House of Representatives

Tax and Superannuation Laws Amendment (2015 Measures No. 2) Bill 2015

Replacement Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Chapter 4 - Company losses

Outline of chapter

4.1 Schedule 4 to this Bill amends the company loss recoupment rules in the Income Tax Assessment Act 1997 (ITAA 1997) by:

modifying the continuity of ownership test for companies whose shares have unequal rights to dividends, capital distributions or voting power;
ensuring that, for the purposes of applying the continuity of ownership test, the ownership of companies does not have to be traced through a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust; and
clarifying that the entry history rule does not operate in relation to an entity that becomes a subsidiary member of a consolidated group or multiple entry consolidated group (MEC group) for the purposes of applying the same business test.

4.2 All legislative references in this Chapter are to the ITAA 1997 unless otherwise indicated.

Context of amendments

4.3 Under the company loss recoupment rules, an entity is able to claim deductions for prior year tax losses or bad debts, or apply net capital losses, only if the tested company satisfies the continuity of ownership test or the same business test. The claiming entity and the tested company may not be the same entity.

4.4 Similarly, any prior year losses or non-membership period losses of a company that joins a consolidated group or a MEC group can only be transferred to the head company of the group at the joining time if the tested company satisfies one of these tests.

Operation of the continuity of ownership test

4.5 The continuity of ownership test broadly requires that the shares carrying more than 50 per cent of all voting, dividend and capital rights be beneficially owned by the same persons at:

all times during the ownership test period; or
specific testing times within the test period.

4.6 The ownership test period is, generally:

the period from the start of the loss year to the end of the income year in which the loss is to be deducted; or
if the company joins a consolidated group or MEC group, the period from the start of the loss year to the end of a trial year.

4.7 Concessional ownership tracing rules apply to widely held companies and certain other companies (known as eligible Division 166 companies).

4.8 The amendments overcome difficulties that arise in the application of the continuity of ownership test where:

a company has different classes of shares with unequal rights to dividends, capital distributions or voting power; and
shares in a company (that is not a widely-held or eligible Division 166 company) are held by superannuation funds and certain other entities.

4.9 The amendments have been developed in consultation with key stakeholders and will provide them with greater certainty by reducing the risk of technical failures to the continuity of ownership test (which arise because a company is unable to determine whether a condition of the test is satisfied) and reducing compliance costs.

Companies with shares that have unequal rights to dividends, capital distributions or voting power

4.10 Companies may have difficulty in satisfying the continuity of ownership test where they have shares with unequal rights to dividends, capital distributions or voting power. In these circumstances, companies may technically be unable to meet the conditions required by the continuity of ownership test even though there is no significant change in underlying beneficial ownership during the ownership test period.

4.11 For example, a company which has more than one class of shares with different owners may be unable to satisfy the continuity of ownership test because, if the classes of shares have unequal rights to dividends and capital distributions or unequal voting power, it may be difficult to identify which particular group of owners have more than 50 per cent of the relevant rights or voting power at a particular time.

4.12 Where a company cannot work out whether it satisfies the continuity of ownership test, the company is regarded as being unable to satisfy the conditions required by the continuity of ownership test.

4.13 The amendments will improve the operation of the continuity of ownership test by modifying the test for companies that have shares with unequal rights to dividends, capital distributions or voting power.

4.14 These amendments apply from 1 July 2002 and are beneficial to taxpayers. Companies will have greater certainty in applying the continuity of ownership test to determine whether:

prior year tax losses and bad debts can be deducted; or
net capital losses can be applied.

Shares held by superannuation funds and certain other entities

4.15 If shares in a company (that is not a widely-held or eligible Division 166 company) are held by an entity that is a complying superannuation fund, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust, the ownership of the company must be traced through the entity for the purposes of applying the continuity of ownership test. However, the ownership of widely-held and eligible Division 166 companies does not have to be traced through these entities. This imposes an unnecessary compliance burden in determining the beneficial ownership of companies that do not qualify for these concessional tracing rules.

4.16 The amendments will improve the operation of the continuity of ownership test where shares in a company are held by an entity that is a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust by removing the need to trace ownership through those entities.

4.17 These amendments are also beneficial to taxpayers and apply from the 2011-12 income year.

Operation of the same business test

4.18 The same business test broadly requires a company to carry on the same business at the following times:

immediately before the 'test time' (which is generally either the point in time at which the continuity of ownership test is no longer satisfied, or the start of the income year when the loss is incurred where it is not practicable for the company to show that there is a period during which it has satisfied the continuity of ownership test); and
throughout the income year the loss is claimed as a deduction.

4.19 These times are modified when a company joins a consolidated group or MEC group.

4.20 Difficulties arise in applying the same business test to the head company of a consolidated group or MEC group because of the operation of the entry history rule.

4.21 The amendments will improve the operation of the same business test by clarifying that consolidated groups and MEC groups can disregard the entry history rule for the purposes of applying the same business test.

4.22 These amendments, which have been developed in consultation with key stakeholders, are beneficial to taxpayers and therefore will apply from 1 July 2002.

4.23 The amendments clarify the operation of the existing law and will make it easier for the head company of a consolidated group or MEC group to determine whether it has satisfied the same business test. Therefore, the amendments will give consolidated groups and MEC groups greater certainty greater certainty in applying the same business test to determine whether:

prior year tax losses and bad debts can be deducted; or
net capital losses can be applied.

Summary of new law

Modifications to the continuity of ownership test

Companies with shares that have unequal rights to dividends, capital distributions or voting power

4.24 The continuity of ownership test is modified for companies whose shares have unequal rights to dividends, capital distributions or voting power.

4.25 Under these modifications, if an entity is unable to work out whether a company satisfies a condition of the continuity of ownership test in respect of dividend or capital distributions, an entity may choose to reconsider the condition in up to three ways:

the first way is to disregard debt interests;
the second way is to disregard debt interests and certain secondary classes of shares; and
the third way is to disregard debt interests and certain secondary classes of shares, and treat each of the remaining shares as having a specified percentage of the rights to receive dividends and capital distributions.

4.26 If a company has shares that have different voting rights or do not carry all of the voting rights in the company, then the continuity of ownership test may be applied by testing voting power solely by reference to the maximum number of votes that could be cast in a poll on:

the election of the company's directors; or
an amendment to the company's constitution (other than an amendment altering the rights carried by any of the company's shares or other forms of voting power in the company).

Shares held by superannuation funds and certain other entities

4.27 The company loss recoupment rules will also be modified so that, in applying the continuity of ownership test, the ownership of companies that are not eligible to access the concessional tracing rules will not have to be traced through an entity that is a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust.

Modifications to the same business test

4.28 The same business test is modified for the head company of a consolidated group or MEC group to ensure that the entry history rule does not operate in relation to an entity becoming a subsidiary member of the group.

Comparison of key features of new law and current law

New law Current law
Where an entity cannot work out whether a condition of the continuity of test is satisfied in respect of shares in a company which have unequal rights to dividends or capital distributions, the entity may choose to reconsider the test in up to three ways:

the first way is to disregard debt interests;
the second way is to disregard debt interests and certain secondary share classes;
the third way is to disregard debt interests and certain secondary share classes, and treat the remaining shares as having certain relative rights (fixed percentage) to receive dividends and capital distributions.

As a result, a company that has shares with unequal rights to dividends or capital distributions will not fail the continuity of ownership where there is no significant change in underlying beneficial ownership during the ownership test period.

Under the company loss recoupment rules, a company is able to deduct prior year tax losses or bad debts, or apply net capital losses, only if it satisfies the continuity of ownership test or the same business test.

A company that has shares with unequal rights to dividends or capital distributions may technically fail the continuity of ownership test even though there is no significant change in underlying beneficial ownership during the ownership test period.

