Private ruling: Treatment of research and development tax offsets on entry to consolidated group
Published: August 2014
Ruling period: 2014 income year
Date scheme commenced: Joining date in the 2014 income year

Ruling: Q1: Were the non-refundable research and development tax offsets carried forward by Company B from previous income years inherited by Company A, as head company of an income tax consolidated group, under section 701-5 of the Income Tax Assessment Act 1997 (ITAA 1997) when Company B became a subsidiary member of the consolidated group? | A1: Yes | Q2: Does the operation of subsection 65-40(1) of the Income Tax Assessment Act 1997 prevent Company A from applying the non-refundable carried forward research and development tax offsets? | A2: No | Q3: Are the non-refundable carried forward research and development tax offsets taken into account in calculating the joined group's allocable cost amount for Company B under section 705-60 of the Income Tax Assessment Act 1997 ? | A3: No | Q4: Does Subdivision 707-C of the Income Tax Assessment Act 1997 limit the utilisation of the non-refundable carry forward research and development tax offsets by Company A? | A4: No

Relevant facts and circumstances: • Company A is a resident company listed on an approved stock exchange. It is the head company of a consolidated group for the purposes of Part 3-90 of the Income Tax Assessment Act 1997 (ITAA 1997). • Company A's capital structure consists of ordinary fully paid shares. Company A's share structure as at the following times: Shareholder End 2011 income year End 2012 income year End 2013 income year End 2014 income year Entity 1 >10% >10% >10% >10% Notional shareholder (direct stakes in Company A of less than 10%) >80% >80% >80% >80% • At all of the relevant times in the period commencing from the 2012 income year and ending in the 2014 income year, ordinary shares in Company A were the only interest in the company that carried with them voting power in the company and rights to dividends and capital distributions of the company. • The ownership interest in Entity 1 is beneficially held by one individual shareholder which did not change throughout the relevant period. This interest is held by that individual shareholder indirectly via a trust. The trustee of the trust has a right to receive indirectly through their interest in Entity 1, a percentage of a dividend or a distribution of capital of Company A. • No corporate change in Company A as defined in section 166-175 of the ITAA 1997 occurred in the period commencing from the 2012 income year and ending in the 2014 income year. • Company A as head company of the Company A consolidated group, is a registered research and development (R&D) entity. Acquisition of remaining interests in Company B • Company B is a company resident in Australia. • The Company A consolidated group held an % interest in Company B. The remaining % interest in Company B was held by two trusts. • The Company A consolidated group acquired the remaining % interest in Company B on the joining date, and Company B became a subsidiary member of the Company A income tax consolidated group for the purposes of Part 3-90 of the ITAA 1997 from that date. • Company B's capital structure as at the following times and the joining date: Ultimate shareholder End 2011 income year End 2012 income year End 2013 income year Joining date Direct stakes in Company B Interests held by two trusts 20% 20% 20% 20% Subtotal 20% 20% 20% 20% Indirect stakes in Company B Indirect stakeholders (attributed to the single notional shareholder under s 166-230 of the ITAA 1997) 80% 80% 80% 80% Subtotal 80% 80% 80% 80% Total 100% 100% 100% 100% • At all relevant times in the period commencing from the 2012 income year to the joining date, ordinary shares in Company B were the only interest in the company that carried with them voting power in the company and rights to dividends and capital distributions of the company. • No corporate change in Company B as defined in section 166-175 of the ITAA 1997 occurred in the period commencing from the 2012 income year to the joining date. R&D tax offsets carried forward by Company B • Company B was eligible under the Research & Development (R&D) Incentive Regime to claim non-refundable R&D tax offsets for certain expenditure incurred on R&D activities from start of 2012 income year to the joining date. • For the 2012 income year, Company B was entitled to non-refundable R&D tax offsets. • For the 2013 income year, Company B was entitled to non-refundable R&D tax offsets. • For the stub income year from the start of the 2014 income year to the joining date (2014 stub income year), Company B will be entitled to non-refundable R&D tax offsets (the exact amount to be determined).

Relevant legislative provisions: International Tax Agreements Act 1953 section 24 | Income Tax Assessment Act 1997 section 4-10 | Income Tax Assessment Act 1997 subsection 4-10(3) | Income Tax Assessment Act 1997 section 4-15 | Income Tax Assessment Act 1997 section 13-1 | Income Tax Assessment Act 1997 section 36-10 | Income Tax Assessment Act 1997 section 65-40 | Income Tax Assessment Act 1997 subsection 65-40(1) | Income Tax Assessment Act 1997 section 165-10 | Income Tax Assessment Act 1997 section 165-12 | Income Tax Assessment Act 1997 subsection 165-12(1) | Income Tax Assessment Act 1997 section 165-13 | Income Tax Assessment Act 1997 section 165-70 | Income Tax Assessment Act 1997 subsection 166-5(1) | Income Tax Assessment Act 1997 subsection 166-5(2) | Income Tax Assessment Act 1997 subsection 166-5(3) | Income Tax Assessment Act 1997 subsection 166-145(2) | Income Tax Assessment Act 1997 section 166-175 | Income Tax Assessment Act 1997 section 166-225 | Income Tax Assessment Act 1997 section 166-230 | Income Tax Assessment Act 1997 subsection 166-235(7) | Income Tax Assessment Act 1997 section 166-240 | Income Tax Assessment Act 1997 section 175-35 | Income Tax Assessment Act 1997 section 701-1 | Income Tax Assessment Act 1997 subsection 701-1(1) | Income Tax Assessment Act 1997 subsection 701-1(2) | Income Tax Assessment Act 1997 subsection 701-1(3) | Income Tax Assessment Act 1997 subsection 701-1(4) | Income Tax Assessment Act 1997 subsection 701-5 | Income Tax Assessment Act 1997 section 701-30 | Income Tax Assessment Act 1997 section 705-60 | Income Tax Assessment Act 1997 section 705-65 | Income Tax Assessment Act 1997 section 705-70 | Income Tax Assessment Act 1997 section 705-90 | Income Tax Assessment Act 1997 section 705-93 | Income Tax Assessment Act 1997 section 705-95 | Income Tax Assessment Act 1997 section 705-100 | Income Tax Assessment Act 1997 section 705-110 | Income Tax Assessment Act 1997 section 705-115 | Income Tax Assessment Act 1997 section 707-115 | Income Tax Assessment Act 1997 subsection 707-305(1) Income Tax Assessment Act 1997 section 960-135 | Income Tax Assessment Act 1997 subsection 995-1(1) | Income Tax Assessment Act Regulations 1997 regulation 995-1.05 of Schedule 5 | Income Tax (Transitional Provisions) Act 1997 section 36-105 | Income Tax (Transitional Provisions) Act 1997 section 36-110

