House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 2 - Company losses and bad debts and technical amendments

Outline of Chapter

2.1 This Chapter discusses amendments to the ITAA 1997 contained in Schedule 1 to this Bill. These amendments are required as a consequence of the new inter-entity measures (discussed at Chapter 1). The Schedule amends the continuity of ownership test applying to companies' losses and aligns the application date of the unrealised loss measures with that of the inter-entity measures.

2.2 This Chapter also discusses amendments that are mainly of a technical nature to refine and clarify the unrealised loss measures, the excess mining deductions measures and the 13 month prepayment measures as enacted by the Integrity and Other Measures Act.

Context of Reform

2.3 This Bill makes changes to the continuity of ownership test as announced in the Treasurer's Press Release No. 74 of 11 November 1999. The announcement foreshadowed changes to the continuity of ownership test to provide an appropriate link to the new inter-entity measures (discussed at Chapter 1). The proposed inter-entity measure is consistent with the Review of Business Taxation's recommendation No. 6.9(b).

Summary of new law

2.4 The amendments will:

•

amend the continuity of ownership tests contained in Division 165 of the ITAA 1997 to provide an appropriate link to the new inter-entity measures;

•

include saving provisions in specific circumstances to enable a loss or deduction to be claimed without being subject to the same business test as though there was continuity of ownership;

•

refine aspects of the continuity of ownership test as enacted by the Integrity and Other Measures Act;

•

apply existing tracing rules applicable to certain listed public companies (and their 100% subsidiaries) in relation to the unrealised loss measures and the inter-entity measures;

•

in relation to the unrealised loss measures:

-

align the application date of the unrealised loss measures enacted in the Integrity and Other Measures Act with the inter-entity measures contained in this Bill;

-

introduce measures to reduce compliance costs associated with the valuation requirement;

-

strengthen the unrealised loss measures to ensure that these rules are not undermined by the transfer of loss assets within a company group;

-

exclude CFCs from the unrealised loss measures; and

•

make technical corrections in relation to the excess mining deductions measures and the 13 month prepayment rule.

Detailed explanation of new law

2.5 The Integrity and Other Measures Act contained measures that removed defects in the existing continuity of ownership test applying to companies' prior and current year tax losses, net capital losses and bad debts. The Integrity and Other Measures Act also contained measures that apply the amended continuity of ownership test to companies with unrealised net losses.

2.6 It is necessary to amend certain aspects of the continuity of ownership test, both as a consequence of the introduction of the new inter-entity measures in this Bill and in order to refine the new test as enacted in the Integrity and Other Measures Act. Both aspects of the changes to the continuity of ownership test are incorporated in the same provisions of the new Bill, as the test is connected to tax losses, net capital losses, bad debt deductions, unrealised net losses and now to the new inter-entity adjustment provisions.

Changes to the continuity of ownership test consequential upon the new inter-entity measures

Same share or interest rule

2.7 A company may be prevented from deducting a loss or a deduction unless it satisfies the continuity of ownership test and the same control is maintained throughout the relevant test period. Where a company fails to maintain continuity of ownership and control, a loss or deduction will only be available if the same business test is satisfied.

2.8 The Integrity and Other Measures Act inserted changes to rules in section 165-165 of the ITAA 1997 applying to tests to determine whether there has been continuity of ownership in a relevant test period. Essentially, these changes were designed to ensure that a company would fail the continuity of ownership test where the loss has been substantially duplicated by individual shareholders disposing of their shares in a loss company. The company will fail the continuity of ownership test even though the same individual shareholders have reacquired the same shares within the relevant test period.

2.9 Under the changes in the Integrity and Other Measures Act, rights and powers attaching to an individual's share in a company may only be taken into account if the individual owns the same share throughout the relevant period. This is known as the 'same share' rule. It is irrelevant under this rule whether there has been a change in the way a share was held. For example, a share in a loss company initially held by an individual through an interposed company that is then transferred to the individual will be counted for the purposes of the test as having been owned continuously.

2.10 The same share rule is now extended by Schedule 1 to this Bill to direct and indirect equity interests in a company to provide an appropriate link to the inter-entity adjustment rules in new Subdivision 165-CD. Broadly, where any interests (interposed interests) in an entity interposed between an individual and a loss company are to be taken into account for the purposes of the continuity of ownership test, those interests must not only be exactly the same interests, they must be held by the same persons. (A 'person' includes a company or an interposed entity.) If this is not the case, the interposed interests will not be taken into account in determining whether a condition is satisfied, or a changeover time or alteration time has occurred. The extended rule is referred to in this Chapter as the same share or interest rule . [Schedule 1, item 22, subsection 165-165(1)]

2.11 The condition that has to be satisfied as referred to in the new provision may be, for example, a condition listed in section 165-12 (relating to prior year tax losses or net capital losses). The test for determining whether there has been a changeover time is contained in section 165-115C of the ITAA 1997 (the unrealised loss measures). The test for determining whether there has been an alteration time is being inserted as section 165-115L of the ITAA 1997 (the inter-entity measures). Broadly, a changeover time or an alteration time occurs when a company fails to maintain continuity of majority ownership throughout the period from 11 November 1999 (the application date of both the unrealised loss measures and the inter-entity measures). Where there has been a previous failure, a changeover time or an alteration time occurs when the company fails to maintain continuity from the previous changeover time or alteration time.