If the shares of a company have different voting rights, or do not carry all of the voting rights in the company, for the purpose of applying the continuity of ownership test, a choice can be made to test voting power solely by reference to the maximum number of votes that could be cast on a poll on:

the election of the company's directors; or
an amendment to the company's constitution (other than an amendment altering the rights carried by any of the company's shares or other forms of voting power in the company).

As a result, it is likely that the company will not have a technical failure of the continuity of ownership.

If the shares of a company have different voting rights, or do not carry all of the voting rights in the company, the company may technically fail the continuity of ownership test because it is unable to determine the continuity of voting power.
For the purposes of applying the continuity of ownership test, the ownership of companies that are not eligible to access the concessional tracing rules will not have to be traced through an entity that is a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust. For the purposes of applying the continuity of ownership test, the ownership of companies that are not eligible to access the concessional tracing rules must be traced through an entity that is a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust.
For the purpose of applying the same business test, the head company of a consolidated group or MEC group will not need to take into account the history of a subsidiary member prior to the time that it joined the group. For the purpose of applying the same business test, the head company of a consolidated group or MEC group may need to take into account the history of a subsidiary member prior to the time that it joined the group.

Detailed explanation of new law

Modifications to the continuity of ownership test

4.29 The continuity of ownership test is modified for companies whose shares have unequal rights to dividends, capital distributions or voting power so that companies may test the possession of those rights in a way that is analogous to a company whose shares are all of a single class with the same rights. [Schedule 4, item 1, sections 167-1, 167-5, 167-7 and 167-75]

4.30 The modifications that apply depend upon whether the tested company has:

shares with unequal rights to dividends or capital distributions (Subdivision 167-A); or
shares with unequal voting rights or that do not carry all of the voting rights in the company (Subdivision 167-B).

4.31 An entity may choose to reconsider a condition of the continuity of ownership test using the Subdivision that is relevant for the tested company's circumstances. For example, an entity may reconsider the test in respect of the tested company using:

the dividend modifications only - because the tested company's shares have equal rights to capital distributions and equal voting power;
the voting power modifications only - because the tested company's shares have equal rights to dividend and capital distributions; and
all modifications - because the tested company's shares have unequal rights to dividend and capital distributions, and some voting power is not attached to shares.

4.32 In some cases, the entity making the choice may not be the company to which the continuity of ownership test is being applied. For example, in the case of a consolidated group, the head company of the group is the entity that will make the choice to reconsider the continuity of ownership test. However, the head company may not be the entity being tested where the losses being utilised are 'transferred losses'.

Companies with shares that have unequal rights to dividends or capital distributions

4.33 An entity can choose to reconsider the continuity of ownership test in respect of a company that cannot work out whether it satisfies the dividend or capital distribution conditions (including certain loss integrity rules) because the company has an unequal share structure, or because a holding company has an unequal share structure, in up to three ways:

the first way is to disregard debt interests;
the second way is to disregard debt interests (if any) and certain secondary classes of shares; and
the third way is to disregard debt interests (if any) and certain secondary classes of shares (if any), and treat the remaining shares as carrying certain percentages of the rights to receive dividends and capital distributions.

[Schedule 4, item 1, section 167-7]

4.34 The modifications must be applied in order. The second way can only be tried after the first way, while the third way can only be tried after the second way.

4.35 However, an entity is not prevented from reconsidering the test using the second and third ways if the tested company does not have debt interests. Similarly, an entity is not prevented from reconsidering the test using the third way if the tested company does not have debt interests or certain secondary share classes.

Example 4.1 Quick Co has no debt interest shares. However, it has classes of shares that qualify as secondary classes of shares for the purpose of the second modification to the continuity of ownership test.In reconsidering the continuity of ownership test in the first way, Quick Co has no debt interests, so the outcome of the continuity of ownership test does not change.Quick Co then reconsiders the continuity of ownership test in the second way. Quick Co has shares that are disregarded as they are treated as secondary share classes by section 167-20. Those shares can be excluded from measuring the continuity of ownership in Quick Co.

4.36 The modifications, which are in new Subdivision 167-A, apply in relation to a company if:

disregarding the operation of Subdivision 167-A, the company would fail the continuity of ownership test because it is unable to work out whether it satisfies a condition at the test time or for the test period; and
the company, or a holding company that has a shareholding interest in the company, has an unequal share structure at the test time or at one or more times during the test period.

[Schedule 4, item 1, subsection 167-10(1)]

4.37 Each condition listed in the tables in section 167-10 must be considered separately. The fact that a company is unable to work out whether a condition in respect of dividend distributions has been satisfied does not mean that the company will be unable to work out whether it has satisfied a condition in respect of capital distributions.

Example 4.2 Company A is a widely held company that is subject to the concessional tracing rules when applying the continuity of ownership test.Company A has ordinary shares and preference shares on issue. Both share classes are equally entitled to the same capital distributions. However, the preference shares have priority rights to dividends and are entitled to dividend distributions at 150 per cent the rate of the ordinary shares.Company A can reconsider conditions that are concerned with the right to dividend distributions, but cannot reconsider conditions that are concerned with the right to capital distributions.

4.38 A condition of the continuity of ownership test may be considered at a particular time or times, in order to work out if the test is satisfied. If there is an unequal share structure at a particular test time, the condition can be reconsidered under Subdivision 167-A for that particular test time. A condition cannot be reconsidered under Subdivision 167-A if an unequal share structure is not present at the particular test time. [Schedule 4, item 1, subsection 167-10(2)]

4.39 Consequently, it is possible to use a combination of conditions that have, and have not, been reconsidered when working out if the continuity of ownership test has been satisfied.

Example 4.3 Company A, from Example 5.2, redeems its preference shares prior to the second test time under the continuity of ownership test. It reconsiders the condition under Subdivision 167-A at the first test time.However, Company A cannot reconsider the conditions related to the right to dividend distributions under Subdivision 167-A for the second test time because it no longer has an unequal share structure.

What are the relevant conditions?

4.40 The conditions that can be reconsidered under Subdivision 167-A are listed in the tables in subsections 167-10(1) and (2). These conditions, which are summarised in Table 5.1, can be reconsidered by:

first, disregarding debt interests;
second, disregarding debt interests and certain secondary classes of shares; and
third, treating the remaining shares as having fixed rights to dividends and capital distributions at certain times during the test period (or at one or more of the test times).

[Schedule 4, item 1, subsections 167-10(1) and (2)]

Table 4.1
Provision Condition
Subsection 165- 12(3)
Subsection 165-12(4)
Paragraph 165-37(1)(b)
Paragraph 165-37(1)(c)
Subsection 165-123(3)
Subsection 165-123(4)
Paragraph 175-10(3)(b)
Paragraph 175-10(3)(c)
Paragraph 175-45(3)(b)
Paragraph 175-45(3)(c)
Paragraph 175-85(3)(b)
Paragraph 175-85(3)(c)
Subparagraph (b)(ii) of the definition of eligible Division 166 company in subsection 995-1(1)
Subparagraph (b)(iii) of the definition of eligible Division 166 company in subsection 995-1(1).
There must be persons who have rights to more than 50 per cent of the company's dividends or capital distributions at all times during the test periods.
Subsection 166-145(3)
Subsection 166-145(4)
Subparagraph 166-175(1)(e)(ii)
Subparagraph 166-175(1)(e)(iii)
Paragraph 166-225(1)(b)
Paragraph 166-225(1)(c)
Subparagraph 166-230(1)(a)(ii)
Subparagraph 166-230(1)(a)(iii)
Paragraph 166-240(1)(b)
Paragraph 166-240(1)(c)
Subparagraph 166-255(1)(e)(ii)
Subparagraph 166-255(1)(e)(iii)
Subparagraph 166-260(1)(e)(ii)
Subparagraph 166-260(1)(e)(iii)
Paragraph 166-260(3)(b)
Paragraph 166-260(3)(c)
Paragraph 166-270(2)(c).
The company must be a widely held company or an eligible Division 166 company and there must be persons who have rights to more than 50 per cent of the company's dividends or capital distributions at particular test times.
Paragraph 165-115C(1)(b)
Paragraph 165-115C(1)(c)
Paragraph 165-115L(1)(b)
Paragraph 165-115L(1)(c)
Subparagraph 165-115X(1)(b)(ii)
Subparagraph 165-115X(1)(b)(iii)
Paragraph 165-115Z(1)(b)
Paragraph 165-115Z(1)(c)
Paragraph 170-260(3)(b)
Paragraph 170-260(3)(c)
Paragraph 170-265(2)(b)
Paragraph 170-265(2)(c).
Testing whether there are persons who have rights to a certain percentage of the company's dividends or capital distributions at particular test times.

