Edited version of private ruling

Authorisation Number: 1011741479099

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Ruling

Subject: prior year losses

Question

Can the losses you incurred from your former construction business that ceased trading in 19XX be offset against profits from a new project commencing in the 2010-11 financial year?

Answer: No

This ruling applies for the following period

Year ending 30 June 2012

The scheme commenced on

1 July 1991

Relevant facts and circumstances

You are a shareholder of the company.

The company is primarily involved in the construction of residential housing.

In the early 1990's the company started construction of its first project, a block of properties. At this time the company had two equal shareholders, you and your business partner.

The company incurred significant losses in the early 1990's and once all creditors were paid the company ceased trading and lay dormant.

A few years ago ownership of the company changed. You now own XX% of the shareholding with your business partner reducing his share from 50% to XX%.

You are considering undertaking a new project. Through the company you intend to acquire a partly finished block of properties with some retail shops underneath. The properties will be acquired from a liquidator as a result of a builder going into liquidation.

You intend to sell more than 50% of your shares in order to raise funds to undertake the new venture. The change of ownership is expected to occur in the 2010-11 financial year.

You expect the 2011-12 financial year to be the first recoupment year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 165-10

Income Tax Assessment Act 1997 Section 165-12

Income Tax Assessment Act 1997 Section 165-13

Income Tax Assessment Act 1997 Section 165-210

Income Tax Assessment Act 1997 Subsection 165-210(1)

Income Tax Assessment Act 1997 Subsection 165-210(2)

Reasons for decision

Summary

The company fails both the ownership test required in section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997) and the same business test required by section 165-13 of the ITAA 1997. Therefore under section 165-10 of the ITAA 1997, the company cannot deduct the tax loss incurred during the early 1990's in the 2011-12 financial year.

Detailed Reasoning

Section 165-10 of the ITAA 1997 states a company cannot deduct a tax loss unless it either meets:

(a) the conditions in section 165-12 of the ITAA 1997, which is about the company maintaining the same owners; or

(b) the condition in section 165-13 of the ITAA, which is about the company satisfying the same business test.

Section 165-12 of the ITAA 1997 states the ownership test period is the period from the start of the loss year to the end of the income year and a company has the same owners if the same persons have the rights to more than 50% of the company voting power, dividends and capital distributions during the ownership test period.

(The loss year is the year in which the loss was incurred and the income year is the year in which the company claims the loss).

In your situation, the loss year was in the early 1990's, a change of more than 50% of the ownership will occur in the 2010-11 financial year with the losses expected to be claimed in the 2011-12 financial year. Therefore, you do not meet the ownership test under section 165-12 of the ITAA 1997 because you did not have the same owners from the start of the loss year to the end of the income year.

Section 165-13 of the ITAA 1997 states a company must satisfy the same business test in section 165-210 of the ITAA 1997. Subsections 165-210(1) and 165-210(2) of the ITAA 1997 include three tests, each of which must be satisfied by a company in order for the company to meet the requirements of section 165-13 of the ITAA 1997 and thereby not be prevented by section 165-10 of the ITAA 1997 from deducting prior year losses.

Subsection 165-210(1) of the ITAA 1997 states a company satisfies the same business test if throughout the same business test period it carries on the same business as it carried on immediately before the test time. (Section 165-13(2) of the ITAA 1997 states the same business test period is the income year in which the loss company claims the loss and the test time, in your situation, is the period immediately before the change of ownership occurred).

However, subsection 165-210(2) of the ITAA 1997 states a company does not satisfy the same business test if, at any time during the same business test period, it derives assessable income from: (a) a business of a kind that it did not carry on before the test time; or (b) a transaction of a kind that it had not entered into in the course of its business operations before the test time.

The Commissioner's view on the same business test is found in Taxation Ruling TR 1999/9 Income tax: the operation of sections 165-13 and 165-210, paragraph 165-35(b), section 165-126 and section 165-132). Paragraph 30 of TR 1999/9 states, for a company to satisfy the same business test, the company must be able to show it carried on, at all times during the income year, the same business it carried on immediately before the change of ownership.