2.12 Where an individual disposes of a share to an entity interposed between the individual and a loss company, rights and powers attaching to the share will not be taken into account even if it is ultimately owned by the same individual throughout the test period. Similarly, a share previously held indirectly through an interposed entity is not allowed to be taken into account if it is disposed of to another interposed entity. In these circumstances, the share in the loss company cannot be included because the same person (in this case, the same interposed entity) did not hold it throughout the test period.

Example 2.1

Bridget holds 100% of the shares in an interposed company (X Co) that in turn owns all the shares in a loss company. Over the course of several months during the relevant test period, X Co disposes of 60% of its shares in the loss company to Y Co, another interposed entity controlled by Bridget. Y Co then owns a 60% interest in the loss company. Only 40% of the original shares held by X Co in the loss company can be counted for the purposes of determining whether there has been a substantial change in the ownership of the loss company. While Bridget has retained 100% underlying ownership throughout the test period, only the shares held by the same persons (i.e. 40% of the shares held by X Co in the loss company) may be counted.

Share splits and consolidations - same share or interest rule

2.13 The rules relating to share splits and consolidations contained in amended section 165-165 will now also apply to unit splits and consolidations. The amendments prevent a loss company from failing the continuity of ownership test simply because a unit in a unit trust interposed between a person and the loss company is split into 2 or more units or consolidated with other units to form a new unit. The amendments to section 165-165 will enable a company to take into account the rights and powers attached to the split or consolidated units even though the units were not held (and did not exist) from the start of the test period. [Schedule 1, item 22, subsections 165-165(3) and (5)]

2.14 For a new share to be treated as the old share under these rules, each of the shares resulting from a share division must be owned or held throughout the rest of the period after the division occurred by the same person who owned the original shares which were split. A similar rule applies to unit divisions. This is consistent with the existing subsection 165-165(2). In the absence of such a rule, substantial loss duplication could occur without a company failing the continuity of ownership test. Shareholders could dispose of a majority of their divided shares leaving a token number of shares (carrying a small fraction of the power or rights attaching to the original shares) to satisfy the continuity requirements.

2.15 A company could fail the continuity of ownership test simply because a shareholder sold a divided share carrying a small fraction of the powers or rights attaching to the original share. In these circumstances, the relevant saving provision (discussed at paragraphs 2.23 to 2.39) could treat the company as having satisfied the continuity of ownership test.

2.16 The rules relating to share or unit splits and consolidations apply only where a share or unit held at the start of a relevant test period is split or consolidated during the period. In relation to a test period after the test period in which the share or unit split occurred, the split share or unit is treated in the same way as any other share or unit. For example, the requirement that the person (i.e. shareholder) continues to be the beneficial owner of each of the shares or units resulting from the split will be irrelevant in relation to a subsequent testing period. [Schedule 1, item 22, subsections 165-165(2) to (6)]

Application of modified same share or interest rule to 100% subsidiary of listed public company

2.17 Division 166 of the ITAA 1997 contains a modified continuity of ownership test that applies special tracing rules to listed public companies. The rules make it easier for a listed public company to determine whether it satisfies the continuity of ownership test. The tracing rules also apply to 100% subsidiaries of a listed public company. The tracing rules currently applying to a company's tax losses, net capital losses and bad debt deductions will be extended by this Bill to apply for the purposes of the unrealised loss measures and the inter-entity measures(the extension is discussed at paragraphs 2.40 to 2.49 and paragraphs 2.75 and 2.76).

2.18 Schedule 1 introduces a modified same share or interest rule to determine whether a 100% subsidiary satisfies the continuity of ownership test in Division 166. The special tracing rules in Division 166 (including the tracing rules introduced in this Bill in relation to the unrealised loss measures and the inter-entity measures) will now be subject to a modified same share or interest rule when applied in relation to a 100% subsidiary of a listed public company.

2.19 Under this rule, the 100% subsidiary will be treated as not having satisfied a condition or as having experienced a changeover time or alteration time unless:

•

the shares directly held by a listed public company (the holding company in section 166-10(2)) in the subsidiary that are taken into account in determining whether the condition is satisfied are the same shares held by the holding company throughout the relevant test period; and

•

any direct or indirect equity interests held by the holding company in an entity interposed between the holding company and the subsidiary that are to be taken into account are exactly the same interests held by the same persons throughout the relevant test period. (A company or an interposed entity is a 'person' for the purposes of this provision.)

[Schedule 1, item 34, subsection 166-170(1) and (2)]

2.20 A share or an interest not allowed to be taken into account under the modified same share or interest rule will not, however, affect the way a subsidiary company's total voting power or rights to capital or dividends are determined [Schedule 1, item 34, subsection 166-170(7)] .

2.21 In effect, the conditions applying to a 100% subsidiary of a listed public company are more stringent than those applying to the listed public company itself. Under the provision, a 100% subsidiary will fail the continuity conditions where, although there is continuity of majority ownership of the listed public company (and therefore the 100% subsidiary), the way in which the listed public company's direct or indirect interest in the subsidiary is held has changed substantially during the test period. Losses in the 100% subsidiary will generally have been substantially duplicated in these circumstances(refer to discussions at paragraphs 2.33 to 2.35 regarding the application of the saving provisions to 100% subsidiaries of a listed public company).

