House of Representatives

Explanatory Memorandum

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

Chapter 6 - Consolidation - providing greater flexibility

Outline of chapter

6.1 Schedule 6 to this Bill:

•

ensures that certain liabilities taken into account when an entity leaves a consolidated group that correspond to liabilities brought into a consolidated group with a joining entity have the same value at the leaving time that the liabilities had at the joining time;

•

ensures that there is no double reduction in working out step 3 of the allocable cost amount (ACA) on entry;

•

ensures that when debts which have had a connection with a consolidated group are written off, the claimant can claim a bad debt deduction; and

•

clarifies the taxation consequences for life insurance companies and general insurance companies that join or leave a consolidated group.

6.2 All references to legislative provisions in this chapter are references to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

6.3 Unless otherwise stated a reference in the chapter to a consolidated group should be read as including a multiple entry consolidated group.

Context of amendments

6.4 A number of modifications are being made to the consolidation regime to provide greater flexibility, further clarify certain aspects of the regime and ensure that it interacts appropriately with other areas of the income tax law.

Summary of new law

Value of certain liabilities when an entity leaves a consolidated group

6.5 Part 2 of Schedule 6 to this Bill ensures that certain liabilities taken into account when an entity leaves a consolidated group (in working out the head company's cost for membership interests in the leaving entity) that correspond to liabilities brought into a consolidated group with a joining entity have the same value at the leaving time that the liabilities had at the joining time.

Ensuring no double reduction in step 3 of the allocable cost amount calculation on entry

6.6 Part 3 of Schedule 6 to this Bill ensures that there is no double reduction in working out step 3 of the ACA where an entity joins a consolidated group by removing the requirement to reduce accrued undistributed profits to the extent that they have recouped particular sorts of losses.

Bad debts

6.7 Part 4 of Schedule 6 to this Bill inserts bad debt rules to ensure that an entity can deduct a bad debt that has been for a period owed to a member of a consolidated group, and has for another period been owed to an entity that was not a member of that group.

Life insurance companies

6.8 Part 5 of Schedule 6 to this Bill will clarify the taxation consequences for life insurance companies that join or leave a consolidated group by ensuring that:

•

no taxation distortions arise when risk policy liabilities are transferred to or from the head company when a life insurance company joins or leaves a consolidated group;

•

any complying superannuation class tax losses and net capital losses from virtual pooled superannuation trust assets held by a life insurance company that joins a consolidated group are transferred to the head company and retain their character;

•

losses held by a subsidiary of a life insurance company that joins a consolidated group where all the membership interests of the subsidiary are virtual pooled superannuation trust assets can, provided certain conditions are satisfied, be transferred to the head company and will become either:

-

complying superannuation class tax losses of the head company; or

-

net capital losses from virtual pooled superannuation trust assets of the head company;

•

losses held by a subsidiary of a life insurance company that joins a consolidated group where all the membership interests of the subsidiary are segregated exempt assets cannot be transferred to the head company;

•

franking surpluses held at the joining time in the franking account of a subsidiary of a life insurance company that is a member of the consolidated group are applied to the benefit of the head company in a way that is consistent with the outcome that would arise if the group did not consolidate;

•

the head company will be taxed appropriately if it has excess assets in its segregated exempt assets because another member of the consolidated group holds an immediate annuity contract with a life insurance company that is a member of the group; and

•

the tax cost setting rules that apply when a life insurance company leaves a consolidated group are modified to specify the value of certain assets and the value of policyholder liabilities.

General insurance companies

6.9 Part 5 of Schedule 6 to this Bill will also clarify the taxation consequences for general insurance companies that join or leave a consolidated group by ensuring that:

•

if a general insurance company that has demutualised joins a consolidated group, the goodwill asset of the company is a retained cost base asset for tax cost setting purposes; and

•

no taxation distortions arise when outstanding claims liabilities and unearned premiums are transferred to or from the head company when a general insurance company joins or leaves a consolidated group.

Comparison of key features of new law and current law

Detailed explanation of new law

Value of certain liabilities when an entity leaves a consolidated group

6.10 Liabilities that were brought into a group by a joining entity may leave a consolidated group with an entity when it ceases to be a member of the group. The amount of the liability that is taken into account in calculations the cost for membership interests in the leaving entity is worked out by adding up all of the entity's 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 entity's statement of financial position.

6.11 Part 2 of Schedule 6 to this Bill ensures that where the same liability (i.e. excluding any new liabilities) that was brought into a consolidated group leaves, the value of that liability should be the same at both the joining time and the leaving time. An example of a liability that may vary in amount is an accounting provision for damages under a legal case.

6.12 If the value of the liability in these circumstances was allowed to be different, then the change in the value of that liability would not have been recognised under the consolidation cost setting rules. The problem occurs because the amount of the liability at the joining time is used in setting the cost for tax purposes of the joining entity's assets.

6.13 On entry, liabilities are added in working out the ACA of an entity that joins a consolidated group under step 2 (sections 705-70, 705-75, 705-80 and 705-85). On exit, liabilities are subtracted in working out the ACA to be used in setting the cost for membership interests in an entity that leaves a consolidated group under step 4 (section 711-45).

6.14 Where a liability of a joining entity that is taken into account at step 2 of the ACA calculation is discharged for a different amount after the joining time (and this change would have resulted in a variation to the original ACA), a capital gain or loss will arise under section 104-530 (CGT event L7). If the joining entity had not joined the group then the change in the amount of the liability would be reflected in the value of membership interests in the leaving entity and therefore would have affected the owner's gain or loss when it disposed of those membership interests.

6.15 The purpose of the alignment in the value of particular liabilities on exit with their value on entry is to ensure that there is a consistent outcome with what would have occurred if the relevant liability had been discharged and CGT event L7 had been triggered.

Example 6.1

Assume the amount of a liability taken into account at step 2 of working out the ACA on joining was $100 and the same liability had a value for the purposes of step 4 of working out the ACA for a leaving entity at the leaving time of $150. The increase in the amount of the liability would have the effect of reducing the tax cost for the membership interests in the leaving entity (thereby potentially increasing the amount of a capital gain or reducing the amount of a capital loss on the disposal of those interests).

If the liability had not left with the leaving entity but had been discharged by the consolidated group instead for $150 then the consolidated group would have received a capital loss of $50 (under CGT event L7). Only taking into account the amount of the liability that was taken into account at the joining time ensures that no capital gain or loss arises from the difference in the amount of the liability between the joining and the leaving times.

6.16 An adjustment to the amount of a liability for the purposes of working out the ACA when an entity leaves a consolidated group will occur where:

•

a liability is taken into account in working out the ACA for an entity that leaves a consolidated group under subsections 711-45(1) to (7) [Schedule 6, item 2, paragraph 711-45(8)(a)] ;

•

that liability was a liability of an entity that became a subsidiary member of a consolidated group (not necessarily the same entity as the leaving entity) that was taken into account in working out the ACA for the subsidiary member in accordance with Division 705 [Schedule 6, item 2, paragraph 711-45(8)(a)] ;

•

the amount of the liability that was taken into account on entry (called the 'entry amount') is different from the amount taken into account on exit (called the 'exit amount') in applying one of subsections 711-45(1) to (7) [Schedule 6, item 2, paragraph 711-45(8)(b)] ; and

•

the ACA for the subsidiary member on joining would have been different if the amount of the liability at the leaving time had been taken into account in working out the ACA for the subsidiary member at the joining time [Schedule 6, item 2, paragraph 711-45(8)(c)].

6.17 Then the amount of the liability that is taken into account in working out the ACA for an entity that leaves is taken to be the amount that was taken into account on entry. As discussed below, this replacement amount becomes the starting point for applying section 711-45. The amount that is taken into account under step 4 on exit may be modified by particular subsections of section 711-45 (after the application of subsection 711-45(8)). [Schedule 6, item 2, subsection 711-45(8)]

Liability at exit must be the same liability as on entry

6.18 The adjustment only applies where the liability at the leaving time is the same as the liability at the joining time. Consequently, no adjustment is made to the extent that the liability is different as a result of, for example, a partial repayment of the liability or an increase in the amount of a liability that accrued after the joining time. The reference to "a leaving entity's liability ... was taken into account" in paragraph 711-45(8)(b) means that the liability on entry has to be the same liability as the liability that is in existence at the leaving time. [Schedule 6, item 2, paragraph 711-45(8)(a)]

Liability must have been taken into account in working out the allocable cost amount for an entity that joined

6.19 The adjustment only applies to liabilities that were taken into account in working out the ACA for an entity that joined the consolidated group. Consequently, no adjustment will apply to liabilities that were brought into a group by the head company or an entity that was a chosen transitional entity. [Schedule 6, item 2, paragraph 711-45(8)(a)]

There must be a difference between the entry amount and the exit amount

6.20 No adjustment is made where there is no difference between the amount of the liability that was taken into account in working out the allocable amount on entry and the amount of that liability that is taken into account where an entity leaves a consolidated group. This is because, in these circumstances, there is no change in the amount of the liability that has affected the tax cost set for assets of a joining entity. For example, subsection 705-80(1) (which adjusts the amount of a liability for unrealised gains and losses) may have applied in working out the amount of the liability on entry and consequently there may not be a difference if the amount of the liability on exit was substituted for the amount on entry. [Schedule 6, item 2, paragraph 711-45(8)(b)]

The change in the liability would have changed the amount of the allocable cost amount for the joining entity

6.21 No adjustment is made if the change in the liability would not have resulted in a change in the ACA for the joining entity if the changed amount of the liability had been used. This is because the change in the amount of the liability would not have affected the amount of the ACA and consequently the amount allocated to the assets. [Schedule 6, item 2, paragraph 711-45(8)(c)]

6.22 This condition is consistent with the operation of CGT event L7 (in particular paragraph 104-530(3)(c)). This outcome may arise because not every change in the amount of a liability between the joining time and the time the liability leaves with an entity that exits a group will affect the ACA calculation. This is because the ACA calculation factors in future tax effects for the liability, and after taking those into account, there may be no net change in the ACA.

