Tas Division 28 November 2008 Hobart Function and Conference Centre TAX AT THE PIER Tax consolidations for corporate groups Getting on board Written by/presented by: Ken Spence & Narelle McBride Greenwoods & Freehills Ken Spence & Narelle McBride 2008 Disclaimer: The material and opinions in this paper are those of the authors and not those of the Taxation Institute of Australia. The Taxation Institute of Australia did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests. No liability is accepted by the authors, Greenwoods & Freehills or the Taxation Institute of Australia for any action taken by any person as a result of comments in this paper.
CONTENTS 1 Entry tax value resetting Basic ACA Step 1... 4 2 Entry tax value resetting BASIC ACA Step 2... 5 3 Entry tax value resetting BASIC ACA Step 6... 6 4 Entry tax value resetting BASIC ACA STEP 7... 7 5 Entry tax value resetting Incremental acquisition ACA STEP 1... 8 6 Entry tax value resetting incremental acquisition ACA Step 3... 9 7 Entry tax value resetting incremental acquisition ACA Step 4... 11 8 Entry tax value resetting incremental acquisition ACA Step 4... 12 9 Entry tax value resetting incremental acquisition ACA Step 5... 13 10 Entry tax value resetting INCREMENTAL ACQUISITION ACA STEP 7... 14 11 Entry tax value resetting ACA allocation... 15 12 modifications To Utilisation of LOSSES... 16 13 leaving aca... 17 Ken Spence & Narelle McBride 2008 2
This paper provides basic consolidation examples and solutions covering the following components of the income tax consolidation regime: entry tax cost setting; transfer and utilisation of losses; and exit tax cost setting. These examples and solutions are intended to illustrate some basic consolidation concepts and have deliberately ignored some more complicated implications. Further, the comments contained in this paper in relation to the examples are of a general nature and specific advice should be obtained in relation to any proposed transaction. The examples and solutions are based on taxation law and other relevant material at 26 November 2008 and takes into account legislative amendments before parliament and Government policy announcements. However, it must be appreciated that tax law is subject to change, both prospectively and retrospectively. Also, relevant material is continually being released by the Australian Tax Office. Ken Spence & Narelle McBride 2008 3
1 ENTRY TAX VALUE RESETTING BASIC ACA STEP 1 1.1 Example Parent Ltd (head of company of a consolidated group) bought 100% of Sub Pty Ltd for $300 on 1/7/04. What is Sub s step 1 amount? Variation: What if, after the joining time, Parent paid a further $5 to the original Sub shareholders under an earn-out agreement? 1.2 Solution Sub s step 1 is $300 Variation: If Parent paid a further $5 after the joining time under an earn-out, Sub s step 1 would be increased by $5. Ken Spence & Narelle McBride 2008 4
2 ENTRY TAX VALUE RESETTING BASIC ACA STEP 2 2.1 Example Just before the joining time (1/7/04), Sub has: bank liability of $100 contingent liability of $50 for rehabilitation of land it occupies under a lease accrued employee annual leave of $100 deferred tax liability of $10 a liability of $10 settled for $7 after the joining time 2.2 Solution Sub s step 2 amount is $190 as follows: Item Step 2 treatment Result $ Bank Loan Include 100 Rehabilitation liability Exclude nil Accrued employee annual leave Reduce by 30% 70 Deferred tax liability Include (but see below) 10 Liability settled for different amount Include (but see below) 10 Total step 2 190 Note that when the tax costs of Sub s assets are reset, the deferred tax liability will change. This will change the step 2 amount which will then change the tax cost of Sub s assets again. This reiterative calculation is complicated and not covered in this paper. Also, when the liability is settled for $7, Parent may have a capital gain of $3 (subject to potential legislative amendment). Ken Spence & Narelle McBride 2008 5
3 ENTRY TAX VALUE RESETTING BASIC ACA STEP 6 3.1 Example Sub has an unused tax loss of $100 (pre-consolidation) that it can transfer to Parent. What is Sub s step 6 amount? Variations: What if the loss is a net capital loss? What if the loss cannot be transferred to Parent? 3.2 Solution If Sub has a pre-consolidation unused tax loss of $100 that it transfers to Parent (when it joins Parent s group on 1/7/04), its step 6 amount will be $30. This is because the loss is a pre-acquisition loss and did not accrue in a period when Parent held shares in Sub. Variations: Consolidation s loss rules also apply to carried forward net capital loss, foreign losses and film losses. Therefore, if the loss was a net capital loss, the step 6 amount would continue to be $30. Although we note that in a real case, it would be necessary to determine when the capital loss accrued (not just when it was realised for tax purposes). The step 6 adjustment is not made where the loss is not eligible to be transferred to Parent or where Parent cancels the loss. Therefore, the step 5 adjustment would be nil in this case. Ken Spence & Narelle McBride 2008 6
