JOINT SUBMISSION BY. Draft Taxation Determination TD 2006/D41

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1 JOINT SUBMISSION BY The Institute of Chartered Accountants in Australia, CPA Australia, National Institute of Accountants, The Taxation Institute of Australia and Taxpayers Australia Draft Taxation Determination TD 2006/D41 Income tax: consolidation: subsidiary in liquidation - for the purposes of subsection (1) of the Income Tax Assessment Act 1997, is the amount of an unsatisfied liability owed to another member of the consolidated group ('intra-group liability') by a subsidiary member at the time it is deregistered equal to the market value of the corresponding asset of that other member? Date: 17 November 2006 The Professional Bodies welcome the opportunity to comment on Draft Taxation Determination TD 2006/D41 ( the Draft Determination ). GENERAL COMMENTS Overall, we reiterate that it is our view that the draft determination does not accord with the overall policy of Part 3-90 of the Income Tax Assessment Act We note that the professional bodies submitted this view in our submissions on draft determinations TD 2006/D1 and 2006/D2. We note that the ATO ignored all points raised in those submissions as, essentially, no changes were made to those determinations. We have also reviewed the responses by the ATO to those submissions which effectively disagree with all points raised by the professional bodies. We again reiterate our concerns. We further note that the ATO have concluded that CGT event L5 can therefore apply in respect of a deregistration of an entity. We do not agree with this view, and put forward additional points to the contrary. We believe the ATO views do not correspond with the legal and accounting requirements of a deregistration of an entity. A summary of our concerns are outlined below. 1. Accounting treatment of liabilities on an involuntary deregistration We note the accounting analysis provided in TD 2006/59 is fundamental to the conclusions in both TD 2006/D41 and TD 2006/D42. However, that analysis of the relevant Statement of Accounting Concepts (SAC s) and Accounting Standards in that final determination is based on the going concern basis of preparing accounts. A company that is deregistered involuntarily would not prepare its accounts on a going concern basis. The applicable accounting standards that have been referred to would not be relevant, and it is open for the company to prepare its financial statements on an alternative authoritative basis.

2 2. Requirements for a voluntary deregistration In the case of a voluntary deregistration of a company, we highlight the important fact that a company cannot be deregistered voluntarily when liabilities exist. Such a case would contravene the Corporations Act. Accordingly, in a voluntary deregistration case, we cannot see the relevance of the operation of section (as no liabilities can exist where a company is to be deregistered). If liabilities were found to exist, this would enable the company to be reinstated with the effect that it had never been deregistered (in accordance with TD 2006/D39). Once again, in the latter case, this would provide no relevant application of section , as the entity would still be considered a member of the tax consolidated group. 3. Interaction with subsection (8) The Draft Determination does not consider the application of subsection (8). As a large number of cases will require the operation of this subsection, we believe that it is imperative that the final Determination provide an analysis of the interaction of with subsection (4). In this regard, we believe that any adjustment under subsection (8) would only adjust the starting amount, which would then be subject to the adjustment in subsection (4). We believe (4) will still have the effect of aligning the exit ACA step 4 amount with the market value of the corresponding asset of the other group member. An alternative view would result in a different outcome as compared to a debt forgiveness as outlined in TD 2004/65, and accordingly would not be consistent with the policy of subsection (8). SPECIFIC COMMENTS Accounting treatment of liabilities in an involuntary deregistration We note the ATO view that is contained in TD 2006/59 in respect of the accounting treatment of liabilities for a deregistered entity. We do not agree with this view provided by the ATO in respect of an involuntary deregistration. Where a company is deregistered involuntarily, it will generally be the case that the company will not be considered a going concern. We refer to AASB 101, para 23 which states: 23. When preparing financial reports, management shall make an assessment of an entity s ability to continue as a going concern. Financial reports shall be prepared on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity s ability to continue as a going concern, those uncertainties shall be disclosed. When the financial report is not prepared on a going concern basis, that fact shall be disclosed, together with the basis on which the financial report is prepared and the reason why the entity is not regarded as a going concern. Per the Auditing Standard AUS 708 Going Concern, at para , the liquidation basis would be used to prepare the financial statements of the relevant company where the going concern basis is not appropriate.

