Edited version of your written advice

Authorisation Number: 1012715112873

Ruling

Subject: Continuity of Ownership, tax losses, capital losses and Part IVA

Question 1

Is Entity A entitled to deduct tax losses and apply net capital losses of the earlier income years ended 30 June 200X to 30 June 20XX in the income year ended 30 June 2014?

Answer

Yes.

The ruling for question 1 applies for the following period:

1 July 2013 to 30 June 2014

Question 2

Will the Commissioner make a determination under Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) to disallow a deduction for tax losses of earlier income years by Entity A to the extent that those tax losses have been deducted against assessable income referable to the Company A Trust and the Property B Trust?

Answer

No.

The ruling for question 2 applies for the following periods:

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

Question 3

Will the Commissioner make a determination under Part IVA of the ITAA 1936 to include in the assessable income of Entity A the amount of any net capital losses applied against the capital gain made from the disposal of Property A to the Property A Trust?

Answer

No.

The ruling for question 3 applies for the following period:

1 July 2014 to 30 June 2015

Question 4

Will the Commissioner make a determination under Part IVA of the ITAA 1936 that Entity A is subject to withholding tax in respect of borrowings from Company E in respect of Property A?

Answer

No.

The ruling for question 4 applies for the following periods:

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

Relevant facts and circumstances

Overview

Company C is a foreign company incorporated in Country C and various other countries around the world.

Only one shareholder (Shareholder A), has held an interest of 10% or more in Company C. The precise percentage holding has varied but has not exceeded a small percentage holding during the relevant period, being from 1 July 200Y to 30 June 20YY.

Relevant structure

Country C resident

Company C owns 100% of Company D which is resident in the Country C.

Country A residents

Company D has always owned at least greater than 50% of the rights to dividends, capital and voting power in Property Fund A which is resident in Country A.

Property Fund A owns 100% of Holding Company A which is resident in Country A.

Holding Company A owns 100% of Company E which is resident in Country A.

(The entities controlled by the parent entity of Company E in the overseas region are referred to as the Property Fund Group.)

Country B resident

Company E owns 100% of Company A. Important facts about Company A that are relevant for the purposes of this ruling are:

• Company A is a company resident in Country B

• the only asset held by Company A is its beneficial interest in an Australian bare trust, known as the Company A Trust

• the trustee of the Company A Trust is Company A Pty Limited

• Company A Trust holds some of the units in an Australian resident unit Trust, ABC Trust and

• ABC Trust indirectly holds (through an interposed trust) 100% of the interest in the Australian real property asset Property C - the remaining units in ABC Trust are held by an unrelated entity

Country C resident

Company E also owns 100% of Entity A. Important facts about Entity A that are relevant for the purposes of this ruling are:

• Entity A is a company resident in Country C

• Entity A currently holds a direct interest in Property A

• Property A has undergone significant redevelopment

• during redevelopment, Entity A remitted interest withholding tax to the ATO in respect of its borrowings from Company E attributable to Property A and

• as at 30 June 2013, Entity A had tax losses and net capital losses

Restructure - 3 Transactions

Overview

The following three transactions are designed to ensure that three main Australian investment property interests forming part of Property Fund A's Australian property portfolio are held by Entity A after the restructure.

Transaction Number 1 - transfer of Entity A's direct interest in Property A to the Property A Trust

Entity A has established a wholly owned Australian unit trust named the Property A Trust.

Entity A has agreed to transfer its interest in Property A to the Property A Trust. The consideration for the transfer was the issue of additional units in the Property A Trust to Entity A and the creation of a receivable due to Entity A.

A taxable gain may be derived in Australia by Entity A on the transfer of its direct interest in Property A to the Property A Trust. Based on the current information as at the date of this ruling application no gain should arise but in the event it does, this will be negligible and will be offset by the significant carried forward capital losses available to Entity A.

The Property A Trust will pay Entity A a cash amount over time by drawing down from pre-committed loan funding provided by Australian Bank. These funding commitments will allow the Property A Trust to repay the receivable due to Entity A. The security provided to Australian Bank will be limited to the interest in Property A. Borrowing direct from Australian Bank ensures that only Property A is provided as security for the finance provided whereas other means, such as raising overseas external debt, would require providing and risking additional security such as Property B, another Australian property acquired pursuant to Transaction 2 detailed below.

