House of Representatives

Taxation Laws Amendment Bill (No. 8) 1999

Explanatory Memorandum

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

Chapter 9 - Concessional tracing rules for company loss etc. provisions

In this Chapter, the following Acts are referred to by the abbreviations indicated:

Income Tax Assessment Act 1936 ITAA 1936

Income Tax Assessment Act 1997 ITAA 1997

Overview

9.1 Schedule 9 to this Bill will amend the company prior year, current year and capital loss rules, and rules for bad debt and certain debt/equity swap deductions (referred to in this Chapter as debt deductions). The amendments will make available to companies 2 concessional tracing rules that are available to trusts under the trust loss measures which are contained in Schedule 2F to the ITAA 1936.

9.2 These amendments were originally introduced into Parliament in Taxation Laws Amendment Bill (No. 6) 1997 and lapsed when Parliament was prorogued for the election. The reintroduced measures have been modified to take into account the Tax Law Improvement Project (TLIP) rewrite of the bad debt and capital loss rules (ie. Subdivisions 165-CA, 165-CB, 165-C, 166-C, 175-CA, 175-CB and 175-C of the ITAA 1997). The rewritten provisions were included in Taxation Law Improvement Act (No.1) 1998 . The reintroduced measures also include a transitional rule which will allow a trust to make a family trust election for the purpose of the family trust concession for earlier income years. Similarly, entities wishing to be members of the same family group as the trust making the family trust election will be able to make interposed entity elections for those same income years. (See Chapter 10 of this Explanatory Memorandum).

9.3 The Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998 inserted Schedule 2F into the ITAA 1936. Schedule 2F contain rules to restrict the recoupment of prior year and current year losses and debt deductions of trusts in order to prevent the transfer of the tax benefit of those losses or deductions. References to Schedule 2F in this Chapter refer to Schedule 2F to the ITAA 1936.

Summary of the amendments

Purpose of the amendments

9.4 The amendments will extend to companies 2 concessional tracing rules which are available to trusts under the trust loss measures. The concessions are referred as the family trust concession and the alternative condition .

Date of effect

9.5 The amendments will apply to company losses and debts incurred in the 1996-97 year of income or later years of income.

Background to the legislation

Outline of the provisions

9.6 Under the income tax law, a tax loss incurred by a taxpayer in a year of income may generally be carried forward and deducted from the taxpayers assessable income in a later year. Losses incurred in the 1989-90 and later income years may be carried forward indefinitely until recouped. The relevant provisions are sections 79D, 79E, 80 and 160AFD of the ITAA 1936 and Division 36 of the ITAA 1997.

Prior year loss rules

In the case of companies there are provisions in the law which limit the deductibility of prior year losses (sections 80A to 80F of the ITAA 1936 and Divisions 165, 166 and 175 of the ITAA 1997).

9.8 These provisions contain tests that need to be satisfied by a company before losses can be recouped in a later income year. These tests have the effect that a company can carry forward a loss if there is continuity of majority beneficial ownership of certain dividend, capital and voting rights of the company. Where there is a change in the beneficial ownership of shares in the company or another company which has resulted in that continuity not being satisfied, the company can, nevertheless, carry forward a loss if, among other things, it carries on the same business as it carried on at the time of the change in ownership.

9.9 There are rules which modify the way the above rules apply to listed public companies and their wholly owned subsidiaries. These rules, which are contained in Division 166 of the ITAA 1997, make it easier for these companies to trace ownership interests for the purpose of meeting the requirements of the continuity of majority beneficial ownership test for the 1997-98 year of income and later years of income.

9.10 Also there are rules that deal with arrangements (eg. income injection arrangements) to use company losses to avoid tax. These rules operate to deny a deduction even though the continuity of beneficial ownership test is satisfied but the benefits from the allowance of the deductions would flow wholly or mainly to persons who were not shareholders in the company when the losses or deductions were incurred. The rules may not apply in certain circumstances where the Commissioner of Taxation (the Commissioner) considers the benefits received by a person are reasonable having regard to the persons shareholding interest in the company.

Current year loss rules

9.11 There are also provisions which limit deductibility of current year losses of companies (sections 50A to 50N of the ITAA 1936 and Divisions 165, 166 and 175 of the ITAA 1997). A company may be required to calculate its taxable income and tax loss for an income year in a special way if an event occurs during the income year which is similar to those events which result in the company not being able to deduct a prior year loss (see paragraph 9.8). Under this system, the income year is divided into periods on the basis of when a specified event (eg. a change in beneficial ownership) occurs. In effect, a taxable income or tax loss is calculated separately for each period.

9.12 There are also rules that deal with arrangements (eg. income injection arrangements) similar to those described in paragraph 9.10 which use company deductions to avoid tax.

Debt deduction rules

9.13 Provisions are contained in sections 63A to 63C of the ITAA 1936 and Divisions 165, 166 and 175 of the ITAA 1997 which limit the deductibility of certain debt deductions [F1] . These provisions are similar to the prior year loss provisions applying to companies, but apply for different periods relating to the incurring and writing off of the relevant debt.

9.14 There are also rules that deal with arrangements that bring together in the same company, assessable income and bad debts that would not otherwise be used or would be used at a later time.

