Edited version of your written advice

Authorisation Number: 1013104078890

Date of advice: 7 October 2016

Ruling

Subject: Income tax ~~ Tax losses ~~ Continuity of ownership test ~~ Modified rules

Issue

Can you utilise carried forward tax losses post sale of your business.

Question 1

Will you be prevented from deducting a carry forward tax losses due to a failure to maintain the same owners for the ownership test period as specified in section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Even if you meet the conditions in section 165-12 of the ITAA1997, will you be prevented by the application of section 165-15 of the ITAA 1997 from deducting carry forward tax losses due to a failure to maintain the same people controlling the voting power in you?

Answer

No.

Question 3

Is the Commissioner prevented by the application of Division 175 of the ITAA 1997 from disallowing deductions for your current year and carry forward tax losses on the basis that it is fair and reasonable for continuing shareholders to benefit from the derivation of income from the sale of business?

Answer

Yes.

This ruling applies for the following periods:

1 July 20XX to 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are in the process of selling your business in the year ended 30 June 20YY.

Shares will not be sold and will remain in the ownership of the Trustee.

You have carried forward tax losses.

Tax losses were generated from the conversion of excess franking credits received from franked distributions made by the Trust.

All your shares have always been legally held by the Trust since registration with ASIC.

The Trust is a discretionary trust.

A Family Trust Election ('FTE') was made by the Trust with retrospective application.

An Interposed Entity Election ('IEE') was made by you with retrospective application.

Both you and the Trust have passed the family control test specified in section 272-87 of the Income Tax Assessment Act 1936 (ITAA 1936).

The Trustee may make any appointment or determination by resolution of its directors.

Controlling Individual is the "Class A Beneficiary" of the Trust.

A "Class B Beneficiary" means the lineal descendants of the "Class A Beneficiary".

"Class A Beneficiaries" and "Class B Beneficiaries" are together known as "Family Beneficiaries."

The Appointor of the Trust is Company A.

The Appointor may remove any Trustee at any time and may appoint any person or corporation as Trustee, in addition to or in place of an existing Trustee.

The Trustee may only act in accordance with the consent of the Appointor to:

• Exclude any person from capital

• Accumulate some or all of the annual income

• Appoint some or all of the annual income to any one or more of the Family Beneficiaries and Discretionary Income Beneficiaries

• Make amendments to the trust deed

If any annual income is not accumulated or appointed it vests in the Class A Beneficiary if she/he is still alive and if not it vests in the children of the Class A Beneficiary in equal shares.

There has been no variation in the trust deed.

The sole shareholder of Company A is X.

The directors of Company A are Controlling Individual and their spouse.

There has been no change in directorships and shareholdings in Company A.

Assumptions

A retrospective FTE was validly made by the Trust and no variation or revocation has been or will be made to this. The FTE will remain in force in the year ended 30 June 20YY.

A retrospective IEE was validly made by you and no variation or revocation has been or will be made to this. The IEE will remain in force in the year ended 30 June 20YY.

There are no collateral arrangements with third parties for the conferral of benefits through income injection schemes involving your tax losses.

For the income year ended 30 June 20YY:

• There will be no variation in the trust deed.

• The sole shareholder of Company A will be X.

• The directors of Company A will be Controlling Individual and their spouse.

• There will be no change in directorships and shareholdings in Company A.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 165-10

Income Tax Assessment Act 1997 section 165-12

Income Tax Assessment Act 1997 subsection 165-12(2)

Income Tax Assessment Act 1997 subsection 165-12(3)

Income Tax Assessment Act 1997 subsection 165-12(4)

Income Tax Assessment Act 1997 subsection 165-12(5)

Income Tax Assessment Act 1997 subsection 165-12(6)

Income Tax Assessment Act 1997 section 165-15

Income Tax Assessment Act 1997 subsection 165-15(1)

Income Tax Assessment Act 1997 section 165-165

Income Tax Assessment Act 1997 section 165-207

Income Tax Assessment Act 1997 paragraph 165-207(1)(a)

Income Tax Assessment Act 1997 subsection 165-207(1)

Income Tax Assessment Act 1997 subsection 165-207(2)

Income Tax Assessment Act 1997 subsection 165-207(2)

Income Tax Assessment Act 1997 division 175

Income Tax Assessment Act 1997 section 175-10

Income Tax Assessment Act 1997 subsection 175-10(2)

Income Tax Assessment Act 1997 subsection 175-10(3)

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1936 section 272-75

Income Tax Assessment Act 1936 section 272-87

Question 1

Will you be prevented from deducting carry forward tax losses due to a failure to maintain the same owners for the ownership test period as specified in section 165-12 of the ITAA 1997?

