Journal of Australian Taxation
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CONSOLIDATION ISSUES FOR FINANCIERS
CONSOLIDATION ISSUES FOR FINANCIERS
By Teresa Dyson[∗]
The Australian income tax system has recently undergone perhaps its most significant structural change, with the introduction of the consolidation regime. This regime radically changes the way in which corporate groups are taxed and has an enormous impact on all businesses.
Corporate groups that include entities that are in the business of banking or providing or raising finance (“Financiers”) will be subject to the same changes as other corporate groups, but, given the nature of their business, additional issues will arise for Financiers.
Financiers must consider the impact of consolidation on their own tax profile; as well as the impact of the consolidation regime on borrowers from members of the Financier consolidated group. In addition, the way in which the consolidation regime will affect transaction structures; the sale or acquisition of subsidiaries; and the creation and disposal of financial assets, must be carefully considered by Financier groups.
The nature of the business of Financiers and the types of assets that Financier groups typically own or create (in an intra-group context and in their transactions with entities outside the Financier group) result in particular issues for these entities. This article outlines some of the major impacts of the consolidation regime on Financiers.
The consolidation regime, which took effect from 1 July 2002, has significant implications for all corporate taxpayers. There has, to date, been a great deal of attention paid to issues arising in relation to formation of consolidated groups, which is appropriate, given the fact that, in the last three years Australian companies (and other relevant entities) have undergone the process of considering whether they will consolidate and, if so, how that process will be effected, having regard to specific transitional rules relating to asset cost allocation.
Now, however, it is appropriate to consider some of the issues that will arise for consolidated groups going forward in respect of:
• treatment of their own taxation affairs;
• the impact of consolidation on their business transactions;
• changes to intra-group arrangements;
• the impact of consolidation on entities with which they deal in the course of their business; and
• entities joining and exiting consolidated groups.
This article seeks to identify particular issues that arise in respect of financiers. Issues relating to formation of a consolidated group and transitional measures associated with that formation are not considered in this article.
2. CONSOLIDATION - GENERAL PRINCIPLES
2.1 Consolidatable Group
The consolidation regime was introduced with effect from 1 July 2002. It applies to Australian resident companies, trusts and partnerships that are wholly owned by a single Australian company.[1] The regime is operable on an elective basis, but, if the election to consolidate is made, all consolidatable entities must form part of the consolidated group.[2]
The consolidated group comprises:
| • | a head company – an Australian resident company that is not wholly owned (directly or indirectly) by any other Australian company; and |
| • | subsidiary members – Australian resident companies, trusts or partnerships that are wholly-owned (directly or indirectly) by the head company.[3] |
For the purposes of consolidation, a company will be wholly-owned by another entity (“Owner”) if all the shares in the company, disregarding any shares that are characterised as “debt interests” under Div 974 of the Income Tax Assessment Act 1997 (Cth) (“ITAA97”) and certain employee shares,[4] are owned by the Owner (or a group of entities that are all, directly or indirectly, owned by the same ultimate head company).[5] Similarly, if all the units or other beneficial interests in a trust or interests in a partnership (disregarding any “debt interests”) are owned by a single entity (or a group of entities that are all, directly or indirectly, owned by a single company), that trust or partnership will be treated as wholly-owned for the purposes of consolidation.
The election to consolidate is made by the head company or the group and has the effect of forming a consolidated group with all the then existing subsidiary members, with effect from the date nominated by the head company.[6]
Specific rules also apply in relation to companies that are ultimately foreign-owned, where multiple entry points are used in making investments in Australia.[6] In these cases, the Multiple Entry Consolidated (“MEC”) rules apply and, to a large extent, replicate the treatment arising in respect of other consolidated groups. For the purpose of this article, all references made to consolidated groups should be considered as being equally applicable to MEC groups, unless otherwise indicated.
Any Australian resident entity that becomes wholly-owned by the head company or one of the subsidiary members after the formation of the consolidated group will automatically become a subsidiary member of that consolidated group.[7]
2.2 Single Entity Rule
The cornerstone concept of the consolidation regime is that, for certain taxation purposes, all subsidiary members of a consolidated group (for the period for which they are members of the same wholly owned group) are treated as parts of the head company and not separate entities.[8] This means that the head company of a consolidated group is the only tax paying entity in the group. In calculating the tax liability of the head company, all intra-group transactions are disregarded. Further, all transactions and arrangements entered into by any subsidiary member with entities outside the consolidated group are taken to have been entered into by the head company for the purposes of working out the head company’s tax liability or tax loss for an income year.[9]
The single entity rule has a significant impact on the business of financiers; the major implications of which are outlined in more detail below. Importantly, structures that had been previously used by financiers and credit approval operations will be impacted by this rule.
The consolidation regime applies only in relation to certain income tax purposes; it does not apply outside the taxation system. This means that legal relationships between entities will be respected in all other contexts and will, in some cases, determine certain tax consequences. For example, in a case where a subsidiary member of a consolidated group is the owner of an asset that is leased to a tax exempt entity and that subsidiary member is a special purpose entity, the fact that the subsidiary member is, for tax purposes, a member of a consolidated group with significant assets and resources, may not (from a legal perspective) matter in the context of determining whether s 51AD of the Income Tax Assessment Act 1936 (Cth) (“ITAA36”) will apply to the subsidiary member in respect of that asset. Similar issues may also apply in the context of Div 243 of the ITAA97.[10]
In addition, the legal obligations of the subsidiary member remain contained in that entity, so that the head company (or any other member of the consolidated group) will not become liable to perform obligations (including payment obligations) of the subsidiary member unless separately legally obliged (such as under a guarantee arrangement). This could mean that, notwithstanding the taxation relationship of members of a consolidated group as being treated as a single entity, members of a consolidated group may effectively enforce legal arrangements against other members of the same consolidated group (such as suing for intra-group debts). Further, it will still be effective (and, in some cases, prudent) for intra-group debts to be supported by security arrangements.[11]
2.3 What Taxes are Covered?
The consolidation regime only applies in relation to income tax liabilities and payments of instalments of tax; franking taxes; general interest charges applicable to those liabilities; and penalties relating to those liabilities. Importantly, Goods and Services Tax (“GST”), withholding tax liabilities (and, if relevant, penalties relating to withholding taxes or failures to withhold), Pay-As-You-Go withholdings, fringe benefits taxes and foreign taxes are not covered by the consolidation regime.
2.4 GST and Consolidated Groups
The GST legislation contains its own grouping rules. However, it is important to note that the head company of an income tax consolidated group is not required to also elect to form a GST group. Even if the head company elects to form a GST group, there is no requirement to include every eligible entity in the GST group and accordingly the GST group may not necessarily include every member of the income tax consolidated group.
The head company may therefore suffer GST that is both non-creditable and non-deductible in respect of transactions between entities that are members of the income tax consolidated group but not members of the GST group. This is a particular problem for financial institutions that make input-taxed financial supplies.
The problem may be illustrated through the following example:
| • | LenderCo and ManageCo are members of an income tax consolidated group but are not members of the same GST group. |
| • | LenderCo makes input-taxed financial supplies (eg loans) to borrowers that are not members of its GST group. Accordingly, no GST is imposed on those supplies but LenderCo cannot claim an input tax credit in respect of GST on the associated costs. |
| • | ManageCo makes GST-taxable supplies (eg management services) to LenderCo. GST is imposed on the management fees but, as noted in the previous bullet point, LenderCo cannot claim an input tax credit in respect of the GST. |
ManageCo will disregard the provision of the management services to LenderCo under the “single entity rule” and accordingly will not be assessable on any of the management fees.[12] However, even if the two companies had not been members of the same consolidated group, ManageCo would still not have been assessable on the GST component of the management fees.[13]
LenderCo must also disregard the transaction under the “single entity rule” and accordingly cannot deduct any of the management fees.[14] However, if the two companies had not been members of the same consolidated group then LenderCo would have been allowed to claim an income tax deduction for the unrelieved GST on the management fees.[15]
LenderCo will therefore incur unrelieved GST on the ManageCo management fees that will not be allowable as a deduction.
