CONSOLIDATION – TAXING WHOLLY OWNED GROUPS AS SINGLE ENTITIES
The income taxation of consolidated and MEC (Multiple Entry Consolidated) groups has been in force since 1 July 2002.
Eligible companies, partnerships and trusts that are wholly owned are taxed as if they are part of a single head company. Many small businesses use simple structures (a single company, partnership, or trust) and will not be affected by the consolidation legislation. It is not relevant to the business activity of individuals (such as people operating as sole traders or in partnership). However, consolidation may be an option for your business if the business structure includes a company that wholly owns one or more entities.
Some key elements of the Consolidation regime:
- To form a consolidated group, a group must consist of an Australian resident head company and at least one other Australian resident entity – a company, trust, or partnership – wholly owned by the head company.
- The choice to consolidate is optional but irrevocable.
- If a head company of a consolidated group chooses to consolidate on a specified date, then, from that time, both the head company and all its eligible wholly owned subsidiaries will be part of the consolidated group for income tax purposes.
- The head company of a consolidated group must notify the Tax Office of its decision to consolidate using the appropriate approved form by the earliest of either:
- The end of the day on which it gives the Commissioner its income tax return for the year which contains its chosen date of consolidation; or
- The end of the day on which it is required to lodge that income tax return. The period for choosing to consolidate cannot be changed. If you cannot lodge your notification of choice with the Commissioner by this time, you should contact the ATO to discuss extending the due date of your income tax return.
Suppose the head company is not required to lodge an income tax return for the year containing the chosen consolidation date. Notification of choice must be given to the Commissioner on or before the date a return would need to be lodged for that year if a return was required.
- If notification of choice is not given to the Commissioner on or before the relevant time, the group cannot be treated as consolidated for that income year.
- Suppose a foreign company has multiple entry points into Australia, either directly or through its wholly owned foreign entities. In that case, special MEC group rules will apply where a MEC group is formed.
- A MEC group will have a provisional head company (PHC) during the course of the income year. The PHC at the end of the income year will be the head company for that particular income year.
- On consolidation, the head company of a consolidated or MEC group and its entire eligible wholly owned subsidiary members are treated as a single entity for their income tax purposes. That is, each subsidiary member is treated as a part of the head company.
- The tax costs of assets of an entity joining a consolidated or MEC group (other than eligible tier-1 companies) that become assets of the head company under the single rule are reset according to special tax cost setting rules (see below).
- The consolidated or MEC group operates as a single entity for income tax purposes. The head company lodging a single income tax return and then paying a single set of PAYG instalments for the group.
- A consequence of choosing to consolidate is that transactions that occur solely between members of the consolidated or MEC group will not result in income or deductions to the group’s head company.
- Suppose an entity becomes a subsidiary member of a consolidated or MEC group part-way through its income year. It has a period in the year that it is not a subsidiary member for any other reason (non-membership periods). In that case, it will also need to lodge a tax return for that income year. However, the tax return will be based only on amounts properly attributable to all the periods that the company was not a subsidiary member of a consolidated or MEC group during the income year.
- The losses, franking credits, pre-commencement excess foreign income tax, and conduit foreign income and attribution account surpluses of each subsidiary member can generally be brought into, and used by, the Head Company of a consolidated or MEC group.
- Carry-forward losses, franking balances, pre-commencement excess foreign income tax, and conduit foreign income transferred to the group’s head company remain with the head company when an entity leaves the group. Special rules apply regarding the treatment of carry-forward losses transferred into the consolidated or MEC group.
- The consolidation regime does not affect a subsidiary member’s obligations in relation to other taxes such as goods and services tax (GST), fringe benefits tax (FBT) and pay as you go (PAYG) withholding.
- Certain corporate unit trusts and public trading trusts may form a consolidated group and be treated like the group’s head company.
- Where a consolidated or MEC group includes one or more subsidiary members that are life insurance companies, special consolidation rules apply to take into account the particular taxation treatment of life insurance companies.
