Edited version of private advice

Authorisation Number: 1052396604018

Date of advice: 16 May 2025

Ruling

Subject:Deductions - continuity of ownership

Question 1

Will the Company be entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of payments of the various lease incentives by the Company?

Answer

Yes

Question 2

Will the Company be prevented from deducting prior year tax losses in the years ended 30 June 20XZ to 30 June 20YY due to a failure to maintain the same owners for the ownership test period as specified in section 165-12 of ITAA 1997?

Answer

No

Question 3

Will the Company be prevented from deducting prior year tax losses in the years ended 30 June 20XZ to 30 June 20YY due to the operation of section 165-15 of ITAA 1997?

Answer

No

Question 4

Will the Commissioner disallow a deduction for prior year tax losses proposed to be utilised by the Company during the years ended 30 June 20XZ to 30 June 20YY under section 175-10 of ITAA 1997?

Answer

No

Question 5

Will the Commissioner disallow a deduction for prior year tax losses proposed to be utilised by the Company during the years ended 30 June 20XZ to 30 June 20YY under section 175-15 of ITAA 1997?

Answer

No

Question 6

Will the Commissioner disallow a deduction proposed to be utilised by the Company during the years ended 30 June 20XX and 30 June 20XZ under section 175-20 of ITAA 1997?

Answer

No

Question 7

Will the Commissioner disallow a deduction proposed to be utilised by the Company during the years ended 30 June 20XX and 30 June 20XZ under section 175-30 of ITAA 1997?

Answer

No

This private ruling applies for the following period:

Years ended 30 June 20XX to 30 June 20YY (Ruling Period)

The scheme commenced:

When the Company and the Tenant executed the Agreement for Lease (AFL).

Relevant facts and circumstances

Ownership and directorship of the company

1.            The Company is a commercial property leasing company that is directed by Individual 1 and Individual 2.

2.            Since incorporation, the Company has had on issue 100 ordinary shares, held as follows:

•                     50 ordinary shares (50%) - Trustee 1 as trustee for the Family Trust 1; and

•                     50 ordinary shares (50%) - Trustee 2 as trustee for the Family Trust 2.

3.            Ordinary shareholders in the Company have equal rights to vote at all meetings, participate in all dividends declared by the company in respect of the ordinary shares and participate in all distributions of surplus assets of the company.

4.            Family Trust 1 and Family Trust 2 are both discretionary investment trusts of which Individual 1 and Individual 2 are potential beneficiaries.

5.            Family Trust 1 and Family Trust 2 are both controlled (directly or indirectly) by Individual 1 and Individual 2.

6.            Family trust elections (FTE's) have been made in respect of both the Family Trust 1 and Family Trust 2 and each has Individual 1 as the specified individual for the purposes of section 272-80(3) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) such elections specifying a year ending prior to the commencement of the Ruling Period.

Building activities and financing

7.            The Company's primary asset is real property.

8.            Legal title to the real property was acquired prior to the Ruling Period and since that time substantial building activities have occurred including the construction of a commercial office building (Office Building).

9.            Construction of the Office Building was completed after the Ruling Period commenced.

10.         Construction of the Office Building was primarily financed by way of loans made to the Company by related companies (Related Party Loans).

11.         The Related Party Loans were unsecured and are not subject to interest.

Lease agreement and lease incentive

12.         Development of real property and construction of the Office Building was conducted by the Company.

13.         The Company and the unrelated Tenant executed an Agreement for Lease (AFL) prior to completion of the Office Building. The AFL forms part of and is to be read with this description.

14.         Pursuant to the AFL it was agreed that:

•                     The Company would complete the Office Building in compliance with various design and use requirements imposed by the Tenant.

•                     The Tenant would lease the Office Building from the Company upon its completion on the terms set out in the AFL and the Lease contained in Annexure F of the AFL.

15.         Clauses in the Information Table of the AFL provides that the Company agrees to pay an incentive to the Tenant, for entering into the AFL and the Lease (Lease Incentive).

16.         The quantum of the Lease Incentive is determined by reference to the formula included in the clause, and is calculated as a percentage of the first year agreed rent per square meter multiplied by the net lettable area of the Office Building and the agreed term of the lease (i.e. the Lease Incentive has been calculated by reference to the amount of income likely to be derived under the Lease by the Company). An estimate was provided.

