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Date Posted: 05:17:15 01/22/03 Wed http://www.pwcglobal.com.ro/Extweb/service.nsf/docid/C8763CD980C46251CA256B59000E55D1 Tax Australia home Business Tax Reform International Tax & Transaction Services Structuring & Trade Human Resource Consulting Tax Management & Process Services BASchool Global Visa Guide A career @ PwC Other services Industry issues Contact us Home > About us > Services Please enable JavaScript to view this page properly. Australian Tax Services Who are we? | What services do we offer? | Contact us | Tax reform archives Tax consolidation redesigned - A closer look at the impacts Following on from our Executive Summary, this paper provides a more detailed overview of the draft tax consolidation package issued today by the Federal Government, together with a suggested action plan and timeline. Overview of the new rules The proposed tax consolidation rules are necessarily quite complex. Very broadly, they will: allow wholly-owned groups of companies (including wholly-owned subsidiary trusts and partnerships) resident in Australia to make a choice to consolidate for tax purposes, provided the head entity is a company. A consolidated group will be treated as a single entity for income tax purposes and will file a single income tax return. However, this choice does not extend to other taxes such as fringe benefits tax or goods and services tax. For income tax purposes, all intra-group transactions will be ignored and the group's income tax return will not require schedules identifying income on a member-by-member basis. set out rules under which the tax losses of group members may be transferred to the head entity when they enter the group. The measures also outline how the losses may then be used by the head entity. These rules are very complex. provide for franking credits and other tax attributes of group members to be transferred to the head entity. set out rules for determining the tax values of assets under the "asset based method". Very broadly, this method spreads what is known as the "allocable cost amount" (that is, the cost of acquiring a joining entity plus its liabilities, subject to adjustments) among the entity's assets to determine their tax value. The cost of assets, except certain monetary assets, will be reset. The allocable cost amount is allocated first to monetary assets. What remains is then allocated to other assets in proportion to their market value, subject to adjustments. When the entity exits the group, to determine the capital gain or loss on any disposal of membership interests in the entity, the tax value of those interests in the entity is reconstructed, based on the tax value of the entity's assets at the time of exit, less its liabilities. Repeal the current grouping provisions, including thin capitalisation grouping rules, from 1 July 2002. This means that from that time there will be no ability to transfer losses between members of a (non-consolidated) wholly-owned company group or to roll over assets between them on a tax-free basis. The existing intercorporate dividend rebate will also be removed. However, the current grouping provisions will continue to apply to a substituted accounting period group after 30 June 2002 provided the head entity chooses to consolidate on the first day of its next income year starting after 1 July 2002. Provide certain concessions for groups that consolidate in the transitional period (see below). Transitional period The transitional period is from 1 July 2002 to 30 June 2003. Groups consolidating in that period may: elect to "stick" with existing tax values of assets, on a member-by-member basis (provided the member was continuously wholly-owned from 30 June 2002 until the date of consolidation), rather than resetting those values by "spreading" the "allocable cost amount" across underlying assets. This "stick" or "spread" choice provides the opportunity to preserve or maximise tax values across the group. retain pre-consolidation rates of tax depreciation for assets, provided the asset's post-consolidation tax value does not exceed its value immediately before consolidation see below for more detail. elect not to reset doubtful debts to their market value if opting to reset asset tax values see below for more detail. boost "loss factors", which establish the rate at which groups can use their pre-consolidation losses, by taking into account the market value of potential (pre-consolidation) transferees of losses, including other loss companies. Alternatively, for certain losses incurred in a year ending on or before 21 September 1999 that satisfy the continuity of ownership test (COT), groups can access the losses over a three-year period, rather than use the loss factor rule. Key actions for business While for many corporate groups, tax consolidation will simplify their tax affairs after transition, it is vital that businesses do not underestimate the many tasks required during transition. Here are some key actions that will be required: 1. Prepare a plan for your group's consolidation, including timelines and personnel responsible for tasks. 