rules - see Example 3.7.

Pooling rules

Overview

3.50 One of the policy objectives of the consolidation regime is to allow the tax free transfer of assets within a consolidated group without requiring cost base adjustments to address value shifting. Broadly, this is achieved through the operation of the cost setting rules that apply when an entity joins or leaves a consolidated group or MEC group.

3.51 The cost setting rules however are limited in their operation to membership interests held by the head company of the group as a result of the operation of the single entity rule. Without further measures, much of the benefits of forming a MEC group would disappear as entities who hold membership interests in eligible tier-1 companies would still be required to make value shifting adjustments when assets are transferred between members of the group.

3.52 The pooling rules are designed to facilitate the tax free transfer of assets within a MEC group by removing the need to make value shifting adjustments at the eligible tier-1 company level. The pooling rules achieve this by pooling the cost base of all membership interests in eligible tier-1 companies just before certain events happen and resetting the cost base of those membership interests based on an allocation from the pool.

When do the pooling rules apply?

3.53 The pooling rules apply when one of the following events (for ease called the trigger events ) happen in relation to one or more eligible tier-1 companies who are members of the MEC group:

•

the company ceases to be a member of the group; or

•

a CGT event happens in relation to one or more membership interests in the company.

[Schedule 8, item 8, subsection 719-555(1)]

3.54 The time at which a trigger event happens is referred to as the trigger time . An eligible tier-1 company in relation to which a trigger event happens is referred to as a trigger company . Not all the eligible tier-1 companies in the group need be trigger companies at the time of a trigger event. For instance, if the foreign parent company disposed of only one of the eligible tier-1 companies in a MEC group, only that company would be a trigger company. If, on the other hand the foreign parent disposed of all of the eligible tier-1 companies in the MEC group, each of those companies would qualify as trigger companies. [Schedule 8, item 8, subsection 719-555(1)]

Which membership interests do the pooling rules apply to?

3.55 The pooling rules apply to those membership interests that are referred to as pooled interests. A pooled interest is a membership interest that an entity, not being a member of the MEC group, holds in an eligible tier-1 company of a MEC group. However, it does not include:

•

the 1% employee share scheme exception to the wholly-owned requirements for eligible tier-1 companies found in subsection 719-30(2); or

•

a membership interest that is held by an entity only as a nominee of one or more other entities each of which is a member of the group.

[Schedule 8, item 8, section 719-560; Schedule 8, item 10, subsection 995-1(1)]

3.56A membership interest is defined in section 960-135 of the May Consolidation Act. Briefly, it means each interest or set of interests or each right or set of rights in relation to an entity by virtue of which an entity is a member. For example, a unitholder of a trust is a member of a public trading trust. However, it does not include debt interests (see section 960-130 of the May Consolidation Act).

3.57 The 1% employee share scheme interest has been excluded from the definition of the term pooled interest as it would not be possible for the holder of such an interest to obtain the necessary market valuation figures needed to apply the pooling rules. A membership interest that is held by an entity as a nominee of one or more members of the MEC group is also excluded from the definition of a pooled interest as the cost base of such interests would be reset under the cost setting rules contained in Division 711 of the May Consolidation Act. [Schedule 8, item 8, subsection 719-560(2)]

Example 3.5

The pooling rules are focussing on the external interests (i.e. X Companys interests - where the stars are on the diagram below) in Companies A, B and C (all eligible tier-1 companies) that, together with Company D, constitute the MEC group. The pooling rules will be triggered, for example, when Company X sells Company C so it is no longer a member of the MEC group. The pooling rules have no application to Company Bs interest in its subsidiary, Company D.

Pooling rules not to apply if market value of the group is nil

3.58 The pooling rules will not apply to reset the cost of pooled interests if the market value of the pooled interests as a whole is nil just before the trigger time. The pooling rules will not apply because it is not possible to allocate a cost from the pool based on market value where the market value of those interests as a whole is nil. The existing cost base or reduced cost base of the pooled interests will be retained in these circumstances. [Schedule 8, item 8, paragraph 719-555(1)(c)]

How do the pooling rules operate?

3.59 The pooling rules operate by pooling the cost base of all pooled interests in eligible tier-1 companies just before the trigger time. The cost of the membership interests is then reset based on an allocation from the pool. The cost of the pooled interests is reset just before the trigger time because the original cost base of the pooled interests in the MEC group may no longer be appropriate. Reasons for this include the fact that assets held at the time the eligible tier-1 company was acquired may now be held by other members of the group. Alternatively, assets held by other members of the group may now be held by the exiting eligible tier-1 company.

3.60 The amount allocated from the pool for each membership interest is referred to as the cost setting amount . The calculation of the cost setting amounts is discussed in paragraphs 3.62 to 3.69. The cost setting amount represents:

•

if Parts 3.1 or 3.3 apply in relation to the pooled interest - the cost base or reduced cost base of the interest just before the trigger time; and

•

if a provision of the ITAA 1936 or the ITAA 1997 applies other than Parts 3.1 and 3.3 - the cost of the interest just before the trigger time.