Furthermore, the decision for the Property A Trust to borrow from Australian Bank (as opposed to borrowing from overseas or funds being provided as an intercompany loan) was primarily driven by regional investment allocations (i.e. the fund has target levels in respect of which jurisdictions its investments should be made. The location of investment in turn impacts on where external debt is raised). Raising external Australian debt allows for a natural currency hedge against the asset and therefore lowers the currency exposure for Property Fund A.

The net effect of the above transaction is that the new wholly-owned subsidiary trust, the Property A Trust, will hold Property A (instead of Entity A) and it will be the borrowing party to the loan with Australian Bank.

Income

The Property A Trust is not a Managed Investment Trust (MIT) and will have a 30% withholding tax on any income to which Entity A is presently entitled pursuant to subsections 98(3) and (4) of the Income Tax Assessment Act 1997 (ITAA 1997).

Transaction Number 2 - acquisition of Property B by the Property B Trust

Entity A has established a wholly owned Australian unit trust named Property B Trust.

Entity A will use a portion of the cash consideration received from the sale of its interest in the Property A to the Property A Trust to subscribe for new units in the Property B Trust to allow for the Property B Trust to complete its acquisition of Property B. Accordingly, there will be no external debt funding for this acquisition.

Income.

Accordingly, as with Property A, the Property B Trust is not a MIT so it will have a 30% withholding tax on any income to which Entity A becomes presently entitled pursuant to subsections 98(3) and (4) of the ITAA 1997.

This acquisition will ensure that the thin capitalisation capacity of Entity A will be below the new 60% threshold.

Transaction Number 3 (proposed) - Transfer of Company A's beneficial interest in the Company A Trust, to Entity A

It is proposed that the beneficial interest held by Company A in the Company A Trust will be transferred to Entity A. At the time of transfer, there will be a valuation so that the transfer occurs at market value.

Entity A will fund the acquisition of the beneficial interest in the Company A Trust by way of financing from Company E and Holding Company A as follows:

• Company E will make an equity contribution to Entity A by way of promissory note (PNote)

• Entity A will then acquire the Company A interest for a fixed dollar amount. Consideration will be given in the form of two PNotes from Company E (both when combined representing the fixed dollar amount agreed to)

• Company A will then be placed into liquidation and will make a distribution of the PNote from the sale of its Company A Trust interest, to Company E, which is then cancelled

There is currently no debt funding for Company A Trust or at any level below this entity

Income

Rental income from Property C, previously returned by Company A will now be derived by and assessed to Entity A. As with Transactions 1 and 2 above, the Company A Trust is not a MIT so it will have a 30% withholding tax on any income to which Entity A becomes presently entitled pursuant to subsection 98(3) and (4) of the ITAA 1997.

Company A will make an election pursuant to Subdivision 126-B of the ITAA 1997 to obtain rollover relief and disregard any capital gains made on the transfer. There will be no stamp duty on this transfer and no Country A or Country B tax payable on the transfer or distribution.

Outcome summary of new structure - commercial benefits

The key outcomes of the above three transactions will be that:

• the Australian property assets of the Property Fund Group will be increased (Entity A will have an interest in three trusts (two unit trusts and one bare trust))

• external funding will be introduced but with security limited to a single asset, namely Property A (The Company A Trust and Property B Trust investments will have no debt funding and the Property A Trust will hold the loan with the Australian bank) and

• Entity A will maintain the current intercompany loan (from Company E ), and the loan balance may be varied but will not breach thin capitalisation limits

In addition, the management time, material compliance costs and Country B tax risks associated with the Company A structure will be removed, the thin capitalisation position of Property Fund Group in Australia will be brought into line with new lower safe harbour thresholds and the Australian ownership structure will be in a more traditional form which may allow new investors at some future point in time (this is not currently under contemplation).

