Edited version of private ruling

Authorisation Number: 1011564957098

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Ruling

Subject: Same business test

Question 1

Is Z company still carrying on the same business for the purposes of section 165-13 of the Income Tax Assessment Act 1997 (ITAA 1997) as it carried on immediately before the change of ownership on date D?

Answer

No

Question 2

If it is considered that Z company is not carrying on the same business as it carried on immediately before date D what constituted the failure of the same business test?

Answer

The business had not commenced at that time.

Question 3

Is Z company still carrying on the same business as it carried on immediately before the change of ownership on date E?

Answer

Yes

Question 4

If it is considered that Z company is not carrying on the same business as it carried on immediately before date E what constituted the failure of the same business test?

Answer

Not Applicable

The scheme commences on:

The scheme has already commenced.

Relevant facts and circumstances

Z company is a widely held company listed on the Australian Stock Exchange (ASX).

The Z company group comprises Z company and its wholly owned subsidiaries which have been acquired in Australia and overseas between date D and date F.

Prior to date D, Z company did not trade - its only activities being investments in listed shares and cash deposits.

In date D, following approval by shareholders at a general meeting, Z company changed the focus of its business to commercialisation. On this date the company acquired all of the shares of AB, and formed a consolidated group.

AB owned intellectual property which Z company intended to develop.

Z company issued additional shares in date D.

The issue of additional shares resulted in a substantial change in proportionate shareholding of continuing shareholders in date D and therefore triggered the failure of the Continuity of Ownership Test (COT) for widely held companies.

Since the relevant year Z company was required to raise further capital. In date E a 'three for one' rights issue to existing shareholders was completed. Not all of the existing shareholders exercised their rights entitlement and this resulted in a substantial change in proportionate shareholding of continuing shareholders in date E and therefore triggered a failure of the (COT).

The applicant advises that Z company failed the COT in date D and date E, so these dates are test times for the Same Business Test (SBT).

Z company business activities during the relevant year (the first test time) year were as follows:

1. the shares in AB were acquired

2. the intellectual property rights were assigned to Z company by AB

3. the company recruited the management personnel required to effectively pursue its business objectives.

4. the company raised the initial capital required to pursue its business objectives by issuing a prospectus to raise funds for the commercialisation of the intellectual property, and the securities of the company commenced official quotation on the ASX.

The prospectus confirmed the business objectives of Z company, which mainly included:

· commercialisation and production of the intellectual property;

· identifying strategic partnerships and sales opportunities in the overseas markets; and

· establishing a program of research and development that focuses on developing other related products and enhancement and additional products and services for the wider market

No losses have been claimed in relation to the period prior to the date of consolidation.

Z company has continued to focus on the business objectives set by the company management in date D.

Activities of the company since the relevant year to date have been as follows:

1. manufacturing devices utilising the intellectual property owned by AB

2. bank interest received from depositing extra cash in short term bank notes.

3. ongoing research and development

4. in line with its business objectives, Z company has established a local and international sales and distribution network consisting of the wholly owned subsidiary companies. All international sales and distribution are conducted by overseas subsidiaries. Z company provides its subsidiaries with the following:

(i) intellectual property for use by those subsidiaries in carrying on its business. The subsidiaries have been supported by Z company during the start-up phase. No royalties are charged until the subsidiary is profitable. To date, only the one subsidiary is profitable and therefore it is now being charged royalties on a per unit basis by Z company.

(ii) management services to its subsidiaries. No management fees are charged until the subsidiary is profitable. To date, only one subsidiary is profitable and therefore it is now being charged management fees by Z company on the basis of time and cost expended.

5. due to the extensive ongoing research conducted and availed by the management, in line with its business objectives of the company, Z company is in the process of introducing various additional devices

6. as a result of the on-going research, Z company commenced marketing an additional product which has evolved from the original technology.

7. Z company is also in the process of introducing other devices.

8. manufacture of these devices will use the same raw materials, equipment, facilities and management. There is no change in the structure of the business or any additional overheads or capital investment required to introduce the additional product lines.

All relevant business activities have occurred subsequent to consolidation.

The applicant has for purposes of this ruling treated all activities of companies within the group as activities of Z company, in accordance with the single entity rule in Part 3-90 of the ITAA 1997.

No members have exited the consolidated group.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 105-255(1)

Income Tax Assessment Act 1997 section 165-12.

Income Tax Assessment Act 199 sections 165-13.

Income Tax Assessment Act 1997 section 165-210.

Reasons for decision

Question 1

Summary

For the purposes of section 165-13 of the ITAA 1997 the company is not considered to be carrying on the same business as it carried on immediately before the change of ownership.

Detailed reasoning

A company cannot deduct a tax loss incurred in prior years unless it satisfies either the continuity of ownership test (COT) under section 165-12 of the ITAA 1997 or the same business test (SBT) under section 165-13 of the ITAA 1997.

Section 165-255 of the ITAA 1997 states that where there is a requirement for a company to meet or satisfy a condition or test or work out an amount for a period and the company is only in existence after the beginning of that period then the period is taken to start on the first day that the company is in existence. In this case the period will start in date D because that is the day on which Z company acquired AB (the owner of intellectual property) with the intention to commence carrying on a business. It is the date on which a tax consolidated group was formed.

The company is not able to satisfy the COT because of a significant change of ownership which occurred in date D therefore it will only be able to deduct its prior year loss if it satisfies the SBT.

In accordance with Subdivision 165-E of the ITAA 1997 to satisfy the SBT in respect of its prior year loss the company must satisfy all of the following tests:

· a positive test that, at all times throughout the same business test period, the company must carry on the 'same business' as it did immediately before the test time (same business test);

· a negative test that the company must not, at any time during the SBT period, have derived assessable income from a 'business of a kind' that it did not carry on before the test time (new business test); or

· a negative test that the company must not, at any time during the SBT period, have derived assessable income from a 'transaction of a kind' that it had not entered into in the course of its business operations before the test time (new transactions test).