Capital loss rules

9.15 There are provisions which limit the ability of a company to set off a net capital loss of an earlier income year against capital gains derived in a later income year. The company must satisfy the same tests that it would have to satisfy before it can deduct a tax loss of an earlier income year, ie. the tests explained at paragraph 9.8 (Divisions 165, 166 and 175 of the ITAA 1997). The rules dealing with the carry forward of net capital losses were amended by Taxation Laws Amendment Act (No. 2) 1997 to ensure their proper application from the 1996-97 income year and later income years. The amendments were made so that any unrecouped losses for earlier years are reflected in a net capital loss in respect of the 1995-96 income year [F2] .

9.16 There are also rules which require a company to work out its net capital gain and net capital loss differently for a year in which it has not had the same majority ownership and control and does not satisfy the same business test. The company must work out its net capital gain and net capital loss under the special rules if it is required to calculate its taxable income and tax loss for an income year in a special way (see paragraph 9.10) but only if it had a notional net capital loss in a period.

9.17 There are also rules that deal with arrangements (eg. where a capital gain is injected into a company with unused capital losses) to avoid a capital gains tax liability.

Relationship between the ITAA 1936 and ITAA 1997

9.18 The company prior and current year loss provisions were rewritten, with effect from the 1997-98 income year, as part of the Tax Law Improvement Project and are included in the ITAA 1997. For income years before 1997-98, the ITAA 1936 provisions are applicable. The company capital loss and debt deduction rules have also been re-written and were passed by Parliament in Taxation Law Improvement Act (No. 1) 1998 . The redrafted debt deduction and capital loss rules which were inserted into Divisions 165, 166 and 175 of the ITAA 1997 take effect from the 1998-99 income year [F3] . For income years before 1998-99 income year the ITAA 1936 provisions are applicable.

Tracing rules

9.19 The continuity of ownership tests in the above provisions contain tracing rules so that where, at any time during the relevant period, the shares in a company are held otherwise than by natural persons, voting, dividend and capital interests can be traced through the interposed entities to the ultimate natural persons who have beneficial ownership.

9.20 Tracing through interposed entities to underlying beneficial owners cannot occur through a discretionary trust as beneficiaries of discretionary trusts do not have fixed interests in the income or capital of the company or interposed entity. Tracing rules can only be applied in circumstances where the beneficial owners have fixed quantifiable interests in the things being traced.

9.21 Thus, in the absence of special tracing concessions, a company could not carry forward losses or deduct debts where 50% or more of the interests in the company are held by a discretionary trust or trusts (including family discretionary trusts).

9.22 The same business test is unavailable to a company in which a majority of the shares are held by discretionary trusts. This test is only available if there has been a change in the beneficial ownership of a loss companies shares which has resulted in failure of the continuity of beneficial ownership test.

9.23 The trust loss measures contain 2 special tracing rules which modify the rule that there is no tracing through non-fixed trusts. These rules are as follows:

·
The family trust concession applies where a fixed interest in a loss trust is held, directly or indirectly, by a family trust. The family trust is treated as an individual holding the interest for its own benefit.
·
The alternative condition applies for the purpose of the ownership test (50% stake test) that applies to fixed trusts. If the interests in a fixed trust are held by non-fixed trusts such that it is not able to pass the 50% stake test, the fixed trust can still deduct its losses if certain conditions are satisfied.

9.24 There are no special tracing rules for companies which are held by discretionary trusts (including family trusts) similar to those that are included in the trust loss measures for tracing interests in trusts.

Amendments to the ITAA 1936 and the ITAA 1997

9.25 Because of the application date of the changes, amendments will be made to both the ITAA 1936 and the ITAA 1997.

9.26 Amendments will be made to the ITAA 1936 for the purpose of the current year loss rules and the debt deduction provisions. The amendments to the current year loss rules will only apply for the 1996-97 income year.

9.27 Amendments will also be made to the ITAA 1997 for the purpose of the prior year and current year loss, capital loss and debt deduction rules.

9.28 It is not necessary to make amendments for the purpose of the prior year loss rules contained in sections 80A to 80F of the ITAA 1936. This is because, under the application rules, the amendments apply only to losses incurred in the 1996-97 income year and later income years. The earliest time a tax loss from the 1996-97 income year can be deducted is in the 1997-98 income year. The ITAA 1997 applies from this income year. Because of transitional provisions included in the Income Tax (Transitional Provisions) Act 1997 , a loss incurred in the 1996-97 income year will be a tax loss for the purposes of the ITAA 1997.

Administrative arrangements for losses and debts incurred in income years before 1996-97

9.29 For losses incurred in the 1995-96 income year or earlier years of income, the Commissioner has advised the Government that he will interpret the existing continuity of beneficial ownership test consistently with the broad principles that have been adopted in relation to section 160ZZS of the ITAA 1936. That is, where in the context of a family discretionary trust, the trustee continues to administer the trust for the benefit of members of a particular family, the Commissioner will accept that, for all practical purposes, there has been a continuity of beneficial ownership for the purposes of the ITAA 1936. If there are non-family trust arrangements which fall outside this interpretation, the Commissioner will look at the arrangements on a case by case basis to see whether the continuity of beneficial ownership test can be satisfied. The Commissioners preliminary, though considered, view on this matter is outlined in draft Taxation Determination TD 96/D17.

