House of Representatives

New Business Tax System (Consolidation) Bill (No. 1) 2002

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 6 - Transferring losses to a consolidated group

Outline of chapter

6.1 This chapter explains:

·
which losses may be transferred to the head company of a consolidated group; and
·
the effects of transferring a loss.

6.2 The rules are contained in Subdivisions 707-A and 707-D.

6.3 Modifications to the general loss rules which will apply in determining whether a transferred loss can be used by a head company are explained in Chapter 7.

6.4 The rules that limit the amount of a transferred loss that may be used by the head company are discussed in Chapter 8. Concessions available to groups that form during the transitional period are discussed in Chapter 9.

Context of reform

6.5 The scheme for consolidated groups is based on the principles recommended by A Tax System Redesigned . One of the principles is that a company or trust entering a consolidated group should be able to bring its losses into the group.

6.6 The rules that provide for this are designed to ensure that the use of a joining entitys losses by the group approximates the rate at which they would have been used had the entity not joined the group. A Tax System Redesigned identified a large store of unused losses in the taxation system. Allowing losses to be automatically transferred to a group and used against group income without restriction would be too costly to the revenue.

6.7 Two main sets of rules govern losses and consolidated groups. To the extent these specific loss rules are inconsistent with the single entity or entry history rules discussed in Chapter 2, they override the single entity and entry history rules. [Schedule 1, item 2, section 701-90]

6.8 First, the amount of losses that can be transferred to a consolidated group is restricted by ensuring that entities seeking to transfer losses to a consolidated group pass, at the transfer time, modified versions of the current tests for deducting or applying losses.

6.9 Second, the rate at which transferred losses can be used by the group is restricted. The method by which this is achieved departs from that recommended by A Tax System Redesigned . The new method was developed in consultation with interested taxpayers and their advisers and is discussed in Chapter 8.

6.10 The provisions allowing the transfer (and use) of losses are not designed to facilitate the earlier or greater use of those losses. Rather, they ensure that the tax system does not stand in the way of commercial group restructures, impediments to which will be removed by the introduction of the consolidation regime.

Summary of new law

Transferring losses to a consolidated group

6.11 Each time an entity becomes a member of a consolidated group (whether as head company or a subsidiary) its unused carry-forward losses are tested to determine whether they can be transferred to the group. [Schedule 1, item 2, Subdivision 707-A]

6.12 Broadly, a loss can only be transferred to the head company of a consolidated group if the loss could have been used outside the group by the entity seeking to transfer it (called the joining entity). That is, the loss can be transferred if the joining entity could have deducted or applied the loss in the period immediately before transfer assuming it had sufficient income or gains of the relevant kind. Losses are tested for this purpose at the time the joining entity becomes a member of a group (called the joining time).

6.13 Basically, the joining entity applies the general rules for deducting or applying prior year losses as though the 12 months prior to the entity joining the group were the loss claim year. This will generally involve ascertaining whether, for the period since the loss was incurred up until the joining time, the joining entity has maintained substantially the same ownership or the same business. These ownership and business tests are modified to ensure they work appropriately as transfer tests.

The effects of transfer

6.14 A transferred loss is taken to have been made by the head company to which it is transferred. This means the head company may either use the loss in working out its taxable income or transfer it to another group of which it becomes a subsidiary member. A loss transferred by a subsidiary member of a group is no longer available for use by the subsidiary, even if it subsequently leaves the group. [Schedule 1, item 2, subsections 707-105(1) and 110(1)]

6.15 Losses that do not satisfy the transfer tests are effectively cancelled in that they may not be used by any entity. [Schedule 1, item 2, subsection 707-105(2)]

Comparison of key features of new law and current law
New law Current law
All entities that can be members of a consolidated group (i.e. most companies and trusts) may transfer losses to the group. Only companies may transfer losses to members of the same wholly-owned group. There is no provision for the transfer of losses by or to a trust.
All loss types (i.e. tax losses, net capital losses and foreign losses) may be transferred, provided they satisfy the transfer tests. Only tax losses and net capital losses may be transferred. There is no provision for the transfer of foreign losses.
All of an entitys losses are tested when the entity joins a consolidated group. Those that pass are transferred to the group for possible later use by the group. Those that do not are effectively cancelled. Losses may be transferred for use in a particular income year. But only to the extent the transferee has sufficient income, in that income year, against which the loss can be offset.
The head company can choose to cancel the transfer of a loss. Losses are transferred by agreement between the transferor and transferee. There is therefore no provision for cancellation of a transfer.
Losses made by a joining entity before it became a member of the group may be transferred to the group, provided they satisfy the transfer tests. Losses may only be transferred if the transferor and transferee were both members of the same wholly-owned group from when the loss was made until the time of transfer.