The tax profile for the structure at this time is that a taxable distribution will be payable by each of the Company A Trust, Property A Trust and Property B Trust (on which withholding tax will be payable at 30%). Entity A will lodge a return including these amounts as assessable income, whilst deducting interest on the loan from Company E and nominal corporate costs.

As part of the reorganisation Enity A will review its transfer pricing documentation for its current loan from its parent company, Company E.

Finally, for the purposes of rollover relief:

• Company A's beneficial interest in the Company A Trust will not be trading stock in the hands of Entity A

• the interest in the Company A Trust will satisfy the non-portfolio test and principal asset test for the purposes of section 855-25 of the ITAA 1997 both just before and just after the trigger event and

• a capital gain will be realised by Company A in respect of the transfer of its beneficial interest in the Company A Trust to Entity A

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 166-5

Income Tax Assessment Act 1997 Section 166-145

Income Tax Assessment Act 1997 Section 166-230

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177CB

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177F

Reasons for decision

Pursuant to Division 166 of the ITAA 1997 modified COT rules apply to widely held companies and eligible Division 166 companies with losses incurred on or after 1 July 2002. These modified rules are necessary as without them these entities would have difficulty tracing through the layers of shareholders to determine the ultimate beneficial owners of the shares that have voting power and rights to dividend and capital distributions.

Division 166 of the ITAA 1997 applies where a company is a 'widely held company' or 'eligible Division 166 company' at all times during the income year in which the deduction is sought. Subsection 166-5(1) of the ITAA 1997 states:

This Subdivision modifies the way Subdivision 165-A applies to a company that is:

(a) a *widely held company at all times during the income year; or

(b) an *eligible Division 166 company at all times during the income year; or

(c) a widely held company for a part of the income year and an eligible Division 166 company for the rest of the income year.

The term 'widely held company' is defined in section 995-1 of the ITAA 1997 and includes all companies that are listed on an approved stock exchange and all unlisted companies with more than 50 members where no 20 or fewer persons hold 75% or more of the voting, dividend or capital distribution rights.

The term 'eligible Division 166 company' is also defined in section 995-1 of the ITAA 1997 and means a company (other than a widely held company) in which more than 50% of the voting power, dividend rights or capital distribution rights are beneficially owned by one or more of the following:

• a widely held company;

• a deemed beneficial owner (i.e. a complying superannuation fund, foreign superannuation fund, complying ADF, special company, managed investment scheme or other entity prescribed for the purposes of s 166-245);

• a non-profit company; or

• a charitable body.

Entity A is not a widely held company as it is not listed on an approved stock exchange and has less than 50 members (it is owned 100% by Company E). The Commissioner does, however, accept that Entity A is an eligible Division 166 company as it is ultimately beneficially held by a widely held company, being Company C, which is listed on the overseas stock exchange (an approved stock exchange) and has more than 50% of the voting power in Entity A.

Accordingly, the modified COT rules in Division 166 of the ITAA 1997 can apply Entity A.

Modified Test Times

Subsections 166-5(2) and 166-5(3) of the ITAA 1997 state:

Meaning of test period

166-5(2)

The company's test period is the period consisting of the *loss year, the income year and any intervening period.

Substantial continuity of ownership

166-5(3)

The company is taken to have met the conditions in section 165-12 (which is about the company maintaining the same owners) if there is *substantial continuity of ownership of the company as between the start of the *test period and:

(a) the end of each income year in that period; and

(b) the *end of each *corporate change in that period.

Accordingly, the primary modification in Division 166 of ITAA 1997 applicable to an 'eligible Division 166 company' is a 'substantial continuity of ownership' test that allows continuity of beneficial ownership to be tested at specified points in time rather than throughout the ownership test period. The test is satisfied if there is substantial continuity of ownership of the company as between:

• the beginning of the loss year (the start of the test period);

• the end of each income year between the beginning of the loss year and the end of the year when the loss is deducted (the test period); and, where applicable,

• the end of each 'corporate change' in the test period.

Tracing rules

Pursuant to section 166-145 of the ITAA 1997 substantial continuity of ownership as between two points of time is determined by reference to whether there are persons (other than companies or, in the case of voting rights, trustees) who have more than 50% of the voting power in the company and rights to more than 50% of the company's dividends and capital distributions.