This outcome probably arises from a legislative oversight but, until it is corrected, it would be wise to ensure that any member of an income tax consolidated group that makes input-taxed supplies, and any members of the group that make taxable supplies to such a supplier, are members of the same GST group.
2.5 Withholding Taxes
Withholding taxes generally represent the tax liability of the payee, but, for ease of administration and collection, the obligation to deduct and remit the tax from relevant payments rests, statutorily, with the payer.
However, the fact that these withholding and remission obligations remain with the actual entity making the payment (rather than the head company of a consolidated group, where relevant) creates a disconnect in relation to the treatment of the payment in the hands of the payer and the head company of the consolidated group of which the payer is a member. For example, if a subsidiary member is a borrower under a loan granted by a non-resident of Australia, interest payments made by the subsidiary member will (generally) be subject to interest withholding tax.[16] The subsidiary member will have the obligation to withhold the interest withholding tax from any interest payments that it makes to the lender, but the entitlement to a deduction for the interest expense will remain with the head company of the consolidated group. This disconnect is interesting in the context of s 221YRA of the ITAA36, which denies a borrower a deduction for an interest expense if an amount in respect of interest withholding tax is required to be deducted and remitted to the Australian Taxation Office (“ATO”) and has not been so deducted or remitted. This means that the withholding and remission obligations must be satisfied (in fact) by the borrowing subsidiary, but, for the purposes of calculating the income tax liability of the group, that withholding (if made and the appropriate funds remitted to the ATO) will be effectively taken to have been made by the head company, to enable the interest deduction to be claimed.
Accordingly, whilst the actual withholding obligation and penalty regimes associated with withholding taxes will continue to impact directly on subsidiary members of consolidated groups, where they make relevant payments to entities outside the consolidated group, the head company must ensure that those obligations have been complied with to ensure that its calculation of tax liability is accurate.
Withholding tax obligations that arise in other jurisdictions also give rise to interesting issues. In particular, if an Australian resident entity lends to a resident of another country (say, for example, Canada), interest in respect of that borrowing will generally be subject to Canadian interest withholding tax. As noted above, interest withholding taxes, whilst often collected by the borrower in the source country, generally represent the tax liability (subject to any relevant Double Tax Treaty) of the lender. In the case of a consolidated group, it would generally still be the actual lending entity, that would incur the tax liability that was met by the administrative withholding made by the non-resident borrower under the foreign law and any relevant Double Tax Treaty.
The withholding and remission of that amount to the relevant foreign tax authority would generally give rise to a foreign tax credit arising for the lender.
If the lender is a subsidiary member of a consolidated group, it will not have a tax profile against which to attribute the foreign tax credit. However, pursuant to s 717-10 of the ITAA97, the foreign tax credit will be available to the head company of the consolidated group to apply against its relevant income.[17]
3. IMPACT ON STRUCTURES
Many financial structures have developed over time to achieve particular commercial objectives. In many cases it will be necessary to revisit certain elements of those structures, where members of the same consolidated group are involved. This is because the taxation treatment that may have arisen previously may not apply in a consolidation environment.
For example, industry-standard structures supporting infrastructure arrangements and domestic and cross-border leasing arrangements have developed responding to commercial, legal and economic imperatives. Whilst these structures may continue to satisfy continuing commercial objectives, in some cases, elements of those structures may no longer have any meaning from a tax perspective. This will be the case where members of the same consolidated group perform different roles in the structure.
It will be important for business units responsible for formulating structures to be aware of the changes to the tax profile of relevant arrangements, as modelling and pricing could be affected if modelling assumptions are not updated to recognise the different income tax treatment.
Additionally, it is important to ensure that, if structures are initially (say, for expedience) established using other members of the same consolidated group and subsequently ownership of participants changes (to someone outside the consolidated group) or one level of participation is transferred, replicated or otherwise dealt with, the potential tax consequences of such a change are fully understood. In many cases, the result of such changes may not simply reflect the treatment that would have arisen if the non-consolidated entity had been involved in the transaction from commencement. Some of the issues outlined below in respect of the disposal (or creation) of interests will be relevant in this context.
This could require a process of re-education for members of business units and internal tax functions that support those business units within Financier groups.
4. CREDIT ISSUES
4.1 Joint and Several Liability and Tax Sharing Agreements
An important element of the consolidation regime is the fact that members of a consolidated group, prima facie, have joint and several liability for all of the tax liabilities of the consolidated group, in the event that the head company fails to pay its tax liabilities by the due time. This does not arise if the relevant tax liabilities of the consolidated group (generally, those taxes outlined above as being subject to the consolidation regime) are covered by a valid Tax Sharing Agreement (“TSA”).[18] A valid TSA is one in which the liabilities of all relevant members of the consolidated group are reasonably allocated between those members. Also, a TSA will only be valid if:
| a) | it is executed prior to the “due time” in relation to the tax liabilities purported to be covered by the TSA; and |
| b) | a copy of the TSA is provided by the head company of the consolidated group to the Commissioner of Taxation (“Commissioner”) within 14 days of a written request from the Commissioner.[19] |
The issues outlined above relating to joint and several liability and TSAs are also relevant for the financier consolidated group. This is discussed in more detail in Section 6.1 below, particularly in relation to securitisation vehicles or similar entities.
4.2 Lending to Subsidiary Members of a Consolidated Group
In undertaking a reasonable credit analysis of a potential borrower, it will be critical to ensure that, if the borrower is a member of a consolidated group, that group is covered by a valid TSA. If this is not ensured, there is a risk that the borrower entity, even if it is not the head company, could be liable for the entire tax liability of the consolidated group of which it is a member. Obviously, the larger the group, the greater this exposure will be.
Unfortunately, complete protection for a financier against joint and several liability is practically impossible, as the validity of the TSA will always be dependent on a reasonable allocation of tax liabilities being made between members, which will be extremely difficult for a financier (or indeed, anyone other than the head company) to confidently or accurately predict.[20] Further, indemnities or guarantees provided by the parent company are also unlikely to be of much benefit, as the joint and several liability will only arise if the head company (which, in the case of domestic groups, will commonly be the parent company) fails to pay the group’s tax liabilities by the due time. It could be expected that if the head company has failed to meet the group’s tax liabilities to the extent to which the Commissioner is considering pursuing one of the subsidiary members, the group (including the parent indemnifier/guarantor) is experiencing financial difficulties, making full recovery under an indemnity or guarantee unlikely.
