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Authorisation Number: 1011475365195

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Ruling

Subject: Carry forward losses

'A' is a private company which is presently 100% owned by another private company 'B'. B has maintained a continuing 55% interest in A since March 2006. B has subsequently increased its shareholding in A to 100% in June 2009.

B in turn has been 100% owned by C Trust since November 2005. C Trust is a discretionary trust which has made a family trust election effective from 1 July 1998.

Company A has tax losses of approximately $5 million that arose after March 2006.

In order to simplify the ownership structure it is proposed that company B be liquidated and all shares in company A will be distributed to C Trust as an 'in specie' liquidation distribution.

When the proposed liquidation occurs, a CGT event C2 will arise in relation to the share of company B which comprise an indirect equity interest in company A. However as the cost base of the shares is approximately $200,000, this would represent the maximum capital loss arising from this CGT event.

It is expected that company A will start to claim a deduction for prior year losses in the 2010 income year.

Question 1

If a company has deductions that exceed its assessable income and net exempt income in an income year, the company has a loss which it can carry forward and use as a deduction in a future income year. However the company can only deduct the tax loss if it satisfies either the continuity of ownership test (COT) or the same business test (SBT).

The COT is satisfied if the same people hold more than 50% of the voting power and rights to dividends and capital distributions at all times during the relevant test period. To apply the COT a company must trace its ownership through companies and trusts to identify the people who ultimately hold, directly or indirectly, voting power and rights to dividends and capital distributions.

The continuity of ownership test in Division 165 of the ITAA 1997.

Section 165-10 of the Income Tax Assessment Act 1997 (ITAA 1997) stipulates that a company cannot deduct a tax loss unless:

§ it meets the conditions in either section 165-12 of the ITAA 1997, which is about the company maintaining the same owners (the COT), or

§ it meets the condition in section 165-13 of the ITAA 1997, which is about the company satisfying the same business test (the SBT).

The test in section 165-12 of the ITAA 1997 is applied over the ownership test period, which is the period from the start of the loss year to the end of the income year in which the loss is to be deducted.

According to subsections 165-12(2) to (4) of the ITAA 1997 the COT will only be passed if at all times during the ownership test period the were persons who had

§ more than 50% of the voting power in the company;

§ rights to more than 50% of the company's dividends; and

§ rights to more than 50% of the company's capital distributions.

These conditions are applied either as a primary test or as an alternative test. According to subsection 165-12(5) of the ITAA 1997 the primary test will apply for a condition unless subsection 165-12(6) of the ITAA 1997 requires that the alternative test applies if one or more other companies beneficially owned shares or interests in shares in the test company during the ownership test period. In this instance the shares in company A are wholly owned by company B. Therefore the alternative test needs to be considered.

The alternative tests are set out in subsections 165-150(2), 165-155(2) and 165-160(2) of the ITAA 1997. These subsections require that there are persons, or it is reasonable to assume that there are persons

§ none of whom are companies or trustees who between them at a particular time control, or are able to control directly or indirectly (through an interposed entity) more than 50% of the voting power;

§ none of whom are companies who between them at a particular time have the right to receive for their own benefit, whether directly or indirectly, more than 50% of the dividends the company may pay: and

§ none of whom are companies who between them at a particular time have the right to receive for their own benefit, whether directly or indirectly, more than 50% of any distribution of capital of the company.

Effect of section 165-207 of the ITAA 1997

Section 165-207 of the ITAA 1997 contains measures designed to ensure that concessional tracing rules are available for companies which are held by family trusts (as defined in section 272-75 of Schedule 2F to the Income Tax Assessment Act 1936). The trustee of a trust which has made a Family Trust Election (FTE) is taken to be a single notional entity that is a person (being neither a company nor trustee) and is taken to beneficially own shares in a company.

In this instance the trustee of C Trust has made an FTE effective from 1 July 1998 and is therefore taken to be a person (being neither a company nor trustee) that beneficially owns all the shares in company B. The Trustee is also taken to have 100% of voting rights, rights to distributions of income and capital distributions.