The replacement amount becomes the starting point for applying section 711-45

6.23 Subsection 711-45(8) adjusts the amount of the liability that is used as the starting point for the application of any of the other subsections in section 711-45. For example:

•

in applying subsection 711-45(4), it is necessary to work out the market value of the asset that corresponds to the liability on the assumption that the amount of that liability is equal to the entry amount;

•

in applying subsection 711-45(5), the payment necessary to discharge the liability will be a reference to the payment necessary to discharge that liability on the assumption that its amount were equal to the entry amount; and

•

in applying subsection 711-45(6), the entry amount of the liability rather than its exit amount will be used as the step 4 amount to which the market values mentioned in subsection (6) are added.

[Schedule 6, item 2, subsection 711-45(8)]

Ensuring no double reduction in step 3 of the allocable cost amount calculation on entry

6.24 Part 3 of Schedule 6 to this Bill ensures that a single economic loss does not result in a double reduction in working out step 3 of the ACA calculation (section 705-90). Prior to this amendment, a single economic loss may have inappropriately reduced the step 3 amount twice. First, by reducing the amount of available profits that are taken into account under subsection 705-90(2) where the economic loss has been recognised as an accounting loss. Secondly, under paragraph 705-90(6)(b) which would reduce the available profits to the extent they have been sheltered from income tax because of a loss of a sort stated in subsection 701-1(4) that is recognising the same economic loss.

6.25 Step 3 of the ACA calculation provides that undistributed frankable profits accruing to direct or indirect membership interests that the consolidated group held continuously in a joining entity are to be added when working out the joining entity's ACA. This amount is known as the joining entity's 'step 3 amount'. The purpose of the step is, consistent with the imputation system, to prevent double taxation by allowing a consolidated group a cost for retained taxed profits that accrued to membership interests during the period when the consolidated group held the membership interests.

6.26 The calculation of the step 3 amount commences with accounting profits as determined under subsection 705-90(2). This amount is limited under subsection 705-90(3) by reference to the balance of the entity's franking account. The subsection 705-90(3) amount operates as a cap after identifying the undistributed owned profits that accrued to the joined group to be counted under paragraph 705-90(6)(a). Prior to this amendment, the paragraph 705-90(6)(a) amount would then be reduced under paragraph 705-90(6)(b) to the extent that the undistributed profits recouped tax losses that accrued to the group.

6.27 As a result of the running balance nature of the calculation of the undistributed profits for accounting purposes, the amount sought to be excluded by paragraph 705-90(6)(b) may already have been reduced by a corresponding accounting expense or loss for the purposes of determining the subsection 705-90(2) starting amount of undistributed profits.

6.28 Consequently, to remove the potential for a double reduction, subsection 705-90(6) has been replaced by the words formerly contained in paragraph 705-90(6)(a). The requirement previously contained in paragraph 70590(6)(b) that the step 3 amount be reduced to the extent that the undistributed profits recouped losses that accrued to the group is repealed. [Schedule 6, item 3, subsection 705-90(6)]

6.29 Following the repeal of paragraph 705-90(6)(b), an amendment is made to paragraph 701-30(2)(a) of the Income Tax (Transitional Provisions) Act 1997 to remove the reference to paragraph 705-90(6)(b). [Schedule 6, item 4, paragraph 701-30(2)(a)]

Bad debts

6.30 Part 4 of Schedule 6 to this Bill amends the consolidation regime to determine when an entity (called the claimant) that is or has been a member of a consolidated group can deduct against its assessable income a debt, or part of a debt, that has been written off.

6.31 Broadly, to be entitled to deduct a bad debt the claimant (and any entity that has for a period been owed the debt) must satisfy certain conditions. These conditions ensure that each entity that has been owed the debt for a period between when the debt was incurred and when it is written off, could have deducted the debt at the end of its holding period. [Schedule 6, item 5, section 709-210]

6.32 The rules that are used to determine if a debt is deductible for each entity are the general deduction provisions of sections 8-1 and 25-35, subject to certain modifications.

6.33 Section 25-35 contains the rules that specifically allow a deduction for bad debts. The general rules about deductions in Division 8 apply in conjunction with section 25-35. Both of these rules are not specific to any particular type of entity. Further rules that regulate deducting debts which go bad within a company are in Subdivisions 165-C and 166-C. These rules ensure that there has not been a significant change in ownership or control of the entity from when the debt was incurred to when it seeks a deduction for the bad debt. If there is such a change, the company must satisfy the same business test. Similar rules in relation to trusts are contained in Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936).

6.34 The consolidation bad debt rules ensure that each entity which has been owed the debt and that has been related to a consolidated group is tested when the claimant writes off the debt.

6.35 The standard continuity of ownership test and same business test principles are modified by the amendments in this Bill to make allowance for the different entity types that may be owed a debt within the consolidated group context. For example, these amendments allow deductions for debts that may have first been incurred by a trust which later becomes a subsidiary member of a consolidated group, and then leaves the group with a company, before being written off by that entity. Modified tests are required because the different types of entity that may form consolidated groups would fail the standard continuity of ownership and same business test tests because their membership interests are not readily comparable.

6.36 Each period that an entity is owed a debt is called a 'debt test period'. For example, from the previous paragraph, from the time that the trust incurred the debt to when it joined the consolidated group would be one debt test period. Similarly, the time that the debt was within the group would be another debt test period. Although the debt may legally always be owed to the same entity, under the single entity principle, for tax purposes, the debt is taken to be owed to a head company as long as the creditor is part of the consolidated group.

6.37 In order for the consolidation bad debt rules to apply, the debt must have been owed to an entity that was a member of a consolidated group for one debt test period, and owed to an entity (which could be the same entity) for a different debt test period while that entity was not a member of that group. Also, the claimant entity must have been owed the debt for one of the debt test periods and must have written off the debt. [Schedule 6, item 5, subsection 709-205(2)]

6.38 For the purposes of determining the debt test periods, the entry and exit history rules in sections 701-5 and 701-45 respectively are ignored. This prevents these rules applying to look through each entity back to when the debt was first incurred. This would be inappropriate because it would effectively create a single debt test period. [Schedule 6, item 5, subsection 709-205(3)]

6.39 The consolidation bad debt rules do not apply merely because a debt is assigned to or from a member of a consolidated group [Schedule 6, item 5, subsection 709-205(4)]. This is because when the debt is assigned it is taken to be a new debt in the hands of the assignee, whose debt test period would start at the date of assignment. If the assignee subsequently joined or left a consolidated group, the consolidation bad debt rules would not apply to the assignor if the assignor was never part of that consolidated group (i.e. the consolidated group the assignee has joined or left, whatever the case may be). Similarly, if the debt is assigned from one entity to another, the head entity of the second entity would not be required to apply the consolidation bad debt rules when it writes off the debt, as the previous creditor was never a member of the second consolidated group.

Limit on deduction for bad debts

6.40 The ability to claim a deduction for a bad debt is limited to claimants who can show that for each debt test period the entity that was owed the debt would have been able to deduct a bad debt under section 8-1 or 25-35 if the debt was written off in the debt test income year.

6.41 In considering if a deduction is available under section 25-35, subsection 25-35(5) is ignored as it applies the tests contained in that subsection without modification. These tests would be inappropriate for consolidated groups. [Schedule 6, item 5, subsections 709-215(1) and (2)]

6.42 In determining if the debt is deductible throughout the debt test income year, modified ownership test provisions inserted by this Bill operate in a similar way to the standard continuity of ownership and same business test provisions for companies, trusts and other entities. [Schedule 6, item 5, paragraph 709-215(2)(b)]

6.43 To avoid the complication of splitting income years, certain provisions that deal with debts which are incurred and written off in the same income year (and at the end of an income year) are not applied in determining if a debt is deductible. [Schedule 6, item 5, paragraph 709-215(2)(c)]

6.44 Each entity that was taken for tax purposes to be owed the debt for a debt test period will have a debt test income year. The 'debt test income year' starts and ends at different times depending on whether the entity that is owed the debt for that debt test period is the claimant and whether the debt test period ends before or after the claimant has written off the debt. The relevant times are set out in the table in subsection 709-215(3). [Schedule 6, item 5, subsection 709-215(3)]

6.45 Each entity will have to test whether it could have deducted the debt if it had been written off in the debt test income year. For companies, this will involve satisfying a modified continuity of ownership or same business test. For trusts, this will mean satisfying the relevant test in Schedule 2F to the ITAA 1936 as modified.

6.46 In order to show that it can claim a deduction for the duration of the debt test income year, companies must be able to either satisfy the modified continuity of ownership or same business test for that year. The first step in satisfying the modified continuity of ownership is to set up the relevant continuity periods that are used to establish the ownership test period. That is, we need to define the first and second continuity periods (the ownership test period starts at the start of the first continuity period and ends at the end of the second continuity period).

Tests for companies

6.47 Once the ownership test period has been established (by setting the first and second debt test periods) the same business test parameters must also be defined. For the purposes of applying the same business test, the second continuity period differs from the second continuity period used for continuity of ownership purposes. This is because for continuity of ownership purposes, the second continuity period needs to include ownership changes that occur when an entity joins a consolidated group. Accordingly for continuity of ownership purposes, in certain circumstances the second continuity period ends just after the end of the debt test period (i.e. just after joining).

6.48 In order for continuity of ownership changes that may occur when an entity leaves a consolidated group to be included in the ownership test period, the first continuity period is set so that it starts just before the start of the debt test period. That is, just before the entity leaves the group and starts to be owed the debt. [Schedule 6, item 5, subsection 709-215(4) item 2 in the table]

6.49 For same business test purposes, the second continuity period will be the debt test income year, as set by subsection 709-215(3). This effectively becomes the same business test period.

6.50 The relevant start and end times for continuity periods for continuity of ownership and same business test are set by reference to both the debt test income year and the table in subsection 709-215(4). [Schedule 6, item 5, subsection 709-215(4)]

6.51 An explanation of these periods and how they operate within the continuity of ownership and same business test framework can be found in Examples 6.2 and 6.3.

Example 6.2: Subsidiary member incurs a debt and joins a consolidated group which then writes off the debt

In this example there are two debt test periods, one for Sub A (1 August 2001 to 30 June 2002) and one for Head Co (1 July 2002 to 30 June 2003).