17.         Clauses of the Information Table of the AFL provides that the Lease Incentive is paid to the Tenant free from obligation as to how it is used. That clause provides expressly that:

The Landlord acknowledges and agrees that the Tenant can utilise the [Lease Incentive] for any purpose that the Tenant requires in its absolute discretion.

18.         The AFL and the Lease specifically contemplate the Tenant undertaking fit-out works in the Office Building (Tenant's Works) at the Tenant's sole cost to enable the Tenant to use the Office Building in accordance with the Tenant's operational requirements but do not make any tie between the payment of the Lease Incentive and the undertaking of the Tenant's Works.

19.         Under clauses of the AFL, the Lease Incentive is to be paid by the Company in cash instalments according to a schedule. The Lease Incentive was invoiced in accordance with the schedule and has been paid by the Company to the Tenant.

Financing of lease incentive

20.         Given the quantum and timing of the Lease Incentive, a third-party loan has been obtained by the Company for the purposes of paying the Lease Incentive.

21.         The third party loan is made out to the Company as the borrower and is secured by way of:

•                     a mortgage over the real property

•                     a general security interest over all the existing and future assets and undertakings of the Company

•                     a personal guarantee and indemnity provided by Individual 1.

Desired extinguishment of liabilities

22.         The directors of the Company are acutely aware of the debt load that is carried by the Company. They are experienced directors of property building and leasing entities and prefer to undertake business activities with limited debt financing. The directors are desirous of quickly reducing the quantum of the third party loan and the Related Party Loans (collectively, Outstanding Debt).

23.         Further, Individual 1 is cognisant of the personal guarantee made in respect of the third party loan and is desirous of having that guarantee released by way of prompt extinguishment of the loan.

Income distributions to the company

24.         To facilitate the reduction of the Outstanding Debt, distributions of income have or are expected to be made to the Company during each of the financial years during the Ruling Period (Income Distributions) by the following related discretionary trusts:

•                     Family Trust 1

•                     Family Trust 2, and/or

•                     Family Trust 3.

25.         A distribution has already been declared in favour of the Company by the trustee of the Family Trust 3, that is comprised of ordinary income of the family trust.

26.         The Income Distributions in the future are expected to comprise of ordinary income derived by the three family trusts.

27.         The Income Distributions have, or will be, promptly followed by the payment of cash to the Company, with such cash to be utilised to extinguish (as far as is possible) the Outstanding Debt.

28.         As the Lease Incentive payments are expected to create substantial deductions (subject to this ruling in relation to 'Question One'), the Income Distributions are expected to be applied against either those deductions or prior year tax losses attributable to those deductions.

The family trusts

29.         Individual 1 and Individual 2 are directors of the trustees of the three Family Trusts.

30.         The three Family Trusts have a broad range of potential beneficiaries, which include, but are not limited to:

•                     Individual 1;

•                     various other natural persons who are members of Individual 1's family; and

•                     various trusts and companies (including the Company) that are related to Individual 1's family.

31.         No FTE has been made in respect of Family Trust 3.

Extent of current and prior year tax losses, ignoring income distributions

32.         Ignoring the impact of any Income Distributions or the utilisation of any prior year losses, the Company has forecast its profit for the Ruling Period and provided this information to the Commissioner.

Assumptions

33.         The FTEs made pursuant to section 272-80 of Schedule 2F to the ITAA 1936 by the trustee of Family Trust 1 and Family Trust 2 have been validly made and are in force prior to the commencement of the Ruling Period.

34.         Individuals 1 and 2 control, and will continue to control, the three Family Trusts. Notwithstanding, if either passes away or loses capacity during the Ruling Period this ruling will continue to bind the Commissioner for the remainder of the Ruling Period provided the other assumptions remain true.

35.         The Company will maintain the same shareholders, holding exactly the same shares, throughout the Ruling Period.

36.         The relevant 'ownership test periods' shall commence from the start of the Ruling Period to the date that is the end of the relevant financial year in which any Income Distribution is received and is sought to be applied against the carried forward losses during the Ruling Period.

37.         Any arrangements involving the conferral of benefits through income injection schemes involving the Company's tax losses will flow only to members of Individual 1's Family Group (as defined in section 272-90 of Schedule 2F to the ITAA 1936).

