Issue
Does Subdivision 705-C of the Income Tax Assessment Act 1997 (ITAA 1997) apply where all the newly issued shares in a head company of a consolidated group are acquired by the head company of another consolidated group, as a result of implementing 'Demutualisation method 3' as prescribed in Division 9AA of the Income Tax Assessment Act 1936 (ITAA 1936), so that 'CGT event L5' either does not occur or is not relevant with respect to a subsidiary member of the first mentioned group?
Decision
Yes, Subdivision 705-C of the ITAA 1997 will apply where all the newly issued shares in a head company of a consolidated group are acquired by a head company of another consolidated group, as a result of implementing 'Demutualisation method 3' as prescribed in Division 9AA of the ITAA 1936, so that 'CGT event L5' will not occur with respect to a subsidiary member of the first mentioned group.
Facts
Head co is a friendly society that proposes to demutualise pursuant to section 121AH of the ITAA 1936, adopting Demutualisation method 3. Under this method, in connection with the implementation of the demutualisation: • the liability of each member and past member of Head co is extinguished; • the members cease to be members of Head co; • shares in Head co are issued to another company (Holding co); • shares in Holding co are taken to be issued to each person specified in the List*; and • each person specified in the List* becomes a member of Holding co.
List* means a list referred to in subsection 163(3) of the Corporations Act 2001 (Cth) which must accompany an application to change from a company limited by guarantee to a company limited by shares, setting out prescribed details about each person to whom shares will be issued on such change of type.
Until the time of demutualisation, Head co is a head company of a consolidated group, the members of which are Head co and one other wholly-owned subsidiary, Sub Co.
Holding co is the head company of another consolidated group.
At the point in time that the Holding co acquires all the newly issued shares in Head co, the consolidated group of which Head co is the head company ceases to exist.
Reasons for Decision
Paragraph 703-5(2)(a) of the ITAA 1997 provides that a consolidated group continues to exist until the head company of the group ceases to be a head company. The consolidated group, of which Head co is the head company, continues to exist up until the time that Head co issues all its shares to Holding co, being one of the steps involved in the adoption of Demutualisation method 3 pursuant to section 121AH of the ITAA 1936. From this point in time, Head co ceases to be a head company as it fails to satisfy all the conditions specified in Table 1 of subsection 703-15(2) of the ITAA 1997. In particular, it becomes a wholly-owned subsidiary of another company that qualifies as a head company. Consequently the consolidated group, of which Head co is the head company, ceases to exist at the point in time that Head co issues all its shares to Holding co.
Ordinarily, the tax cost of membership interests in each entity that ceases to be a subsidiary member of a consolidated group, being Sub co in this case, would be set under section 701-15 of the ITAA 1997, at an amount worked out through section 701-60 of the ITAA 1997 in accordance with Division 711 of the ITAA 1997.
However, where Subdivision 705-C of the ITAA 1997 applies, subsection 705-180(1) of the ITAA 1997 precludes the operation of certain provisions in Division 701, including sections 701-15 and 701-60 of the ITAA 1997. Subsection 705-180(1) of the ITAA 1997 states: If, because an entity ceases to be a subsidiary member of the acquired group when this Subdivision applies, a provision of Division 701 (other than section 701-25) would otherwise apply, in relation to the acquired group for the head company core purposes set out in subsection 701-1(3), the provision does not so apply.
Consequently, a tax cost is not determined for the membership interests in a leaving entity, under section 701-15 of the ITAA 1997, where Subdivision 705-C of the ITAA 1997 applies.
Subsection 705-175(1) of the ITAA 1997 provides that Subdivision 705-C of the ITAA 1997 applies if all the members of a consolidated group (the acquired group) become members of another consolidated group (the acquiring group) at a particular time (the acquisition time) as a result of the acquisition of membership interests in the head company of the acquired group.
In this case, the members of the acquired group are Head co and Sub co, the head company of which is Head co. Head co and Sub co will become members of the acquiring group when Holding co acquires all the membership interests in Head co. Consequently, Subdivision 705-C of the ITAA 1997 applies in this instance to modify the rules in Division 701 and Subdivision 705-A of the ITAA 1997 such that sections 701-15 and 701-60 of the ITAA 1997 will not apply and a tax cost is not determined for the membership interests in Sub co.
According to subsection 104-520(1) of the ITAA 1997, CGT event L5 happens where: (a) an entity ceases to be a *subsidiary member of a *consolidated group or a *MEC group; and (b) in working out the group's *allocable cost amount for the entity, the amount remaining after applying step 4 of the table in section 711-20 is negative.
In this case, the first condition required for CGT event L5 to happen is satisfied as Sub co ceases to be a subsidiary member of a consolidated group. The second condition required for the application of CGT event L5 is not satisfied because the group is not required to determine an allocable cost amount for Sub co as a consequence of the application of Subdivision 705-C of the ITAA 1997.
Consequently, CGT event L5 does not apply.