[Schedule 8, item 8, section 719-565]

3.61 An example of where the cost setting amount would be used to set a cost in the above mentioned second scenario would be where the membership interests are held on revenue account but not as trading stock.

How is the cost setting amount worked out?

3.62 The method to be adopted for working out the cost setting amount for each pooled interest differs depending on whether or not the interest is held in a trigger company at the trigger time. Each pooled interest for which a cost setting amount is worked out is referred to as a reset interest . [Schedule 8, item 8, subsection 719-555(2)]

Reset interests held in trigger companies

3.63 A cost setting amount is worked out for each reset interest held in each trigger company just before the trigger time. Broadly, the cost setting amount for each reset interest will equal the percentage of the pool that equals the market value of the reset interest as a proportion of the market value of the group. The cost setting amount is worked out under the formula:

(Market value of the reset interest / Market value of the group) * Pooled cost amount


Where:

Market value of the reset interest is the market value (just before the trigger time) of all reset interests in the trigger company (in the same class as the interest) divided by the number of reset interests in that company in that class;

Market value of the group is either:

•

if each eligible tier-1 company of the group, just before the trigger time, is a trigger company - the sum of the market value (just before the trigger time) of all reset interests in each eligible tier-1 company of the MEC group; or

•

the market value of the reset interests as a whole (including the market value of synergies arising from the combination of those interests) just before the trigger time.

[Schedule 8, item 8, subsections 719-555(2) and 719-570(1)]

Pooled cost amount is the sum of the cost bases of all reset interests just before the trigger time. [Schedule 8, item 8, subsection 719-570(1)]

3.64 The meaning to be given to the term market value of the group in the formula differs depending on whether or not all the eligible tier-1 companies that were members of the group are trigger companies. In cases where this is so, the market value of the group will simply equal the sum of the market value of all reset interests in each eligible tier-1 company just before the trigger time. Adopting this amount as the denominator ensures the sum of the numerators in the formula will equal the denominator, thereby ensuring the total pooled cost amount is allocated across the reset interests.

3.65 In situations where not all the eligible tier-1 companies are trigger companies, the market value of the group is to be worked out taking into account the market value of the reset interests as a whole including any synergies arising from the combination of those interests. The market value of the group in this situation is therefore simply not the sum of the market values of each of the eligible tier-1 companies.

3.66 The market value of the reset interest is to be worked out on a class by class basis. This ensures the cost setting amount calculated for the reset interest takes into account market valuation variances between different classes of membership interests in the company.

Example 3.6

Companies A and B are the two eligible tier-1 companies of a MEC group. Company X holds 100 C class shares in Company A and it sells 40 of these shares to Company B (the trigger time) for $2 per share. Just before the trigger time the market value of all C Class shares in Company A (the trigger company) must be divided by the total number of C class shares in Company A. Therefore, the market value of the reset interest will be $200 100 = $2.

3.67 Where the cost setting amount constitutes the reduced cost base of a reset interest in a trigger company, the cost setting amount is calculated in the same manner as outlined in paragraph 3.63 except that references in that paragraph to cost base are to be replaced by references to reduced cost base. [Schedule 8, item 8, subsection 719-570(3)]

Reset interests held in other eligible tier-1 companies

3.68 A cost setting amount is also worked out for each reset interest in each eligible tier-1 company that is a member of the MEC group but which is not a trigger company at the trigger time. Broadly, the cost setting amount for each reset interest will equal the balance of the pool not allocated to reset interests in trigger companies divided by the number of reset interests in those eligible tier-1 companies. The cost setting amount for these interests is worked out under the formula:

(Pooled cost amount - Amount allocated to trigger company interests) / Number of non-trigger company interests


Where:

Pooled cost amount has the same meaning as in paragraph 3.63;

Amount allocated to trigger company interests is the sum of all the cost setting amounts worked out for the reset interests held in the trigger companies; and

Number of non-trigger company interests is the number of reset interests held in eligible tier-1 companies that are not trigger companies. [Schedule 8, item 8, subsection 719-570(2)]

3.69 Where the cost setting amount constitutes the reduced cost base of a reset interest in an eligible tier-1 company other than a trigger company, the cost setting amount is calculated in the same manner as outlined in paragraphs 3.68 except that references in that paragraph to cost base are to be replaced by references to reduced cost base. [Schedule 8, item 8, subsection 719-570(3)]

Example 3.7

X Company has three wholly-owned Australian subsidiaries, Companies A, B and C. One hundred shares in each of these 3 companies have been issued. However, Company X only owns 50 of those shares in Company B with Company A owning the other 50. Companies A, B and C are all eligible tier-1 companies and comprise a MEC group. At the time of joining the MEC group the cost base of the membership interests in Companies A and C is both $100 and the cost base of the membership interests in Company B held by Company X is $50.

