James Macky and Steve Plant discuss new tax consolidation rules that can disadvantage taxpayers.
Warning! The new churning rules, introduced when the Treasury Laws Amendment (Income Tax Consolidation Integrity) Act 2018 received Royal Assent on 28 March 2018 but effective for group restructures occurring after 14 May 2013, can significantly disadvantage taxpayers.
Broadly, the churning rules can apply when a consolidated group acquires a new subsidiary member (the Target) from a foreign related company, where that foreign related company was able to disregard any gain or loss made on the sale of the Target through the application of Division 855.
Where the churning rules apply, the head company of the joined consolidated group is not able to reset the tax cost of the assets of the Target at the joining time.
The danger for taxpayers arises because the churn rules turn off the asset cost setting rules but do not turn off the liability resetting rules in section 715-375.
Section 715-375 relates to Taxation of Financial Arrangements (TOFA), specifically those that are recognised as liabilities for accounting purposes. Broadly, section 715-375 operates to treat the head company as having been paid an amount to assume the liability, so any future TOFA gain or loss calculated by the head company in respect of the TOFA liability is by reference only to payments and receipts after the joining time.
This lack of symmetry between the asset and liability cost setting under the churning rules can create tax costs for groups completing restructures.
For example, assume the Target has a US dollar (USD) loan receivable asset. To protect against foreign currency movements, the Target entered into an USD forward contract. Due to the depreciation of the Australian Dollar (AUD), the USD loan asset increased in value, and the foreign exchange (FX) forward contract was therefore ‘out of the money’ and was recognised as an accounting liability at the joining time.
Because of the churning rules, the tax cost of the USD loan asset will not be reset, but the FX forward contract liability will be affected by section 715-375. If the asset and liability are settled immediately following the restructure, the head company would be taxed on the FX gain on the USD loan asset, but would get no deduction for the loss on the FX forward contract. So even though there is no economic gain to the Target from foreign exchange movements, the churn rules will create a tax liability for the head company.
Given this disparity, prior to undertaking transactions which are captured by the provisions taxpayers should be aware that they can still be burned through the churn.