Information provisions

9.30 The trust loss measures contain information-gathering provisions to ensure that the company prior and current year loss and debt deduction rules cannot be avoided where a non-resident entity is taking advantage of the 2 concessional tracing rules. Under these provisions the Commissioner can obtain information to ensure that the family trust concession or conditions associated with the alternative condition are complied with. It is also necessary to include information gathering provisions for the purpose of the company rules.

Explanation of the amendments

First concession family trust concession

9.31 This Bill will make amendments to the ITAA 1936 and the ITAA 1997 so that the family trust tracing concession available to trusts under the trust loss measures will also be available to companies. The concession that applies to trusts is contained in subsection 272-30(2) of Schedule 2F. Broadly, the concession will apply for the purposes of the company rules so that where the relevant interests in a company are held by a family trust, the trustee of the family trust will be taken to own the interests as an individual. [Part 1 of Schedule 9]

9.32 Amendments will be made to the ITAA 1936 for the purpose of the current year loss provisions (sections 50A to 50N) and the debt deduction provisions (sections 63A to 63C). Amendments will be made to the ITAA 1997 for the purpose of the current and prior year loss, capital loss and debt deduction provisions which are found in Divisions 165, 166 and 175.

What if a trust is interposed between a company and a family trust?

9.33 Amendments have been made which refer to the trustee of a family trust owning shares or an interest in shares. A trust may be interposed between the company and the family trust. In these circumstances, the trustee of a family trust will be treated as owning the shares or the interest in shares in the necessary sense provided that the trustee has a vested and indefeasible interest in the shares held by the interposed trust. Although the trustee is not the legal owner, it is an equitable, although not beneficial owner, of the shares.

What is a family trust?

9.34 The term family trust which is used in the amendments takes on the same meaning as in section 272-75 of Schedule 2F. Under this provision, a trust will be a family trust where the trustee of the trust has made an election (known as a family trust election) that the trust be a family trust and the election is in effect. A consequence of making a family trust election is that any distributions (broadly defined) outside the family group of the family trust by the trust will be taxed at the top marginal rate applying to individuals plus the Medicare levy.

Amendment of the ITAA 1936

Current year loss rules

Shareholding interests

9.35 Subsection 50H(1) identifies disqualifying events that are taken to have occurred for the purpose of the current year loss rules. A disqualifying event is the type of event or circumstance discussed at paragraph 9.8. The disqualifying events that are taken to have occurred under paragraphs 50H(1)(e), (f) and (g) deal with some of the tax avoidance arrangements described at paragraph 9.10. Under subsections50H(3), (4) and (6) a disqualifying event will be taken not to have occurred under those paragraphs where the Commissioner considers that benefits received by a person referred to in those subsections are reasonable having regard to their shareholding interests. Subsection50H(7) defines when a person has a shareholding interest.

9.36 This Bill will replace paragraph 50H(7)(a) so that a person will be taken to have a shareholding interest in a company if:

·
the person is the beneficial owner of, or of an interest in, any shares in the company (this reflects the existing paragraph50H(7)(a)); or
·
the person is the trustee of a family trust who owns or has an interest in any of the shares of the company (this incorporates the family trust concession). [Item 1]

9.37 As a result of this amendment, a company may be able to meet the conditions set out in subsection 50H(3), (4) or (6) because the trustee of a family trust holds a shareholding interest.

Continuity of beneficial ownership

9.38 Section 50H (which sets out when a disqualifying event is taken to have occurred) and subsection 50D(2) (which determines whether an amount can be taken into account in determining an eligible notional loss in the income year) contain continuity of beneficial ownership tests. These provisions refer to natural persons who beneficially own shares in a company. A provision will be inserted into section 50K (which contains special provisions relating to the ownership tests) to provide that where the trustee of a family trust owns shares in a company, the trustee will be taken to beneficially own the shares [item 2, new subsection50K(1A)] . Section 50K also applies for the purpose of section 50J which specifies when a natural person is (or under subsection 50J(6) is taken to be) the beneficial owner of shares in a company where the interests in the shares are held through an interposed company or companies.

9.39 The trustee of a family trust may not be a natural person or persons but a company. If the trustee of the family trust is a company which is taken to be the beneficial owner of shares as a result of new subsection 50K(1A) or subsection 50J(6) (or both those subsections), the company trustee will be taken to be a natural person [item 3, new section 50KA] . As a result of this provision, a company trustee of a family trust will be treated as having the same ownership rights as a natural person.

Debt deduction rules

Continuity of beneficial ownership

9.40 This Bill inserts a new provision into section 63A so that for the purposes of the continuity of ownership tests in subsections 63A(2) and 63A(6), the trustee of a family trust that owns shares in the company will be taken to beneficially own the shares [item 6, new subsection 63A(6A)] . Because this amendment applies only for the purposes of subsections 63A(2) and (6), the trustee of a family trust that is a company will not be taken to beneficially own the shares for the purposes of the tracing rules in subsections 63A(3) and (7) [F4] .