To ensure that the financier is appropriately protected (noting that complete protection is practically impossible), it should seek to have as much information as possible in relation to the TSA and the methodology to be employed in ascertaining the reasonable allocation of tax liabilities. At a minimum, the following representations and warranties would be required:
| • | A valid TSA is in place. |
| • | The head company and all relevant members of the consolidated group are covered by the TSA.[21] |
| • | The TSA will be amended to ensure that it remains valid at all times (this would include amendment in the event of exiting or joining entities and any relevant changes in circumstances of the consolidated group members, and may be practically achieved by having a Master Agreement, with associated Deeds of Adherence being executed or terminated in respect of joining and exiting members; or ensuring Deeds of Accession and Deeds of Release are entered into by joining and exiting members, respectively). |
| • | The head company will provide a copy of the TSA that is provided to the Commissioner within 14 days of a written request for the TSA. |
| • | There will always be a valid TSA in place prior to any relevant tax liability becoming due. |
It would also be preferable for a lender to require the borrower to identify all members of the borrower’s consolidated group and confirm that the allocation methodology used in the TSA is, in fact, reasonable in the circumstances of the borrower’s group. For recently formed groups, it may also be possible for the lender to approve the form and content of the TSA, as it is being drafted.
Cashflow issues will also be important considerations in lending to any member of a consolidated group to ensure that funds derived by subsidiary members are able to be released from any waterfall arrangements or restrictions on distributions to ensure that the head company has sufficient funds in each income year to pay the tax liabilities of the consolidated group. These arrangements should either be formalised as a part of any revenue waterfall provisions or recognised in the form of a Tax Funding Agreement or Tax Contribution Agreement discussed further in Section 4.3 below as part of the transaction documents relating to a particular project. This will be particularly relevant in project finance and infrastructure finance arrangements.
4.3 Lending to a Head Company
If the borrower is, itself, the head company of a consolidated group, then it will have the primary liability for all of the relevant tax liabilities of the entire consolidated group. This will also give rise to specific credit issues, as the liabilities of the head company will, prima facie, relate to the entire group, without the head company necessarily having resources or cash available to fund those obligations. In the case of a loan to the head company of a consolidated group, it would be reasonable for the financier to require that, in addition to the points above, the consolidated group has in place an agreement that contractually requires the members of the consolidated group to put the head company in funds (preferably by reference to a reasonable allocation of the relevant tax liabilities among member) to pay the tax liabilities of the consolidated group as they become due. Commonly these arrangements will be included in Tax Funding Agreements or Tax Contribution Agreements, but there is no specifically required nomenclature or form of such an arrangement.[22] Importantly, this arrangement does not need to conform with the requirements of a TSA, but it will still be necessary for the consolidated group to have a separate TSA (or provisions of a TSA included in the same “funding” agreement) that is continually valid for the purposes of Div 721 of the ITAA97.
These arrangements may also facilitate payments (commonly referred to as “subvention payments”) to members of the group that would (on a stand-alone tax basis) have derived a tax loss; but this is not required from a contractual or statutory perspective and should be considered on a case-by-case basis.
As noted in Section 4.2 above, in the case of project finance or infrastructure finance arrangements, it will be necessary to ensure that any restrictions on the release of funds derived by subsidiary members of the consolidated group or cash waterfall provisions are drafted in a manner that does not prevent funds flowing from subsidiary members of a consolidated group to the head company to enable tax liabilities of the consolidated group to be paid by their respective due times.
4.4 Security
Importantly, the rights of the Commissioner do not rank in priority to any secured creditor. To the extent to which the lender is able to take security over assets of the lender (most appropriately, assets being acquired or constructed using the borrower funds), the lender would be in a superior position to the Commissioner in the event of the insolvency of the borrower or the head company of the consolidated group of which the borrower was a member.[23] Even a secondary ranking security interest (say behind a senior lender) will take priority to the Commissioner’s interest in the event of an insolvency, so may be worth considering in appropriate situations.
4.5 Lending to a Stand-alone Entity
Finally, if a borrower is not a member of a consolidated group, by virtue of it being a stand-alone entity, the lending criteria and financial modelling that would be usually applied to borrowers should be applied. The issues relating to consolidated groups will not arise in these cases.
5. TRANSFERS
5.1 Transfers and the Single Entity Rule
The Single Entity Rule (“SER”) in s 701-1 of the ITAA97 generally treats the head company and subsidiary members of an income tax consolidated group as parts of a single entity:
If an entity is a *subsidiary member of a *consolidated group for any period, it and any other subsidiary member of the group are taken for the purposes covered by subsections (2) and (3) to be parts of the *head company of the group, rather than separate entities, during that period.
Transactions between the members of a consolidated group must therefore be disregarded when calculating the income tax liability or tax loss of each member.[24]
Section 701-85 of the ITAA97 nonetheless allows other parts of the tax legislation to over-ride the SER in appropriate circumstances:
The operation of each provision of this Division is subject to any provision of this Act that so requires, either expressly or impliedly.
Note: An example of such a provision is Division 707 (about the transfer of certain losses to the head company of a consolidated group). That Division modifies the effect that the inheritance of history rule in section 701-5 would otherwise have.
Sections 701-1 and 701-85 of the ITAA97 therefore create uncertainty as to the circumstances in which the SER will apply. This uncertainty is exacerbated by the adoption of “principle-based drafting” in the consolidation regime. This is because the absence of specific legislative rules for particular circumstances makes it difficult to determine how the regime should apply in every case.
On 22 September 2004 the Commissioner released Taxation Ruling TR 2004/11 to set out his views on the meaning and application of the SER. Paragraphs 26 to 28 of the Ruling explain the approach that should be adopted in relation to the interpretation of the SER:
With the single entity rule, Parliament has expressed its intended policy outcome in broad and simple language, in this case by equating a consolidated group with a single entity. A necessary feature of this drafting approach is the omission of statutory mechanisms for effecting the policy for each provision of the income tax law (although in some cases they are provided). In construing a rule drawn this way, like in all cases of statutory interpretation, the fundamental object is to ascertain the legislative intent by reference to the language of the instrument as a whole: Cooper Brookes (Wollongong) v FC of T [1981] HCA 26; (1981) 35 ALR 151 at 169-170 per Mason and Wilson JJ. See also the legislated approach to statutory interpretation in the Acts Interpretation Act 1901 (Cth).
Accordingly, relying on these established approaches to statutory interpretation, (and notwithstanding the operation of s 701-85 - itself an interpretive directive), interactions with other provisions in the Income Tax Assessment Acts need to be taken into account in applying the SER. For example, a mechanical application of the SER should not defeat the policy underpinning the SER by producing results in relation to transactions that would not occur for a single company that operates by division.
Rather, when considering transactions or dealings the correct use of the rule is to indicate when, and for what purposes, transactions or parts of transactions are to be regarded or disregarded in determining the income tax position of the head company of the consolidated group. For this reason, the way the rule applies will depend on the purpose for which a transaction is being considered and the perspective of the relevant taxpayer (also see paragraphs 36-39).
The corresponding paragraphs of the original draft of this Ruling (paras 27-29 of Draft Taxation Ruling 2004/D2) expressly acknowledged that the SER embodies a “principle-based drafting” approach:
The single entity principle is an example of the new style of “principle-based drafting”. In this style of drafting, Parliament expresses its intended policy [outcome] in broad and simple language, in this case by equating a consolidated group with a single entity. A necessary feature of such a style of drafting is the omission of statutory mechanisms for effecting the policy for each provision of the income tax law (although in some cases they are provided).
The single entity rule is not a mere statutory fiction to be used itself as a mechanism for achieving the outcome intended by policy. In fact, applying the single entity rule across the board as a statutory fiction may have the opposite of the intended effect: it may defeat the policy by producing results in relation to transactions that could never occur for a single company that operates by division.