Detailed explanation of new law

Which losses can be transferred to a consolidated group?

6.16 The following losses may be transferred to a consolidated group:

·
tax losses (including film losses);
·
net capital losses; and
·
foreign losses.

[Schedule 1, item 2, subsection 707-115(1) and definition of sort of a loss in subsection 701-5(4)]

6.17 These are losses that have been realised by the joining entity before the joining time.

6.18 Two broad categories of losses may be transferred:

·
those that have been generated by the joining entity; and
·
those that have previously been transferred to the joining entity.

6.19 This reflects the fact that an individual entity may join a consolidated group or, alternatively, the head company of one consolidated group may become a subsidiary member of another group. A head company joining another group may have both loss types - those generated by the group and those transferred into the group.

6.20 If the joining entity is also the head company of the group, the losses it generated as a single entity are transferred to itself in its capacity as head company.

6.21 There are generally 3 steps to be followed each time an entity seeks to transfer losses to the head company of a consolidated group:

·
step 1 - the entity works out its taxable income (or loss) for the period up to the time it joins the group;
·
step 2 - the entity identifies the amount of its unused carry-forward losses as at the joining time; and
·
step 3 - the entity determines whether those losses satisfy the modified tests for using them.

Step 1: Work out taxable income up to consolidation

6.22 Where an entity joins a group as a subsidiary member part way through the entitys income year, it must work out its taxable income up to the joining time. The rules for this are discussed in Chapter 2.

6.23 In working out the pre-joining taxable income, carry-forward losses from previous income years are deducted or applied. A loss worked out for this pre-consolidation (or non-membership) period is also available for transfer.

Step 2: Work out the amount of unused carry-forward losses

6.24 An entity may only transfer carry-forward losses that have not previously been used or otherwise reduced (e.g. under the debt forgiveness rules) for an income year (or a non-membership period) that ends at or before the joining time. [Schedule 1, item 2, subsection 707-115(2)]

6.25 Broadly, an entity utilises a loss if it takes it into account in working out its taxable income. Specifically, if it:

·
deducts a tax loss from assessable or exempt income;
·
applies a net capital loss in reducing capital gains; or
·
takes into account an overall foreign loss in respect of a class of assessable foreign income in reducing that income.

[Schedule 1, item 2, definition of utilises a loss in subsection 707-110(2)]

6.26 Therefore, for example:

·
losses deducted or applied in working out taxable (or exempt) income up to the joining time are not available for transfer; and
·
any losses that result from working out a final tax position for an income year (or non-membership period) that ends at the joining time are available for transfer.

[Schedule 1, item 2, section 701-35, paragraph 707-115(1)(b), and section 707-405]

Step 3: Work out which unused carry-forward losses satisfy the use tests

6.27 Only unused carry-forward losses that, at the joining time, also satisfy the tests for utilising them may be transferred. These tests are discussed in paragraphs 6.36 to 6.89. [Schedule 1, item 2, section 707-120]

How are the tests applied for transferring losses to a group?

6.28 The normal loss recoupment tests apply as though the joining entity had sought to use the loss in an income year that ended immediately after it joined the group.

Assumptions to be used in applying the transfer tests

6.29 Because those tests are normally only triggered when a loss is actually claimed, some assumptions are made to facilitate their use as loss transfer tests. The tests are applied to an unused carry-forward loss as though:

·
the entity had sought to claim the loss for an income year called the trial year (the trial year generally starts 12 months before, and ends immediately after , the entity joined the group);
·
the entity has sufficient income of the relevant type against which its losses may be offset;
·
the entity had not joined the group:

-
since a subsidiary entity cannot use its own losses after joining a consolidated group, the transfer tests (which test whether the joining entity could have used the losses) must pretend the entity had not joined the group; and

·
the entity was a wholly-owned subsidiary of the head company if it joined as a subsidiary member:

-
this clarifies that the previous assumption does not alter the ownership structure of a subsidiary member (which means that changes that cause it to enter the group are taken into account in determining whether the loss can be transferred).