9.41 Subsection 63A(9) provides rules to trace rights to dividends and capital through interposed companies and trusts for the purpose of subsections 63A(4) and 63A(8) (see paragraph 9.42). This is done by looking at who would have beneficially received the dividends or capital if they were distributed through the interposed companies and trusts. The operation of this provision will be modified so that the requirement that a person must have received the amount otherwise than in the capacity of trustee is to be disregarded in the case of a trustee of a family trust [item8, subsection 63A(9A)] . This amendment, together with that discussed in paragraph 9.42, will ensure that the trustee of a family trust will be taken to indirectly receive the amounts as a person for his or her own benefit.

9.42 Paragraphs 63A(4)(b) and (c) and 63A(8)(b) and (c) refer to the right of a person or persons (not being a company) to directly or indirectly receive dividends or distributions of capital from a company for his or her own benefit. For this purpose, a trustee of a family trust will be taken to have that right for his or her own benefit. In relation to the right to indirectly receive dividends or distributions of capital, subsection 63A(9) will apply in accordance with new subsection 63A(9A) as described above. If the trustee of a family trust is a company it will be taken not to be a company. [Item 8, new subsection 63A(9B)]

Shareholding interests

Section 63B is directed at the tax avoidance arrangements discussed at paragraph 9.10. Subsection 63B(5) defines the term shareholding interest.

9.44 This Bill will replace paragraph 63B(5)(a) so that a person will be taken to have a shareholding interest in a company for the purposes of subsection 63B(4) if:

·
the person is the beneficial owner of or has an interest in any shares in the company (this reflects the existing paragraph63B(5)(a)); or
·
the person is the trustee of a family trust who owns or has an interest in any of the shares of the company (this incorporates the family trust concession). [Item 9]

9.45 As a result of this amendment, a company may be able to deduct a debt, where the deduction may otherwise be disallowed by the Commissioner under section 63B, because a family trust has a shareholding interest.

Related amendments

9.46 This Bill amends subsections 63A(2), (4), (6) and (8) by inserting a reference to new section 63CB after the reference to section63C. The amendment ensures that those subsections are subject to the operation of new section 63CB . This section operates to disallow a company a deduction for a debt where the company has not given the Commissioner certain information in respect of a non-resident family trust that holds an interest in a company [items 5 and 7] . The information requirements are explained at paragraphs 9.72 to 9.83.

Amendment to the ITAA 1997

Continuity of beneficial ownership

9.47 The beneficial ownership rules for the prior year, current year and capital loss and debt deduction rules are contained in the primary and alternative tests set out in Subdivision 165-D (sections 165-150 to 165-160) of the ITAA 1997. This Bill will insert a new section into Subdivision 165-D of Division 165 to provide as follows:

·
for the purposes of the primary test, the trustee of a family trust who owns shares in a company is taken to be the beneficial owner of the shares;
·
for the purposes of the alternative test, the trustee of a family trust who has the right to receive, directly or indirectly, any dividend or distribution of capital is taken to have the right to receive the dividend or distribution for the trustees own benefit. If the trustee of a family trust is a company, the trustee will be taken not to be a company. [Item 11, new section 165-207]

9.48 This Bill inserts a definition of the term family trust in the Dictionary at subsection 995-1(1). It is defined as having the same meaning as in section 272-75 of Schedule 2F [F5] . [Item 15]

9.49 Special tracing rules that apply to listed public companies are contained in Division 166. Subsection 166-165(1) ensures that certain rules contained in Division 165 also apply for the purpose of Division 166. This subsection will be replaced so that the rule contained in new subsection 165-207(2) will also apply for the purpose of the special tracing rules that apply to listed public companies. [Item 12]

Shareholding interests

9.50 Division 175 of the ITAA 1997 contains the rules that apply to the tax avoidance arrangements discussed at paragraph 9.10, 9.12 and 9.14. It contains rules for prior and current year losses, net capital losses of an earlier income year, current year capital losses and debt deductions. Section 175-95 sets out when a person has a shareholding interest in a company for the purposes of sections 175-15, 175-20, 175-25, 175-30, 175-50, 175-60, 175-65, 175-70 and 175-90 [F6] . This Bill will replace subsection 175-95(1) so that a person will have a shareholding interest in the company not only where the person is the beneficial owner of shares or of an interest in shares in the company but also if the person is the trustee of a family trust which owns shares or an interest in shares in the company. [Item 13]

9.51 The effect of the amendment is that the Commissioner will not be able to disallow a tax loss, net capital loss of an earlier income year, capital loss of the current year or other deduction of a company under the above sections in some additional cases. Broadly, this would be where the benefits referred to in those sections flow to the trustee of a family trust that has a shareholding interest in the company and the extent of the benefit is fair and reasonable having regard to the extent of the family trusts shareholding interest in the company.

Second concession - alternative condition

9.52 This Bill will make amendments to the ITAA 1936 and the ITAA1997 so that the alternative condition that is available to fixed trusts under section 266-45 in Schedule 2F will also be available to companies. [Part 3 of Schedule 9]

9.53 This Bill will make amendments to the ITAA 1936 for the purpose of the current year loss rules and debt deduction rules and amendments to the ITAA 1997 for the purpose of the prior year and current year loss and the debt deduction rules. A special alternative is not required for the capital loss rules because:

·
the ability of a company to set off a net capital loss of an earlier income year is subject to the same conditions that it must satisfy to deduct a tax loss of an earlier income year;
·
the requirement for a company to work out its net capital gain and net capital loss under special rules is subject to whether the company is required to calculate its taxable income and tax loss under special rules for the income year of change.

