Consolidation: allocable cost amount and the TOFA transitional balancing adjustment

Where: • an entity becomes a subsidiary member of a consolidate group as a result of a 100% acquisition of its membership interests at the particular time; and • under the entry history rule in section 701-5 of the Income Tax Assessment Act 1997 (ITAA 1997), the head company inherits that entity's deductions in respect of the transitional balancing adjustment (TBA) made under sub-item 104(13) of Schedule 1 to the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 (TOFA Act) in calculating the entry allocable cost amount (ACA) under section 705-60 of the ITAA 1997, does the step 7 calculation in section 705-115 of the ITAA 1997 include an amount in respect of the inherited TBA deductions?

Yes. The step 7 calculation in section 705-115 of the ITAA 1997 includes an amount in respect of the inherited TBA deductions in calculating the ACA under section 705-60 of the ITAA 1997.

A Co (who is not a member of a consolidated group) acquired financial arrangements before 1 July 2010.

The taxation of financial arrangements (TOFA) rules in Division 230 of the ITAA 1997 applied to A Co from 1 July 2010.

A Co made an election, under sub-item 104(2) of Schedule 1 to the TOFA Act, to apply Division 230 of the ITAA 1997, from 1 July 2010, to its existing financial arrangements. As a result, A Co had amounts it could deduct in respect of the TBA.

H Co, a head company of a consolidated group, acquired 100% of the membership interests in A Co on 1 July 2011. At that time, A Co became a subsidiary member of the consolidated group.

Under the entry history rule in section 701-5 of the ITAA 1997, H Co inherited the amounts to be deducted after the joining time in respect of the TBA.

All legislative references are to the ITAA 1997.

Section 705-115 contains the rules for working out the amount (the step 7 amount) that is subtracted at step 7 in calculating the ACA for a joining entity under section 705-60. The step 7 amount concerns certain deductions that the head company becomes entitled to. The purpose of step 7 is to prevent the joined group from getting benefits from both higher tax cost setting amounts for the joining entity's assets and the deductions inherited by the head company.

Step 7 includes deductions covered by subsection 705-115(2) which are any deductions to which the head company becomes entitled to under the entry history rule in section 701-5, other than deductions for expenditure: • that is, forms part of or reduces, the cost of assets of the joining entity that become assets of the head company because the single entity rule in subsection 701-1(1) applies; or • to which section 110-40 (about expenditure on assets acquired before 7.30 pm on 13 May 1997) applies; or • to the extent that the expenditure reduced the undistributed profits comprising the step 3 amount in the table in section 705-60.

The inherited TBA deductions in question come within the deductions covered by subsection 705-115(2) and none of the exclusions contained in the subsection apply.

Subsection 705-115(1) makes a distinction between 'owned deductions' and 'acquired deductions'. In essence, owned deductions are deductions covered by subsection 705-115(2) that accrued to the joined group and acquired deductions are deductions covered by subsection 705-115(2) other than owned deductions.

As H Co did not own any membership interests in A Co before the joining time on 1 July 2011, the inherited TBA deductions are acquired deductions.

Consequently, under the formula in subsection 705-115(1), the step 7 amount is calculated by multiplying the inherited TBA deductions by the corporate tax rate.