Rather, when considering transactions or dealings the appropriate use of the rule is to indicate when, and for what purposes, transactions or parts of transactions are to be disregarded in determining the income tax position of the head company of the consolidated group. For this reason, the rule will apply in different ways to a transaction, depending on the purpose for which a transaction is being considered. When it is being considered in relation to the assessment of a taxpayer that is not a consolidated group, it is not applied at all. When a transaction involves members of a consolidated group and an external party, either at one time or sequentially, the rule disregards the transaction to the extent necessary to achieve taxation of the consolidated group as if it were a single entity, and in a way that results in that outcome. This last category exhibits the most complexity because the rule will often disregard steps in transactions, rather than entire transactions, and may only disregard them at a certain stage.
One would be cautious about citing words from a draft ruling that did not appear in the final ruling. However, it seems that the final ruling simply expresses the same view of the drafting approach to the consolidation rules without using the phrase “principle-based drafting”. In this context, it is considered to be quite appropriate to interpret the SER by reference to this drafting approach. In particular, the absence of specific provisions to cover particular transactions does not prevent one from reading other parts of the tax legislation as though they contained such provisions. Specific provisions can, and should, be implied into other parts of the tax legislation in order to give the SER an appropriate effect (subject to the operation of s 701-85 of the ITAA97 which requires the outcome to be consistent with the legislative intent of those other parts).
Paragraph 36 of the Ruling recognises that in most cases the transfer of an intra-group asset to a non-member of an income tax consolidated group would be treated as a “transfer”:
The transfer of intra-group assets to non-group entities will have income tax implications for the head company. The SER gives effect to the legislative intention that the consolidated group (being the head company) should be treated in a similar way to a single company for income tax purposes. An analogy used is that the income tax outcomes of transactions within the group should be similar to the outcomes for a single company that operates through divisions. However, the intra-group assets of a consolidated group represent rights between members of the group. Such rights could not exist between divisions of a divisional company. Accordingly, the income tax law has regard to intra-group assets on being transferred to a non-group entity.
However, paras 41 and 42 of the Ruling warn that this will not always be the correct interpretation of the SER:
The SER may be modified in certain circumstances. Section 701-85 of the ITAA97 provides that “[t]he operation of each provision of this Division is subject to any provision of this Act that so requires, either expressly or impliedly”. As such, the operation of the SER may be modified by a provision in Part 3-90 of the ITAA 1997 or any other provision of the Income Tax Assessment Acts (and certain related Acts) that so requires it, expressly or impliedly.
This subjects the SER to the purposes of the other provisions of the Act where this is explicit or implied. Whilst the intention is for consolidated groups to be treated as single entities and comparably to the way non-consolidated companies are treated, if achieving the purposes of another provision runs contrary to this broad intent, the SER should yield to those purposes. Whether section 701-85 will apply in any given situation will depend on the particular provisions being considered.
The Commissioner has issued a number of Taxation Determinations (“TDs”) to address particular aspects of the SER. Some of these TDs identify circumstances in which the transfer of intra-group assets might be dealt with differently (eg as the creation, not the transfer, of the relevant asset):[25]
a) Assignment of debts (TD 2004/33)
Q: Does a CGT event happen to the head company of a consolidated group if a debt is created within the consolidated group and later transferred to a non-group entity?
A: No. This transaction is treated as the borrowing of money by the head company. One may infer that Div 16E of Pt III of the ITAA36 could apply if the face value of the debt exceeds the consideration received on transfer.
b) Assignment of options (TD 2004/34)[26]
Q: Does s 104-10 (CGT event A1) happen to the head company of a consolidated group if an option granted within the consolidated group is later transferred to a non-group entity?
A: Yes. This transaction is treated as the assignment of the option by the head company.
c) Assignment of licence (TD 2004/35)
Q: Does s 104-10 (CGT event A1) happen to the head company of a consolidated group if a licence granted within the consolidated group is later transferred to a non-group entity for no capital proceeds?
A: Yes. This transaction is treated as the assignment of the licence by the head company.
d) Interest-free loans (TD 2004/36)
Q: Can the head company of a consolidated group claim a deduction under s 8-1 for interest paid on funds borrowed before consolidation and on-lent interest-free to a subsidiary member of the consolidated group?
A: Yes, if from the group’s perspective the funds were ultimately used to produce assessable income (or in carrying on a business to produce such income).
e) In-house financiers (TD 2004/37)
Q: Are intra-group money lending transactions or dealings taken into account in determining if the head company of a consolidated group is carrying on business as a money lender?
A: No. The SER requires such transactions or dealings to be disregarded.
f) Sale of assets (TD 2004/39)
Q: Does s 104-10 (CGT event A1) happen to the head company of a consolidated group if an asset is sold by a subsidiary member to an entity outside the group?
A: Yes. This transaction is treated as the sale of the asset by the head company.
g) Sale of membership interests – Timing (TD 2004/40)
Q: Does s 104-10 (CGT event A1) happen to the head company of a consolidated group when a contract is made to sell a membership interest in a subsidiary member of the group to a purchaser outside the group?
A: Yes. This transaction is treated as the sale of the membership interest by the head company for the purposes of CGT event A1 even though, at the time of the sale, the SER requires the head company to disregard the membership interest for most other purposes.
h) Sale of membership interests – Market value substitution (TD 2004/41)
Q: Can a membership interest in a subsidiary member of a consolidated group be recognised for the purpose of applying the market value substitution rule in s 116-30 if CGT event A1 happens to the group’s head company when a contract is entered into to dispose of the interest?
A: Yes. This transaction is treated as the sale of the membership interest by the head company for the purposes of the market value substitution rule even though, at the time of the sale, the SER requires the head company to disregard the membership interest for most other purposes.
i) Small business concessions (TD 2004/47)
Q: Does the single entity rule affect the application of the controlling individual test in para 152-10(2)(a) when a CGT event happens to a share or trust interest that is a membership interest in a subsidiary member (company or trust) of a consolidated group?
A: No. Although the SER requires the head company to disregard the membership interest for some purposes, it is still taken into account for the purposes of the “controlling individual test”.
j) Demergers (TD 2004/48)
Q: For the purposes of Subdiv 125-C, can the head company of a consolidated group meet the requirements of a demerging entity in subs 125-70(7) where a subsidiary member is demerged from the group?
A: Yes. Although the SER requires the head company to disregard the membership interest in the subsidiary member for some purposes, this transaction is still treated as the demerger of the membership interests in the demerger subsidiary.
k) Discharge of intra-group liabilities (TD 2004/65)
Q: Does s 104-530 (CGT event L7) happen where: (a) an entity becomes a member of a consolidated group; (b) the entity owes a liability to another member of the group at that time; and (c) the liability is later discharged?
A: No. The discharge of the liability would be disregarded under the SER.
l) Transfer of loss assets (TD 2004/81)
Q: Does the deregistration of a subsidiary member of a consolidated group cause a “new event” to happen under para 170-275(1)(a) if, before the subsidiary joined that group, a transfer of shares in it was a “deferral event” under s 170-255 and the group’s head company is the “originating company” for the deferral event?
A: Yes. Although the SER requires the head company to disregard the membership interest in the subsidiary member for some purposes, the de-registration is still recognised for the purposes of the loss deferral rules.
In determinations where the Commissioner does not apply the SER to other parts of the tax legislation, he usually explains his reasons in terms such as the following:[27]
However, the single entity rule does not apply to defeat a clearly intended outcome under provisions outside the consolidation rules (such as Parts 3-1 and 3-3 of the ITAA 1997). In such cases, intra-group interests, or legal entities that are part of the head company for consolidation purposes, require a level of recognition in applying provisions that have regard to such interests and entities (for example, in determining eligibility for a concession). Paragraphs 8(c) and 26 to 28 of Taxation Ruling TR 2004/11 explain the Commissioner’s view that reading the Act as a whole achieves this outcome (and without the need to rely on section 701-85 of the ITAA97).
