Virtually every M&A transaction involving the acquisition of Australian corporate entities will require consideration of the tax consolidation regime. With careful planning, tax consolidation can offer advantages but there are also some potential pitfalls to watch out for. Some of these aspects are discussed in this article.
The minimum requirement to form a tax consolidated group (TCG) requires an Australian head company (Head Co) and an Australian wholly owned subsidiary.
- Must be an Australian resident company (A trust taxed as a corporate may also qualify)
- Must not be a wholly owned entity of a consolidatable or consolidated group
- Must be a resident company, trust or partnership
- Must be a wholly-owned subsidiary of the head company
Forming a TCG provides a range of advantages including the following:
- A single income tax return is required for the TCG;
- Transactions between members of the TCG are ignored for tax purposes (eliminates many complex provisions applying to intra-group transactions);
- Losses of one member can be offset against income and gains of another member;
- Tax losses and other tax attributes (e.g. franking credits) may be transferred to the Head Co upon a subsidiary joining the TCG. These attributes remains with the Head Co even if the subsidiary leaves the TCG;
- The tax cost base of assets of a joining subsidiary are reset on the joining date under the allocable cost amount (ACA) method which in some circumstances may result in an uplift to the tax cost of depreciable assets.
Some practical points of forming a TCG which should be noted are:
- The choice to form a TCG is voluntary but irrevocable. The Commissioner must be notified of the choice to consolidate by the lodgement date of the income tax return of the year in which the choice is effective;
- Changes to the composition of a TCG must be notified to the Commissioner within 28 days;
- Each subsidiary member remains responsible for its own non-income tax obligations e.g. FBT, GST (unless grouped for GST purposes), payroll tax and stamp duty etc;
- One in, all in rule – if a Head Co chooses to consolidate, all its wholly owned subsidiaries automatically become members of the TCG;
- Planning is required when forming or dissolving a TCG as capital gains tax (CGT) liabilities can be inadvertently triggered and with planning often a better tax outcome can be achieved.
Tax cost setting rules
When a subsidiary joins a TCG, the Head Co must ascertain the tax value of the joining subsidiary's assets as the Head Co is deemed to hold the assets for tax purposes. The tax value of assets will also affect the TCG's income tax position. The method for this calculation involves an 8 step calculation known as the allocable cost amount (ACA) calculation. Broadly, this is done by adding the cost of the shares in the entity to the accounting value of its liabilities.
Once calculated, the ACA is allocated to the joining subsidiary's assets firstly to "retained cost base assets" (e.g. cash and receivables) and the balance (if any) is 'spread' across the remaining assets (referred to as "reset cost base assets") in proportion to their relative market values. Importantly, we note there are rules which operate to cap the allocation to certain assets such as depreciating assets. The resulting values will be the new tax values of the joining subsidiary's assets. A number of steps in the ACA calculation comprise several sub-steps and can require complex calculations. Furthermore, careful planning may be required to ensure that CGT events are not inadvertently triggered when the ACA is applied.
Joining company with carry forward losses.
When purchasing a company with tax losses, a Head Co may seek to utilise those losses to offset the income of the TCG. Unutilised losses of a joining subsidiary may be transferred to the Head Co on the date of formation subject to satisfying certain loss transfer tests. These losses are referred to as 'transferred losses'. Losses that are transferred are forfeited.
The use of transferred losses is also subject to available fraction (AF) limits. The AF is designed to restrict the rate at which transferred losses can be utilised by the TCG in order to ensure that the amount of transferred losses that can used by the TCG approximates the amount of losses the joining subsidiary would have been able to use had it remained outside of the TCG.
It should also be noted that certain ordering rules prescribes that losses made by the TCG (referred to as 'group losses') must be used ahead of transferred losses.
Head Co may choose to cancel the transferred losses.
As a planning point, in certain circumstances, Head Co may choose to cancel the transfer of losses even though the loss transfer tests are met. This is because the losses transferred to the Head Co is treated as an asset in the ACA calculation, reducing the tax value of the other assets. As a result the cancellation of losses will increase the ACA thereby providing more tax cost base to allocate to assets which can in turn lower the TCG's tax liability, e.g. where more ACA is allocated to depreciable assets. Another reason Head Co may consider cancelling losses is to mitigate the potential triggering of a CGT event.
An understanding of the advantages and pitfalls of the tax consolidation regime is essential when structuring an M&A deal in order to ensure that valuable tax benefits are not lost or unforeseen tax liabilities do not arise. In a future article, we will explore the importance of Tax Sharing Agreements and Tax Funding Agreements for a TCG.
The most recent federal budget included important amendments to the tax consolidation regime which although not yet law, may have retrospective application which may be unfavourable. We also note that recently laws have been passed that directly amends the tax consolidation regime. Therefore it is important to seek specific advice when contemplating a transaction.
This publication is issued by Moore Stephens Australia Pty Limited ACN 062 181 846 (Moore Stephens Australia) exclusively for the general information of clients and staff of Moore Stephens Australia and the clients and staff of all affiliated independent accounting firms (and their related service entities) licensed to operate under the name Moore Stephens within Australia (Australian Member). The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Moore Stephens Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication. Copyright © 2011 Moore Stephens Australia Pty Limited. All rights reserved.