2.22 Rules relating to share or unit splits and consolidations apply to equity interests held directly or indirectly by a listed public company in a 100% subsidiary. The provisions will enable a subsidiary to take into account the rights and powers attached to split or consolidated shares or units in a unit trust in some cases even though the shares or units were not held from the start of the relevant test period. The provisions are similar to the ones discussed above applying to companies generally. [Schedule 1, item 34, subsection 166-170(3) to (6)]

Saving provisions

2.23 Saving provisions are contained in each of the provisions relating to conditions or circumstances operating on tests in relation to tax losses, net capital losses, unrealised net losses and bad debts to offset the effect of the same share or interest rule. The saving provisions will enable a loss or a deduction to be claimed as though the continuity of ownership test was satisfied.

2.24 Subject to certain criteria being satisfied, saving provisions will apply if a company fails the continuity of ownership test while retaining majority underlying ownership throughout the relevant period. A company could fail the test where those majority shareholders no longer hold direct or indirect equity interest in the company in the same way (because of the operation of the same share or interest rule).

2.25 To address this situation, the conditions set out in the relevant provisions may be treated as having been satisfied, or a changeover time (in relation to the unrealised loss measures) is deemed not to have occurred, if:

•

apart from the operation of the same share or interest rule, the continuity of ownership test would have been satisfied; and

•

the company proves that less than 50% of the tax loss, unrealised net loss, notional loss or bad debt (whichever is relevant) has resulted in the making of a loss or is reflected in increased losses or reduced gains on any direct and indirect equity interests in the company that were disposed of during the relevant test period.

2.26 An equity interest whose cost base has been adjusted by the inter-entity measures (discussed at Chapter 1) is to be excluded for the purposes of providing the required proof. A loss on the disposal of such an interest that reflects the loss in the company will effectively be prevented under those measures. [Schedule 1, item 3, subsection 165-12(7); item 5, subsection 165-37(4); item 15, subsection 165-115C(4); item 20, subsection 165-123(7)]

2.27 A company will be able to use the saving provisions in relation to a tax loss where the same persons have retained more than 50% of the voting power in the company or rights to more than 50% of the company's dividends or capital distributions throughout the ownership test period. The loss will not be treated as having failed the continuity of ownership test where the loss company can demonstrate, for example, that the only equity interests in the company that were sold during the relevant test period have been subject to the inter-entity measures.

2.28 A company's tax loss, net capital loss, notional loss (for the purposes of the current year loss rules) or bad debt deduction will often result in equity interests being disposed of for an increased loss. There is an increased loss on the sale of equity for the purposes of the saving provision if, for example, the loss that would have arisen on the sale of equity in the absence of the company's tax loss is increased because of the tax loss. The tax loss is reflected in increased losses on the sale of equity to the extent of the increase. Alternatively, a loss on the sale of equity in a company could relate solely to the company's loss or deduction. This is where, for example, the shareholder would not have experienced a loss on the sale of equity but for the company's loss or deduction.

2.29 A tax loss, net capital loss, notional loss or bad debt deduction could also result in equity interests being disposed of for a reduced gain. There is a reduced gain if, for example, the gain that would have arisen on the sale of equity in the absence of the company's tax loss is reduced because of the tax loss. The tax loss is reflected in reduced gains on the sale of equity to the extent of the reduction.

2.30 Where a company's tax loss relates not to an economic loss suffered by the company but to a taxation incentive, for example, accelerated depreciation, the tax loss will generally not be reflected in increased losses or reduced gains on the sale of equity.

2.31 The relevant test period in relation to tax losses, net capital losses and bad debt deductions is the ownership test period. In relation to unrealised losses, the relevant test period is the period between the last changeover time (and where there has never been a changeover time before, 11 November 1999) and the current changeover time. The start of the relevant test period is referred to in the law as the reference time. [Schedule 1, item 10, subsection 165-115A(2A)]

2.32 A disposal of direct or indirect equity interests in a company that causes the company to experience a changeover time is to be treated as a disposal during the relevant test period. This ensures that a loss company must take into account any loss on such a disposal in obtaining the requisite proof under a saving provision. [Schedule 1, item 3, subsection 165-12(8); item 5, subsection 165-37(5); item 15, subsection 165-115C(5); item 20, subsection 165-123(8)]

Saving provision applying to 100% subsidiaries of a listed public company

2.33 A saving provision will apply to prevent a loss or deduction from being subject to the same business test where a continuity of ownership test is failed because of the modified same share or interest rule applying to a 100% subsidiary of a listed public company under Division 166 (discussed at paragraphs 2.17 to 2.22).

2.34 The provision is almost identical to the saving provisions applying generally to other companies, with one important difference. The difference is that in proving that not more than 50% of the loss or deduction of the subsidiary has been reflected in the disposal of direct or indirect equity interests in a 100% subsidiary, the only relevant equity interests are those that have been disposed of either by the holding listed public company or by an entity interposed between the holding company and the subsidiary.