[Schedule 1, item 2, subsection 707-120(1)]

6.30 The transfer tests may also be applied to losses generated in the income year of consolidation as a result of working out a final taxable income under step 1. That is, the usual rule that losses may only be used if they were incurred in a prior year is overridden so that the transfer tests can be applied to step 1 losses. [Schedule 1, item 2, subsection 707-120(4)]

6.31 The assumptions are supplemented by some modifications to the ownership and business tests to ensure they work appropriately as transfer tests.

Distinguishing between transfer and recoupment tests

6.32 Because the tests work slightly differently when applied to determine whether a loss can enter a consolidated group, it is important to distinguish their use as transfer tests from their normal application in determining whether a loss can be used (i.e. as recoupment tests).

6.33 In particular, the transfer process must be distinguished from the step 1 process of working out taxable income up to the joining time. In working out its taxable income up to the joining time, an entity may have used the relevant tests to deduct or apply losses. That occurs first. Transfer tests then apply for the purpose of determining whether any unused losses can be transferred to the head company.

6.34 However, events such as ownership changes that have occurred from the time the loss was incurred until immediately after the joining time may be relevant to both processes.

6.35 The application of the ownership and business tests as transfer tests must also be distinguished from their subsequent use by the head company as recoupment tests when seeking to use transferred losses.

How do the loss recoupment tests work as transfer tests?

6.36 The entities and the tests relevant to each of them are listed in Table 6.3 (at the end of this chapter). The tests can broadly be categorised as follows:

·
continuity of ownership;
·
control;
·
same business; and
·
pattern of distributions.

6.37 The way in which each of them works as a transfer test is discussed in paragraphs 6.39 to 6.89. All of the tests are applied on the basis of the assumptions discussed in paragraphs 6.29 to 6.31.

6.38 The company tests for revenue and net capital losses are contained in Part 3-5 of the ITAA 1997. The company tests for foreign losses are those contained in sections 80A and 80DA of the ITAA 1936. The trust tests for revenue and foreign losses are contained in Schedule 2F to the ITAA 1936.

Transfer test - continuity of ownership

6.39 The COT applies to companies and the 50% stake test applies to trusts.

6.40 Broadly, a company satisfies the COT if, from the start of the income year in which it made the loss until the end of the income year in which it claims the loss, the same individuals have, directly or indirectly (through the continuous holding of the same shares or interests):

·
control of more than 50% of the voting power in the company;
·
rights to more than 50% of the companys dividends; and
·
rights to more than 50% of the companys capital distributions.

6.41 Corporate limited partnerships that are treated as companies because of section 94J of the ITAA 1936 also apply these tests, though they are not required to test maintenance of voting power.

6.42 The 50% stake test for trusts operates in a broadly similar manner, though trusts are not required to examine voting power.

6.43 If the test is passed, the loss may generally be used and therefore transferred. However, if the entity is a company, it must also satisfy the control test. Further, if the entity is a non-fixed trust, it must also pass the pattern of distributions test (if relevant) and a control test.

Testing ownership over a period

6.44 Most companies and trusts to which the ownership test is relevant are required to test ownership continuously from the commencement of the income year in which the loss was incurred until the end of the income year in which it is sought to be deducted or applied (referred to as the ownership test period or test period).

6.45 Because the trial year ends immediately after joining time, the relevant test periods for transfer purposes also end immediately after joining time. Therefore, a joining entity that would normally be required to test continuously must test its ownership from the commencement of the income year in which the loss was incurred until immediately after joining time.

6.46 The test has deliberately been extended until after the joining time to ensure that ownership changes that occur as part of a consolidation event are taken into account.

6.47 While the trial year ensures that the ownership test period ends immediately after joining time, it does not affect the commencement of the ownership test period. This period continues to start at the start of the loss year. This means the ownership test period may start before or after the start of the trial year.

Example 6.1 Subco joins a consolidated group on 1 December 2004. It incurs a loss during the pre-consolidation (or non-membership) period from 1 July 2004 to the joining time. The trial year is from 1 December 2003 to 1 December 2004. However, ownership is tested during the period from the commencement of the loss year (1 July 2004) to just after the joining time (1 December 2004).

owner test period

6.48 However, listed public companies and their 100% subsidiaries are only required to test ownership each time there is an abnormal trading in their shares and at the end of an income year (including the income year in which the loss is claimed). An entity required to test ownership at the end of the income year will be required to test immediately after joining to see whether losses may be transferred. Again, any changes in ownership that result in the entity joining a consolidated group will be taken into account.