Summary

No. Subsection 165-207(2) of the ITAA 1997 applies to deem that the Trust owns all your shares beneficially throughout the ownership test period such that you will satisfy the continuity of ownership test (COT) under 165-12 of the ITAA 1997.

Detailed reasoning

In order to deduct your carried forward tax losses, you will need to satisfy the general loss recoupment provisions in section 165-10 of the ITAA 1997. This requires you to pass the COT in section 165-12 of the ITAA 1997 and control test in section 165-15 of the ITAA 1997 or the same business test (SBT) in section 165-13 of the ITAA 1997.

Continuity of Ownership Test (COT) - section 165-12

Under section 165-12 of the ITAA 1997, a company cannot deduct a prior year tax loss unless it satisfies the COT, which is about the company maintaining the same owners. The COT broadly consists of three conditions under subsections 165-12(2), 165-12(3) and 165-12(4) of the ITAA 1997. Broadly, this means that there must be persons who, at all times during the ownership test period 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.

Ownership test period

The tests in section 165-12 of the ITAA 1997 are 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 sought to be deducted.

Primary test applies

The three conditions under subsections 165-12(2) to (4) of the ITAA 1997 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 unless subsection 165-12(6) of the ITAA 1997 requires that the alternative test applies. Subsection 165-12(6) of the ITAA 1997 states that the alternative test applies if one or more other companies beneficially owned shares or interests in shares in the company during the ownership test period.

In the current circumstances, the primary test applies because no companies beneficially owned shares or interests in you during the ownership test period.

Applying the primary tests, the COT is satisfied for you if there are persons who, at all times during the ownership test period, beneficially own (between them) shares that carry (between them):

• The right to exercise more than 50% of the voting power in you;

• The right to receive more than 50% of the dividends you may pay; and

• The right to receive more than 50% of the capital distributions you may make.

Company owned by a discretionary trust cannot satisfy COT

In the current circumstances, all the shares in you are held by the Trust. In the absence of special rules under section 165-207 of the ITAA 1997, you will not be able to satisfy the COT since tracing through interposed entities to underlying beneficial owners cannot occur through a discretionary trust as beneficiaries of a discretionary trust do not have fixed interests in the income or capital of the company [Refer to TD 2000/27 Income tax: can a company satisfy the requirements of section 80A or section 80E of the Income Tax Assessment Act 1936 if 50% or more of its shares are held by the trustee(s) of a discretionary trust(s)?]

Section 165-207 - concessional tracing rules

Section 165-207 of the ITAA 1997 states:

(1) This section applies if one or more trustees of a family trust:

(a) owns shares in a company; or

(b) controls, or is able to control, (whether directly, or indirectly through one or more interposed entities) voting power in a company; or

(c) has a right to receive (whether directly, or indirectly through one or more interposed entities) a percentage of a dividend or a distribution of capital of a company.

(2) For the purposes of a primary test, a single notional entity that is a person (but is neither a company nor a trustee) is taken to own the shares beneficially.

(3) Omitted

(4) Omitted

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 by section 272-75 of Schedule F of the ITAA 1936). A trust is a 'family trust' at any time when a FTE in respect of the trust is in force (see sections 995-1 of the ITAA 1997 and section 272-75 of Schedule 2F of the ITAA 1936).

Under section 165-207 of the ITAA 1997, for the purposes of the primary tests, the trustee of a trust which has made a FTE is taken to be a single notional entity that is a person and is taken to beneficially own shares in a company. This is evident in paragraph 9.31 of the Explanatory Memorandum to Taxation Laws Amendment Bill (No.8) 1999 which states:

….Broadly, the concession will apply for the purposes of the company rules so that where the relevant interests in a company are held by a family trust, the trustee of the family trust will be taken to own the interest as an individual.

In the current circumstances, the Trust has made a FTE. The Trust is a 'family trust' throughout the ownership test period. As the Trust is a 'family trust' and the Trust owns all the shares in you, paragraph 165-207(1)(a) of the ITAA 1997 is satisfied, resulting in subsection 165-207(2) of the ITAA 1997 applying. The effect of subsection 165-207(2) of the ITAA 1997 is that, for the purposes of the primary test, a single notional entity that is a person (but is neither a company nor a trustee) is taken to own all the shares in you. As a result, you are able to satisfy the COT.

