Issue
The head company of a consolidated group is treated as a life insurance company. The consolidated group includes two subsidiary members that are unit trusts. The first unit trust is held under the virtual PST of the head company. The underlying assets of this unit trust are segregated to support virtual PST life insurance policy liabilities. The underlying assets of the second unit trust are not segregated and form part of the ordinary assets of the head company. That unit trust can be said to be held under the 'ordinary component' of the head company.
Each trust will issue an additional unit to the other component of the head company's life insurance business resulting in each trust ceasing to be a subsidiary member of the consolidated group.
When these unit trusts cease to be subsidiary members of the consolidated group and the units are recognised for income tax purposes: (a) Will there be any taxable capital gains or losses under either CGT event A1, Division 320 of the Income Tax Assessment Act 1997 (ITAA 1997) or on application of any other CGT event arising from the disposal of the underlying assets by the head company as a result of the unit trusts leaving the consolidated group? (b) Will the head company derive any assessable income, or incur any deductible losses or outgoings (under ordinary concepts) in respect of the underlying assets as a result of the unit trusts leaving the consolidated group?
Decision
(a) No. There will not be any taxable capital gains or losses (under either CGT event A1, Division 320 or on application of any other CGT event) arising from the disposal of the underlying assets by the head company as a result of the unit trusts leaving the consolidated group. (b) No. The head company will not derive any assessable income, or incur any deductible losses or outgoings (under ordinary concepts), in respect of the underlying assets as a result of the unit trusts leaving the consolidated group.
Facts
Head Co is the head company of a consolidated group. Under section 713-505 of the ITAA 1997, Head Co is treated as a life insurance company for the purposes of applying the income tax law.
Investment policies are issued to trustees of superannuation funds and to ordinary (non-superannuation) policyholders. The assets supporting these policies are held through two subsidiary member unit trusts: • Trust V is held under the virtual PST. In accordance with Division 320 of the ITAA 1997, the underlying assets of this unit trust are segregated to support virtual PST life insurance policy liabilities, and • Trust O is held under the 'ordinary component'. The underlying assets of this unit trust are not segregated and form part of the ordinary assets of Head Co's life insurance business.
It is proposed to issue an additional unit from each unit trust to other 'components' of Head Co for market value, namely: • One unit will be issued by Trust V to the 'ordinary component' of Head Co; • One unit will be issued by Trust O to the virtual PST of Head Co.
Therefore, in accordance with subsection 713-510(2) of the ITAA 1997, Trust V and Trust O will cease to be subsidiary members of the consolidated group.
Reasons for Decision
Section 6-1 of the ITAA 1997 provides that assessable income consists of: • Ordinary income, being income according to ordinary concepts (see section 6-5 of the ITAA 1997); and • Statutory income, being amounts included in assessable income by a specific provision of the Act (see section 6-10 of the ITAA 1997).
Under subsection 104-10(1) of the ITAA 1997, CGT event A1 happens if you dispose of a CGT asset.
Subsection 104-10(2) of the ITAA 1997 provides that: You dispose of a *CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law... * denotes a term defined in section 995-1 of the ITAA 1997.
When the unit trusts cease to be members of the consolidated group, the respective tax cost setting amounts for the group's membership interests in the unit trusts will be set by section 701-15 of the ITAA 1997.
This cost setting process does not set the tax costs of the underlying assets of a leaving entity but rather is a mechanism used to set the tax costs of membership interests in a leaving entity.
Therefore, any unrealised gains or losses on the underlying assets of the unit trusts that exit the consolidated group will be reflected in any realised gains or losses on the future disposal of the membership interests (being the units in the unit trusts).
The exit of the unit trusts from the consolidated group will not cause a change in ownership of the underlying assets of those unit trusts. Although the unit trusts will cease to be members of the consolidated group, the head company will continue to hold all the units in those trusts and will therefore continue to have a beneficial interest in the underlying assets of the unit trusts.
CGT event A1 will only happen where there is a change in the ownership of the units in the unit trusts from a member of the consolidated group to another entity or person outside the group.
No other CGT events apply in respect of the unit trusts ceasing to be subsidiary members of the consolidated group.
Among other things, Subdivision 713-L of the ITAA 1997 sets out special rules for the head company of a consolidated group where a life insurance company is a subsidiary member of the group. In particular, section 713-505 treats the head company as a life insurance company. It states: This Act, and the Income Tax Rates Act 1986, apply to the head company of a consolidated group as if it were a life insurance company for an income year if one or more life insurance companies are subsidiary members of the group at any time during that year.
This rule ensures that the special provisions in the income tax law (such as Division 320 of the ITAA 1997) that apply to life insurance companies will continue to apply to the consolidated group. (see paragraph 1.10 of Explanatory Memorandum to the New Business Tax System (Consolidation and Other Measures) Bill (No. 2) 2002)
Section 320-15 of the ITAA 1997 specifically includes additional amounts in the assessable income of life insurance companies. Additionally, Subdivision 320-C specifies particular deductions that are available to a life insurance company.
The exit of the unit trusts from the consolidated group and the recognition of the units for tax purposes, will not give rise to additional amounts (in respect of the underlying assets) being included in the assessable income of the head company by virtue of section 320-15 of the ITAA 1997.
Similarly, the exit of the unit trusts will not give rise to particular deductions, in respect of the underlying assets, being available to the head company by virtue of Subdivision 320-C of the ITAA 1997.
Despite the exit of the unit trusts from the consolidated group, the units in the trusts and any underlying assets held according to the terms of the trusts will continue to be beneficially owned by the head company.
Whilst the exit of unit trusts from the consolidated group will not directly result in the production of assessable income or deductible losses or outgoings under Division 320 of the ITAA 1997, there may be Division 320 consequences arising under section 320-180 of the ITAA 1997 because of a valuation of virtual PST assets and virtual PST liabilities under section 320-175 of the ITAA 1997.
The exit of the unit trusts will mean that the single entity rule under section 701-1 of the ITAA 1997 will no longer apply to those unit trusts. The membership interests in those unit trusts will be recognised for income tax purposes. Consequently, for the purposes of Division 320 and segregation of assets, the virtual PST assets of the head company will include the membership interests (being units) in the unit trusts.
Under subsection 6-5(1) of the ITAA 1997, your assessable income includes income according to ordinary concepts, which is called ordinary income.
In accordance with subsection 6-5(2) of the ITAA 1997: If you are an Australian resident, your assessable income includes the *ordinary income you derived directly or indirectly from all sources, whether or not in or out of Australia, during the income year.
Subsection 8-1(1) of the ITAA 1997 provides that: You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
The exit of the unit trusts from the consolidated group will not produce any income assessable under subsection 6-5(1) of the ITAA 1997, nor will it produce any loss or outgoing deductible under subsection 8-1(1) in respect of the underlying assets.
Although the unit trusts will cease to be subsidiary members of the consolidated group, the units in the trusts and the underlying assets held according to the terms of the trusts will continue to be beneficially owned by the head company.