Testing ownership where the loss has been previously transferred

6.49 Broadly, a head company seeking to transfer a previously transferred loss need only test its ownership from the time the loss was first transferred to it. However, there are further modifications to the ownership test if the loss was previously transferred to it by another company because that other company satisfied the ownership test. These modifications are discussed in Chapter 7.

Transfer test - control

6.50 There are 2 control tests:

·
that which applies to companies - it is failed if a person starts to control the entitys voting power for the purpose of gaining a tax benefit or advantage; and
·
that which applies to non-fixed trusts - it is failed if, at any time during the test period, a group commences to control the trust (e.g. so it can obtain beneficial enjoyment of the capital or income of the trust).

6.51 Again the tests are applied as though the test period ended immediately after the joining time. It continues to start from the beginning of the loss year. Therefore, the purpose of the groups acquisition of a company may be relevant in determining whether the company passes the control test and so can transfer losses.

Transfer test - same business

6.52 A company that fails the ownership or control tests, may nonetheless use (and therefore transfer) losses if it passes an SBT.

6.53 When used as a recoupment test, the SBT is basically passed if the business a company carries on during the income year in which it seeks to use the loss is the same as the one it carried on immediately before the ownership or control changed.

6.54 However, when used as a transfer test, the SBT is modified in 2 ways. First, by modifying the periods during which the same business must be carried on. This is discussed in paragraphs 6.55 to 6.74. Second, by applying an additional test if the loss was previously transferred because the SBT was passed. This is discussed in paragraphs 6.75 to 6.84.

Same business test - modifying the periods during which it applies

6.55 The SBT is modified so that there is a period of sufficient length to which it can be applied, given that the change in ownership and the joining time may coincide. This is achieved by ensuring that, on transfer, one of the periods during which the joining entitys business is tested is the trial year . This is basically the 12 months before the joining time. [Schedule 1, item 2, subsections 707-120(1) and (2)]

6.56 However, the period will be less than 12 months if the joining entity did not exist for the whole of the 12 months prior to the joining time. In that case, the trial year only extends back to when the entity came into existence. The trial year may also be less than 12 months where the joining entity had previously been a subsidiary member of another consolidated group. In that case, the trial year does not go back any further than the time it last ceased to be a member of a consolidated group.

6.57 Also, in applying the SBT as a transfer test, the test period effectively ends immediately before the joining time. This is achieved by assuming that the business carried on by the joining entity at and just after the joining time is the same as the business it carried on just before the joining time. [Schedule 1, item 2, subsection 707-120(3)]

6.58 A further rule ensures that a head company seeking to transfer (previously) transferred losses is not required to compare its business as a head company with the business it carried on as a single entity prior to consolidation. In the absence of this rule, it may prove difficult for a head company to pass the SBT if such a comparison was required. [Schedule 1, item 2, section 707-400]

6.59 For example, a company (the original head company) chooses to consolidate a group on 1 April 2004. Losses are transferred to it at that time. On 1 June 2004 the original head company is acquired by a new group. Between those 2 dates the original head company fails the ownership test in respect of the transferred losses so they can only be transferred to the new group if the transfer SBT (referred to in paragraph 6.54) is passed. In the absence of this rule, the trial year concept would require the original head company to test its ownership for a minimum 12 month period which would cover both its business as a single entity and as a head company of a consolidated group.

6.60 This rule applies to any of the transfer SBTs including the additional test discussed in paragraphs 6.75 to 6.84. However, it does not apply if the head company is seeking to transfer the loss to itself on initial formation of the group. The rule is not needed in that context as only the business of the head company as a single entity will be tested. The rule has been drafted in general terms so is also capable of applying to a head company seeking to actually use or recoup a transferred loss.

6.61 Additional modifications are made to the test periods for losses made for an income year starting after 30 June 1999. These are discussed in paragraphs 6.62 to 6.74.

