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Where a company incurs a deduction in respect of the novation of a financial instrument to another entity that is a member of the same 'linked group', is the deduction to be disregarded under section 170-270 of Subdivision 170-D of the Income Tax Assessment Act 1997 ?

No. As the novation of the financial instrument does not constitute the disposal of a CGT asset under subparagraph 170-255(1)(b)(ii) of the ITAA 1997, the deduction is not disregarded under Subdivision 170-D of the ITAA 1997.

Company X entered into a financial instrument with another party. Company X subsequently novated the financial instrument to another entity.

The financial instrument constituted a CGT asset of Company X.

As a result of company X's novation of its rights and obligations under the financial instrument to another entity, Company X became entitled to a deduction.

The relevant novation agreement provided that the rights and obligations of Company X were discharged and equivalent rights and obligations were created as between the other entity and the other party to the original financial instrument.

At the time of the novation (deferral event) the other entity was not a connected entity of Company X under section 170-265 of the ITAA 1997. Company X and the other entity were linked at this time under section 170-260 of the ITAA 1997.

Where section 170-255 of the ITAA 1997 applies, a deduction (or capital loss) that would otherwise be allowable to an 'originating company' (Company X) is disregarded pursuant to section 170-270 of the ITAA 1997.

For section 170-255 of the ITAA 1997 to apply such that a deduction may be disregarded, then subparagraph 170-255(1)(b)(ii) of the ITAA 1997 must apply as follows: the deferral event would have resulted in the originating company becoming entitled to a deduction in respect of the disposal of a CGT asset or of an interest in a CGT asset;

The relevant novation agreement expressly provided that the original financial instrument between Company X and another entity was discharged, and in substitution, a new agreement on identical terms was created between the other entity and the other party to the original financial instrument.

As the novation agreement provided that the relevant CGT asset, being the original financial instrument, was discharged, rather than transferred to another entity, then no 'disposal' is taken to have occurred in respect of the CGT asset for the purposes of subparagraph 170-255(1)(b)(ii).

Accordingly, Subdivision 170-D of the ITAA 1997 does not operate to disregard the relevant deduction.

Note: This ATO Interpretative Decision is only interpreting the operation of Subdivision 170-D of the ITAA 1997 and is not interpreting the circumstances in which a deduction may arise in respect of the novation of a financial instrument.