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Edited version of private ruling

Authorisation Number: 1011820006509

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Ruling

Subject: same business test - negative limbs

Question

Will subsection 165-210(2) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the company as a result of entering into the proposed transaction so that the company do not satisfy the same business test provided by section 165-210 of the ITAA 1997?

Answer

No.

This ruling applies for the following period

1 July 2010 to 30 June 2014

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 165-13

Income Tax Assessment Act 1997 Subsection 165-13(2)

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)

Income Tax Assessment Act 1997 Paragraph 165-210(2)(a)

Income Tax Assessment Act 1997 Paragraph 165-210(2)(b)

Relevant facts

The company's business prior to the proposed transaction

1. The company was incorporated in 1990s. The company commenced operating and maintaining an asset. The asset is used by customers to transport their products. The company does not resell or trade the products but provide a variety of transportation services.

2. The company incurred tax losses in the income years ended 31 December 2000; 31 December 2001; 31 December 2002; 31 December 2003 and 30 June 2005. As at 30 June 2010, tax losses incurred by the company in these years are available to claim as a (carry forward) tax loss in the year ended 30 June 2011 (and future years) subject to the Continuity of Ownership Test (COT) or the Same Business Test.

3. The company failed the COT at some point during the 2000 calendar year; and again during the 2004 calendar year. The company satisfies COT from the time the company failed it in the 2004 calendar year onwards.

4. The company's business during the period from incorporation to 2004 was as follows:

5. This description of the company's business during the period from incorporation to 2004 is based on the following:

6. The company submitted an arrangement, outlining the services the company proposed to offer, for approval to a regulatory body and a proposed access arrangement for the asset to that entity for approval. The regulator assessed the proposed arrangement against relevant legislative requirements and principles of the relevant laws. A final decision was made in 2003 on the services to be offered. The company offered a series of services where the company transported the customer's products in various ways.

7. The company's business during the period beginning in 2004 and ending on 30 June 2008 was as follows:

8. The description of the company's business during this time is based on the following:

9. Following the change in ownership in 2004, the company submitted revisions to the access agreement to the relevant regulatory body for approval. This document outlined the services the company intended to offer. The company offered a series of services where the company transported the company's customer's products in various ways that were more extensive than the company's previous agreement.

The company's customers

10. The company enter into transportation contracts with customers. These contracts require the customer to deliver their products to the company and collect them each day. These contracts recognise that this sometimes not all products are collected and include an allowance for uncollected products. This margin allows for a variance between the amount of product delivered and the amount collected on a given day by a customer. When the allowable variance is exceeded by a customer, that customer pays a fee, or faces contractual consequences, depending on the terms of the customer's contract.

11. The company provided services to more customers in the 2008 income year than it did in 199X; however the largest customers remained the same and continued to account for more than 85% of customer revenue. New customers all operated within the same industries and terms as the existing customers. The number of customers increased due to the assignment of contractual rights and obligations to new parties and growth in the company's core customer base.

12. The company have provided services from the earliest test time until 30 June 2008 on the same basis with respect pricing policies and access to the company's services by customers. A majority of the company's revenue is from reservation charges with the remainder derived from usage charges. This has remained constant until today and is expected to remain constant until 30 June 2014 income year.

13. From the period beginning immediately before the earliest test time until 30 June 2008 each of the services provided were based on the applicable standard customer contract in place with the relevant customers. A majority of the company's revenue was derived from providing these services in each of the income years during this period.

14. The contracts the company have entered into since the earliest test time require the company to provide the same services, however, in some instances the terms and conditions of services have changed. These changes provide additional flexibility to the customers in their usage of the company's services, particularly in relation to enabling them to deliver more of their products on a given day than they collect on that day.

15. One of the company's customer contracts entitles the customer that is party to the contract to keep a permanent excess of its product that it delivers to the company over what it has collected. This customer has always had this right consistently since 199X. The contracted capacity for this customer contract, and hence the revenues from this contract, represent one of the company's largest customers that have remained the same since 199X.