In order for Head Co to be able to claim a bad debt deduction, both Sub A and Head Co will need to satisfy the modified continuity of ownership test or, failing that, the same business test for the relevant periods.

Testing of Sub A - debt test period 1

Sub A must satisfy the modified continuity of ownership or same business test on the assumption that the debt was written off in the debt test income year. The debt test income year in this case is determined by subitem 2(a) in the table in subsection 709-215(3). That is, it starts either 12 months before the end of the debt test period (1 July 2001) or the start of the debt test period (1 August 2001).

Accordingly, Sub A's debt test income year begins on 1 August 2001. Sub A's debt test income year ends at the end of the debt test period (i.e. 30 June 2002).

In order to apply the modified continuity of ownership and same business test to Sub A we must also determine Sub A's first and second continuity periods. In this example, Sub A joined the consolidated group on 1 July 2002 and, prior to this occurring, Sub A was never part of another consolidated group. As a result, item 3 in the table in subsection 709-215(4) applies to set the first continuity period, which starts at the start of the debt test period (i.e. 1 August 2001) and ends at the start of the debt test income year, which is also 1 August 2001.

Subparagraphs 709-215(4)(b)(i) and (ii) set Sub A's second continuity period to begin at the start of the debt test income year (1 August 2001) and end just after Sub A joins the consolidated group (i.e. just after 1 July 2002). (See item 3 in the table in subsection 709-215(4).) The end time is set at just after Sub A joins to ensure that any changes in ownership that occurred on 1 July 2002 are taken into account.

For the purposes of applying the continuity of ownership test, Sub A's ownership test period will run from the start of the first continuity period (1 August 2001) until the end of the second continuity period (just after 1 July 2002).

If, during this time Sub A fails to satisfy the continuity of ownership test, it will need to satisfy the same business test in order for Head Co. to remain eligible for a bad debt deduction. For same business test purposes, the second continuity period is the debt test income year. The 'test time' for the purposes of applying subsection 165-126(2) is the later of the first time that Sub A cannot show it meets the continuity of ownership test or the time just after the start of the debt test period (1 August 2001).

Making the test time the later of these two times ensures that the business of Sub A prior to the debt being incurred is not tested. Without this requirement, if there was a change in ownership on the same day as when the debt was incurred, the test time would be on that day and the business that would be tested for same business test would be the business carried on immediately before the test time, which would be prior to the debt being incurred.

Testing of Head Co - debt test period 2

Head Co will also need to satisfy continuity of ownership or same business test for its debt test period in order for it to claim a deduction for the bad debt.

Head Co's debt test income year is set by item 1 in the table in subsection 709-215(3) as Head Co is the entity writing off the debt. Head Co's debt test income year will start on 1 July 2002 and end on 30 June 2003 (being the start and end of the income year in which the write off occurs). If Sub A had joined the group part way through Head Co's income year (e.g. on 1 January 2003), then Head Co's debt test income year would have started at this later time.

In order to apply the continuity of ownership and same business tests to Head Co, we must also determine Head Co's first and second continuity periods. As Head Co is the claimant and is writing the debt off, item 1 in the table in subsection 709-215(4) applies to set Head Co's first continuity period. Head Co's first continuity period starts at the start of the debt test period (1 July 2002) and ends at the start of the debt test income year, which is also 1 July 2002.

Head Co's second continuity period for the continuity of ownership test purposes begins at the start of the debt test income year (1 July 2002) and ends at the end of the income year in which the write-off occurs (i.e. 30 June 2003).

Therefore, for the purposes of applying the continuity of ownership test, Head Co's ownership test period will run from the start of the first continuity period (1 July 2002) until the end of the second continuity period (30 June 2003).

If, during Head Co's ownership test period, Head Co fails to satisfy the continuity of ownership test, it would have to satisfy the same business test in order to claim a deduction for the bad debt. For same business test purposes, the second continuity period is the debt test income year. The 'test time' for the purposes of applying subsection 165-126(2) is the later of the first time Head Co cannot satisfy the continuity of ownership test or the time just after the start of the debt test period (1 July 2002).

Making the test time the later of these two times ensures that the business of Head Co prior to the debt being owed to it is not tested. Without this requirement, if there was a change in ownership in Head Co on the same day as the debt began to be owed to Head Co, the test time would be on that day and the business that would be tested for same business test would be the business carried on immediately before the test time, which would be prior to the debt being owed to Head Co.

Example 6.3: The subsidiary member leaves a consolidated group and joins another consolidated group (and takes the debt with it) or the head company ceases to be the head company (but does not join another consolidated group)

In this example there are three separate debt test periods:

•

one when the debt was owed to Sub A (debt test period 1);

•

one when the debt was owed to Head Co X (debt test period 2); and

•

one when the debt was owed to Head Co Y (debt test period 3).

In order for Head Co Y (the claimant) to be able to deduct the debt, each of the entities that have been owed the debt during each of the debt test periods must satisfy the modified continuity of ownership and same business tests.

Testing of Sub A - debt test period 1

Sub A's debt test period is from 1 August 2001 to 30 June 2002, as it is owed the debt for this period. Applying subitem 2(a) in the table in subsection 709-215(3), Sub A's debt test income year starts at the start of the debt test period (1 August 2001) and ends at the end of the debt test period (30 June 2002).

As Sub A is not writing off the debt and did not begin to be owed the debt because it ceased to be a member of a consolidated group, item 3 in the table in subsection 709-215(4) will apply to set Sub A's first continuity period. This begins at the start of the debt test period (1 August 2001) and ends at the start of the debt test income year (which is also 1 August 2001).

For the purposes of applying the continuity of ownership test, Sub A's second continuity period begins at the start of the debt test income year (1 August 2001) and ends just after the end of the debt test period (which is just after 1 July 2002). Accordingly, for continuity of ownership test purposes, Sub A's ownership test period starts at 1 August 2001 and ends on 2 July 2002.

If Sub A failed the continuity of ownership test during the ownership test period the same business test would apply. For the purposes of applying the same business test, Sub A's second continuity period is the debt test income year, which is 1 August 2001 to 30 June 2002. Subsection 709-215(6) would apply to set the test time as the later of the first time that Sub A cannot satisfy the continuity of ownership test or the time just after the start of the debt test period (1 August 2001).

Testing of Head Co X - debt test period 2

Head Co X's debt test period runs from 1 July 2002 until 31 December 2002 (the time the debt is taken for tax purposes to be owed to Head Co X). Again, subitem 2(a) in the table in subsection 709-215(3) is relevant in determining Head Co X's debt test income year. This begins at the later of 12 months before the end of the debt test period (i.e. 31 December 2001) and the start of the debt test period (1 July 2002). Accordingly, Head Co X's debt test income year begins on 1 July 2002. Head Co X's debt test income year ends at the end of the debt test period, which is 31 December 2002.

As Head Co X is not the claimant and its debt test period ends when Sub A joins another consolidated group, item 4 in the table in subsection 709-215(4) will apply to set the start of Head Co X's first continuity period, which begins at the start of the debt test period (1 July 2002). Head Co X's first continuity period ends at the start of the debt test income year, which is also 1 July 2002.

Head Co X's second continuity period begins at the start of the debt test income year (1 July 2002) and ends at the end of the debt test period (31 December 2002). Accordingly, Head Co X's ownership test period runs from 1 July 2002 (start of the first continuity period) and ends on 31 December 2002 (the end of second continuity period for the continuity of ownership test).

If the same business test must be applied, Head Co X's second continuity period is the debt test income year (1 July 2002 to 31 December 2002).

Testing of Head Co Y- debt test period 3

Head Co Y's debt test period runs from 1 January 2003 until 30 June 2003 (the time the debt is taken for tax purposes to be owed to Head Co Y). Item 1 in the table in subsection 709-215(3) determines Head Co Y's debt test income year as Head Co Y is the claimant and is writing off the debt. Head Co Y's debt test income year begins at the later of the start of the income year in which the write off time occurs (1 July 2002) and the start of the debt test period (1 January 2003). Accordingly, Head Co Y's debt test income year begins on 1 January 2003 and ends at the end of the income year in which the write off time occurs.

As Head Co Y is the claimant and it is the head company of a consolidated group at the write off time, item 1 in the table in subsection 709-215(4) will apply to set Head Co Y's first continuity period. This begins at the start of the debt test period (1 January 2003) and ends at the start of the debt test income year, which is also 1 January 2003.

For the purposes of applying the continuity of ownership test, Head Co Y's second continuity period begins at the start of the debt test income year (1 January 2003) and, applying item 1 in the table in subsection 709-215(4), ends at the end of the income year in which the write off time occurs (30 June 2003). Accordingly, Head Co Y's ownership test period runs from 1 January 2003 (start of the first continuity period) and ends on 30 June 2003 (the end of the second continuity period for the continuity of ownership test).

If the same business test is applied, Head Co Y's second continuity period is the debt test income year, which as discussed above, runs from 1 January 2003 to 30 June 2003.

Tests for trusts

6.52 Where the entity being tested under the consolidation bad debt rules is a trust, the trust must satisfy the modified tests in Schedule 2F to the ITAA 1936. That is, the trust must be able to satisfy the modified rules in Schedule 2F as if the debt was written off in the debt test income year. The consolidation bad debt rules modify the rules in Schedule 2F by modifying the relevant 'test period'. [Schedule 6, item 5, subsection 709-215(4)]

6.53 Effectively, the modified test period for the purposes of the provisions in subsection 709-215(2) is set by reference to the table in subsection 709-215(4). Note that when applying the consolidation bad debt provisions to trusts, the test period is determined only by reference to the table in subsection 709-215(4) and not by reference to both tables in subsections 709-215(3) and (4) as is the case for companies. [Schedule 6, item 5, subsection 709-215(5)]

6.54 To avoid comparing the business of a head company under the same business test with a time that is prior to when the head company was owed the debt, the timing of subsection 165-126(2) is modified to specify a test time that is just after the start of the head company's debt test period. [Schedule 6, item 5, subsection 709-215(6)]

6.55 Similarly, in the case of a subsidiary joining a consolidated group, the subsidiary's debt test period ends as a result of the subsidiary joining the same business test will apply as though the subsidiary was carrying on the same business that it conducted just prior to when the debt test period ended (i.e. just before it joined the group). [Schedule 6, item 5, subsection 709-215(7)]

Life insurance companies

6.56 Subdivision 713-L of the ITAA 1997 contains special rules that apply when a life insurance company joins or leaves a consolidated group. Part 5 of Schedule 6 to this Bill will further clarify the taxation consequences for life insurance companies that join or leave a consolidated group.