2.35 The saving provision will not, however, apply for the purposes of determining whether there is an alteration time for the purposes of the inter-entity measures. This is consistent with the general rules for determining the alteration time in respect of other companies. [Schedule 1, item 34, subsection 166-170(9)]

New shares or units

2.36 A company that issues new shares, for example under a rights issue, or because of the exercise of an option, could fail the continuity of ownership test even though there has been no change in its ownership. This is because only shares held by a particular shareholder throughout the relevant test period may be counted for the purposes of the continuity of ownership test (see discussion at paragraphs 2.7 to 2.12).

2.37 While a person's new share issued during the relevant test period will not be counted as a share held throughout the period, the new share will nevertheless be included for the purpose of working out the total voting power or rights in the company. Amendments have been made to the rules affecting totals of shares, or powers or rights attaching to shares to ensure that this occurs. In effect, section 165-165 will not affect how powers and rights carried by shares are counted for the purpose of determining the total voting power, total dividends or total distributions of capital [Schedule 1, item 23, Heading to section 165-200; Schedule 1, item 24, section 165-200]

2.38 Similarly, interests in an interposed trust that are ignored under section 165-165 because of the application of the same share or interest rule will nevertheless be taken into account for the purposes of determining a company's total voting power or rights to capital or dividends. [Schedule 1, item 25, subsection 165-200(2)]

2.39 The saving provisions could apply to a company that fails the continuity of ownership test because of the issue of new shares. The company's loss or deduction will be treated as having satisfied the continuity of ownership test where the conditions are satisfied and the necessary proof is obtained.

Example 2.2

At the start of an ownership test period, Alex holds 90% of shares in a company. Brian owns the remaining 10%. The company has issued 100 ordinary shares (i.e. Alex owns 90 shares and Brian owns 10 shares).

100 more new shares are issued at some time during the test period. Of these, Alex owns 90 and Brian owns 10. The total share issue is now 200. The original shares held by Alex now only carry 45% of the power and rights in the company (90/200 = 45%). The original shares held by Brian now carry 5%of the power and rights in the company (10/200 = 5%). Due to the operation of the same share rule, only those original shares may be counted for the purposes of determining whether there has been continuity of ownership throughout the period.

In the absence of a saving provision, the company would fail the continuity of ownership test because only 50% of the power and rights in the company have been maintained throughout the test period. To satisfy the test, more than 50% continuity must be maintained.

Under the saving provision, the company will be treated as though it satisfies the continuity of ownership test if it is able to prove that:

•

there has been no substantial change in proportionate shareholding between Alex and Brian throughout the period Alex has maintained a 90% interest and Brian has maintained a 10% interest; and

•

less than 50% of the loss has been duplicated during the period neither Alex nor Brian have sold any of their original shares.

Special tracing rules for listed public companies (and their subsidiaries) in relation to the inter-entity measures

2.40 New Subdivision 166-CA applies the special tracing rules in Division 166 to modify the way the inter-entity measures apply to a listed public company and its 100% owned subsidiaries (100% subsidiaries). The rules will make it easier for such a company to determine whether there has been a substantial change of ownership and therefore, whether an alteration time has occurred within the meaning of section 165-115L of the inter-entity measures.

2.41 The rules are to apply at the company's option. There is a presumption that a listed public company and its 100% subsidiaries will rely on the special tracing rules unless the relevant company chooses to apply the inter-entity measures in Subdivision 165-CD without modification. A company must make such a choice on or before the day it lodges its tax return for the income year in which an alteration time (under section 165-115L) has occurred. [Schedule 1, item 30, section 166-90]

2.42 Under the new rules, a listed public company will be taken not to have experienced an alteration time under section 165-115L if there is substantial continuity of ownership :

•

between the start of the relevant test period (the reference time) and the time immediately after each abnormal trading in shares of the company; and

•

between the reference time and the end of each income year.

2.43 Broadly, section 166-145 applies to treat a company as having achieved substantial continuity of ownership between 2 specified points in time where the persons who had more than 50% of the voting power, or rights to dividends or capital (whichever is relevant) at one point in time also had more than 50% of the relevant power or right at the other point in time.

2.44 An alteration time is taken to have occurred in relation to a company immediately after the time of an abnormal trade in its shares where there is no substantial continuity of ownership between the reference time and the time immediately after the abnormal trade. Where there has not been abnormal trading in the company's shares, an alteration time is taken to have occurred at the end of an income year where there is no substantial continuity of ownership between the reference time and the end of the income year. [Schedule 1, item 30, subsection 166-80(2) and (3)]

2.45 The special tracing rules apply to a company that is a listed public company at all times during the relevant test period [Schedule 1, item 30, paragraph 166-80(3)(a)] . The existing continuity of ownership tests in section 166-145 of the ITAA 1997 will apply in determining whether there is substantial continuity of ownership of a listed public company in terms of voting power and rights to capital and dividends [Schedule 1, item 30, section 166-80] .