Scenario 1

On 1 July 2003, Company X disposes of its membership interests in Company C to a company that is not a member of the same wholly-owned group. This causes Company C (the trigger company) to cease being a member of the MEC group. To work out the income tax consequences for Company X, it is necessary to reset the cost base of the pooled interests in Company C as well as the pooled interests in the remaining eligible tier-1 companies of the group.

If just before the trigger time (i.e. just before Company C is sold) the market value of Company C is $290 and the market value of the reset interests as a whole is $850, the cost setting amount for each reset interest in Company C will be worked out under the formula:

(Market value of the reset interest / Market value of the group) * Pooled cost amount


The market value of the reset interest:

$290 / 100 = $2.90


The pooled cost amount:

($100 * 2) + $50 = $250


Therefore the cost setting amount for each reset interest in Company C will be:

($2.90 / $850) * $250 = $0.85


Therefore, for the purposes of applying Parts 3-1 and 3-3, the new cost base for each reset interest in Company C will be $0.85. As 100 shares are being sold the total cost base for all membership interests in Company C:

$0.85 * 100 shares = $85.


From this Company X can work out any capital gain or loss it made from selling all of the membership interests in Company C. (In this example, a gain of $205, being the difference between $290 and $85.)

The cost setting amount for each reset interest that is held in the remaining eligible tier-1 companies of the MEC group will be worked out under the formula:

(Pooled cost amount - Amount allocated to trigger company interests) / Number of non-trigger company interests
($250 - ($0.85 * 100 shares in Company C)) / 150 shares in Companies A and B = $1.10


The new cost base for the remaining interests Company X has in Companies A and B is $1.10 per pooled interest.

Scenario 2

Assume Company X subsequently sells its interests in Company B for $75. The market value of the reset interests as a whole at this time is $400. The partial sale of Company B will cause that company (the trigger company) to cease being a member of the MEC group. To work out the income tax consequences for Company X, and to ensure Company A has an appropriate cost base for its membership interests in Company B, it is necessary to reset the cost base of the membership interests in Company B.

However, only the membership interests in Company B held by Company X will qualify as pooled interests. Accordingly, a cost setting amount will not be calculated under the pooling rules for the membership interests held in Company B by Company A. Rather, a cost for those membership interests will be set under the internal cost setting rules discussed in paragraphs 3.40 to 3.49.

Under the pooling rules, the cost setting amount for each reset interest in Company B, held by Company X, will be worked out under the formula:

(Market value of the reset interest / Market value of the group) * Pooled cost amount


The market value of the reset interest:

$75 / 50 = $1.50


The pooled cost amount:

$1.10 * 150 shares = $165


Therefore the cost setting amount for each reset interest in Company B will be:

($1.50 / $400) * $165 = $0.62


From this Company X can work out any capital gain or loss it made from selling all of the membership interests it held in Company B. (In this example, a gain of $44, being the difference between $75 and $31.)

The cost setting amount for each reset interest that is held in the remaining eligible tier-1 company of the MEC group will be worked out under the formula:

(Pooled cost amount - Amount allocated to trigger company interests) / Number of non-trigger company interests
($165 - $0.62 * 50 shares in Company B) / 100 shares in Company A = $1.34


The new cost base for the remaining interests Company X has in Company A is $1.34 per pooled interest.

What happens when a trigger time occurs more than once to a trigger company?

3.70 If a trigger time happens to a trigger company on more than one occasion, this Subdivision applies successively at each trigger time.

Provisions that adjust cost base and reduced cost base of membership interests

3.71 Under the ITAA 1936 and the ITAA 1997, various provisions apply to adjust the cost base and the reduced cost base of membership interests. Amendments consequential to the pooling rules will be made to those provisions in subsequent legislation to ensure they apply to cost bases and reduced cost bases that have been reset under these measures in a manner that is consistent with the current operation of the law.

Available fractions for MEC groups

3.72 Generally, available fractions for MEC groups will be calculated and adjusted in the same way as they are for ordinary consolidated groups.

3.73 However, a groups existing available fractions will be adjusted if the group expands because a new eligible tier-1 company joins the group. Also, an available fraction must be calculated for any group losses held by the groups head company when the new eligible tier-1 company joined. Essentially, the inclusion of a new eligible tier-1 company is treated as a merger between the existing group and the new eligible tier-1 company. [Schedule 8, item 8, Subdivision 719-F]

Why are available fractions calculated or adjusted when a new eligible tier-1 company joins?

3.74 All losses transferred to the head company of a consolidated group from a joining loss entity form a single loss bundle for which an available fraction is calculated. The available fraction is basically the proportion that the loss entitys market value at the joining time bears to the value of the whole group at that time.

3.75 A groups annual use of its transferred losses is limited by their available fraction. That is, they may only be offset against a fraction of the groups income and gains. Essentially the available fraction is a proxy for determining the proportion (i.e. fraction) of the groups income or gains generated by the loss entity. The inclusion of a new eligible tier-1 company increases the groups income generating capacity which reduces the proportion of the groups income that the original loss entities can now be regarded as generating.