Note the careful exclusion of any operation for s 701-85 of the ITAA97 in these circumstances. The Commissioner’s approach to the application of the SER is therefore to analyse the particular transaction in a way that balances the legislative intention that underlies the SER with the intention that underlies another part of the tax legislation. Section 701-85 of the ITAA97 could only apply if the outcome of such an analysis is inconsistent with the express or implied requirements of the “other” part of the legislation.
Two issues of particular importance to financiers are:
| • | The transfer of intra-group debts; and |
| • | The transfer of other intra-group assets. |
These issues are discussed in more detail below.
5.2 Transfer of Intra-group Debt
It is common for financiers to have intra-group debts. Further to the single entity rule described above, the debt (while between members of the same consolidated group) will be ignored for certain tax purposes. This will apply equally to instruments that are treated as debt interests and non-share equity interests.
Whilst such an interest will not give rise to any tax consequences for the period that the interest continues to be between members of the same consolidated group, there will be tax implications for the consolidated group if the interest, or any part of the interest, is transferred outside the group.
As the intra-group interest is disregarded for taxation purposes, it is not treated as being in existence for taxation purposes. It is the Commissioner’s view that, notwithstanding the legal existence of an arrangement between members of the consolidated group, on transfer of the interest or any part of the interest a new debt interest is “created” or “issued”, rather than transferred.[28] If the terms of the transfer of the debt give rise to a “qualifying security”,[29] the Commissioner will treat the transferred debt as being subject to Div 16E of Pt III of the ITAA36 and taxable on an accruals basis.
Further, if only an element of the intra-group debt is transferred (such as the right to payment of the principal or the interest stream), it is the Commissioner’s view that the transfer of that element of the original security will constitute the creation or “issue” of a qualifying security (if the elements of s 159GP of the ITAA36[30] are satisfied).[31]
In Taxation Determination TD 2004/84 (about the assignment of the right to receive principal), the Commissioner states:[32]
“Issue” of the security
12. Subsection 159GP(1) of the ITAA 1936 defines the “issue” of a security (apart from a security that is a bill of exchange) to be the creation of the liability to pay an amount or amounts under the security. “Issuer” is defined in that subsection to be the person who would be liable to pay the amount or amounts under the security (apart from a security that is a bill of exchange) if the amount or amounts payable were due and payable at the time.
13. The assignment of the principal will give rise to what is effectively a borrowing of money by the head company from a non-group entity. This will be treated as a creation of contractual rights under the income tax laws and therefore involves an “issue”. of a security for the purposes of Division 16E of the ITAA 1936. After the assignment of the principal to a non-member, the “issuer”. of the security for the purposes of Division 16E will be the head company because of the effect of section 701-1 of the ITAA 1997.
This treatment is consistent with the general taxation concept of a single taxable entity, but is not necessarily consistent with the legal position, which would treat the rights and obligations under the arrangement to have been created within the consolidated group (even if no taxation consequences arose) and then recognising the transfer of those existing rights.
Further, in some cases, it may be that the Commissioner’s treatment of debt being transferred outside the group as the “issue” of a debt may create some difficulties in interpretation or application of some provisions of the Act. This could be the case in determining the impact of an arrangement whereby limited recourse intra-group funding was provided for the acquisition of a depreciating asset. If that debt is transferred or refinanced using limited recourse debt, the potential application (if any) of Div 243 of the ITAA97[33] on ultimate termination of the new debt funding will need to be considered. This change in the arrangement will be important, as, while the funding is provided by another member of the same consolidated group, it will be ignored for tax purposes (including Div 243 of the ITAA97), but will certainly become relevant if those arrangements change during the term of the arrangement.
Following the Commissioner’s treatment of the transfer of interests in intra-group debts as the issue of new debts (rather than the transfer of existing rights) in the relevant TDs summarised above and the Consolidation Reference Manual C–9-5-230, there should be no immediate impact on the asset owner (and borrower) at the time of transfer of the interests. However, there may be a risk that, if the legal relationships had been respected and the debt treated as if it had been created within the consolidated group and then transferred, the transfer, itself, could give rise to a calculation for the purposes of Div 243 of the ITAA97 being required (and inclusion of an amount in the consolidated group’s assessable income) at the time of transfer. The Commissioner has not specifically commented (in either binding or non-binding form) on this issue.
Accordingly, some caution should be taken in relation to transfers of intra-group loans that provided limited recourse debt funding for the acquisition of depreciating assets. There is always a risk when relying on the Commissioner’s practice, when that practice does not reflect a strict legal analysis of the underlying arrangements, that, unless the facts involved exactly mirror the facts outlined in a public ruling binding on the Commissioner, the Commissioner may apply a treatment that is inconsistent with his rulings and a court will apply a legal interpretation of the Act (recall: Bellinz Pty Ltd v FC of T 98 ATC 4634; and Coleambally Irrigation Mutual Co-operative Ltd v FC of T [2004] FCAFC 250; (2004) 57 ATR 104).
5.3 Transfer of Intra-group Asset
When any member of a consolidated group disposes of an asset to an entity that is outside the consolidated group, the head company will be treated as if it had disposed of that asset. Importantly, any asset transfers between members of the same consolidated group will be disregarded for tax purposes.
If the asset transferred is an item of trading stock, the trading stock provisions in Div 70 of the ITAA97 will apply to the head company and the sale proceeds (if the item was sold in the ordinary course of business) will be included in the head company’s assessable income in the income year of the sale. If the value of the trading stock held at the end of an income year exceeds its value at the start of the income year, then the excess is included in the head company’s assessable income. If the value of the trading stock at the end of an income year is less than its value at the start of the income year, then the difference is allowable as a deduction.[34]
The disposal of any assets that are held by the head company or any subsidiary member as revenue assets, but are not trading stock, will give rise to:
| a) | in the case of a profit arising on sale – an amount equal to the profit being included in the head company’s assessable income in the income year in which the disposal occurred;[35] and |
| b) | in the case of a loss arising on sale – an amount equal to the loss being allowable as a deduction against the head company’s assessable income in the income year in which the disposal occurred.[36] |
If the asset transferred is a depreciating asset, the capital allowance provisions in Div 40 of the ITAA97 will apply to the head company. Specifically, the balancing adjustment provisions in Subdiv 40-D of the ITAA97 will be applied to determine whether an amount is included in the head company’s assessable income or an allowable deduction arises. Also relevant in determining the head company’s taxation position in any income year in which a depreciating asset is disposed of (or ceased to be used for a taxable purpose) will be Div 45 of the ITAA97 (if the asset was leased for most of the time during which it was owned by the member of the consolidated group) and Div 243 of the ITAA97 (if the asset was acquired using limited recourse debt). Again, these sections will apply to the calculation of the head company’s tax liability, regardless of which entity within the consolidated group had legal title (or was otherwise treated as the “holder” of the asset under s 40-40 of the ITAA97).
When capital assets are transferred out of the consolidated group, the capital gains tax provisions in Pt 3-1 of the ITAA97 will apply to determine whether the head company has derived a capital gain or incurred a capital loss. The amount of any assessable gain may also be reduced if, because of the CGT event, another provision of the Act (outside the capital gains tax provisions) includes an amount (for any income year) in the head company’s assessable income.[37] The head company’s cost base will be determined using the asset allocation provisions in Div 705 of the ITAA97, with relevant adjustments if the asset was brought into the group at the time of formation of the consolidated group (with transitional treatment, if relevant), or subsequently acquired either by a member of the consolidated group or as a result of the head company (directly or indirectly) acquiring all of the ownership interests of the owner of the asset. A complete examination of the cost setting rules is outside the scope of this article, but should be carefully considered in respect of every asset within the consolidated group.