Reasons for decision

Question 1

Will the Company be entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the payments of the Lease Incentive by the Company?

Summary

The Lease Incentive is a loss or outgoing incurred by the Company in gaining or producing assessable income. The Lease Incentive is not capital in nature or otherwise excluded by subsection 8-1(2) of the ITAA 1997. Therefore, the Lease Incentive is deductible to the Company under subsection 8-1(1) of the ITAA 1997.

Detailed reasoning

1.            Subsection 8-1(1) of the ITAA 1997 allows a deduction for any loss or outgoing to the extent that:

•                     it is incurred in gaining or producing assessable income; or

•                     it is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

2.            However, subsection 8-1(2) of the ITAA 1997 provides that a loss or outgoing is not deductible to the extent that:

•                     it is capital or of a capital nature;

•                     it is of a private or domestic nature;

•                     it is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income; or

•                     a provision of the ITAA 1997 or Income Tax Assessment Act 1936 (ITAA 1936) prevents its deduction.

Incurred

3.            There is no statutory definition for the term 'incurred'. A loss or outgoing is incurred for the purposes of section 8-1 of the ITAA 1997 if the taxpayer is definitely committed to and has a presently existing liability to pay the outgoing in the year of income. This is notwithstanding that actual payment may not have been made or the outgoing may be subject to defeasance.

Positive limbs

4.            For the relevant expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of your assessable income. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income. The occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if no assessable income is produced, what would have been expected to produce assessable income: Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47.

Negative limb - capital or of a capital nature

5.            The exclusion in paragraph 8-1(2)(a) of the ITAA 1997 prevents an amount from being deducted if it is capital or of a capital nature.

6.            The guidelines for distinguishing between capital and revenue outgoings were laid down in Sun Newspapers Ltd and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 (Sun Newspapers). In that case, Dixon J stated that the distinction between expenditure on revenue account and on capital account corresponds with" the distinction between the business entity, structure or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay". After discussing this distinction and the difficulties inherent in applying the distinction in a practical sense, his Honour said:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

7.            In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 the High Court pointed out that the character of the advantage sought by the making of the expenditure is the chief, if not critical, factor in determining the character of what is paid.

8.            In Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634 Dixon J stated:

What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.

9.            Paragraph 38 of Taxation Ruling IT 2631 Income Tax: Lease Incentives (IT 2631) relevantly states:

The provision of lease incentives will usually give rise to an allowable deduction to the lessor under section 51(1). This would follow from the characterisation of the outgoing as having been incurred for the purpose of gaining or producing assessable income. However, that conclusion may not be appropriate where the true purpose of providing the incentive was not to induce the entering into of the lease, and it might therefore be appropriate to apply Part IVA. Examples might include the purposes of benefiting an associate or shifting income to an associate with carry forward losses. Such cases will depend on their facts including the degree of association between the parties, their relative financial positions and whether the incentive can be characterised as being at arm's length. The general conclusion expressed above would not be appropriate if the landlord retained ownership of the fit-out (refer to paragraph 26). In that case the expenditure is capital in nature and therefore not an allowable deduction under subsection 51(1). Depreciation would be allowable in respect of plant or articles.

Application to your circumstances

10.         The Lease Incentive is a series of cash payments that are to be made by the Lessor (the Company) as an inducement to secure the Tenant to enter into a lease from which the Company will receive rent. This is expressly stated in clauses of the AFL which provides that the Lessor agrees to pay the Lease Incentive in consideration of the Lessee agreeing to accept the Lease.

11.         The Lease Incentive is incurred as the Company is definitively committed to make the cash payments by instalments in accordance with the payment schedule in clauses of the AFL.

12.         Payment of the Lease Incentive has been made for the purpose of incentivising the Tenant to take up tenancy at the Office Building. Payment of the Lease Incentive is the result of negotiations between unrelated parties, dealing at arm's length.

13.         Payment of the Lease Incentive has no contractual relationship to the undertaking of any Tenant's Works. The AFL expressly stipulates that the Lease Incentive can be used for 'any purpose that the Tenant requires in its absolute discretion' and the Tenant's Works are required to be undertaken at the sole cost of the Tenant in accordance with clauses of the AFL.