TR 1999/9 refers to the High Court case of Avondale Motors (Parts) Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 97; 2 ATR 312; 71 ATC 4101 (Avondale Motors) as the leading authority on the application of the same business test, where it was held the reference to 'same business' in the legislation required the taxpayer carry on the 'identical business' at all times during the income year rather than a business of the same kind or of a similar kind.

In Avondale Motors, the taxpayer company had ceased business completely at the ownership change-over. However, at 124 CLR 97 at 104; 2 ATR 312 at 316; 71 ATC 4101 at 4105, Gibbs J concluded that even if the company's former business had been carried on at the change-over, the taxpayer would not have satisfied the same business test, since during the income year:

it carried on the same kind of business but under a different name, at different places, with different directors and employees, with different stock and plant and in conjunction with a motor dealer having different franchises.

However, this does not mean that a business carried on by a taxpayer during the income year must be identical in every respect with the business that was carried on immediately before the change-over. As Walton J observed in Rolls-Royce Motors Ltd v. Bamford (1976) 51 TC 319 at 344:

There is all the difference in the world between an organic growth of trade and a sudden and dramatic change brought about by either the acquisition or loss of activities on a considerable scale.

The existence of a period of 'dormancy' often raises an issue as to whether the business is truly still in existence, though greatly reduced in scale, or has actually ceased altogether. If, before the end of the income year, a taxpayer completely ceases to carry on the business it carried on immediately before the change-over, it necessarily fails the same business test.

Any other business it thereafter carries on must be a new business that it has commenced after the cessation of the old business and, therefore, a different business from the business carried on before the change-over.

In Avondale Motors, Gibbs J held the taxpayer company did not satisfy the same business test on the basis that prior to the change-over, the business activities of the company, which comprised dealing in motor vehicle spare parts and accessories, had ceased completely. At 124 CLR 98 at 103; 2 ATR 312 at 315f; 71 ATC 4101 at 4105, Gibbs J said:

It is further submitted on behalf of the taxpayer that, quite apart from the rather artificial rule to which I have just referred, it should be held that it was still carrying on business after 29 February 1968 notwithstanding its inactivity after that date. It is said that those controlling the taxpayer had no intention of putting it into liquidation and that on the contrary it was obviously their intention that it should again engage in business of a similar kind, after its shares had been sold to a purchaser who wished to benefit by its accrued losses. To say this, however, clearly does not mean that the taxpayer was still carrying on business. There are cases in which it has been held that a company does not cease to carry on business notwithstanding that its activities are reduced to a minimum or indeed are almost entirely suspended. In South Behar Railway Company Limited v. IRC Lord Sumner said: "Business is not confined to being busy; in many businesses long intervals of inactivity occur." In some cases the very nature of the business is such that its conduct may require little activity, e.g. the business ...of acquiring a concession and turning it to financial benefit.

In other cases it has been held that a company continues to carry on business notwithstanding a suspension of activity due to causes beyond its control, e.g. where a steamship company had lost its only ship and was in the course of building another ... In the present case the taxpayer's activity had ceased completely. The cessation of activity was not due to the nature of the business which the taxpayer carried on, or to some temporary adversity which the taxpayer intended to endeavour to overcome; it was due to a decision to discontinue the business previously carried on because it had been unprofitable and there was no intention to resume the conduct of that business. The plain fact of the matter is that the taxpayer was not carrying on any business immediately before 15 March 1968. It follows that [the same business test is] not satisfied.

In your case, the company for which you are now the majority shareholder completely ceased trading in the early 1990's. You expect to commence a new construction business in the 2010-11 financial year through the company which has undergone a change of ownership in excess of 50%. The period of dormancy in which your company did not carry on a construction business was in excess of 15 years.

The ceasing of your former construction business was not due to the nature of the business or some temporary adversity in which you intended to overcome but was due to the significant losses incurred on the company's first project.

Considering the reasons behind the suspension of operations and the period of dormancy, your former and current construction projects are considered not to be the same business. As such you do not pass the same business test required by section 165-13 of the ITAA 1997.

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