Continuing Majority-Owned Entity Test

Can the trading stock assets of an entity that becomes a subsidiary member of a consolidated group be retained cost base assets for the purposes of Division 705 of Income Tax Assessment Act 1997 (ITAA 1997) where the subsidiary member fails to meet the requirements of section 701A-1 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A 1997)?

No. The trading stock assets of a subsidiary member are not eligible to be treated as retained cost base assets where the subsidiary member fails to meet the requirement of section 701A-1 of the IT(TP)A 1997.

From 1 July 2001, YCo (a listed Australian public company) owned 90% of the shares in ACo which held all of the shares in BCo. There has been no change to the underlying majority ownership of YCo from 27 June 2002.

On 1 July 2003 ACo and BCo form a tax consolidated group with ACo as the head company. On the same day YCo and its subsidiary members also formed a consolidated group.

On 1 July 2004 A Co acquires 100% of D Co's consolidated group of which ECo is a subsidiary member.

On 1 July 2005 ACo and its subsidiary members (BCo, DCo and ECo) join YCo's consolidated group upon YCo acquiring the remaining membership interest in ACo from ZCo.

BCo, D Co and ECo, as individual entities, hold trading stock assets just before becoming a subsidiary member of YCo's consolidated group.

The integrity measures in relation to trading stock (section 701A-5 of the IT(TP)A 1997) and internally generated assets (section 701A-10 of the IT(TP)A 1997) apply to an entity that is a continuing majority-owned entity under section 701A-1 of the IT(TP)A 1997.

An entity is a continuing majority-owned entity if that entity becomes a subsidiary member of a consolidated group on or after 1 July 2002 and a person or persons continued to be the majority owners of the entity from the start of 27 June 2002 until the entity became a subsidiary member of the group (subsection 701A-1(1) of the IT(TP)A 1997). A person or persons are the majority owners of an entity if they beneficially own, directly or indirectly through one or more interposed entities, membership interests in the entity whose market value is more than 50% of the market value of all of the membership interests in the entity (subsection 701A-1(2) of the IT(TP)A 1997).

The majority owner/s referred to in subsection 701A-1(2) of the IT(TP)A 1997 are the ultimate beneficial owners.

Paragraph 1 of Taxation Determination TD 2004/88 states that: In determining whether there has been a change in the majority ownership of an entity, for the purpose of applying the continuing majority-owned entity test in section 701A-1 of the Income Tax (Transitional Provisions) Act 1997 ('IT(TP)A 1997'), it is necessary to trace through all interposed entities to the ultimate beneficial owners of the entity.

To determine continuing majority-ownership it is therefore necessary to 'look through' a consolidated group to ascertain the ultimate beneficial owners of each individual entity that become a subsidiary member. That is, the continuing majority-owned entity test under section 701A-1 of the IT(TP)A 1997 is applied at the individual entity level since the section requires an examination of the individual entity's ultimate beneficial ownership starting from 27 June 2002 until becoming a subsidiary member of a consolidated group.

If an entity is a continuing majority-owned entity, the operation of Part 3-90 of the ITAA 1997 is modified in relation to each asset of a continuing majority-owned entity that is trading stock just before the entity becomes a subsidiary member of the entity's designated group (section 701A-5 of the IT(TP)A 1997).

In this case, it is necessary to look at ACo, BCo, DCo and ECo and test whether each individual entity is majority owned at all times from the start of 27 June 2002 until the entity became a subsidiary member of YCo's consolidated group.

There has been no change in the ultimate beneficial ownership of ACo and BCo throughout the test period. Therefore, ACo and BCo as individual entities satisfy the continuing majority-owned entity requirement under section 701A-1 of the IT(TP)A 1997.

In respect of DCo and ECo, the acquisition by ACo of the shares in DCo in 2004 means a person or persons did not continue to be the majority owners of those entities in the test period of 27 June 2002 until the entities became a subsidiary member of YCo's consolidated group. Therefore, DCo and ECo are not continuing majority-owned entities under section 701A-1 of the IT(TP)A 1997.

Even though ACo is a continuing majority-owned entity, it does not hold trading stock as an individual entity on a 'look through' basis in order for section 701A-5 of the IT(TP)A 1997 to apply. BCo on the other hand is a continuing majority-owned entity and holds trading stock as an individual entity. Thus, the trading stock assets held by BCo are eligible to be treated as retained cost base assets. The trading stock assets held by DCo and ECo are not eligible to be treated as retained cost base assets because those entities are not continuing majority-owned entities under section 701A-1 of the IT(TP)A 1997.