Rights to future income & TOFA consolidation interactions
Draft legislation released
On 18 April 2012, the Government released exposure draft legislation and related materials aiming to largely reverse measures previously enacted less than two years earlier affecting tax consolidated groups. The proposed amendments are largely unchanged from that outlined in the government’s announcement on 25 November 2011 and therefore do not appear to have resolved any of the uncertainties arising from the announcement.
Specifically, the proposed measures reverse certain amendments enacted by Tax Laws Amendment (2010 Measures No. 1) Act 2010 (the 2010 amendments) relating to the residual cost setting and rights to future income rules that will make the tax outcomes for consolidated groups more consistent with those that arise when assets are acquired outside the consolidation regime. Measures are also proposed to amend the interaction of the TOFA rules with consolidation.
The Government is looking to correct a number of unintended outcomes that have arisen following the enactment of the 2010 amendments, such as the tax timing/recognition of the tax cost of some assets being brought forward, and/or brought to account where they otherwise ought not to have been which has led to windfall gains and advantages for tax consolidated groups that are not otherwise available for non-consolidated taxpayers.
Different rules will apply depending on the joining time
Each taxpayer will need to carefully consider how the proposed changes will apply to their particular circumstances. This will not be an easy task. The rules are complex as there are different rules for different periods. Which period you fall in will depend on a matrix of factors based on the joining time, the arrangement time and when the assessment/amended assessment was issued.
The proposed measures are split into three periods: the pre-rules, interim rules, and prospective rules. The following table explains the application dates for each period together with the requirements to be met to fall within the relevant period and the key changes proposed under each period.
|Application||Before 12 May 2010|
|Joining time||Before 12 May 2010|
|Other requirements||Where the joining time was not before 12 May 2010, the arrangement commenced/was entered into before 10 February 2010|
The pre-rules seek to return the residual tax cost setting and rights to future income rules to the way they were before the 2010 amendments, with modifications to:
|Application||Between 12 May 2010 and 30 March 2011|
|Joining time||Before 12 May 2010||After 12 May 2010|
|Other requirements||Latest notice of assessment relating to the application of the original 2010 rules was provided between 12 May 2010 and 30 March 2011||Between 10 February 2010 and 30 March 2011|
The interim rules will retain the current residual tax cost setting and rights to future income rules, with modifications to:
|Application||After 30 March 2011|
|Joining time||On or after 31 March 2011|
|Other requirements||Neither the pre-rules or interim rules apply to the arrangement|
The prospective rules will significantly diminish the scope of the rules to:
The proposed amendments are detrimental to some tax consolidated groups that may previously have recognised the benefits of the 2010 amendments in their financial accounts, particularly those that have recognised the benefits of RTFI assets that were customer relationships and know-how. As a consequence, these groups will need to consider what disclosure or adjustment may need to be made to their financial accounts. Other consolidated groups that have received benefits following the 2010 amendments will also need to carefully consider the proposed changes to determine whether there are any adverse implications.
Limited definition for work in progress
Consultation undertaken prior to the release of the exposure draft argued that the definition of work in progress should not be limited to ‘work performed’, but should also include amounts for ‘services performed or undertaken’, as in many cases they are one and the same. However, it seems the Government has decided not to modify the WIP rule to address this perceived weakness as compared with the former RTFI definition.
What protection is available?
Some taxpayers whose circumstances would otherwise fall within the scope of the proposed changes will be protected from their effect. However, the proposed mechanisms to protect certain existing tax positions are again quite complex. As a general proposition, however, the following observations can be made:
- At a minimum, existing claims will be upheld where a private ruling or written advice under an Advanced Compliance Arrangement issued before 31 March 2011 has been followed (this will include the treatment of ‘tail-claims’, the treatment of which will depend on whether the ruling issued under the original 2002 or amended 2010 rules)
- Under the current rules, the Commissioner is generally required to amend an assessment within four years of the date of the notice of assessment. As the pre-rules and interim rules apply to periods where the four year amendment period has expired:
- The operative provisions will be modified so that where an assessment was made before the commencement of these amendments, either the Commissioner or the taxpayer has a further period of two years from the date these amendments are enacted to amend a return to give effect to these amendments
- No interest or penalties will be payable where additional tax becomes payable because the Commissioner amends an assessment that was issued before 31 March 2011, or further amends an amended assessment that was issued before that date to disallow a deduction for a claim under either the pre-rules or the interim rules. The normal rules relating to interest on refunds and overpayments will also be turned off in respect of changes affecting the retrospective and transitional periods (interest previously received by taxpayers will not be 'clawed back', however). The amendments to implement these changes are still to be developed.
The proposed changes to the operation of the TOFA/consolidation interaction provisions are intended to:
- Clarify that, if the head company is subject to the TOFA rules, it will be treated as assuming financial arrangement liabilities of a joining entity at the joining time, regardless of the TOFA status of the joining entity
- Deem the head company to have received an amount for the assumption of the joining entity's financial arrangement liabilities at the joining time. In particular, for liabilities that are subject to a tax timing method other than the fair value, reliance on financial reports or foreign exchange retranslation method (namely, the default methods or hedging election), the head company will be deemed to have received an amount equal to the accounting value of the liability at the joining time
- Ensure that a tax consolidated group takes into account certain TOFA/consolidation interaction provisions in working out any transitional balancing adjustment where an entity with financial arrangement assets or liabilities joined the group pre-TOFA.
The proposed TOFA interaction amendments are retrospective. Importantly, the amendments highlighted at the second point above will potentially affect acquisitions that have occurred since the commencement of the TOFA rules. For example, if a joining entity had financial arrangement liabilities, such as out of the money derivatives or foreign currency loans in respect of which there were unrealised losses, these changes may mean that those acquisitions were incorrectly priced based on the availability of deductions for those losses which will no longer be available. Tax consolidated groups that acquired entities with financial arrangement liabilities after the TOFA start date should consider the implications of these changes.
Furthermore, under the amendments highlighted under the third point, tax consolidated groups which made transitional elections and had pre-TOFA acquisitions of joining entities with financial arrangements may need to revisit transitional balancing adjustment calculations.
What should you do now?
The proposed measures are complex and each affected taxpayer will need to carefully consider how the proposed changes will apply to their particular circumstances in collaboration with their Deloitte adviser.