Reasons for decision: Summary: Under the entry history rule in section 701-5 of the Income Tax Assessment Act 1997 (ITAA 1997), the non-refundable research and development tax offsets (R&D tax offsets) carried forward by Company B from previous years were inherited by Company A when Company B joined the Company A income tax consolidated group. | Detailed Reasoning - Detailed reasoning: Section 701-1 of the ITAA 1997 (the single entity rule) provides that if an entity is a subsidiary member of a consolidated group for any period, it and any other subsidiary member of the group are taken for 'head company core purposes' and 'entity core purposes' to be part of the head company, rather than separate entities during that period. Subsection 701-1(2) of the ITAA 1997 states that the 'head company core purposes' are: (a) working out the amount of the *head company's liability (if any) for income tax calculated by reference to any income year in which any of the period occurs or any later income year; and (b) working out the amount of the head company's loss (if any) of a particular *sort for any such income year. Subsection 701-1(3) of the ITAA 1997 states that the 'entity core purposes' are: (a) working out the amount of the entity's liability (if any) for income tax calculated by reference to any income year in which any of the period occurs or any later income year; and (b) working out the amount of the entity's loss (if any) of a particular *sort for any such income year. Section 701-5 of the ITAA 1997 provides the entry history rule and states: For the head company core purposes in relation to the period after the entity becomes a *subsidiary member of the group, everything that happened in relation to it before it became a subsidiary member is taken to have happened in relation to the *head company. As provided in paragraph 701-1(2)(a) of the ITAA 1997, the head company core purposes include working out the head company's liability for income tax. Therefore, in accordance with section 701-1 of the ITAA 1997, items relevant for the purposes of calculating the income tax liability for a subsidiary member of a consolidated group or an entity that becomes a subsidiary member of a consolidated group during a period will be taken to be part of the head company. The amount of income tax for a financial year is calculated in accordance with the formula in subsection 4-10(3) of the ITAA 1997: Income tax = (Taxable income x Rate) - Tax offsets It is evident from this formula that tax offsets are relevant for the purposes of calculating income tax liability. Research and development tax offsets (as governed by Division 355 of the ITAA 1997) are listed in section 13-1 of the ITAA 1997 as a type of tax offset for the purposes of the income tax calculation in subsection 4-10(3) of the ITAA 1997. Therefore, when Company B joined the Company A income tax consolidated group on the joining date, Company B's non-refundable carried forward R&D tax offsets are inherited by Company A through the application of the entry history rule in section 701-5 of the ITAA 1997. | Summary: Subsection 65-40(1) of the Income Tax Assessment Act 1997 will not prevent Company A from applying the non-refundable carried forward research and development tax offsets (R&D tax offsets) inherited from Company B. | Detailed Reasoning - Detailed reasoning: Subsection 65-40(1) of the ITAA 1997 states: In working out its *tax offset for the *current year, a company cannot apply a *tax offset it has carried forward if, assuming: (a) the tax offset were a *tax loss of the company for the income year in which it became entitled to the tax offset; and (b) section 165-20 (deducting part of a tax loss) were disregarded; Subdivision 165-A would prevent the company from deducting it for the current year. To determine if the operation of subsection 65-40(1) of the ITAA 1997 prevents Company A from applying the non-refundable carried forward R&D tax offsets in the relevant income year, Company A is required to assume that the tax offsets were a tax loss of the company for the relevant income year, and apply the provisions in Subdivision 165-A of the ITAA 1997 (disregarding section 165-20 of the ITAA 1997). Assuming the R&D tax offsets were a tax loss, Company A will be prevented from applying the R&D tax offsets if the provisions of Subdivision 165-A prevent Company A from deducting the tax offset. Subdivision 165-A comprises sections 165-5 to 165-20 of the ITAA 1997. The provisions of Subdivision 165-A are also affected by other provisions of the Act including certain other provisions of Division 165 and Division 166 of the ITAA 1997 which includes the concessional tracing rules. Under section 165-10 of the ITAA 1997, a company cannot deduct a tax loss unless either: (a) it meets the condition in section 165-12 (which is about the company maintaining the same owners), or (b) it meets the condition in section 165-13 (which is about the company satisfying the same business test). A company only needs to satisfy one of the tests referred to above. The same business test in section 165-13 of the ITAA 1997 does not apply unless the company fails to meet one of the tests in subsection 165-12 of the ITAA 1997 which is about the company maintaining the same owners. The test in section 165-12 is often referred to as the continuity of ownership test (COT). Under subsection 165-12(1) of the ITAA 1997, the ownership test period is the period from the start of the loss year to the end of the income year in which the loss is sought to be applied. Under section 165-12 of the ITAA 1997, the COT requires that there must be persons who had: • more than 50% of the voting power in the company at all times during the ownership test period • rights to more than 50% of the company's dividends at all times during the ownership test period, and • rights to more than 50% of the company's capital distributions at all times during the ownership test period. When applying the COT, there is both a primary and alternative test for determining who has more than 50% of the voting power, rights to dividends and rights to capital distributions in the company. Under subsection 165-12(6) of the ITAA 1997, the alternative test will apply where one or more companies beneficially owned shares or interests in shares in the company being tested (tested company) at any time during the ownership test period. This typically requires the tested company to trace ownership interests through companies, trusts and certain other entities to identify individuals and other entities who ultimately hold the relevant voting power, rights to dividends and capital distributions in the tested company. However, the rules in Division 165 of the ITAA 1997 are modified in certain instances for a company that meets specific requirements. Where the modified COT rules apply, concessional tracing rules deem certain entities to hold voting, dividend or capital stakes in the