2.46 Special tracing rules also apply to a 100% subsidiary of a listed public company where certain conditions are satisfied. The conditions are the same as those applying in relation to the special tracing rules for tax losses, net capital losses and bad debt deductions. To be eligible, the company must have been a 100% subsidiary of a listed public company throughout the relevant test period . [Schedule 1, item 30, subsections 166-85(1) to (3)]

2.47 The relevant test period in this context is the period from and including the reference time (defined at subsection 165-115L(2)) to the test time. [Schedule 1, item 30, subsection 166-85(2)]

2.48 Unless the subsidiary chooses otherwise, the special tracing rules will apply to a 100% subsidiary that satisfies the specified conditions as if the subsidiary were itself a listed public company. Furthermore, any abnormal trading in the holding company's shares will be treated as if it were abnormal trading in the subsidiary's shares. [Schedule 1, item 30, section 166-90 and subsection 166-85(5), paragraph 166-85(2)(a)]

2.49 The provision that a 100% subsidiary will be treated as if it were a listed public company is, however, subject to the limited same share or interest rule applying in respect of the listed public company's equity interest in the subsidiary. The limited same share or interest rule is discussed above at paragraphs 2.17 to 2.22.

Alignment of commencement time as a consequence of the inter-entity measures

2.50 The unrealised loss measures in Subdivision 165-CC of the ITAA 1997 will now only apply to companies that experience a changeover time after 1 pm, by legal time in the Australian Capital Territory, 11 November 1999. This will align the commencement dateof the unrealised loss measures with the inter-entity measures contained in this Bill. The adjustment will minimise the circumstances where companies will be required to determine their unrealised net losses at different times in respect of inter-entity measures and the unrealised loss measures. [Schedule 1, item 9, paragraph 165-115A(2)(a)]

Refinements of the continuity of ownership test as enacted by the Integrity and Other Measures Act

2.51 The Integrity and Other Measures Act contains certain key amendments to the substantive tests contained in section 165-12 (company must maintain the same owners) and section 165-13 (company must carry on the same business in the relevant period). The supporting tests in sections 165-150 to 165-160 for establishing whether the company has maintained the same owners during the test period were accordingly also modified by the Integrity and Other Measures Act.

2.52 Schedule 1 of this Bill will make technical modifications to the tests enacted in the Integrity and Other Measures Act in the following respects:

•

the words 'rights to' previously omitted from subsection 165-155(1) and subsection 165-160(1) of the ITAA 1997 will be inserted. The amendment will ensure consistency between the listed provisions and the provisions being referred to [Schedule 1, item 21, subsections 165-155(1) and 165-160(1)] ;

•

the alternative tests forming part of the continuity of ownership test will be amended so that they recognise that shareholders of a company do not have beneficial interests in a company's assets. The relevant provisions as they stand incorrectly imply the contrary [Schedule 1, item 21, subsections 165-150(2), 165-155(2) and 165-160(2)] ; and

•

the alternative tests relating to voting power will also be amended to exclude trustees from being taken into account when determining the identity of persons with majority ownership [Schedule 1, item 21, subsection 165-150(2)]

2.53 The modifications with respect to trustees are also made to the tests contained in Subdivision 166-D (tests for finding out whether a listed public company has maintained the same owners) and Subdivision 166-G (special tracing rules for listed public companies). [Schedule 1, item 31, subsections 166-145(2) to (4); item 32, section 166-150; item 35, paragraph 166-265(1)(a); item 36, subsections 166-265(2) and (3)]

2.54 Further technical amendments have been made to the tests incorporated in the Integrity and Other Measures Act:

•

the Integrity and Other Measures Act referred previously to 'rights to more than 50% of the voting power in the company' for the purposes of the continuity of ownership tests for the deduction of tax losses and bad debts. As it is erroneous to refer to 'rights to voting power', the relevant provisions have been amended to remove the reference [Schedule 1, item 2, subsection 165-12(2) (note); item 19, subsection 165-123(2) (note)] ; and

•

the alternative test provisions (for the deduction of current year losses in a year) will now be applicable where there has been a company or companies interposed between individual owners and a loss company at the beginning of the ownership test period. Previously the provisions applied the alternative test where a company is interposed at any time during the ownership test period. This amendment is consistent with changes made in the Integrity and Other Measures Act to sections 165-12(6) and 165-23(6) and will apply to net capital losses or tax losses claimed in a return for an income year ending after 21 September 1999. [Schedule 1, item 4, subsection 165-37(3); sub-item 68(2)]

Consequential amendments

Rules affecting the operation of the ownership tests applying to listed public companies

2.55 Division 165 of the ITAA 1997 contains rules which affect the operation of the ownership tests in Subdivision 166-D. Broadly, certain general rules in Division 165 also apply for the purposes of the modified continuity of ownership tests in Subdivision 166-D. As these general rules were amended by the Integrity and Other Measures Act, the provisions applying to the operation of the ownership tests in relation to listed public companies have been amended to ensure that the general rules in Division 165 continue to apply to listed public companies and their subsidiaries. [Schedule 1, item 33, section 166-165]

Rules applying to loss companies owned by non-fixed trusts

2.56 Schedule 9 to the Taxation Laws Amendment Bill (No. 8) 1999 currently before the Parliament will amend the continuity of ownership test applying to companies losses and deductions. This Bill introduces concessional tracing rules to companies that are owned by non-fixed trusts under certain conditions.

