Issue
When a subsidiary member leaves a consolidated group, are liabilities that are extinguished by virtue of the transaction that causes the entity to leave the group (being the issue of shares in that entity to an entity outside the group), included at step 4 of the calculation of allocable cost amount (ACA) under section 711-20 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
Yes. When the subsidiary member leaves the consolidated group, liabilities that are extinguished by virtue of the transaction that causes the entity to leave the group (being the issue of shares in that entity to an entity outside the group) are included at step 4 of the calculation of ACA under section 711-20 of the ITAA 1997.
Facts
A Co is the head company of a consolidated group and Sub Co is a subsidiary member of that group. The group consolidated on 1 July 2003.
At the joining time Sub Co recognised in its statement of financial position a $100 loan liability owed to creditor A (an entity outside the consolidated group).
On 1 July 2004, the directors of Sub Co resolved to issue new shares to creditor A in full satisfaction of the outstanding debt and signed Directors Minutes to that effect.
On 2 July 2004 new shares in Sub Co are issued and registered to creditor A, and Sub Co ceases to be a subsidiary member of the consolidated group.
The issue of the shares extinguished the liability of Sub Co and also caused the Sub Co to leave the group.
Immediately prior to the issue of the new shares, Sub Co had a $100 loan liability owing to creditor A.
Reasons for Decision
When an entity (the leaving entity) ceases to be a subsidiary member of a consolidated group the tax cost of each membership interest in the leaving entity that the head company of the group holds in the entity is set just before the entity ceases to be a member of the group at its tax cost setting amount (see section 701-15 of the ITAA 1997).
The tax cost setting amount of each membership interest in the leaving entity is worked out by determining the head company's ACA for the leaving entity in accordance with the five step process (the exit ACA process) set out under section 711-20 of the ITAA 1997. The ACA is then allocated in accordance with section 711-15 of the ITAA 1997 (where there are no multiple exits) or section 711-55 of the ITAA 1997 (where there are multiple exits).
The ACA process on exit aligns the cost of membership interests in a leaving entity with the cost of the net assets in the entity at the leaving time (see subsections 701-15(2) and 711-5(2) of the ITAA 1997). The cost of the net assets is the cost of the leaving entity's assets at the leaving time reduced by the amount of its liabilities (see subsection 711-5(3) of the ITAA 1997).
For the purposes of aligning the cost of the net assets with the cost of the membership interests, all the assets and liabilities in the leaving entity must be considered just before the entity ceases to be a subsidiary member of the consolidated group.
At issue in the present case is the amount worked out under step 4 of the exit ACA process. Step 4 subtracts from the total of the previous three steps of the calculation, amounts in respect of accounting liabilities of a leaving entity at the leaving time, as well as particular amounts that are treated as liabilities of the leaving entity under the exit ACA rules. The liabilities subtracted are the liabilities that can or must be identified in the statement of financial position of the leaving entity at the leaving time (see subsection 711-45(1) of the ITAA 1997).
The starting point in working out the step 4 amount is subsection 711-45(1) of the ITAA 1997. That subsection specifically provides that: For the purposes of step 4 in the table in subsection 711-20(1), the step 4 amount is worked out by adding up the amounts of each thing (an accounting liability ) that, in accordance with accounting standards, or statements of accounting concepts made by the Australian Accounting Standards Board, is a liability of the leaving entity at the leaving time that can or must be identified in the entity's statement of financial position. (emphasis added)
Subsection 711-5(1) of the ITAA 1997 introduces the concept of the leaving time and states: This Division [Division 711] has effect....if an entity (the leaving entity ) ceases to be a subsidiary member of a consolidated group (the old group ) at a particular time (the leaving time ).
The phrase 'leaving time' takes its meaning from context. Even though: • subsection 711-5(3) of the ITAA 1997 appears to draw a distinction between 'just before the leaving time' and 'the leaving time', and • step 4 in the table in subsection 711-20(1) of the ITAA 1997 refers to 'liabilities that the leaving entity takes with it when it ceases to be a subsidiary member' we consider that on a purposive construction of Division 711 of the ITAA 1997 having regard to the object set out in subsection 711-5(2) of the ITAA 1997, the words 'at the leaving time' in Division 711 cannot be construed as the point in time when the entity has left the group.
The context for subsection 711-45(1) of the ITAA 1997 is the preparation of a notional statement of financial position (balance sheet) for the leaving entity by applying accounting standards and other authoritative pronouncements of the Australian Accounting Standards Board. At the leaving time, in the context of subsection 711-45(1), means just before the leaving entity ceases to be a subsidiary member of the consolidated group. This interpretation accords with the tax cost setting process on exit which is to set the tax cost of the membership interest just before the entity ceases to be a subsidiary member (see subsection 701-15(3) of the ITAA 1997).
Accordingly, as the $100 loan liability is an accounting liability that can or must be identified in Sub Co's notional statement of financial position immediately before it ceased to be a subsidiary member of the consolidated group, it is subtracted at step 4 of the exit ACA process.