6.57 When a life insurance company joins a consolidated group, the amendments:

•

clarify the nature of the membership interests in wholly-owned subsidiaries that can be members of the same consolidated group;

•

ensure that the head company's opening value of risk policy liabilities reflects the joining life insurance company's value of those liabilities;

•

allow complying superannuation classes losses held by the joining life insurance company and, provided that certain conditions are satisfied, losses held by certain subsidiaries of the joining life insurance company to become either:

-

complying superannuation classes losses of the head company; or

-

net capital losses from virtual pooled superannuation trust assets of the head company;

•

prevent losses held by other subsidiaries of the joining life insurance company from being transferred to the head company;

•

ensure that franking surpluses held by subsidiaries of the joining life insurance company are applied to the head company in a neutral way; and

•

ensure that amounts in relation to annuities held with the joining life insurance company by another member of the consolidated group are taxed in a neutral way.

6.58 When a life insurance company leaves a consolidated group, the amendments:

•

ensure that the head company's closing value of risk policy liabilities reflects the leaving life insurance company's value of those liabilities;

•

clarify that complying superannuation class losses held by the head company at the leaving time can be transferred to the leaving life insurance company in certain circumstances; and

•

modify the tax cost setting rules for the leaving life insurance company.

Wholly-owned subsidiaries that can be members of the same consolidated group as a joining life insurance company

6.59 A consolidated group generally consists of the head company and all of its subsidiaries (sections 703-10 and 703-15). Section 713-510 modifies this principle for consolidated groups that include life insurance company members. That section specifies the circumstances in which a wholly-owned subsidiary of a life insurance company can be a member of the same consolidated group as the life insurance company.

6.60 The amendments modify section 713-510 to clarify the operation of the section to an entity that is a wholly-owned subsidiary of the joining life insurance company where the membership interests in the subsidiary are held indirectly.

Certain wholly-owned subsidiaries cannot be members of the same consolidated group

6.61 The amendments clarify that a wholly-owned subsidiary of a life insurance company cannot be a member of the same consolidated group as the life insurance company if the life insurance company owns, either directly or indirectly through one or more interposed entities, all the membership interests in the entity and either:

•

some, but not all, of the key interests are virtual pooled superannuation trust assets of the life insurance company; or

•

some, but not all, of the key interests are segregated exempt assets of the life insurance company.

[Schedule 6, item 21, paragraph 713-510(1)(a)]

6.62 In addition, a subsidiary of a life insurance company cannot be a member of the same consolidated group as the life insurance company if the life insurance company owns, either directly or indirectly through one or more interposed entities, only some of the membership interests in the entity and any of the key interests are virtual pooled superannuation trust assets or segregated exempt assets of the life insurance company. [Schedule 6, item 21, paragraph 713-510(1)(b)]

6.63 The key interests are the membership interests the life insurance company owns directly in the entity or in an interposed entity. [Schedule 6, item 21, subsection 713-510(3)]

Certain wholly-owned subsidiaries cannot continue to be members of the same consolidated group

6.64 An entity cannot continue to be a subsidiary member of a consolidated group of which a life insurance company is a member if the life insurance company owns, either directly or indirectly through one or more interposed entities, all the membership interests in the entity and, had the entity not been a subsidiary member of the group, either:

•

some, but not all, of the key interests would be pooled superannuation trust assets of the life insurance company; or

•

some, but not all, of the key interests would be segregated exempt assets of the life insurance company.

[Schedule 6, item 21, paragraph 713-510(2)(a)]

6.65 In addition, an entity cannot continue to be a subsidiary member of a consolidated group of which a life insurance company is a member if the life insurance company owns, either directly or indirectly through one or more interposed entities, only some of the membership interests in the entity and, had the entity not been a subsidiary member of the group, any of the key interests would be virtual pooled superannuation trust assets or segregated exempt assets of the life insurance company. [Schedule 6, item 21, paragraph 713-510(2)(b)]

Example 6.4

Life Co joins a consolidated group and has the following wholly-owned subsidiaries:

All of the membership interests held directly by Life Co in A Co, B Co, C Co and E Co are virtual pooled superannuation trust assets.

A Co, B Co and C Co can be members of the same consolidated group as Life Co because all of their membership interests are key interests held directly by Life Co and are virtual pooled superannuation trust assets.

D Co can be a member of the same consolidated group as Life Co because all of its membership interests are held indirectly by Life Co through more than one interposed entity (i.e. A Co and B Co) and all the key interests in those interposed entities are virtual pooled superannuation trust assets of Life Co.

E Co can be a member of the same consolidated group as Life Co because:

•

25 per cent of its membership interests are key interests held directly by Life Co and are virtual pooled superannuation trust assets;

•

25 per cent of its membership interests are held indirectly by Life Co through an interposed entity (i.e. C Co) and all the key interests in that interposed entity are virtual pooled superannuation trust assets of Life Co; and

•

50 per cent of its membership interests are held indirectly by Life Co through more than one interposed entity and all the key interests in two of those interposed entities (i.e. A Co and B Co) are virtual pooled superannuation trust assets of Life Co.

Risk policy liabilities when a life insurance company joins a consolidated group

6.66 Movements in the value of a life insurance company's net risk component of life insurance policies are reflected in the calculation of the company's taxable income. The company must compare the value of its net risk component of life insurance policies at the end of an income year with the value of the net risk component of those policies at the end of the previous income year:

•

Paragraph 320-15(1)(h) includes in the company's assessable income the amount of any decrease in the value of the net risk component of life insurance policies over the income year.

•

Section 320-85 allows the company to deduct the amount of any increases in the value of the net risk component of life insurance policies over the income year.

6.67 The amendments clarify that, for the income year in which a life insurance company joins a consolidated group, the head company's opening value of the net risk component of life insurance policies reflects the joining life insurance company's value of the net risk component of life insurance policies at the joining time. [Schedule 6, item 21, section 713-511]

The head company does not already carry on life insurance business

6.68 Therefore, if the head company does not already carry on life insurance business because no other member of the consolidated group is a life insurance company, the head company's opening value of the net risk component of life insurance policies for the income year in which joining time occurs will be equal to the joining life insurance company's value of the net risk component of life insurance policies at the joining time.

Example 6.5

The value of the net risk component of life insurance policies of a life insurance company as at 30 June 2004 is $150 million. The company joins a consolidated group on 1 January 2005. At that time the value of the net risk component of those policies is $165 million.

If no other member of the consolidated group is a life insurance company, the head company's opening value of the net risk component of life insurance policies for the income year in which 1 January 2005 occurs will be $165 million.

The head company already carries on life insurance business

6.69 If the head company already carries on life insurance business at the joining time because, for example, another member of the group is a life insurance company, the head company's opening value of the net risk component of life insurance policies for the income year in which joining time occurs will be the sum of:

•

the head company's value of the net risk component of life insurance policies at the end of the income year prior to the income year in which the joining time occurs; and

•

the joining life insurance company's value of the net risk component of life insurance policies at the joining time.

Example 6.6

If in Example 6.5 another member of the consolidated group is a life insurance company, the head company's opening value of the net risk component of life insurance policies for the income year in which 1 January 2005 occurs will reflect the joining life insurance company's value of the net risk component of life insurance policies at the joining time.

Therefore, if the head company's closing value of the net risk component of life insurance policies as at 30 June 2004 was $90 million, its opening value of the net risk component of life insurance policies for the income year in which 1 January 2005 occurs will be $255 million (i.e. $90 million + $165 million).

Complying superannuation classes losses held by the joining life insurance company

6.70 The taxable income of life insurance companies is divided into the complying superannuation class (which is taxed at a rate of 15 per cent) and the ordinary class (which is taxed at a rate of 30 per cent).

6.71 Life insurance companies are required to segregate assets (virtual pooled superannuation trust assets) that support complying superannuation policies (section 320-170). Income derived on virtual pooled superannuation trust assets is included in the complying superannuation class of taxable income (section 320-137). Tax losses of the complying superannuation class are quarantined so that they can only be applied against the complying superannuation class of taxable income (section 320-141).

6.72 Similarly, net capital losses relating to virtual pooled superannuation trust assets are effectively quarantined so that they can only be used to reduce future capital gains from virtual pooled superannuation trust assets (section 320-125).

Complying superannuation class losses transferred to the head company

6.73 Generally, losses held by a joining entity can be transferred to the head company only if the rules in Division 707 are satisfied. Those rules broadly ensure that tax losses can be transferred to the head company only if the joining entity could have deducted or applied those losses in the period immediately before the transfer, assuming it had sufficient income or gains of the relevant kind.

6.74 The rules in Division 707 will not apply to any tax losses of the complying superannuation class and net capital losses relating to virtual pooled superannuation trust assets of a life insurance company that joins a consolidated group. [Schedule 6, item 25, subsection 713-530(4)]

6.75 Rather:

•

any tax losses of the complying superannuation class held by a life insurance company that joins a consolidated group will be regarded as being tax losses of the complying superannuation class made by the head company for the income year in which the joining time occurs and will be able to be utilised by the head company in that income year; and

•

any net capital losses from virtual pooled superannuation trust assets held by a life insurance company that joins a consolidated group will be regarded as being net capital losses from virtual pooled superannuation trust assets made by the head company for the income year in which the joining time occurs and will be able to be utilised by the head company in that income year.

[Schedule 6, item 25, subsections 713-530(1) to (3)]

Step 5 of the allocable cost amount

6.76 Step 5 in the table in section 705-60 reduces a joining entity's ACA by certain losses that have not been utilised by the joining entity and that accrued to the joined group before the joining time (section 705-100). A loss is taken to have accrued to the joined group before the joining time if, assuming that as it arose it was instead profit that was accruing, a distribution of that profit would have been a distribution made to the joined group out of profits that accrued to the joined group before the joining time (subsection 705-90(8)).