3.76 The increase in value or income generating capacity occurs because the group has not paid cash or assets (or increased its liabilities) in order to acquire the additional eligible tier-1 company. That is, there has been no exchange of one type of group assets for another (which would generally leave the groups value unchanged). The inclusion in the group of the additional eligible tier-1 company (and its wholly-owned subsidiaries) occurs purely because of the companys relationship with the groups top company.

3.77 Therefore, the inclusion of a new eligible tier-1 company in a group effectively introduces capital into the group from outside the group. However, it is not covered by the existing rule requiring a groups available fractions to be adjusted if there is an injection of capital into the group. That is because the existing rule is triggered by an injection of capital into a member of the group. That has not happened here. Rather, the eligible tier-1 company is included in the group purely because of its relationship with the groups top company. Nevertheless, the effect is the same. For that reason, a groups existing available fractions will be adjusted whenever a new eligible tier-1 company joins.

3.78 If the group has group losses when the new eligible tier-1 company joins it, the losses will also be given an available fraction as though they were transferred losses of the expanded group. This is consistent with the treatment of these cases as a merger of 2 groups of entities. Assigning group losses an available fraction broadly ensures they can only be offset against the portion of the groups income that can be said to have been generated by the entities that contributed to the making of the loss.

The new eligible tier-1 company is already a consolidated group

3.79 New eligible tier-1 companies and their subsidiaries may, prior to their acquisition by the group, have themselves been an ordinary group or a MEC group. In that case, available fractions for losses held by them will be adjusted in the normal manner. That is, using the rules in section 707-320 of the May Consolidation Act that adjust available fractions for losses that are transferred on a second or subsequent occasion.

When are available fractions calculated or adjusted?

3.80 The calculation and adjustment rules described in paragraphs 3.86 to 3.104 apply if:

•

a MEC group expands to include a new eligible tier-1 company; or

•

an ordinary consolidated group converts to a MEC group.

[Schedule 8, item 8, subsections 719-300(1), (2) and (3)]

Expansion of a MEC group

3.81 A MEC group can expand after formation to include a new eligible tier-1 company of the top company. The new eligible tier-1 company will become a member of the group if the groups provisional head company notifies the Commissioner. (See subsection 719-5(4) of the May Consolidation Act.) The expanded group will also include wholly-owned subsidiaries of the new eligible tier-1 company.

Example 3.8

A MEC group forms comprising eligible tier-1 companies T1 and T2 and their subsidiaries A and B. Subsequently, Top Co acquires another company T3 which also meets the requirements to be an eligible tier-1 company. The existing MEC group expands to include T3 and its subsidiary C.

Conversion of an ordinary group to a MEC group

3.82 An ordinary consolidated group can convert to a MEC group if the head company of the group is also an eligible tier-1 company of the top company, another company becomes an eligible tier-1 company of the top company and the original head company notifies the Commissioner that a MEC group is to come into existence. (See section 719-40 of the May Consolidation Act.) The converted group will include the ordinary group plus the additional eligible tier-1 company and its wholly-owned subsidiaries.

The rules do not apply if the new eligible tier-1 company was already a member of the group

3.83 The new calculation and adjustment rules do not apply if the new eligible tier-1 company had, immediately before becoming an eligible tier-1 company, been a member of the MEC or consolidated group. That is, they do not apply if, for example, membership interests in a member company held by an eligible tier-1 company are transferred (rolled-up) to the groups top company resulting in the member company becoming a new eligible tier-1 company of the group. [Schedule 8, item 8, subsections 719-300(4), (5) and (6)]

3.84 The calculation and adjustment rules discussed in paragraphs 3.86 to 3.104 are not appropriate in a roll-up case. They are based on a merger of 2 groups of entities whereas the roll-up scenario simply involves a reorganisation of a groups existing entities.

3.85 Nonetheless, the roll-up of interests will enhance the groups income generating capacity if, for example, the top company paid the group cash or assets in exchange for the interests. But in that case it can be said that capital has been injected into the group and therefore the groups available fractions would be adjusted under item 4 of the table in subsection 707-320(2) of the May Consolidation Act.

Rule 1: Calculating an available fraction for group losses

3.86 Any group losses held by a groups ongoing head company when a new eligible tier-1 company joins are treated as though they were transferred losses of the expanded group. This ensures they form a loss bundle for which an available fraction is calculated. The losses are not actually tested and transferred. Rather they are treated as if they had passed the transfer tests and were transferred to the head company under Subdivision 707-A of the May Consolidation Act at the time the new eligible tier-1 company joined. [Schedule 8, item 8, subsections 719-305(1) and (2)]

3.87 This deemed transfer is for the purpose of applying Subdivision 707-C of the May Consolidation Act. That is, Subdivision 707-C will apply in determining how much of the losses can be used for an income year (in the same way that Subdivision already applies in determining the maximum annual usage of a transferred loss). [Schedule 8, item 8, subsections 719-305(1) and (2)]

3.88 However, these rules only apply to (and therefore available fractions are only calculated for) group losses made in an income year that is earlier than the income year in which the new eligible tier-1 company joined the group. This matches what occurs when a group forms part way through the head companys income year. In that case, the head company transfers to itself any losses made by it in income years prior to the formation year, but is not required to calculate a separate taxable income or loss for the period from the start of the formation year to the formation time.