Determining whether a company is an eligible Division 166 company

4.41 For the purposes of applying the continuity of ownership test, concessional ownership tracing rules apply to widely held companies and eligible Division 166 companies. A company is an eligible Division 166 company (as defined in subsection 995-1(1)) if, so far as is relevant, the company is not a widely held company and certain specified entities beneficially own:

dividend stakes that carry rights to receive more than 50 per cent of any dividends that the company may pay; or
capital stakes carry rights to receive more than 50 per cent of any distributions of capital of the company.

4.42 The specified entities are:

widely held companies;
superannuation funds and approved deposit funds;
first home savers account trusts;
special companies;
managed investment schemes;
non-profit companies; and
charitable institutions, funds and bodies.

4.43 Currently, a company that has an unequal share structure may not qualify as an eligible Division 166 company because the dividend and capital distribution conditions are unable to be satisfied.

4.44 The conditions in the definition of eligible Division 166 company can be reconsidered under Subdivision 167-A, even though the definition of an eligible Division 166 company doesn't expressly apply to a particular period.

4.45 However, the condition in paragraph 166-245(5)(b) cannot be reconsidered. That condition, broadly, modifies the ownership test tracing concession for certain types of entities (such as superannuation funds and managed investment schemes) with 10 members or fewer, where the proportion of voting power, rights to dividends or rights to capital distributions in, or paid by, the tested company which is attributed to each member of the entity under subsection 166-245(4) is less than 10 per cent.

When does a company have an unequal share structure?

4.46 A company has an unequal share structure at a particular time if:

the company's shares do not all carry the same rights to dividends or capital distributions of the company;
some or all of the company's shares carry discretionary rights to dividends or capital distributions of the company; or
the company is a co-operative company that has on issue one or more interests (other than shares) in the company's capital.

[Schedule 4, items 1 and 52, subsection 167-10(3) and the definition of 'unequal share structure' in subsection 995-1(1))]

4.47 A company is likely to have an unequal share structure at a test time (or during a test period) if, for example, it has:

more than one class of shares on issue at the test time, where those classes of shares have different rights;
a single class of shares on issue at the test time, where those shares have rights to dividend or capital distributions that are at the discretion of the company or some other entity; or
more than one class of shares on issue at the test time, where those classes of shares have identical rights but those rights are discretionary.

4.48 A company may have both an equal and an unequal share structure during the test period or at different test times.

4.49 Where an unsatisfied condition is listed in the table in subsection 167-10(1), Subdivision 167-A must be applied to the entire test period, even if a company is an unequally structured company for only part of the test period. This is because the company needs to satisfy the condition throughout the test period in order to pass the test, not just particular times within that period.

4.50 When measuring ownership changes, the modified rules will only have effect during the part of the period where the unequal share structure is in place.

4.51 Where more than one ownership test period applies, the company must have an unequal share structure for at least part of each period in order to reconsider the continuity of ownership test in each of those periods.

4.52 Although an entity can reconsider the continuity of ownership test for test times that occur when a company has an unequal share structure, it cannot reconsider the continuity of ownership test for test times, or another part of a test period, at which a company does not have an unequal share structure. In these instances, a combination of modified and unmodified tests will apply.

4.53 Where an unsatisfied condition is listed in the table in subsection 167-10(2), a company must be eligible, and a choice must be made, to apply Subdivision 167-A separately at each relevant test time.

Example 4.4 Company A has both ordinary shares and preference shares (a secondary share class) on issue at the start of a loss year. As a result, Company A has an unequal share structure at a particular test time.Company A redeems all of its preference shares between test times. Consequently, it no longer has an unequal share structure from that time onwards as all of the shares carry the same rights. Therefore, Company A cannot choose to apply Subdivision 167-A from that time onwards.

Co-operative companies

4.54 A company that is a co-operative company may be able to issue interests, other than shares, in the company's capital in order to overcome legislative restrictions relating to the issue of shares. For example, in New South Wales, section 269 of the Co-operatives Act 1992 allows co-operative companies to issue co-operative capital units in order to obtain greater access to capital.

4.55 A co-operative company that issues co-operative capital units or similar interests may technically fail the continuity of ownership test, even though the ownership of the company remains unchanged. To overcome this difficulty, a co-operative company that has on issue one or more interests (other than shares) in the company's capital will be taken to have an unequal share structure. [Schedule 4, item 1, paragraph 167-10(3)(c)]

Debt interests disregarded

4.56 An entity may reconsider the unsatisfied condition if the company being tested has an unequal share structure and was unable to satisfy a particular condition of the continuity of ownership test at the test time or during any part of the test period.

4.57 The first way that the entity can choose to reconsider an unsatisfied condition is to disregard any debt interests at the test time, or for the test period, in the unequally structured company. [Schedule 4, item 1, subsection 167-15(1)]

4.58 The way the entity prepares its income tax return is sufficient evidence of it choosing to disregard any debt interests for the purpose of working out whether a company satisfies a condition. [Schedule 4, item 1, subsection 167-15(2)]

4.59 A debt interest in an entity is defined to have the meaning given by Subdivision 974-B (see the definition of debt interest in subsection 995-1(1)). Broadly an interest in an entity will be a debt interest if it satisfies the debt test in section 974-20. Where the characterisation of an interest changes, for example, from debt to equity or vice versa, a new interest in the company comes into existence at this time. This may result in the failure of the continuity of ownership test even though the beneficial owners of the interest have not changed.

Example 4.5 Zed Co has the following shareholders on 1 July 2015:

Alex owns 100 ordinary shares;
Barry owns 100 ordinary shares;
Claude owns 50 ordinary shares and 100 shares that are debt interests; and
David owns 50 ordinary shares and 100 shares that are debt interests.

The shares that are debt interests have first priority rights to dividends and capital distributions.It is assumed that the voting power in Zed Co did not change throughout the ownership test period.Zed Co makes a $500 tax loss in the 2015-16 income year.On 1 July 2016, Claude and David sell all of their ordinary shares and shares that are debt interests to Edward.Zed Co has a taxable income (before deducting tax losses) of $1,000 in the 2016-17 income year. It seeks to deduct the $500 tax loss from its taxable income for the income year.The ownership test period is from the start of the loss year (1 July 2015) to the end of the income year in which the loss is to be deducted (30 June 2017).The continuity of ownership test is applied to all 500 shares in the first instance. On 30 June 2017, Alex and Barry hold 200 ordinary shares. These shares have been held throughout the ownership test period. As the 200 shares that are debt interests have different rights to dividend and capital distributions compared to the ordinary shares, Zed Co is unable to work out if it satisfies the dividend and capital distribution conditions of the continuity of ownership test.However, as Zed Co has an unequal share structure, it reconsiders the dividend and capital distribution conditions under section 167-15. Zed Co reconsiders the unsatisfied conditions by disregarding the 200 shares that are debt interests during the test period.As Alex and Barry have continually held 200 of the remaining 300 ordinary shares in Zed Co, they have held rights to more than 50 per cent of the company's dividend and capital distributions throughout the ownership test period.After disregarding the shares that are debt interests, Zed Co is able to work out whether it satisfies the dividend and capital distribution conditions of the continuity of ownership test. Zed Co satisfies the continuity of ownership test because of majority continuity of:

voting power (as is assumed at the start of this example); and
rights to dividends and capital distributions.