16. Since the company's incorporation, the total revenue generated from charges where products delivered by customers exceeded what they collected on a given day has been negligible in terms of total revenue in any given income year.

17. Certain data had always been provided at the relevant times to customers in accordance with provisions within their contracts. In the year ended 30 June 2008 additional data was provided to customers comply with legislative requirements.

18. Immediately before the test times until 30 June 2008 special projects/ chargeable services were undertaken. These include the construction of customer specific facilities. These facilities form part of the asset.

19. The company provide ongoing operation and maintenance of customer specific works, and facilities that are linked to the asset for other facility owners. For the period beginning 199X and ending 30 June 2008 the resources required to provide such services were sourced from a combination of services and equipment provided by the owner of asset under the asset operating agreement and from specialist contractors and consultants. The specialist contractors and consultants changed between the test times and 30 June 2008 however the nature of the services to which they were engaged did not.

Location

20. The location of the asset has not changed since 199X. There have been some minor changes to where the company carry out the company's support services.

Operation of the asset

21. All of the company's activities in relation to carrying on the company's business were carried out in the same manner from199X and will continue to be carried on in this manner until 30 June 2014.

22. The asset underwent several capacity increases since the company's incorporation.

The company

23. The company's trade names, trade marks and branding were unchanged from immediately before the earliest test time.

24. The company did not hold any patents. The company was not party to any royalty arrangements for the period immediately before the test times.

25. The asset is owned by an entity with an identical ownership structure to the company. The capacity of the asset has doubled since this expansion began in 2004. Prior to this expansion the company would have been able to undertake the proposed transaction, however, the terms of the transaction would have been on a smaller scale.

Staffing

26. The company have never employed any staff directly and have always outsourced the labour and services required to operate and maintain the asset to third parties.

27. The labour required to operate and maintain the asset increased during the period starting immediately before the earliest test time and the year ended 30 June 2008, however, the nature of the services performed did not change. The nature of the services performed is presently not expected to change until 30 June 2014.

28. The asset was operated and maintained in the same way as it was immediately before the earliest test time and will continue to be the case until 30 June 2014. The increase in labour and associated expenditure required has been driven by the increased capacity of the asset and due to an increase in the unit cost of labour.

Proposed transaction

29. An opportunity has arisen for the company to provide a service (proposed transaction) to an existing customer (Customer A).

30. The proposed transaction will support Customer A's existing customer contract by providing Customer A with an assurance of supply of their products to their commercial operations.

31. Customer A approached the company to enter the agreement. The company did not approach Customer A with the proposal.

32. The company and Customer A have been parties to a customer contract since the company's incorporation.

33. The Terms Sheet for the proposed transaction would constitute a separate legal arrangement to Customer A's customer contract. However, some aspects of the contract would be subject to agreement in Customer A's existing agreement.

34. The proposed transaction allows Customer A to commence delivering its products to the company at an agreed maximum daily rate until late 2012. The quantity of products delivered would be in addition to Customer A's delivery limits imposed in their existing customer agreement.

35. After the particular date in 2012 Customer A will be able to commence collecting its products stored under the proposed transaction over a period of time at an agreed rate until the end 2013. The company must approve the collection of stored product. Each collection must be within Customer A's collection limits as imposed in their existing customer agreement. The company may refuse a collection.

36. The pricing of the proposed transaction is similar to the pricing structure of existing customer contracts.

37. The proposed transaction will generate negligible total revenue from the execution date until completion.

38. For commercial flexibility for Customer A, the proposed transaction includes an option for Customer A to reduce its service. However, Customer A would remain liable for charges equal to 180 days to protect the company's commercial position.

39. The proposed transaction will not give rise to any change in the manner in which the company carry out day to day activities, nor will it impact on the way the asset is operated and maintained overall. The company will run the asset in exactly the same way, using the same people, techniques and processes that the company currently use. The only impact the proposed transaction may have would be a greater emphasis on the daily tracking of customer's products, however, this can be accommodated by the data collection and management systems the company already have in place.