3.89 The available fraction is calculated under subsection 707-320(1) of the May Consolidation Act using this fraction:

Modified market value of the real loss-maker at the initial transfer time / Transferees adjusted market value at the initial transfer time


Numerator: real loss-makers modified market value

3.90 The head company, in its capacity as the head company of the original group, is the real loss-maker referred to in the numerator - it is taken to have made the group loss by virtue of the single entity rule.

3.91 Section 707-325 of the May Consolidation Act sets out how a real loss-makers modified market value is worked out. But that section only applies to work out the modified market value of an entity that becomes a member of a consolidated group. In the expansion case, the ongoing head company continues as a member of the MEC group - it does not become a member of a new group. Therefore, in working out an available fraction for the group loss bundle, it is assumed that the ongoing head company did become a member of a group at the time the new tier-1 company joined. [Schedule 8, item 8, paragraph 719-305(3)(a)]

3.92 Also, section 707-325 requires a real loss-maker to work out its modified market value as a separate entity. Section 707-330 ensures that when the real loss-maker was the head company of a group (the old group) and is transferring its group losses to another group (the new group) the modified market value of the whole of the old group is used in working out an available fraction for the losses.

3.93 However, that section only applies when the ex-head company of the old group becomes a subsidiary member of a new group. It therefore cannot apply when all that happens is a new eligible tier-1 company joins the head companys group. Therefore, equivalent rules will apply in working out the modified market value of a head company of the original group as a result of a new eligible tier-1 company joining. That is, the head company works out its modified market value as if:

•

each subsidiary member of the original group at the time the eligible tier-1 company joined were a part of the head company [Schedule 8, item 8, paragraph 719-305(3)(b)] ; and

•

the single entity rule also applies to the period the original group was in existence before the eligible tier-1 company joined [Schedule 8, item 8, paragraph 719-305(3)(c)]:

-

this ensures that capital injected into (or non-arms length transactions involving) subsidiary members of the original group before the new tier-1 company joins are taken into account in working out the head companys modified market value.

Denominator: transferees adjusted market value

3.94 The head company of the new group is also the transferee referred to in the denominator - the group losses are taken to have been transferred to that entity. The single entity rule ensures that in working out the head companys adjusted market value, all of the other group members, including the new eligible tier-1 company, are treated as a part of the head company.

Transferred group losses retain their original date of occurrence

3.95 The transferred group losses retain their original date of incurrence. That is, the group losses continue to be made by the head company for the income year in which the head company actually made them (rather than the income year of the deemed transfer). This means that when they are tested to determine whether they can be used they are tested from the date they were actually made. [Schedule 8, item 8, subsection 719-305(4)]

Transferred group losses cannot access transitional concessions

3.96 In calculating an available fraction for group losses, access to the value and loss donor transitional concession is specifically denied. In the absence of this rule it could perhaps have been argued that the concession could apply in working out an available fraction for group losses in respect of a consolidated group that converted to a MEC group during the transitional period. [Schedule 10, item 2, section 719-305]

Rule 2: Adjusting existing available fractions

3.97 The ongoing head company adjusts its existing available fractions when a new eligible tier-1 company joins by multiplying each available fraction by:

Market value of the existing group just before the eligible tier-1 company joins / Market value of the new group just after the eligible tier-1 company joins


[Schedule 8, item 8, subsections 719-310(1) and (2)]

3.98 This adjustment is based on the one in item 1 of the table in subsection 707-320(2) of the May Consolidation Act. That item adjusts the available fractions of a group that is acquired by another group. That is, the inclusion of a new eligible tier-1 company is treated as a merger between the existing group and the new tier-1 company.

Application of item 3 of the table in subsection 707-320(2) is restricted

3.99 The adjustment set out in paragraph 3.97 applies regardless of whether the new eligible tier-1 company or any of its subsidiaries are loss entities. It therefore applies instead of the one in item 3 of the table in subsection 707-320(2) of the May Consolidation Act. [Schedule 8, item 8 , paragraph 719-310(3)(b)]

3.100 Item 3 adjusts an existing groups available fractions when a new loss entity joins the group as part of ensuring that a groups available fractions cannot total more than one. It does not provide the appropriate adjustment for a group when a new eligible tier-1 company joins - even if the new tier-1 company is a loss entity. That item only gives an appropriate outcome when there has been value exchanged for an incoming entity and the incoming entity is a loss entity.