In Avondale Motors (Parts) Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 97 the term 'same' was interpreted to mean 'identical' and not merely 'the same kind of business' or 'similar'.

In Taxation Ruling TR 1999/9 at paragraph 13 the SBT is explained in the following way:

In the same business test, the meaning of the word `same' in the phrase `same business as' imports identity and not merely similarity; the phrase `same business as' is to be read as referring to the same business, in the sense of the identical business.  However, this does not mean identical in all respects: what is required is the continuation of the actual business carried on immediately before the change-over.

The company is not considered to be carrying on the same business as it carried on immediately before the change of ownership in date D.

Question 2

Summary

The company is not considered to have commenced business operations before the 'test time'.

Detailed reasoning

For the company to be able to establish that it is carrying the 'same business' it must have commenced business operations.

The COT failed in date D. Immediately prior to that date the company had gained approval from the shareholders to change the focus of its business to commercialisation whereas it had previously derived income from investments in listed shares and cash deposits.

In date D Z company acquired all of the shares of AB which owned intellectual property. It acquired the shares from the inventor of the device which Z company intended to develop. The shares in AB were acquired in exchange for shares in Z company.

Z company issued additional shares in date D which resulted in the substantial change in proportionate shareholding thus triggering the failure of the COT.

In terms of section 165-212E of the ITAA 1997 the entry history rules do not apply for the same business test. This means that if a joining company (AB) is carrying on a business prior to becoming a member of the group the head company cannot use the business of the joining member to satisfy the SBT.

A prospectus was issued to raise funds for the commercialisation of the device, maintaining the objective of the company. The intellectual property rights held by AB were transferred to Z company.

It is considered that in the time between the acquisition of AB and the failure of the COT the business which is later carried on by Z company (that is the manufacture of devices) had not yet commenced.

Whitfords Beach Pty Ltd v. FC of T 83 ATC 4277; (1983) 14 ATR 247 examines the issue of the commencement of a *business activity and the factors to consider when determining the commencement of a *business activity. These factors were a consideration of the taxpayer's purpose and the taxpayer's activities. Bowen CJ, Morling and Fitzgerald JJ said, at ATC 4282; ATR 253:

Of course it does not follow that all the activities engaged in by the taxpayer were necessarily in the course of that business or that some of them were not merely preparatory to it. In order to determine when the taxpayer's relevant business commenced and when its land or the various parts of it were committed to or ventured in that business, it is necessary to have regard both to the taxpayer's purposes and to its activities. (emphasis added).

Whilst it is acknowledged that Z company had demonstrated a commitment to commence the business by making the resolution between shareholders at a general meeting and by purchasing AB it is actions taken subsequent to the failure of the COT such as issuing the prospectus, recruiting personnel and gaining the assigned rights to the intellectual property which led to the commencement of the business which was eventually carried on.

Question 3

Summary

Z company is carrying on the same business throughout the same business test period which commenced in date E.

Detailed reasoning

In accordance with section 165-210 of the ITAA 1997 a company satisfies the SBT if it carries on the same business as it carried on immediately before the test time which in this instance is date E.

The company has been able to demonstrate that immediately before that test time it was carrying on the same business as it is currently carrying on. At that time the company had raised capital through the issue of a prospectus, acquired the rights to intellectual property rights previously held by AB, recruited management personnel and acquired an international subsidiary.

The production of the new devices which may have occurred subsequent to the test time can be considered to be part of the evolution of the same business which was carried on immediately prior to the test time.

The new business test provides that a loss company must not derive assessable income from carrying on a business of a kind that it did not carry on before the test time in accordance with subsection 165-210(2) of the ITAA 1997.

As stated in TR 1999/9 the organic growth of a business through the adoption of new compatible operations will not ordinarily cause it to fail the same business test provided the business retains its identity; nor would discarding, in the ordinary way, portions of its old operations. But, if through a process of evolution a business changes its essential character, or there is a sudden and dramatic change in the business brought about by either the acquisition or the loss of activities on a considerable scale, a company may fail the test.

The company has progressed in manufacturing further devices requiring the use of the same raw materials, equipment, facilities and management. There has been no change to the structure of the business. Assessable income derived from the sale of those devices is not income from carrying on of a business of a kind which the company did not carry on before the test time.

At paragraph 15 of TR 1999/9 the Commissioner makes the following comments about the new transactions test:

Generally speaking, the new transactions test is not failed by transactions of a type that are usually unmotivated by tax avoidance, namely, transactions that could have been entered into ordinarily and naturally in the course of the business operations carried on by the company before the change-over. Conversely, a transaction entered into during the period of recoupment and which is outside the course of the business operations before the change-over, or which is extraordinary or unnatural, when judged by the course of the business operations before the change-over, is usually a transaction of a different kind from the transactions actually entered into by the company before the change-over.

The new transactions test provides that a loss company must not derive assessable income from a transaction of a kind that it had not entered into in the course of business operations before the test time. The receipt of income in the form of royalties and management fees from the now profitable overseas subsidiary arises from the ownership of the subsidiary prior to the same business test period. Therefore this income does not arise from a new transaction and does not cause failure of the test.

The new business test and new transaction test require a loss company to derive assessable income from the new business undertaking or new transaction, before the tests are breached. Z company does not derive assessable income from a kind of business which it did not carry on at the test time, nor does it derive assessable income from a transaction of a kind which it had not entered into before the test time.

It is considered that the company will satisfy the SBT if it seeks to recoup its prior year loss commencing in the income year.

Question 4

Summary

Not Applicable

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