40. When the customer delivers its products to the company the title, risk and control of the products would pass to the company.

41. The company should not incur more than a relatively negligible amount per annum of additional operating expenditure to facilitate implementation of the proposed transaction. This will be incurred in relation to refining management of the company's procedures.

42. The company will not be making any new capital investment to enable the company to provide the proposed transaction.

43. The company will not utilise additional staff or alter role of existing staff to provide the proposed transaction.

44. No existing contracts to which the company are a party will be amended as part of or as a result of providing the proposed transaction.

45. The proposed transaction will have no impact whatsoever on the company's ability to service existing customers, nor on the company's ability to accept customers requiring the same services as currently received by existing customers.

46. The proposed transaction is the only transaction of its type that the company are currently considering.

47. The company will make a taxable profit (i.e., total assessable income will exceed total allowable deductions) for the years ended 30 June 2011 to 30 June 2014, inclusive (not including any allowable deductions for tax losses incurred in prior years).

48. The company has not, and will not, enter into any business activities other than those identified in this ruling. That is, this ruling is limited to the business activities described in the scheme including the proposed transaction.

49. The company has stated that apart from the proposed transaction that is described in this ruling, the company's business will be the same for the purposes of subsection 165-210(1) of the ITAA 1997 as the business described in these facts for the period from immediately before the earliest test time to 30 June 2008.

50. The pricing structure to be used in the proposed transaction is an arm's length price.

Reasons for decision

Detailed reasoning

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Subsection 165-210(1) states that 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.

However, subsection 165-210(2) states that a company does not satisfy the same business test if at any time during the same business test period the company derives assessable income:

Section 165-13 provides the meaning of 'the same business test period' and 'test time' when determining whether or not an entity satisfies the requirements of subsection 165-210(2). Subsection 165-13(2) states that the 'same business test period' for a company is the income year in which the company wishes to deduct tax losses of earlier income years. The 'test time' is determined by the table provided by subsection 165-13(2) as shown below:

Test time

Item if:

The test time is:

1

It is practicable to show there is a period that meets these conditions:

(a) the period starts at the start of the ownership test period or, if the company came into being during the loss year, at the time the company came into being;

(b) the company would meet the conditions in subsections 165-12(2), (3) and (4) if the period were the ownership test period for the purposes of this Act

The latest time that it is practicable to show is in the period

2

Item 1 does not apply and the company was in being throughout the *loss year

The start of the loss year

3

Item 1 does not apply and the company came into being during the *loss year

The end of the loss year

The Commissioner's views concerning the application of the 'same business test' are set out in Taxation Ruling TR 1999/9.

The meaning of 'before the test time' is considered in paragraph 88 of Taxation Ruling TR 1999/9. It is recognised that in applying the new business test it is relevant to examine the period immediately before the test time. However, it is also recognised that not all business undertakings will be evident immediately before the test time. Therefore, for the purposes of the new business test, it is only necessary that the new business undertaking be part of the overall business of the taxpayer immediately before the test time, not necessarily that the specific undertaking be conducted immediately before the test time. This recognises that some business that is carried on may be intermittent or dormant immediately before the test time, but still form part of the overall business of the taxpayer at that time.

The company has stated that it will make a taxable profit (ie, total assessable income will exceed total allowable deductions) for the years ended 30 June 2011 to 30 June 2014, inclusive (not including any allowable deductions for tax losses incurred in prior years). Therefore, the same business test period under subsection 165-13(2) in relation to the proposed transaction will be the income years ended 30 June 2011 to 30 June 2014, inclusive.

The company does not satisfy item 1 of the table provided by subsection 165-13(2) at any time during the following loss years:

1 January 2000 to 31 December 2000;

1 January 2001 to 31 December 2001;

1 January 2002 to 31 December 2002; and

1 January 2003 to 31 December 2003.

Given that the company was in being throughout each of the above loss years, item 2 of subsection 165-13(2) applies to determine that the company will have a test time in relation to its losses of 1 January in each of those loss years.

