Contributed by Enzo Coia, Partner, and Anna Chen, Manager, Deloitte M&A Tax
Whilst the prospect of hoverboards and self-lacing sneakers were exciting glimpses into a possible future as presented in the movie Back to the Future Part II, less exciting were warnings about the impact that making changes in one place can have on another.
Exposure draft legislation released on 5 May 2021 provides welcome relief from the uncertainty and potential inappropriate outcomes caused by a change in accounting standards relating to leases in a tax consolidation context.
The Australian income tax system usually operates independently from accounting concepts and standards. As this article illustrates, that is often an approach that means the tax system needs less ongoing maintenance.
The concepts of assessable income and allowable deductions share similarity with their accounting counterparts of revenue and expenses. And there are many cases referring to the usefulness (but not conclusiveness) of accounting outcomes in analysing the tax legislation. For example:
- FC of T v James Flood Pty Ltd (1953) 10 ATD 240;  HCA 65; (1953) 88 CLR 492, where the High Court stated “… [c]ommercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by sec 51(1) but it cannot be substituted for the test”1
- RACV Insurance Pty Ltd v Federal Commissioner of Taxation 74 ATC 4169, in which the Supreme Court of Victoria held that the provisions for unreported insurance claims recognised in the accounts of an insurer are presently existing liabilities and therefore an allowable deduction so long as they are a reasonable actuarial estimate.
- The thin capitalisation rules in Div 820 of ITAA 1997. In particular, where they rely upon accounting standards in determining an entity’s assets and liabilities per s 820-680.
- The ability for an entity to rely on its financial reports to determine the tax treatment of its gains or losses under a financial arrangement, per Subdiv 230-F of ITAA 1997.
- The inclusion of an entity’s accounting liabilities for working out the tax cost setting amount of the assets of an entity upon joining (at Step 2) and exiting (at Step 4) an income tax consolidated group in accordance with s 705-70 and 711-45 of ITAA 1997 respectively.
Tax consolidation and finance leases
When the tax consolidation regime was first introduced in 2002, there were no specific rules relating to entities that had leasing arrangements (finance leases or otherwise).
The lack of specific rules for finance leases created problems for taxpayers. In relation to the lessor, there was uncertainty as to whether it had two assets (being the actual plant and the right to receive lease payments). Correspondingly, in relation to the lessee, it was uncertain whether the lessee should have an amount included in Step 2 of the allocable cost amount (ACA) calculation in respect of the lease liability, as recognised under accounting standards, and whether it also had an asset recognised under the finance lease to which the ACA needs to be allocated.
To address this uncertainty, s 705-56 of ITAA 1997 was introduced in March 2005 to clarify the treatment of finance leases on entry into a tax consolidated group. Section 705-56 operates such that only the entity which ‘holds’ the underlying asset for ITAA 1997 Div 40 purposes is able to assign a tax cost setting amount to it, as set out in the table below.