tested company so that it is unnecessary for the test company to trace through to the ultimate beneficial owners of the stakes. The modified COT rules and their application to the circumstances of Company B and Company A are examined below. | Detailed Reasoning - Modified COT rules: In general, subdivision 166-A of the ITAA 1997 modifies the way Subdivision 165-A of the ITAA 1997 applies to a company that is: • a widely held company at all times during the income year, or • an eligible Division 166 company at all times during the income year, or • a widely held company for a part of the income year and an eligible Division 166 company for the rest of the income year. A widely held company is defined in subsection 995-1(1) of the ITAA 1997 to mean a company whose shares (except shares that carry a right to a fixed rate of dividend) are listed for quotation in the official list of an approved stock exchange. An "eligible Division 166 company" is defined in subsection 995-1(1) of the ITAA 1997 to mean a company: (a) that is not a * widely held company; and (b) in which: (i) * voting stakes that carry rights to more than 50% of the voting power in the company; or (ii) * dividend stakes that carry rights to receive more than 50% of any dividends that the company may pay; or (iii) * capital stakes that carry rights to receive more than 50% of any distribution of capital of the company; are beneficially owned (whether directly, or * indirectly through one or more interposed entities) by: (iv) a widely held company; or (v) an entity mentioned in subsection 166-245(2) that satisfies the condition in subsection 166-245(3); or (vi) a * non-profit company; or (vii) a charity; or (viii) 2 or more entities mentioned in subparagraphs (iv) to (vii). Company A is listed on an approved stock exchange listed in regulation 995-1.05 of Schedule 5 to the Income Tax Assessment Regulations 1997 . Therefore, Company A meets the definition of a widely held company. The capital structure of Company B consists of ordinary shares which carry voting, dividend and capital distribution rights. 80% of the shares were beneficially held by Company A (a widely held company) during the ownership test period. Therefore, Company B meets the definition of an "eligible Division 166 company". As Company A is a "widely held company" and Company B is an "eligible Division 166 company", subsection 166-5(1) of the ITAA 1997 will apply such that the modified COT rules can apply to both companies. Importantly, this means that the concessional tracing rules in Subdivision 166-E of the ITAA 1997 may apply to both Company A and Company B. The concessional tracing rules and how they apply to Company A and Company B are examined below. | Detailed Reasoning - Concessional Tracing Rules: Subdivision 166-E of the ITAA 1997 provides concessional tracing rules for widely held companies and eligible Division 166 companies under the modified COT. As noted above, Company A is a widely held company and Company B is an eligible Division 166 company. For the purposes of applying the modified COT to Company A and Company B, the following are relevant. • Under section 166-225 of the ITAA 1997, a direct voting, dividend or capital stake in the tested company of less than 10% is attributed to a single notional entity. • Under section 166-230 of the ITAA 1997, an indirect voting, dividend or capital stake in the tested company of less than 10% is attributed to the top interposed entity. • Under section 166-240 of the ITAA 1997, a direct or indirect voting, dividend or capital stake of between 10% and 50% (inclusive) in the tested company, held by a widely held company is attributed to the widely held company as if company was a person (other than a company). • Under subsection 166-235(7) of the ITAA 1997, where a nominee company holds a direct or indirect voting, dividend or capital stake in a company as nominee for more than one other entity, then for each entity for whom a part of the stake is held by the nominee entity, that entity's part of the stake may be treated instead as a separate stake. The meaning of voting stake, dividend stake and capital stake are given by subsections 166-235(1) to 166-235(6) of the ITAA 1997: Meaning of voting stake (1) An entity holds a voting stake in a company if: (a) the entity is the registered holder of *shares in the company; and (b) the shares carry rights to exercise voting power in the company. (2) An entity (the stakeholder ) also holds a voting stake in a company if: (a) one or more other entities are interposed between the company and the stakeholder; and (b) the stakeholder controls, or is able to control, voting power in the company indirectly through the interposed entity or entities. Meaning of dividend stake (3) An entity holds a dividend stake in a company if: (a) the entity is the registered holder of *shares in the company; and (b) the shares carry rights to all or any *dividends that the company may pay. (4) An entity (the stakeholder ) also holds a dividend stake in a company if: (a) one or more other entities are interposed between the company and the stakeholder; and (b) the stakeholder has the right to receive, for its own benefit and *indirectly through the interposed entity or entities, all or any *dividends that the company may pay. Meaning of capital stake (5) An entity holds a capital stake in a company if: (a) the entity is the registered holder of *shares in the company; and (b) the shares carry rights to all or any of a distribution of capital of the company. (6) An entity (the stakeholder ) also holds a capital stake in a company if: (a) one or more other entities are interposed between the company and the stakeholder; and (b) the stakeholder has the right to receive, for its own benefit and *indirectly through the interposed entity or entities, all or any of a distribution of capital of the company. Ordinary shares in Company B and ordinary shares in Company A were at all ownership test times, the only interests in the relevant companies that carried with them voting power in the companies and rights to dividends and capital distributions of the companies. Therefore the shareholding percentages of entities with interests in Company B and Company A also represent the voting stake, dividend stake and capital stake of those entities at those times. In relation to the modified COT rules, subsection 166-5(3) of the ITAA 1997 provides that a company is taken to have met the conditions in section 165-12 of the ITAA 1997 if there is substantial continuity of ownership of the company as between the start of the test period and: • the end of each income year in that period, and • the end of each corporate change in that period. Each of these times is referred to as an 'ownership test time'. Subsection 166-5(2) of the ITAA 1997 defines the 'test period' as the period consisting of the loss year, the income year in which the loss is sought to be applied and any intervening period. The start of the test period is therefore the start of the income year in which