This Bill will insert Notes after subsection 165-96(1) and paragraph 165-102(a) which deal with capital losses to alert readers to the special alternative condition contained in Subdivision 165-F [items 32 and 33] .

9.54 Certain expressions which have been used in Schedule 2F are also used in the provisions which make the alternative condition available to companies. These terms which include control a non-fixed trust , directly or indirectly , fixed trust , excepted trust , family trusts , fixed entitlement , group , more than a 50% stake and non-fixed trust are given the same meanings as in Schedule 2F [items 22, 23, 28 and 35, new paragraph 50H(1A)(d) and new subsections 50HA(6), 63AA(6) and 63AB(6) of the ITAA 1936 ; new section 165-245 of the ITAA 1997] . A glossary of terms is provided in the Appendix at the end of this Chapter.

9.55 The alternative condition is available for the purpose of the prior and current year loss, capital loss and debt deduction rules if the company satisfies the tests contained in the alternative condition. [Items 22, 23, 28 and 35 ; new subsections 50H(1A), 50HA(1), 63AA(1) and 63AB(1) of the ITAA 1936 ; new subsections 165-215(1), 165-220(1) and 165-230(1) of the ITAA 1997]

When can the alternative condition be applied?

9.56 The condition will apply where individuals do not , directly or indirectly, hold fixed entitlements to more than 50% of the income or capital of the company at the start of the relevant period and either of the 2 conditions below are met.

·
Fixed entitlements to 50% or more of the income or capital of a company must be held, throughout the relevant period, by a non-fixed trust or trusts (other than family trusts).
·
Both of the following are satisfied:

-
fixed entitlements to all the income and capital of the company are held, directly or indirectly and throughout the relevant period, by a fixed trust or another company (the holding entity ); and
-
a non-fixed trust or trusts (other than family trusts) hold, throughout the relevant period, fixed entitlements to a 50% or greater share of the income or capital of the holding entity.

[Items 23, 28 and 35 ; new subsections 50HA(2) and (4), 63AA(2) and (4) and 63AB(2) and (4) of the ITAA 1936 ; new subsections 165-215(2) and (4), 165-220(2) and (4) and 165-230(2) and (4) of the ITAA 1997]

When is the alternative condition met?

9.57 The 2 requirements set out below must be satisfied if the alternative condition is to be met.

·
Where the company is held directly by the non-fixed trusts, there must be no change in the persons directly holding, throughout the relevant period, fixed entitlements to shares of the income or capital of the company nor the percentage of their shares. Where the company is held, directly or indirectly, by a holding entity (see paragraph 9.56), this requirement is instead applied to the holding entity rather than the company [items 23, 28 and 35 ; new subsections 50HA(3), 63AA(3) and 63AB(3) of the ITAA 1936 ; new subsections 165-215(3), 165-220(3) and 165-230(5) of the ITAA 1997] .
·
Every non-fixed trust (that is not a family trust or other excepted trust) that holds, at any time in the relevant period, fixed entitlements in the company, directly or indirectly, must satisfy the relevant tests that apply to non-fixed trusts if they stood in place of the loss company [items 23, 28 and 35 ; new subsections 50HA(5), 63AA(5) and 63AB(5) of the ITAA 1936 ; new subsections 165-215(5), 165-220(5) and 165-230(5) of the ITAA 1997] .

What are the relevant periods for applying the alternative condition?

9.58 The relevant period for the purposes of the conditions discussed in paragraphs 9.56 and 9.57 depends on whether the alternative condition is being applied for prior year loss, current year loss or debt deduction purposes. The following table sets out what the relevant period is.

Table 9.1 Relevant period for the purposes of the conditions discussed in paragraphs 9.56 and 9.57
Rule for which the alternative condition is being applied Relevant period for meeting either condition
Prior year losses All times during the loss year and the income year. [New subsection 165-215(2) of the ITAA 1997]
Current year losses All times during the year of income. [New subsection 50HA(2) of the ITAA 1936; new subsection 165-220(2) of the ITAA 1997]
Earlier year debts All times during the earlier year of income from the day the debt was incurred and at all times in the year of income. [New subsection 63AA(2) of the ITAA 1936; new subsection 165-230(2) of the ITAA 1997]
Current year debts All times during the year of income. [New subsection 63AB(2) of the ITAA 1936; new subsection 165-230(2) of the ITAA 1997]

Tests to be satisfied by non-fixed trusts

9.59 Under the condition discussed in the second dot point at paragraph 9.57, non-fixed trusts which hold, directly or indirectly, a fixed entitlement to a share of the income or capital of the company are required to meet certain tests under Schedule 2F. The loss deductibility tests for non-fixed trusts are a 50% stake test, a control test and a pattern of distributions test. The pattern of distributions test is, however, not applicable for current year loss purposes. The tests that apply for debt deduction purposes depend on whether the debt was incurred in a prior year income or the current income year. For prior year loss purposes, any non fixed trust that holds the interest in the company will have to apply the tests throughout the test period that applies for trust loss purposes (ie. the period from the start of the loss year to the end of the income year) see section 267-20 in Schedule 2F.

