Income tax: capital gains: if a company transfers a net capital loss under Subdivision 170-B of the Income Tax Assessment Act 1997 ('the 1997 Act'):(a) when do the adjustments required by section 170-175 or 170-180 to the cost base and reduced cost base ('RCB') of a group company's interests in the loss company or the gain company take effect; and (b) what happens if a subvention payment (loss company) or a tax benefit (gain company) that would otherwise be taken into account in determining the amount of any adjustment, is no longer reflected in the market value of an interest at the time a CGT event happens to it because the subvention payment or tax benefit has been distributed as a dividend?

Adjustments to the cost base and RCB of a group company's direct and indirect interests in the loss or gain company on the transfer of a net capital loss take effect at the end of the application year (i.e., the income year of the gain company for which the amount is transferred: subsection 170-115(1)).

An adjustment made to the cost base and RCB may have regard to an amount representing: (a) a subvention payment in relation to an interest in the loss company (section 170-175); or (b) a tax benefit arising from the transferred loss in relation to an interest in the gain company (section 170-180); except (as set out in paragraph 3) to the extent that the amount is distributed as a dividend for tax purposes and is no longer reflected in the market value of the interest at the time a CGT event happens to it.

If: (a) a CGT event happens to an interest; (b) a subvention payment or a tax benefit would otherwise be taken into account in determining the amount of an adjustment required by section 170-175 or 170-180; and (c) all or part of the increase in the value of the interest attributable to the subvention payment or tax benefit is not reflected at the time of the CGT event because the subvention payment or tax benefit has been distributed (in whole or in part) as a dividend; the distributed amount is not taken into account in making the adjustment.

We accept that an amount referable to all or part of a subvention payment or tax benefit has not been distributed as a dividend, provided the company can do either of the following: • demonstrate that the subvention payment or tax benefit (or part thereof) has not been distributed as a dividend for tax purposes; or • point to an amount of undistributed profit in its accounts equal to the whole or part of the subvention payment or tax benefit. If more than one subvention payment has been made (or tax benefit has arisen) then an assertion that more than one amount has not been distributed requires identification of the sum of the relevant amounts. In either case, however, strict tracing of a subvention payment or tax benefit to a particular undistributed amount is not required.

Taxpayers may apply the approach set out in this Taxation Determination to adjustments under section 160ZP of the Income Tax Assessment Act 1936 ('the 1936 Act') subject to the statutory limits of section 170 of the 1936 Act.

This draft Determination, when finalised, will replace Taxation Determination TD 94/90, which will then be withdrawn. The draft Determination is more favourable than TD 94/90 and will have both a past and future application (subject again to the statutory limits of section 170 of the 1936 Act).

Facts: After 19 September 1985, Parent capitalised Subsidiary 1 with $60,000 and Subsidiary 2 with $50,000. Subsidiary 1 purchased an asset for $60,000, which later declined in value and was sold for $10,000. Subsidiary 1 made a capital loss of $50,000, which became a net capital loss. Later, Subsidiary 2 made a capital gain of $50,000 on the sale of an asset and an agreement was made whereby Subsidiary 1 transferred the net capital loss of $50,000 to Subsidiary 2. A subvention payment of $18,000 was made for the net capital loss transferred.

If Parent later sells its shares in Subsidiary 1 for $28,000 and, immediately before that time, Parent can show it has received no dividend from Subsidiary 1 since the end of the application year, or Parent can point to an undistributed profit amount of $18,000 in Subsidiary 1, it would be appropriate to reduce the cost base and RCB of Parent's shares in Subsidiary 1 by $32,000 (from $60,000 to $28,000). The adjustments would take effect at the end of the application year (i.e., the income year of the gain company for which the amount is transferred: subsection 170-115(1)).

Assume the same facts as for Example 1, except that Subsidiary 2 makes no subvention payment for the transferred net capital loss. If Parent later sells its shares in Subsidiary 2 and, immediately before that time, Parent can show it has received no dividend from Subsidiary 2 since the end of the application year, or can point to $18,000 undistributed profits in Subsidiary 2, a cost base and RCB increase of $18,000 to its shares in Subsidiary 2 would be appropriate. The increase would take effect at the end of the application year. In respect of the cost base, indexation would be available from that time.

If, for example, the entire gain of $50,000 were distributed before Parent sold its shares in Subsidiary 2, and Subsidiary 2 has no other distributable profits immediately before the shares are sold, no increase to the cost base and RCB of the shares would be made.

If you wish to comment on this draft Taxation Determination, please send your comments by Friday 6 August 1999 to: Contact officer details have been removed following publication of the final ruling.