6.77 If tax losses of the complying superannuation class and net capital losses relating to virtual pooled superannuation trust assets were instead profits, those profits would be allocated to virtual pooled superannuation trust policyholders (and therefore would not be available as a distribution to the joined group). Therefore, step 5 in the table in section 705-60 does not apply to a joining life insurance company's tax losses of the complying superannuation class and net capital losses relating to virtual pooled superannuation trust assets.

Step 6 of the allocable cost amount

6.78 Step 6 in the table in section 705-60 reduces a joining entity's ACA by an amount that reflects losses that are transferred to the joined group under Subdivision 707-A. As the rules in Division 707 will not apply to any tax losses of the complying superannuation class and net capital losses relating to virtual pooled superannuation trust assets of a life insurance company that joins a consolidated group, step 6 will not apply to reduce the joining life insurance company's ACA by an amount that reflects the losses transferred.

6.79 This outcome is appropriate because tax losses of the complying superannuation class and net capital losses relating to virtual pooled superannuation trust assets are already reflected in the value of virtual pooled superannuation trust liabilities that is taken into account for determining a joining life insurance company's ACA.

Losses held by certain life insurance subsidiaries

6.80 A consolidated group generally consists of the head company and all of its subsidiaries (sections 703-10 and 703-15). As outlined in paragraphs 6.59 to 6.65, section 713-510 modifies this principle for consolidated groups that include life insurance company members.

6.81 Generally, subject to certain conditions, losses held by a joining entity are transferred to, and can be used by, the head company (Division 707). It is not appropriate to apply these rules to losses that economically belong to life insurance company policyholders. Therefore, to ensure that relevant policyholders are not disadvantaged, the rules in Division 707 will be modified in respect of losses held by life insurance subsidiaries where all of the membership interests are, directly or indirectly through one or more interposed entities, virtual pooled superannuation trust assets or segregated exempt assets of the joining life insurance company.

Modifications where the membership interests in the life insurance subsidiary are virtual pooled superannuation trust assets

6.82 The rules in Division 707 will be modified where:

•

a life insurance company becomes a member of a consolidated group;

•

at the same time, a subsidiary entity that is, either directly or indirectly through one or more interposed entities, wholly-owned by the joining life insurance company, joins the consolidated group; and

•

all of the membership interests that the joining life insurance company owns directly in the life insurance subsidiary or in an interposed entity are virtual pooled superannuation trust assets of the joining life insurance company.

[Schedule 6, item 25, paragraphs 713-535(1)(a) to (c)]

6.83 In these circumstances, any tax losses or net capital losses held by the life insurance subsidiary at the joining time will be able to be transferred to the head company only if the rules in Subdivision 707-A are satisfied. That Subdivision ensures that losses of an entity that joins a consolidated group can be transferred to the head company at the joining time only if, broadly, the entity could have utilised the loss had the entity not become a member of the group.

6.84 If any tax losses or net capital losses held by the life insurance subsidiary at the joining time can be transferred to the head company under Subdivision 707-A, the rules in Subdivisions 707-B, 707-C and 707-D (which generally apply to specify how losses can be utilised) will not apply. [Schedule 6, item 25, subsection 713-535(3)]

6.85 Rather:

•

any tax losses of the life insurance subsidiary will be regarded as being tax losses of the complying superannuation class made by the head company for the income year in which the joining time occurs and will be able to be utilised by the head company in that income year; and

•

any net capital losses of the life insurance subsidiary will be regarded as being net capital losses from virtual pooled superannuation trust assets made by the head company for the income year in which the joining time occurs and will be able to be utilised by the head company in that income year.

[Schedule 6, item 25, paragraph 713-535(1)(d) and subsection 713-535(2)]

Modifications where the membership interests in the life insurance subsidiary are segregated exempt assets

6.86 The rules in Division 707 will also be modified where:

•

a life insurance company becomes a member of a consolidated group;

•

at the same time, a subsidiary entity that is, either directly or indirectly through one or more interposed entities, wholly-owned by the joining life insurance company, joins the consolidated group; and

•

all of the membership interests that the joining life insurance company owns directly in the life insurance subsidiary or in an interposed entity are segregated exempt assets of the joining life insurance company.

[Schedule 6, item 25, subsection 713-540(1)]

6.87 In these circumstances, any tax losses or net capital losses held by the life insurance subsidiary at the joining time cannot be utilised by the subsidiary for an income year after the joining time. [Schedule 6, item 25, subsection 713-540(2)]

6.88 This will prevent the loss from being transferred to the head company under Subdivision 707-A and therefore prevents the loss from being utilised by the head company under Subdivisions 707-B, 707-C and 707-D. This outcome is appropriate because income from segregated exempt assets is non-assessable non-exempt income.

Life insurance subsidiaries affected by these modifications cannot be value donors

6.89 Subdivision 707-C of the ITAA 1997 generally limits the rate of utilisation of losses transferred to the head company by, broadly, specifying the available fraction that is worked out for a bundle of losses. One factor that is taken into account to work out the available fraction for a bundle of losses is the modified market value of a loss entity.

6.90 Subdivision 707-C of the Income Tax (Transitional Provisions) Act 1997 contains transitional provisions that increase the available fraction by, broadly, allowing a loss entity to add the modified market value of another entity (referred to as a value donor) to its modified market value.

6.91 Consequential amendments ensure that a life insurance subsidiary whose losses become tax losses of the complying superannuation class or net capital losses from virtual pooled superannuation trust assets of the head company because of section 713-535 of the ITAA 1997 cannot be a value donor. [Schedule 6, item 29, subparagraph 707-325(1)(ea)(i) of the Income Tax (Transitional Provisions) Act 1997]

6.92 Similarly, a life insurance subsidiary that is unable to utilise its losses because of section 713-540 of the ITAA 1997 cannot be a value donor. [Schedule 6, item 29, subparagraph 707-325(1)(ea)(ii) of the Income Tax (Transitional Provisions) Act 1997]

Time for making choices not affected by utilisation of complying superannuation class losses

6.93 The application of various aspects of the transitional provisions in Subdivision 707-C of the Income Tax (Transitional Provisions) Act 1997 is based on the head company making a number of choices. These choices must be made by the day on which the head company lodges its income tax return for the first income year in which it utilises transferred losses.

6.94 Consequential amendments will ensure that the time for making these choices is not affected if the head company utilises losses that become tax losses of the complying superannuation class or net capital losses from virtual pooled superannuation trust assets because of section 713-535 of the ITAA 1997. [Schedule 6, items 30 to 34, section 707-355 of the Income Tax (Transitional Provisions) Act 1997]

Franking surpluses held by life insurance subsidiaries

6.95 Generally, if a joining entity's franking account is in surplus at the joining time, a debit equal to the amount of the surplus is made to the joining entity's franking account (paragraph 709-60(2)(a)) and a credit for that amount is made to the head company's franking account (paragraph 709-60(2)(b)).

6.96 Difficulties arise with this treatment for entities that are subsidiaries of life insurance companies because of the special rules that apply to life insurance companies under the simplified imputation system. Broadly, if a life insurance company receives a franked dividend, then the simplified imputation system applies so that:

•

to the extent that the dividend relates to shareholders, the life insurance company is entitled to a credit to its franking account; and

•

to the extent that the dividend relates to policyholders, the life insurance company is entitled to a refundable tax offset.

6.97 Modifications are required to ensure that the franking surplus is applied to the head company in a way that is consistent with the outcome that would arise if the group did not consolidate.

6.98 Therefore, paragraph 709-60(2)(b) will not apply if:

•

a life insurance company becomes a member of a consolidated group;

•

at the same time, a subsidiary entity that is, either directly or indirectly through one or more interposed entities, wholly or partly owned by the joining life insurance company joins the consolidated group; and

•

the life insurance subsidiary has a surplus in its franking account just before the joining time.

[Schedule 6, item 25, subsections 713-545(1) and (2)]

6.99 Rather, a franking credit will be made to the head company's franking account in respect of part of the franking surplus and the head company may be entitled to an immediate refundable tax offset for some or all of the remaining franking surplus.

Credit to the head company's franking account

6.100 If the life insurance subsidiary has a franking surplus, a franking credit will be made to the head company's franking account. The amount of the credit will be the amount of franking credit that would arise in the life insurance company's franking account under item 5 in the table in subsection 219-15(2) if:

•

the life insurance subsidiary made a franked distribution to the life insurance company just before the joining time; and

•

the amount of the franking credit on the distribution was equal to the whole amount of the franking surplus.

[Schedule 6, item 25, subsections 713-545(3) and (4)]

6.101 That is, broadly, the amount of the franking credit that will be made to the head company's franking account will be that part of the deemed franked distribution to the life insurance company that would be attributable to shareholders.

Refundable tax offset

6.102 The head company may also be entitled to a refundable tax offset for the income year in which the joining time occurs. The amount of the tax offset will depend on the nature of the membership interests in the life insurance subsidiary. [Schedule 6, items 17 and 25, subsections 67-25(5) and 713-545(5)]

Tax offset if membership interests are segregated exempt assets

6.103 If immediately before the joining time all the membership interests in the life insurance subsidiary are, directly or indirectly through one or more interposed entities, segregated exempt assets of the life insurance company, then the amount of the tax offset will be the amount of the surplus in the franking account reduced by the amount of the franking credit that is made to the head company's franking account as a consequence of the deemed franked distribution to the life insurance company. [Schedule 6, item 25, paragraph 713-545(5)(a)]

Example 6.7

A Co is a wholly-owned subsidiary of a life insurance company that joins a consolidated group. All of the membership interests in A Co are segregated exempt assets of the life insurance company.

A Co has a franking surplus of $1,000 in its franking account immediately before the joining time. If A Co made a distribution to the life insurance company that included the whole of the franking surplus, no part of the distribution would be attributable to shareholders of the life insurance company.

Therefore, no part of A Co's franking surplus will be credited to the head company's franking account. However, the head company will be entitled to a refundable tax offset of $1,000.