3 .08 When it is clear that an entity will not continue as a going concern, its financial report would ordinarily be prepared on a liquidation basis. In these circumstances, the realisation value of assets assumes importance, additional liabilities may accrue, for example provisions in respect of redundancy payments, and the current versus noncurrent classification of liabilities becomes less critical than the seniority features of debt and other preferences in liquidation. On 1 July 2006, AUS 708 was replaced with ASA 570 Going Concern. At para 45, the audit standard allows the accounts to be prepared on an alternative authoritative basis. 45 When the entity s management has concluded that the going concern assumption used in the preparation of the financial report is not appropriate, the financial report needs to be prepared on an alternative authoritative basis. If on the basis of the additional audit procedures carried out and the information obtained the auditor determines the alternative basis is appropriate, ordinarily the auditor can issue an unqualified opinion if there is adequate disclosure but may require an emphasis of matter in the auditor s report to draw the user s attention to that basis. Furthermore, we refer to AASB Framework for the Preparation and Presentation of Financial Statements, which, at para 91, states that: A liability is recognised in the balance sheet when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably. In accordance with TD 2006/58, deregistration results in the leaving of a subsidiary member at the time of deregistration. Under subsections 509(5) and 601AC(2) of the Corporations Law, ASIC deregisters a company following winding up at the end of the 3 month period after the return for the final meeting is lodged by the liquidator. This is consistent with the view provided by the ATO in TD 2000/7. At this time, and where accounts are not prepared on the going concern basis, the following two conditions (per the AASB framework) are not satisfied: the probability test an outflow of economic benefits will result test. Unsatisfied liabilities will not meet the recognition criteria at the time of deregistration. Therefore, under the liquidation basis of preparing the accounts, at the time of deregistration (i.e. after the 3 month period) an entity would not be required to record a liability in the statement of financial position in accordance with AASB 101. Accordingly, we do not agree with the conclusions raised by the ATO that a company will have outstanding accounting liabilities at the time of deregistration where the deregistration is an involuntary deregistration. Requirements for a voluntary deregistration The conclusions raised by the ATO, in taxation determinations TD 2006/58, 2006/59, and draft determinations TD 2006/D41 and TD 2006/D42, make no reference to the requirements of deregistration under the Corporations Act 2001.

4 In the case of a voluntary deregistration of a company, section 601AA provides that certain requirements need to be satisfied. In particular, subsection (2) only allows an application to be made where, under paragraph (e), the company has no outstanding liabilities. Accordingly, a company that is deregistered is taken to have no liabilities in order for the deregistration to be legally effective. On deregistration the company ceases to exist and all the company's property vests in ASIC under section 601AD. However, if the condition in paragraph (e) is held not to be true (i.e. liabilities existed at the time of deregistration), then ASIC may reinstate a company if it is satisfied that the company should not have been deregistered or the court so orders this under subsections 601AH(1) and (2). If a company is reinstated it is taken to have continued in existence as if it had not been deregistered under subsection 601AH(5). The effect of subsection 601AH(5) was considered in the case of re Future Life Enterprises Pty Ltd (1994) 33 NSWLR 559. In that case, it was held that the effect of reinstatement was for all purposes and was not limited. The following quote has been taken from that case. By subs (5) the court is empowered to "give such directions and make such provisions... as seem just for placing the company and all persons in the same position, so far as possible, as if the company's registration had not been cancelled". None of these provisions provide any warrant for a limitation to be placed on the effect of the reinstatement of a company. A company either exists or it does not exist. It cannot exist for some purposes and not exist for others. Accordingly, if a company were to be reinstated, it would also exist for all purposes, which would not exclude provisions contained in the Income Tax Assessment Act (i.e. including the tax consolidation provisions). We note that the ATO has, in principle, agreed with this view, with the issue of the draft determination TD 2006/D39. This would therefore lead to the conclusion that the company would have always existed for the purpose of being a member of the tax consolidated group under section Furthermore, this would also result in there being no CGT event L5 gain, as the conditions in subsection 711-5(1) would never have been satisfied (i.e. the company would not cease to be a subsidiary member of the consolidated group). In conclusion, the existence of a liability in a voluntary deregistration case is contrary to the strict legal requirements of the Corporations Act. In the case that the ATO would to apply CGT event L5 in the case of a voluntary deregistration of a company (as explained in TD 2006/D42) this would provide cause for a company to be reinstated, which would in turn result in CGT event L5 not applying. We believe that the approach adopted by the ATO appears to be significantly flawed in the case of a voluntary deregistration, as outlined above. We do not believe that the conclusions drawn in these determinations (and especially in draft determination TD 2006/D42) can be made without addressing this issue.