Therefore, Zed Co is able to deduct the prior year tax loss of $500 in the 2016-17 income year.

Secondary share classes disregarded

4.60 The second way that an entity can choose to reconsider an unsatisfied condition is to disregard the debt interests (if any) and certain secondary share classes in the unequally structured company. [Schedule 4, item 1, section 167-20]

4.61 The entity can choose to reconsider an unsatisfied condition by disregarding certain secondary share classes if:

the unsatisfied condition cannot be worked out at the test time or during the test period because:

-
there are no shares in the unequally structured company that are debt interests; or
-
after disregarding shares that are debt interests, the unsatisfied condition remains unsatisfied;

after disregarding shares that are debt interests (if any) in an unequally structured company, the company has on issue, at the test time or on the last day of the test period:

-
the class or classes of ordinary or common shares that represent the majority of that company's value; and
-
at least one other class of shares (the secondary share classes);

it is reasonable to conclude that the total market value of all of the secondary share classes on issue at the relevant time does not exceed 25 per cent of the total market value of all the company's shares (other than debt interests); and
it is reasonable to conclude that the market value of each of the secondary share classes on issue at the relevant time does not exceed 10 per cent of the total market value of the unequally structured company's shares.

[Schedule 4, item 1, subsections 167-20(1) and (2)]

4.62 The total market value of the company's shares at a particular time is the sum of the market values of all of the shares (other than debt interests) in the company at that time.

4.63 If a company has a secondary class of shares on issue during the test period but not at the end of that period, an entity cannot disregard the secondary class of shares for that test period.

Example 4.6 Rush Co has two secondary share classes. The market value of the Class B shares is 15 per cent of the total market value of all of the company's shares. The market value of the Class C shares is 9 per cent of the total market value of all of the company's shares.The Class C shares in Rush Co may be disregarded when reconsidering the continuity of ownership test.

Example 4.7 Speedy Co has two secondary share classes. The market value of the Class B shares is 11 per cent of the total market value of all of the company's shares. The market value of the Class C shares is 13 per cent of the total market value of all of the company's shares.Neither of these secondary share classes in Speedy Co can be disregarded when reconsidering the continuity of ownership test, because they each breach the 10 per cent requirement.

Example 4.8 Tizzy Co has three secondary share classes. The market value of each secondary share class is 9 per cent of the total market value of all of the company's shares.None of these secondary share classes in Tizzy Co can be disregarded when reconsidering the continuity of ownership test, because in total, they breach the 25 per cent ceiling.

4.64 The market value used for the purposes of working out secondary share classes depends on the condition being reconsidered. For an ownership test period, the relevant market value is the market value of the shares on the last day of the test period. For test times, it is the market value at each of the relevant test times.

4.65 If a company's shares are available and traded on the open market, the market value of the shares can be worked out on a reasonable basis having regard to the open market value of those shares.

4.66 An entity may reconsider an unsatisfied condition by disregarding all debt interests and those secondary share classes that satisfy the criteria in subsection 167-20(1). [Schedule 4, item 1, subsection 167-20(3)]

4.67 The way that the entity prepares its income tax return is sufficient evidence of it choosing to disregard the secondary share classes and debt interests (if any) for the purpose of applying the continuity of ownership test. [Schedule 4, item 1, subsection 167-20(4)]

4.68 If an entity considers that it is impractical to work out the market value of shares, the entity may not choose to reconsider an unsatisfied condition in this second way. In that event, the entity may choose to use the third way to reconsider an unsatisfied condition.

Example 4.9 Wai Co has the following shareholders on 1 July 2015:

Frances owns 500 ordinary shares;
Gabrielle owns 500 ordinary shares;
Hermione owns 200 ordinary shares and 100 preference shares; and
Indira owns 200 ordinary shares and 100 shares that are debt interests.

The shares that are debt interests have first priority rights to dividends and capital distributions, but do not carry any voting power (as determined under section 167-80). The preference shares have the second priority rights to dividends and capital distributions. For the purposes of this example, it assumed that the voting power in the company did not change throughout the ownership test period.Wai Co makes a $1,000 tax loss in the 2015-16 income year.On 1 July 2016, Hermione and Indira sell all of their ordinary shares, preference shares and debt interest shares to Jacqueline.On the last day of the ownership test period (30 June 2017), the market value of each ordinary share is $1 and the market value of each preference share is $1.50.Wai Co has a taxable income (before deducting tax losses) of $4,000 in the 2016-17 income year. It seeks to deduct the $1,000 tax loss from its taxable income for the income year.The ownership test period is from the start of the loss year (1 July 2015) to the end of the income year in which the loss is to be deducted (30 June 2017).The continuity of ownership test is applied to all 1,600 shares in the first instance. On 30 June 2017, Frances and Gabrielle hold 1,000 ordinary shares. These shares have been held throughout the ownership test period. As the different classes of shares do not have the same rights to dividends and capital distributions, Wai Co is unable to work out whether it satisfies the dividend and capital distribution conditions of the continuity of ownership test.As Wai Co has an unequal share structure, it reconsiders the dividend and capital distribution conditions under section 167-15. Therefore, Wai Co reconsiders the unsatisfied conditions by disregarding the 100 shares that are debt interests throughout the test period.However, despite disregarding the shares that are debt interests, Wai Co is still unable to work out if it satisfies the dividend and capital distribution conditions of the continuity of ownership test.Therefore, Wai Co further reconsiders the unsatisfied conditions under section 167-20. On the last day of the test period (30 June 2017):

the market value of 1,400 ordinary shares is $1,400;
the market value of 100 preference shares is $150; and
the total market value of all shares is $1,550.

The total market value of the secondary share class does not exceed 25 per cent of the total market value of all of Wai Co's shares (excluding shares that are debt interests) on that day:

$1,550.00 x 25 per cent = $387.50
$150.00 is less than $387.50.

The market value of the preference shares ($150) does not exceed 10 per cent of the total market value of Wai Co shares on that day:

($150 + $1,400) x 10 per cent = $155
$150 is less than $155.

Therefore Wai Co reconsiders the unsatisfied conditions having regard solely to the ordinary shares during the test period.As Frances and Gabrielle have continually held 1,000 of the remaining 1,400 ordinary shares in Wai Co, they have held rights to more than 50 per cent of the company's dividends and capital distributions throughout the ownership test period.After disregarding the debt interests and the secondary share class, Wai Co is able to work out the dividend and capital distribution conditions of the continuity of ownership test. Wai Co satisfies the continuity of ownership test because of majority continuity of:

voting power (as is assumed at the start of this example); and
rights to dividends and capital distributions.

Wai Co is able to deduct the prior year tax loss of $1,000 in the 2016-17 income year.