14.         In summary, the payments are incurred in earning rental income. The character of the advantage sought by the incentive payments is the winning of a lessee to be retained for a period of time to generate revenue in the form of rent. The Lease Incentive is not capital or of a capital nature.

15.         Further, the Lease Incentive is not of a private or domestic nature, it is not incurred in relation to gaining or producing exempt income or non-assessable non-exempt income, and no other provision would prevent its deduction.

16.         The Lease Incentive is an outgoing incurred by the Company for the purpose of gaining or producing its assessable income and is deductible under section 8-1(1) of the ITAA 1997 and the payments are not excluded from being deducted under subsection 8-1(2).

Question 2

Will the Company be prevented from deducting prior year tax losses in the years ended 30 June 20XZ to 30 June 20YY due to a failure to maintain the same owners for the ownership test period as specified in section 165-12 of ITAA 1997?

Summary

No. Subsection 165-207(2) of the ITAA 1997 applies to deem the trustee of the Family Trust 1 and the trustee of the Family Trust 2 to be a single notional entity that is a person (but is neither a company nor a trustee) to own 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

The continuity of ownership test (COT) - section 165-12 of the ITAA 1997

17.         Under section 165-10 of the ITAA 1997, a company cannot deduct a prior year tax loss unless it meets the conditions in section 165-12, which is about a company maintaining the same owners (COT). If a company fails the COT, it may be able to deduct its losses if it satisfies the condition in section 165-13, which is about meeting a business continuity test. This question considers whether the Company meets the COT.

18.         The COT broadly consists of three conditions. To satisfy the COT 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

•                     rights to more than 50% of the company's capital distributions.

Ownership test period

19.         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

20.         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'.

21.         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.

22.         The primary test is contained in subsection 165-150(1), 165-155(1) and 165-160(1). Applying the primary tests, the COT is satisfied 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 any dividends the company may pay, and

•                     the right to receive more than 50% of any capital distributions of the company.

Company owned by a discretionary trusts

23.         In the absence of special rules, a company owned by discretionary trusts 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.[1]

Section 165-207 of the ITAA 1997 - concessional tracing rules

24.         Relevantly, 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.

...

25.         Section 165-207 of the ITAA 1997 is 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 2F to the ITAA 1936).[2] A trust is a 'family trust' at any time when a family trust election (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).

26.         Under section 165-207 of the ITAA 1997, for the purposes of the primary test, the trustee of a trust which has made an FTE is taken to be a single notional entity that is a person and is taken to beneficially own shares in a company.

Application to your circumstances

27.         The earliest time at which losses sought to be deducted were incurred was in the year ended 30 June 20XX. Therefore, the start of the earliest ownership test period is 1 July 20WW.

28.         The shareholders of the Company are the trustee of Family Trust 1 (as to 50% of the ordinary shares) and the trustee of Family Trust 2 (as to 50% of the ordinary shares). The ordinary shares confer on their holders' equal rights to vote at all meetings, participate in all dividends declared by the company in respect of the ordinary shares and participate in all distributions of surplus assets of the company. The Commissioner has been requested to assume that at all times during the Ruling Period such shareholding will not be altered.

29.         The trustee of the Family Trust 1 and Family Trust 2 have made an FTE nominating Individual 1 as the specified individual, such elections being effective from a date prior to commencement of the Ruling Period. These FTEs are assumed to have been validly made.

30.         As such, trustees of family trusts will own 100% of the ordinary 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.

31.         Accordingly, subsection 165-207(2) of ITAA97 shall operate, for the purposes of the primary test, such that a single notional entity that is a person (but is neither a company nor a trustee) is taken to own the shares held by the trustee of the Family Trust 1 and the trustee of the Family Trust 2 in the Company beneficially. As a result, the Company will satisfy the COT subject to further integrity measures.

'Same share - same interest' rule - section 165-165 of the ITAA 1997

32.         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.

33.         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.

Application to your circumstances

34.         The trustee of the Family Trust 1 and the trustee of the Family Trust 2 will hold the same shares for the entire ownership test period. The assumptions confirm that this will be the case for the entirety of the Ruling Period.

35.         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.

