On 18 April 2012 the Treasury released an Exposure Draft (the "ED") of legislation to retrospectively amend certain "unintended" aspects the tax consolidation regime relating to rights to future income and the residual cost setting rules. If legislated the proposed rules will operate to restrict tax deductions in relation to certain assets for corporate groups which have undertaken mergers, acquisitions and restructures.
What are rights to future income?
Under amendments introduced in 2010, 'rights to future income' are assets such as:
- long term construction contracts;
- broker trailing commissions;
- perpetual or annual service contracts;
- funds management fees; and
- unbilled income.
The 2010 amendments allowed companies joining consolidated groups (for example, following a merger) to reset the tax cost of these, and then claim a tax deduction for that cost over a set period. In many cases the tax cost of these assets was reset at a higher value, meaning that companies could claim higher tax deductions following mergers.
The release of ED follows a number of related developments, which have previously been analysed by Moore Stephens.
- On 12 May 2010 Parliament legislated amendments to the consolidations regime, which included the rights to future income rules: Consolidations of the Past - Opportunities Exist
- On 30 March 2011 the Assistant Treasurer announced the Board of Taxation would review the rights to future income rules: Tax consolidated groups: rights to future income deductions under threat?
- The Board's report was released on 25 November 2011, together with the Government's response: Tax Consolidation: Treasury says no to your "rights to future income" deductions
How might the changes impact on you?
The ED is very closely modelled on the Government's response to the Board of Taxation's review. As highlighted in our previous article, the tax treatment of rights to future income and similar assets will depend on when the joining company entered the tax consolidated group – in other words, when the acquisition or restructure took place.
We have provided a brief summary of the 'pre' and 'interim' rules below, followed by a more detailed explanation of the prospective rules.
Arrangements prior to 12 May 2010 - the "pre-rules"
- The 2010 amendments are significantly modified to restrict deductions for rights to future income.
- 'Rights to future income' assets are limited to unbilled work in progress ("WIP") and consumables. This replicates similar deductions available to non-consolidated corporate entities.
Arrangements between 12 May 2010 and 30 March 2011 – the "interim rules"
- Certain assets will be included as goodwill rather than rights to future income.
- Mine site improvements will be excluded from the residual tax cost setting rules.
- No value can be attributed to contractual rights to future income where the right is contingent on renewal.
The prospective rules - "how will my upcoming deal be impacted?"
The prospective rules apply to arrangements (i.e. mergers and restructures) which take place after 30 March 2011. All groups considering acquisitions or restructures should factor the rules into their analysis prior to undertaking the transaction.
Under these rules deductible rights to future income will be limited to WIP and consumable stores. Other rights to future income will be treated as retained cost base assets, meaning that their tax value will not change after the transaction (i.e. there will be no uplift in value). These assets will probably not be deductible.
The residual tax cost setting rule will be modified to apply a business acquisition approach. This broadly means that the consolidated group will be treated as acquiring the joining company's assets directly. Comments in the explanatory materials indicate that this approach will ensure most assets will be treated as capital assets, and taxed under the CGT rules.
Finally, the tax cost setting rules will be modified so that they only apply to CGT assets (as defined under section 108-5 of the Income Tax Assessment Act 1997). Consequently assets that are not "any kind of property" or "legal or equitable rights" will be allocated a tax cost setting amount; even if such assets are required to be recognised under accounting standard. Such assets may include:
- customer lists, order backlogs and customer relationships
- marketing intangibles such as unregistered trademarks and trade names
- technology based intangibles such as databases and trade secrets.
We recommend that tax consolidated groups undertake preliminary modelling of the tax cost setting process to determine how these changes impact on upcoming deals.
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