5.4 Transfer of Shares or Other Membership Interests
If shares or other membership interests in an entity (“Exiting Member”) are transferred to an entity outside the consolidated group, the Exiting Member will cease to be a member of the consolidated group. This will be the case regardless of whether a single share (or membership interest) or all of the shares (or other membership interests) in the Exiting Member are transferred outside the consolidated group.
At the time of exit, the head company will be treated as disposing of the relevant membership interests in the Exiting Member. Whilst all of the assets of the Exiting Member will also cease to be assets of the head company at the time of exit, no specific termination event occurs in relation to those assets. Rather, the tax consequences of the disposal are calculated by reference to the tax cost setting amount (based on the sum of the termination values of the assets in the Exiting Member at the time of the exit).[38] This calculation also takes into account any outstanding liabilities between the Exiting Member and remaining members of the consolidated group.
Adjustments to these calculation processes are applied where more than one member of the consolidated group exits (as a result of the Exiting Member owning all of the membership interests in another member).
5.5 CGT Events and Exits from Consolidated Groups
One or more of the following capital gains tax events may occur when a subsidiary member leaves an income tax consolidated group:
| a) | CGT event A1[39] (ie the sale by the head company of its membership interest in the subsidiary member); |
| b) | CGT event J1[40] (ie if assets had been previously rolled over and the subsidiary member ceases to be a 100% subsidiary of the head company of the group, but only if the time at which that happens is not the same as the time at which the subsidiary ceases to be a member of the consolidated group); and |
c) CGT event L5[41](ie the exit of the subsidiary member from the group).
It is most common for the head company to enter into a contract for sale of its interest in the subsidiary member. CGT event A1 will therefore usually happen when the head company enters into that sale contract.[42]
CGT event L5 will happen when the subsidiary member ceases to be a wholly-owned subsidiary of the head company.[43] This is deemed to occur when the head company ceases to be entitled to be registered as the holder of its interest in the subsidiary member.[44] This is usually the date on which the sale contract is settled rather than the date on which the head company entered into the sale contract.
It is therefore possible for CGT event A1 to occur in one income year and for CGT event L5 to occur in the following year. In the first income year the head company would recognise a capital gain under CGT event A1 equal to the amount of any sale proceeds. In the second income year the head company would recognise a capital gain under CGT event L5 equal to the negative allocable cost amount calculated under s 711-20 of the ITAA97.
A CGT event J1 happens if assets were previously rolled over into a subsidiary member under Subdiv 126-B of the ITAA97 and, after the roll-over, the subsidiary member ceases to be a “100% subsidiary” of the head company.[45] The time at which the subsidiary member ceases to be a 100% subsidiary of the head company is referred to as the “break up time” and is the time at which the CGT event J1 occurs. A CGT event J1 will generally not happen when a member of a consolidated group exits that consolidated group, if that event happens at the same time as the “break up time”.[46] In most cases, these events would coincide. However, in the circumstances described above, the timing of those events is different and the head company may also realise a capital gain under CGT event J1, as well as under CGT event A1 and, possibly CGT event L5. In this example the subsidiary member ceases to be a 100% subsidiary of the head company when the head company enters into the contract for sale of its membership interest because, after that time, the purchaser will be in a position to affect the head company’s rights in relation to the subsidiary member.[47] Section 104-182 of the ITAA97 does not prevent CGT event J1 from occurring where, as here, a subsidiary member does not leave the group at the break-up time. This appears to be a drafting oversight.
5.6 Clean Exit
The Exiting Member (or members) will be entitled to leave the consolidated group free of any future liability in respect of taxes arising in the period during which the exit occurs if there is a valid TSA[48] in place at the time of exit and the Exiting Member (or members) make a payment to the head company equal to a reasonable estimate of the Exiting Member’s reasonable allocation of tax liability for the period prior to exiting the group.
If the head company fails to provide a copy of the TSA to the Commissioner within 14 days of a request, any particular member that is covered by the TSA may avoid joint and several liability for a tax liability of the group, if:
| a) | the Commissioner gave written notice of the liability to that particular group member; |
| b) | apart from the failure of the head company to provide a copy of the TSA to the Commissioner within 14 days of a request, the member would have been treated as having left the group clear of the liability; |
| c) | the relevant member gave the Commissioner a copy of the TSA within 14 days of receiving written notice of the liability.[49] |
5.7 Documentation Considerations
At the time of exit, the vendor member will also need to carefully consider assumptions, representations, warranties and indemnities contained in the sale documentation. Additionally, any adjustments to the purchase price referable to tax should be carefully considered - does it require an adjustment in addition to the exiting payment made under the TSA to ensure valid clean exit; how is it calculated?
6. SECURITISATION VEHICLES
6.1 Consolidatable Entities
Securitisation arrangements generally involve the assumption of economic risk in relation to particular assets funded through the issue of debt through debt capital markets. Variations apply, but, for the purposes of the following discussion, the characteristics described above will be assumed.
If the securitisation vehicle is a trust (as is often the case), it will be important to ensure that the holder of the income (or residual income) unit(s) in the trust and the capital unitholder are not members of the same consolidated group, unless that is the commercial intention of the arrangements. It will also be important to ensure that entities that act as the trustee of securitisation trusts do not put their assets or assets of other trusts for which they act as trustee at risk by ensuring that trust deeds are appropriately drafted.
If the securitisation vehicle is a member of a consolidated group, it will be critical for credit ratings purposes that the consolidated group has a valid TSA in place. This is generally a specific requirement of the ratings agencies for the purposes of rating a debt issue that will be backed by the securitisation of assets or an income stream.
6.2 Thin Capitalisation
An examination of the general application of the thin capitalisation rules and an outline of the elements required to pass one of the relevant tests is outside the scope of this paper. However, there are specific implications of the thin capitalisation regime on securitisation entities that are members of consolidated groups.
As noted above, if the head company elects to form a consolidated group, all wholly-owned entities (directly or indirectly) will be members of the consolidated group. This impacts on all entities in the group, but is particularly significant for securitisation vehicles. This is because securitisation vehicles will generally be very highly leveraged to achieve the financial profile usual for those types of entities and will also frequently require that debt that they issue to the public be rated by credit rating agencies.
An entitlement to interest deductions is subject to the thin capitalisation rules in Div 820 of the ITAA97. Pursuant to these rules, entities that are controlled or owned by non-residents (inward investing entities) or that own or control foreign operations (outward investing entities) must pass a safe harbour debt ratio test or a prescriptive arm's length debt test. In addition, if outward investing entities fail both of those tests, they may pass a worldwide gearing test. The safe harbour ratio is, generally,[50] 75% debt (for entities or groups that are not authorised deposit taking institutions)[51] and 96% debt[52] (for entities or groups that are authorised deposit taking institutions).[53]
If an entity or, in the case of a consolidated group, the head company (incorporating all members of the consolidated group) will generally be denied a portion of its interest deductions. However, the leverage ratio for securitisation vehicles typically exceeds the safe harbour ratio and could contribute to the consolidated group failing or approaching the safe harbour ratio. To address this issue, certain entities are exempt from the thin capitalisation regime[54] and, if those entities are members of a consolidated group, they are not treated as being a member of the consolidated group for thin capitalisation purposes.[55]
The exemption applies to entities that pass the following conditions:[56]
| a) | the entity is one established for the purposes of managing some or all of the economic risk associated with assets, liabilities or investments (whether the entity assumes the risk from another entity or creates the risk itself); and |
| b) | the total value of debt interests in the entity is at least 50% of the total value of the entity’s assets; and |
| c) | the entity is an insolvency-remote special purpose entity according to criteria of an internationally recognised rating agency that are applicable to the entity’s circumstances.[57] |
How broadly this exemption (particularly the terms of condition (a)) will be interpreted remains to be seen: there being no current indication as to the appropriate breadth of interpretation from the Commissioner, nor any guidance in the Explanatory Memorandum to the Taxation Laws Amendment Bill (No 5) 2003 (Cth).
