Mergers & Acquisitions
6. Tax Cost Setting Process
Last updated: 06 Jul 2015
- This is the most complex and costly part of consolidation. Whenever a new consolidated group is formed or when an entity joins an already existing consolidated group the values of the assets will have to be reset to reflect the price paid by the head company for the membership interest in the joining entity.
- The tax cost setting amount (TCSA) will be used to calculating a future capital gain or loss on the sale of Capital Gains Tax (CGT) assets and deductions available for depreciation.
- For the of tax cost setting, assets are divided into:
- retained cost base assets; and
- reset cost base assets.
- A retained cost base asset is either Australian currency or a right to receive a specified amount of Australian currency. Other assets of the entity are reset cost base assets.
- The first step in calculating the tax cost is the determination of the allocable cost amount (ACA) of the joining subsidiary.
- The method to be adopted in determining the ACA of an entity is contained in section 705-60 of the Income Tax Assessment Act 1997 (Cth).
- The calculation begins with the cost to the head company associated with purchasing a membership interest in the subsidiary.
- Adjustments are then made to this amount to account for:
- the liabilities of the joining entity obtained from the entity’s statement of accounts;
- undistributed frankable profits which refers to profits that could be distributed fully franked;
- pre-joining time distributions of profits earned before membership interest was acquired;
- losses accruing to continuously held membership interests;
- losses transferred to the head company; and
- deductions to which the head company is entitled.
- The following steps are followed when allocating the ACA to assets of a subsidiary:
- subtract the value of any retained cost base assets;
- apportion the balance of the ACA among the reset cost base assets of the subsidiary in proportion to their market values; and
- adjust for over depreciated assets.
- Goodwill of a joining entity is a reset cost base asset. According to Taxation Ruling 2005/17 goodwill includes:
- inherent goodwill attaching to the business of the joining entity; and
- synergistic goodwill which arises from the relationship between the joining entity and the acquiring entity.
- Pre-CGT assets of a joining entity will continue with that status even after consolidation.
- A problem arises if membership interests in the joining entity were pre-CGT and the balance membership interest is acquired post- CGT. Here a pre-CGT proportion is applied.
- Market valuation is a complex process and can be costly. The Australian Tax Office (ATO) has released general guidelines on market valuation for tax purposes. Depending on the asset and other circumstances of the business the market valuation may be conducted by:
- an external qualified valuer;
- an internal qualified valuer;
- a member of a recognized professional valuation body; or
- a person without formal valuation qualifications who bases the valuation on reasonably objective and supportable data.
- Documentation supporting market valuation must be kept for at least 5 years.
- A scheme involving consolidation may be subject to Part IVA anti-avoidance provisions where there is adjudged to be a sole or dominant purpose of obtaining a tax benefit. This accusation can be a difficult to disprove in consolidation since almost all decisions to consolidate are aimed at securing some tax benefit.
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