Shares taken to have fixed rights to dividends and capital distributions

4.69 The third way that an entity can choose to reconsider an unsatisfied condition is to treat certain shares in the unequally structured company as having fixed rights to dividends and capital distributions. [Schedule 4, item 1, section 167-25]

4.70 A company with an unequal share structure can have its shares treated as having fixed rights to dividends and capital distributions if the unsatisfied condition cannot be worked out at the test time or for the test period where:

there are no shares in the unequally structured company that are debt interests;
after disregarding shares in the unequally structured company that are debt interests, the unsatisfied condition remains unsatisfied;
the unequally structured company does not have secondary share classes; or
the unequally structured company has one or more secondary share classes, but one or more of those secondary share classes cannot be disregarded because their combined or individual market value exceeds the thresholds to be disregarded.

[Schedule 4, item 1, subsection 167-25(1)]

4.71 An entity can choose to reconsider an unsatisfied condition by treating the shares on issue in the unequally structured company that remain after applying subsection 167-25(3) (that is, the remaining shares) as having, at the test time, relative rights to receive dividends and capital distributions that are fixed. [Schedule 4, item 1, subsection 167-25(4)]

4.72 The basis of working out the relative rights to receive dividends and capital distributions depends on whether or not it is reasonably practicable to work out the relative market value of each remaining share in the unequally structured company at the test time. [Schedule 4, item 1, subsection 167-25(4), sections 167-30 and 167-35]

4.73 The way an entity prepares its income tax return is sufficient evidence of it choosing to treat the remaining shares in the tested company as having fixed rights to dividends and capital distributions for the purpose of working out whether a company satisfies a condition. [Schedule 4, item 1, subsection 167-25(5)]

4.74 For provisions covered by item 1 in the table in subsection 167-10(1), the conditions must be satisfied during the whole of, or at all times, during the test period. However, this rule is modified by section 167-40, which identifies specific valuing times within the test period. Each of these valuing times is a test time for the purposes of the third way to reconsider an unsatisfied condition. A fixed value is attributed to each remaining share at the relevant valuing times. [Schedule 4, item 1, sections 167-25, 167-30, 167-35 and 167-40]

4.75 The valuing times for the test period conditions listed in subsection 167-10(1) are all of the following times that occur during the test period:

the time the period starts;
the time just before, and the time just after, any of the following events that happen during the test period:

-
the issue of shares of a class of remaining shares;
-
the variation of rights attached to any remaining shares to receive dividends or capital distributions; or
-
the redemption or cancellation of any remaining shares; and

the time the period ends.

4.76 Any valuing time that occurs outside of the test period is disregarded. [Schedule 4, item 1 subsection 167-40(2)]

4.77 There may be multiple valuing times, and consequently test times, occurring during a test period.

Example 4.10 After disregarding shares that were debt interests and secondary classes of shares, Kaz Co reconsidered the continuity of ownership tests by fixing the rights attached to the remaining shares.During the test period, Kaz Co issued a class of shares that is not disregarded under subsection 167-20(3) on two separate occasions.Under subsection 167-40(1), the valuing times for Kaz Co are:

the time the test period starts (the beginning of the loss year);
the time just before the first issue of shares was issued;
the time just after the first issue of shares was issued;
the time just before the second issue of shares was issued;
the time just after the second issue of shares was issued; and
the time the test period ended (the end of the income year).

4.78 Where an unsatisfied condition has one or more fixed test times (that is, where the unsatisfied condition is covered by items 1 or 2 of the table in subsection 167-10(2)), a fixed value is worked out for, and attributed to, each remaining share at each of the fixed test times. [Schedule 4, item 1, sections 167-30 and 167-35]

Where it is practicable to work out the market value of each remaining share

4.79 Where it is reasonably practicable to work out the relative market value of each remaining share in the unequally structured company at the test time, each remaining share is treated at the test time as carrying the percentage of rights to receive dividend and capital distributions from the company worked out under the formula:

[Share's market value / Sum of the market values of all remaining shares ] * 100

[Schedule 4, item 1, paragraph 167-25(4)(a) and section 167-30)]

4.80 For the purposes of applying the formula:

the remaining shares are those remaining after disregarding debt interests and the secondary share classes disregarded under subsection 167-20(3);
if the unsatisfied condition is covered by item 1 of the table in subsection 167-10(1), the market value is worked out at each valuing time as each valuing time is a test time; and
if the unsatisfied condition is covered by item 1 of the table in subsection 167-10(2) the market value is worked out at the particular test time.

[Schedule 4, item 1, section 167-30]

4.81 In the case where there is more than one test time, it is necessary to apply the formula at each test time.

Where it is impracticable to work out the market value of each remaining share

4.82 Where it is not reasonably practicable to work out the relative market value of each remaining share in the unequally structured company at the test time, or the sum of the market values of all of the remaining shares is nil, each remaining share is treated as carrying a percentage of rights to receive dividend and capital distributions from the company as is reasonable, worked out at:

each of the valuing times (which are also test times), if the unsatisfied condition is covered by item 1 of the table in subsection 167-10(1); or
each test time, if the unsatisfied condition is covered by item 1 of the table in subsection 167-10(2).

[Schedule 4, item 1, paragraph 167-25(4)(b) and subsection 167-35(1)]

4.83 In either case, regard should be had to the purpose of the unsatisfied condition.

4.84 In working out what is reasonable, regard must be had to:

the company's constitution;
any agreements between the company and its shareholders (including any associate of a shareholder);
any statement by the company of its policy in paying dividends or making capital distributions;
the ability of an entity to control (either directly or indirectly through one or more interposed entities) how the company pays dividends or makes capital distributions;
how the company has previously paid dividends or made capital distributions;
whether all classes of shares carry substantially the same rights to receive dividends and capital distributions; and
the principle that a tax loss or a bad debt should only be deductible, and a net capital loss should only be applied, if a majority of the persons entitled to the benefits of dividend and capital distributions of the company is maintained.

[Schedule 4, item 1, subsection 167-35(2)]

Example 4.11 Kommissar Co Pty Ltd has the following shareholders on 1 July 2015:

Leisl owns 550 ordinary shares and 100 shares that are debt interests;
Mark owns 300 preference shares; and
Olivier owns 450 ordinary shares, 50 preference shares and 250 shares that are debt interests.

The shares that are debt interests have first priority rights to dividends and capital distributions. The preference shares have the second priority rights to dividends and capital distributions. The ordinary shares have last priority rights to dividends and capital distributions. For the purposes of this example, it is assumed that the voting power in the company remains unchanged throughout the ownership test period.Kommissar Co makes a $1,000 tax loss in the 2015-16 income year.On 1 July 2016, Paula buys:

250 debt interest shares from Olivier;
300 preference shares from Mark; and
230 ordinary shares and 100 debt interest shares from Leisl.

In the 2016-17 income year, Kommissar Co has a taxable income (before deducting tax losses) of $5,000. It seeks to deduct the $1,000 tax loss from its taxable income for the income year.The ownership test period is from the start of the loss year (1 July 2015) to the end of the income year in which the loss is to be deducted (30 June 2017).The continuity of ownership test is applied to all 1,700 shares in the first instance. On 30 June 2017:

Leisl holds 320 ordinary shares, which have been held throughout the ownership test period;
Olivier holds 450 ordinary shares and 50 preference shares, which have been held throughout the ownership test period; and
Paula holds 230 ordinary shares, 300 preference shares and 350 debt interest shares, which were acquired during the ownership test period.

As the different classes of shares do not all carry the same rights to dividends and capital distributions, Kommissar Co is unable to work out whether it satisfies the dividend and capital distribution conditions of the continuity of ownership test (that is, the conditions in subsections 165-12(3) and (4) referred to in item 1 of the table in subsection 167-10(1)).As Kommissar Co has an unequal share structure, it reconsiders the dividend and capital distribution conditions under section 167-15. Therefore, Kommissar Co reconsiders the unsatisfied conditions by disregarding the 350 shares that are debt interests throughout the ownership test period.However, despite disregarding the shares that are debt interests, Kommissar Co is still unable to work out whether it satisfies the dividend and capital distribution conditions of the continuity of ownership test.Therefore, Kommissar Co reconsiders the unsatisfied conditions under section 167-20. After disregarding the 350 shares that are debt interests, Kommissar Co has:

an ordinary or common class of shares - being the 1,000 ordinary shares; and
a secondary class of shares - being the 350 preference shares.

