Issue
Does A, the head company of a consolidated group, which has, over a period of time, acquired 100% of the membership interests in B, the head company of another group, meet the conditions for exemption from the application of subsection 705-47(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provided by paragraph 705-47(5)(b) of the ITAA 1997 in that A and B were not associates just before the joining time?
Decision
No. Because of the period of time taken by A to acquire 100% of the membership interests of B, for the purposes of subsection 705-47(5) of the ITAA 1997, A is an associate of B just before the joining time.
Facts
B is the head company of the B consolidated group which was formed on 1 July 2002.
Prior to the formation of the B consolidated group, B, an Australian resident, held a number of privatised assets that were subject to the operation of Division 58 of the ITAA 1997.
A, an Australian resident, is the head company of the A consolidated group.
At 1 August 2004 A held approximately 5% of the interests in B, acquired on-market, and announced its intention to acquire 100% of the interests in B through an off-market takeover bid.
As at 1 October 2004, A held an ownership interest of 75% in B and on 31 October 2004, A announced that its off-market take-over bid had closed and that compulsory acquisition of the outstanding interests in B would proceed. At that time it held approximately 95% of the interests in B.
It was decided that B would join the A consolidated group upon A acquiring 100% of the interests in B on 1 December 2004.
Reasons for Decision
Division 58 of the ITAA 1997 sets out the rules for calculating deductions for the decline in value of, and balancing adjustments for, depreciating assets previously owned by, or purchased from, a tax-exempt entity. Broadly, Division 58 applies where a tax-exempt entity becomes taxable to any extent (an 'entity sale') or, as in this case, where a taxable entity acquires depreciating assets from an exempt entity in connection with the acquisition of a business from the exempt entity (an 'asset sale').
The effect of Division 58 of the ITAA 1997 is to limit the first element of the cost of a privatised asset. As tax exempt entities are not subject to balancing charge events, the absence of Division 58 would potentially enable values to be shifted into depreciating assets and higher tax benefits to be claimed by the newly privatised business. Division 58 ensures that the depreciation deductions are capped until such time as the privatised asset is disposed of in an asset sale and a special balancing adjustment (SBA) occurs. Where the asset is disposed of in an entity sale, prior to the SBA occurring, the depreciation deductions remain capped.
Section 705-47 of the ITAA 1997 was introduced to ensure the appropriate interaction of Division 58 of the ITAA 1997 with the consolidation provisions of that Act. Where a company holds a privatised asset at the time of consolidation, the cost allocated to that asset is restricted, for depreciation purposes, by reference to the Division 58 capped amount. Section 705-47 also applies to limit the cost of a privatised asset held by a consolidated group which joins another consolidated group.
However, exemption from the application of subsection 705-47(2) of the ITAA 1997 is provided by subsections 705-47(3) to 705-47(5) of the ITAA 1997. Paragraph 705-47(3)(a) of the ITAA 1997 is satisfied where the old head company is not an exempt entity. Paragraph 705-47(3)(b) of the ITAA 1997 then requires the conditions of either of subsections 705-47(4) or (5) of the ITAA 1997 to be met.
Under subsection 705-47(5) of the ITAA 1997, the head company of the earlier group needs to have held the asset for more than 24 months and the purchasing entity, the head company of the joined group, just before the joining time, must not be an associate of the head company of the earlier (joining) group.
Paragraph 318(2)(d) of the Income Tax Assessment Act 1936 defines associates of a company ('primary entity') to include another entity ('controlling entity') where: (i) the primary entity is sufficiently influenced by; (A) the controlling entity; or (B) the controlling entity and another entity or entities; or (ii) a majority voting interest in the primary entity is held by; (A) the controlling entity...
A was, therefore, an associate of B at the time A held a majority voting interest (greater than 50% interest in it) and since A held 75% of the interest in B at 1 October 2004, it therefore held a majority voting interest in B at least two months before 100% ownership of B was achieved.
One of the defining terms used in the conditions of paragraph 705-47(5)(b) of the ITAA 1997 is 'just before the joining time'. The announcement of the cash take-over offer on 1 August 2004, while it is a point at which the parties were not associates, cannot be considered to be just before the joining time.
It must therefore be concluded that A, as head company of the joined consolidated group, and B, as head company of the joining group, do not meet the conditions for exemption from the application of subsection 705-47(2) of the ITAA 1997 provided by paragraph 705-47(5)(b) of the ITAA 1997, in that A and B were associates just before the joining time.