Same business test - companies

6.62 As stated in paragraph 6.61, the test to be applied depends on the income year in which the loss was made.

Table 6.1: Same business transfer tests for companies
Item no. In these circumstances Test the joining entitys business at these points
1 The loss was made by the joining entity for an income year starting after 30 June 1999.

·
just before the end of the income year in which the loss was made;
·
the income year in which the joining entity first fails the ownership or control tests; and
·
the trial year.

2 The loss was made by the joining entity for an income year starting before 1 July 1999.

·
just before the ownership or control tests were first failed; and
·
the trial year.

[Schedule 1, item 2, subsections 707-120(1) and 707-125(1) to (3)]

6.63 A loss made by the joining entity means either a loss that was actually made by the joining entity or one it is taken to have made as a result of being transferred to it previously (i.e. when it was a head company).

6.64 Therefore, the test in item 1 in Table 6.1 will also apply to a loss that has been the subject of one or more previous transfers for whatever reason. However, if the loss was previously transferred as a result of the SBT having been passed, there is an additional test that must be applied. This is discussed in paragraphs 6.75 to 6.84.

6.65 A previously transferred loss will always be covered by item 1 in Table 6.1 because transferred losses are taken to have been made by the head company in the income year of transfer. Given that the consolidation regime does not commence until 1 July 2002, this will always be an income year starting after 30 June 1999.

6.66 The test points of the same business transfer tests that refer to a failure of the ownership or control tests necessarily refer to a failure that occurs after the commencement of the income year in which the loss was made. That is, these test points are linked to a failure of the ownership or control tests during the ownership test period.

6.67 The same business transfer test for losses made in an income year that starts after 30 June 1999 is stricter than the normal same business recoupment test. It is stricter because it tests at an additional point, namely just before the end of the income year in which the loss was made, and because it tests the whole of the income year in which the ownership or control tests are failed. This assists in giving the test integrity when used as a transfer test. Integrity is required because of the possibility that some or all of the test points will overlap or coincide.

6.68 Further integrity is built in by the concept of a trial year, which generally ensures that the business is tested for a minimum 12 month period. The trial year test point applies regardless of when the loss was made.

6.69 The acquisition of an entity may result in both the first change in ownership and entry of the entity into the group. In the absence of a 12 month test period, losses could be transferred and the SBT would be ineffective.

Example 6.2 The joining entity makes a loss for the 2002-2003 income year which ended on 30 June 2003. It joins a consolidated group on 2 July 2003. On joining, it fails the ownership test.If the existing SBT for recoupment of losses applied, the joining entity would only need to carry on the same business:

·
immediately before 2 July 2003 (as that is when the change in ownership occurred); and
·
for the 2 days from commencement of the 2003 income year (as, in the absence of a trial year rule, that would effectively be the loss claim year).

Instead, the proposed 3 point test applies. That means the joining entity must carry on the same business for the whole of the 12 months before the joining time (i.e. from 2 July 2002 to the joining time).

6.70 Examples 6.3 to 6.5 show 3 possibilities for losses made in an income year starting after 30 June 1999, depending on the extent to which the testing points overlap.

Example 6.3: The test points are 3 separate periods

Losses made in income year: The test points are three seperate periods

The joining entity must compare its business at 3 points:

·
just before the end of the 2000-2001 income year (the loss year);
·
the whole of the 2002-2003 income year (the year COT is failed); and
·
1 November 2003 to 1 November 2004 (the trial year).

Example 6.4: The test points are 2 separate periods

Losses made in income year: The test points are two seperate periods

The joining entity must compare its business at 2 points:

·
just before the end of the 2000-2001 income year (the loss year); and
·
the whole of the 2004-2005 income year (the year the COT is failed and the trial year overlap).

Example 6.5: All 3 test points overlap

Losses made in income year: All 3 test points overlap

The entity must compare its business just before the end of the 2004-2005 income year (the loss year) with that carried on during the whole of the 2004-2005 income year (the year the COT is failed and the trial year overlap).

6.71 The requirement that a minimum 12 month period be tested may result in the joining entitys business being tested for a period prior to the commencement of the income year in which the loss was made. That is, before the commencement of the ownership test period.

Example 6.6 An entity joins a consolidated group on 1 November 2004. It makes a loss for the non-membership period 1 July 2004 to the joining time. In testing its loss at the joining time, it is found that the COT is failed.Applying the 3 point test, the joining entity must carry on the same business for the 12 months before the joining time (i.e. from 1 November 2003 to the joining time).