3.101 This means that item 3 only applies to a MEC group if the new entity is a wholly-owned loss subsidiary of an existing eligible tier-1 company. In that case, the group will have exchanged value in order to acquire the entity and so item 3 provides the appropriate adjustment.

3.102 Also, item 3 does not apply if the head company is taken to have transferred group losses to itself as a result of an eligible tier-1 company joining. [Schedule 8, item 8, paragraph 719-310(3)(a)]

Rule 3: Capping available fractions if the group has both group losses and transferred losses

3.103 A group may have both group losses and transferred losses when the new eligible tier-1 company joins. In that case, the groups available fractions for its group and transferred losses, calculated and adjusted as set out in paragraphs 3.86 to 3.98 are capped so their total does not exceed what would otherwise have been the available fraction for the group losses. Each available fraction is multiplied by this fraction:

The available fraction for the group loss bundle / The sum of the available fraction for the group loss bundle and the (adjusted) available fractions for the existing transferred loss bundles


[Schedule 8, item 8, section 719-315]

3.104 This adjustment is based on the one in item 2 of the table in subsection 707-320(2) of the May Consolidation Act. That item caps the available fractions of a group that is acquired by another group.

Example 3.9

The ongoing [T1, T2] group

T1 and T2 are eligible tier-1 companies of the top company. They choose to form a MEC group. That group comprises T1, T2, S1 and S2.

On formation, S1 and S2 transfer losses to the group. Their available fractions are:

S1	0.246
S2	0.312

After formation, the group makes a tax loss.

The joining [T3] group

Subsequently, the groups top company acquires T3 (an eligible tier-1 company) and S4. As a result, the MEC group expands to include T3 and S4.

Prior to their acquisition, T3 and S4 had been a consolidated group. S4 had transferred losses to the consolidated group on its formation. Those losses are now transferred from T3 to the MEC group. The available fraction for this bundle prior to that transfer was 0.214. After formation of the T3 and S4 consolidated group, this group made a tax loss.

The values when T3 and S4 join the MEC group are:

•

the market value (and modified market value) of the continuing MEC group comprising T1 and T2 and their subsidiaries is $5,000; and

•

the market value of the T3 and S4 group is $3,000.

Work out available fractions for the ongoing [T1, T2] group

Step 1: Calculate an available fraction for the group loss
Group loss	$5,000 / $8,000 = 0.625
Step 2: Adjust the available fractions for the S1 and S2 bundles
S1	0.246 * ($5,000 / $8,000) = 0.154
S2	0.312 * ($5,000 / $8,000) = 0.195
Step 3: Cap the step 1 and 2 available fractions
Group loss	0.625 * (0.625 / 0.974) = 0.401
S1	0.154 * (0.625 / 0.974) = 0.099
S2	0.195 * (0.625 / 0.974) = 0.125

Note: 0.974 is the sum of the available fractions calculated or adjusted under steps 1 and 2 (i.e. 0.625 + 0.154 + 0.195).

Work out available fractions for the joining [T3] group

Step 1: Calculate an available fraction for the group loss
Group loss	$3,000 / $8,000 = 0.375
Step 2: Adjust the available fraction for the S4 bundle
S4	0.214 ($3,000 $8,000) = 0.080
Step 3: Cap the step 1 and 2 available fractions
Group loss	0.375 * (0.375 / 0.455) = 0.309
S4	0.080 * (0.375 / 0.455) = 0.066

Total available fractions for the expanded group

T1, T2 group loss	0.401
S1	0.099
S2	0.125
T3 group loss	0.309
S4	0.066
Total	1.000

Eligible tier-1 company joins part way through the income year

3.105 A groups use of its existing (group and transferred) losses will be apportioned if the new eligible tier-1 company joins the group part way through the groups income year.

3.106 For a groups transferred losses, the existing apportionment rule in section 707-335 of the May Consolidation Act applies. This rule ensures that where the numerical value of an available fraction changes during the income year, the new adjusted fraction only applies from the time of the event that triggered the adjustment. In this case, that would mean the adjusted available fraction applied from the time the new eligible tier-1 company joined.

3.107 A new principle will be added to section 707-335 to cover group losses that are treated as transferred losses. It will ensure that in the income year in which the new eligible tier-1 company joined, the groups use of the losses for the pre-joining period is unrestricted (in accordance with their status as group losses for that period) but their use is subject to their new available fraction for the post-joining period (in accordance with their status as transferred losses for that period). This will be achieved by treating the group losses as being in a bundle with an available fraction of one for the pre-joining period. [Schedule 6, item 3, paragraph 707-335(1)(a)) and item 4, paragraph 707-335(3)(e)]

3.108 This principle will also ensure a similar outcome when a head company transfers its own losses to itself on formation part way through its income year. That is, the groups use of the head companys own losses is only subject to their available fraction for the post-formation period. No restrictions apply to their use for the pre-formation period. This is discussed in more detail in Chapter 8.