Related Amendments

ITAA 1936

9.60 This Bill amends subsections 50H(1) and 63A(2), (4), (6) and (8) of the ITAA 1936 which contain the continuity of ownerships tests for the purpose of the current year loss rules and debt deduction provisions. The amendments insert the section number which contains the alternative condition so that the operation of those subsections are subject to the alternative condition. [Items 21, 24, 25, 26 and 27]

ITAA 1997

9.61 A company cannot deduct a tax loss unless it meets the rules set out in section 165-10. The condition set out in paragraph 165-10(a) provides that a company cannot deduct a tax loss unless it satisfies the ownership tests set out in section 165-12.

9.62 This Bill will insert a Note after paragraph 165-10(a) to direct readers to the alternative condition in new section 165-215 that may be available if a company cannot meet these ownership tests. [Item 29]

9.63 A company must calculate its taxable income and tax loss in a special way if it does not meet the conditions contained in section 165-35. The condition contained in paragraph 165-35(a) requires that persons must meet an ownership test (ie. hold more than a 50% stake in the company) during the whole of the income year.

9.64 This Bill will insert a Note after paragraph 165-35(a) to direct readers to the alternative condition contained in new section 165-220 that may be available to a company if it cannot meet the ownership test. [Item30]

9.65 A company cannot deduct a bad debt unless it meets the rules in section 165-120. The condition set out in paragraph 165-120(1)(a) provides that a company cannot deduct a bad debt unless it satisfies the ownership tests set out in section 165-123.

9.66 This Bill will insert a Note after paragraph 165-120(1)(a) to direct readers to the alternative condition contained in new section 165-230 that may be available to a company seeking to deduct a bad debt if it cannot meet the ownership test. [Item 34]

Special rules for current year losses - dividing the year of income into periods

ITAA 1936

9.67 As outlined in paragraph 9.11 above, the current year loss rules apply where an event described in that paragraph occurs in relation to the company during the income year. Section 50H of the ITAA 1936 lists such events or circumstances which are referred to as disqualifying events. If one or more disqualifying events are deemed to have occurred during the income year, the income year is divided into relevant periods. The start or end of a period is determined according to the time a disqualifying event is deemed to have occurred.

9.68 This Bill will insert new provisions into section 50H which set out when a disqualifying event will be deemed to have occurred where the company satisfies 2 conditions which are set out in new subsections 50HA(2) and (4) [item 23] . These are the conditions that a company must meet before the alternative condition can be applied (see paragraph 9.56 above). If the company satisfies these conditions then, instead of paragraphs 50H(1)(a), (b) and (c) applying, a disqualifying event will be taken to have occurred when:

·
the persons holding the fixed entitlements in the company (or holding entity), or the percentages that the persons hold, changes;
·
a non-fixed trust (other than an excepted trust) that holds a direct or indirect fixed entitlement in the company fails to meet the 50% stake condition;
·
a group begins to control one of the non-fixed trusts (other than excepted trusts) that holds a direct or indirect fixed entitlement in the company. [Item 22 ; new subsection 50H(1B)]

ITAA 1997

9.69 Under section 165-35 of the ITAA 1997 a company must calculate its taxable income or tax loss in a special way if the conditions set out in that section are not satisfied. For the purpose of calculating the companies taxable income under those provisions, the income year must be divided into periods under the rules set out in section 165-45.

9.70 This Bill will insert a Note after section 165-45 which will direct readers to new section 165-225 [item 31] . This section will substitute the rules contained in section 165-45 where:

·
the company does not meet the requirement contained in paragraph 165-35(a);
·
the two requirements that must be satisfied if the alternative condition is to be applied are not satisfied, ie. the requirements contained in new subsections 165-220(2) and (4) (see paragraph 9.56).

9.71 Under the substituted rules a period will end where one of the following events occur:

·
when the persons holding the fixed entitlements in the company (or holding entity), or the percentages that the persons hold, changes;
·
the latest time at which all the non-fixed trusts (other than excepted trusts) holding a direct or indirect fixed entitlement in the company meet the 50% stake condition in relation to the start of the period;
·
the first time a group begins to control one of the non-fixed trusts (other than excepted trusts) that holds a direct or indirect fixed entitlement in the company. [Item 35 ; new section 165-225]

Provisions relating to non-resident trusts

9.72 Provisions are included in this Bill to ensure that the trust loss and company loss measures cannot be avoided where non-resident trusts are concerned. These provisions do not need to be considered by resident taxpayers who are not connected to a non-resident entity.

What is a non-resident trust?

9.73 For the purposes of the explanation in this Chapter, the term non-resident trust means a trust where either a trustee is a non-resident or the central management and control of the trust is outside Australia.

