House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 4 Consolidation: Application of losses with nil available fraction

Outline of chapter

4.1 Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to ensure losses transferred to the head company of a consolidated group or a multiple entry consolidated group (MEC group) by a joining entity that is insolvent at the joining time can be used by the head company in certain circumstances.

Context of amendments

4.2 The consolidation regime applies primarily to a group of Australian resident entities wholly owned by an Australian resident company that choose to form a consolidated group. Specific rules provide for the membership of certain resident wholly owned subsidiaries of a foreign holding company (that is, a MEC group). The references in this chapter to a consolidated group include a MEC group.

4.3 Following a choice to consolidate, members of the group are treated as a single entity for their income tax purposes. Subsidiary entities lose their individual income tax identity on entry into a consolidated group and are treated as part of the head company.

4.4 When an entity (the joining entity) becomes a member of a consolidated group (including an entity that becomes the head company of the group) any tax losses and net capital losses of the joining entity are transferred to the head company of the group, provided certain tests are satisfied (Subdivision 707-A).

4.5 Transferred losses are given an available fraction that represents the joining entity's market value in proportion to the market value of the group as a whole (section 707-320). The available fraction limits the rate at which transferred losses can be used by the group. The objective is to ensure that the group cannot use the losses at a substantially faster rate than the joining entity could if it had not joined the group.

4.6 Where the value of a joining entity's liabilities exceeds the value of its assets at the time it joins a consolidated group (that is, where the joining entity has a market value of nil at the joining time), any losses of the entity that are transferred to the head company of the group will have an available fraction of nil. Consequently, assuming that no transitional concessions apply, the losses can never be used by the group.

4.7 Concerns have been raised that inequitable outcomes arise in respect of a transferred loss with a nil available fraction where the loss is wholly or partly attributable to:

•

a debt that is forgiven after the joining time, resulting in the head company being subject to the commercial debt forgiveness rules (Division 245 in Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936));

•

a debt that is terminated after the joining time, resulting in the head company being subject to the limited recourse debt rules (Division 243); or

•

a liability that is taken by an entity which leaves the group, resulting in the head company making a capital gain because capital gains tax (CGT) event L5 (section 104-520) happens.

Summary of new law

4.8 Schedule 4 to this Bill amends the consolidation provisions in the income tax law to ensure losses transferred to the head company of a consolidated group by a joining entity that is insolvent at the joining time can be used by the head company in certain circumstances.

4.9 Therefore, if the transferred losses of a joining entity have an available fraction of nil, the head company can apply the losses to:

•

reduce a net forgiven amount under the commercial debt forgiveness rules;

•

reduce a capital allowance that is adjusted under the limited recourse debt rules; or

•

reduce the capital gain that arises under CGT event L5 when the joining entity subsequently leaves the group.

Comparison of key features of new law and current law

Detailed explanation of new law

4.10 The operation of the commercial debt forgiveness rules, the limited recourse debt rules and CGT event L5 will be modified if:

•

an entity (the joining entity) becomes a member of a consolidated group (including an entity that becomes the head company of the group);

•

a tax loss or net capital loss was transferred from the joining entity to the head company of the group at the joining time under Subdivision 707-A; and

•

the loss is in a bundle of losses for which the available fraction is nil.

[ Schedule 4, item 4, subsection 707-415(1 )]

4.11 In these circumstances, subject to certain conditions, the head company can choose to apply the loss to, broadly:

•

reduce the net forgiven amount under the commercial debt forgiveness rules;

•

reduce the capital allowance adjustment under the limited recourse debt rules; or

•

reduce the capital gain that arises under CGT event L5 when the joining entity subsequently leaves the group.

[ Schedule 4, item 4, subsection 707-415(2 )]

4.12 However, the loss can be applied to reduce the net forgiven amount, capital allowance adjustment or capital gain in relation to an income year only to the extent that the loss could be utilised by the head company for the income year on the assumption that the available fraction for the bundle of losses was one. [ Schedule 4, item 4, subsection 707-415(3 )]

4.13 In addition, a loss can be applied to reduce the net forgiven amount, capital allowance adjustment or capital gain only to the extent that it has not already been applied. [ Schedule 4, item 4, subsection 707-415(7 )]

Applying the loss under the commercial debt forgiveness rules

4.14 The head company can choose to apply the loss under the commercial debt forgiveness rules if:

•

the joining entity owed a debt just before the joining time to an entity that was not a member of the group at that time;

•

the loss is wholly or partly attributable to the debt; and

•

Subdivision 245-E in Schedule 2C to the ITAA 1936 (which outlines how the total net forgiven amount is applied) applies in relation to the debt (or another debt that is reasonably connected to the debt) because the debt is forgiven after the joining time.