the loss is incurred. In the present circumstances it is the start of the income years in which Company B incurred eligible expenditure which gave rise to an entitlement to non-refundable R&D tax offsets. There were no corporate changes as defined in section 166-175 of the ITAA 1997 in the relevant test periods. Substantial continuity of ownership is determined under section 166-145 of the ITAA 1997. Broadly, section 166-145 of the ITAA 1997 requires that at each 'ownership test time': • there must be persons (none of them companies or trustees), who had more than 50% of the voting power in the in the company; • there must be persons (none of them companies) who had rights to more than 50% of the company's dividends; • there must be persons (none of them companies) who had rights to more than 50% of the company's capital distributions In working out whether a condition in section 166-145 of the ITAA 1997 is satisfied at each ownership test time, the company applies the alternative tests in subsections 165-150(2), 165-155(2) and 165-160(2) of the ITAA 1997 (subsection 166-145(6) of the ITAA 1997). | Detailed Reasoning - Additional considerations resulting from joining of consolidated group: When Company B joined the Company A consolidated group on the the joining date', its shares no longer existed for income tax purposes under the single entity rule in subsection 701-1(1) of the ITAA 1997. Further, under the entry history rule contained in section 701-5 of the ITAA, everything that happened to Company B before it became a subsidiary of Company A is taken to have happened to Company A as the head company of the income tax consolidated group that Company B joined. Accordingly, to determine whether the modified COT is satisfied in relation to the non-refundable carried forward R&D tax offsets of Company B, it is necessary to consider it in 2 steps: • Step 1 - It is necessary to confirm that Company B would have been able to apply the tax offsets itself at the joining time. This requires that the voting, dividend and capital stakes in Company B be traced for the period commencing from the beginning of the income year in which Company B incurred eligible expenditure (which gave rise to an entitlement to non-refundable R&D tax offsets) up until just after the date in which Company B joined the Company A income tax consolidated group. • Step 2 - It is then necessary to confirm that Company A will be able to apply the tax offsets. Due to the operation of the entry history rule, Company A (as head company) is taken to have incurred the eligible expenditure giving rise to the entitlement to non-refundable R&D tax offsets at the same time as Company B in the income years prior to the time Company B joined the group. This requires tracing the voting, dividend and capital stakes in Company A from the beginning of the income year that Company B incurred the relevant eligible expenditure up until the end of the income year that the non-refundable carried forward R&D tax offsets are sought to be applied. Step 1 - Application of modified COT to Company B As noted above, it is necessary to confirm that Company B would have been able to apply the R&D tax offsets at the time that it joined the Company A income tax consolidated group. If Company B would not have been able to apply the tax offsets itself, then Company A will be unable to apply the R&D tax offsets. As there were no corporate change events during the relevant test periods, the start and end of the income year in which the entitlement to an R&D tax offset arose and the end of each income year up to and including the date that Company B joined the Company A consolidated group (the end of the 2014 stub income year) will be an ownership test time. The ownership test period and test times for the R&D tax offsets arising in the 2012 and 2013 income years and the 2014 stub income year are: Income year in which entitlement to R&D tax offset arose Ownership Test Period Ownership Test Times 2012 Start 2012 income year to the date that Company B joined the Company A consolidated group ("joining date") Start and end of 2012 income year, end 2013 income year and the joining date 2013 Start 2013 income year to the joining date Start and end 2012 income year, end 2013 income year and the joining date 2014 stub year Start 2014 stub income year to the joining date Start 2014 stub income year and joining date Each income year or stub income year in which R&D tax offsets arose for Company B will need to be examined separately. As noted above, only ordinary shares in Company B carry voting power and right to dividends and capital distributions of the company. The percentage shareholdings therefore also represent the voting, dividend and capital stakes held by each of the relevant shareholders. Also, as noted above, both Company A and Company B are eligible for the concessional tracing rules. At the start of the test period and the ownership test times, Company A owned 80% of the ordinary shares in Company B and is the top interposed entity for that 80% shareholding. | Detailed Reasoning - 2012 Income Year: For the R&D tax offsets arising in the 2012 income year, the direct and indirect shareholding percentages (represented by ordinary shares) in Company B at each ownership test time are: | Detailed Reasoning - Continuity of ownership percentage: Direct stakes in Company B Interests held by two trusts 20% 20% 20% 20% N/A Subtotal 20% 20% 20% 20% N/A Indirect stakes in Company B Indirect stakeholders (attributed to the top interposed entity under section 166-230 and 166-235(7) of the ITAA 1997) 80% 80% 80% 80% 80% | Detailed Reasoning - 80%: The indirect stakeholders identified above comprise of entities that indirectly hold voting, dividend and capital stakes in Company B of less than 10%. Section 166-230 of the ITAA 1997 provides that indirect voting, dividend and capital stakes in a company of less than 10% are attributed to the top interposed company. The top interposed company is Company A. The minimum shareholding percentage attributed to Company A as the top interposed entity throughout the relevant ownership test times was 80%. Therefore, there is an 80% continuity of ownership percentage at the relevant ownership test times from the indirect stakes attributed to Company A. As noted above, the shareholding percentages in Company B represent the voting, dividend and capital stakes in the company as ordinary shares are the only interests in the company which carry such rights. Therefore, as the shareholding percentage of Company A is over 50% at all relevant ownership test times, Company B will satisfy the continuity of ownership test for the R&D tax offsets arising in the 2012 income year. | Detailed Reasoning - 2013 Income Year: For the R&D tax offsets arising in the 2013 income year, the direct and indirect shareholding percentages (represented by ordinary shares) in Company B at each ownership test time are: | Detailed Reasoning - Continuity of ownership percentage: Direct stakes in Company B Interests held by two