The company satisfied item 1 of subsection 165-13(2) in relation to the period from 1 January 2004 to 30 June 2005. Given that you failed COT on at some stage during this period (day x), 'day x' represents the latest time that you are able to practicably show that you satisfy item 1. Therefore, your test time for the income year ending on 30 June 2005 is 'day x'.

New business test

Paragraph 14 of TR 1999/9 provides that the new business test considers whether the company derived assessable income from a kind of enterprise, or undertaking of a kind, that it had not engaged in before the test time. Where income is derived from an enterprise or undertaking of a kind that had not previously been engaged in, the new business test is failed. Paragraph 16 states that the content of the word 'kind' in the context of the new business test is to be derived from the course of the company's business operations before the test time.

Paragraphs 68 to 77 of TR 1999/9 provide an explanation to the interpretation of the 'new business test'. The new business test looks at each particular undertaking or enterprise carried on or out by the company during the same business test period and compares them to the undertaking or enterprises that formed the taxpayers business immediately before the test time. Where activities of a different kind are carried on after the test time with some degree of system, repetition and continuity and are distinguishable from the other activities of the company before the test time, it is likely a new undertaking has been commenced that is different in kind to those carried on before the test time. Where such activities are carried on the new business test is failed.

Paragraph 71 states that where a company commences a new undertaking and amalgamates it in its overall business the Commissioner must determine whether the amalgamated undertaking was of the same kind as the undertakings of the business carried on by the taxpayer immediately before the test time. Here, the new business test considers whether even though the same business is taken to be carried on after the amalgamation of the new business, that same business includes activities of a kind not carried on before the test time.

Paragraph 72 states that generally, the new business test permits a company to expand or develop during the same business test period within the same fields of endeavour as it was engaged in prior to the test time, provided the effect of any expansion or development does not cause the company to fail the same business test. Cases where failure occurs tend to be where income is being injected or could be injected as a result of the new business.

Prior to the test times the company's business involved the operation and maintenance of the asset. This entailed determining whether customers would be granted access to deliver their products to the asset and collect the products at a later time that day as required by their commercial needs. At different times since the company began operating the asset in 199X, this has required the company to allow customers not to collect their products from the asset for various reasons. This was extended in 200X to allow customers to deliver their products and collect them up to a month later as part of a service the company provided. The company has also had in place a contractual requirement for one of its customers to maintain a permanent amount of its product stored using the asset. Whilst the company has stated that the revenue it has received from these activities has never represented more than a negligible amount of its total revenue in an income year, it could be said that the company has derived income by allowing customers to store their products using the asset since 199X

The company is considering entering the proposed transaction. This transaction will enable one of its current customers to utilise the asset to deliver more products than it collects on a given day from the asset until the certain date in 2012 and collect more products than it delivers on a given day from then until 31 December 2014. There is a limit to the quantity of products that can be delivered without being collected on a given day. The company will receive revenue for granting the capacity to the customer to store its products using the asset. Allowing the customer to do this under a one off contract would cause a negligible change to the way in which the company's business is operated and negligible increase in the company's expenses.

As demonstrated above, the company has always derived income from allowing customers to store their products using the asset since the time the company began operating it. As outlined in paragraph 14 of TR 1999/9 the new business test is concerned with whether the new undertaking that derives income is of a kind that was not a part of the business of a company prior to the test time. Based on the above comparison it would appear reasonable that deriving income by allowing a customer store its products using the asset does not represent a new business relative to the kind of business the company carried on immediately before the test times. The new activity is merely an extension of the terms previously made available to customers.

TR 1999/9 also prescribes that where activities of a different kind are carried on after the test time with some degree of system, repetition and continuity and are distinguishable from the other activities of the company before the test time, it is likely a new undertaking has been commenced that is different in kind to those carried on before the test time. As discussed above, entering into a one off transaction to expand the contracted capacity for an existing customer to store more of its products using the asset for a set period of time does not represent the necessary degree of system, repetition, or continuity to be considered a new undertaking of a different kind to those the company carried on before the test time.

