ATO ID 2004/735: Consolidation: testing 'continuing majority-owned entity' status for a demerged entity in a multi-tiered corporate structure
Date of decision: 16 August 2004
Year of income: Year ended 30 June 2004
Business line: Consolidation Centre of Expertise

Issue
Will C Ltd, whose parent company B Ltd was demerged under Division 125 of the Income Tax Assessment Act 1997 (ITAA 1997) from the A Ltd Group, be a 'continuing majority-owned entity' (CMOE) as defined in subsection 701A-1(1) of the Income Tax Transitional Provisions Act 1997 (IT(TP)A 1997)?

Decision
Yes, C Ltd is a CMOE based on the following:

Facts
A demerger of B Ltd and its wholly owned subsidiary C Ltd took place from the A Ltd Group after 27 June 2002. The result of the demerger was that immediately after the demerger A Ltd shareholders held all the shares in B Ltd. At all times from 27 June 2002 until the demerger all the shares in C Ltd were owned directly by A Ltd. As part of the demerger, A Ltd firstly sold all the shares in C Ltd to B Ltd, and then A Ltd sold the shares in B Ltd to the shareholders of A Ltd. There has been more than a 50% continuity of ownership of membership interests (measured by the market value of registered shareholders) for the period 27 June 2002 until immediately before the consolidation formation time. This continuity is shown in the A Ltd share register until immediately before the demerger, and in the B Ltd share register from immediately after the demerger until the consolidation formation time.

Reasons for decision
Summary: As C Ltd holds trading stock, it is necessary for consolidation asset cost setting purposes for the B Ltd Group to determine whether C Ltd is a CMOE, as defined in subsection 701A-1 of the IT(TP)A 1997. If C Ltd is a CMOE, trading stock held at the date of formation of the consolidated group will be treated as a retained cost base asset under section 701A-5 of the IT(TP)A 1997. If C Ltd is not a CMOE, trading stock will be treated as a reset cost base asset for asset cost setting purposes under Division 705 of the ITAA 1997. A CMOE is an entity for which a person or persons continued to be the majority owners of the entity from the start of 27 June 2002 until the entity became a subsidiary member of a consolidated group (paragraph 701A-(1)(b) of the IT(TP)A 1997). A person or persons are the majority owners of an entity if they beneficially own, directly or indirectly through one or more interposed entities, membership interests in the entity whose market value is more than 50% of the market value of all of the membership interests in the entity (subsection 701A-1(2) of the IT(TP)A 1997). Subsection 701A-1(2) of the IT(TP)A 1997 refers to beneficial ownership directly or indirectly through interposed entities. A worked example in the Consolidation Reference Manual at C2-4-855 also shows that, in determining whether there was a change in the majority ownership of joining entities after 27 June 2002 to the date an entity becomes a member of a consolidated group, it is necessary to trace the ultimate beneficial owners and ignore any entities interposed between the ultimate beneficial owners and the joining entity. As continuing majority ownership testing requires tracing through to the ultimate beneficial owners, in testing whether C Ltd is a CMOE it is necessary to 'look through' A Ltd (pre demerger) and B Ltd (post demerger) to their ultimate beneficial shareholders. C Ltd will be a CMOE if the ultimate beneficial shareholders of A Ltd (pre demerger) continued to hold more than 50% of the shares of B Ltd (post demerger) until the consolidation formation time. A Ltd and B Ltd have stated that there has been more than 50% continuity of ownership interests (measured by market value of registered shareholders) for the period 27 June 2002 to the consolidation formation time; for A Ltd until immediately before the demerger and for B Ltd immediately after the demerger until the consolidation formation time. It is relevant to note that the B Ltd demerger was structured so that the shareholders in A Ltd (pre demerger) received shares in B Ltd (post demerger) based on their original shareholding proportions, such that each shareholder's proportionate interest in the demerged B Ltd group was the same as their proportionate interest in A Ltd. Therefore, apart from a minor change in ownership of less than 5% between the registered shareholdings of A Ltd and B Ltd resulting from the demerger, the demerger itself should not have caused any change in ownership, at least at the registered shareholder level. As the demerger itself caused the registered shareholdings of A Ltd to change by less than 5% as compared to that of B Ltd, it is unlikely that the ultimate beneficial owners of the shares would have changed by 50% or more as a result of the demerger. So even without proving that there has been continuity of ownership by actually tracing to the ultimate beneficial owners of A Ltd and B Ltd, a conclusion may be made that there has been continuing majority ownership of C Ltd before and after the demerger. The example at C2-4-855 in the Consolidation Reference Manual states that in most cases it will be clear whether or not there has been a change in the majority ultimate beneficial ownership of an entity. By implication, it should normally only be necessary to prove a change in majority ownership where this has clearly occurred. Based on the minor change between A Ltd's and B Ltd's registered ownership due to the demerger, it is likely that there would also have been only a minor change to the ultimate beneficial ownership due to the demerger. As there has been more than 50% continuity of registered share ownership from 27 June 2002 until the demerger and from then until the formation time, it is concluded that C Ltd is a CMOE for the purposes of subsection 701A-1(1) of the IT (TP) Act 1997. Therefore, trading stock held by C Ltd will be a retained cost base asset for the purposes of the tax cost setting rules in Division 705 of the ITAA 1997.

Legislative references: Income Tax (Transitional Provisions) Act 1997 subsection 701A-1(1) subsection 701A-1(2) subsection 701A-5(3)
Related ATO interpretative decisions: ATO ID 2003/452 | ATO ID 2004/197
Other references: Consolidations Reference Manual C2-4-855
Subject references: Consolidation - continuity of ownership test Cost setting rules Formation time Joining entity Joining time Minerals as trading stock Retained cost base asset Trading stock