trusts 20% 20% 20% N/A Subtotal 20% 20% 20% N/A Indirect stakes in Company B Indirect stakeholders (attributed to the single notional shareholder under section 166-230) 80% 80% 80% 80% Subtotal 80% 80% 80% 80% For the same reasons referred to above for the R&D tax offsets arising in the 2012 income year, the indirect interests held by the indirect stakeholders are attributed to Company A as the top interposed entity (section 166-230 of the ITAA 1997). The minimum shareholding percentage held by Company A during the relevant ownership test times for R&D tax offsets arising in the 2013 income year is 80%. Therefore, the continuity of ownership percentage as at the joining date is 80%. As the continuity of ownership percentage is more than 50%, Company B will satisfy the continuity of ownership test for the relevant period. | Detailed Reasoning - 2014 Stub Year: For the R&D tax offsets arising in the 2014 stub income year, the direct and indirect shareholding percentages (represented by ordinary shares) in Company B at each ownership test time are: | Detailed Reasoning - Continuity of ownership percentage: Direct stakes in Company B Interests held by two trusts 20% 20% N/A Subtotal 20% 20% N/A Indirect stakes in Company B Indirect stakeholders (attributed to the single notional shareholder under section 166-230) 80% 80% 80% Subtotal 80% 80% 80% For the same reasons referred to above for the R&D tax offsets arising in the 2012 income year, the interests held by the indirect stakeholders can be attributed to Company A as the top interposed entity (section 166-230 of the ITAA 1997). This minimum shareholding percentage held by Company A during the relevant ownership test times for R&D tax offsets arising in the stub income year ending at the joining date is 80%. Therefore, in relation to the R&D tax offsets arising in the stub year ending at the joining date, the continuity of ownership percentage is 80%. As this is more than 50%, Company B will satisfy the continuity of ownership test for the relevant period. | Detailed Reasoning - Step 2 - Application of modified COT to Company A: Due to the operation of the entry history rule, Company A (as head company) is taken to have incurred the eligible expenditure giving rise to the entitlement to non-refundable carried forward R&D tax offsets at the same time as Company B in the income years prior to the time Company B joined the group. This requires tracing the voting, dividend and capital stakes in Company A from the beginning of the income year that Company B incurred the relevant eligible expenditure up until the end of the income year that the non-refundable carried forward R&D tax offsets are sought to be applied. The relevant ownership test periods and ownership test times for Company A are: Income year in which entitlement to R&D tax offset arose Ownership Test Period Ownership Test Times 2012 Start 2012 income year to end 2014 income year Start and end 2012 income year, end 2013 income year and end 2014 income year 2013 Start 2013 income year to end 2014 income year Start and end 2013 income year, and end 2014 income year 2014 Start and end 2014 income year Start and end 2014 income year | Detailed Reasoning - 2012 Income year: For the R&D tax offsets arising in the 2012 income year, the shareholding percentages as at the relevant ownership test times are: | Detailed Reasoning - Continuity of ownership percentage: Direct stakes in Company A Entity 1 >10% >10% >10% >10% >10% Other direct stakeholders (attributed to single notional shareholder under section 166-225 of the ITAA 1997) >80% >80% >80% >80% >80% | Detailed Reasoning - >90%: During the relevant ownership test times, Entity 1 directly held interests in the ordinary shares of Company A of greater than 10%. The ownership interest in Entity 1 is beneficially held by one individual shareholder which did not change throughout the relevant ownership test times. This interest is held by that individual shareholder indirectly via a trust. The trustee of the trust has a right to receive indirectly through their interest in Entity 1 a percentage of a dividend or a capital distribution of Company A. Therefore at the relevant ownership test times, the voting power can be traced to the individual shareholder and the rights to dividends and capital distributions can be traced to the trustee of the trust. The other direct stakeholders identified in table 4 above had shareholding percentages of less than 10%. Consequently, section 166-225 of the ITAA 1997 can apply to attribute their stakes to a single notional shareholder. The minimum shareholding percentages for the combined interests attributed to a single notional shareholder throughout the relevant ownership test times is greater than 80% Therefore, for the ownership test period there is a total continuity of ownership percentage of greater than 90%, being the >10% held by Entity 1 and the >80% attributed to the single notional shareholder. As this is more than 50%, Company A satisfies the COT for the R&D tax offsets arising in the 2012 income year for Company B and taken to have arisen for Company A as a result of the entry history rule. | Detailed Reasoning - 2013 year: For the R&D tax offsets arising in the 2013 income year, the direct shareholding percentages (represented by ordinary shares) in Company A at each ownership test time are: | Detailed Reasoning - Continuity of ownership percentage: Direct stakes in Company A Entity 1 >10% >10% >10% >10% Other direct stakeholders (attributed to single notional shareholder under section 166-225 of the ITAA 1997) >80% >80% >80% >80% | Detailed Reasoning - >90%: During the relevant ownership test times, Entity 1 directly held interests in the ordinary shares of Company A of greater than 10%. For the reasons described above in the Company A COT analysis for the income year ended 30 June 2012, the voting power, rights to dividends and capital distributions can at all relevant times be traced to either the same individual shareholder or trustee. Similarly, for the reasons described above in the Company A COT analysis for the income year ended 30 June 2012, the other direct stakeholders in Company A as identified in the table 5 above can be attributed to a single notional shareholder under section 166-225 of the ITAA 1997. This single notional shareholder held a minimum of greater than 80% of the ordinary shares in Company A at each relevant ownership test time during the ownership test period. Therefore for the ownership test period there is a total continuity of ownership percentage of greater than 90%, being the >10% held by Entity 1 and the >80% attributed to the single notional shareholder. As this is more than 50%, Company A satisfies the COT for the R&D tax offsets arising in the income year ended 30 June 2013 for Company B and taken to have arisen for Company A as a result of the entry history rule. | Detailed Reasoning - 2014 income year: For the R&D tax offsets arising in the 2014 income year, the shareholding percentages (represented by ordinary