'Same share - same interest' rule - section 165-165 of the ITAA 1997

A further requirement of the COT is that exactly the same shares or interests must be held during the test time. Subsection 165-165(1) of the ITAA 1997 relevantly states:

For the purpose of determining whether a company has satisfied a condition or whether a time is a changeover time or an alteration time in respect of a company:

(a) condition that has to be satisfied is not satisfied; or

(b) a time that, apart from this subsection, would not be a changeover time or alteration time is taken to be a changeover time or alteration time, as the case may be;

unless at all relevant times:

(c) the only shares in the company that are taken into account are exactly the same shares and are held by the same persons; and

(d) the only interests in any other entity (including shares in another company) that are taken into account are exactly the same interests and are beneficially owned by the same persons.

The purpose of this rule is to ensure that the same people under consideration for the COT must hold exactly the same shares or interests in shares for the entire ownership test period.

It is evident from the facts provided that the liquidation of company B would mean that the same persons would no longer hold the shares in company A for the duration of the ownership test period which would result in company A failing the COT.

The 'savings rule' - subsection 165-12(7) of the ITAA 1997

In certain circumstances where a company fails the COT because of the 'same share, same interest' rule in subsection 165-165(1), there is a savings rule which will allow the company to be treated as if it has satisfied the COT. Subsection 165-12(7) of the ITAA 1997 relevantly states:

165-12(7)

If any of the conditions in subsections (2), (3) and (4) have not been satisfied, those conditions are taken to be satisfied if:

a) they would have been satisfied except for the operation of section 165-165; and

b) the company has information from which it would be reasonable to conclude that less than 50% of the tax loss has been reflected in deductions, capital losses, or reduced assessable income, that occurred, or could occur in future, because of the happening of any CGT event in relation to any direct equity interests or indirect equity interests in the company during the ownership test period.

Under this savings rule a company will be treated as having satisfied the COT where it is reasonable to conclude that less than 50% of its tax loss has been or might be duplicated through transactions affecting equity interests in the company. The meaning of 'reasonable to conclude' is discussed in the minutes of the Losses and CGT Sub-committee meeting of 15 November 2006:

A reasonable conclusion is one that a reasonable person would draw from the information available…Each case is likely to be different and prescriptive guidelines cannot be given. However, it is clearly not enough for a company to say it doesn't know whether or not its losses have received duplicate recognition. The required reasonable conclusion must be capable of being drawn. However, if it can be reasonably concluded that, say, not more than 10% of the company's losses have received multiple recognition, it need not be established exactly what percentage has been multiplied.

The proposed liquidation of company B will result in a CGT event C2 happening to its shares (indirect equity interests). As the expected capital loss is significantly less than 50% of the carry forward losses available to company A, the conditions of subsection 165-12(7) of the ITAA 1997 are satisfied. Therefore the company can be treated as if it has satisfied the COT.

Question 2

The operation of section 165-15 of the ITAA 1997

Subsection 165-15(1) of the ITAA 1997 relevantly states:

Even if a company meets the conditions in section 165-12 or 165-13, it cannot deduct the tax loss if:

a) for some or all of the part of the ownership test period that started at the end of the loss year, a person controlled, or was able to control, the voting power in the company (whether directly, or indirectly through one or more interposed entities); and

b) for some or all of the loss year, that person did not control, and was not able to control that voting power (directly, or indirectly in that way); and

c) that person began to control, or became able to control, that voting power (directly, or indirectly in that way) for the purpose of:

I. getting some benefit or advantage in relation to how this Act applies; or

II. getting such a benefit or advantage for someone else;

or for purposes including that purpose.

This section operates to deny deductions for prior year losses if a person who controlled, or was able to control, the voting power in the company for some or all of the ownership test period did not control or was not able to control, that voting power for the whole of the loss year with the purpose or purposes of obtaining a tax advantage for that person or someone else. The control or ability to control voting power may be direct, or indirect, through one or more interposed entity.

For the relevant period the trustee of C Trust is taken to be a single notional entity that is a person (being neither a company nor trustee) and is taken to beneficially own the shares in company B, which in turn is able to control the voting power in company A. The control of voting power in the loss company has remained unchanged.

Therefore the conditions in section165-15 of the ITAA 1997 will be met as there has not been a change in voting power during the loss year or the income year. The purpose of the proposed liquidation of company B is not to gain a tax advantage, notwithstanding that there will be some loss duplication.

