ATO ID 2006/170: Consolidation: MEC group - eligible tier-1 company (wholly-owned by non-resident) and its wholly-owned subsidiary cease to be members of the MEC group
Date of decision: 19 April 2006
Year of income: Year ended 31 December 2006
Business line: Consolidation Centre of Expertise

Issue
Can section 104-520 (CGT event L5) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the head company of a MEC (multiple entry consolidated) group with respect to an eligible tier-1 (ET-1) company which is wholly-owned by a non-resident company, when both the ET-1 company and its wholly-owned subsidiary cease to be members of the MEC group?

Decision
No. Section 104-520 (CGT event L5) of the ITAA 1997 will not apply to the head company of the MEC group with respect to an ET-1 company which is wholly-owned by a non-resident company, when both the ET-1 company and its wholly-owned subsidiary cease to be members of the MEC group.

Facts
B Co is a wholly-owned subsidiary of A Co, a non-resident company. The ultimate parent company for A Co and B Co is Top Co, another non-resident company. B Co and Head Co are ET-1 companies of Top Co. They, with C Co, a wholly-owned subsidiary of B Co, are a MEC group with Head Co as the head company. Top Co sells all the membership interests in A Co, the non-resident company, together with its wholly-owned subsidiaries B Co and C Co, to a third party which is not a wholly owned subsidiary of Top Co.

Reasons for decision
Summary: CGT event L5, in section 104-520 of the ITAA 1997, happens where the following conditions are satisfied: Subsection 104-520(2) of the ITAA 1997 and subsection 104-520(3) of the ITAA 1997 respectively provide that CGT event L5 happens to the head company of the consolidated or MEC group at the time the entity ceases to be a subsidiary member of the group and the capital gain is equal to the amount remaining. | Detailed Reasoning - Will B Co, an ET-1 company which is wholly-owned by a non-resident company, cease to be a subsidiary member of the MEC group?: For paragraph 104-520(1)(a) of the ITAA 1997 to be satisfied, an entity must cease to be a subsidiary member of a consolidated or MEC group. Section 719-25 of the ITAA 1997 provides that all members of a MEC group, other than the head company, are subsidiary members of the group. In this instance as B Co is not the head company of the MEC group, it is a subsidiary member. When Top Co disposes of its interests in A Co, the non-resident company, B Co ceases to be a subsidiary member of the MEC group, consequently paragraph 104-520(1)(a) of the ITAA 1997 will be satisfied. | Detailed Reasoning - Will Head Co have to work out an allocable cost amount for B Co, an ET-1 company that is wholly-owned by a non-resident company?: For paragraph 104-520(1)(b) of the ITAA 1997 to be satisfied, the consolidated or MEC group must calculate an allocable cost amount, under section 711-20 of the ITAA 1997, for the entity ceasing to be a subsidiary member and there must be a negative amount remaining after applying step 4 of the calculation in section 711-20. Division 711 of the ITAA 1997 applies to MEC groups by virtue of section 719-2 of the ITAA 1997. Subsection 711-5(1) of the ITAA 1997 provides that Division 711 has effect for head company and entity core purposes (subsections 701-1(2) and 701-1(3) of the ITAA 1997), where an entity ceases to be a subsidiary member of a consolidated group. The operation of Division 711 of the ITAA 1997 is modified for MEC groups by Subdivision 719-J of the ITAA 1997. In particular, subsection 719-510(1) of the ITAA 1997 provides that the leaving entity, referred to in subsection 711-15(1) of the ITAA 1997, is a subsidiary member of the old group that is an ET-1 company. The leaving entity that is referred to in subsection 711-15(1) is an entity in whom membership interests are held by members of the old group. The application of subsection 719-510(1) of the ITAA 1997 in conjunction with subsection 711-15(1) of the ITAA 1997, ensures that Division 711 of the ITAA 1997 will only apply to work out the MEC group's allocable cost amount, under section 711-20 of the ITAA 1997, for an ET-1 company that ceases to be a subsidiary member of the MEC group if some of the membership interests in the ET-1 company are held by members of the MEC group. In this instance B Co, the ET-1 company that ceases to be a subsidiary member of the MEC group, is wholly-owned by A Co, a non-resident company. A Co fails to meet the residency requirements set out in the table in subsection 719-10(2) of the ITAA 1997 and is therefore, not a member of the MEC group. As none of the members of the MEC group holds membership interests in B Co, one of the ET-1 companies, Division 711 of the ITAA 1997 would not apply in respect of B Co when it ceases to be a subsidiary member of the MEC group. A Co's interests in B Co are pooled interests (section 719-560 of the ITAA 1997). The head company of the MEC group, Head Co, will not be required to work out an allocable cost amount for B Co, therefore paragraph 104-520(1)(b) of the ITAA 1997 will not be satisfied. Because paragraph 104-520(1)(b) of the ITAA 1997 will not be satisfied, CGT event L5 cannot happen to Head Co with respect to B Co, an ET-1 company of the MEC group, when both B Co and its wholly-owned subsidiary, C Co, cease to be subsidiary members of the MEC group.

Legislative references: Income Tax Assessment Act 1997 section 104-520 paragraph 104-520(1)(a) paragraph 104-520(1)(b) subsection 104-520(2) subsection 104-520(3) paragraph 104-520(1)(a) Division 711 section 711-20 Subdivision 719J section 719-2 section 719-25 subsection 719-510(1) section 719-560
Related ATO interpretative decisions: ATO ID 2006/171
Subject references: Allocable cost amount Calculation of the allocable cost amount Capital gains tax CGT events CGT events L1-L8 - consolidated and MEC groups Consolidation Consolidation - exiting Consolidation - multiple entry consolidated group Cost of membership interests Cost setting rules Eligible tier-1 company Head company Head company of a MEC group Interposed foreign resident Leaving entity Leaving time Member of a group Pooled interests Potential MEC group Provisional head company Subsidiary member of a MEC group Tax cost setting amount Time of CGT event Top company Wholly owned subsidiary