Consolidation: disposal of intra-group asset - traditional security that is a debt

Where a traditional security: • that is in substance a debt • is issued by a subsidiary member of a consolidated group to a non-group entity

is acquired back by the head company of that group and later sold to a non-group entity, does section 26BB or section 70B of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the head company of that group in relation to the sale of that intra-group asset?

No. Neither a gain nor a loss will arise under sections 26BB or 70B of the ITAA 1936 respectively to the head company of a consolidated group from the sale of this intra-group asset. The relevant transaction is in substance equivalent to the head company's borrowing of money or the obtaining of credit from another entity, and therefore, has the equivalent effect of issuing a security that is a debt.

As part of an arrangement, an Australian resident entity that is a member of a consolidated group will issue two debt instruments to an entity that is resident offshore (the offshore entity) in return for the face value of the each of the debt instruments.

The interest rate applicable to the debt instruments is between 0% and 0.5%.

Each debt instrument constitutes a traditional security.

Immediately after their issue, the offshore entity will then sell the securities back to the head company of the consolidated group for the face value of each debt instrument.

At the end of this arrangement, or at the occurrence of specified events terminating the arrangement, the head company of the consolidated group will sell the debt instruments back to the offshore entity for the face value of each debt instrument, plus any payable or accrued unpaid interest.

When the head company acquires the traditional securities that were issued to the offshore entity by the member of the group, they become intra-group assets (that is, assets where the rights and obligations are between members of a consolidated group). At that time, the Single Entity Rule (SER) in section 701-1 of the Income Tax Assessment Act 1997 (ITAA 1997) operates such that these intra-group assets are not recognised for income tax purposes during the period that they are held within the consolidated group (see Taxation Ruling TR 2004/11 subparagraph 8(c)).

When the head company sells the traditional securities back to the offshore entity, as the traditional securities are in substance debt instruments, the principle provided in Taxation Determination TD 2004/33 will apply. From the head company's perspective, it has entered into an arrangement where there is a creation of a liability to pay an amount to a third party. In other words, the relevant transaction is, in substance, equivalent to the head company's borrowing of money or the obtaining of credit from another entity, and therefore has the equivalent effect of issuing a security that is a debt.

This is also consistent with the principles provided in Taxation Determination TD 2004/84 which deals with the application of Division 16E of the ITAA 1936 to the assignment of the principal of an intra-group debt. The disposal concept in sections 26BB and 70B of the ITAA 1936 is equivalent to the transfer concept in Division 16E of the ITAA 1936 and the issue concept and the transfer concept are mutually exclusive in Division 16E. As the ATO view expressed in the above taxation determination is that the assignment of an intra-group debt that effectively amounts to the borrowing by the head company is the issue of a security, it cannot amount to the transfer of a security for Divisions 16E purposes. Therefore, it cannot amount to the disposal of a security for the purpose of sections 26BB or 70B of the ITAA 1936.