Question 3

The operation of section 165-180 of the ITAA 1997

Section 165-180 of the ITAA 1997 relevantly states:

165-180(1) For the purposes of a test, the Commissioner may treat a person as not having beneficially owned particular shares at a particular time if the conditions in subsections (2) and (3) are met.

…

165-180(2) An arrangement must have been entered into at some time that in any way (directly or indirectly) related to, affected, or depended on its operation on:

(a) the beneficial interest in the shares, or the value of that beneficial interest; or

(b) a right carried by, or relating to, the shares; or

(c) the exercise of such a right.

165-180(3) The arrangement must also have been entered into for the purpose, or for the purposes including the purpose, of eliminating or reducing a liability of an entity to pay income tax for a financial year.

This section allows the Commissioner to treat a person as not having beneficially owned particular shares at a particular time if certain types of arrangements are entered into for the purpose of avoiding the continuity of ownership requirement. This section is intended to deal with arrangements under which rights in relation to shares are manipulated in order to satisfy the COT. An example of such an arrangement was considered in K Porter & Co Pty Ltd v. Federal Commissioner of Taxation (1977) 138 CLR 648; (1977) 8 ATR 88; (1977) 77 ATC 4472).

In that case the taxpayers agreed to sell their tax loss company but on the understanding that they would retain 2 shares, representing 40% of the shares in the company until such time as the tax losses had been absorbed. The taxpayers resigned as directors and the persons buying the company were appointed as directors in their place. It was at all times understood by the taxpayers that the management and control of the company would be exercised by the new buyers. The new buyers were issued with shares which gave them 60% of the share capital. The Court concluded that what resulted was at least an arrangement, if not an agreement, which both 'related to' and 'affected' the taxpayers' right to sell their beneficial interests in those shares.

It is not considered that section 165-180 of the ITAA 1997 will apply in this case as the purpose of the arrangement is not to eliminate or reduce a tax liability. Under the proposed scheme, the beneficial ownership of shares in company A will pass from company B to C Trust. However ultimate control and voting rights will still rest with C Trust as the liquidation of company B will merely alter that control from indirect to direct.

Question 4

The operation of section 175-15 of the ITA 1997

Section 175-15 of the ITAA 1997 relevantly states:

175-15(1) The Commissioner may disallow the excluded loss if:

a) a person has obtained or will obtain a tax benefit in connection with a scheme; and

b) the scheme would not have been entered into or carried out if the excluded loss had not been available to be taken into account for the purposes of:

§ Division 36 (which is about tax losses of earlier years0;

§ Division 165 (which is about the income tax consequences of changing ownership or control of a company;

§ Subdivision 375-G (which is about film losses).

175-15(2) However, the Commissioner cannot disallow the excluded loss if:

(a) the person had a shareholding interest in the company at some time during the income year; and

(b) the Commissioner considers that the tax benefit to be fair and reasonable having regard to that shareholding interest.

175-15(3) An expression means the same in this section as in Part IVA of the Income Tax Assessment Act 1936.

Under section 175-15 of the ITAA 1997 the Commissioner may disallow a deduction for prior year losses if a person obtains a tax benefit in connection with a scheme entered into because of the availability of the losses. However, the Commissioner cannot disallow the loss if the person had a shareholding interest in the company and any tax benefit obtained is considered to be fair and reasonable in relation to the shareholding.

Under the proposed scheme company B is to be liquidated and its shares in company A are to be transferred as an in specie distribution to C Trust. C Trust has held a 100% shareholding interest in company B since 20 November 2005. Company B has had a 55% shareholding interest in company A since 16 March 2006. This shareholding interest increased to 100% on 29 June 2009.

Meaning of 'shareholding interest'

The meaning of shareholding interest is defined in section 175-95 of the ITAA 1997. Shareholding interest includes:

175-95(2) A person has a shareholding interest in the company if;

a) the person has a shareholding interest in another company; and

b) the other company has a shareholding interest in the company (including one resulting from any other application or applications of this subsection).

C Trust has a shareholding interest in company A through its shareholding in company B. The liquidation of company B will result in C Trust changing its indirect shareholding interest in company A to a direct 100% shareholding interest.

The Commissioner considers that any tax benefit obtained by C Trust will be fair and reasonable considering the level of shareholding interest held during the relevant period.

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