Consolidation for SME groups
A discussion of tax consolidation issues from an SME perspective by Greg Mascaro and Jeffrey Chang
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| Location: | Melbourne |
| Division: | Tax Consulting |
| Publish Date: | 15/07/2009 |
Introduction
Upon the introduction of the tax consolidation regime from 1 July 2002, many advisers took the view that it was just for the “big end of town.” This may be true for a large proportion of closely-held SME groups, in particular those that use some combination of partnerships and trusts.
But as an SME group’s business evolves, its advisers will often be called upon to consider the appropriateness of the structure.. Eventually, consideration may be required as to whether it is appropriate to adopt a consolidated group structure.
This article sets out an overview of the consolidation regime from an SME perspective. We will also consider some of the options and tools that are available when restructuring to form a consolidated group.
Consolidation overview
The tax consolidation regime was introduced with effect from 1 July 2002. From that date, the head company of a “consolidatable group” (i.e. a group that can be consolidated) can choose to consolidate for income tax purposes.
A consolidatable group will include the head company, together with all entities that are wholly-owned by the head company (including subsidiary companies, trusts and partnerships).
Once the group has consolidated, all members of the group will be treated as a single entity (or taxpayer) for the purposes of income tax. Note that consolidation does not affect GST, and the entities would still need to register as a GST group to achieve an equivalent GST outcome.
Also note that consolidation does not affect the separate legal existence of the various group members.
The carrot and the stick
The incentive to consolidate (i.e. the “carrot”) is that all acts of the subsidiaries are deemed to be acts of the head company for income tax purposes. This means that, in general:
- assessable income, deductions and losses of a subsidiary fall upon the head company automatically, without any need to distribute the income or transfer the loss to the head company; and
- all transactions between members of the consolidated group are ignored for income tax purposes, as they are effectively treated as having occurred between divisions of a single entity.
- From 1 July 2003, a range of previously-available tax measures ceased to be available for non-consolidated groups. This constitutes the “stick” for those groups that remain outside the consolidation regime.
These include:
- the loss of the inter-corporate dividend rebate for unfranked dividends. This means that an unfranked dividend paid by a subsidiary to the head company of an unconsolidated group will be subject to tax. Conversely, where a dividend is paid within a consolidated group, there is no income tax consequence;
- the loss of the ability to transfer Australian tax losses between Australian companies that are members of a wholly-owned corporate group;
- the loss of the ability to transfer excess foreign tax credits between members of a wholly-owned corporate group;
- the repeal of the previously-applicable grouping rules for thin capitalisation; and
- the loss of CGT roll-overs that were previously available for the transfer of assets between members of a wholly-owned corporate group.
The removal of these previously-available tax concessions has made the tax management of unconsolidated SME groups increasingly difficult.
Advantages of consolidation
In evaluating whether an existing SME group should now move to a consolidated structure, the following advantages should be considered:
- the loss of the tax concessions mentioned above will be of no consequence, as all members of the group will be treated as a single entity for income tax purposes;
- the resetting of tax costs for various assets of the group may result in increased depreciation deductions (although careful analysis is required, as the reverse may also be true);
- consolidation will often enable recognition of a CGT cost base amount for internally-generated goodwill of a subsidiary member of the group. This should reduce the liability to capital gains tax upon a future sale of the goodwill by the subsidiary;
- once consolidated, assets may be moved from one group member to another without triggering a capital gain or balancing adjustment event. Cash may also be transferred within the group without any income tax consequence; and
- the head company will prepare and lodge a single income tax return in relation to the activities of all of the members of the group. Also, each of the group members’ PAYG instalments will become the responsibility of the head company. This may provide benefits in the nature of administrative convenience.
Who can consolidate?
Only members of a consolidatable group can consolidate. A consolidatable group will comprise:
- a single head company; and
- all wholly-owned subsidiary members of the group.