In scenario 2 of example 7 of TR 1999/9 a company mined and sold gold prior to the test time. As part of its operations before the test time the company also stockpiled copper concentrate, a by product of its gold mining for which it already had the necessary plant. When the company begins to sell the copper concentrate it does not fail the new business test as the business of selling minerals (including copper concentrate) commenced with the mining and concentration of those minerals. However, it is noted that had the company decided to sell pure copper it would have failed the new business test as this would have required the installation of new plant.

This scenario is similar to the company's circumstances. To enable the company to undertake the proposed transaction the impact on the company's expenses and current operations is relatively negligible, requiring no changes or expenditure on plant, minimal increase in expenses, and only a minor increase in the company's data monitoring and provision to the customer. The fact that undertaking the proposed transaction has such a minimal impact on the company's business supports the fact that the new business test is satisfied, as it was in the above scenario of example 7.

In Example 8 of TR 1999/9 a company held shares for their yield with the occasional speculation in shares for profit by sale prior to the test time. After the test time the company acquired shares in a one off transaction for profit by sale and satisfied the same business test. However, when the company acquired shares for profit by sale in a second transaction and intended to regularly buy speculative shares the company now failed the new business test.

This example is similar to the company's circumstances in that the company is entering a one off transaction. Entering this one off transaction that is of the same kind of business the company carried on prior to the test times will not see the company fail the new business test. However, should there be an increase in the number of transactions of this type that the company enter into beyond this one off transaction; it may constitute the undertaking of a new business, different in kind to the business carried on before to the test times.

Conclusion

Undertaking the proposed transaction will not cause the company to fail the new business test under paragraph 165-210(2)(a). That is, it will continue to satisfy the new business test. It is not considered that the proposed transaction represents a business of a kind that the company did not carry on before the test time. However, any further transactions of this type undertaken by the company may result in them not satisfying the same business test.

New transactions test

Paragraph 165-210(2)(b) states that a company does not satisfy the same business test if at any time during the same business test period, the company derives 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. This is generally referred to as the 'new transactions test'.

The meaning of 'the same business test period' and 'test time' in the context of the new transactions test use the same meaning outlined above when considering the new business test.

The meaning of 'before the test time' is considered in paragraph 88 of Taxation Ruling TR 1999/9. It is recognised that in applying the new transactions test it is relevant to examine the period immediately before the test time. However, it is also recognised that not all transactions will be evident immediately before the test time, therefore, for the purposes of the new transactions test it is only necessary that the new transaction be part of the overall business of the taxpayer immediately before the test time, not necessarily that like transactions be conducted at that time, as it is recognised that some transactions entered into may be intermittent or dormant immediately before the test time, but still form part of the overall business of the taxpayer at that time.

Paragraph 15 of TR 1999/9 states that the new transactions test is directed at preventing the injection of income into a loss company that has satisfied the same business test and the new business test. The new transactions test includes all transactions entered into in the course of the company's business operations and not only 'isolated' or 'independent' transactions. Generally, the new transactions test is not failed by transactions of a type that are usually unmotivated by tax avoidance, that is, transactions that could have been entered into ordinarily and naturally in the course of business operations carried on by the taxpayer before the test time.

The company was approached by the customer to enter the contract. Whilst the company has stated that the customer is an associate of the company, it is noted that the customers representatives were excluded from the decision making process when the company determined whether the terms of the transaction would be accepted. This would indicate that the transaction is motivated by the needs of one of the customers rather than any tax avoidance on the company's part.

Paragraph 16 of TR 1999/9 states that the content of the word 'kind' in the context of the new transactions test is to be derived from the course of the company's business operations before the test time. A transaction from which income is derived during the same business test period, which could have been entered into before the test time in the course of the company's business operations, and which is neither extraordinary nor unnatural in the context of the business carried on by the company at the test time, is generally a transaction of the same kind as transactions actually entered into by the company before the test time.