3.109 The available fraction of one, that is assigned to the group loss bundle, is not adjusted if any of the adjustment events set out in the table in subsection 707-320(2) of the May Consolidation Act occur during the pre-joining period. This is consistent with the losses having group loss status for that period.

Losses retain their status as group losses for the pre-joining period

3.110 The amount of transferred group losses that can be used and which are attributable to the period for which the bundle had an available fraction of one (i.e. the pre-joining period) is taken not to have been a loss transferred under Subdivision 707-A. That is, that amount is a group loss and must therefore be deducted from the groups income and gains before applying the available fraction for other loss bundles. [Schedule 8, item 8, section 719-320]

3.111 Giving the group loss bundle an available fraction of one for the pre-joining period is simply a technique to ensure that use of the losses for that period is unrestricted. It is not intended to change the fact that in all other respects the losses used for that period retain their status as group losses.

New power to cancel losses

3.112 The head company of the expanded or converted MEC group may choose to cancel all the losses in:

•

its group loss bundle; and

•

any of its existing bundles.

[Schedule 8, item 8, subsection 719-325(1)]

3.113 A head company may achieve a better outcome under the capping rule 3 by cancelling some or all of its existing transferred loss bundles. Alternatively, it may avoid the application of rule 3 altogether by cancelling its group loss bundle. The choice to cancel a loss cannot be revoked. [Schedule 8, item 8, subsections 719-325(2), (5) and (7)]

3.114 Broadly, the effect of cancellation is that the cancelled losses can be used up until the new eligible tier-1 company joins but cannot be used thereafter. The apportionment rule in section 707-335 of the May Consolidation Act is applied on the assumption that:

•

the cancelled group losses are in a bundle with an available fraction of one during the pre-joining period [Schedule 8, item 8, paragraph 719-325(3)(a)]:

-

the cancelled transferred losses would already have been in a bundle with an available fraction for the pre-joining period; and

•

the cancelled group and transferred losses have an available fraction of zero for the post-joining period [Schedule 8, item 8, paragraph 719-325(3)(b)] .

3.115 Cancelled losses cannot be used by any entity for an income year following the income year in which the new tier-1 company joined. [Schedule 8, item 8, subsection 719-325(6)]

3.116 Also, the ability to transfer cancelled losses under Subdivision 707-A of the May Consolidation Act (or Division 170 of the ITAA 1997) is specifically denied. This closes off an argument that may otherwise arise that the unused portion of a cancelled loss could be transferred to a new group on the basis that the rules provide for it to be utilised for the income year in which the tier-1 company joined. [Schedule 8, item 8, subsection 719-325(4)]

Change in head company

3.117 The membership rules for MEC groups can accommodate changes to the identity of the head company of the group. A change to the head company of a MEC group will occur when a company (the old head company) that is the head company of the group at the end of an income year is different to the company (the new head company) that is the head company at the start of the next income year.

3.118 When one head company of a MEC group is replaced with another, everything that happened in relation to the old head company of a MEC group before the time that it ceased to be the head company (the transition time) is instead taken to have happened in relation to the new head company of the group, just as if the new head company had been the old head company at all times before the transition time [Schedule 8, item 8, section 719-85 and subsection 719-90(1)]. For brevity, this will be referred to as the transfer of history rule in this explanatory memorandum.

3.119 The transfer of history rule also ensures that things that happened to the old head company prior to the transition time because of the single entity rule, the entry history rule, the substitution rule (see paragraph 2.16 in Chapter 2) or a previous application of the transfer of history rule will be taken to have happened to the new head company [Schedule 8, item 8, subsection 719-90(2)] . The single entity rule and the entry history rule were contained in the May Consolidation Act. The single entity rule treats subsidiary members of a MEC group or a consolidated group as part of the head company of the group and allows such groups to be treated as single entities for income tax purposes. The entry history rule allows the head company to inherit the income tax history of subsidiary members once they become subsidiary members of the group.

3.120 The transfer of history rule applies for the purposes of calculating the new head companys income tax liability or tax loss for any income year that ends after the transition time. [Schedule 8, item 8, paragraph 719-90(3)(a)]

3.121 The transfer of history rule also applies for the entity core purposes for an income year that ends after the transition time [Schedule 8, item 8, paragraph 719-90(3)(b)] . However, this will be subject to the exit history rule and any provisions which the exit history rule is subject to [Schedule 8, item 8, subsection 719-90(4)] . The entity core purposes relate to the purposes of a subsidiary member working out its income tax liability or loss for any period during which it is a subsidiary member of a MEC group or consolidated group or any later income year. The exit history rule allows an entity to inherit certain income tax history on ceasing to be a subsidiary member of a MEC group or consolidated group. Both the entity core purposes and the exit history rule were contained in the May Consolidation Act.