The head company of a consolidated or MEC group or an Australian Parent Company or (eligible tier-1 companies), where relevant must (among other things):
- Notify the ATO of the decision to consolidate
- Pay the group’s PAYG instalments when it is issued with a consolidated instalment rate after the lodgement by the head company of its first group tax return
- Determine, report, and make any balancing adjustments to meet the group’s annual income tax liabilities
- Manage any ongoing income tax liabilities and supply income tax information to the ATO when required; and
- Notify the ATO of any members that join or leave the group.
TAX Cost Setting Rules
When a consolidated group forms or a new member is added to that group, the head company is deemed to have acquired those assets.
The amount that the head company paid for those assets may be different to the book value of those assets in the subsidiary company.
The cost of each incoming asset to the head company is determined using the allocable cost amount (ACA). Determining the ACA is an intricate calculation that involves a series of processes. The resulting ACA aims to allocate the actual cost of the incoming assets in an economic way.
Example: Big Bob Enterprises is an existing group of five wholly-owned Australian companies consolidated for tax purposes. Big Bob Enterprises acquires all the shares in Little Bob Pty Ltd for $50,000. Little Bob Pty Ltd has liabilities of $100,000, no retained earnings or tax losses. Little Bob Pty Ltd.’s assets consist of:
|Existing Tax Cost||Base/WDV||Market Value|
|Plant & equipment||$25,000||$40,000|
The ACA is calculated as $150,000 (i.e., cost of shares plus liabilities).
This ACA is then allocated to the assets based on relative market values as follows:
|Base/WDV||ACA Allocated||Market Value|
|Plant & equipment||$25,000||$40,000||$40,000|
From the example above, there can be opportunities to increase the cost base of CGT and depreciable assets on the purchase of a subsidiary member. In this example, the following is of advantage to Big Bob:
- Big Bob will be able to depreciate plant and equipment based on a value of $40,000 instead of the $25,000 value that it was being held at in the books of Little Bob.
- The increase in the value of the trading stock held by Big Bob will result in a greater cost of goods sold (and tax deduction).
- Due to the higher cost base for the land and goodwill held by Big Bob, any subsequent sale will have a reduced capital gain.
Tax Sharing Agreement (TSA)
Under consolidation, the head company is liable for the taxation liabilities of the consolidated group. In the event of the default of the head company, all members are jointly and severally liable for the outstanding amount.
A Tax Sharing Agreement (TSA) can be entered into to limit the liability of the subsidiary members.
A TSA is a legal document that requires a number of attributes to be valid. The most important is the calculation of how each member of the group calculates their taxation liability. The method used must be “reasonable”, and if deemed by the Commissioner to inhibit his ability to recover taxation, the TSA may be deemed invalid.
TSAs offer protection to subsidiary group members from other subsidiary group members who fail to meet their taxation liabilities.
PAYG Instalments and the Consolidated Group
Where the head company has not yet been assessed as the head of the consolidated group for PAYG purposes, instalments of all members of the group must still be paid. When the head company lodges its first consolidated return, it will receive a credit for amounts already remitted by its subsidiary members.
From this point on, the head company will receive an instalment rate for the whole group.
The Government has announced three new measures designed to modify, broaden, and defer certain previously announced integrity measures within the tax consolidation scheme.
Integrity measures for liabilities from securitised assets
The Government has announced an extension of measures concerning the recognition of liabilities for non-financial institutions arising from securitisation arrangements for the purposes of the entry and exit cost calculations.
When a company holds securitised assets, the accounting treatment requires the company to recognise the liability, but not the asset. This can create a tax benefit when joining or leaving a consolidated group. These measures address the mismatch by requiring the liability to be excluded when undertaking entry and exit calculations unless the associated asset is included.
Removal of deferred tax liabilities
The tax consolidations regime’s treatment of the deferred tax liability will be amended by removing adjustments to deferred tax liabilities from the consolidation entry and exit calculations. Including the liabilities creates a commercial/tax mismatch and gives rise to integrity risks and uncertainty.