shares) in Company A at each ownership test time are: | Detailed Reasoning - Continuity of ownership percentage: Direct stakes in Company A Entity 1 >10% >10% >10% Other direct stakeholders (attributed to single notional shareholder under section 166-225 of the ITAA 1997) >80% >80% >80% | Detailed Reasoning - >90%: During the relevant ownership test times, Entity 1 directly held interests in the ordinary shares of Company A of greater than 10%. For the reasons described above in the Company A COT analysis for the 2012 income year, the voting power, rights to dividends and capital distributions of Company A can at all relevant times be traced to either the same individual shareholder or trustee. Similarly, for the reasons described above in the Company A COT analysis for the 2012 income year, the direct interests identified in table 6 above can be attributed to a single notional shareholder under section 166-225 of the ITAA 1997. This single notional shareholder held a minimum of greater than 80% of the ordinary shares in Company A at each relevant ownership test time during the ownership test period. Therefore, in relation to the ownership test period there is a total continuity of ownership percentage of greater than 90%, being the >10% held by Entity 1 and the >80%% attributed to the single notional shareholder. As this percentage is more than 50%, Company A satisfies the COT for the R&D tax offsets arising in the 2014 income year. | Detailed Reasoning - Conclusion: Both Company B and Company A satisfy the continuity of ownership tests for the R&D tax offsets at all relevant times during the relevant ownership test periods. It is unnecessary to consider the same business test in section 165-13 of the ITAA 1997. Therefore, subsection 65-40(1) of the ITTA 1997 will not prevent Company A from applying the non-refundable carried forward research and development tax offsets. | Summary: The non-refundable research and development tax offsets (R&D tax offsets) carried forward by Company B are not taken into account in calculating the joined group's allocable cost amount for Company B under section 705-60 of the Income Tax Assessment Act 1997 . | Detailed Reasoning - Detailed reasoning: When an entity (joining entity) joins a consolidated group, the tax cost of each of the joining entity's assets is set at the asset's tax cost setting amount. The tax cost setting amount is the amount worked out in accordance with Division 705 of the ITAA 1997. Calculating the tax cost setting amount involves firstly working out the allocable cost amount (ACA) for the joining entity in accordance with section 705-60 of the ITAA 1997. Section 705-60 of the ITAA 1997 provides a table summarising the 8 steps of the calculation: | Detailed Reasoning - Purpose of the step: 1 Start with the step 1 amount worked out under section 705-65, which is about the cost of *membership interests in the joining entity held by *members of the joined group To ensure that the allocable cost amount includes the cost of *acquiring the membership interests 2 Add to the result of step 1 the step 2 amount worked out under the section 705-70, which is about the value of the joining entity's liabilities To ensure that the joining entity's liabilities at the joining time, which are part of the joined group's cost of acquiring the joining entity, are reflected in the allocable cost amount 3 Add to the result of step 2 the step 3 amount worked out under: (a) section 705-90, which is about undistributed, taxed profits accruing to the joined group before the joining time; or (b) if the joining entity is a trust (and not a *corporate tax entity) - section 713-25, which is about undistributed, realised profits accruing to the joined group before the joining time that could be distributed tax free To increase the allocable cost amount: (a) to reflect undistributed, taxed profits and so prevent double taxation; or (b) if the joining entity is a trust - to reflect the undistributed, realised profits that could be distributed tax free 3A For each step 3A amount (if any) under section 705-93 (which is about pre-joining time roll-overs): (a) if the step 3A amount is a *deferred roll-over loss - add to the result of step 3 (as affected by any previous application of this step) the step 3A amount; or (b) if the step 3A amount is a *deferred roll-over gain - subtract from the result of step 3 (as affected by any previous application of this step) the step 3A amount To adjust for certain roll-overs before the joining time affecting deferred gains and losses 4 Subtract from the result of step 3A the step 4 amount worked out under section 705-95, which is about pre-joining time distributions out of certain profits To prevent the allocable cost amount reflecting return of part of the amount paid to *acquire the *membership interests in the joining entity 5 Subtract from the result of step 4 the step 5 amount worked out under section 705-100, which is about certain losses accruing to the joined group before the joining time To prevent: (a) a double benefit arising from the losses; and (b) losses that cannot be transferred to the *head company, or are cancelled by the head company, under Subdivision 707-A being reinstated in an unrealised form or reducing unrealised gains 6 Subtract from the result of step 5 the step 6 amount worked out under section 705-110, which is about losses that the joining entity transferred to the *head company under Subdivision 707-A To stop the joined group getting benefits both through higher *tax cost setting amounts for the joining entity's assets and through losses transferred to the head company 7 Subtract from the result of step 6 the step 7 amount worked out under section 705-115, which is about certain deductions to which the *head company is entitled To stop the joined group getting benefits both through the *tax cost of the joining entity's assets being set and through certain tax deductions of the joining entity being inherited by the head company 8 If the remaining amount is positive, it is the joined group's allocable cost amount. Otherwise the joined group's allocable cost amount is nil. In determining whether the R&D tax offsets are taken into account for the ACA calculation when Company B joins the Company A income tax consolidated group, the characterisation of the R&D tax offset amounts is critical. In addition to being an amount of tax offset as defined in section 4-10 of the ITAA 1997, section 65-40 of the ITAA 1997 effectively requires that tax offsets be treated as "assumed tax losses" for certain purposes. The scope of section 65-40 of the ITAA 1997 is considered in more detail below. Therefore, it is necessary to ascertain whether the R&D tax offsets, as a particular type of tax offset or an assumed tax loss under section 65-40 of the ITAA 1997 are taken into account in the calculation of the ACA for a joining entity. Each of the eight steps of the ACA calculation is examined below: | Detailed Reasoning - Step 1 - cost of acquiring the membership interest: Broadly, step 