Head company
A “head company” is an Australian resident company that is subject to tax on its taxable income at the general company tax rate and is not a “wholly-owned subsidiary” of another entity. Where a company is itself a wholly-owned subsidiary of another head company, the subsidiary cannot be the head company of a consolidated group. Only the ultimate Australian resident head company can be the head company of the consolidated group.
Subsidiary member
A subsidiary member of a consolidated group can be any of:
- an Australian resident company;
- a resident trust; or
- a partnership,
where the head company beneficially owns (either directly or indirectly) all membership interests (i.e. shares, trust interests or partnership interests) in the subsidiary.
Having regard to the above, many SME groups will be unable to form a consolidated group unless a restructure is first undertaken.
Restructuring tools
A number of tools are available to assist an SME group to restructure its affairs so as to form a consolidatable group. This includes a range of CGT roll-overs, which may be used alone or in combination. Some commonly-used roll-overs are discussed below.
Subdivision 124-G ITAA97
In broad terms, the purpose of Subdivision 124-G is to provide CGT relief to shareholders of a company where a new company is interposed between those shareholders and the original company. The Commissioner of Taxation (“Commissioner”) has confirmed in TR 97/18 that Subdivision 124-G may also apply in the case of multiple companies with common shareholders.
Subdivision 124-M ITAA97
The scrip for scrip roll-over provisions under Subdivision 124-M provide CGT roll-over relief where certain post-CGT interests in companies or trusts are exchanged for similar interests in another entity. Consequently, the scrip for scrip roll-over provisions have opened up a number of opportunities for SMEs operating via a company, or trust, to merge their respective operations without triggering a CGT liability.
Other CGT roll-overs
Other useful CGT roll-overs include:
- Subdivision 122-A: the disposal of assets by an individual or a trustee to a wholly-owned company;
- Subdivision 122-B: the disposal of assets by partners to a wholly owned company;
- Subdivision 124-H: the effective substitution of a company in place of a unit trust; and
- Subdivision 124-N: the disposal of assets by a unit trust to a wholly-owned company.
Stamp duty
Where the assets of the group include real property, an exemption may be available in respect of stamp duty that would otherwise apply in the case of a pre-consolidation restructure. For example, see sections 250DA-DG of the Duties Act 2000 (Vic).
Part IVA
In the case of any reorganisation of a group’s structure with a view to consolidation, the potential application of the general anti-avoidance provisions in Part IVA ITAA36 should be considered.
The Commissioner has outlined his opinion on this issue in a paper entitled “The application of Part IVA to elections to consolidate”.
Importantly, the Commissioner makes some observations in relation to the factors that may indicate whether reorganisations fall within the ambit of section 177D of Part IVA.
The Commissioner notes in the paper that:
“… the substance of the relationship between two companies is therefore a good indicator of whether the companies should, or should not, be consolidated. If there is a lack of identity or interest in companies in substance, bringing about the circumstances that enable the head company to choose to consolidate those companies may be a scheme to which Part IVA applies.”
The Commissioner also adds that Part IVA may also apply where the tax cost of a subsidiary’s asset is reset upon consolidation to an amount that is, “substantially at variance with the genuine value of that asset”. In other words, where consolidation results in a substantial uplift in the tax value of the assets, this may result in a tax benefit that is at risk under Part IVA.
The above observations represent the views of the Commissioner and his possible approach, and should be taken guidance only. Nonetheless, it is important that the potential application of Part IVA be considered in the context of any consolidation project.
Conclusion
It is easy for SME groups to fall into the trap of thinking that their business operations are relatively small, therefore their tax issues should be relatively uncomplicated. Unfortunately this is often not the case.
Whilst there is a perception that consolidations and corporate restructures are matters that only affect the “big end of town”, this is far from the truth. For many SME groups, the loss of a raft of tax concessions that were previously available for wholly-owned corporate groups will increasingly force consolidation onto their tax planning agenda.
Given that many SME groups are not able to be consolidated in their present form, complex restructuring may be required in order to form a consolidatable group. With the careful use of CGT roll-overs, the benefits of operating via a consolidated group can often be achieved with less pain than might first be feared.