36.         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

37.         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 (these rights are attached to the ordinary shares and the same shareholders will have owned these throughout the Ruling Period)

•                     the right to receive more than 50% of the dividends the company may pay (these rights are attached to the ordinary shares and the same shareholders will have owned these throughout the Ruling Period), and

•                     the right to receive more than 50% of the capital distributions of the company (these rights are attached to the ordinary shares and the same shareholders have owned these throughout the Ruling Period).

Question 3

Will the Company be prevented from deducting prior year tax losses in the years ended 30 June 20XZ to 30 June 20YY due to the operation of section 165-15 of ITAA 1997?

Summary

No, the Company will not be prevented from deducting prior year tax losses in the years ended 30 June 20XZ to 30 June 20YY due to the operation of section 165-15 of ITAA 1997.

Detailed reasoning

38.         Section 165-15 of ITAA 1997 is an additional integrity provision which acts to deny a company the use of its tax losses:

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.

Application to your circumstances

39.         During the entirety of the Ruling Period, the Commissioner has been requested to assume that the Company will continue to be wholly owned by the trustee of the Family Trust 1 (as to 50%) and the trustee of the Family Trust 2 (as to 50%).

40.         It is also assumed that Individual 1 and/or Individual 2 will continue to control, the Family Trust 1 and Family Trust 2 throughout the Ruling Period.

41.         In the event of a change of control as a result of the death or incapacity of Individual 1 or Individual 2, this alone would not cause 165-15 to apply.

42.         As the shareholdings will not change and control of the Family Trust 1 and Family Trust 2 is assumed not to change, or not to change in a way described in paragraph 165-15(c), section 165-15 of ITAA 1997 will have no application to the Company.

Question 4

Will the Commissioner disallow a deduction for prior year tax losses proposed to be utilised by the Company during the years ended 30 June 20XZ to 30 June 20YY under section 175-10 of ITAA 1997?

Summary

No, the Commissioner will not disallow a deduction for prior year tax losses proposed to be utilised by the Company during the years ended 30 June 20XZ to 30 June 20YY under section 175-10 of ITAA 1997.

Detailed reasoning

43.         Subsection 175-10(1) of the ITAA 1997 relevantly provides that the Commissioner may disallow a deduction for a prior year tax loss in an income year in which the company derives assessable income or capital gains some or all of which (the injected amount) would not have been derived if the loss had not been available to be taken into account for the purposes of Division 36 or Division 165.

44.         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 that the Commissioner thinks fair and reasonable having regard to their respective rights and interests in the company.

45.         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.

46.         In ATO ID 2010/49[3] the Commissioner referred to the Explanatory Memorandum (EM) 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, which states that:

The effects of the amendments proposed in clauses 8 to 13 will be -

(a)   to strengthen the [COT] -

(ii)           by requiring as an additional safeguard that the loss deduction will not be allowable where the benefit of the deduction will flow, to a disproportionate extent, to persons who were not beneficial owners, directly or indirectly, of an interest in the company in the year in which the loss was incurred. This safeguard is contained in the provisions of a new section - section 80DA - which is proposed by clause 11.

...

The provisions of section 80DA are designed to ensure that deductions for previous years losses are not allowed to a company in circumstances where, although the [COT] has been technically satisfied, the benefits from the allowance of the deductions would, in fact, flow wholly or mainly to persons who were not shareholders in the company during the years in which the losses were incurred. The section is mainly intended to ensure the effectiveness of the [COT]...

47.         From this the Commissioner observed that 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.

48.         ATO ID 2006/157[4] 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.

49.         In ATO ID 2002/845[5], shares in a company that had recently sold its business were always held by two individuals who were also the controllers and beneficiaries of a related discretionary trust. The related discretionary trust owned property from which the company had conducted its business. That property was leased to the purchaser of the business following its sale. The trustee determined to distribute future leasing income of the trust to the company, which would claim a deduction for carried forward losses against this distributed income.

50.         In the circumstances in ATO ID 2002/845, there was no change in the shareholders themselves or their combined 100 per cent continuous holding of shares in the company. The benefit from the injection of the distributed income would flow only to persons who were shareholders during the years in which the losses were incurred by the company and this continuous shareholding was to remain unchanged for the period in which deductions for losses would be claimed. Therefore, the Commissioner determined that it was fair and reasonable to accept that the continuing shareholders would benefit from the injection of funds having regard to their respective rights and interests in the company.