Information about non-resident family trusts with interests in a company

9.74 This Bill includes provisions to allow the Commissioner to require a company to give information in certain cases about conferrals of present entitlement to, or distributions of, income or capital [F7] of non-resident family trusts that hold interests in the company. If this information is not given, the company will be taken not to have satisfied the relevant requirements that would allow it to deduct a current or prior year loss, apply a net capital loss of an earlier or current year, or to deduct an amount in respect of a debt. [Items 4, 10 and 14 ; new sections 50P, 50Q, 63CA and 63CB of the ITAA 1936 ; new sections180-5, 180-10, 180-15 and 180-20 of the ITAA 1997]

9.75 The information will allow the Commissioner to determine whether any family trust distribution tax is payable in respect of conferrals of present entitlement to, or distributions of, income or capital of the non-resident family trusts. Under the trust loss measures, a liability for family trust distribution tax arises where a trustee of a trust has made a family trust election and the trustee makes conferrals or distributions outside the family group. The rules that apply to the payment of this tax are explained in Chapter 11 of the Explanatory Memorandum that accompanied the Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998 .

When can a notice be given?

9.76 The Commissioner can give a notice to a company where the company is able to satisfy the tests for deducting a prior or current year loss, applying earlier or current year capital losses or deducting an amount in respect of a debt only because one or more non-resident trusts that hold the relevant interests in the company are family trusts. [Items 4, 10 and 14 ; new subsections 50P(2) to (4), 63CA(2) and (3) of the ITAA 1936 ; subsections 180-5(2) to (4) and 180-15(2) to (4) of the ITAA 1997]

9.77 The Commissioner must give the notice to the company before the later of :

·
5 years after the income year to which the return relates; and
·
the end of the period in which the company is required to keep records under section 262A of the ITAA 1936 in relation to the income year mentioned above. [Items 4, 10 and 14 ; new subsections 50P(5) and 63CA(4) of the ITAA 1936 ; new subsections 180-5(5) and 180-15(5) of the ITAA 1997]

What information can be requested?

9.78 Under the notice, the Commissioner can require the company to provide information in respect of conferrals of present entitlement to, or distributions of, income or capital of the non-resident family trusts. The Commissioner can require information on conferrals or distributions from the times set out in Table 9.2 below.

Table 9.2 Conferrals and distributions since the following times can be required by the Commissioner
Rules being applied by the company Commissioner can require information about conferrals and distributions since the following times.
Prior year losses The start of the loss year of the company. [New paragraphs 180-10(1)(a) and 180-20(1)(a) of the ITAA 1997]
Current year losses The start of the year of income to which the companies return relates. [New subsection 50Q(1) of the ITAA 1936; new paragraphs 180-10(1)(b) and 180-20(1)(b) of the ITAA 1997]
Net capital loss of the current income year The start of the current income year. [New paragraphs 180-10(1)(b) and 180-20(1)(b) of the ITAA 1997]
Net capital loss of an earlier income year The start of the earlier income year. [New paragraphs 180-10(1)(c) and 180-20(1)(c) of the ITAA 1997]
Earlier year debts The start of the day in the year of income in which the debt was incurred. [New paragraph 63CB(1)(a) of the ITAA 1936; new paragraph s180-10(1)(d) and 180-20(1)(e) of the ITAA 1997]
Current year debts The start of the year of income to which the companies return relates. [New paragraph 63CB(1)(b) of the ITAA 1936; new paragraphs 180-10(1)(d) and 180-20(1)(d) of the ITAA 1997]

9.79 The information need not be within the knowledge of the trustee at the time the notice is given [items 4, 10 and 14; new subsections 50Q(2) and 63CB(2) of the ITAA 1936; new subsections 180-10(2) and 180-20(2) of the ITAA 1997] .

9.80 The notice must specify a time within which the company is to provide the Commissioner with the information. The Commissioner must allow a period of at least 21 days commencing on the date that the notice was given [new subsections 50Q(3) and 63CB(3) of the ITAA 1936; new subsections 180-10(3) and 180-20(3) of the ITAA 1997] . The Commissioner can extend the time for compliance with the notice.

What are the consequences of not giving the information?

9.81 If a company does not comply with the request for information, it will be taken not to have satisfied the relevant tests under the prior or current year loss, capital loss or the debt deduction rules and thus:

·
the company is not entitled to deduct the tax loss or an amount in respect of a debt [item 10 ; new subsection 63CB(4) ; item 14, new paragraphs 180-10(4)(a) and (d) of the ITAA 1997] or the Commissioner is not prevented from disallowing a tax loss or other deduction under Division 175 [item 14 ; new paragraph 180-20(4)(a) of the ITAA 1997] ;
·
the company must calculate its taxable income or tax loss in accordance with the current year loss rules in sections 50A to 50N of the ITAA 1936 or Subdivision 165-B of the ITAA 1997 [items 4 and 14 ; new subsection 50Q(4) of the ITAA 1936 ; new paragraph 180-10(4)(b) of the ITAA 1997] ;
·
the company is not entitled to apply a net capital loss of an earlier income year [item 14 ; new paragraph 180-10(4)(c) of the ITAA 1997] or the Commissioner is not prevented from disallowing a net capital loss of an earlier income year under Division 175-CA [item 14, new paragraph 180-20(4)(b) of the ITAA 1997] ;
·
the company must calculate its net capital gain and net capital loss for the income year under Subdivision 165-CB of the ITAA 1997 [item 14 ; new paragraph 180-10(4)(b) of the ITAA 1997] or the Commissioner is not prevented from disallowing a capital loss under Subdivision 175-CB [item 14, new paragraph 180-20(4)(c) of the ITAA 1997] .