If a securitsation vehicle fails this test, the head company of the group may still be entitled to apply a specific concessional calculation methodology to assets of the vehicle if the requirements of Subdiv 820-K are satisfied.
7. OFFSHORE BANKING UNITS
Special rules exist in Div 9A of Pt III of the ITAA36 in relation to the taxation of .offshore banking units. (“OBUs”), such that specified “offshore banking” (“OB”) income is concessionally taxed at a rate of 10%.
For an entity to be an OBU, the Treasurer must declare, by way of written determination or gazettal, that the entity is an OBU for the purposes of Div 9A of Pt III of the ITAA36.[58] Entities that are OBUs are concessionally taxed on income relating to OB activities, which include:
| a) | a borrowing or lending activity, if: |
| (i) | of money – the money raised is not in Australian currency and is lent to or borrowed from a non-resident; or |
| (ii) | of gold – lent to, or borrowed from, a non-resident; |
| b) | a guarantee-type activity, including guarantees, letters of credit, underwriting, syndication or issuing a performance bond in favour of an offshore person in relation to events or activities to occur wholly outside Australia; |
| c) | a trading activity in: |
| (i) | trading with an offshore person in securities issued by non-residents or eligible contracts, under which any amounts payable are payable by non-residents; |
| (ii) | trading with an offshore person in shares in non-resident companies or units in non-resident trusts; |
| (iii) | trading with an offshore person in options or rights in respect of securities, eligible contracts, shares or units referred to above; |
| (iv) | trading (including on behalf of an offshore person) on the Sydney Futures Exchange in futures contracts, or options contracts, under which any money payable in not Australian currency); |
| (v) | trading in currency, or options or rights in respect of currency, with any person, where the currency is not Australian currency; |
| (vi) | trading in currency, or options or rights in respect of currency, with an offshore person; |
| (vii) | trading in gold bullion, or in options or rights in respect of such bullion: |
A. with an offshore person where the money or moneys payable or receivable is or are in any currency; or
B. a person other than an offshore person where the money or moneys payable or receivable is or are in a currency other than Australian currency;
| (viii) | trading with an offshore person in silver, platinum or palladium bullion, or in options or rights in respect of such bullion; or |
| (ix) | trading with an offshore person in base metals; |
d) acting as a broker or agent for, or trustee for the benefit of, an offshore person in making an investment with an offshore person, where the currency in which the investment made is not Australian currency and the investment involves the purchase of:
| (i) | a share in a non-resident company; |
| (ii) | a unit in a non-resident unit trust. |
| (iii) | land or buildings outside Australia; or |
| (iv) | any thing located outside Australia; |
e) relevant offshore portfolio management activities and investments;
f) investment or financial advisory activities to an offshore person, where the investment is outside Australia; or
g) hedging contracts entered into with an offshore person for the sole purpose of eliminating or reducing the risk of adverse financial consequences that might result for the OBU from interest rate exposure or currency rate exposure relating to other offshore banking activities.[59]
Any income derived by an OBU that arises from OB activities will be taxed concessionally at 10%.[60] Income that the OBU derives from activities that are not OB activities are taxed at the ordinary company tax rate.
Under consolidation, if any member of the consolidated group is an OBU, the head company will be treated as if it were an OBU for the purposes of Div 9A of Part III of the ITAA36[61]. This deeming provision means that any OB activity performed by any member of the consolidated group (while one of the group’s members is, in fact, an OBU) could be taxed in the concessional manner.
However, s 121EH of the ITAA36 provides that if more than 10% of the OB activity of the OBU is attributable to the lending, investing or other use of non-OB money,[62] then none of the OB income will qualify for the concessional treatment. As the OBU entity is treated as being the entire consolidated group, this means that, in most cases, the entire OBU concession will be lost.
8. BAD DEBTS
Entities that conduct a business of moneylending are generally entitled to claim a deduction for bad debts that are written off, if the written off-debts were lent in the ordinary course of carrying on the moneylending business.[63] This general rule extends to writing off debts that were acquired in the ordinary course of carrying on a moneylending business.[64]
However, limitations generally apply to the deductibility of bad debts if there was a change in ownership of the entity between the date on which the debt was incurred and the end of the income year in which it is written off[65] and if the same business test is not passed for the relevant test time.[66] The relevant test times differ between non-listed companies and listed public companies (and their subsidiaries) and there are choices that the entities may make in relation to determining the testing times. In many cases, the test time will be from either the start of the income year in which the debt was incurred or the start of the income year in which the company failed to continuity of ownership test until the end of the income year in which the debt was written off as bad.[67]
If either of the continuity of ownership test or the same business test is not passed, the entity will not be entitled to claim a deduction for writing off the bad debt (subject to the Commissioner exercising his discretion not to disallow the deduction).[68]
Legislation that has been recently enacted[69] amends the application of these provisions in respect of consolidated groups. This amending legislation introduces a new Subdiv 709-D into the Act, the object of which is to:
is to ensure that the claimant can deduct the debt, or part of it, only if each entity that was owed the debt for a debt test period could have deducted the debt if it had been written off as bad at the end of the period.[70]
Essentially, the new legislation will modify the test periods that are applied in determining whether the continuity of ownership test or the same business test applies in relation to the debt.[71] This will be particularly significant where the entity that is owed the debt either joins or exits a consolidated group between the time at which the debt was incurred and the time at which the debt was written off as bad.
9. CONCLUSION
The consolidation regime affects all Australian entities that are members of a wholly owned (or consolidatable)[72] group. To date, Australian corporate taxpayers have been most keenly interested in issues relating to the formation of consolidated groups and ensuring that appropriate cost allocation methodologies and processes are undertaken.
It is appropriate that corporate Australia now turn its attention to issues affecting the operation of consolidated groups and, more specifically, issues that apply to particular sectors. Particular issues will arise for financiers, based on the nature of their business and the nature of some of the entities that form part of a financier group. Some of these issues are outlined in this article. Unfortunately, this article does not provide an exhaustive list of all issues arising under the consolidation regime that affect financiers; nor does it completely examine the issues that are enunciated herein.
In the age of “principle-based drafting”, it will be left to taxpayers to navigate their way through the new taxing regime, hopeful that reasonable approaches to interpretation taken in relation to the situations that arise on a day-to-day basis will align with the Commissioner’s interpretation of the law, or, ultimately, the courts that are entrusted with the task of resolving the inevitable disputes.
[∗] Partner, Blake Dawson Waldron. The author gratefully acknowledges the assistance of Duncan Baxter (Consultant, Blake Dawson Waldron) in reviewing and providing useful input into this article.
[1] It also applies (as amended by Div 719 of the Income Tax Assessment Act 1997 (Cth) (“ITAA97”)) to entities that are foreign owned and have multiple entry points into Australia: Multiple Entry Consolidated groups (“MEC groups”).