Application to your circumstances

51.         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.

52.         The trustee of the Family Trust No 1 and Family Trust No 2 have made FTEs. They are, and will continue to be, the continuing shareholders in the Company throughout the ownership test periods, in accordance with the assumptions that they will continue to hold the same shareholdings and shares in the Company.

53.         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 years in which the Company's tax losses were incurred and they will maintain the same shareholdings and hold the same shares throughout the Ruling Period.

54.         The Income Distributions have, or will be, promptly followed by the payment of cash to the Company, with such cash to be utilised to extinguish (as far as is possible) the Outstanding Debt.

55.         The Continuing Shareholders when the tax losses were incurred will benefit wholly or mainly from any injected amounts, because:

•                     The Distributed Amounts will be paid in cash and used to retire the debt of the Company, and

•                     Individual 1, a beneficiary of the Family Trust 1 and Family Trust 2, has provided the Guarantees and Indemnities in respect of the third party finance to assist in paying the Lease Incentive, that will be discharged from the Distributed Amounts.

56.         Further, in accordance with the assumptions, any arrangements for the conferral of benefits through income injection schemes involving the Company's tax losses will flow only to members of Individual 1's Family Group (as defined in section 272-90 of Schedule 2F to the ITAA 1936).

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

Question 5

Will the Commissioner disallow a deduction for prior year tax losses proposed to be utilised by the Company during the years ended 30 June 20XZ to 30 June 20YY under section 175-15 of the ITAA 1997?

Summary

No, the Commissioner will not disallow a deduction for prior year tax losses proposed to be utilised by the Company during the years ended 30 June 20XZ to 30 June 20YY under section 175-15 of the ITAA 1997.

Detailed reasoning

58.         Section 175-15 of the ITAA 1997 relevantly provides that the Commissioner may disallow a deduction for all or part of a tax loss where a person has obtained a tax benefit in connection with a scheme and the scheme would not have been entered into or carried out if the loss had not been available to be taken into account under Division 36 or Division 165.

59.         However, subsection 175-15(2) provides that the Commissioner cannot disallow the tax loss if the person had a shareholding interest in the company at some time during the income year and the Commissioner considers the tax benefit to be fair and reasonable having regard to that shareholding interest.

60.         The term 'shareholding interest' is defined in subsection 175-95 of the ITAA 1997 and relevantly provides that a person has a shareholding interest if the person is a beneficial owner or the trustee of a family trust who is the owner of shares in the company or an interest in shares in the company.

61.         In ATO ID 2002/836[6], shares in the company that had recently sold its business were always held by two individuals who were also the controllers and the beneficiaries of a related discretionary trust. The related discretionary trust owned property from which the company had conducted its business. That property was leased to the purchaser of the business following its sale. The trustee determined to distribute future leasing income of the trust to the company, which would claim a deduction for its carried forward losses against this distributed income.

62.         In the circumstances in ATO ID 2002/836, the Commissioner considered a tax benefit would arise as the income would otherwise be assessed by the trustee or an alternate beneficiary of the trust (at the trustee's discretion). However, as the primary beneficiaries of the trust had maintained beneficial ownership of all of the shares in the company since its incorporation and this shareholding interest was to remain the same throughout implementation of the proposal, the persons who were to gain the tax benefit from the proposal have always been, and will continue to be, the sole beneficial owners of the shares. Accordingly, the Commissioner concluded that the tax benefit is fair and reasonable having regard to the shareholding interest.

Application to your circumstances

63.         In this case, the shareholding interest in the Company has been held by the trustee of the Family Trust 1 and the trustee for the Family Trust 2, and will continue to be so held throughout the Ruling Period. The trustees of those trust have made FTEs specifying Individual 1 as the individual whose family group is to be taken into account in relation to the election.

64.         Individual 1 and their family as defined in section 272-90 of Schedule 2F to the ITAA 1936, are beneficiaries of the relevant trusts and ultimately will benefit from any injected amounts because the Distributed Amounts will be paid in cash to the Company and used to retire the debt of the Company.

65.         Further, this ruling is on the assumption that any other arrangements for the conferral of benefits through income injection schemes involving the Company's tax losses will flow only to members of Individual 1's Family Group (as defined in section 272-90 of Schedule 2F to the ITAA 1936).

