Edited version of your written advice

Authorisation Number: 1051332661085

Date of advice: 01 February 2018

Ruling

Subject: Company losses

Question 1

Will the Company 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 Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

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 the Company on the basis that it is fair and reasonable for continuing shareholders to benefit from the derivation or accrual of an injected amount?

Answer

Yes.

This ruling applies for the following period:

1 July 2015 to 30 June 2017

The scheme commenced on:

1 July 2015

Relevant facts and circumstances

The Company made a tax loss in the year ended 30 June 2015.

The Company intends to recoup the tax loss in the income year ended 30 June 2017.

The Company has had the same four shareholders at all times from 1 July 2015 to 30 June 2017.

They have held exactly the same shares.

The shareholders are trustees of discretionary trusts (the Family Trusts) which have made family trust elections (FTEs) which are in force from 1 July 2015.

Collateral arrangements for the conferral of benefits through income injection schemes involving the Company's tax losses will not be entered into.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 165-12

Income Tax Assessment Act 1997 section 165-165

Income Tax Assessment Act 1997 Subdivision 165-D

Income Tax Assessment Act 1997 section 165-207

Income Tax Assessment Act 1997 Division 175

Income Tax Assessment Act 1997 Subdivision 175-A

Income Tax Assessment Act 1997 section 175-10

Income Tax Assessment Act 1997 section 175-15

Income Tax Assessment Act 1997 section 175-20

Income Tax Assessment Act 1997 section 175-30

Income Tax Assessment Act 1997 subsection 175-95(1)

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1936 section 272-75 of Schedule 2F

Income Tax Assessment Act 1936 section 272-80 of Schedule 2F

Income Tax Assessment Act 1936 section 272-90 of Schedule 2F

Reasons for decision

Question 1

Will the Company 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 a Family Trust (a single notional entity that is a person) to own all the shares beneficially in the Company throughout the ownership test period such that the Company will satisfy the continuity of ownership test (COT) under 165-12 of the ITAA 1997.

Detailed reasoning

COT – section 165-12 of the ITAA 1997

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 a 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. This period is from 1 July 2015 to 30 June 2017.

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 shares in the Company during the ownership test period.

Applying the primary tests, the COT is satisfied for the Company 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 the company;

● The right to receive more than 50% of the dividends the company may pay; and

● The right to receive more than 50% of the capital distributions of the company.

Company owned by a discretionary trust cannot satisfy COT

In the current circumstances, all the shares in the Company are held by the trustees of four discretionary trusts in equal proportions (25% each). In the absence of special rules under section 165-207 of the ITAA 1997, the Company 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 ATO ID 2003/508: Income Tax: Company losses: shares in loss company held by corporate trustee of non-fixed trust - whether shareholders of corporate trustee beneficially own the shares].

Section 165-207 of the ITAA 1997 – 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 to 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 to 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 interests as an individual.

As such, Family Trusts owned shares in the Company, such that 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 100% of the shares in the Company in the income years ended 30 June 2016 and 30 June 2017. As a result, the Company is able to satisfy the COT.

‘Same share – same interest’ rule – section 165-165 of the ITAA 1997

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 the Company held by the trusts 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.

The Company 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.

Conclusion on COT

In the current circumstances the COT is satisfied for the Company as, 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 the company;

● The right to receive more than 50% of the dividends the company may pay; and

● The right to receive more than 50% of the capital distributions of the company.

Question 2

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 the Company on the basis that it is fair and reasonable for continuing shareholders to benefit from the derivation or accrual of an injected amount?

Summary

Yes, as:

● the four trustee shareholders will hold the same shares throughout the Ruling Period in the Company; and

● collateral arrangements for the conferral of benefits through income injection schemes involving the Company's tax losses will not be entered into

it is fair and reasonable for the four trustee shareholders to benefit from the 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 carried forward tax losses in the Company.

Detailed Reasoning

Subdivision 175-A of the ITAA 1997 – First case

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) of the ITAA 1997 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 four trustee shareholders that have made FTEs are the continuing shareholders in the Company 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 the Company.

The 'continuing shareholders' of the Company (as defined in subsection 175-10(3) of the ITAA 1997) owned shares that carried 100% of the voting power in the Company, and rights to 100% of the dividends and capital distributions of the Company, during the 2016 and 2017 income years.

For the purposes of the company loss deduction rules, the Company satisfies the conditions of the COT in section 165-12 of the ITAA 1997.

The 'continuing shareholders' when the tax losses were incurred will benefit wholly or mainly from the injected amount. This is because the continuing shareholders were the shareholders in the Company in the year in which the Company’s tax loss was incurred and the income year in which the tax loss will be recouped.

Further, there will be no collateral arrangements for the conferral of benefits through income injection schemes involving the Company's tax losses.

The Commissioner is, therefore, prevented from disallowing deductions for prior year tax losses carried forward by the Company under section 175-10 of the ITAA 1997.

Subdivision 175-A of the ITAA 1997 – Second case

Subsection 175-15 of the ITAA 1997 provides that the Commissioner may disallow the *excluded loss if:

175-15(1)

(a) a person has obtained or will obtain a tax benefit in connection with a *scheme; and

(b) the scheme would not have been entered into or carried out if the excluded loss had not been available to be taken into account for the purposes of:

● Division 36 (which is about tax losses of earlier years);

● Division 165 (which is about the income tax consequences of changing ownership or control of a company);

● Former Subdivision 375-G (which is about film losses).

175-15(2)

However, the Commissioner cannot disallow the *excluded loss if:

(a) the person had a *shareholding interest in the company at some time during the income year; and

(b) the Commissioner considers the tax benefit to be fair and reasonable having regard to that shareholding interest.

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.

Throughout the Ruling Period, the 'continuing shareholders' own shares that carry 100% of the voting power in the loss company, and rights to 100% of the dividends and capital distributions of the loss company, during the whole of the income year.

There will be no collateral arrangements for the conferral of benefits through income injection schemes involving the Company's tax losses.

The term ‘shareholding interest’ is defined in subsection 175-95(1) of the ITAA 1997 and relevantly provides that:

A person has a shareholding interest in the company if the person is:

(a) the beneficial owner; or

(b) the trustee of a *family trust who is the owner;

of:

(c) *shares in the company; or

(d) an interest in *shares in the company.

Having regard to the relevant assumptions and the continuing shareholdings of the Company, the tax benefit is fair and reasonable having regard to the shareholding interest. Therefore, the Commissioner is prevented from disallowing deductions for prior year tax losses during the Ruling Period.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).