Jenny Wong explains what is known as the ‘churning measures’ and how they affect foreign owned groups under the new Consolidation Integrity Measures.
What is known as the 'churning measures' are now contained in new Exposure Draft legislation (see my previous article on treatment of liabilities) and will affect foreign owned groups that sell their non-land rich Australian subsidiaries to other members of the Australian tax consolidated or Multiple Entry Consolidated (MEC) group and potentially would get a step up in the tax cost of their assets.
Essentially, the new proposals will wipe out the step up in the tax cost of the Australian subsidiary’s assets when the Australian subsidiary is sold by the foreign owner to the Australian group because no capital gains tax consequences arise for the foreign owner because shares being disposed of are not land rich (Div 855) that broadly occurs after 14 May 2013 (yes, retrospective). These measures were a result of Recommendation 5.6 of the Board of Taxation’s June 2012 Report.
Specifically, the new provisions ‘switch off’ the tax cost setting rules for the subsidiary member at the joining time so that the subsidiary member retains the tax value of its assets. It’s pretty technical and there are a few conditions that need to be met and it’s best to illustrate by way of example:
So Target Co doesn’t get an uplift in the tax cost of its assets at the joining time because it meets the following conditions under the new rules (s716-440) in the Exposure Draft:
Target Co became a subsidiary member of a consolidated group (with Head Co as head company) at the joining time (1 September 2019)
Foreign Resident Co ceased to hold membership interests in Target Co on 1 September 2019 which is during the test period. The test period is a period of 12 months ending just after the joining time (1 September 2019)
Capital Gains Tax (CGT) Event A1 happened as a result of Foreign Resident Co ceasing to hold membership interests in Target Co and the capital gain (or capital loss) was disregarded under Div 855.
If the churning measure did not apply, the tax cost of Target Co’s assets would be reset under the consolidation entry tax cost setting rules
Foreign Resident Co, as the control entity, maintained a total participation interest of at least 50 percent in the Target Co throughout the test period (actually 100 percent) comprising of a direct participation interest of 100 percent at the beginning of the test period and at the end of the test period, Foreign Resident Co had an indirect participation interest of 100 percent.
Note the last condition (in s716-440) does not apply i.e. if the control entity is not the disposing entity, it is reasonable to conclude that the sum of the total participation interests held by the control entity and its associates in the disposing entity was 50 percent or more at the time the CGT event happened. Foreign Resident Co is the controlling entity and the disposing entity so this provision is irrelevant.
If you have this sort of restructuring that is happening or has happened, you should review the Exposure Draft and assess the impact on your tax costs of your Australian subsidiary’s assets. Interestingly, the new rules don’t switch off taxation of financial arrangements (TOFA) liabilities. Please raise any issues for a submission with me or your tax advisor by 6 October 2017.