1 of the ACA as calculated under section 705-65 of the ITAA 1997 includes the total cost of membership interests that members of the joined group hold in the joining entity at the joining time. The R&D tax offsets are not a type of membership interest (as defined in section 960-135 of the ITAA 1997) and are not relevant to step 1 of the ACA calculation. | Detailed Reasoning - Step 2 - liabilities of the joining entity: Broadly, step 2 of the ACA as calculated under section 705-70 of the ITAA 1997, includes the sum of all the accounting liabilities of the joining entity at the joining time. The step 2 amount may in certain circumstances be adjusted. The amount added under step 2 of the ACA is the total of the joining entity's liabilities in accordance with its accounting principles for tax cost setting. The joining entity's accounting principles for tax cost setting are the accounting standards or authoritative pronouncements of the Australian Accounting Standards Board that the entity would use if it were to prepare its financial statements just before the joining time. The R&D tax offsets would not constitute accounting liabilities of the joining entity or affect the potential adjustments to the step 2 amount. Consequently, they are not taken into account under step 2 of the ACA calculation. | Detailed Reasoning - Step 3 - undistributed taxed profits accruing to joined group before joining time: Broadly, step 3 of the ACA as calculated under section 705-90 of the ITAA 1997, includes the sum of undistributed, taxed profits of the joining entity that accrue to the joined group before the joining time. The R&D tax offsets are not relevant to this step as they do not constitute the undistributed profits of Company B. | Detailed Reasoning - Step 3A - pre joining-time roll-over from foreign resident company or head company: Broadly, step 3A of the ACA as calculated under section 705-93 of the ITAA 1997 concerns potential adjustments for deferred roll-over gains or deferred roll-over losses arising from certain pre-joining time roll-overs from a foreign resident company to a resident company. The R&D tax offsets are not relevant to this step. They are not deferred roll-over gains or deferred roll-over losses. | Detailed Reasoning - Step 4 - pre-joining distributions out of certain profits: Broadly, step 4 of the ACA as calculated under 705-95 of the ITAA 1997, concerns distributions made by the joining entity out of certain profits before the joining time. The R&D tax offsets are not relevant to this step. They do not constitute profits of Company B. | Detailed Reasoning - Steps 5 and 6 - losses accruing to joined group before joining time / losses transferred to the head company: Broadly, step 5 of the ACA as calculated under section 705-100 of the ITAA 1997, concerns unutilised carry forward losses accruing to the joined group prior to the joining time. Step 6 of the ACA, calculated under section 705-110 of the ITAA 1997 concerns losses of the joining entity which do not accrue to the joined group prior to the joining time and are transferred to the joined group. Section 705-100 of the ITAA 1997 provides: 705-100(1) For the purposes of step 5 in the table in section 705-60, the step 5 amount is the sum of all the losses of any *sort of the joining entity that: (a) had not been *utilised by the joining entity for the income year in which the joining time occurred or any earlier income year; and (b) accrued to the joined group before the joining time (see subsection 705-90(8). 705-100(2) However, a loss is not taken into account under subsection (1) to the extent that it reduced the undistributed profits comprising the step 3 amount in the table in section 705-60. Section 705-110 of the ITAA 1997 states: 705-110(1) For the purposes of step 6 in the table in section 705-60, the step 6 amount is worked out by multiplying the sum of the losses mentioned in subsection (2) by the *corporate tax rate. 705-110(2) The losses are the joining entity's losses of any *sort that: (a) were not *utilised by the joining entity for the income year in which the joining time occurred or any earlier income year; and (b) did not accrue to the joined group before the joining time (see subsection 705-90(8)); and (c) are transferred to the *head company under Subdivision 707-A; and (d) are not cancelled under section 707-145. Steps 5 and 6 of the ACA calculation concern "losses of any *sort". Therefore, the R&D tax offsets will only be relevant to these steps of the ACA calculation if they are considered to be a sort of loss for income tax purposes. Subsection 995-1(1) of the ITAA 1997 provides that a *sort of loss has the meaning given by section 701-1 of the ITAA 1997. Subsection 701-1(4) of the ITAA 1997 provides: Each of these paragraphs identifies a sort of loss: (a) *tax loss (b) *film loss (c) *net capital loss This subsection lists all the sorts of loss. Film loss is defined in section 36-40 of the ITAA 1997. Net capital loss has the meaning given by sections 102-10 and 165-114 of the ITAA 1997. Relevantly, on the facts, the R&D tax offsets are neither a film loss or net capital loss for the purposes of steps 5 and 6 of the ACA calculation. "Tax loss" is defined in subsection 995-1(1) of the ITAA 1997 as meaning: (a) a tax loss worked out under section 36-10, 165-70, 175-35 or 701-30 of this Act (including such a tax loss as increased under section 415-15); or (b) a tax loss as defined by section 36-105 (Tax losses for 1989-90 to 1996-97 income years) of the Income Tax (Transitional Provisions) Act 1997 ;. or (c) a tax loss as defined by section 36-110 (Tax losses for the 1957-58 to 1988-89 income years) of the Income Tax (Transitional Provisions) Act 1997 ; or (d) a tax loss determined under section 24 of the International Tax Agreements Act 1953 (about relief from double taxation where profits are adjusted) (including such a tax loss as increased under section 415-15 of this Act). In relation to each section referred to in the definition of "tax loss" above: • section 36-10 of the ITAA 1997 is about the calculation of tax losses for the income year. • section 165-70 of the ITAA 1997 is about the calculation of tax losses for a company that has not satisfied the COT and same business test for an income year. • section 175-35 of the ITAA 1997 is about tax losses which arise as a result of the Commissioner disallowing certain deductions in Subdivision 175-B of the ITAA 1997. • section 701-30 of the ITAA 1997 is about how the entity core rules apply to an entity for periods where an entity is not part of a consolidated group. Subsection 701-30(8) of the ITAA 1997 effectively alters the ownership test period for the continuity of ownership test for the period in the income year when a joining entity joins a joined group. • sections 36-105 and 36-110 of the Income Tax (Transitional Provisions) Act 1997 concern the treatment of tax losses from the 1989-90 to 1996-97 income years. • section 24 of the International Tax Agreement Act 1953 provides the Commissioner the power