'Same share - same interest' rule - section 165-165

A further requirement of the COT is that exactly the same shares or interests must be held during the relevant 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) 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.

Based on the information provided, all the issued shares in you held by the Trust have been exactly the same shares for the entire ownership test period.

The requirements of section 165-165 of the ITAA 1997 have been met and consequently section 165-165 of the ITAA 1997 will not cause the COT to be failed.

You will therefore not be prevented from deducting carry forward tax losses due to a failure to maintain the same owners for the ownership test period.

Question 2

Even if you meet the conditions in section 165-12 of the ITAA1997, will you be prevented by the application of section 165-15 of the ITAA 1997 from deducting carry forward losses due to a failure to maintain the same people controlling the voting power in you?

Summary

As Controlling Individual controls the voting power in you throughout the ownership test period, the anti-avoidance measures detailed in section 165-15 of the ITAA 1997 are not triggered.

Detailed reasoning

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 tax 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 including the purpose 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.

The Trust is the sole shareholder of your shares.

Controlling Individual controls the Trust for the following reasons:

• Controlling Individual is the sole beneficial shareholder in the corporate trustee and appointor Company A

• As the Trustee is a corporation it may make any appointment or determination by resolution of its directors.

• Together with their spouse, Controlling Individual is Director of Company A.

• "Family Beneficiaries" include Controlling Individual ("Class A Beneficiary") and Controlling Individual's lineal descendants ("Class B Beneficiary").

• Controlling Individual is the primary individual for the purposes of passing the family control test in section 272-87 of the ITAA 1936 in relation to the Family Trust Election made for the Trust.

There has been no variation in the trust deed.

There has been no change in directorships and shareholdings in Company A.

For these reasons, Controlling Individual controls the voting power in you through their ability to have the Trust act in accordance with their directions, instructions or wishes throughout the ownership test period.

Also, it is assumed that for the income year ended 30 June 20YY:

• There will be no variation in the trust deed.

• The sole shareholder of your shares will be Controlling Individual.

• The directors of Company A will be Controlling Individual and their spouse.

• There will be no change in directorships and shareholdings in Company A.

Question 3

Is the Commissioner prevented by the application of Division 175 of the ITAA 1997 from disallowing deductions for current year and carry forward tax losses in you on the basis that it is fair and reasonable for continuing shareholders to benefit from the derivation of income from the sale of business?

Summary

As the Trust is the sole continuing shareholder in of your shares throughout the ownership test period and there is no evidence of collateral arrangements for the conferral of benefits through income injection schemes involving your tax losses, it is fair and reasonable for the Trust to benefit from current year and prior year carry forward tax losses. For these reasons the Commissioner is prevented by the application of Division 175 of the ITAA 1997 from disallowing deductions for current year and carry forward tax losses in you.

Detailed Reasoning

Prior year losses - Subdivision 175-A

In ATO ID 2010/49 the Commissioner referred to the explanatory memorandum to the Income Tax Assessment Bill 1973 which introduced section 80DA of the ITAA 1936, the predecessor to section 175-10 of the ITAA 1997. From this the Commissioner observed the purpose of section 175-10 of the ITAA 1997:

is to counter collateral arrangements for the conferral of benefits through income injection schemes involving a company's tax losses. These collateral arrangements might otherwise be veiled by the legal shareholdings (as recorded on the company's share register) demonstrating satisfaction of the COT.

Section 175-10 of the ITAA 1997 provides that the Commissioner may disallow a deduction for a prior year tax loss in an income year in which the company derives income or capital gains (the injected amount) which it would not have derived if the loss had not been available.

However, subsection 175-10(2) of the ITAA 1997 explains that the Commissioner cannot disallow the tax loss if the continuing shareholders will benefit from the derivation of the injected amount to an extent which the Commissioner considers is fair and reasonable.

Section 175-10(3) provides:

The continuing shareholders are:

(a) all of the persons who had *more than 50% of the voting power in the company during the whole (or the relevant part) of the *loss year and during the whole of the income year; and

(b) all of the persons who had rights to *more than 50% of the company's dividends during the whole (or the relevant part) of the loss year and during the whole of the income year; and

(c) all of the persons who had rights to *more than 50% of the company's capital distributions during the whole (or the relevant part) of the loss year and during the whole of the income year.