Same business test - listed public companies (and their 100% subsidiaries)

6.72 Tests similar to those set out in Table 6.1 also apply to listed public companies and their 100% subsidiaries.

6.73 However, when seeking to claim a loss, those entities are only required to test their ownership each time there is abnormal trading in their shares and at the end of each income year, including the year in which the loss is claimed.

6.74 These special testing rules are contained in Division 166 of the ITAA 1997. They apply to listed public companies and their 100% subsidiaries. The rules in Division 166 are modified as set out in Table 6.2.

Table 6.2: Same business transfer tests for listed public companies and their 100% subsidiaries
Item no. In these circumstances Test the joining entitys business at these points
1 The loss was made by the joining entity for an income year starting after 30 June 1999.

·
just before the end of the income year in which the loss was made;
·
the income year in which the joining entity first finds there is no substantial continuity of ownership as a result of testing at the prescribed times; and
·
the trial year.

2 The loss was made by the joining entity for an income year starting before 1 July 1999.

·
just before the joining entity first finds there is no substantial continuity of ownership as a result of testing at the prescribed times; and
·
the trial year.

[Schedule 1, item 2, subsections 707-120(1) and 707-125(1) and (4)]

Transfer test - previously transferred SBT losses

6.75 A loss that has been transferred because the joining entity satisfied an SBT is referred to in this explanatory memorandum as an SBT loss (though that expression does not appear in the law).

6.76 SBT losses may only be transferred again if the loss passes an additional test. [Schedule 1, item 2, subsection 707-135(1)]

6.77 This additional test applies to the second transfer of the loss and to each subsequent transfer of the loss. It applies even if the COT is passed at the second or subsequent transfer time.

6.78 Under the additional test, a loss transferred because an SBT was passed may only be transferred again if the entity transferring the loss carried on the same business at these times:

·
just before the end of the income year in which the loss was previously transferred to it (this is also the income year in which the loss was taken to have been made); and
·
during the trial year.

[Schedule 1, item 2, subsection 707-135(2)]

6.79 This test is additional in that it is only applied after the usual (ownership and same business) transfer tests have been applied, and then only if one of those tests have been passed. (If the usual tests are failed the loss is effectively cancelled and the provision imposing this test can therefore not apply.)

6.80 If the additional test is passed, the loss will be transferred. If it is failed, the loss will effectively be cancelled.

Comparing the additional business test to the usual one

6.81 The usual SBT only applies on transfer if the ownership or control tests are failed. However, the additional test applies even if the ownership or control tests have been passed.

6.82 For that reason, the additional test is contained entirely within the consolidation rules. It does not rest upon the normal deduction rules, or rely upon their triggers as do, for example, the same business transfer tests set out in Tables 6.1 and 6.2.

Why is there an additional test for transferring SBT losses?

6.83 A transferred loss is taken to be made by the head company to which it is transferred in the income year in which the transfer occurs. This effectively erases the previous failure of the ownership test if the loss is an SBT loss. Therefore, there may be no failure of the ownership test when the loss is sought to be transferred subsequently to the head company of another group. For example, the second group may acquire the first group simply by increasing its ownership percentage in the head company of the first group from 90% to 100%.

6.84 In the absence of the additional test, an SBT loss would only need to pass the SBT when transferred the first time. It could then effectively be transferred subsequently without further SBT testing. That result would be contrary to the way in which the loss would be treated had it not been transferred at all. That is, in order to deduct the loss outside a consolidated group, the loss entitys business immediately before the ownership change is compared with its business in the claim year. The additional test ensures that this is effectively what will happen each time an SBT loss is sought to be transferred.

Transfer test - pattern of distributions

6.85 The pattern of distributions test is one of the loss recoupment tests for non-fixed trusts. The test is triggered where there is a distribution of income in the loss claim year and in at least one of the 6 earlier income years. The test is also triggered where there is a distribution of capital in the loss claim year and in at least one of the 6 earlier income years.

6.86 The test requires a comparison of the distribution made in the loss claim year with distributions made in the 6 earlier income years. The test is passed if more than 50% of a trusts income and capital distributions are made (directly or indirectly) for each of the test years to the same individuals.

