ATO ID 2012/50: Part IVA: multiple entry consolidated group - cancel tax benefit
Date of decision: 1 June 2012
Year of income: Year ended 31 December 2005 Year ended 31 December 2006 Year ended 31 December 2007 Year ended 31 December 2008 Year ended 31 December 2009
Business line: Tax Counsel Network

Issue
Does Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to cancel the tax benefit obtained by an Australian resident company in respect of the financing cost of an off-shore investment made by an Australian MEC group?

Decision
Yes. Part IVA of the ITAA 1936 applies to cancel the tax benefit, being interest incurred and claimed as a deduction under section 25-90 of the Income Tax Assessment Act 1997 (ITAA 1997), obtained by the Australian resident entity.

Facts
Prior to the relevant transactions, an international group of companies was controlled by a US resident company, US Head Co which owned US Sub Co amongst other entities. Aust Co was the head entity of a tax consolidated group consisting of four Australian resident entities that operated the US Head Co business in Australia, and wholly owned by US Sub Co through a US resident intermediate holding company. Then, the following transactions and events took place: No income was recognised as having been derived overseas in relation to amounts represented by interest deductions claimed in Australia. The RPS carried a sufficient voting interest of greater than 10% such that the dividends were non-portfolio dividends as defined in section 317 of the ITAA 1936 and therefore non-assessable non-exempt income of the Australian MEC group pursuant to section 23AJ of the ITAA 1936. Aust Co as provisional head entity of the MEC group claimed interest expenses on the Promissory Note pursuant to sections 25-85 and 25-90 of the ITAA 1997. US Head Co at the time it borrowed to purchase US New Co was in a Net Operating Loss (NOL) position for US income tax purposes. The additional annual interest US Head Co incurred in the course of financing its acquisition of US New Co would add to its NOL position. The Australian group was in a tax positive position prior to and throughout the period of investment. The stated purpose for the transfer of US LLC to New Aust Co was to provide commercial benefits arising from the Australian group having greater access to US clients in respect of the business of US New Co. The ownership changes effected by the transaction were said to facilitate this access.

Reasons for decision
Summary: For the purposes of considering Part IVA of the ITAA 1936, the following conclusions were made: Had the Scheme not been carried out, ownership of US LLC would not have been transferred to New Aust Co by transferring RPS in US LLC in return for a Promissory Note issued by New Aust Co. The stated commercial purpose of the transfer could have been achieved by simpler means not involving ownership transfers. The dominant purpose of the scheme under section 177D of the ITAA 1936 was concluded to be the obtaining of the tax benefits. Entry into the scheme had no financial impact on US Head Co and its worldwide group of companies aside from the tax savings derived by the Australian part of the group. Since New Aus Co. was a wholly owned subsidiary of US Sub Co, any commercial benefits were economically owned by US Sub Co. and not Aust Co which was merely a sister company. The main purpose of the scheme was to take advantage of the tax capacity of the Australian group to decrease the total amount of the income tax incurred by the international group. This was accomplished by a contrived scheme that generated allowable deductions in Australia without off-setting assessable income being derived in Australia or anywhere else. There was a lack of evidence and credibility concerning the commercial benefits said to arise from the scheme as compared to the tax benefits. Accordingly, Part IVA of the ITAA 1936 applies to cancel the tax benefit obtained by an Australian resident company in respect of the financing cost of an off-shore investment.

Legislative references: Income Tax Assessment Act 1936 subsection 177A(1) subparagraph 177C(1)(b) section 177D section 317
Subject references: Interest expense Part IVA Tax benefits under tax avoidance schemes Redeemable preference shares Consolidation - multiple entry consolidated group