4 ENTRY TAX VALUE RESETTING BASIC ACA STEP 7 4.1 Example Sub entered into its bank loan on 1/7/03, paying a $10 establishment fee. What is Sub s step 7 amount? Variation: What if Sub had $100 of consumable items used and deducted after consolidation? 4.2 Solution If Sub entered into its bank loan on 1/7/03, paying a $10 fee, Sub s step 7 amount would be $2 as follows: $ Future deductions (post 1/7/04) 8 Amount not accrued to Parent 8 Step 7 adjustment (30%) 2 Variation: If Sub had $100 of consumable items deductible on a usage basis, there would be no step 7 amount for any future deduction for the items because the expenditure relates to an asset. Ken Spence & Narelle McBride 2008 7
5 ENTRY TAX VALUE RESETTING INCREMENTAL ACQUISITION ACA STEP 1 5.1 Example Parent bought 40% of Sub Pty Ltd for $100 on 1/7/03 and the remaining 60% on 1/7/04 for $200. What is Sub s step 1 amount? Variations: What if Parent was subject to Division 149 on 1/7/03 when the market value of Sub was $400? What if Parent acquired 10 options in Sub before 1/7/04 for $1 each? 5.2 Solution Sub s step 1 is $300 as follows: Cost base $ Shares acquired 1/9/85 100 Shares acquired 1/7/04 200 Total Step 1 300 Variations: If Parent was subject to Division 149 on 1/7/03, when the market value of Sub was $400, the pre- CGT shares would have a deemed cost base under Division 149 of $200 and Sub s step 1 would be $300 as follows: Cost base $ Comments Shares acquired 1/9/85 160 40% of $400 Shares acquired 1/7/04 200 Total Step 1 360 ` If Parent acquired 10 options in Sub before 1/7/04 for $1, each Sub s step 1 would be increased by $10. Ken Spence & Narelle McBride 2008 8
6 ENTRY TAX VALUE RESETTING INCREMENTAL ACQUISITION ACA STEP 3 6.1 Example What is Sub s step 3 amount? y Acquired 40% 1/7/03 Acquired 60% 1/7/04 Retained profits $100 Retained profits $700 Franking credits $300 Variations: What if the original 40% interest was acquired pre-cgt and Division 149 applied on 1/7/03? What if the retained profits at 1/7/03 were negative $100? 6.2 Solution Sub s step 3 amount is $240 as follows: Distributable profits 700 $ Notes Limit to amount accrued to Parent 240 $600 accrued in the ownership period (that is, the period that 40% of the shares were held by Parent) Limit to franking balance 240 Variations: If the original 40% interest was acquired pre-cgt and Division 149 applied on 1/7/03, Sub s step 3 amount would continue to be $240. This is because 1/7/03 is the relevant date for determining whether Sub s profits accrued to Parent. Therefore, as above, $600 of profits would have accrued in the ownership period (40% of $600 is $240). If Sub s retained profits at 1/7/03 were negative $100, Sub s step 3 amount would be $300, calculated as follows: Ken Spence & Narelle McBride 2008 9
Distributable profits 700 $ Notes Limit to amount accrued to Parent 320 The losses at the beginning of the period of ownership are ignored. Therefore, the amount accrued in the ownership is grossed up to $800. Limit to franking balance 300 Ken Spence & Narelle McBride 2008 10
7 ENTRY TAX VALUE RESETTING INCREMENTAL ACQUISITION ACA STEP 4 7.1 Example (illustrative only) Parent Ltd acquires Sub Pty Ltd for $300 Sub immediately pays a $50 dividend Parent immediately elects to form a consolidated group Sub has cash assets of $250 Should Sub s ACA be $300 or $250? 7.2 Solution If parent acquires Sub for $300 and Sub immediately pays a $50 dividend, Sub s ACA should be $250. This is effectively the cost of the shares to Parent. This is appropriate as Sub has cash assets of $250 and will have an ACA of $250. Ken Spence & Narelle McBride 2008 11
8 ENTRY TAX VALUE RESETTING INCREMENTAL ACQUISITION ACA STEP 4 8.1 Example (illustrative only) Parent Ltd acquires Sub Pty Ltd on 1/7/03 for $300 Sub has an accounting loss of $70 in the 30/6/04 year and an accounting profit of $70 in the 30/6/05 year Sub pays a dividend of $70 on 30/6/05 Parent elects to form a consolidated group from 1/7/05 Assets of Sub: 30/6/2003 30/6/2004 30/6/2005 Cash $300 $230 $230 Should Sub s ACA be $300 or $230? 8.2 Solution If Parent acquires Sub for $300 and Sub has an accounting loss of $70 that it recovers with a profit of $70 in the following year but pays a dividend out of that profit, its ACA should be $230. This is effectively the cost of the shares to Parent. This is appropriate as Sub has cash assets of $230 and an ACA of $230 to match it. Ken Spence & Narelle McBride 2008 12