To find out who they were, apply whichever tests are applied in order to determine whether the company can deduct the *tax loss (or the part of the tax loss) in the first place.

ATO ID 2006/157 confirms that a 'continuing shareholder' for the purposes of section 175-10 of the ITAA 1997 can include a family trust that is deemed to be a notional entity under section 165-207 of the ITAA 1997. This is because the COT in section 165-12 of the ITAA 1997 is used to establish who are the 'continuing shareholders' under subsection 175-10(3) of the ITAA 1997. The COT is expanded upon by the rules in Subdivision 165-D of the ITAA 1997, including section 165-207 of the ITAA 1997.

The Trust is the sole continuing shareholder in you throughout the ownership test period. Under subsection 175-10(2) of the ITAA 1997 the Commissioner cannot disallow a deduction for a prior year tax loss if the continuing shareholders will benefit from the derivation of the injected amount to an extent which the Commissioner considers is fair and reasonable. In determining this, the Commissioner must have regard to the continuing shareholders respective rights and interests in you.

ATO ID 2002/845 in reviewing a similar factual scenario involving the sale of a business to a non-related third party by a company with carry forward tax losses reached the following conclusion:

There is to be no change in either the shareholders themselves or their 100 per cent continuous holding of shares in the company. The benefit from this injection of income will flow only to persons who were shareholders during the years in which the losses were incurred by the company (i.e., the continuing shareholders). This continuous shareholding is to remain unchanged for the period in which deductions for losses will be claimed.

The Commissioner has determined that it is fair and reasonable to accept that the continuing shareholders will benefit from the injection of funds in proportion to their respective rights and interests in the company. Therefore subsection 175-10(1) of the ITAA 1997 cannot apply to enable the Commissioner to disallow a claim by the company for prior year tax losses.

For the same reason it is fair and reasonable to accept that the Trust as sole continuing shareholder will wholly benefit from the injection of funds. There is no evidence of collateral arrangements for the conferral of benefits through income injection schemes involving your tax losses. The Commissioner is, therefore, prevented from disallowing deductions for prior year tax losses carried forward in you from the years ended 30 June 2014 and 30 June 2015.

Section 175-15 of the ITAA 1997 also has application where someone else obtains a tax benefit because of tax losses available to the company. ATO ID 2002/836 reviewed a similar factual scenario involving the sale of a business to a non-related third party by a company with carry forwarded tax losses.

Similar to the facts in ATO ID 2002/836, income will be distributed from the Trust to you with an offsetting deduction for prior year tax losses being claimed by you. There is a tax benefit as this income would otherwise be assessed to the Trustee of the Trust or to the beneficiaries of the Trust.

However, as the beneficiaries of the Trust have continuously maintained a 100% beneficial ownership of shares in you since your incorporation and this shareholding interest is to remain the same throughout implementation of the proposed transaction, it follows that the persons who are to gain the tax benefit from the transaction have always been the sole beneficial owners of the shares. There is no evidence of collateral arrangements for the conferral of benefits through income injection schemes involving your tax losses. The 'continuing shareholders' when the tax losses were incurred will benefit wholly from the injected amount.

Accordingly, the tax benefit is fair and reasonable having regard to the shareholding interest. Again, the Commissioner is prevented from disallowing deductions for prior year tax losses carried forward from the years ended 30 June 2014 and 30 June 2015.

Current year losses - Subdivision 175-B

For the same reasons, as detailed above, the Commissioner is prevented from disallowing deductions for current year tax losses in the year ended 30 June 20YY following the comparable application of section 175-20 of the ITAA 1997 (tax benefits having regard to the respective shareholding interests in you) and section 175-30 of the ITAA 1997 (someone else obtains a tax benefit) in respect of tax losses incurred in the year ended 30 June 20YY.

ATO view documents

TD 2000/27 Income tax: can a company satisfy the requirements of section 80A or section 80E of the Income Tax Assessment Act 1936 if 50% or more of its shares are held by the trustee(s) of a discretionary trust(s)?.

ATO ID 2010/49 Company tax loss: whether the Commissioner can be prevented from disallowing any part of a tax loss following an injection of income.

ATO ID 2006/157 Company tax loss: whether 'continuing shareholders' include trusts that have made family trust elections.

ATO ID 2002/845 Tax benefits from unused company tax losses

ATO ID 2002/836 Tax benefits from unused company tax losses

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