[ Schedule 4, item 4, item 1 in the table in subsection 707-415(2 )]

4.15 In these circumstances, the head company can choose to apply the loss to reduce the total net forgiven amount mentioned in subsection 245-105(1) for the purposes of applying that total net forgiven amount to:

•

reduce deductible revenue losses in accordance with subsection 245-105(5);

•

reduce deductible net capital losses in accordance with subsection 245-105(6);

•

reduce deductible expenditures in accordance with subsection 245-105(7); and

•

reduce relevant cost bases of certain assets in accordance with subsection 245-105(8).

[ Schedule 4, item 4, item 1 in the table in subsection 707-415(2 )]

4.16 However, the amount of the loss that can be applied to reduce the total net forgiven amount cannot exceed the gross forgiven amount (within the meaning of section 245-75) of the debt to which the loss was attributable. [ Schedule 1, item 4, subsection 707-415(4 )]

Applying the loss under the limited recourse debt rules

4.17 The head company can choose to apply the loss under the limited recourse debt rules if:

•

the joining entity owed a limited recourse debt just before the joining time to an entity that was not a member of the group at that time;

•

the limited recourse debt rules apply in relation to the debt; and

•

the loss is wholly or partly attributable to a deduction mentioned in paragraph 243-15(1)(c) for an income year ending before the joining time - that is, the loss is wholly or partly attributable to, broadly, a capital allowance deduction in respect of finance expenditure, refinance expenditure or financed property.

[ Schedule 4, item 4, item 2 in the table in subsection 707-415(2 )]

4.18 In these circumstances, the head company can choose to apply the loss to reduce the deduction mentioned in paragraph 243-15(1)(c) for the purposes of working out whether the capital allowance deductions are excessive under subsection 243-35(1). [ Schedule 4, item 4, item 2 in the table in subsection 707-415(2 )]

4.19 However, the amount of the loss that can be applied to reduce the deduction mentioned in paragraph 243-15(1)(c) cannot exceed the amount of the loss that is attributable to the deduction. [ Schedule 4, item 4, subsection 707-415(5 )]

Applying the loss to reduce the CGT event L5 capital gain

4.20 The head company can choose to apply the loss to reduce the capital gain arising under CGT event L5 if:

•

the joining entity ceases to be a subsidiary member of the group after the joining time; and

•

the entity's liabilities at the leaving time are the same as, or are reasonably connected to, the liabilities that it had at the joining time.

[ Schedule 4, item 4, item 3 in the table in subsection 707-415(2 )]

4.21 In these circumstances, the head company can choose to apply the loss to reduce the amount remaining after applying step 4 in the table in subsection 711-20(1) for the purposes of working out whether CGT event L5 happens at the leaving time and, if so, the amount of any capital gain arising under CGT event L5. [ Schedule 4, item 4, item 3 in the table in subsection 707-415(2 )]

4.22 However, the total amount of losses in the bundle of losses that can be applied to reduce any capital gain arising under CGT event L5 cannot exceed the amount of the capital gain that would be made under CGT event L5 assuming the joining entity ceased to be a member of the consolidated group just after the joining time. [ Schedule 1, item 4, subsection 707-415(6 )]

Application and transitional provisions

4.23 The measure will apply from 1 July 2002 - that is, from the commencement of the consolidation regime. [ Schedule 1, item 5 ]

4.24 The measure is to apply from 1 July 2002 as it has been sought by, and is beneficial to, taxpayers. In this regard, the measure ensures that losses transferred to the head company of a consolidated group by a joining entity that is insolvent at the joining time can be used by the head company and therefore are not wasted.

Amendment of assessments

4.25 Generally, the Commissioner of Taxation can amend an assessment of a company, other than a small business entity, within four years from the date of the notice of assessment (section 170 of the ITAA 1936.

4.26 As these amendments apply from 1 July 2002, the period for amending assessments will be extended. That is, the operation of section 170 will be modified so that it does not prevent the amendment of an assessment if:

•

the assessment was made before the commencement of Schedule 4;

•

the amendment is made within two years after that date; and

•

the amendment is made for the purpose of giving effect to the amendments in Schedule 4.

[ Section 4 ]

Consequential amendments

4.27 Consequential amendments will insert notes into the commercial debt forgiveness rules, the limited recourse debt rules and CGT event L5 to refer to the adjustments made by section 707-415. [ Schedule 4, items 1 to 3, subsections 104-520(3 ) and 243-35(2 ) of the ITAA 1997 and subsection 245-105(1 ) in Schedule 2C to the ITAA 1936 ]