What is Tax Consolidation?
Australian tax law allows for an election to be made to treat a wholly owned corporate group as if the group were a single company for tax purposes. This allows intra-group transactions to be disregarded and losses made by one part of the corporate group to be used to offset assessable income by another part of the group. Foreign wholly owned groups investing into Australia with the same ultimate foreign parent company have wide discretion to choose to group, or not to group, their Australian subsidiaries together.
Tax consolidation applies for Australian income tax purposes only. Other Australian taxes such as Goods and Services Tax have different grouping provisions.
Benefits of Tax Consolidation
- Can transfer assets intra-group without capital gains tax;
- Intra-group sales are ignored;
- Intra-group dividends are ignored; and
- One tax return across the group.
Resetting the Tax Cost of Subsidiary Member Assets
When a company joins a tax consolidated group as a subsidiary member, the tax cost of the assets of the subsidiary member will be reset according to a statutory calculation based on the acquisition price of the shares in the new company, the liabilities of the new company and other statutory criteria. This calculation can be complicated but may also be beneficial.
For example, when a tax consolidated group pays a premium for the shares in a company carrying on a business, that will be taken into account in resetting the tax cost of the assets used in the business of the new company when the company joins the tax consolidated group. This could mean that, for example, higher depreciation deductions may be claimed in respect of the new company’s assets after the company joins the tax consolidated group.
Various Tricks and Traps
The tax consolidation rules are complex and there are various tricks and traps that can arise. For example, there are provisions dealing with the circumstances where group members have made different and inconsistent elections for tax purposes. Complicated provisions apply if a company has tax losses when the company joins a tax consolidated group.
Tax Sharing Agreement and Tax Funding Agreement
A common but not compulsory practice is for members of tax consolidated groups to enter into two types of tax related agreements between themselves, a Tax Sharing Agreement and Tax Funding Agreement.
The head company of a tax consolidated group has the primary tax liability for the whole consolidated group. In the event of failure to pay by the head company, all members of a tax consolidated group then become jointly and severally liable for any unpaid tax liability, unless an appropriate Tax Sharing Agreement exists. The effect of a Tax Sharing Agreement that satisfies the legislative requirements is to limit the tax liability of each subsidiary member in the event that the head company defaults to the extent the relevant tax liability is attributable to each subsidiary member.
The purpose of a Tax Funding Agreement is to fund the head company to make ongoing tax payments to the Australian Taxation Office and also to compensate loss making subsidiary members for a reduction in an overall group tax liability as a result of those losses. A consequence of this is that entity level tax effect accounting can be done for the subsidiary members on a similar basis to as if they were stand-alone entities. As the Tax Sharing Agreement and the Tax Funding Agreement have distinct purposes, they are typically two separate documents.
Tax consolidation is an extremely complicated area of the Australian income tax law.