5 Interaction with subsection (8) Background We note the conclusions raised in the draft determination appear appropriate (i.e. in most circumstances, the market value of such a debt would be equal to nil). However, we do not believe that the ATO can conclude on section without addressing subsection (8). In most cases, intra-group debts will consist of liabilities that were there on entry. We believe that, in the context of a deregistration of a company, it is critical to include an analysis of the operation of this provision and the possible implications. The following example demonstrates the possible issue that would occur if the ATO were to take the view that subsection (8) were to apply to the deregistration of a company. Example 1 Aco is the head company of a tax consolidated group. Aco owns 100% of the shares in Bco. The balance sheet of Bco is as follows. Assets Liabilities and Equity Cash $100 Loan from Aco $500 Share capital $100 Accumulated. Losses ($500) Total $100 $100 On deregistration, Bco distributes all assets to Aco (i.e. the $100 cash). The loan from Aco remains unpaid. The market value of the loan on deregistration is $0. Per draft determination TD 2006/D41, subsection (4) results in no amount being included in Step 4 of the exit calculation. However, assume in Example 1 that the $500 loan was there on entry, and that Division 705 was used to calculate the ACA of Bco. There is a question as to whether subsection (8) will adjust the liability amount for the purpose of the Step 4 of the exit calculation. Subsection (8) was introduced by Tax Laws Amendment (2004 Measures No. 7) Act 2005 and (per the EM at para 6.11) was inserted to ensure that where the same liability (i.e. excluding any new liabilities) that was brought into a consolidated group leaves, the value of that liability should be the same at both the joining time and the leaving time. We understand that the ATO and Treasury are still considering the operation of subsection (8).

6 There are three tests in subsection (8). These are outlined below and are applied to the example: Test Para (a) - A leaving liability was taken into account in working out the ACA of the leaving subsidiary Para (b) the amount of the liability taken into account on entry (entry amount) is different to the amount taken into account on exit (exit amount) Para (c) the entry ACA was different to what it would have been had the exit amount been used instead. Application Yes Yes due to the market value rule in subsection (4) Yes Step 2 on entry would have been reduced by $500. As all of the conditions are satisfied, the consequence of subsection (8) is that for the purpose of applying the subsection, the liability is taken to be of an amount equal to the entry amount. In relation to subsection (4), the EM provides a brief description of the intended consequence at para Subsection (8) adjusts the amount of the liability that is used as the starting point for the application of any of the other subsections in section For example: in applying subsection (4), it is necessary to work out the market value of the asset that corresponds to the liability on the assumption that the amount of that liability is equal to the entry amount. The explanation provided by the EM is not entirely clear, and accordingly this could result in two interpretations. The first is that subsection (8) simply adjusts the starting amount of the liability. Accordingly, the starting position ($500) still has a market value of nil, and is reduced to nil under subsection (4). The second view is that subsection (8) adjusts the subsection (4) amount to $500 and that this becomes the exit value. Implications of the two alternative views For an intragroup debt, the first view provides for the correct outcome in the deregistration of a company. In this case, the deregistration of a company would not result in CGT event L5 in respect of the intra-group debt. The second view would appear to result in an inappropriate outcome when compared to a case where the debt is forgiven prior to deregistration of the company. That is, the second view would result in a Step 4 amount of $500 and a CGT event L5 capital gain of $500. This should be compared to the result of a debt forgiveness, as outlined in TD 2004/65. In this determination, the ATO conclude that a forgiveness of an intra-group debt would not result in CGT event L7. Subsection (8) is clearly intended to provide for outcomes that are the same as CGT event L7. This intention is stated in the EM to the introduction of subsection (8) The purpose of the alignment in the value of particular liabilities on exit with their value on entry is to ensure that there is a consistent outcome with what would have occurred if the relevant liability had been discharged and CGT event L7 had been triggered.

7 We therefore believe that the first view is the appropriate view, given the intention of subsection (8). We believe that it is critical that the ATO confirm this in the final Determination. Additional implications If the ATO do not agree with the first view, then we request the ATO to consider the implications in relation to the receivable that is held by the other consolidated group member. In Example 1, Aco holds a receivable of $500. In accordance with section and the table in section , item 3, the asset is set with a tax cost equal to its market value. Aco is provided with a cost base of nil. Accordingly, Aco will not be able to realise a capital loss in relation to the receivable even though a capital gain was derived under CGT event L5 in relation to the deregistration of the subsidiary. Accordingly, we believe that the first view is the correct view in the case of the deregistration of a company, and strongly request the ATO to provide such commentary in the final taxation determination to avoid all doubt in relation to this critical issue. Furthermore, if the ATO were to take an alternative view, we request that the ATO ensure that this issue is included in any discussion with Treasury on the application of subsection (8), as contained in the ATO s T list of issues 1. 1 Refer to