Whilst everyone focuses on the GST, a sleeper issue known as the Consolidations regime deserves a lot more mainstream media attention.
The Consolidations regime was proposed in John Ralph’s Review of Business Taxation report to the Government. The Ralph report, which should not be confused with the “men’s magazine” of the same name (which, incidentally, makes for a far more interesting read than John Ralph’s lengthy tome), proposed that the Consolidations regime should apply from 1 July 2001. Basically, the consolidations regime provides for companies within a wholly-owned group to disregard for tax purposes all transactions between group members and to prepare a single tax return for the entire group. Presently, each separate legal entity must prepare an individual tax return. For your large corporate groups, this can present quite a compliance burden. Part of the benefit of the proposed Consolidations regime has been to remove this. Naturally, it’s not all for the good of our corporates – there is an appeal to the revenue in removing the ability of corporates to fiddle with their tax through corporate group structures.
But the most alarming feature of the proposed changes is the fact that with less than five months to go before it starts, neither the affected parts of the business community nor the Tax Office / Treasury seem to be sufficiently down the track to cope with its introduction.
The press has naturally played up troubles with the GST and the shambolic introduction of the much-maligned Business Activity Statement – after all, anything that has the capacity to upset The Prime Miniature’s beloved small business community will hurt The Prime Miniature at the ballot box. But the corporate community will rarely apply any meaningful pressure at the ballot box via the press, so concerns about the Consolidations regime have generally gone unreported.
In December of last year, the Government introduced their first tranche of exposure draft legislation in relation to specific aspects of the Consolidations regime, which your humble correspondent would estimate will account for about a third of the legislation required. And remember, these rules are slated to apply from 1 July 2001. Compare that to the GST, where we had virtually the entire legislation rolled out a good 18 months prior to the introduction of the tax. Obviously amendments were made to the GST legislation up to the time the tax commenced and amendments are still being made, so the picture is grim for corporates who are trying to prepare for the introduction of Consolidations but are at present pretty much flying blind.
The most critical thing for companies to do prior to 1 July 2001 is to decide whether or not they should consolidate – given the removal of many tax benefits for those who elect not to, this is pretty much a lay down misere – and if so, to determine what their asset cost base allocations will be.
Corporate groups who choose not to consolidate will, after 1 July 2001, have three important tax benefits removed – the ability to transfer tax losses between group companies, the inter-corporate dividend rebate and the ability to transfer assets tax-free under capital gains tax “rollover” relief. Given the removal of these important features if corporate groups choose not to consolidate, it is likely that most corporate groups will consolidate.
An important transitional consideration for corporate groups as they move into consolidations is how to allocate cost bases to their assets for tax purposes. This is relevant for such things as depreciation (i.e. taxpayers obtaining an annual deduction based on the diminution in value of their assets over their useful lives) and for capital gains tax purposes. (When an asset is sold, the capital gain or loss is the difference between the proceeds on disposal and the asset’s cost base.) The exposure draft legislation proposes two methods of determining the cost base of a company’s assets when it is made part of a consolidated group – the “allocable cost amount” method and the “existing joining value” method.
Broadly, the ACA method requires a company to take the total of its membership interests (i.e. shareholders’ equity) and liabilities and allocate this across its various assets in proportion to their respective market values. Given that this may be a difficult exercise for many entities, as a transitional concession applying only to entities that choose to consolidate within the first year of the new regime, taxpayers can use the EJV method. This involves the consolidated group taking the historical cost base of their assets (i.e. what the particular entity joining the consolidated group paid to acquire them) for each asset that comes into the consolidated group.
The two methods can provide starkly contrasting results. For instance, in the case of a company that has been around since Adam was playing fullback for Jerusalem and which has significant internally generated goodwill, they have no cost base in their goodwill for tax purposes under the existing law. However, if they enter into consolidations as part of a consolidated group, some of their allocable cost amount may be apportioned to the goodwill and hence result in a step-up in cost base for tax purposes if they adopt the ACA method.
This simple example illustrates that there will be plenty of work that corporate groups can do prior to 1 July 2001 before entering into consolidations. They have the choice on an entity-by-entity basis as to whether to use the ACA or EJV method and therefore may be able to realise significant benefits if they go through the hoops and do a thorough analysis of their tax profile before 1 July 2001.
But for your larger corporate groups with Balance Sheets longer than your right arm, this is plenty of work to do with only 5 months to go. (Although realistically not every i has to be dotted nor every t crossed by 1 July.)
And this is but one of the many issues corporate groups will have to consider if they choose to consolidate. Another concern will be how their reporting systems will cope with the new regime. At this stage, no draft legislation has been released which tells us how a consolidated group will calculate its taxable income or loss.
Another concern is that the Consolidations regime has strict rules which affect how many of the group’s existing carried forward tax losses can be brought into the Consolidated group and utilised in the future. A major problem in this regard is that in some instances the rules may result in the Consolidated group not being able to use certain losses that individual entities in the group have carried forward, or the losses will be subject to restrictions as to how quickly the group can recoup them. These provisions may result in companies having to write off carried forward tax losses in their accounts, thereby generating a hit to their Profit and Loss.
So why hasn’t the business community been up in arms about the Government setting these unrealistic expectations, especially given that these large corporates had to also cope with the introduction of the GST less than a year ago? And why hasn’t the press cottoned on to this?
Well, part of the reason is that business leaders largely brought this on themselves. The authors of the Ralph report – John Ralph and Dicky Warburton in particular – advocated the Consolidations regime and for a long time have ignored concerns from their underlings that this will cause us a few headaches to adopt this. Obviously the top brass don’t have to get dirt under their fingernails like the shit-shovellers at the lower end of the corporate pecking order. What do they care if their company has to re-jig its tax accounting system only a year after re-configuring it for the GST? What do they care if some jabroni in accounts has to obtain a valuation for every asset on its Balance Sheet?
Another reason for the silence on this is that the large corporates have no need to flex their political muscle through the press. The Ralph Review of Business Taxation process and the subsequent Treasury / Tax Office consultation process has involved all sectors of the affected business community, from the companies themselves, to their professional advisers and to academia. So while your small business types are continually bleating to the press about the difficulties of filling in the Business Activity Statements – which, incidentally, is such a hot potato that the Government and Tax Office are bending over backwards to accommodate your Ipswich Fish & Chip shop owner and the like – big business is silent on this significant change to the tax landscape, at least publicly.
But you can bet that while BAS problems will dominate press coverage up to the next election, big business will be silent on the Consolidations issue. And as sure as your Ipswich Fish & Chip shop owner and their ilk are struggling with their BAS, the poor little tax accountant in your big corporate group will be struggling with getting their head around a whole new way of their companies doing their tax returns.