Tax offset if membership interests are virtual pooled superannuation trust assets

6.104 If immediately before the joining time all the membership interests in the life insurance subsidiary are, directly or indirectly through one or more interposed entities, virtual pooled superannuation trust assets of the life insurance company, then the amount of the tax offset will be:

the amount of the surplus in the franking account reduced by the amount of the franking credit that is made to the head company's franking account as a consequence of the deemed franked distribution to the life insurance company * the complying superannuation class tax rate, currently 15%, divided by the ordinary class tax rate, currently 30%


[Schedule 6, item 25, paragraph 713-545(5)(b) and subsection 713-545(6)]

Example 6.8

B Co is a wholly-owned subsidiary of a life insurance company that joins a consolidated group. All of the membership interests in B Co are virtual pooled superannuation trust assets of the life insurance company.

B Co has a franking surplus of $1,200 in its franking account immediately before the joining time. If B Co made a distribution to the life insurance company that included the whole of the franking surplus, no part of the distribution would be attributable to shareholders of the life insurance company.

Therefore, no part of B Co's franking surplus will be credited to the head company's franking account. However, the head company will be entitled to a refundable tax offset of $600.

(i.e. $1,200 * 15% / 30%)

No tax offset if membership interests are ordinary assets

6.105 If immediately before the joining time, all the membership interests in the life insurance subsidiary are assets other than segregated exempt assets or virtual pooled superannuation trust assets of the life insurance company, then the amount of the tax offset will be nil. [Schedule 6, item 25, paragraph 713-545(5)(c)]

Example 6.9

C Co is a wholly-owned subsidiary of a life insurance company that joins a consolidated group. All of the membership interests in C Co are assets other than segregated exempt assets or virtual pooled superannuation trust assets of the life insurance company.

C Co has a franking surplus of $800 in its franking account immediately before the joining time. If C Co made a distribution to the life insurance company that included the whole of the franking surplus, no part of the distribution would be attributable to shareholders of the life insurance company.

Therefore, no part of C Co's franking surplus will be credited to the head company's franking account. Nor will the head company be entitled to a refundable tax offset in respect of the franking surplus.

Sections 709-70 and 709-75 do not apply

6.106 Sections 709-70 and 709-75 clarify that if a credit or debit arise in the franking account of a subsidiary member of a consolidated group after the joining time, then that credit or debit arises in the head company's franking account.

6.107 Sections 709-70 and 709-75 will not apply to a life insurance subsidiary. However, if the life insurance subsidiary receives a franked distribution that would result in an amount being added to its franking account if it was not a member of a consolidated group, the single entity rule will ensure that the simplified imputation system will apply appropriately to the head company in respect of the franked distribution. [Schedule 6, item 25, section 713-550]

Amounts in relation to annuities held with a life insurance company by another member of the consolidated group

6.108 A life insurance policy that provides for an immediate annuity is an exempt life insurance policy provided that the policy meets certain conditions. Assets supporting liabilities under exempt life insurance policies can be held in a life insurance company's segregated exempt assets. Income generated on segregated exempt assets is non-assessable non-exempt income.

6.109 When the life insurance company makes an annuity payment, the amount payable represents a discharge of liabilities and is paid directly from the life insurance company's segregated exempt assets. Therefore, the payment of an annuity does not cause any tax consequences to arise for the life insurance company.

6.110 In most cases, the holder of the annuity is taxed on the annuity payments received in accordance with subsection 27H(1) of the ITAA 1936. Subsection 27H(1) includes the annuity payments received, reduced by the deductible amount, in a taxpayer's assessable income. The deductible amount effectively represents the capital component of the annuity. Any unused deductible amount is referred to as the reduced purchase price.

6.111 However, if the annuity contract is not held by an individual, the annuity may be a qualifying security that is taxed under Division 16E of Part III of the ITAA 1936. If the annuity is a qualifying security, the holder of the annuity is taxed on an accruals basis - that is, the accrual amount (worked out under section 159GQ) is included in the holder's assessable income. If a qualifying security is transferred (as defined in section 159GP), a balancing adjustment is included in assessable income or allowed as a deduction (section 159GS). A qualifying security is transferred if, broadly, it is sold, assigned or disposed of in any way.

6.112 A difficulty arises with the operation of the current law if a life insurance company is a member of a consolidated group and another member of the group holds an immediate annuity policy with the life insurance company. In these circumstances, the single entity rule will apply so that liabilities under the policy will cease to be recognised as exempt life insurance policy liabilities. Consequently, the head company will have excess segregated exempt assets that, once identified, must be transferred from the segregated exempt assets (subsections 320-235(1) and 320-250(2)).

6.113 An anomaly arises because the whole of the transfer value of the assets (which will include a capital component of the annuity) will be included in the head company's assessable income under paragraph 320-15(1)(f). In addition, any annuity payments made between the joining time and the time excess assets are transferred from the segregated exempt assets will not be taxed appropriately.

Circumstances in which modifications will apply

6.114 To overcome these concerns, modifications will apply if:

•

the fused entities - that is, a life insurance company and an entity (the policyholder) holding an immediate annuity policy - become members of the same consolidated group;

•

the immediate annuity policy was issued by the life insurance company to the policyholder prior to that time (the fusion time); and

•

the head company of the group determines the total transfer value of its segregated exempt assets and the amount of its exempt life insurance policy liabilities (either at the fusion time or at a subsequent time).

[Schedule 6, item 25, section 713-553]

Excess assets transferred from the segregated exempt assets

6.115 The first modification will apply if:

•

the head company determines that it has excess segregated exempt assets as at the determination time;

•

that excess is attributable to liabilities in respect of the policyholder's immediate annuity policy that, because of the single entity rule, are no longer recognised; and

•

as a consequence, the head company transfers under subsection 320-235(1) or 320-250(2) assets having a transfer value equal to the excess from its segregated exempt assets.

[Schedule 6, item 25, subsection 713-555(1)]

6.116 In these circumstances, the operation of Division 320 will be modified so that paragraph 320-15(1)(f) (which includes the whole of the transfer value of the assets in assessable income) will not apply to the transfer. [Schedule 6, item 25, subsection 713-555(2)]

6.117 Rather, if the immediate annuity policy is not a 'qualifying security' (as defined in Division 16E of Part III of the ITAA 1936), the head company's assessable income for the income year in which the company transfers the policy assets will include the income component, if any, of the amount transferred. The income component of the amount transferred is the total transfer value of the assets transferred reduced by the 'reduced purchase price' (as defined in subsection 27A(1) of the ITAA 1936, taking into account any annuity payments assessable under section 713-560 to the head company in the period between the fusion time and the determination time) of the annuity. [Schedule 6, item 25, subsection 713-555(3)]

6.118 If the immediate annuity policy is a qualifying security, the head company will include in its assessable income, or will be able to deduct, the amount of the balancing adjustment worked out under section 159GS of the ITAA 1936 as if there had been a transfer of the qualifying security. Any amounts assessable or deductible under section 713-560 to the head company in the period between the fusion time and the determination time must be taken into account in working out the balancing adjustment. [Schedule 6, item 25, subsection 713-555(4)]

Annuity payments made between the fusion time and the determination time

6.119 The second modification will apply if, when the fused entities are both members of the consolidated group, there is a period (the gap) between the fusion time and the earlier of:

•

the determination time; or

•

the time at which the policyholder ceases to be a member of the consolidated group.

[Schedule 6, item 25, subsection 713-560(1)]

6.120 In these circumstances, the operation of the single entity rule will be modified so that liabilities in relation to the immediate annuity policy continue to be recognised as exempt life insurance policy liabilities during the gap. This will ensure that, during the gap, assets in relation to the policy can continue to be held in the head company's segregated exempt assets. [Schedule 6, item 25, subsection 713-560(2)]

6.121 In addition, the operation of Division 320 will be modified so that, during the gap, the head company can transfer assets from its segregated exempt assets to provide for immediate annuity payments that arise under the terms of the policy. Any fees and charges that arise in relation to the immediate annuity policy during the gap can continue to be transferred from the head company's segregated exempt assets under subsection 320-250(2). [Schedule 6, item 25, subsection 713-560(3)]

6.122 If the head company transfers assets (other than money) from its segregated exempt assets under subsection 713-560(3), section 320-255 will apply to the asset in the same way as that section applies to an asset transferred under subsection 320-250(2). Consequently, for example, for capital gains tax purposes the cost base of the asset transferred will be reset at its market value at the time of transfer. [Schedule 6, item 25, paragraph 713-560(4)(a)]

6.123 In addition, the head company will include in its assessable income, or will be able to deduct, the amount that would have been assessable or deductible to the policyholder if the fused entities were not members of the same consolidated group during the gap. [Schedule 6, item 25, paragraph 713-560(4)(b)]

6.124 If the immediate annuity policy is not a qualifying security, the head company's assessable income will include the amount that is derived in the gap and would have been included in the policyholder's assessable income if the life insurance company and the policyholder were not members of the same consolidated group. That is, the head company's assessable income will include the transfer value of the assets transferred, reduced by the deductible amount in relation to the annuity worked out under section 27H of the ITAA 1936. [Schedule 6, item 25, subsection 713-560(5)]

6.125 If the immediate annuity policy is a qualifying security, the head company will include in its assessable income, or will be able to deduct, the amount attributable to the gap that would have been assessable or deductible to the policyholder under section 159GQ of the ITAA 1936 if the life insurance company and the policyholder were not members of the same consolidated group. [Schedule 6, item 25, subsection 713-560(6)]

Risk policy liabilities when a life insurance company leaves a consolidated group

6.126 As previously discussed, movements in the value of a life insurance company's net risk component of life insurance policies are reflected in the calculation of the company's taxable income. The company must compare the value of its net risk component of life insurance policies at the end of an income year with the value of the net risk component of those policies at the end of the previous income year:

•

Paragraph 320-15(1)(h) includes in the company's assessable income the amount of any decrease in the value of the net risk component of life insurance policies over the income year.

•

Section 320-85 allows the company to deduct the amount of any increases in the value of the net risk component of life insurance policies over the income year.