[2] Modifications to this rule apply in the case of “eligible tier-1” companies in the context of the MEC rules in Div 719 of the ITAA97, so that while an additional entry point into Australia of a foreign resident may be consolidatable, it is not necessary that an existing MEC group be expanded to include that entity (or any subsidiaries of that entity): ITAA97, Subdiv 719-B.
[3] ITAA97, s 703-15.
[4] Employee shares that meet certain conditions outlined in s 703-35 of the ITAA97 and Div 13A of Pt III of the Income Tax Assessment Act 1936 (Cth) (“ITAA36”) are disregarded in determining whether a company is wholly-owned for consolidation purposes, if the total number of those shares is not more than 1% of the number of ordinary shares in the company: ITAA97, s 703-35(4).
[5] ITAA97, ss 703-30 and 960-130.
[6] ITAA97, s 703-50. The head company can nominate a date for the formation of the consolidated group as any date in an income year up until the end of the day on which the income tax return for that year is lodged, but cannot be a date prior to 1 July 2002.
[6] ITAA97, Div 719.
[7] Subject to the comments in note 2 above in relation to .eligible tier-1 entities. in the context of MEC groups: ITAA97, Subdiv 719-B.
[9] Calculation of the head company’s tax liability or tax loss are the head company core purposes: ITAA97, s 701-1.
[10] Note also the discussion in Section 6 below in relation to securitisation vehicles.
[11] See discussion in Section 4 below in relation to credit issues.
[13] ITAA97, s 17-5(a).
[15] See ITAA97, s 27-5 which only denies a deduction for an amount relating to an input tax credit.
[16] There are a number of measures that provide an exemption from interest withholding tax, such as s 128F of the ITAA36 (in respect of certain widely issued debentures or debt interests) and payments by an Australian resident borrower to a United Kingdom bank or financial institution or a United States bank or financial institution that has the benefit of the Australia/United States Double Tax Treaty.
[17] The impact of relevant treaties and, where relevant, foreign concepts of fiscally transparent entities, should also be considered on a case-by-case basis.
[18] ITAA97, s 721-15.
[19] ITAA97, s 721-25(3).
[20] The Commissioner has provided guidelines as to allocation methodologies that might be reasonably applied in s C9-7 of the ATO's Consolidation Reference Manual.
[21] Whether all members of the consolidated group are required to be parties to the TSA has been a matter of debate. As the TSA must represent a “reasonable allocation” of the tax liabilities covered by the TSA, it is prudent to require that all members of the consolidated group are parties to the TSA (the head company and the TSA contributing members: ITAA97, s 721-25). If any tax liability covered by the TSA would be appropriately distributed between some (but not all) of the members of the consolidated group, there is an argument that only those members need to be parties to that TSA. That argument is supportable in respect of particular tax liabilities, but risks not identifying all of the relevant parties (either at the time of entering into the TSA or as a result of a subsequent change to parties or arrangements), which could render the entire TSA invalid.
[22] These arrangements may also be entered into for accounting purposes, to ensure pushdown of expense and liability.
[23] Other than in respect of taxes due by a liquidator, such as taxes arising on any capital gain on an asset sale, where the liquidator has priority; or taxes due by a receiver, where the secured creditor who appointed the receiver normally gives an indemnity.
[24] Refer to the definitions of “head company core purposes” in s 701-1(2) of the ITAA97 and “entity core purposes” in s 701-1(3) of the ITAA97.
[25] This is by no means an exhaustive list. In practice is would always be advisable to check whether your particular transaction is addressed in an applicable TD.
[26] This TD is inconsistent with the Consolidation Reference Manual C9-5-230, which states that the sale of an intra-group asset would not be treated as a CGT event A1 disposal, but would be treated as a CGT event D2 grant of an option. The TD is binding on the Commissioner, whereas the Consolidation Reference Manual is not. The TD also reflects a more accurate legal analysis of the underlying arrangements than the statements in the Consolidation Reference Manual.
[27] Refer to para 5 of Taxation Determination TD 2004/48 (in relation to the demerger rules).
[28] Consolidation Reference Manual C9-5-230; and Taxation Determination TD 2004/33.
[29] Essentially, a security that has a term exceeding one year and either has an unascertainable eligible return or the eligible return (excluding periodic interest) exceeds 1.5% of the total amount payable under the security multiplied by the number of years of the security: ITAA36, s 159GP.
[31] Taxation Determination TD 2004/84 and Taxation Determination TD 2004/85.
[32] Taxation Determination TD 2004/84 para 12-13. See also, Taxation Determination TD 2004/85 paras 12-13.
[33] Division 243 of the ITAA97 can include a balancing adjustment in the assessable income of an entity that owns a depreciating asset if the acquisition of that asset was financed or refinanced using limited recourse debt and, at the time of termination of the debt (within the extended meaning of that term: ITAA97, s 243-25) an amount of the debt remains outstanding or was repaid using the proceeds of sale of the depreciating asset.
[34] ITAA97, s 70-35.
[38] ITAA97, Div 711.
[39] ITAA97, s 104-10.
[40] ITAA97, s 104-175, subject to ITAA97, s 104-182.
[41] ITAA97, s 104-520.
[42] ITAA97, s 104-10(3)(a). Refer to Taxation Determination TD 2004/40 for the Commissioner’s confirmation that this treatment applies in the context of income tax consolidation even though the .single entity rule. requires the head company to disregard the membership interest in the subsidiary member for so long as it remains a member of the group.
[43] ITAA97, s 104-520(1)(a) and column 4 of item 2 of the table in s 703-15(2) of the ITAA97.
[44] ITAA97, s 703-30 as modified by the timing rules in s 703-33 of the ITAA97.
[46] ITAA97, s 104-182.
[47] ITAA97, s 975-505(2).
[48] The requirements for a valid TSA are detailed above in Section 4.1.
[49] ITAA97, s 721-15(3A).
[50] Subject to many exceptions, specific to each class of investor.
[51] ITAA97, ss 820-95 and 820-205.
[52] Referable to risk-weighted assets.
[53] ITAA97, ss 820-310 and 820-405.
[54] ITAA97, s 820-39.
[55] ITAA97, s 820-584.
[56] ITAA97, s 820-39.
[57] This condition can be met without the rating agency determining that the entity meets those criteria: ITAA97, s 820-39(4).
[60] ITAA36, s 121EG: this is achieved by only including an amount equal to: OB income * (10/current company tax rate) in assessable income. At the current time, that means ⅓ of the OB income is treated as assessable. Similarly, ⅓ of the OB deductions are deductible, resulting in the net OB activity income being taxed at 10%.
[61] ITAA97, s 717-710.
[62] Non-OB money is money of the OBU other than money received by the OBU.
[63] ITAA97, s 25-35. Bad debts may also be written off under s 8-1 (the general deductibility) if s 25-35 of the ITAA97 does not apply and if the loss was incurred in the ordinary course of carrying on business.
[64] ITAA97, s 25-35(3).
[65] ITAA97, Subdiv 165-C and Subdiv 166-C (in relation to publicly listed companies).
[66] ITAA97, ss 165-126, 166-40 and 166-45.
[67] ITAA97, ss 165-126, 166-40 and 166-45.
[69] Tax Laws Amendment (2004 Measures No 7) Act 2005 (Cth), Sch 6.
[70] ITAA97, s 709-210.
[71] ITAA97, s 709-215.
[72] ITAA97, ss 703-10 and 703-15.
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