2. Assess internal and external resourcing and the capacity to deal with changes once they hit it is possible that key resources may be in short supply. This is a reason to start preparing early, so that your group is ready to consolidate at the most appropriate time. Include the cost of consolidation in budgets. Consider whether there may be other issues arising over the same period (such as corporate plans, or other major tax or accounting changes) which may limit your ability to respond in time. 3. Consider if and when to consolidate. 4. Consider who will be members of your group. An "all-in" rule applies, so that all qualifying members at the time of consolidation must be included. As a result, should: steps be taken to change the ownership of some wholly owned subsidiaries so they sit outside the group? minority shareholdings in partly owned subsidiaries be acquired, so they can join the group? your consolidated group for income tax be the same as your GST group? If they will differ, should the membership of the groups be aligned? 5. Assess possible strategies pre and post consolidation. Consider what transactions should be undertaken before consolidation for example, payment of some dividends, transfer of certain assets between group members or to unrelated parties, sale or liquidation of some subsidiaries. 6. Assess the key accounting issues associated with consolidation, including the interaction with the revised accounting standard, AASB1020. Consolidation may affect income tax expense, positively or negatively. 7. Ensure data capture and fixed asset registers are up-to-date. Check that all assets are identified, even if they have a nil value for tax purposes, as they will be given a tax value if the tax values of the member's assets are reset. Be sure to identify goodwill, intellectual property and other intangible assets. Check whether existing cost base records are up to date. Have the cost base of shares in subsidiaries been adjusted for loss transfers? 8. After entering into consolidation, determine asset tax values of members. Should a particular member "stick" with existing tax values under the transitional option or "spread" the allocable cost amount over underlying assets and reset asset tax values? Market valuations will be required if you choose to "spread". 9. Many groups with 20 January 1997 or 30 June 1999 capital gains tax (CGT) breach dates have deferred obtaining market valuations for formerly pre-CGT assets. It is important to start assembling the information a valuer will require. Even when a member "sticks" with existing tax values under the transitional option, this information will ultimately be needed to ascertain the tax value of formerly pre-CGT assets (such as land and buildings or goodwill) and, in turn, the tax value of shareholdings in the subsidiary that holds them. 10. Determine the treatment of losses transferred to the head company. Should an election be made to utilise the "concessional" rules for COT losses incurred in years ending before 21 September 1999, or is the treatment under the "loss factor" rules more favourable? Market valuations will be required to determine loss factors. 11. Assess current technology, processes and people involved in collecting and processing tax information to ensure they are appropriate to a consolidation environment. The accounting consolidation may not be the starting point for all groups, particularly where there are significant differences between the accounting and tax groups. In these circumstances, separate tax computations, including eliminations, might be prepared and aggregated. Consider also the interaction of requirements imposed by consolidation with those imposed by the revised accounting standard, AASB1020 and, potentially, the tax value method (TVM) of calculating taxable income. 12. Check all your systems are operating as intended. Prepare your group's consolidated income tax return and election to consolidate, and lodge them by the due date. When should a group consolidate? Most wholly owned company groups will effectively be obliged to consolidate during the transitional period. This is because the current group relief rules cease and the various transitional concessions will not be available once the transitional period has elapsed. A number of important factors that can influence the timing for groups consolidating are set out below. Losses For company groups with losses that can only be claimed if the same business test (SBT) is satisfied, there will be a benefit in electing to consolidate sooner rather than later. Once they consolidate, assuming the SBT is passed at the time of consolidation, the losses will generally be refreshed as COT losses. A delay in consolidating may result in denial of ability to claim the losses. This will be the case if some future event causes failure of the SBT before the group consolidates. There is a further potential benefit, for company groups with losses, in consolidating early. Under the pay-as-you-go (PAYG) rules, the instalment rates for members of unconsolidated groups are calculated without regard to tax losses transferable between members. It is proposed that if a consolidation election is lodged early, the group will be able to pay a single instalment for each quarter based on an ATO-approved method to calculate the instalment rate for 2002-2003. This will be contingent on sufficient historical financial information being available. Asset tax values Some groups may find that consolidation allows them to uplift the tax values of depreciable or deductible assets, even though there are rules designed to limit this. Where these