2.57 Amendments will be made to the tracing rules as a consequence of the changes contained in the Integrity and Other Measures Act to the continuity of ownership test. These amendments are of a technical nature. They essentially reflect the fact that the relevant test period for applying the continuity of ownership test is now the ownership test period. [Schedule 1, item 26, subsection 165-215(2) and (3); item 27, subsection 165-215(5); item 28, subsection 165-230(2) and (3); item 29, subsection 165-230(5)]

Amendments relating to the unrealised loss measures

2.58 Measures relating to unrealised losses were enacted by the Integrity and Other Measures Act. Broadly, the measures will apply to a company that:

•

fails the continuity of ownership test; and

•

at the time of failure (changeover time), has an unrealised net loss in respect of all of the company's assets (changeover assets) held at the time.

2.59 The following are refinements to the recently enacted measures.

Compliance cost saving measures

2.60 Schedule 1 to this Bill contains amendments to the unrealised loss measures directed at reducing the cost of compliance. The amendments are introduced in recognition that the valuation requirement under the measure could impose compliance costs on affected taxpayers. [Schedule 1, item 6, section 165-115]

2.61 The following are the measures directed at reducing compliance costs associated with the valuation requirement:

•

exclusion of small business taxpayers;

•

exclusion of low cost assets;

•

in relation to depreciable plant, the option to use tax written-down value as a proxy for market value where certain conditions are satisfied; and

•

empowering the Commissioner to give guidance about valuation methods and approaches in relation to the operation of unrealised loss and gain asset calculations.

[Schedule 1, item 17, subsection 165-115F(7)]

Exclusion of small business

2.62 Any company that has a net asset value of $5 million or less (as determined under section 152-15 of the ITAA 1997) at the time of change of ownership or control is exempt from the unrealised loss rules in Subdivision 165-CC. This will assist small businesses with unrealised net losses that would otherwise be prevented from using losses unless the company satisfies the same business test. [Schedule 1, item 7, paragraph 165-115A(1)(d)]

Exclusion of low cost assets

2.63 A company will now be allowed to make an election to exclude from the unrealised loss measures all of its assets acquired for less than $10,000 [Schedule 1, item 8, section 165-115A(1B)] . A company is required to make such an election on or before the day it lodges its income tax return for the income year in which the relevant changeover time occurred [Schedule 1, item 8, section 165-115A(1C)] .

2.64 There are 2 consequences of making such an election. Firstly, losses and gains on assets acquired for less than $10,000 will be excluded when calculating a company's unrealised net loss at changeover time. Secondly, losses on assets held at the changeover time that were acquired for less than $10,000 will be allowed regardless of whether the company satisfies the same business test. Accordingly, a loss company will not have to calculate a notional capital loss, notional revenue loss or trading stock loss in respect of CGT assets acquired for less than this amount.

Market value proxy for depreciable plant

2.65 Special rules may apply in determining the market value of depreciable plant for the purposes of calculating a company's unrealised net loss. A company may choose to use the written down value of depreciable plant at a relevant time instead of the market value at that time, provided that certain conditions in relation to that plant are satisfied. Essentially, the plant must be of a type that is eligible for a depreciation deduction. Further, the expenditure to acquire the plant must be less than $1 million. Finally, it must be reasonable for the company to conclude that the market value of the plant at the relevant time was at least 80% of its written down value at that time. [Schedule 1, item 17, subsections 165-115F(5) and (6)]

Disposal of trading stock held at changeover time

2.66 The unrealised loss rules have also been amended to apply the same business test to a loss on an item of trading stock held at changeover time. As with other assets, the same business test will apply to a trading stock loss arising when the item is disposed of or when the item ceases to be trading stock. Broadly, a trading stock loss will have occurred if the market value at the time of disposal or cessation as trading stock is less than the value of the item chosen for the purposes of Division 70, or in any other case, less than the cost of the item at the time of disposal or ceasing to be trading stock. [Schedule 1, item 7, paragraph 165-115A(1)(c); item 8, subsection 165-115A(1D)]

2.67 If a company makes a trading stock loss after a changeover time and the same business test is not satisfied, the amount of trading stock loss is included in the company's assessable income. A trading stock loss is included in assessable income only to the extent of the company's residual net unrealised loss at the time of disposal or cessation. Any part of a trading stock loss in excess of the residual net unrealised loss is ignored. [Schedule 1, item 15, subsection 165-115BA(1) to (3)]

2.68 There will, however, be no inclusion in the company's assessable income if the company satisfies the same business test in relation to the trading stock loss. Broadly, for the purposes of determining whether the company has satisfied the same business test, section 165-13 must be applied as if the trading stock loss were a net capital loss of the year immediately prior to the year in which a change of ownership or control occurred. The company is treated as having failed to meet the ownership conditions in relation to voting power, rights to dividends and rights to capital distributions at the changeover time and the continuity period is treated as ending at that time. [Schedule 1, item 15, subsections 165-115BA(4) and (5)]

2.69 The provisions of Subdivision 165-CC are generally adjusted to ensure that a company's residual unrealised net loss will now be reduced by trading stock losses that are subject to these rules. After a changeover time, a company is required to calculate its residual net unrealised loss to determine the extent to which the same business test will be applied to subsequently realised losses (including trading stock losses). The residual net unrealised loss is now calculated by subtracting any previous capital losses, deductions or trading stock losses from the amount of the unrealised net loss determined at the relevant time. [Schedule 1, item 11, subsection 165-115B(1); item 12, subsection 165-115B (2); item 13, subsection 165-115B(5) and (6); item 14, subsection 165-115B(8); item 15, subsection 165-115BB(2)]