To reconsider the condition, Kommissar Co must use the market values on the last day of the test period. On 30 June 2017:

the market value of the preference shares is $525 (350 x $1.50); and
the total market value of all of the company's shares (disregarding debt interests) is $1,525 ((1,000 ordinary shares x $1) + (350 preference shares x $1.50)).

As the market value of the preference shares ($525) exceeds 10 per cent of the total market value of all of the company's shares ($1,525 x 10 per cent = $152.50), Kommissar Co cannot reconsider the unsatisfied conditions under section 167-20 by disregarding the secondary class of shares (that is, the preference shares).Therefore, Kommissar Co reconsiders the unsatisfied conditions under section 167-25 as if:

the shares in the company (the remaining shares) consisted solely of the ordinary shares and the preference shares - that is, the debt interest shares are disregarded; and
those shares had fixed rights to receive dividends and capital distributions relative to their market value at each test time in the ownership test period.

The unsatisfied conditions are the conditions in subsections 165-12(3) and (4). During the ownership test period (1 July 2015 to 30 June 2017) Kommissar Co has not issued shares, varied rights attached to any of the remaining shares or cancelled any of the remaining shares. Therefore, the valuing time is the time that the ownership test period starts and ends - that is, 1 July 2015 (paragraph 167-40(1)(a)) and 30 June 2017 (paragraph 167-40(1)(c)).On 1 July 2015 and 30 June 2017, the market value of each ordinary share in Kommissar Co was $1. The market value of each preference share at those times was $1.50.Therefore, as it is reasonably practicable for Kommissar Co to work out the market value of each of the remaining shares as at 1 July 2015 and 30 June 2017, the remaining shares are taken to have relative rights to receive dividend and capital distributions worked out under the formula in section 167-30 (paragraph 167-25(4)(a)).Applying that formula:

each ordinary share is taken to carry 0.06557 per cent of the rights to receive dividends and capital distributions from the company at 1 July 2015 and 30 June 2017, worked out as follows:

Share's market value (MV) / [MV of all ordinary shares + MV of all preference shares] * 100
= $1.00 / [(1000 * $1.00) + (350 * $1.50)] * 100
= 0.06557%

each preference share is taken to carry 0.09836 per cent of the rights to receive dividends and capital distributions from the company at 1 July 2015, worked out as follows:

Share's market value (MV) / [MV of all ordinary shares + MV of all preference shares] * 100
= $1.50 / [(1000 * $1.00) + (350 * $1.50)] * 100
= 0.09836%

Therefore, at 1 July 2015:

Leisl, who held 550 ordinary shares, had 36.06 per cent
(550 x 0.06557 per cent) of the rights to receive dividends and capital distributions from the company;
Mark, who held 300 preference shares, had 29.51 per cent
(300 x 0.09836 per cent) of the rights to receive dividends and capital distributions from the company;
Olivier, who held 450 ordinary shares and 50 preference shares, had 34.43 per cent of the rights to receive dividends and capital distributions from the company - that is:

-
the 450 ordinary shares had 29.51 per cent
-
(450 x 0.06557 per cent) of the rights to receive dividends and capital distributions from the company; and
-
the 50 preference shares had 4.92 per cent (50 x 0.09836 per cent) of the rights to receive dividends and capital distributions from the company.

At 30 June 2017:

Leisl, who held 320 ordinary shares, had 20.98 per cent
(320 x 0.06557 per cent) of the rights to receive dividends and capital distributions from the company;
Olivier, who held 450 ordinary shares and 50 preference shares, had 34.43 per cent of the rights to receive dividends and capital distributions from the company - that is:

-
the 450 ordinary shares had 29.51 per cent
-
(450 x 0.06557 per cent) of the rights to receive dividends and capital distributions from the company; and
-
the 50 preference shares had 4.92 per cent (50 x 0.09836 per cent) of the rights to receive dividends and capital distributions from the company.

Leisl and Olivier have held rights to more than 50 per cent of Kommissar Co's dividends and capital distributions throughout the ownership test period by using the third way. That is:

Leisl and Olivier have continually held 50.49 per cent of the rights to receive dividends and capital distributions in respect of ordinary shares issued by Kommissar Co (770 ordinary shares x 0.06557 per cent); and
Olivier has continually held 4.92 per cent of the rights to receive dividend and capital distributions in respect of preference shares issued by Kommissar Co (50 preference shares x 0.09836 per cent).

Kommissar Co satisfies the continuity of ownership test because of majority continuity of voting power (as assumed at the start of this example), and rights to dividends and capital distributions. Therefore, Kommissar Co is able to deduct the prior year tax loss of $1,000 in the 2016-17 income year.

Application of these modifications to consolidated groups and MEC groups

4.85 Division 167 can apply in the case of a consolidated group or MEC group where the conditions in the continuity of ownership test are applied to a company. That company may be the head company of the group or another company.

4.86 The conditions of the continuity of ownership test could be reconsidered in the following circumstances, if the entity has an unequal share structure:

utilising a group loss by the head company of a consolidated group (the conditions are examined for the head company);
utilising a group loss by the head company of a MEC group - the conditions are examined for the top company of the MEC group;
utilising a transferred loss by the head company of a consolidated group where the loss was transferred as a continuity of ownership test transfer (COT transfer) - the conditions are examined for the test company identified in Subdivision 707-B;
utilising a transferred loss by the head company of a consolidated group where the loss was not transferred as a COT transfer - the conditions are examined for the head company;
utilising a transferred loss by the head company of a MEC group - the conditions are examined for the test company identified in Subdivision 719-F;
determining whether a company's unused carry-forward losses can be transferred to the head company of a consolidated group or MEC group when the company joins the group - the conditions are examined for the joining company;
determining if an entity can deduct a bad debt where Subdivision 709-D applies where the debt was owed to a company in a debt test period - the conditions are examined for the company who was owed the debt during its debt test period, except where the company is the head company of a MEC group; and
determining if the head company of a MEC group can deduct a bad debt, or could have deducted the debt in respect of its debt test period where Subdivision 709-D applies - the conditions are examined for the top company of the MEC group pursuant to modifications in Subdivision 719-I.

4.87 Apart from the conditions in the continuity of ownership test, Division 167 can also apply where, under a provision for consolidated groups or MEC groups, an unsatisfied condition listed in section 167-10 or the voting power in a company is worked out. For example:

whether there is a changeover time for a leaving entity for purposes of Subdivision 715-A; or
whether there is an alteration time for a leaving entity and whether the head company has a relevant equity interest in the leaving entity for purposes of Subdivision 715-B.

4.88 The way the head company of the consolidated group or MEC group prepares its income tax return is sufficient evidence of its choosing to work out the unsatisfied condition for the test company under each of the ways it can reconsider the continuity of ownership test. [Schedule 4, item 1, subsections 167-15(2), 167-20(4) and 167-25(5)]

Companies with shares that have unequal voting rights

4.89 Subdivision 167-B modifies the way voting power in a company is worked out where shares in the company:

do not all carry the same voting rights; or
do not carry all of the voting rights in the company.

