ATO ID 2006/171: Consolidation: MEC group - wholly-owned subsidiary of an eligible tier-1 (ET-1) company ceases to be a member of the MEC group at the same time as the ET-1 company
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 apply to the head company of a MEC (multiple entry consolidated) group with respect to a wholly-owned subsidiary of an eligible tier-1 (ET-1) company of the MEC group when both the ET-1 company and its wholly-owned subsidiary cease to be members of the MEC group?

Decision
Yes. Section 104-520 (CGT event L5) of the ITAA 1997 can apply to the head company of a MEC group with respect to a wholly-owned subsidiary of an ET-1 company of the MEC group when both the ET-1 company and its wholly-owned subsidiary cease to be members of the MEC group. CGT event L5 will happen where, in working out the MEC group's allocable cost amount for the wholly-owned subsidiary of the ET-1 company, there is a negative amount remaining after applying step 4 of the calculation in section 711-20 of the ITAA 1997.

Facts
C Co is a wholly-owned subsidiary of B Co, which is a wholly-owned subsidiary of A Co, a non-resident company. The ultimate parent company for A Co, B Co and C 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 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 C Co 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. C Co is wholly-owned by B Co, an ET-1 company in the MEC group. C Co will cease to be a subsidiary member of the MEC group when B Co ceases to be a subsidiary member. B Co will cease to be a subsidiary member of the MEC group when Top Co disposes of its interests in A Co, the non-resident company. Therefore the requirement in 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 C Co?: Paragraph 104-520(1)(b) of the ITAA 1997 requires the consolidated or MEC group to calculate an allocable cost amount, under section 711-20 of the ITAA 1997, for the entity ceasing to be a subsidiary member and that there be a negative amount remaining after applying step 4 of the calculation in section 711-20. Subsection 701-15(3) of the ITAA 1997 provides that for each membership interest that the head company of the group holds or, under the single entity rule (section 701-1 of the ITAA 1997), is taken to hold, in an entity that ceases to be a subsidiary member, the interests' tax cost is set at its tax cost setting amount just before the entity ceases to be a subsidiary member. Section 701-50 of the ITAA 1997 ensures that for entity core purposes, when an entity ceases to be a subsidiary member (leaving entity) of a consolidated group and it holds membership interests in another leaving entity, the tax cost of the those membership interests is set at their tax cost setting amount. Item 2 of the table in section 701-60 of the ITAA 1997 provides that the tax cost of the membership interests in an entity that leaves the group is the amount worked out in accordance with section 711-15 of the ITAA 1997 or section 711-55 of the ITAA 1997. Item 4 of the table in section 701-60 provides that where section 701-50 of the ITAA 1997 applies, the interests' tax cost is worked out in accordance with section 711-55. Subsection 711-15(1) of the ITAA 1997 provides that the tax cost of the membership interests in a leaving entity that are held by members of the old group is determined by first working out the old group's allocable cost amount under section 711-20 of the ITAA 1997. Section 711-55 of the ITAA 1997 applies where there is more than one entity ceasing to be a subsidiary member (leaving entities) of a consolidated group because of an event happening to one of them and both members of the old group and the entities ceasing to be subsidiary members of the group, hold membership interests in the leaving entities. The table in subsection 711-20(1) of the ITAA 1997 sets out the manner in which the old group's allocable cost amount for the leaving entity is worked out. Item 5 of the table in subsection 711-20(1) provides that the old group's allocable cost amount will be the positive amount remaining after applying step 4 of the allocable cost amount calculation otherwise, the old group's allocable cost amount will be nil. Subsection 711-5(1) of the ITAA 1997 provides that Division 711 of the ITAA 1997 has effect for both head company and entity core purposes (subsections 701-1(2) and 701-1(3) of the ITAA 1997) when an entity ceases to be a subsidiary member of a consolidated group. Through the application of section 719-2 of the ITAA 1997, Division 711 of the ITAA 1997 will have the same effect for an entity that ceases to be a member of a MEC group. As both B Co and C Co will cease to be subsidiary members of the MEC group because of an event that happens to B Co, section 711-55 of the ITAA 1997 will apply to the membership interests B Co holds in C Co. Therefore Head Co, the head company of the MEC group, will be required to work out an allocable cost amount for the C Co under section 711-20 of the ITAA 1997. If, in working out this allocable cost amount, there is a negative amount remaining after applying step 4 of the calculation in section 711-20 of the ITAA 1997, the allocable cost amount and the tax cost setting amount for the membership interests that B Co holds in C Co will be nil. If, in respect of C Co, there is a negative amount remaining after applying step 4 of the calculation in subsection 711-20 of the ITAA 1997, this amount will be the capital gain that arises for Head Co, the head company of the MEC group, under CGT event L5. This capital gain will arise at the time B Co and 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) subsection 701-15(3) section 701-50 section 701-60 Division 711 subsection 711-5(1) section 711-15 subsection 711-15(1) section 711-20 subsection 711-20(1) section 711-55 section 719-25
Related ATO interpretative decisions: ATO ID 2006/170
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