ATO ID 2004/835: Consolidation - modified market value and a non-arm's length loan
Date of decision: 14 October 2004
Business line: Consolidation Centre of Expertise

Issue
Is there more than one event, as described in subsection 707-325(4) of the Income Tax Assessment Act 1997 (ITAA 1997) for the purpose of preventing the inflation of the modified market value (integrity rule), in respect of a non-arm's length loan where the terms and conditions of the loan remain unchanged?

Decision
No. The only event, as described in subsection 707-325(4) of the ITAA 1997, is the non-arm's length loan transaction. There is no event subsequent to that transaction.

Facts
Entity A becomes a member of a consolidated group and, as at the joining time, the modified market value of Entity A is determined for the purpose of calculating an available fraction for a bundle of losses. Prior to joining the consolidated group, Entity A borrowed funds at less than a commercial rate of interest in a transaction that did not take place at arm's length. The terms and conditions of the loan remain unchanged.

Reasons for decision
Summary: The basic rule for working out the modified market value of an entity that becomes a member of a consolidated group is contained in subsection 707-325(1) of the ITAA 1997. It provides that the modified market value of an entity at the joining time is the market value of the entity at that time based on certain assumptions. Subsection 707-325(2) of the ITAA 1997 provides that if: then the modified market value 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 two events that are referred to in subsection 707-325(2) of the ITAA 1997. Paragraph 707-325(4)(a) of the ITAA 1997 identifies one event as an injection of capital into the entity or an associate. Paragraph 707-325(4)(b) of the ITAA 1997 identifies the other event as a transaction that did not take place at arm's length that involved the entity or an associate. Under section 707-329 of the Income Tax (Transitional Provisions) Act 1997 , events that occurred before 9 December 2000 are disregarded in calculating the modified market value of an entity. As Entity A borrowed the funds in a transaction that did not take place at arm's length, it is an event as described in paragraph 707-325(4)(b) of the ITAA 1997 at the time the funds were borrowed. Entity A has an ongoing benefit of not having to pay a commercial rate of interest which may affect its market value at the joining time. However, for the purposes of subsection 707-325(4) of the ITAA 1997, there is considered to be no injection of capital nor any non-arm's length transaction in relation to the ongoing continuation of the loan at unchanged terms and conditions. The only event for purposes of the integrity rule is the transaction where Entity A borrows the funds. Therefore, this integrity rule would have no application if the transaction (borrowing of the funds) occurred prior to 9 December 2000 or more than four years before the joining time.

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)(a) paragraph 707-325(4)(b)
Related public rulings and determinations: Taxation Ruling TR 2004/9
Related ATO interpretative decisions: ATO ID 2004/182
Subject references: Arms length transactions Available fraction Borrowings & loans Bundle of losses Consolidation - event Consolidation - losses Consolidation - non-arm's length transaction Consolidation - reduction Group company loss transfers Joining entity Modified market value Non arms length transactions Transferred losses