On 11 September 2017 the Government released exposure draft legislation that contains six tax consolidation integrity measures designed to remove perceived anomalous tax outcomes that arise under the tax cost setting rules when an entity joins or leaves a tax consolidated group. BDO lodged a submission on some of the measures on 6 October 2017. The proposed changes will impact the way in which consolidated groups have and will calculate their allocable cost amount (ACA) and will retrospectively affect many entities’ entry and/or exit ACA calculations undertaken over the last few years.
The measures and their respective start dates are shown in the table.
|Deductible liabilities excluded from step 2 of entry ACA
||1 July 2016
|Deferred tax liabilities excluded from step 2 of entry ACA and step 4 of exit ACA
||The date the Bill is introduced into Parliament
|Securitised assets – related liabilities excluded from both entry and exit ACA
||13 May 2014 (for ADIs and financial entities)
3 May 2016 for all other entities
|Foreign resident 'churning measure' – assets of joining entity to retain tax cost
||14 May 2013
|Alignment of consolidation with Taxation of Financial Arrangements (TOFA 3&4 provisions) when an asset or liability emerges because a subsidiary leaves a consolidated group
||1 July 2011 (or 1 July 2010 if TOFA 3&4 provisions early adoption election made)
|Anti-value shifting measure for intra group nondebt asset leaving the group
||14 May 2013
Treatment of deductible liabilities
The Government is proposing to remove the double benefit that arises in relation to deductible liabilities when an entity joins a consolidated group by excluding deductible liabilities from step 2 of the entry ACA calculation with effect from 1 July 2016. Deductible liabilities are generally liabilities that will result in a future tax deduction when an accounting provision such as the provisions for annual leave and long service leave are expensed.
This measure is the most significant of the proposed amendments and the one with the widest likely application and may lead to higher tax outcomes for such consolidated groups.
Currently, when an entity joins a tax consolidated group holding deductible liabilities, the value of the joining entity’s liabilities is added to step 2 of the ACA calculation using a complex calculation where at least part of the value of the deductible liability is included in in the cost allocation for the joining entity’s assets. This will usually result in a tax benefit to the head company in the form additional deprecation and/or CGT cost bases. There is then an additional benefit because the head company can claim a tax deduction for the liability when the relevant expense is incurred.
In addition, where the joining entity is acquired from another tax consolidated group, deductible liabilities of the entity when it leaves the old group generally increase the CGT cost base of the shares in the entity for the old group, thus giving a tax benefit to the old group.
The proposed amendments attempt to reduce the additional tax benefits by excluding the deductible liabilities from step 2 of the entry ACA calculation.
However, for joining entities where the shares have been fully or partially owned by the consolidated group i.e. a formation case or gradual acquisition case, the deductible liabilities are currently also reduced from step 3 of the entry ACA, being the owned retained earnings. To ensure there is not a double detriment in these situations the exposure draft legislation provides a compensating adjustment increasing the step 3 amount for the entry ACA. This results in the ACA being increased by the amount of the deductible liabilities that are taken to have ‘accrued to the joined group’, which has the effect of reversing the exclusion of the deductible liabilities from step 2 for deductible liabilities that ‘accrued to the group’.
There are also some exclusions from the deductible liabilities measure. Certain deductible liabilities for retirement village liabilities, taxation of financial arrangement (TOFA) liabilities and private health/life and general insurance liabilities will continue to be included at step 2 of the entry ACA.
All consolidated groups that have a consolidation entry since 1 July 2016 should review their ACA calculations and tax cost allocations for the assets of the joining entities. This is particularly important for innovative and early stage businesses where some of the largest liabilities on their balance sheet are deductible in the future e.g. annual leave liabilities and provisions to do with ‘making good’ leased premises. Therefore, this measure may also have an impact on decisions about the acquisition of such companies by consolidated groups.
Deferred tax liabilities
Currently, there is a commercial/tax mismatch under the consolidation entry and exit tax cost-setting processes for deferred tax liabilities which gives rise to integrity concerns and uncertainty. The new measure proposes that deferred tax liabilities (DTL) be excluded from entry ACA calculations (step 2) as well as exit ACA calculations (exit ACA step 4). These modifications are expected to simplify the entry and exit tax cost setting rules.
The reason for excluding the deferred tax liabilities is to reduce some of the complexities in relation to the consolidation regime. One example among several is where, on entry into a consolidated group, a joining entity’s deferred tax liabilities are adjusted because the DTL of the joining entity would be different when it became a member of the joined group (e.g. where the consolidated group’s accounting policies for the DTL differ to the joining members accounting policies for the DTL). The calculation of the amount of the adjustment can be complicated and therefore this measure should reduce the complexity.
Also under the current law, there is no equivalent of the adjustment for the DTL on exit from the consolidated group. This can result in the cost base allocated to the membership interests in the leaving entity being inflated.
These changes will apply to accounting liabilities of entities that join or leave a consolidated group from the date the amending legislation is introduced. Transitional rules apply that require a DTL to be included in the exit ACA calculation if it was included in the entry ACA calculation before the date the amending legislation is introduced.