6.127 For the income year in which a life insurance company leaves a consolidated group:

•

the head company's value of the net risk component of life insurance policies at the end of the income year in which the leaving time occurs reflects the leaving life insurance company's value of the net risk component of life insurance policies at the leaving time; and

•

the leaving life insurance company's opening value of the net risk component of life insurance policies reflects the head company's value of the net risk component of those policies at the leaving time.

[Schedule 6, item 25, section 713-565]

The head company ceases to carry on life insurance business

6.128 Therefore, if the head company ceases to carry on life insurance business because no other member of the consolidated group is a life insurance company, the head company's value of the net risk component of life insurance policies as at the end of the income year in which leaving time occurs will be equal to the leaving life insurance company's value of the net risk component of life insurance policies at the leaving time.

6.129 For the subsequent income year, the head company's value of the net risk component of life insurance policies at the end of the income year in which the leaving time occurs will not include the leaving life insurance company's value of the net risk component of life insurance policies at the leaving time (and therefore will be nil).

Example 6.10

The value of the net risk component of life insurance policies of the head company of a consolidated group that has a life insurance company member as at 30 June 2007 is $135 million. The life insurance company leaves the consolidated group on 1 January 2008. At that time the value of the net risk component of those policies is $125 million.

If no other member of the consolidated group is a life insurance company:

•

for the purpose of working out the amount that is assessable or deductible in the income year in which 1 January 2008 occurs:

•

the head company's value of the net risk component of life insurance policies as at the end of that income year will be $125 million; and

•

the leaving life insurance company's opening value of the net risk component of life insurance policies for that income year will be $125 million; and

•

for the purpose of working out the amount that is assessable or deductible in the subsequent income year, the value of the head company's net risk component of life insurance policies as at the end of the income year in which 1 January 2008 occurs will be nil.

The head company continues to carry on life insurance business

6.130 If the head company continues to carry on life insurance business after the leaving time because, for example, another member of the group is a life insurance company, the head company's value of the net risk component of life insurance policies as at the end of the income year in which leaving time occurs will be the sum of:

•

the head company's actual value of the net risk component of life insurance policies at the end of the income year in which the leaving time occurs; and

•

the leaving life insurance company's value of the net risk component of life insurance policies at the leaving time.

6.131 For the subsequent income year, the head company's value of the net risk component of life insurance policies at the end of the income year in which the leaving time occurs will not include the leaving life insurance company's value of the net risk component of life insurance policies at the leaving time.

Example 6.11

If in Example 6.10 another member of the consolidated group is a life insurance company, the head company's closing value of the net risk component of life insurance policies for the income year in which 1 January 2008 occurs will reflect the leaving life insurance company's value of the net risk component of life insurance policies at the joining time. Therefore, if the head company's actual value of the net risk component of life insurance policies as at 30 June 2008 is $90 million:

•

for the purpose of working out the amount that is assessable or deductible in the income year in which 1 January 2008 occurs:

•

the head company's value of the net risk component of life insurance policies as at the end of that income year will be $215 million (i.e. $90 million + $125 million); and

•

the leaving life insurance company's opening value of the net risk component of life insurance policies for that income year will be $125 million; and

•

for the purpose of working out the amount that is assessable or deductible in the subsequent income year, the head company's value of the net risk component of life insurance policies as at the end of the income year in which 1 January 2008 occurs will be $90 million.

Complying superannuation class losses transferred to a leaving life insurance company

6.132 Currently, section 713-530 applies when a life insurance company leaves a consolidated group and, at the leaving time, no other member of the group is a life insurance company. In those circumstances, any tax losses of the complying superannuation class and net capital losses relating to virtual pooled superannuation trust assets held by the head company are transferred to the leaving life insurance company.

6.133 Due to structural changes to Subdivision 713-L, section 713-530 is relocated and renumbered (so that it becomes section 713-570). In addition, the section is modified to clarify that:

•

the section applies to tax losses of the complying superannuation class and net capital losses relating to virtual pooled superannuation trust assets held by the head company at the leaving time; and

•

for the purposes of income years ending after the leaving time:

•

the leaving life insurance company had made the loss for the income year in which the leaving time occurs and will be able to utilise the loss in that income year; and

•

the head company had not made the loss for the income year in which the leaving time occurs and therefore will not be able to utilise the loss in that income year.

[Schedule 6, item 25, section 713-570]

Modification of the tax cost setting rules when a life insurance company leaves the consolidated group

6.134 Subdivision 713-L modifies the tax cost setting rules in Division 705 for life insurance companies that join a consolidated group. The modifications:

•

specify certain assets to be retained cost base assets (section 713-515); and

•

specify the basis for valuing certain life insurance policy liabilities of joining life insurance companies (section 713-520).

6.135 When an entity leaves a consolidated group, it is necessary to work out the old group's ACA for the leaving entity (section 711-20). Modifications similar to those that apply to a life insurance company that joins a consolidated group will be made to the tax cost setting rules in Division 711 for life insurance companies that leave a consolidated group.

Terminating value of assets used to support policyholders

6.136 Step 1 of the old group's ACA relates to the terminating values of the assets that the leaving entity takes with it (section 711-25).

6.137 If the leaving entity is a life insurance company, the head company's terminating value for an asset will be modified for assets that are used to support policyholders. That is, for the purpose of applying section 711-25 to a life insurance company that leaves a consolidated group, the terminating value of an asset will be the asset's 'transfer value' (as defined in subsection 995-1(1)) at the leaving time if:

•

the asset is a virtual pooled superannuation trust asset;

•

the asset is a segregated exempt asset; or

•

the asset is an asset held for the purpose of discharging liabilities under the net investment component of ordinary life insurance policies (other than policies that provide participating benefits or discretionary benefits under life insurance business carried on in Australia).

[Schedule 6, items 25 and 28, section 713-575 and the definition of 'terminating value' in subsection 995-1(1)]

Value of policyholder liabilities

6.138 Step 4 of the old group's ACA relates to liabilities owed by the leaving entity (section 711-45). The value of those liabilities under step 4 is generally the value that is used for accounting purposes.

6.139 If the leaving entity is a life insurance company, the basis of valuing the leaving entities policyholder liabilities will be modified so that it is consistent with the basis that is used for valuing those liabilities for other taxation purposes.

6.140 That is, for the purpose of applying section 711-45 to a leaving entity that is a life insurance company:

•

the value of the virtual pooled superannuation trust liabilities of the leaving entity will be the amount worked out under section 320-190 at the leaving time;

•

the value of the exempt life insurance policy liabilities of the leaving entity will be the amount worked out under section 320-245 at the leaving time;

•

the value of liabilities under the net risk component of life insurance policies (for which the leaving entity will be able to claim a deduction under section 320-80 after it ceases to be a member of the consolidated group) will be the 'current termination value' (as defined in subsection 995-1(1)) of that component of those policies at the leaving time as calculated by an actuary; and

•

the value of liabilities under the net investment component of ordinary life insurance policies of the leaving entity will be the amount worked out under subsection 320-190(2) as if those liabilities were virtual pooled superannuation trust liabilities at the leaving time.

[Schedule 6, item 25, section 713-580]

Structural changes to Subdivision 713-L

6.141 As a consequence of new rules being inserted for life insurance companies that join or leave a consolidated group, Subdivision 713-L has been restructured. Some consequential amendments are made to reflect this restructuring and, where appropriate, to insert notes that refer to the new modifications. [Schedule 6, items 18 to 20 and 22 to 25, sections 320-175, 320-230, 713-515, 713-520, 713-525 and 713-585]

General insurance companies

6.142 Part 5 of Schedule 6 will also clarify the taxation consequences for general insurance companies that join or leave a consolidated group. The special consolidation rules for general insurance companies will be inserted into new Subdivision 713-M and will apply from 1 July 2002. [Schedule 6, items 26 and 35, Subdivision 713-M of the ITAA 1997 and section 713-700 of the Income Tax (Transitional Provisions) Act 1997]

6.143 When a general insurance company joins a consolidated group, the amendments:

•

modify the tax cost setting rules to treat the goodwill asset of a general insurance company that has demutualised as a retained cost base asset;

•

ensure that the head company's opening value of outstanding claims liabilities reflects the joining general insurance company's value of those liabilities; and

•

ensure that the head company's opening value of its unearned premium reserve reflects the joining general insurance company's value of that reserve.

6.144 When a general insurance company leaves a consolidated group, the amendments:

•

ensure that the head company's closing value of outstanding claims liabilities reflects the leaving general insurance company's value of those liabilities; and

•

ensure that the head company's closing value of its unearned premium reserve reflects the leaving general insurance company's value of that reserve.

Goodwill asset of general insurance companies that have demutualised

6.145 Goodwill accruing to the group as a consequence of its ownership and control of the joining entity is generally a reset cost base asset that is deemed to have been purchased by the head company at the joining time. Consequently, the tax cost setting provisions will generally result in goodwill having a cost base broadly equal to its market value.

6.146 This general rule is modified for the goodwill asset of a joining entity that is a life insurance company that has demutualised. In these circumstances, the goodwill asset is treated as a retained cost base asset provided that the ownership of the company has not changed between the time of demutualisation and the time of joining a consolidated group (paragraph 713-515(1)(c)).

6.147 The rationale for this modification is that Division 9AA of Part III of the ITAA 1936 sets the cost base of demutualisation shares for taxation purposes. As Division 9AA applies to both life insurance companies and to general insurance companies, a similar modification needs to be made to the tax cost setting rules that apply when a general insurance company joins a consolidated group.

6.148 Consequently, the goodwill asset of a joining entity that is a general insurance company that has demutualised will be a retained cost base asset provided that the ownership of the company has not changed between the time immediately after the company demutualised and the time of joining a consolidated group. [Schedule 6, items 26 and 27, subsections 713-705(1) and (2) and the definition of 'retained cost base asset' in subsection 995-1(1)]

6.149 The tax cost setting amount of a goodwill asset of a general insurance company that has demutualised will be the value of the company's goodwill worked out according to Australian accounting practice at the time of demutualisation. [Schedule 6, item 26, subsection 713-705(3)]

Outstanding claims liabilities and unearned premium reserve when a general insurance company joins a consolidated group

6.150 Specific rules for taxing general insurance companies are contained in Division 321 in Schedule 2J to the ITAA 1936.