2.70 Capital losses, deductions and trading stock losses arising in relation to CGT events in respect of CGT assets owned at the changeover time will be subject to the same business test in the order in which the CGT events occurred. [Schedule 1, item 14, subsection 165-115B(7); item 15, subsection 165-115BB(1)]

Transfer of loss assets before changeover time

2.71 The current unrealised loss measures may be undermined by companies transferring their loss assets within a majority-owned group. Broadly, under the recently enacted loss asset transfer measures in Subdivision 170-D of the ITAA 1997, a loss on an asset transferred within a group is quarantined in the transferor company and deferred until the asset is disposed of outside the group. A deferred loss in respect of such an asset will not, however, be subject to the unrealised loss measures where, for example, the loss asset remains within the group but there is a substantial change in the ownership of the group. Under the current unrealised loss measures, the deferred loss is not subject to the same business test because the unrealised loss measures apply only to assets owned by a loss company at changeover time.

2.72 Amendments in this Bill will ensure firstly, that the amount of a capital loss or deduction on a transferred asset (deferred under section 170-270 of the ITAA 1997) will be included in the calculation of a company's unrealised net loss at changeover time. This is appropriate because the loss would have been reflected in the value of the equity of the transferor company and substantially duplicated at changeover time.

2.73 The calculation of the unrealised net loss will only include an amount of capital loss or deduction that remains deferred at the changeover time. Any amount of capital loss or deduction that has been available to the company under section 170-275 before the changeover time will be excluded. Such an amount will already be subject to the continuity of ownership test for realised losses. [Schedule 1, item 16, section 165-115E]

2.74 Secondly, the unrealised loss measures will be extended to apply not only to capital losses and deductions in respect of a company's assets owned at changeover time but also to losses (previously subject to deferral under the loss asset transfer measures) on assets that the company transferred before changeover time. The amendments will ensure that a loss or a deduction on a transferred asset that is eventually allowable to the transferor company (under Section 170-275 Subdivision 170-D of the ITAA 1997) will be subject to the same business test. A loss or deduction is subject to the same business test only to the extent of any residual unrealised net loss as at the time of realisation. A residual unrealised net loss (as defined in section 165-115B) is the amount of any unrealised net loss yet to be reduced by losses or deductions on assets held at changeover time. [Schedule 1, item 8, paragraph 165-115A(1A)(b)]

Special tracing rules for listed public companies (and their subsidiaries) in relation to the unrealised loss measures

2.75 New Subdivision 166-CA applies the special tracing rules in Division 166 to modify the way the unrealised loss measures apply to a listed public company and its 100% subsidiaries. The rules are identical to those applying in relation to the inter-entity measures discussed above. The rules will make it easier for such a company to determine whether there has been a substantial change of ownership and therefore, whether there is a changeover time within the meaning of section 165-115C of the unrealised loss measures.

2.76 In summary, some features of the special tracing rules are as follows:

•

the rules apply to listed public companies and their 100% subsidiaries that satisfy certain eligibility conditions [Schedule 1, item 30, subsections 166-80(1) and 166-85(1) to (3)]

•

the rules apply at the company's option. A company that chooses to apply the unrealised loss measures in Subdivision 165-CC without modification must make such a choice on or before the day it lodges its tax return for the income year in which a changeover time (under section 165-115C) has occurred [Schedule 1, item 30, section 166-90]

•

a listed public company will be taken not to have experienced a changeover time within the meaning of section 165-115C if there is substantial continuity of ownership of the company between the specified times [Schedule 1, item 30, section 166-80]

•

a 100% subsidiary of a listed public company is subject to the modified same share or interest rule applying in respect of the listed public company's equity interest in the subsidiary (discussed at paragraphs 2.17 to 2.22);

•

unless the subsidiary chooses not to apply the special tracing rules, the rules will apply to a 100% subsidiary that satisfies the specified conditions as if the subsidiary were itself a listed public company. Also, any abnormal trading in the holding company's shares will effectively be treated as if it were abnormal trading in the subsidiary's shares. [Schedule 1, item 30, paragraph 166-85(2)(a) and subsection 166-85(5)]

Application of the unrealised loss measures to CFCs

2.77 The unrealised loss measures contained in Subdivision 165-CC of the ITAA 1997 will not apply when calculating the attributable income of a CFC. [Schedule 1, item 67, paragraph 427(ba)]

2.78 The CFC measures prevent tax deferral by taxing Australian residents on their share of certain types of foreign source income accumulated offshore in a CFC (called attributable income). Broadly, the attributable income of a CFC is calculated as if it were a resident taxpayer. The unrealised loss measures would therefore apply unless modifications are made to the calculation of attributable income.

2.79 In principle, the unrealised loss measures should apply when calculating the attributable income of a CFC. Applying the rules to CFCs in the same way that they apply to residents would help ensure residents are not advantaged by accumulating amounts offshore in a CFC. The unrealised loss measures, however, would not mesh well in their current form with aspects of the CFC measures and could produce anomalous outcomes or uncertainty in the law. The rules will therefore not apply to CFCs at this time and will be considered as part of the review of the CFC measures announced in The New Business Tax System: Stage 2 Response (Treasurer's Press Release No. 74 of 11 November 1999). This will allow time for the development of cohesive rules that are properly integrated with other measures.