opportunities exist, businesses will need to strike while the iron is hot. This means consolidating sooner rather than later. The way in which asset tax values are reset on consolidation is impacted by the market values of assets at the date of consolidation. If consolidation is delayed, market values will move on and the potential opportunities will change, possibly for the worse. Disposals or liquidations If a group is planning to sell or liquidate a subsidiary, the business needs to bear in mind that consolidation can produce a better or worse tax outcome. This is because, for a sale, consolidation can change the tax value of shares in the subsidiary, whilst, for a liquidation, consolidation means there will be no tax consequence. Compliance Larger groups, in particular, may prefer to consolidate early rather than late. While opinions differ partly because the circumstances of groups differ the more common view is that once a group has undergone the pain of consolidation, managing its tax affairs will be simpler. Many, but not all, say that preparing a single consolidated tax return will be easier than preparing, say, 100 individual tax returns for the various group members as required currently. A consolidated return may be easier where the group is identical for tax consolidation and accounting purposes, and where the group can start with its consolidated result as the first step in preparing a tax return. The consolidated approach may be more difficult for a group which has to add consolidation as an additional step to existing processes. Which entities can and cannot consolidate? A group consisting of a "head company" and all of its 100 per cent owned Australian resident subsidiaries can elect to consolidate. A "head company" is an Australian resident company which is taxable at the general company tax rate and which is not a 100 per cent subsidiary of another such company. A 100 per cent owned trust or partnership will be included in a group, but cannot itself be the head of the group. Certain entities cannot be members of a consolidated group. These include, for example: tax exempt entities certain "recognised medium credit unions" and "approved credit unions" certain "non-profit companies" certain concessionally taxed co-operatives pooled development funds (PDFs) film licensed investment companies (FLICS) certain superannuation entities approved deposit funds (ADFs). The requirement for 100 per cent ownership is relaxed for certain employee shareholdings that is, those not exceeding one per cent of the number of ordinary shares and provided they satisfy certain Employee Share Acquisition Scheme (ESAS) rules and for certain finance shares that qualify as debt interests. The election to consolidate is made by the head company and cannot be revoked. Who is liable for the income tax of a consolidated group? The head company is legally responsible for the income tax liabilities of a consolidated group. However, the Australian Taxation Office (ATO) may recover the group's tax debts from subsidiary members if the head company defaults on its primary obligation. Special rules will be developed to deal with this. The income tax debts of group members incurred prior to their entry into consolidation will continue to be the liability of those members. If the primary liability for the group's income tax is with the head company, this may limit the foreign tax credits obtained by some foreign owned groups in their domestic jurisdiction. This is a matter that requires further consideration by the Government. Income years of members joining and leaving a consolidated group When an unconsolidated entity joins a consolidated group, its income year ends immediately before it joins the group. If an entity ceases to be a member of a group at a particular time and does not join another consolidated group, it immediately commences a new income year. Asset tax values in a consolidated group What is an "allocable cost amount"? When an entity joins a consolidated group, including on initial consolidation, the tax value of its assets is reset by spreading the entity's "allocable cost amount" over all of its assets. The only exception to this rule is on initial consolidation. If consolidation occurs during the transitional period, there is a choice, on an entity-by-entity basis, either to retain existing tax values or reset them. In broad terms, the allocable cost amount is the cost base of membership interests in the joining entity held by the acquiring group, including indexation to 30 September 1999 where appropriate, and the amount of the joining entity's liabilities. Adjustments are made to reflect certain distributions and losses of the joining entity. Determining allocable cost amounts on initial consolidation will typically be a complicated, time-consuming exercise. Ample time should be allowed for this in the implementation timeline. How do you spread the allocable cost amount? The tax values of the assets directly owned by the head company are not reset when an existing group chooses to consolidate. Spreading of the allocable cost amount only applies to subsidiaries of a head company, including entities that subsequently become a 100 per cent subsidiary of an existing consolidated group. Spreading of the allocable cost amount over the subsidiary's assets effectively treats them as having been acquired by the head entity at