Securitised assets measures
This measure deals with ‘securitisation arrangements’ usually undertaken by banks and other financial institutions but can also be used by other entities. Generally, these arrangements involve the creation of a special purpose vehicle (SPV) to hold mortgage assets and due to particular accounting standard requirements, accounting assets and liabilities are created. However, while the accounting liability is currently recognized in step 2 of the entry ACA, the accounting asset is not. This causes a mismatch in ACA entry and exit calculations.
To address the mismatch, an accounting liability arising from the transfer or equitable assignment of securitised assets will be disregarded for entry and exit ACA calculation purposes from 13 May 2014 - for an authorised deposit-taking institution (ADI) or financial entity; and 3 May 2016 for all other entities.
Foreign resident ‘churning measure’
Churning measures are targeted at preventing cost base uplifts of an entity’s assets when an entity joins a consolidated group after being transferred from a non-resident associate by way of a transaction that is not taxable in Australia under the non-resident CGT rules in Div 855 of the ITAA 1997. This is achieved by switching off the entry tax cost setting rules when there has been no change in the majority economic ownership of the joining entity for a period of at least 12 months before the joining time.
The EM contains an example with a consolidated group consisting of 2 Australian resident companies Head Co and Acquirer Co. Acquirer Co beneficially owns all of the membership interests in Foreign Co which in turn owns an Australian subsidiary, Target Co. Although Target Co is a wholly owned subsidiary of Head Co it is not eligible to be a member of Head Co’s consolidated group because its immediate holding company is a non-resident (Foreign Co).
Foreign Co transfers its membership interests in Target Co to Acquirer Co for market value and becomes a member of Head Co’s consolidated group. However, as the membership interests are not taxable Australian property, the capital gain for Foreign Co is exempt under Div 855. Under the current rules, the step one entry ACA amount for Target Co will also be the market value, which can then be allocated to the assets of Target Co as it enters Head Co’s consolidated group. This gives the group a step up in the tax cost of Target Co assets even though Head Co continues to have the underlying ownership of these assets. The proposed amendments will result in the tax costs of Target Co’s assets being retained.
This measure applies to entities that joined a consolidated group from 14 May 2013.
BDO lodged a submission with Treasury on 6 October 2017 outlining two anomalies we identified with the foreign resident ‘churning measures’.
- The measure applies to retain the tax cost of a joining entity’s assets even where part of the participation interests in the joining entity are acquired from outside the consolidated group, which could result in double taxation for the consolidated group. Therefore, BDO recommends the proposed section be modified to allow a partial ACA process be applicable the proportion of the participation interests in a joining entity that were not previously held by consolidated group members. The application of the proposed section would then be limited to the proportion of the retained cost of the joining entity’s assets that relate to the proportion of the membership interests of the joining entity that were held previously held by consolidated group members.
- The measure also does not take account of capital gains of controlled foreign corporations (CFC’s) that are included in the attributed income of Australian parent companies which could result in double taxation for consolidated groups. Therefore BDO recommends that the proposed section be modified so that it does not apply where the Division 855 exempt gain is included in the attributable income and assessed to one of the members of the consolidated group.
Intragroup assets and liabilities subject to TOFA 3&4
This measure clarifies the operation of the TOFA 3&4 provisions where a subsidiary member of a consolidated group that has intra-group liabilities and/ or assets subject to the Div 230 TOFA 3&4 rules leaves a group. This measure sets a tax value for the intra-group assets or liabilities that are a Div 230 financial arrangement when the asset or liability emerges from the consolidated group because the subsidiary member leaves the group with effect from 14 May 2013. The objective of the TOFA 3&4 rules is to make the tax treatment of intra-group TOFA 3&4 financial arrangements consistent with the economic substance of transactions.
Value shifting measure
This measure overcomes ‘value shifting’ problems that can arise when an entity leaves a consolidated group holding an asset that corresponds to a liability owed by a member of the old consolidated group. Under the current rules the tax cost of the asset of the leaving entity is reset to market value of the asset. However, the government has identified an integrity issue where the liability that relates to the asset is not a ‘debt’ (e.g. a right over an asset of a member of the old consolidated group). In this case there is a potential for an inappropriate uplift of tax cost for the asset, particularly where the right has appreciated in value since it was granted.
To counter this issue the amount taken into account under the exit tax cost setting rules for an intra group asset that corresponds with a liability that is not a debt, will be either:
- XXNil (if the liability arose while one of the entities was a member of the group), or
- XXThe lower of the entry cost setting amount for the asset, and the market value of the asset
Where the asset does correspond with a debt owed by the other member of the group, the current exit tax cost setting rules will apply i.e. it will continue to be set at the asset’s market value.
This measure applies to entities that leave a consolidated group after budget time 14 May 2013.
The retrospective nature of most of the measures and the disparate start dates for the application of the amendments means, in the short term, many consolidated groups will have to review their previous consolidation arrangements to ensure they comply with the new rules. Where amendments are required to either increase or decrease their tax liabilities from the past few years, the ATO has confirmed on its website that no penalties will be imposed. Particularly, where amendments have been made within a short term with respect to announced but un-enacted measures and tax returns have been lodged in accordance to the law at the time or incorrectly in anticipation of the announced but un-enacted new law.