[Schedule 4, item 1, section 167-75]

4.90 Voting power in a company may not be measurable by reference to its shares because:

the constitution confers rights on an entity in relation to some or all matters affecting the company - for example, the constitution may grant a particular shareholder the right to as many votes as constitute a majority for an ordinary resolution or a three-quarters majority for a special resolution;
the shareholders may enter into an agreement that certain (or all) shareholders must consent to pass a resolution on a particular matter, or may effectively grant a shareholder the power to veto a resolution on that matter;
preference shares normally have limited voting rights compared to ordinary shares;
some or all of the classes of shares have the power to appoint a certain number of directors of the company; or
some other reason, for example, the constitution of the company confers voting rights on an entity that is not connected with a share-holding.

[Schedule 4, item 1, subsection 167-80(1)]

4.91 The company may, or may not, be a party to an agreement or arrangement that is the source of unequal voting rights in the company's shares.

4.92 An entity can choose to modify the way that voting power in a company is worked out at a particular time, if the shares in the company do not all carry the same voting rights or do not carry all of the voting rights in the company at that time. [Schedule 4, item 1, subsections 167-80(1) and 167-85(1)]

4.93 If an entity makes such a choice, then the entity can choose which method it will use to determine the voting power in the company. The methods require the voting power in the company at that time to be worked out solely by reference to the maximum number of votes that could be cast on a poll, either:

if the election of the company's directors is determined by the casting of votes, on the election of a director of the company (assuming such a poll were to be held at that time); or
on the adoption of a constitution for the company or the amendment of the company's constitution (assuming such a poll were to be held at that time) other than an amendment altering:

-
the rights carried by the company's shares; or
-
other forms of voting power in the company.

[Schedule 4, item 1, subsection 167-85(1)]

4.94 If one or more directors of a company are chosen by a particular shareholder, or are elected on a poll of the holders of a particular class or classes of shares, the voting power is worked out on a pro rata basis.

Example 4.12 At a particular time, Wooster Co has five directors. Under the company's constitution:

Bertram (who is not a shareholder) chooses one director;
the holders of Class A shares elect two directors by a majority vote of that class - there are five holders of the 2 million Class A shares, each holding 400,000 shares; and
the holders of ordinary shares elect the remaining two directors by a majority vote of that class - there are 20 holders of the 6 million ordinary shares, each holding 300,000 shares.

Wooster Co chooses to work out voting power in the company under paragraph 167-85(1)(a) at the particular time.Therefore, at that particular time:

Bertram holds 20 per cent of the voting power in the company - one of five directors;
each holder of Class A shares owns 8 per cent of the voting power in the company - two of five directors (40 per cent) divided by 5 shareholders with equal holdings; and
each holder of ordinary shares owns 2 per cent of the voting power in the company - two of five directors (40 per cent) divided by 20 shareholders with equal holdings.

Example 4.13 At a particular time, Cart Co has five directors. Under the company's constitution:

Beadle (who is not a shareholder) chooses one director;
the holders of Class A shares elect two directors by a majority vote of that class - there are five holders of the 2 million Class A shares, each holding 400,000 shares; and
all shareholders elect the remaining two directors (ie two-fifths of the directors) by a majority vote of that class - for this purpose Beadle is deemed to hold 2 million ordinary shares and each share in the company carries equal voting rights.

There are 20 holders of 6 million ordinary shares, each holding 300,000 shares.In total, there are 10 million shares that have voting rights:

Beadle is deemed to hold 2 million ordinary shares;
Class A shareholders hold 2 million shares;
ordinary shareholders hold 6 million shares.

Therefore, at that particular time:

Beadle holds 28 per cent of the voting power in the company - that is, the sum of:

-
20 per cent, being for one of five directors; and
-
8 per cent, being for the election of the two directors (40 per cent x 2 million shares/10 million shares);

each holder of Class A shares owns 9.6 per cent of the voting power in the company - that is, the sum of:

-
8 per cent, being for the election of two directors (40 per cent/5 shareholders); and
-
1.6 per cent, being for the election of the remaining two directors (40 per cent x (2 million shares/10 million shares)/5 shareholders); and

each holder of ordinary shares owns 1.2 per cent of the voting power in the company, being for the election of two directors - that is, 40 per cent x (6 million shares/10 million shares)/20 shareholders.

4.95 Voting power must be determined at each of the particular times the conditions of the continuity of ownership test are being considered.

4.96 Where voting power is being determined for a test period, voting power must be determined at each point the maximum number of votes that could be cast on a poll, established by the method chosen in subsection 167-85(1), changes during that period.

Example 4.14 Patrician Co needs to work out whether it satisfies the voting power condition of the continuity of ownership test under subsection 165-12(2) during an ownership test period from 1 July 2015 to 30 June 2017.Patrician Co has two classes of shares on issue from 1 July 2015 to 30 November 2016:

100 Class A shares that carried voting rights in relation to the election of the company's directors;
50 Class B shares that carried voting rights on all matters affecting the company.

On 30 November 2016, Patrician Co issued an additional 50 Class B shares. There were no other changes in the company's voting power during the ownership test period.Patrician Co chooses that the voting power in the company during the ownership test period will be worked out under paragraph 167-85(1)(a) by reference to the maximum number of votes that could be cast on the election of a director of the company. Therefore, both classes of shares will be counted.Two different calculations must be done under subsection 165-12(2) for the ownership test period:

150 shares should be counted until 30 November 2016; and
200 shares from 30 November until 30 June 2017.

If there is less than 50 per cent continuity under either calculation, Patrician Co will fail subsection 165-12(2).

4.97 The way that the entity prepares its income tax return is sufficient evidence of it choosing to modify the way that voting power in a company is worked out at the particular time. [Schedule 4, item 1, subsection 167-85(2)]

4.98 Section 167-85 can be applied to work out the meaning of terms that are used in, or for the purposes of, Part 3-5 of the ITAA 1997 (such as subparagraph (b)(i) of the definition of eligible Division 166 company in subsection 995-1(1)).

4.99 For the purpose of applying Subdivision 167-B, shares that are dual listed company voting shares are disregarded. [Schedule 4, item 1, section 167-90]

4.100 A dual listed company voting share is defined in subsection 125-60(3) to mean a share in a company:

that is issued as part of a dual listed company arrangement, mainly for the purpose of ensuring that shareholders of both companies involved in the arrangement vote as a single decision making body on matters affecting them; and
that does not carry rights to financial entitlements (except the return of an amount paid up on the share and a dividend that is the equivalent of a dividend paid on an ordinary share).

4.101 If an entity chooses to apply section 167-85 to modify the way that voting power in a company is worked out, the modified approach must be applied to all of the shares in the company, not the reduced pool of shares left after the application of the Subdivision 167-A modifications.

Shares held by superannuation funds and certain other entities

4.102 Generally, in applying the continuity of ownership test, a company must trace its ownership through to its ultimate beneficial owners to determine whether certain conditions in section 165-12 are satisfied.

4.103 Currently, in applying the continuity of ownership test, where the ownership structure of the company includes one of a number of specified entities (broadly, government entities, non-profit bodies and charitable entities), the entity is treated as if it is a person (not a company).

4.104 As a result, it is unnecessary to trace through these entities to determine the ultimate beneficial owners of the shares in the company (section 165-202).

4.105 The scope of section 165-202 is being extended so that, in applying the continuity of ownership test, a company will also be able to treat the following entities in its ownership structure as if they are a person:

a complying superannuation fund;
a superannuation fund that is established in a foreign country and is regulated under a foreign law;
a complying approved deposit fund;
a special company; or
a managed investment scheme.

[Schedule 4, item 56, paragraphs 165-202(1)(h) to (l)]

4.106 As a result, a company will not have to trace though such entities in applying the tests to determine whether a company has satisfied the continuity of ownership test.