3.122 One effect of the rule in paragraph 3.121 is that when the old head company ceases to be a subsidiary member of the MEC group, it will take with it only the income tax history that relates to the assets, liabilities and businesses that leave the group with the company.

3.123 The transfer of history rule does not mean that the new head company is given any new responsibility for income tax liabilities relating to periods prior to when it became the head company of the group.

3.124 One implication of the transfer of history rule is that all of the tax attributes of the old head company that are relevant to the head company core purposes (e.g. losses and foreign tax credits) will instead become those of the new head company once the old head company is replaced. This means that those tax attributes that have not affected taxable income or will not affect a later taxable income will not be inherited by the new head company by virtue of the transfer of history rule . For example, the franking credit balances in the old head companys franking account (if any) will not become those of the new head company under the transfer of history rule.

3.125 It is not appropriate that the transfer of history rule be extended to cover the transfer of franking account balances between head companies of a single MEC group. It is necessary for franking credits to be able to be accessed at any given time during an income year but this would not be possible if franking account balances were transferred between head companies of a single MEC group. This is because, unlike the provisional head company of a MEC group, the head company of a MEC group can generally only be determined at the end of any given income year. The transfer of franking account balances between provisional head companies of a MEC group will be regulated by other rules that will be introduced in subsequent legislation.

3.126 A change in the head company of a MEC group also has implications for consolidation provisions that ordinarily apply when an entity becomes a subsidiary member of a MEC group (hereafter called the joining rules) or ceases to be a subsidiary member of a MEC group. [Schedule 8, item 8, section 719-85]

3.127 The joining rules will not apply where an entity becomes a subsidiary member of a MEC group if immediately beforehand it ceases to be the head company of that group (subject to any specific exceptions) [Schedule 8, item 8, subsection 719-95] . A company will cease to be a head company of a MEC group and become a subsidiary member of that group where, for example, membership interests in the company that were previously held by a non-resident entity are transferred to another member of the MEC group. The rule aims to prevent unintended consequences such as double counting of tax attributes that may otherwise occur. In the absence of such a rule, it may be arguable, for example, that losses of the old head company would be transferred to the new head company under the joining rules. The transfer of those losses under the joining rules would be in addition to the transfer that would occur under the transfer of history rule.

3.128 The rule in paragraph 3.127 does not affect the application of the single entity rule. [Schedule 8, item 8, subsection 719-95(2)]

3.129 Consolidation provisions that ordinarily apply when an entity ceases to be a subsidiary member of a MEC group will not apply where immediately after cessation, the entity becomes the head company of the same MEC group (subject to any specific exceptions) [Schedule 8, item 8, subsection 719-95(3)] . The rule aims to prevent unintended consequences, such as the application of the exit history rule to the new head company when it ceases to be a subsidiary member of the MEC group. The exit history rule is clearly only intended to apply when an entity ceases to be a subsidiary member of a MEC group because it leaves the group.

Application and transitional provisions

3.130 The consolidation regime will apply from 1 July 2002.

Cost setting rules

3.131 The transitional cost setting rules introduced in the June Consolidation Bill (Divisions 701 and 702 of the IT(TP) Act 1997) require some modifications so that they apply appropriately in the MEC group context.

3.132 The general modifying rule, discussed in paragraphs 3.25 to 3.26, will generally apply to the transitional cost setting rules. The transitional cost setting rules principally modify the joining and formation rules. The general modifying rule needs to apply to those rules to ensure their appropriate operation in relation to MEC groups (see paragraphs 3.25 to 3.38). [Schedule 10, item 2, subsection 719-160(1)]

3.133 However, the general modifying rule does not apply to sections 701-5, 701-40 or 701-45 of the transitional cost setting rules. These provisions offer choices that need to be made by the actual head company of the MEC group (not by all of the eligible tier-1 companies). In addition, these provisions cover issues dealing with an entity leaving a group: the general modifying rule does not apply when an entity leaves a MEC group. [Schedule 10, item 2, subsection 719-160(2)]

3.134 Although the general modifying rule does not apply to section 701-45, paragraph 701-45(1)(b) is modified so that it also applies to pre-CGT assets held by entities that were eligible tier-1 companies of a transitional MEC group at the time the group was formed. [Schedule 10, item 2, section 719-165]

Available fractions for MEC groups

3.135 The value donor concession cannot be used in calculating an available fraction for a group loss as a result of a new eligible tier-1 company joining the group. [Schedule 10, item 2, section 719-305]

Consequential amendments

3.136 Consequential amendments have been made to subsection 995-1(1) of the ITAA 1997 to include references to new dictionary terms.

3.137 The definition of available fraction in subsection 995-1(1) of the ITAA 1997 will be expanded to include available fractions calculated under the rules discussed in paragraphs 3.97 and 3.103. [Schedule 8, item 9]

3.138 Consequential amendments have also been made to Division 719 of the May Consolidation Act to remove the link note at the end of subsection 719-80(2). [Schedule 8, item 7, subsection 719-80(2)]