6.87 Before a loss can be transferred to a head company, it is tested to ascertain whether it can be utilised during the trial year - usually a period commencing 12 months before the joining time and ending just after the joining time. Normally, the pattern of distributions test requires an examination of trust distributions made in test income years. Where a trust joins the group part way through its income year, the trial year does not match an income year. This makes it difficult to determine the test income years and their distributions.

6.88 Therefore, where the pattern of distributions test is applied as a transfer test, the trial year is modified to be the income year in which the trust joins the consolidated group. [Schedule 1, item 2, subsections 707-130(1) to (3)]

6.89 A trust may make a distribution after the time it joins a group. In working out whether this distribution is counted in determining if the pattern of distributions test is passed as a transfer test, the test only takes account of distributions that are attributable to income or capital of the trust before the joining time. [Schedule 1, item 2, subsection 707-130(4)]

Transferring part year losses

6.90 A special rule ensures that losses referable to only part of an income year can be transferred. It also ensures they are tested on transfer over a period that reflects the fact that they were effectively made for a shortened income year.

6.91 A loss is referable to part of an income year if:

·
an entity joins a group as a subsidiary member, or exits a group, part way through its income year; and
·
it makes a loss for the shortened income period just before it joined, or just after it exited, the group.

6.92 These shortened income periods are called non-membership periods . The rules explaining non-membership periods and for working out taxable income or a loss for such periods are contained in the core rules discussed in Chapter 2. The special losses rule simply ensures that a non-membership period loss can be transferred and is appropriately tested at the transfer time. The rule is that a non-membership period loss made by an entity is, for the purpose of Division 707, taken to be a loss made by the entity for an income year that matches the length of the non-membership period. [Schedule 1, item 2, section 707-405]

Example 6.7

Non-membership period

During its 2003-2004 income year the entity in this example is a member of group 1 for the first period, is a member of no group for the second period (i.e. its non-membership period) and a member of group 2 for the third period.Assume that under the core rules it worked out a loss for its non-membership period. The special losses rule ensures that:

·
the non-membership period loss is ascribed actual loss status (only a loss made for a non-membership period that ends at the end of an income year is an actual loss for an income year) [Schedule 1, item 2, section 701-35] ; and
·
in determining whether the loss can be transferred to group 2 the entitys ownership is tested only from the start of the non-membership period (the definition of trial year ensures that, if necessary, the entitys business is also only tested from the start of the period).

How is a transferred loss treated in the hands of the head company?

6.93 A loss transferred to a head company is taken to be made by the head company for the income year in which the transfer occurs. This means the loss may be used by the head company.

6.94 Other effects of transferring a loss to a head company are:

·
the loss retains its original loss type;
·
the groups use of a transferred loss may depend on whether the COT or SBT was passed in respect of the loss at the transfer time; and
·
all losses transferred by a particular joining entity constitute a bundle which is assigned an available fraction - this is discussed in Chapter 8.

The head company is taken to have made the transferred loss

6.95 The loss is taken to have been made by the head company to which it is transferred. The joining entity is taken not to have made the loss which means that an entity that joins a group as a subsidiary member is no longer able to use the loss. [Schedule 1, item 2, subsection 707-140(1)]

6.96 This means the loss may be used by the head company in working out its taxable income (subject to limitations) or may be transferred to another group of which the head company becomes a wholly-owned subsidiary.

6.97 A transferred loss will continue to be taken as having been made by the head company to which it is transferred, unless the loss is transferred again. This means the limits on the use of transferred losses will continue to apply to an entity even if it ceases to be a head company because, for example, it becomes a non-resident.

A transferred loss is taken to have been made for the transfer year

6.98 A transferred loss is taken to have been made by the head company for the income year in which the transfer occurs. [Schedule 1, item 2, subsection 707-140(1)]

6.99 It may be used by the head company in the same income year in which the transfer occurs. This overrides the general rule that an entity may only deduct or apply losses from earlier income years, thereby matching the existing loss transfer rule in section 170-15 of the ITAA 1997. [Schedule 1, item 2, subsection 707-140(2)]

6.100 However, where a debt of the head company is forgiven (in accordance with Subdivision 245-B in Schedule 2C to the ITAA 1936) in the income year in which the loss transfer occurs, subsections 245-105(5) and (6) apply as if the head company made the transferred loss for an earlier year. This ensures the loss can be reduced by the net forgiven amount of the debt as only prior year losses can be reduced under the debt forgiveness rules. [Schedule 1, item 2, subsection 707-140(3)]

6.101 Even though all transferred losses are taken to be made by the head company in the transfer year (i.e. refreshed), the head company will need to test the ownership of the loss entity from the start of the actual loss year if the loss entity is a company and the loss was transferred because the COT was passed. These rules are discussed in Chapter 7.

