Private ruling: Tax cost setting amount
Published: May 2015
Ruling period: Income year ended 30 June 2014
Date scheme commenced: 31 January 2014

Ruling: Q1: This question is in relation to a lease arrangement that has been classified as a finance lease for accounting purposes, but as an operating lease for taxation purposes. Where, under the relevant lease arrangement, a third party has a leasehold interest in a physical asset but the asset continues to be owned by the lessor, XCo (the joining entity), is the relevant asset for the purposes of determining the tax cost setting amount under section 705-20 of the Income Tax Assessment Act 1997 the physical asset that generates an income stream for the joining entity? | A1: Yes

Relevant facts and circumstances: 1. XYZ Ltd is a public company listed on the Australian Stock Exchange. 2. XYZ Ltd is an Australian resident company for income tax purposes and is the head company of an income tax consolidated group of companies (XYZ TCG), of which X Holdings Pty Ltd is a subsidiary member. 3. XYZ Ltd and its subsidiaries carry on a diversified financial services business. 4. X Holdings Pty Ltd acquired 100% of the membership interests in certain subsidiaries of ABC Ltd, including XCo which owns the relevant lease arrangement. Following the acquisition, XCo joined the XYZ TCG. The relevant lease arrangement 5. XCo (the joining entity) provides a range of lease products to consumers and small to medium enterprises. The physical assets leased to customers are at all relevant times legally owned by XCo. 6. For accounting purposes, the leases entered into by the joining entity are treated as finance leases for financial reporting purposes, in accordance with Australian Accounting Standards Board 117 (AASB 117). 7. Accordingly, the amounts receivable under the leases are recognised, for accounting purposes, as an asset with only the interest component of the periodic lease instalments being recognised as revenue. 8. On the other hand, the leases are treated as operating leases for tax purposes, in that the underlying physical asset is taken to be held by the lessor. 9. The joining entity holds the relevant lease receivables.

Relevant legislative provisions: Section 40-40 of the ITAA 1997 | Section 701-1 of the ITAA 1997 | Subdivision 705-A of the ITAA 1997 | Section 705-20 of the ITAA 1997 | Section 705-56 of the ITAA 1997 | Part 3-90 of the ITAA 1997

Reasons for decision: Summary: 1. Section 701-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that XYZ Ltd, as the head company of the tax consolidated group (XYZ TCG) of which X Holdings Pty Ltd is a subsidiary member, will be the owner of the assets, which includes the relevant lease arrangement brought into the group by XCo (the joining entity), following the acquisition. 2. The question sought under this ruling is to establish whether the relevant asset for the purpose of determining the tax cost setting amount is the physical asset (i.e. depreciating asset) and/or the associated income stream (i.e. the rights to receive lease payments including fees and charges) of the joining entity in relation to the relevant lease arrangement. 3. Section 705-20 of the ITAA 1997 provides that the tax cost setting amount for an asset whose tax cost is set at the time the joining entity becomes a subsidiary member of the joined group is worked out under subdivision 705-A of the ITAA 1997. 4. The term 'asset' is not defined in Part 3-90 of the ITAA 1997 and therefore takes its ordinary commercial or business meaning. 5. Paragraph 5 of Taxation Ruling 2004/13 Income tax: the meaning of an asset for the purposes of Part 3-90 of the Income Tax Assessment Act 1997 (TR 2004/13), provides that the meaning of an asset, for the purpose of the tax cost setting rules, is anything recognised in commerce and business as having economic value to the joining entity at the joining time, for which a purchaser of its membership interests would be willing to pay. Further, paragraph 6 of TR 2004/13 provides that the commercial or business meaning of an asset in Part 3-90 is not limited to assets that would be recognised under accounting standards or statements of accounting concepts. 6. Accordingly, under TR 2004/13 both the underlying depreciating asset and the joining entity's right to receive lease payments could be considered a relevant asset. 7. Section 705-56 of the ITAA 1997 provides a specific modification to the tax cost setting rules in relation to finance leases. This section requires that the lease is a finance lease in accordance with the accounting principles. For a lessor this section operates that only one asset is the relevant asset for determining the tax cost setting amount. That is either, the underlying depreciating asset or the joining entity's right to receive lease payments. 8. For a lessor, how section 705-56 of the ITAA 1997 applies is affected by whether the lessor is taken to 'hold' the asset just before the joining time to determine whether subsection 705-56(2) or 705-56(3) applies. This is determined in accordance with section 40-40 of the ITAA 1997. 9. Given that the joining entity remains the legal owner of the asset throughout the term of the lease and the customer does not have the right to dispose of the asset although it has the right to use the asset immediately, item 6 and 10 of the table in section 40-40 of the ITAA 1997 would apply to treat the joining entity as the 'holder' of the underlying depreciating asset that is subject to the relevant lease arrangement. 10. As the joining entity is the holder of the assets under section 40-40 of the ITAA 1997 then subsections 705-56(2) and 705-56(5) of the ITAA 1997 operate such that the rights to receive lease payments is treated as having a tax cost of nil and the underlying depreciating asset is treated as a reset cost base asset. 11. The ATO Interpretive Decision 2009/153 Income tax consolidation: entry Allocable Cost Amount - identifying the relevant asset for the purposes of section 705-56 of the ITAA 1997 also provides that where subsection 705-56(2) applies, the relevant asset for the purpose of determining the tax cost setting amount of the joining entity is the underlying depreciating asset rather than the associated income stream. However, this does not prevent intangible assets of the leasing business such as goodwill or the lease contracts from also being recognised as assets for consolidating tax cost setting. 12. Therefore, in determining the tax cost setting amount, goodwill and any other intangible assets should be recognised and treated as a reset cost base asset for tax cost setting purposes. 13. It can be concluded that the relevant asset to be recognised for the purposes of determining the tax cost setting amount to the assets generating an income stream from the relevant lease arrangement is the underlying depreciating asset and any intangible assets of the leasing business, such as goodwill.