9 ENTRY TAX VALUE RESETTING INCREMENTAL ACQUISITION ACA STEP 5 9.1 Example Parent acquired 40% of Sub on 1/7/03 and the remaining 60% on 1/7/04. Sub has an unused tax loss of $100 from the 30/6/04 year which it can transfer to Parent. What is Sub s step 5 amount? Variation: What if the loss cannot be transferred to Parent? 9.2 Solution If Sub has an unused capital loss of $100 for the 30/6/04 year, its step 5 amount will be $40. This is because the loss accrued while Parent held 40% of the shares in Sub. Variation: The step 5 adjustment is still made where the loss is not eligible to be transferred to Parent or where the loss is cancelled by the Parent. Therefore, if the loss cannot be transferred to Parent, the step 5 adjustment would continue to be $40. Ken Spence & Narelle McBride 2008 13
10 ENTRY TAX VALUE RESETTING INCREMENTAL ACQUISITION ACA STEP 7 10.1 Example Parent acquired 40% of Sub on 1/7/03 and the remaining 60% on 1/7/04. During the 2004 financial year, Sub entered into its bank loan, paying a $10 establishment fee. What is Sub s step 7 amount? 10.2 Solution If Parent acquired 40% of Sub on 1/7/03 and the remaining 60% on 1/7/04 and Sub entered into a bank loan on during the 2004 financial year, paying $10 establishment fee, Sub s step 7 amount would be $5 as follows: Future deductions (post 1/7/04) 8 $ Amount $ Adjustment $ Comment Amount of future deductions accrued to Parent (40%) 3 3 100% adjustment Amount of future deductions not accrued to Parent (60%) 5 2 30% adjustment Total step 7 adjustment 5 Ken Spence & Narelle McBride 2008 14
11 ENTRY TAX VALUE RESETTING ACA ALLOCATION 11.1 Example Sub s ACA is $590 and Sub has the following assets: Asset Category Tax value $ Market value $ Receivables Retained 290 290 Provision for doubtful debts n/a 0 (10) FITB re doubtful debts Reset 0 3 Depreciating assets Reset (revenue) 50 100 Land Reset 100 100 Total 440 483 What is the reset tax cost of Sub s assets? 11.2 Solution Asset Category Tax value $ Market value $ Allocation 1 $ Allocation 2 $ Receivables Retained 290 290 290 290 Provision for doubtful debts n/a 0 (10) FITB re doubtful debts Reset 0 3 4 5 Depreciating assets Reset (revenue) 50 100 148 100 Land Reset 100 100 148 195 Total 440 483 590 590 In allocation 1, the ACA is allocated to the retained cost base assets then the balance is simply allocated across the reset cost base assets based on their relative market values. In allocation 2, the reset tax cost of the depreciating (revenue) assets are limited to the greater of their existing tax value and market value. Also, the excess is reallocated to the other (non-revenue) reset cost base assets. Note that if the land was instead a building, the Division 43 cost of the building would not be reset, only the CGT cost base of Division 43 assets is reset. Ken Spence & Narelle McBride 2008 15
12 MODIFICATIONS TO UTILISATION OF LOSSES 12.1 Example If the market value of Sub Pty Ltd is $17 and the market value of Parent Ltd (consolidated) is $100, the available fraction for Sub s losses will be 0.17. If Parent issues $50 in additional shares, what are the implications for the available fraction of Sub s losses? 12.2 Solution The available fraction for Sub s losses will be diluted to 0.057 as follows: Market value of Parent just before the event 0.17 x Market value of Parent just before the event + Amount of increase in the market value of Parent as a result of the equity injection $100 = 0.17 x ($100 + $50) = 0.057 Ken Spence & Narelle McBride 2008 16
13 LEAVING ACA 13.1 Example Following examples 2, 4 and 11, what is Sub s leaving ACA? 13.2 Solution Following example 11, Sub s exit step 1 will be as follows: Asset Reset value per example 11 $ Exit value $ Comments Receivables 290 290 Provision for doubtful debts FITB re doubtful debts 5 - It is assumed the FITB did not exist at the leaving time Depreciating assets 100 100 Land 195 195 Total exit step 1 590 585 Following example 4, Sub s exit step 2 will be as follows: Step 2 Entry value per example 4 $ Exit value $ Comments Inherited deduction (2) (2) It is assumed that the leaving time is immediately after the joining time, therefore, the future deductions available are unchanged Total exit step 2 (2) Following example 2, Sub s exit step 3 will be nil as there were no intra-group liabilities in the example. Step 3 Amount $ Intra-group loans Total exit step 3 nil nil Ken Spence & Narelle McBride 2008 17
Following example 2, Sub s exit step 4 will be as follows: Step 4 Entry value per example 2 $ Exit amount $ Comments Bank loan (100) (100) Rehabilitation liability Nil Nil Accrued employee annual leave Liability settled for different amount (70) (70) 0 0 This assumes proposed amendments to the law will be legislated It was assumed this liability was settled so it is assumed it does not exist at exit Deferred tax liability (10) (10) Total step 4 (180) (180) As a result, Sub s exit ACA will be $403 as follows: Step Amount $ Step 1 585 Step 2 (2) Step 3 Nil Step 4 (180) Exit ACA 403 Ken Spence & Narelle McBride 2008 18