Other technical amendments

2.80 Technical amendments have been made to the provisions of the unrealised loss measures in relation to the time at which a company experiences a change in ownership or control. To ensure consistency with the new inter-entity measures, a changeover time is now referred to as the 'test time' for the purposes of determining the point at which there has been a change in ownership or control of a company. [Schedule 1, item 15, sections 165-115C and 165-115D]

2.81 Further, amendments have been made to replace a reference in the existing law to 'that unrealised net loss' with a reference to 'the residual net loss'. This amendment merely clarifies the existing law. [Schedule 1, item 12, subsection 165-115B(2)]

Technical corrections

Excess mining deductions

2.82 A technical correction has been made to the excess mining deduction measures to replace the reference to Subdivision 300-A and Subdivision 300-C with the reference to Subdivision 330-A and 330-C. [Schedule 6, item 1]

13 month prepayment rule

2.83 A pre-RBT obligation is currently defined as being one that arose 'before' 11.45 am 21 September 1999. Item 1 corrects the definition to specify the time as 'at or before' 11.45 am to ensure that the definition includes obligations at that exact time. [Schedule 8, item 1]

2.84 Subparagraph 82KZM(1)(a)(i) and paragraph 82KZMA refer to a 'small business taxpayer'. Items 2 and 4 correct these provisions to state that the taxpayer is a small business taxpayer 'for the year of income'. [Schedule 8, items 2 and 4]

2.85 Item 3 amends subsection 82KZMA(1) to change the wording of 'income year' to 'year of income'. This ensures that the expression is consistent with that used throughout the ITAA 1936. [Schedule 8, item 3]

2.86 Section 82KZMB provides a code for deducting prepayments of 13 months or less for businesses. For a prepayment made in an income year that was not covered by the table in that section, the part of the prepayment relating to future years would never be deductible. Further, if an income year includes 2 of the 21 Septembers described in the table, the table could be interpreted as allowing a double deduction for part of a prepayment. To rectify this problem items 5, 6 and 7 of Schedule 8 amend each of items 2, 3 and 4 in the table in subsection 82KZMB(5), to refer to the immediately preceding item in the table. [Schedule 8, items 5 to 7]

2.87 Item 8 amends the formula in subsection 82KZMC(5) to ensure that the amount of a prepayment that exceeds the amount which may be deducted in the expenditure year is deductible proportionately over the remainder of the eligible service period. [Schedule 8, item 8]

2.88 Items 9 and 10 amend the heading and application provision to Division 2 of Schedule 7 to the Integrity and Other Measures Act to address substituted accounting periods which may overlap the transitional period for the new rules. [Schedule 8, items 9 and 10]

Application provisions

2.89 The amendments made to the continuity of ownership test in relation to the new same share or interest rule are to apply to tax losses, net capital losses or deductions claimed in relation to an income year ending after 21 September 1999. The new same share or interest rule gives effect to the Government's announcement on 21 September 1999 to remove defects in the continuity of ownership test. The measures are aimed at reducing the scope for substantial loss duplication. As the unrealised loss measures and the inter-entity measures only apply from 11 November 1999, the new same share or interest rule will only apply from that date in relation to those measures. The saving provisions, announced on 11 November 1999, will also apply to tax losses, net capital losses or deductions claimed in relation to an income year ending after 21 September 1999. The new same share or interest rule is detrimental to taxpayers as it increases the likelihood of taxpayers failing the continuity of ownership test. Nevertheless, the saving provision will apply in respect of the same losses or deductions to effectively treat a company as not having failed the test in certain circumstances. [Schedule 1, subitem 68(2)]

2.90 Other refinements to the continuity of ownership rules as enacted by the Integrity and Other Measures Act are to apply in respect of tax losses, net capital losses or deductions claimed in relation to an income year ending after 21 September 1999, the date from which the measures relating to the continuity of ownership test apply [Schedule 1, item 68(2)] . The amendments are of a technical nature and give effect to the original intention underlying the measures as announced on 21 September 1999.

2.91 The measures applying the special tracing rules to listed public companies and their 100% subsidiaries in relation to the unrealised loss measures and the inter-entity measures apply to determine whether there is a changeover time or alteration time after 11 November 1999 being the date of announcement of the inter-entity measures. [Schedule 1, item 68(3)]

2.92 The amendment that prevents the unrealised loss measures from applying in the calculation of the attributable income of a CFC commences at 1 pm, by legal time in the Australian Capital Territory, on 11 November 1999, the time from which the unrealised loss measures apply [Schedule 1, item 68(3)] . The other amendments relating to the unrealised loss measures (discussed at paragraphs 2.58 to 2.81) apply to tax losses, net capital losses or deductions claimed in relation to an income year ending after 11 November 1999 [Schedule 1, item 68(1)]

2.93 The technical correction relating to excess mining deductions applies to assessments for the 1999-2000 income year and later years. [Schedule 6, item 2]

2.94 The technical corrections relating to the 13 month prepayment rule apply to expenditure incurred by a taxpayer after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999, and the taxpayer's assessments for the year of income including that day and for later years of income. [Schedule 8, item 11]