the time when the subsidiary entered the consolidated group. The total cost deemed to have been paid for these assets by the head entity is the allocable cost amount. This amount is spread among those assets in the following way: Certain assets of the joining entity broadly retain the tax value they had immediately before consolidation. These "retained cost base assets" are: Australian currency (provided it is not trading stock or collectibles) a right to receive a specified amount of Australian currency, other than a right that is a "marketable security" as defined in the income tax law. The allocable cost amount that has not been allocated to "retained cost base assets" is then allocated among other assets, termed "reset cost base assets", in proportion to their market value. Market valuations will be required for this purpose. Special rules apply to certain types of assets, including over-depreciated assets. A variation from the original draft is that a transitional rule is to be made available regarding doubtful debts. This will allow existing groups consolidating in the transitional period to retain the existing tax value of doubtful debts. The effect of the original draft rules was to substitute the market value of a doubtful debt on entry into consolidation. Existing groups could have been disadvantaged by this when entering into consolidation they would effectively have been denied a deduction when the debt went bad. Another change in this draft relates to depreciated assets. These may continue to be depreciated under the rules that applied to those assets before entry into consolidation, even where their tax value is reset. This is the case provided the reset tax value does not exceed the pre-existing tax value (that is, the written down value when entering into consolidation) and the asset has been owned continuously since 21 September 1999. If there is an excess, the group can elect to abandon the excess value in order to continue with the pre-consolidation depreciation arrangements. Excess value abandoned in this way will not be re-allocated to other assets and will be wasted. However, this loss may be more than offset by the benefit of preserving accelerated rates of tax depreciation. One further change in this latest draft applies to over-depreciated assets. There may be an adjustment to the tax value allocated to over-depreciated assets (that is, assets whose market value exceeds their tax written down value in general when the member joined). This may apply if, in the period since their acquisition, an unfranked dividend has been paid that attracted the intercorporate dividend rebate. Treatment of losses A group loss or a transferred loss? A "group loss" is a tax loss that is incurred by a consolidated group. Where a loss is incurred by a group, it will be subject to the continuity of ownership test (COT) in the same way as if the group were a single corporate entity. This means that if majority continuity of ownership is not maintained after the year of the loss, the group will need to satisfy the SBT in order to be able to deduct the loss. It may be more difficult for a consolidated group to satisfy the SBT. A transferred loss is a pre-consolidation loss which is transferred to the head company when an entity joins the group (including on initial consolidation). In broad terms, a joining entity can only transfer a loss if it could have claimed the loss at the time it joined the group (assuming it had sufficient assessable income at the time). If the loss does not satisfy this test, it can neither be transferred to the head company nor used by the joining entity. With the exception of certain "concessional transferred losses", discussed subsequently, losses transferred to the head company by joining members are subject to a "loss factor" rule see below. Transferred losses SBT or COT? If a transferred loss is an SBT loss, because there has been failure by the joining entity to satisfy the COT, it is treated as incurred by the head company in the year when the joining member enters the group. In practical terms, an SBT loss is refreshed and, broadly, becomes a COT loss. If a transferred loss is a COT loss (because the joining entity satisfies the COT), it is also treated as incurred by the head company in the year in which the loss member joined the group. But, unlike a transferred SBT loss, it is necessary to track changes in ownership from the time when the joining member actually made the loss. There are some new and quite complex rules in the latest draft legislation dealing with how this tracking of ownership will occur, even if the original loss maker is subsequently disposed of or liquidated. In effect, these rules deem the original loss maker not to have been disposed of or liquidated. Once a loss is transferred to the head company, it cannot revert to the "original loss maker" which brought the loss into the group, even if that entity subsequently leaves the group. "Bundles" of losses A "bundle" of losses is a bundle of one or more "sorts" of losses transferred to the head company by a joining entity. Each bundle will carry with it a particular "loss factor" (see below). This same loss factor will apply for each "sort" of loss brought in by the joining entity. For example, one joining entity may have a loss factor of 0.1 attaching to its bundle of losses, so that the various "sorts" of losses in