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Government announces significant changes to the tax consolidation rules

The Federal Government has announced that it will retrospectively amend (and largely reverse) tax consolidation amendments that it enacted in 2010 (the 2010 amendments).

Click here to view the Assistant Treasurer's announcement and related attachments.

What are the key messages?

  • Deductions for rights to future income (RTFI) assets will now be significantly curtailed for tax cost setting processes undertaken prior to 31 March 2011 and repealed entirely for any tax cost allocated to such assets after that date
     
  • The residual tax cost setting rule will be significantly amended to retrospectively exclude a number of assets from its operation. However, its future operation will be modified by applying a "business acquisition approach" which may result in the tax cost of many assets being taken to have a capital character (and therefore prevented from being allowed as a general deduction)

  • Tax costs allocated to customer relationships, know-how and other accounting intangibles will effectively become a non-deductible component of goodwill
     
  • Deductions for consumable stores and work in progress will be confirmed as being available based on the reset tax cost

  • Taxpayers who have previously implemented the 2010 amendments and have sought and obtained confirmatory rulings or have advance compliance arrangements in respect of these matters are likely to be protected from the effect of the proposed changes 

  • Other taxpayers, not so advantaged, will need to carefully consider the effect of the proposed changes on their particular circumstances.

Why are the changes needed?

The 2010 amendments that modified the residual tax cost setting rules allow retrospective deductions for rights to future income to 1 July 2002 because they were thought to be reflecting the original policy intent.  However, the Government now considers that the 2010 amendments have been interpreted more broadly than originally intended, and combined with changes to accounting standards, have resulted in the claiming of tax deductions in an unanticipated way which has led to a significant reduction in revenue collection.

The Government perceived that it was necessary to protect a significant amount of revenue that would otherwise be at risk. This may have significantly diminished its chances of achieving its stated budget surplus in 2012-2013.

Consequently, the Government is implementing changes to the operation of the residual tax cost setting and rights to future income rules which it considers necessary to protect the significant amount of revenue at risk, and to make the tax outcomes for tax consolidated groups more consistent with those for entities outside consolidation, taking into account Board of Tax recommendations.

The effect of the proposed changes will generally be specific to a taxpayer's circumstances.

Each taxpayer will need to carefully consider how the proposed changes will apply to its particular circumstances.

This will not be an easy task, however, and the attachment to the Government's announcement illustrates the inherent difficulty in proposing retrospective amendments across a range of periods (refer below) while also attempting to offer a range of protection mechanisms to taxpayers that have already implemented the 2010 amendments. In some cases the outcome may be made more complicated where the joining time and corresponding assessments occur/arise in different periods.

It is therefore envisaged that many taxpayers will in fact still have some uncertainty of how the proposed changes may affect them even after digesting the complex announcement.

Table 1: Relevant periods

Period

Generally applicable to joining times occurring

Retrospective period Before 12 May 2010
Transitional period Between 12 May 2010 and 30 March 2011
Prospective period After 30 March 2011

 

What are the proposed changes?

While the effect of the announcement will depend on a taxpayer's particular facts, there are some fundamental observations that can be made about the proposed changes:

  • The ability to claim deductions for rights to future income assets will be significantly curtailed in the retrospective and transitional periods and removed entirely in the prospective period.

    In the retrospective period RTFI deductions will be limited to "Category 1" RTFI and in the transitional period will be limited to "Category 1" and "Category 2" RTFI (refer definitions below).

    In the prospective period assets that would otherwise have been RTFI as they were formerly known will become retained cost base assets with the outcome in most cases being that the tax cost will be, or will be close to, nil.

  • The "residual" tax cost setting rule will also be significantly amended, with many assets now being excluded from the scope of these rules.

    In the retrospective period, for example, assets including customer relationships, know-how and other accounting intangibles will now be excluded from the residual tax cost setting rule. A stated outcome of this is that the "blackhole" deduction rules will also be unable to be enlivened for these assets.

    Moreover, the tax cost of these assets will also be taken to be specifically included within goodwill. Consequently, relief for the tax cost of these assets is unlikely to be able to be realised until the asset or relevant holding entity is disposed.

    The effect of the proposed changes in the transitional period largely follows that in the retrospective period and will similarly ensure that separate deductions will not be available for tax costs allocated to customer relationships, know-how and other accounting intangibles as well as contractual rights whose value is contingent on renewal or non-cancellation.

    In the prospective period the existing residual tax cost setting rule will be retained. However the scope of general deductions it facilitates will be diminished by requiring that the characterisation of the asset is determined using a "business acquisition approach" (as foreshadowed by the Board of Taxation report).

    The anticipated outcome of this change is assumed to be that many assets will have a "capital" rather than "revenue" character. Intangible assets of the nature outlined above will also be required to be included within the tax cost of goodwill where they are not separately disposable.

  • Deductions for the reset tax cost of consumables will be available in all periods. Specific law changes will be made to ensure this outcome.

  • The specific deduction for work-in-progress amounts will be amended in the prospective period to allow a deduction under those rules based on the reset tax cost.  It is uncertain whether the existing work-in-progress rules will be further modified to remove some of its existing limitations such as only permitting deductions for work performed or partially performed and excluding work-in-progress amounts that relate to the performance of services or the provision of goods.

Table 2: Categories of rights to future income

Category

Description of right

1 Rights to receive income where the work has been done, or the goods or services have been provided, by the joining entity before the joining time.
2 Rights to receive income where the work will be done, or the goods or services will be provided, after the joining time under a contract that was entered into before the joining time, excluding any rights to income that are contingent on the renewal of the contract (such as rights under a renewal clause which may give rise to the extension of an existing contract, or to a future contract, under which income would be receivable).
3 Rights to receive income arising from an expectation of future work or future provision of goods or services (due to, for example, existing customer relationships), including any rights to income that are contingent on the renewal of the contract.

 

What protections are 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 relatively complicated and in some cases their operation remains uncertain.

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 

  • The normal 'time-barring' periods for raising an assessment or amended assessment are unchanged

  • The Commissioner will be limited in amending assessments and amended assessments issued before 31 March 2011 

  • The normal rules relating to interest on refunds and overpayments will be turned off in respect of changes affecting the retrospective and transitional periods (interest previously received by taxpayers will not be 'clawed back' however).

What should I do now?

Each taxpayer will need to carefully consider how the proposed changes will apply to their particular circumstances in collaboration with their Deloitte adviser.

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