Churning over Consolidation

11 May 2018

The ATO has released Draft Law Companion Ruling 2018/D3 (draft LCR) to provide guidance on the consolidation ‘churning measure’ in s.716-440, which was enacted on 28 March 2018 (Act No 14 of 2018). Broadly, the churning measure is intended to prevent ‘tax free step-ups’ in the tax costs of assets where shares in the joining entity were acquired from a non-resident related party whose gain on the transfer was disregarded under Division 855 on the basis that shares in the joining entity were not taxable Australian property. However, the rules are detailed and potentially apply in a broader range of scenarios.

The bulk of the draft LCR comprises 3 relatively simple examples, each of which involves a conclusion that the churning measure would apply. Unfortunately, the examples don’t:

  • give any meaningful guidance on more complex scenarios;
  • provide insight beyond what is set out in the relevant Explanatory Memorandum; or
  • address the irregularities in the law that have been previously raised with Treasury, for example the application of the rules to a scenario that involves acquisition of a foreign target that has Australian subsidiaries.

In a scenario involving the acquisition of a foreign target with Australian subsidiaries, the correct interpretation of the ‘associate-inclusive’ aspects of the rules, and in particular whether the associate relationship and ownership of participation interests in the joining entity must coincide, is critical.

The draft LCR includes a warning in respect of the potential application of Part IVA in certain circumstances where the churning rules do not apply despite the assets of the joining entity having been majority owned by the same control entity for a period of more than 12 months. The draft LCR does not explain how those circumstances could arise other than from a transfer of assets to the acquired entity post-acquisition, which would be taxable if the assets were transferred from an Australian resident anyway and would be appropriately non-taxable if the assets were transferred from a non-resident.

The draft LCR also does not address how the ATO will approach the application of the churning rules in respect of Division 230 liabilities. Prima facie, s.715-375 requires the tax cost of a joining entity’s Division 230 liabilities to be reset, even if the churning rules prevent the tax cost of the joining entity’s assets being reset (a similar anomaly applies when an entity joins a MEC group as an eligible tier-1 entity). This issue was not addressed in the legislation despite being raised in consultation, and the fact that it is not mentioned in the draft LCR could further suggest the ATO considers that approach to be correct.



Narelle McBride



Daniel Sydes