the bundle will each have a loss factor of 0.1. A "tax loss" (being a loss deductible against all assessable income) or net capital loss in this bundle will therefore be subject to a loss factor of 0.1. Another joining entity may have a loss factor of 0.15 attaching to its bundle of various sorts of losses. The proposed rules for calculating loss factors have been made more generous than those in the original draft legislation. In general, where a group first consolidates during the transitional period, the losses of various loss entities in a group may form a single bundle. This is the case if those losses would have been freely transferable between the loss entities (assuming they had taxable income) before consolidation. The effect of the new rule is that where losses were freely transferable between all members of a 100 per cent owned group (because, for example, all members have been 100 per cent owned for some years), the losses may form a single bundle with a loss factor of one. Where this is so, it will usually be preferable not to exercise the COT loss concession (see below). "Sorts" of losses The different "sorts" of losses listed in the draft legislation are: a tax loss (that is, a loss deductible against all assessable income) a film loss a net capital loss an overall foreign loss in respect of certain interest income an overall foreign loss in respect of "modified passive income" an overall foreign loss in respect of offshore banking income an overall foreign loss in respect of other assessable foreign income. A standard transferred loss or a concessional transferred loss? All SBT losses transferred to a head company will be subject to a loss factor which limits the rate at which they can be used. COT losses incurred in income years ending after 21 September 1999 will also always be subject to a loss factor. A "concessional transferred loss" is a COT loss incurred for an income year ending on or before 21 September 1999. This is provided that the loss was transferred during the transitional period and the head entity has elected to treat all such losses as concessional transferred losses. Broadly, the concessional rule allows the deduction of such losses over a minimum period of three years by the head entity. This provides an alternative to using the loss factor rules outlined below. The loss factor "Standard transferred losses" may only be claimed subject to the loss factor rules. The purpose of the loss factor rules is to create a proxy for the net worth of the loss entity (and where consolidation occurs in the transitional period, potential transferees of its losses) relative to the group as a whole. This is to ensure that losses may only be recouped by the group broadly to the same extent that they would have been recouped if the loss entity had continued to produce assessable income as a standalone entity. Example Calculating and applying the loss factor Group A consolidates in the transitional period. The modified market value of B, a group member is $100. The modified market value of C, a potential transferee of B's losses, is $50. There are no loss entities in the group other than B. There are no other potential transferees. The market value of the group (including B and C) is $1,000. In this case, the loss factor for B is 0.15, that is: $100 + $50 ___________ $1000 If B transfers its tax loss of $100 to A (the head company of Group A) and, in the first year of consolidation, Group A has $200 of assessable income, then in that year a loss of $30 may be claimed by Group A. This is calculated as the group's assessable income of $200 multiplied by the loss factor of 0.15. If in the following year Group A's assessable income is $400, then a loss of $60 can be claimed. In this way, over two years, $90 of the $100 loss has been recouped, leaving only $10 that may be recouped in later years, subject to the loss factor. The loss factor is calculated using the following formula: Loss factor = Modified market value of the real loss maker _______________________________________________ Market value of the group joined In very broad terms, the modified market value of the "real loss maker" (that is, the entity with the loss that is joining the group) is determined ignoring any synergistic benefits that will come from it being a group member, and which may otherwise enhance its market value. The loss maker's modified market value also excludes its income tax attributes (such as the value of losses or franking credits) and the market value of membership interests it has in other group members, but not the market value of debt interests it has in other group members. Foreign owned multiple entry consolidation (MEC) groups MEC groups are groups of resident companies which are foreign-owned and which are ultimately 100 per cent owned by a single non-resident company, but do not have a single Australian head company. These groups will be allowed to consolidate, if all eligible members join and one of the "tier 1" companies (that is, a company that is directly owned by a non-resident) is nominated as a "virtual head" company. If the virtual head leaves the group, the remaining tier 1 companies may nominate a replacement. The requirement in the original draft legislation that MEC groups be in existence as at 19 September 1999 has now been dropped. There was strenuous opposition to this cut-off date, as many potential