to determine a taxpayer's taxable income or tax loss for the purposes of providing relief from double taxation where an adjustment is made under a tax treaty with a foreign country or territory. Whilst a tax offset is generally not a tax loss, subsection 65-40(1) of the ITAA 1997 requires the assumption that tax offsets are tax losses for certain purposes. Subsection 65-40(1) of the ITAA 1997 states: In working out its tax offset for the current year, a company cannot apply a *tax offset it has carried forward if, assuming: (a) the tax offset were a *tax loss of the company for the income year in which it became entitled to the tax offset; and (b) section 165-20 (deducting part of a tax loss) were disregarded; Subdivision 165-A would prevent the company from deducting it for the current year. Subsection 65-40(1) effectively prevents a company from applying a tax offset it has carried forward in the income year in question where the company fails the tests in Subdivision 165-A of the ITAA 1997. Subdivision 165-A of the ITAA 1997 concerns rules restricting the ability of companies to deduct carried forward losses unless they satisfy certain requirements in relation to maintaining the same owners or carrying on the same business. Subsection 65-40(1) of the ITAA 1997 assumes tax offsets, including R&D tax offsets to be tax losses for the purposes of Subdivision 165-A in order to allow these rules to be applied for carried forward tax offsets. The subsection clearly refers to the treatment of tax offsets as tax losses for the purposes of Subdivision 165-A. Nothing in subsection 65-40(1) extends the assumption beyond this purpose, such as for the purposes of calculating the ACA. Therefore, subsection 65-40(1) does not extend to treat the R&D tax offsets as tax losses for the purposes of the ACA calculation. Therefore, the R&D tax offsets are not a sort of tax loss for the purposes of the ACA calculation and are not relevant for steps 5 and 6 of the ACA. | Detailed Reasoning - Step 7 - certain deductions that the head company becomes entitled to: Broadly, step 7 of the ACA as calculated under section 705-115 of the ITAA 1997 concerns certain deductions that the head company of a consolidated group becomes entitled as a result of the joining entity becoming a subsidiary member of the group. The R&D tax offsets are not a type of deduction and are not relevant for the calculation of the step 7 ACA calculation. | Detailed Reasoning - Step 8 - the ACA amount: Step 8 simply involves the result of the ACA calculation in steps 1 to 7. As the R&D tax offsets are not relevant to any of those steps, it is also not relevant to step 8 of the ACA calculation. | Detailed Reasoning - Conclusion: The non-refundable research and development tax offsets carried forward by Company B at the joining time will not form part of the ACA calculation. The R&D tax offsets as a particular type of tax offset or an assumed tax loss under subsection 65-40(1) of the ITAA 1997 are not taken into consideration in calculating the Company A income tax consolidated group's ACA for Company B under section 705-60 of the ITAA 1997. | Summary: Subdivision 707-C of the Income Tax Assessment Act 1997 does not limit the utilisation of the non-refundable research and development tax offsets by Company A as that Subdivision does not apply to such offsets. | Detailed Reasoning - Detailed reasoning: Where an entity transfers prior year losses into an income tax consolidated group (transferred losses), the rate at which those losses can be utilised by the consolidated group in each income year is limited by an available fraction. The method by which the available fraction is determined and applied is governed by Subdivision 707-C of the ITAA 1997. Subsection 707-305(1) of the ITAA 1997 in Subdivision 707-C provides that: The main object of this Subdivision is to limit, in a way that gives effect to the principles in subsections (2) and (3), the amount of losses transferred under Subdivision 707-A that can be *utilised for an income year by the transferee. Therefore, the available fraction rule will apply to losses that are transferred under Subdivision 707-A of the ITAA 1997. Section 707-115 of the ITAA 1997 details the types of losses that Subdivision 707-A of the ITAA 1997 applies to. It provides that: This Subdivision applies to a loss of any *sort if: (a) an entity (the joining entity) becomes a *member of a *consolidated group (the joined group) at a time (the joining time) in an income year (the joining year); and (b) the loss was made by the joining entity for an income year ending before the joining time Subsection 995-1(1) of the ITAA 1997 provides that a *sort of loss has the meaning given by section 701-1 of the ITAA 1997. Subsection 701-1(4) of the ITAA 1997 states: Each of these paragraphs identifies a sort of loss: (a) *tax loss (b) *film loss (c) *net capital loss This subsection lists all the sorts of loss. Therefore, the available fraction rule in Subdivision 707-C of the ITAA 1997 will only apply to the R&D tax offsets if they fall within the definition of a sort of loss as defined in subsection 701-1(4) of the ITAA 1997. "Tax loss" is defined in subsection 995-1(1) of the ITAA 1997 as meaning: (a) a tax loss worked out under section 36-10, 165-70, 175-35 or 701-30 of this Act (including such a tax loss as increased under section 415-15); or (b) a tax loss as defined by section 36-105 (Tax losses for 1989-90 to 1996-97 income years) of the Income Tax (Transitional Provisions) Act 1997 ;. or (c) a tax loss as defined by section 36-110 (Tax losses for the 1957-58 to 1988-89 income years) of the Income Tax (Transitional Provisions) Act 1997 ; or (d) a tax loss determined under section 24 of the International Tax Agreements Act 1953 (about relief from double taxation where profits are adjusted) (including such a tax loss as increased under section 415-15 of this Act). Whilst tax offsets are not normally a sort of loss, subsection 65-40(1) of the ITAA 1997 requires the assumption that tax offsets are a tax loss for certain purposes. However, as noted above in the detailed reasoning for question 3, the scope of subsection 65-40(1) of the ITAA 1997 is limited to the assumption that a tax offset is a tax loss for the purposes of applying the tests in Subdivision 165-A of the ITAA 1997 to determine whether a company can apply carried forward tax offsets. It does not extend to the treatment of tax offsets as tax losses for purposes beyond this, such as the available fraction rule in Subdivision 707-C of the ITAA 1997. Similarly, also as concluded above in the detailed reasoning for question 3, there is nothing in the definition of tax loss in subsection 995-1(1) of the ITAA 1997 and the provisions referred to therein that require that a tax offset be treated as a tax loss, including for the purposes of the available fraction rule. Therefore, Subdivision 707-C of the ITAA 1997 will not limit the utilisation of the non-refundable carried forward research and development tax offsets by Company A.