66.         Therefore, the Commissioner considers any potential tax benefit that may have arisen in connection with the scheme would be in respect of persons in Individual 1's Family Group and any tax benefit is fair and reasonable having regard to the shareholding interests in the Company which will be held by the trustee of the Family Trust 1 and the trustee of the Family Trust 2 throughout the Ruling Period.

67.         Therefore, the Commissioner will not disallow deductions for prior year tax losses during the Ruling Period under section 175-15 of the ITAA 1997.

Question 6

Will the Commissioner disallow a deduction proposed to be utilised by the Company during the years ended 30 June 20XX and 30 June 20XZ under section 175-20 of the ITAA 1997?

Summary

No, the Commissioner will not disallow a deduction proposed to be utilised by the Company during the years ended 30 June 20XX and 30 June 20XZ under section 175-20 of the ITAA 1997.

Detailed reasoning

68.         Section 175-20 of the ITAA 1997 is an anti-avoidance provision that enables the Commissioner to disallow deductions of a company 'for an income year' if the company has derived assessable income or a capital gain in the income year (the injected amount) that would not have been derived if the company did not have those deductions. However, the Commissioner cannot disallow the deductions if the continuing shareholders of the company will benefit from the derivation of the injected amount to an extent that the Commissioner thinks fair and reasonable having regard to their respective shareholding interests in the company.

69.         Section 175-20 is expressed in similar terms to section 175-10 of the ITAA 1997 but applies to current year losses.

Application to your circumstances

70.         For the same reasons as detailed under Question 4, the Commissioner is satisfied that the continuing shareholders will wholly or mainly benefit from the derivation of the injected amount, and therefore, is prevented from disallowing the relevant deductions for the years ended 30 June 20XX and 30 June 20XZ under section 175-20 of the ITAA 1997.

Question 7

Will the Commissioner disallow a deduction proposed to be utilised by the Company during the years ended 30 June 20XX and 30 June 20XZ under section 175-30 of the ITAA 1997?

Summary

No, the Commissioner will not disallow a deduction proposed to be utilised by the Company during the years ended 30 June 20XX and 30 June 20XZ under section 175-30 of ITAA 1997.

Detailed reasoning

71.         Section 175-30 is another integrity provision that allows the Commissioner to deny a deduction of a company if a person obtains or will obtain a tax benefit in connection with a scheme and the scheme would not have been entered into or carried out if the company had not incurred some or all of the loss, outgoing or expenditure that the deduction is for.

72.         However, subsection 175-30(4) provides that the Commissioner cannot disallow the deductions if the person who has obtained or will obtain the tax benefit had a shareholding interest in the company at some time during the income year and the Commissioner considers the tax benefit to be fair and reasonable having regard to that shareholding interest

73.         Section 175-30 is expressed in similar terms to section 175-15 of the ITAA 1997 but applies to current year deductions.

Application to your circumstances

74.         For the same reasons as detailed under Question 5, the Commissioner is satisfied any tax benefit is fair and reasonable having regard to the shareholding interests in the Company. Therefore, the Commissioner will not disallow the relevant deductions for the years ended 30 June 20XX and 30 June 20XZ under section 175-30 of the ITAA 1997.

[1] 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 and Chapter 9, paragraph 9.20 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 8) 1999 - Tracing rules can only be applied in circumstances where the beneficial owners have fixed quantifiable interests in the things being traced.

[2] Paragraphs 9.31 to 9.34 in Chapter 9 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 8) 1999 and Paragraphs 3.22 to 3.25 in Chapter 3 of the Explanatory Memorandum to the Tax Laws Amendment (Loss Recoupment Rules and Other Measures) Bill 2005

[3] ATO Interpretative Decision ATO ID 2010/49 Income Tax Company tax loss: whether the Commissioner can be prevented from disallowing any part of a tax loss following an injection of income

[4] ATO Interpretative Decision ATO ID 2006/157 Income Tax Company tax loss: whether 'continuing shareholders' include trusts that have made family trust elections

[5] ATO Interpretative Decision ATO ID 2002/845 Income tax Tax benefits from unused company tax losses

[6] ATO Interpretative Decision ATO ID 2002/836 Income Tax Tax benefits from unused company tax losses

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