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No. Losses transferred to a joining entity (income company) by another member of a wholly-owned group (loss company) prior to the joining entity becoming a member of a consolidated group are not treated as losses of the joining entity accruing to the group for the purposes of subparagraph 705-95(b)(ii) of the Income Tax Assessment Act 1997 (ITAA 1997). Instead, adjustments may be made at Step 1 and/or step 2 of the allocable cost amount (ACA) for the loss company (see subsection 705-65(3) and 705-75(3) respectively). Adjustments may also be made at step 1 for the income company (see subsection 705-65(3). See paragraph 5.60 and Table 5.2 of the Explanatory Memorandum to the New Business Tax System (Consolidation) Act (No.1) 2002.

On 30 June 2001 Alpha Co is incorporated as a wholly-owned subsidiary of HCo for $100,000.00. On the same day, Beta Co is incorporated as a wholly-owned subsidiary of HCo for $100,000.00. For the year ended 30 June 2002 Alpha Co made a tax loss of $20,000.00. In the year ended 30 June 2002 Beta Co had assessable income of $20,000.00. Alpha Co transferred the tax loss to Beta Co and Beta Co made a subvention payment of $6,000.00. As a result, Beta Co's taxable income was $nil. Beta Co distributed its profit to HCo on 30 June 2002. HCo elects to form a consolidated group, effective 1 July 2002.

Alpha Co's financial position at 1 July 2002 is shown in Table 1. Table 1: Alpha Co - Financial Position at 1 July 2002 ($) Cash 86,000 Equity 100,000 Retained earnings (loss) (14,000) 86,000 86,000

Beta Co's financial position at 1 July 2002 is shown in Table 2. Table 2: Beta Co - Financial Position at 1 July 2002 ($) Cash 100,000 Equity 100,000 Retained earnings (loss) (0) 100,000 100,000

Alpha Co's ACA would be as follows: Table 3: ACA calculation for Alpha Co Step 1 Add cost of membership interests • Subsection 705-65(1): compare the cost base & reduced cost base (adjusted as appropriate under subsection 705-65(3)) and market value: • Cost base less (loss transferred minus subvention payment): 86,000 (100,000 - (20,000 - 6,000)) • Reduced cost base less (loss transferred minus subvention payment): 86,000 (100,000 - (20,000 - 6,000)) • Market value: 86,000 86,000 86,000 Step 8 ACA 86,000

When determining the step 1 amount under subsection 705-65(1), certain adjustments are required [under subsections 705-65(3), (4) and (5)] to the cost base (CB) and reduced cost base (RCB) of membership interests. In Table 3 the step 1 amount of the CB or RCB is reduced for adjustments that would have occurred under Subdivision 170-C had the membership interests been disposed of just prior to the joining time, under subsection 705-65(3). That is, the CB and RCB are reduced by the amount of the loss, net of the subvention payment.

Once the relevant adjustments are made to the CB and RCB of each membership interest, they are then compared against the market value of the relevant membership interest at the joining time. The final step 1 amount is the sum of the following amounts for each membership interest. If the market value is: • equal to or greater than its CB = use its CB; • less than CB but greater than RCB = use its market value; or • less than or equal to RCB = use RCB. In Table 3, the CB, RCB and market value for each share are equal and the shares have been grouped for convenience.

Beta Co's ACA would be as follows: Table 4: ACA calculation for Beta Co ($) Step 1 Add cost of membership interests Subsection 705-65(1) compare the cost base & reduced cost base (adjusted as appropriate under subsection 705-65(3)) and market value: • cost base plus increase in market value: 100,000 (100,000 + 0) • reduced cost base plus increase in market value: 100,000 (100,000 + 0) • market value: 100,000 100,000 100,000 Step 4 Less Pre-joining time distributions out of certain profits (0) Step 8 ACA 100,000

In Table 4, the CB and RCB used in working out the step 1 amount under subsection 705-65(1) are increased to the extent the market value of each membership interest increased as a result of the loss transfer under subsection 705-65(3). These are the adjustments that would have occurred under Subdivision 170-C had the membership interests been disposed of just prior to the joining time. In this case there was no increase in market value of Beta Co's membership interests as a result of the loss transfer because of the subvention payment made. As the market value of each membership interest is the same as both the CB and RCB, the step 1 amount totals $100,000.00.

No amount is subtracted at step 4 as transferred losses are not treated as losses covered under subparagraph 705-95(b)(ii).

The tax cost setting amount for the retained cost base asset (that is, cash) is $100,000.00. There is no shortfall or excess ACA.

When the final Determination is issued, it is proposed to apply both before and after its date of issue. However, the Determination will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Determination (see paragraphs 21 and 22 of Taxation Ruling TR 92/20).

We invite you to comment on this draft Taxation Determination. Please forward your comments to the contact officer by the due date. Due date: 20 August 2004 Contact officer details have been removed following publication of the final ruling.