Private ruling: The application of the consolidation membership and cost setting rules
Date of advice: 15 July 2015
Published: July 2015

Ruling: Q1: Do the cost setting provisions in Subdivision 705-C (as modified by Subdivision 719-C) apply when a subsidiary member of a foreign owned consolidated group (group 1) acquires the membership interests in the head company of another consolidated group (group 2) such that; • the foreign parent company (FCo) of group 1 now qualifies as the top company by reference to the head company of group 2 (HCo 2) which has become a wholly owned subsidiary of the foreign company (FCo), and • at the same time, the head company of group 2 (HCo 2) also becomes an eligible tier-1 company with respect to FCo, and • the head company of consolidated group 1 (HCo 1) chooses to convert group 1 to a MEC group, and all the members of group 2 also become subsidiary members of a MEC group that comes into existence at that time? | A1: Yes | Q2: Would Division 705 as modified by Subdivision 719-C apply to reset the tax cost of the assets of HCo 2 and the subsidiary members of consolidated group 2 when they become members of consolidated group 1? | A2: No

Relevant facts and circumstances: HCo 1 is the head company of consolidated group 1, and is a wholly owned subsidiary of FCo. SCo is a subsidiary member of consolidated group 1. HCo 2 is the head company of consolidated group 2; FCo owns a portion of the membership interests of HCo 2 and, XCo, an unrelated entity, owns the balance. At time T1 SCo acquires XCo's interest in HCo 2. HCo 2 becomes an eligible tier-1 company of FCo at time T1. HCo 1 makes the choice under section 719-40 to convert to a MEC group from time T1. HCo 2 and all other members of consolidated group 2 become members of the MEC group at time T1. All the requirements of subsection 719-40(1) were satisfied so as to allow the making of the choice to convert to a MEC.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 701-10 | Income Tax Assessment Act 1997 Division 705 | Income Tax Assessment Act 1997 Subdivision 705-A | Income Tax Assessment Act 1997 Subdivision 705-C | Income Tax Assessment Act 1997 section 705-175 | Income Tax Assessment Act 1997 subsection 705-175(1) | Income Tax Assessment Act 1997 subsection 705-180(1) | Income Tax Assessment Act 1997 Subdivision 719-BA | Income Tax Assessment Act 1997 Subdivision 719-C | Income Tax Assessment Act 1997 subsection 719-2(1) | Income Tax Assessment Act 1997 subparagraph 719-5(4)(c)(ii) | Income Tax Assessment Act 1997 subsection 719-10(1) | Income Tax Assessment Act 1997 section 719-15 | Income Tax Assessment Act 1997 section 719-40 | Income Tax Assessment Act 1997 subparagraph 719-40(1)(e)(ii) | Income Tax Assessment Act 1997 subsection 719-160(2) | Income Tax Assessment Act 1997 section 719-170

Reasons for decision: Summary: When an entity becomes a subsidiary member of a consolidated group, the tax cost of each of its assets is set at the asset's tax cost setting amount (see section 701-10). Division 705 contains the method statements on how to work out the tax cost setting amounts when an entity becomes a member under various circumstances; Subdivision 705-A details how the tax cost is set when a single entity joins a consolidated group. Subdivision 705-C modifies Subdivision 705-A so that it can apply when all the members of an existing consolidated group become members of another consolidated group as a result of a member or members of the acquiring group acquiring the membership interests in the head company of the acquired group (see section 705-175). Note, for the purposes of applying Subdivision 705-C, the acquiring group and the acquired group can either be a consolidated group or a MEC group; this is because section 719-170 modifies Subdivision 705-C to apply to MEC groups, and subsection 719-2(1) allows for a provision that mentions two consolidated groups to be read as two MEC groups, or one as a consolidated group and the other as a MEC group (see note in subsection 719-2(1)) Subdivision 705-C is a concessional provision designed to reduce compliance costs. This is achieved by treating the members of the acquired group as a single entity, and the head company as the only entity joining the acquired group (see paragraph 705-185(1)(a)). Further, when Subdivision 705-C applies, the members of an acquired group are not considered as leaving entities and therefore, not required to undertake Division 711 calculations (see modifications to core rules in subsection 705-180(1)). For Subdivision 705-C to apply; • all the existing members of the acquired group must become members of the acquiring group, and • it must be as a result of the acquisition of the membership interests in the head company of the acquired group (subsection 705-175(1)). In this case, at time T1, all the members of consolidated group 2 become members of consolidated group 1 because of three events happening simultaneously; 1. the acquisition of the balance of the membership interests by SCo in HCo 2, and 2. HCo 2 becoming an eligible tier-1 company of FCo (section 719-15), and 3. As a result of HCo 1 making the choice to convert to a MEC group (special conversion event; section 719-40). That is, the acquisition of the membership interests by SCo enables HCo 2 to become an eligible tier-1 company of FCo; which enables HCo 1 to make the choice under section 719-40 to convert group 1 to a MEC group. When HCo 2 becomes an eligible tier-1 company and a member of the converted MEC group, all its wholly owned subsidiaries that were subsidiary members will also become members of the MEC group (see subsection 719-10(1)) Note, the time HCo 2 becomes an eligible tier-1 company and the time of special conversion event are prescribed by income tax legislation - see subparagraphs 719-5(4)(c)(ii) and 719-40(1)(e)(ii)) In this case, in considering whether Subdivision 705-C applies, the question arises whether the members of consolidated group 2 become members of the MEC group as a result of SCo acquiring the membership interests in HCo 2, or become members because of the special conversion event. The meaning of the words 'as a result of' has been considered in a number of cases, and it is accepted that the phrase has no technical meaning and should be interpreted as merely requiring a causal relationship and not a direct relationship between events. See Allianz Australia Insurance Ltd v GSF Australia Pty Ltd [2005] HCA 26 ; (2005) 221 CLR 568 at 580-581 and Fagan v Crimes Compensation Tribunal (1982) 150 CLR 666 at 673. Therefore, the requirement that "…. as a result of the acquisition of membership interests in the head company of the acquired group " in subsection 705-175(1) is satisfied by the acquisition of the membership interests by SCo in HCo 2 and the members of consolidated group 2 becoming members of the MEC group. Subdivision 705-C does apply when the members of consolidated group 2 become members of the converted MEC group in the circumstances described in question 1. The members of consolidated group 2 that become members of the MEC group are: HCo 2, which becomes a member as an eligible tier-1 company, and all the subsidiary members. Under Subdivision 705-C, the head company of consolidated group 2, HCo 2 will be taken to be the only entity joining the MEC group (see section 705-185). When an entity becomes a member of a MEC group as an eligible tier-1 company, the cost setting rules in Subdivisions 705-A and 705-C apply as modified by Subdivision 719-C. Under the general modifying rule in subsection 719-160(2), the tax costs of the assets of an eligible tier-1 company are not reset (see note 2 in subsection 719-160(2)), Further, as the acquired group is taken to join as a single entity, the assets of the subsidiary members are taken to be those of the eligible tier-1 company. As such, the tax costs of the subsidiary members' assets are also not reset. Therefore, the overall effect of the Subdivision 719-C modifications is that the tax costs of the assets in the joining group (consolidated group 2) are not reset. The tax cost of the assets of members of consolidated group 2 will not be reset under Division 705 as modified by Subdivision 719-C when those members become members of the MEC group. For completeness, the tax cost of the assets of the continuing members in consolidated group 1 will not be reset because of the operation of provisions in Subdivision 719-BA.