Removing the double benefit of deductible liabilities
Previously a double tax benefit could be achieved when a consolidated group acquired a subsidiary with deductible liabilities. The modifications mean these deductible liabilities are no longer included in the consolidation entry tax cost setting calculation.
CHURNING OVER CONSOLIDATION
Draft Law Companion Ruling 2018/D3 (draft LCR) provides guidance on the consolidation ‘churning measure’ in s.716-440, enacted on 28.3.2018 (Act No 14 of 2018). This measure is intended to prevent ‘tax-free step-ups’ in the tax costs of assets where shares in the joining entity were acquired from a non-resident related party, whose gain on the transfer was disregarded under Division 855 on the basis that shares in the joining entity were not taxable Australian property. However, these detailed rules potentially have wider implications.
The LCR contains 3 examples, each of which involves a conclusion that the churning measure would apply.
While providing valuable guidance, this draft LCR was never finalised.
NEW MEASURES INTRODUCED IN 2017
This measure removes the double benefit (or a double detriment) which can arise in respect of certain deductible liabilities held by a joining entity acquired by a consolidated group. It achieves this by making the amount included in the entry allocable cost amount for the liabilities assessable (or deductible) over a period of time.
The securitised assets measure removes anomalies that arise when an entity with securitised assets joins or leaves a tax consolidated group. It achieves this by modifying the tax cost setting rules to disregards liabilities relating to the securitised assets.
This measure prevents the tax costs of a joining entity’s assets from being uplifted in certain circumstances, where no tax is payable by a foreign resident owner when they cease to hold membership interests in the joining entity. 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.
Interactions with the TOFA provisions
This measure clarifies the operation of the TOFA provisions by setting a tax value for an intra-group asset or liability that is or is part of a Division 230 financial arrangement when the asset or liability emerges from a consolidated group because a subsidiary member leaves the group.
Interactions with value shifting
This measure removes anomalies that arise when an entity leaves a consolidated group and holds an asset that corresponds to a liability owed to it by the group at the date of departure. Anomalies may arise as the value of the asset taken into account for tax cost setting purposes is not always appropriate. This measure ensures that the amount taken into account under the exit tax cost setting rules for the asset is aligned with the tax cost setting amount for the corresponding asset of the leaving entity.
Taxpayer Alert TA 2019/1
Multiple Entity Consolidated (MEC) groups avoiding CGT through intra-group debt
This Taxpayer Alert highlights the ATO’s concern about arrangements that involve non-resident taxpayers using intra-group debt to inappropriately reduce capital gains that would otherwise be taxable upon disposal of their Australian assets.
This concern only relates to arrangements with material debt that exceeds normal commercial arrangements.
The ATO is currently reviewing these types of arrangements and engaging with taxpayers who have entered or plan on entering into them to ensure that the correct amount of tax is being paid.
TEMPORARY FULL EXPENSING INTERACTION WITH TAX CONSOLIDATION RULES
- An entity may have claimed the TFE, receiving a 100 per cent tax deduction, and then be acquired by a tax consolidated group. In this case, the “terminating value” of the asset on which the acquired entity has claimed TFE will be nil. The head company can allocate no part of the allocable cost amount to that asset. Furthermore, the head company cannot allocate that part of the allocable cost amount, which would have been allocated to that TFE-asset to any other asset.
- A head company of a tax consolidated group acquires a subsidiary after 6 October 2020, and that subsidiary holds eligible depreciating assets. The head company will be treated as if it had held itself acquired a second-hand asset. Provided the aggregated turnover of the head company is less than $50 million, the head company may claim the TFE in respect of that asset.
- In the case where a tax consolidated group acquires a subsidiary during the 2016-17, 2017-18 or 2018-19 years of income, the tax cost setting amount of assets that the subsidiary holds can be taken into account in determining whether the group has satisfied the $100 million investment threshold for the purpose of the alternative income test.
CHANGE TO COST SETTING RULES
Note the Treasury Laws Amendment (2021 Measures No5) Bill 2021 contains amendments to the consolidation tax cost setting rules to take into account the new accounting standard for leases (AASB16) which introduces a single accounting model for leases.