4.107 Where the ownership structure of a company includes an entity that is a first home savers account trust, in applying the continuity of ownership test to the company, that entity will also be treated as a person (not a company). [Schedule 4, item 58]

Modifications to the same business test

4.108 The operation of the same business test is modified for the head company of a consolidated group or MEC group. The modifications clarify that, for the purpose of applying the same business test (section 165-210), the entry history rule (section 701-5) does not operate in relation to an entity becoming a subsidiary member of a consolidated group or a MEC group. [Schedule 4, item 54, section 165-212E]

4.109 The amendment clarifies that the head company of a consolidated group or MEC group does not need to take into account the history of a subsidiary member prior to the time that the subsidiary member joined the group for the purposes of determining whether the head company can satisfy the same business test.

Consequential amendments

4.110 Consequential amendments are made to:

notes in Divisions 165, 166, 170, 175, 974 and 995 so that they appropriately refer to the modifications to the continuity of ownership test made by new Subdivisions 167-A and 167-B; and
cross references in Division 707 so that relevant provisions appropriately refer to new Division 167.

[Schedule 4, items 2 to 51, sections 165-12, 165-37, 165-40, 165-115C, 165-115D, 165-115L, 165-115M, 165-115X, 165-115Z, 165-123, 165-129, 166-145, 166-175, 166-225, 166-230, 166-235, 166-240, 166-255, 166-260, 170-260, 170-265, 175-10, 175-45, 175-85, 707-205, 974-10 and 995-1]

Application and transitional provisions

Companies with shares that have unequal rights to dividends, capital distributions or voting power

4.111 The amendments to modify the continuity of ownership test for companies with shares that have unequal rights to dividends, capital distributions or voting power apply from 1 July 2002. [Schedule 4, item 53 section 167-1 of the Income Tax (Transitional Provisions) Act 1997]

4.112 That is, the amendments will apply to:

any tax loss for an income year commencing on or after 1 July 2002;
any net capital loss for an income year commencing on or after 1 July 2002; and
any deduction in respect of a bad debt that is claimed in an income year commencing on or after 1 July 2002.

[Schedule 4, item 53, paragraphs 167-1(1)(a) to (c) of the Income Tax (Transitional Provisions) Act 1997]

4.113 The amendments will also apply in determining whether any changeover time or alteration time occurred on or after 1 July 2002. [Schedule 4, item 53, paragraph 167-1(1)(d) of the Income Tax (Transitional Provisions) Act 1997]

4.114 In addition, the amendments will apply to:

any tax loss of a company for an income year commencing on or before 30 June 2002 that could have been deducted, in accordance with Divisions 165 and 166 as in force at that time, in the first income year commencing after 30 June 2002 if the deduction had not been limited by the company's income for that income year; and
any net capital loss of a company for an income year commencing on or before 30 June 2002 that could have been applied, in accordance with Divisions 165 and 166 as in force at that time, in the first income year commencing after 30 June 2002 if the application of the loss had not been limited by the company's capital gains for that income year.

[Schedule 4, item 53, subsection 167-1(2) of the Income Tax (Transitional Provisions) Act 1997]

4.115 The amendments to improve the operation of the continuity of ownership test for companies that have shares with unequal rights to dividends, capital distributions or voting power apply from 1 July 2002 as they are beneficial to taxpayers. Companies will have greater certainty in applying the continuity of ownership test to determine whether:

prior year tax losses and bad debts can be deducted; or
net capital losses can be applied.

4.116 The amendments have been developed in consultation with affected taxpayers and will reduce the risk of technical failures to the continuity of ownership test.

4.117 The application date for these amendments is consistent with the application date for amendments made by Schedule 1 to the Tax Laws Amendment (Loss Recoupment Rules and Other Measures) Act 2005. That Act introduced the modified continuity of ownership test for widely held companies and eligible Division 166 companies.

4.118 The effect of the amendments for a company with a substituted accounting period is that Division 167 applies for the first accounting period that commences after 1 July 2002.

4.119 For example, a company with a substituted accounting period of 1 April to 31 March, will not be eligible for the modified continuity of ownership test in respect of losses incurred in its income year commencing 1 April 2002, unless it could have deducted those losses under the existing rules in its income year commencing 1 April 2003.

4.120 If a pre-1 July 2002 loss is eligible for Division 167 (that is, it could have been deducted in an income year commencing on or after 1 July 2002), Division 167 will apply at all test times or throughout the test period. For example, if the loss was made in the 2000-01 income year and the company is seeking to deduct it in the 2011-12 income year, Division 167 will be available for use to test ownership in 2000-01 and 2011-12 (as well as intervening years).

4.121 Division 167 cannot apply to deductions for bad debts written-off before 1 July 2002. Unlike tax losses, deduction for bad debts can be claimed in the income year the debt is written off. If the company's deductions for that income year exceed its income, the bad debt deduction merely contributes to the loss (subject to the application of section 165-132).

4.122 In some cases, a tax loss or a net capital loss is taken to have been made in the income year immediately before a changeover time (section 165-115B). Division 167 will not apply to a loss that is treated as having been made in an income year commencing before 1 July 2002 unless the loss could have been used in the first income year commencing on or after that date.

Shares held by superannuation funds and certain other entities

4.123 The amendments to remove the need to trace a company's ownership through superannuation funds and certain other entities applies to tax losses and bad debts that a company seeks to deduct, and net capital losses that a company seeks to apply, in the 2011-12 income year or in a later income year. The amendments will also apply in determining whether any changeover time or alteration time occurred in the 2011-12 income year or in a later income year. [Schedule 4, item 57]

4.124 In addition, the amendment to remove the need to trace through an entity that is a first home savers account trust applies to tax losses and bad debts that a company seeks to deduct, and net capital losses that a company seeks to apply in the 2011-12, 2012-13, 2013-14 and 2014-15 income years. [Schedule 4, item 58]

4.125 These amendments apply from the 2011-12 income year because they are beneficial to taxpayers. The amendments have been sought by affected taxpayers to provide them with greater certainty and reduce compliance costs.

Modifications to the same business test

4.126 The amendment to the same business test applies on and after 1 July 2002. [Schedule 4, item 55]

4.127 These amendments are beneficial to taxpayers as they clarify the operation of the existing law and will make it easier for the head company of a consolidated group or MEC group to determine if the same business test has been satisfied. Therefore, the amendments will give consolidated groups and MEC groups greater certainty in applying the same business test to determine whether:

prior year tax losses and bad debts can be deducted; or
net capital losses can be applied.

Amendment of assessments

4.128 Generally, the Commissioner of Taxation can amend an assessment of a company, other than a small business entity, within four years from the date of the notice of assessment (section 170 of the Income Tax Assessment Act 1936).

4.129 As the amendments that introduce Division 167 and amend the same business test apply from 1 July 2002, the period for amending assessments will be extended. That is, the operation of section 170 will be modified so that it does not prevent the amendment of an assessment if:

the assessment was made before the date of commencement of Schedule 4;
the amendment is made within four years after that commencement date; and
the amendment is made for the purpose of giving effect to the amendments in Schedule 4.

[Section 4]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Company losses

4.130 Schedule 4 to this Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

4.131 This Schedule amends the company loss recoupment rules in the Income Tax Assessment Act 1997 by:

modifying the continuity of ownership test for companies whose shares have unequal rights to dividends, capital distributions or voting power;
ensuring that, for the purposes of applying the continuity of ownership test, the ownership of companies does not have to be traced through a complying superannuation fund, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust; and
clarifying that the entry history rule does not operate in relation to an entity that becomes a subsidiary member of a consolidated group or multiple entry consolidated group for the purposes of applying the same business test.

Human rights implications

4.132 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

4.133 This Schedule is compatible with human rights as it does not raise any human rights issues.


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