MEC groups have expanded or come into existence since then. The ATO and Treasury agreed to accommodate MEC groups on an ongoing basis. The original (quite complex) proposal for dealing with MEC groups in A Tax System Redesigned has been dropped and replaced by more user-friendly rules which pool the tax values for foreign-owned equity. The process through to legislation The new draft legislation has been, and will continue to be, scrutinised on the basis of "integrated tax design" principles. This means that unnecessary detail should be eliminated wherever possible. A quality assurance process is under way in an attempt to ensure that the legislation is not unnecessarily complex. Because of the complexity of the issues, and the need for certainty, it is recognised that not all of the legislation will be able to comply with principle-based drafting. However, wherever possible, the original draft of December 2000 has been streamlined. Parts of the current draft have been vetted by a design group consisting of representatives of various bodies (including PricewaterhouseCoopers), drawn from the professions. A key factor motivating the testing of the legislation for quality assurance is the Government's "near-death experience" with last year's debacle over the Business Activity Statement (BAS). The Government is clearly seeking to remove all features in the legislation with any potential to cause electoral damage. It is expected that the completed legislation will be introduced into Parliament around May 2002, with a view to enactment by the end of June. September 2002 TVM is dead Long live the tax jungle! The announcement by the Federal Treasurer on 28 August 2002 that the Government has backed down on the tax value method (TVM) proposal has come as welcome news for business. However, the Treasurer's indication that the Government will develop a systematic tax treatment of rights and blackhole expenditure is likely to lead it further into controversial territory. Meanwhile, there has been no commitment to further reform or simplification of the core income tax legislation. This is despite the fact that business is still grappling with two tax Acts, fraught with anomalies and legislation running to more than 8,500 pages. "The timely death of the TVM proposal has been met with cheers from most quarters, particularly tax practitioners who have been envisioning further reams of complex and ungainly tax legislation," said Geoff Lehmann, PricewaterhouseCoopers Tax Counsel and a key adviser to Government on TVM. "Alongside this welcome news, has come the announcement of the Government's commitment to developing a new regime for the treatment of rights and blackhole expenditure. Pegged for implementation by July 2005, this is likely to raise a fair degree of concern for business - as there is already some controversy surrounding the rights issue. "However, business will be generally positive about the recognition of blackhole expenditure as there is widespread support for this approach," Mr Lehmann added. No end to tax labyrinth "Disappointingly, the Treasurer gave no indication he plans to undertake any significant overhaul of the core income tax legislation. With two tax Acts - one dating back to the Ark - and a host of anomalies between the two giving rise to ongoing complexities and consternation for business, there is clearly a need to revisit this festering issue. "Although the Government has been making progressive inroads into the business tax reform wish-list, the report card is still somewhat blotchy. The recent general value shifting rules, for example, might well be described as 'much ado about nothing'! "Meanwhile, tax consolidation is ticking over in the background and appears to have met with general acceptance by business at this stage," Mr Lehmann said. A recent PricewaterhouseCoopers Tax study found that 77 per cent of 65 major businesses surveyed are comfortable with the new tax consolidation regime and only 18 per cent have a low level of confidence in it. Furthermore, an overwhelming majority (83 per cent) indicated they expect the overall impact of tax consolidation for business will be positive or neutral, while 88 per cent of the businesses surveyed believe tax consolidation would impact positively or neutrally on shareholder value. Initial hopes dashed on TVM TVM was a key plank in the Ralph Review of Business Taxation's proposal to simplify Australia's tax system. The core concept was to replace a myriad of laws with one simple rule - taxable income would be calculated on the basis of net annual cash flows, and the change in the tax values of assets and liabilities on hand at year end. Business expenditure would be immediately written off, amortised or capitalised, depending on whether it gave rise to an asset at the end of a year. Initially greeted with a wave of enthusiasm, TVM rapidly sank into a mire of complexity as the legislative drafters waded into the detail of trying to make the concept a reality. The Treasurer's announcement has come as little surprise, with opponents over the past six months touting the draft legislation as complex and unintelligible - with growing certainty that it would increase compliance costs and create new tax avoidance opportunities for business. [ Next Thread | Previous Thread | Next Message | Previous Message ] |
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