The company offered additional capacity to a customer to store it products using the asset from 199X, before the earliest test time. The company has continuously provided this service to the customer right through the test times and continue to do so. The company has also allowed other customers to store products since the company began operating the asset. The company does not determine the capacity of the asset. This is controlled by various external influences and the owner of the asset. In 2004 the owner of the asset was required to increase the capacity of the asset. As a result the company has additional capacity in the asset that is available for customer's products that was not available prior to the increased capacity. In light of the above facts, it is not considered unnatural or extraordinary in the context of the business that the company carried on that it would make excess capacity of the asset available to a customer to store products to derive income, particularly given that the company have stated that doing so will have no effect whatsoever on its ability to service existing customers needs and contracts that are in place.

Paragraph 17 of TR 1999/9 states that for the purposes the new transactions test, 'transaction' refers to any operation or dealing from which income directly or indirectly flows or arises, and a company enters into a transaction for the purposes of the new transactions test if it engages or participates in that operation or dealing. The new transactions test is intended to extend to every means by which a company may derive income, including transactions of a passive or investment character. The words 'business operations' refer to everything that a company undertakes or does. Together, the business operations constitute the business, meaning the overall business, of the company.

The company proposes to enter a contract that allows a customer to deliver more products to the asset on a given day than they are able to collect under their current customer contract, until certain date in 2012. This will enable the customer to build up an excess of its products in the asset. After 2012 the customer will collect more of their products than they deliver on a given day until 31 December 2013. This will result in the customer reducing the excess of its products it has delivered to the asset from the date of execution of the contract until certain date in 2012 to the customers normal level by 31 December 2013. The company will derive revenue as a result of entering the contract by charging a fee for making storage capacity within the asset available to the customer and when the customer utilises the capacity.

Paragraph 17 of TR 1999/9 states that by entering into the contract would represent entering a transaction for the purposes of paragraph 165-210(2)(b) as the company would be deriving income as a result of entering and fulfilling the contract.

Paragraph 87 of TR 1999/9 states that when a transaction or extraordinary dealing with an associate is not for an arm's length price it will generally be different in kind from those previously carried on.

The company has stated that the terms of the contract are at an arm's length price. Therefore, even though the customer that is party to the contract is the company's associate, the proposed transaction is not prevented from satisfying the new transaction test.

Scenario 1 of Example 11 in TR 1999/9 considers a situation where a company grows clover for sale on land it owns for sale as fodder. From time to time the company buys virgin land from the Crown, clears it and sows clover (usually a term of the sale is that the land be cleared and a crop sown within 12 months of purchase). The company suffers losses in one year due to a drought. The company is purchased by a new entity (this is the test time). The company buys more virgin land but sows, harvests and sells a crop of wheat due to a shortage of clover seed. Thereafter, the company sells only clover. Although the company has never sown and sold wheat before it passes the new transaction test as the transaction is one that could have been entered into in the course of business operations before the test time and is not extraordinary by reference to the ordinary course of the company's business operations.

The company's circumstances are considered to be similar to those in scenario 1 of example 11 in TR 1999/9. It is considered that the company could have made the extra storage available to a customer prior to the test time. This would not have been considered extraordinary in reference to the ordinary course of the company's business operations before the test times. Therefore, like the company in the example discussed above, it is considered that the company satisfies the new transactions test in relation to the proposed transaction regardless of the fact that the terms of the contract are different to those that the company has entered into prior to the test times.

Conclusion

Undertaking the proposed transaction will not cause the company to fail the new transactions test under paragraph 165-210(2)(b). That is, it will continue to satisfy the new transactions test. It is not considered that the proposed transaction represents a transaction of a kind that the company had not entered into in the course of its business operations before the test time. This is predominately due to the company being able to enter into the transaction, even if on a different scale, before each of the relevant test times.

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