ATO ID 2004/182: Consolidation: effect of 'not at arm's length' transactions on modified market value
Date of decision: 13 February 2004
Year of income: Income year ended 30 June 2003
Business line: Consolidation Centre of Expertise

Issue
Is the purpose of a non-arm's length transaction (that is an event described in paragraph 707-325(4)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)) relevant in determining if a reduction is required to be made to the modified market value (MMV) of the entity under subsection 707-325(2) of the ITAA 1997?

Decision
No. The purpose of a non-arm's length transaction is not relevant in determining if a reduction is required to be made to the MMV of the entity under subsection 707-325(2) of the ITAA 1997.

Facts
After 8 December 2000 (and in the four years before the joining time) Entity B is involved in a non-arm's length transaction. Entity B becomes a member of a consolidated group at a particular time (the joining time) and as at that time, the MMV is required to be determined for the purpose of calculating the available fraction for a bundle of losses. As a result of the non-arms' length transaction, Entity B's MMV at the joining time is greater than it would have been had the transaction not taken place.

Reasons for decision
Summary: The basic rule for working out the MMV of an entity that becomes a member of a consolidated group at a particular time is contained in subsection 707-325(1) of the ITAA 1997. It provides that the MMV of an entity at a particular time is the market value of the entity at that time based on certain assumptions (including the assumptions that the entity had no losses of any sort and the balance of its franking account at that time was nil). Subsection 707-325(2) of the ITAA 1997 provides that if: then the MMV worked out under subsection 707-325(1) of the ITAA 1997 is reduced by the amount worked out under subsection 707-325(3) of the ITAA 1997. Subsection 707-325(4) of the ITAA 1997 contains the events that are referred to in subsection 707-325(2) of the ITAA 1997. Paragraph 707-325(4)(b) of the ITAA 1997 identifies one of the events as a transaction that did not take place at arm's length that involved an entity or an associate of the entity (or the trustee of the entity, if the entity is a trust) at the time of the transaction. If an event described in subsection 707-325(4) of the ITAA 1997 occurs before 9 December 2000, Section 707-329 of the Income Tax (Transitional Provisions) Act 1997 requires that event be disregarded in calculating the MMV of an entity. Therefore, if there has been a transaction that did not take place at arm's length that involved an entity: then a reduction is required to be made (as calculated under subsection 707-325(3) of the ITAA 1997) to the MMV of the entity. The requirement for a reduction to be made to the MMV of an entity under subsection 707-325(2) of the ITAA 1997 (that is, as a result of an event, being a non-arm's length transaction that involved the entity) is not conditional on any purpose in respect of that event. As all of the conditions in subsection 707-325(2) of the ITAA 1997 exist, there will need to be a reduction made to the MMV of Entity B. The reduction will be calculated under subsection 707-325(3) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 707-325 subsection 707-325(1) subsection 707-325(2) subsection 707-325(3) subsection 707-325(4) paragraph 707-325(4)(b)
Related public rulings and determinations: Taxation Ruling TR 2004/9
Subject references: Available fraction Bundle of losses Consolidation - event Consolidation - losses Consolidation - non-arm's length transaction Consolidation - reduction Joining entity Modified market value Transferred losses