Transferred losses retain their original loss type

6.102 The different loss types are tax losses (including film losses), net capital losses and foreign losses. All losses retain their status as one of these types, even after transfer. Each type is a sort of a loss . [Schedule 1, item 2, definition of sort of a loss in subsection 701-5(4)]

6.103 A groups use of a transferred loss may depend on which of the loss recoupment tests were met at the transfer time

6.104 As discussed in paragraph 6.75, a loss that has been transferred because the joining entity satisfied an SBT is referred to as an SBT loss . A transferred loss that has passed the ownership test may still be an SBT loss. For example, a company may pass the ownership test, fail the control test, but pass the SBT. The loss will be an SBT loss because, in the end, passing the SBT was the reason the loss was able to be transferred.

6.105 SBT losses are not subject to further business testing in the hands of the head company unless the head company fails the COT or seeks to transfer the loss again.

6.106 A loss that has been transferred because the joining entity satisfied an ownership test is referred to in this explanatory memorandum as a COT loss (though that expression does not appear in the law).

6.107 Whether a loss is an SBT loss or a COT loss is relevant:

·
in determining whether the loss can be used by a head company:

-
special rules apply in determining whether a COT loss transferred to a head company by another company can be used (see Chapter 7);

·
in determining which of the 2 methods for limiting the use of transferred losses applies:

-
the concessional method for using transferred losses may only be used for some COT losses transferred by a company (see Chapter 9); and

·
in applying the SBT as a transfer test:

-
losses that have previously been transferred because the SBT was passed can only be transferred again if they satisfy an additional SBT (see paragraphs 6.75 to 6.84).

Cancelling the transfer of a loss

6.108 A head company can choose to cancel the transfer of a loss. The choice cannot be revoked. If the choice is made, the transfer is taken never to have occurred which means that the loss itself is effectively cancelled in that it can never be used by any entity. [Schedule 1, item 2, section 707-145 and subsection 707-150(1)]

6.109 A head company may wish to cancel a loss transfer to avoid adjusting the rate at which it can use its existing transferred losses. The rate of use of transferred losses is discussed in Chapter 8. The cancellation of a loss transfer may also affect the calculation of the allocable cost amount for the joining loss entity (discussed in Chapter 5).

The effect on the joining entity

6.110 A loss transferred by an entity that becomes a subsidiary member may never be used by the entity, even if the entity subsequently leaves the group.

6.111 This is because, after transfer, an entity that joins as a subsidiary member is taken not to have made the loss. This would prevent it using the loss either while it is a subsidiary member or after it leaves the group. The single entity rule also means a transferred loss is not available for use by a subsidiary while it is a member of the group. [Schedule 1, item 2, section 701-5 and paragraph 707-140(1)(b)]

6.112 A loss that is unable to be transferred is effectively cancelled in that it cannot be used by any entity for an income year ending after the joining time. There is one exception. A loss that is not transferred because it is required for use in a non-membership period that ends before the joining time may still be used for that period. [Schedule 1, item 2, section 707-150]

6.113 If the head company chooses to cancel the transfer of a loss, the transfer is taken not to have occurred. Again, the loss may never be used by any entity for an income year ending after the joining time. [Schedule 1, item 2, sections 707-145 and 707-150]

Application and transitional provisions

6.114 The consolidation regime will apply from 1 July 2002.

Consequential amendments

6.115 Consequential amendments have been made to subsection 995-1(1) of the ITAA 1997 to include references to new dictionary terms. [Schedule 5, items 10, 19, 26, 27, 32, 34, 37 and 38]

Table 6.3: Which loss tests apply to which entities
These entities Apply these loss tests
Ownership [F1] Control Same business Pattern of distribution
Company . . .
Listed public company (and 100% owned subsidiary) . . .
Ordinary fixed trust .
Unlisted widely-held trust .
Unlisted very widely-held trust .
Wholesale widely-held trust .
Non-fixed trust   (if applicable)     (if applicable)


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