6.151 Division 321 ensures that movements in the value of a general insurance company's outstanding claims liabilities and unearned premium reserve are reflected in the calculation of the company's taxable income. The company must compare the value of its outstanding claims liabilities and unearned premium reserve at the end of an income year with the value of those liabilities and that reserve at the end of the previous income year:

•

Sections 321-10 and 321-50 include in the company's assessable income the amount of any decreases in the value of the outstanding claims liabilities and unearned premium reserve over the income year.

•

Sections 321-15 and 321-55 allow the company to deduct the amount of any increases in the value of the outstanding claims liabilities and unearned premium reserve over the income year.

6.152 The amendments clarify that, for the income year in which a general insurance company joins a consolidated group:

•

the head company's opening value of outstanding claims liabilities reflects the joining general insurance company's value of those liabilities at the joining time; and

•

the head company's opening value of its unearned premium reserve reflects the joining general insurance company's value of that reserve at the joining time.

[Schedule 6, item 26, sections 713-710 and 713-715]

The head company does not already carry on general insurance business

6.153 Therefore, if the head company is not already carrying on general insurance business because no other member of the consolidated group is a general insurance company:

•

the head company's opening value of outstanding claims liabilities for the income year in which joining time occurs, will be equal to the joining general insurance company's value of those liabilities at the joining time; and

•

the head company's opening value of its unearned premium reserve for the income year in which joining time occurs will be equal to the joining general insurance company's value of that reserve at the joining time.

Example 6.12

The value of the outstanding claims liabilities of a general insurance company as at 30 June 2004 is $190 million. The value of its unearned premium reserve at that time is $75 million.

The company joins a consolidated group on 1 January 2005. At that time the value of the outstanding claims liabilities is $205 million and the value of its unearned premium reserve is $60 million.

If no other member of the consolidated group is a general insurance company, for the income year in which 1 January 2005 occurs:

•

the head company's opening value of the outstanding claims liabilities will be $205 million; and

•

the head company's opening value of its unearned premium reserve will be $60 million.

The head company already carries on general insurance business

6.154 If the head company already carries on general insurance business at the joining time because, for example, another member of the group is a general insurance company:

•

the head company's opening value of outstanding claims liabilities for the income year in which joining time occurs will be the sum of:

•

the head company's value of those liabilities at the end of the income year prior to the income year in which the joining time occurs; and

•

the joining general insurance company's value of those liabilities at the joining time; and

•

the head company's opening value of its unearned premium reserve for the income year in which joining time occurs, will be the sum of:

•

the head company's value of that reserve at the end of the income year prior to the income year in which the joining time occurs; and

•

the joining general insurance company's value of that reserve at the joining time.

Example 6.13

If in Example 6.12 another member of the consolidated group is a general insurance company, the head company's opening value of the outstanding claims liabilities and the unearned premium reserve for the income year in which 1 January 2005 occurs, will reflect the joining general insurance company's value of those liabilities and that reserve at the joining time. Therefore, for the income year in which 1 January 2005 occurs:

•

if the head company's closing value of outstanding claims liabilities as at 30 June 2004 was $70 million, its opening value of those liabilities will be $275 million (i.e. $70 million + $205 million); and

•

if the head company's closing value of its unearned premium reserve as at 30 June 2004 was $40 million, its opening value of that reserve will be $100 million (i.e. $40 million + $60 million).

Outstanding claims liabilities and unearned premium reserve when a general insurance company leaves a consolidated group

6.155 The amendments also clarify that, for the income year in which a general insurance company leaves a consolidated group:

•

the head company's value of outstanding claims liabilities at the end of the income year in which the leaving time occurs, reflects the leaving general insurance company's value of those liabilities at the leaving time;

•

the head company's value of the unearned premium reserve at the end of the income year in which the leaving time occurs, reflects the leaving general insurance company's value of that reserve at the leaving time;

•

the leaving general insurance company's opening value of outstanding claims liabilities reflects the head company's value of those liabilities at the leaving time; and

•

the leaving general insurance company's opening value of the unearned premium reserve reflects the head company's value of that reserve at the leaving time.

[Schedule 6, item 26, sections 713-710 and 713-720]

The head company ceases to carry on general insurance business

6.156 Therefore, if the head company ceases to carry on general insurance business because no other member of the consolidated group is a general insurance company:

•

the head company's value of outstanding claims liabilities at the end of the income year in which leaving time occurs, will be equal to the leaving general insurance company's opening value of those liabilities for that income year; and

•

the head company's value of its unearned premium reserve at the end of the income year in which leaving time occurs, will be equal to the leaving general insurance company's opening value of that reserve for that income year.

6.157 For the subsequent income year, the head company's value of outstanding claims liabilities at the end of the income year in which the leaving time occurs will not include the leaving general insurance company's value of those liabilities at the leaving time (and therefore will be nil). Similarly, the head company's value of its unearned premium reserve at the end of the income year in which the leaving time occurs will not include the leaving general insurance company's value of that reserve at the leaving time (and therefore will be nil).

Example 6.14

The value of the outstanding claims liabilities of the head company of a consolidated group that has a general insurance company member as at 30 June 2007 is $245 million. The value of its unearned premium reserve at that time is $80 million.

The general insurance company leaves the consolidated group on 1 January 2008. At that time the value the outstanding claims liabilities is $250 million and the value of the unearned premium reserve is $70 million.

If no other member of the consolidated group is a general insurance company:

•

for the purpose of working out the amount that is assessable or deductible in the income year in which 1 January 2008 occurs:

•

the head company's value of outstanding claims liabilities as at the end of that income year will be $250 million;

•

the head company's value of its unearned premium reserve as at the end of that income year will be $70 million;

•

the leaving general insurance company's opening value of outstanding claims liabilities for that income year will be $250 million; and

•

the leaving general insurance company's opening value of its unearned premium reserve for that income year will be $70 million; and

•

for the purpose of working out the amount that is assessable or deductible in the subsequent income year, the value of the head company's outstanding claims liabilities and unearned premium reserve as at the end of the income year in which 1 January 2008 occurs, will be nil.

The head company continues to carry on general insurance business

6.158 If the head company continues to carry on general insurance business after the leaving time because, for example, another member of the group is a general insurance company:

•

the head company's value of outstanding claims liabilities at the end of the income year in which leaving time occurs will be the sum of:

•

the head company's actual value of those liabilities at the end of the income year in which the leaving time occurs; and

•

the leaving general insurance company's value of those liabilities at the leaving time; and

•

the head company's value of its unearned premium reserve at the end of the income year in which leaving time occurs will be the sum of:

•

the head company's actual value of that reserve at the end of the income year in which the leaving time occurs; and

•

the leaving general insurance company's value of that reserve at the leaving time.

6.159 For the subsequent income year, the head company's value of outstanding claims liabilities at the end of the income year in which the leaving time occurs, will not include the leaving general insurance company's value of those liabilities at the leaving time. Similarly, the head company's value of its unearned premium reserve at the end of the income year in which the leaving time occurs, will not include the leaving general insurance company's value of that reserve at the leaving time.

Example 6.15

If in Example 6.14 another member of the consolidated group is a general insurance company, the head company's closing value of the outstanding claims liabilities and the unearned premium reserve for the income year in which 1 January 2008 occurs, will reflect the leaving general insurance company's value of those liabilities and that reserve at the leaving time. Therefore:

•

for the purpose of working out the amount that is assessable or deductible in the income year in which 1 January 2008 occurs:

•

if the actual value of the head company's outstanding claims liabilities as at 30 June 2008 is $110 million, the head company's value of outstanding claims liabilities as at the end of that income year will be $360 million (i.e. $110 million + $250 million);

•

if the actual value of the head company's unearned premium reserve as at 30 June 2008 is $35 million, the head company's value of its unearned premium reserve as at the end of that income year will be $105 million (i.e. $35 million + $70 million);

•

the leaving general insurance company's opening value of outstanding claims liabilities for that income year will be $250 million; and

•

the leaving general insurance company's opening value of its unearned premium reserve for that income year will be $70 million; and

•

for the purpose of working out the amount that is assessable or deductible in the subsequent income year:

•

the value of the head company's outstanding claims liabilities as at the end of the income year in which 1 January 2008 occurs, will be $110 million; and

the value of the head company's unearned premium reserve as at the end of the income year in which 1 January 2008 occurs, will be $35 million.

Application and transitional provisions

6.160 The amendments discussed in this chapter will take effect on 1 July 2002 (being the commencement date of the consolidation regime). Having the amendments apply from this date will provide maximum certainty and minimise the risk of arbitrary outcomes arising from a later commencement date. [Schedule 6, item 1, application]

6.161 The commencement provisions for Subdivision 709-D were inserted into the Income Tax (Transitional Provisions) Act 1997. [Schedule 6, item 16, after Division 707 of the Income Tax (Transitional Provisions) Act 1997]

Consequential amendments

6.162 Several consequential amendments insert notes into other areas of the law which indicate that Subdivision 709-D modifies how these other areas of the law operate. The laws allowing deductions for trusts are where the majority of these notes are inserted. [Schedule 6, items 6 to 11, subsections 266-35(1), 266-85(3), 266-120(1), 266-160(2), 267-25(1) and 267-65(1) in Schedule 2F to the ITAA 1936]

6.163 A consequential amendment to section 12-5 updates the table that lists particular types of deductions to include a deduction for a debt that used to be owed to a member of a consolidated group by an entity that used to be a member of the group. [Schedule 6, item 12, section 12-5, table item headed 'bad debts']

6.164 Two consequential amendments update the ITAA 1997 to allow for Subdivision 709-D. One of these updates a table in subsection 25-35(5) and the other inserts a note which indicates that Subdivision 709-D modifies the operation of subsection 165-120(1). [Schedule 6, items 13 and 14, subsection 165-5, table item headed 'bad debts']

6.165 The definition of 'test time' for the purposes of the same business test in subsection 995-1(1) was modified to include a reference to 'section 709-215'. [Schedule 6, item 15, subsection 995-1(1)]