For present purposes, in order to assist eligible Division 166 companies evidence substantial continuity of ownership between different points in time in accordance with section 166-145 of the ITAA 1997, the COT tracing rules have been modified pursuant to section 166-230 of the ITAA 1997 so that all indirect stakes of less than 10% in the tested company are aggregated and deemed to be held by the top interposed entity (the company interposed between the stakeholder and the tested company).

Company C is the top interposed entity. Indirect interests (via Company C, the top interposed entity) in Enity A (the tested company) of less than 10 precent will therefore be deemed to be held by Company C pursuant to section 166-230 of the ITAA 1997.

Since the beginning of the first loss year (1 July 200X) until the date of this application, only one shareholder has held an interest of more than 10% in Company A and this was Shareholder A, which, at one stage, held a maximum of slightly greater than 10% per cent interest in Company A. At this point in time (and based on the maximum of slightly greater than 10% per cent interest in Company A) Shareholder A only had an indirect stake in Entity A of less than 10%. If Shareholder A, as the largest shareholder, could have only ever had a less than 10% indirect stake in Entity A at all relevant times then it must follow that at all relevant times, all other than Shareholder A shareholders in Company C had less than a 10% indirect stake in Enity A. Accordingly, all of these indirect stakes (that is, 100% of them) can be deemed to be held by Company C, the top interposed entity, pursuant to section 166-230 of the ITAA 1997. As nothing has changed to alter this shareholding position (that is, 100% of the indirect stakes in Entity A being deemed to be held by Company C) as at the date of this ruling, the Commissioner accepts that substantial ownership has been maintained at all relevant times. The Commissioner therefore accepts Entity A is entitled to deduct tax losses and apply net capital losses of the relevant income years in the 2014 income year.

Question 2

Law Administration Practice Statement PS LA 2005/24 deals with the application of the general anti-avoidance rules, including Part IVA of the ITAA 1936. Before the Commissioner can exercise his discretion to make a determination in respect of Part IVA under subsection 177F(1) of the ITAA 1936, three requirements must be met. These are:

• there must be a scheme within the meaning of section 177A of the ITAA 1936

• a tax benefit must arise based on whether a tax effect would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out, and

• having regard to the matters in paragraph 177D(b) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies (dominant purpose)

On the basis of an analysis of these requirements, the Commissioner will not make a determination under Part IVA of the ITAA 1936 to disallow a deduction for tax losses of earlier income years by Entity A to the extent that those tax losses have been deducted against assessable income referable to the Company A Trust and Property B Trust.

Question 3

Law Administration Practice Statement PS LA 2005/24 deals with the application of the general anti-avoidance rules, including Part IVA of the ITAA 1936. Before the Commissioner can exercise his discretion to make a determination in respect of Part IVA under subsection 177F(1) of the ITAA 1936, three requirements must be met. These are:

• there must be a scheme within the meaning of section 177A of the ITAA 1936

• a tax benefit must arise based on whether a tax effect would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out, and

• having regard to the matters in paragraph 177D(b) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies (dominant purpose)

On the basis of an analysis of these requirements, the Commissioner will not make a determination under Part IVA of the ITAA 1936 to include in the assessable income of Entity A the amount of any net capital losses applied against the capital gain made from the disposal of Property A to the Property A Trust.

Question 4

Law Administration Practice Statement PS LA 2005/24 deals with the application of the general anti-avoidance rules, including Part IVA of the ITAA 1936. Before the Commissioner can exercise his discretion to make a determination in respect of Part IVA under subsection 177F(1) of the ITAA 1936, three requirements must be met. These are:

• there must be a scheme within the meaning of section 177A of the ITAA 1936

• a tax benefit must arise based on whether a tax effect would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out, and

• having regard to the matters in paragraph 177D(b) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies (dominant purpose)

On the basis of an analysis of these requirements, the Commissioner will not make a determination under Part IVA of the ITAA 1936 that Entity A is subject to withholding tax in respect of borrowings from Company E in respect of Property A.

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