9.82 If the company is required to calculate its taxable income or tax loss under Subdivision 165-B or required to calculate a net capital gain or loss for an income year under Subdivision 165-CB, the provisions are to be applied as if they required the year of income to be divided into such relevant periods as would result in the highest possible taxable income for the year of income or as would result in the highest net capital gain for the current year. [New subsection 50Q(5) of the ITAA 1936 ; new subsections 180-10(5) and (6) of the ITAA 1997]

No offences or penalties

9.83 The mere fact that a company fails to provide the Commissioner with the required information so that the consequences outlined above apply does not mean that the company will be taken to have committed an offence or be liable to any penalty under Part VII of the ITAA 1936 for claiming a loss or debt deduction or for not working out the companies taxable income and tax loss under Subdivision 165-B or not calculating a net capital gain or net capital loss under Subdivision 165-CB on lodging the return. Whether the provisions of Part VII of the ITAA 1936 apply would require a separate finding by the Commissioner. [Items 4, 10 and 14 ; new subsections 50Q(6) and 63CB(5) of the ITAA 1936 ; new subsections 180-10(7) and 180-20(5) of the ITAA 1997]

Information about non-resident non-fixed trusts with interests in company

9.84 This Bill includes provisions to allow the Commissioner to require a company to provide certain information to the Commissioner where the company has satisfied the alternative condition. If the company does not provide the information requested by the Commissioner, it will be taken never to have met the condition that would allow it to deduct a current or prior year loss or an amount in respect of a debt. [Items 23, 28, 35 ; new sections 50HB, 50HC, 63AC and 63AD of the ITAA 1936 ; new sections 165-235 and 165-240 of the ITAA 1997]

9.85 This information is needed for the purposes of determining whether the requirements in relation to any non-fixed trust that holds a direct or indirect fixed entitlement in the company are met. One of the tests of the alternative condition is that every non-fixed trust (that is not a family trust or other excepted trust) that holds a fixed entitlement, directly or indirectly, in the company is required to satisfy the relevant tests that apply to non-fixed trusts if they stood in place of the loss company.

When can a notice be given?

9.86 The Commissioner can give a notice to a company where, in relation to a year of income, a company is:

·
able to deduct a tax loss incurred in a loss year;
·
not required to calculate its taxable income and tax loss in accordance with the current year loss rules in sections 50A to 50N of the ITAA 1936 or Subdivision 165-B of the ITAA 1997;
·
the company has not calculated a net capital gain and net capital loss under Subdivision 165-CB;
·
in working out a net capital gain or net capital loss for a current year the company has applied a net capital loss for an earlier income year;
·
able to deduct a debt that it wrote off as bad in the income year;

only because it met the alternative conditions contained in new sections 50HA, 63AA or 63AB of the ITAA 1936 or new section 165-215, or 165-220 or 165-230 of the ITAA 1997. The non-fixed trusts must be non-resident at the time the Commissioner gives the notice. [Items 23, 28 and 35 ; new subsections 50HB(2) to (4) and 63AC(2) to (4) of the ITAA 1936 ; new subsections 165-235(2) to (4) of the ITAA 1997]

9.87 The Commissioner must give the notice to the company before the later of:

·
5 years after the income year in which the company deducted a tax loss or an amount in respect of a debt, did not work out its taxable income or tax loss in accordance with the current year loss rules in sections 50A to 50N of the ITAA 1936 or Subdivision 165-B of the ITAA 1997 or did not work out its net capital gain and net capital loss under Subdivision 165-CB; and
·
the end of the period in which the company is required to keep records under section 262A of the ITAA 1936 in relation to the income year mentioned above.

[Items 23, 28 and 35, new subsections 50HB(5) and 63AC(5) of the ITAA 1936; new subsection 165-235(5) of the ITAA 1997]

What information can be requested?

The notice must set out information that the Commissioner requires. This information need not be within the knowledge of the company at the time the notice is given. [Items 23, 28 and 35 ; new subsections 50HC(1) and (2), 63AD(1) and (2) of the ITAA 1936 ; new subsections 165-240(1) and (2) of the ITAA 1997]

9.89 Under the notice, the Commissioner can seek information on transactions or acts and other matters that would enable him or her to determine whether a non-fixed trust has satisfied the conditions set out in the alternative condition. These are the conditions that need to be satisfied by a non-fixed trust before a prior or current year loss or debt deduction can be deducted. This would include information on distributions of income or capital made by the non-fixed trust, any changes in control of the non-fixed trust and also whether there have been any changes in individuals who hold fixed entitlements in the non-fixed trust. As part of this information-gathering process, the Commissioner may request a copy of the trust deed of the non-fixed trust or other relevant documents relating to the non-fixed trust.

9.90 The notice must specify a time within which the company is to provide the Commissioner with the information. The Commissioner must allow a period of at least 21 days commencing on the date the notice was given [items 23, 28 and 35 ; new subsections 50HC(3) and 63AD(3) of the ITAA 1936 ; new subsection 165-240(3) of the ITAA 1997] . The Commissioner can extend the time for compliance with the notice.

What are the consequences of not giving the information?

9.91 If a company does not comply with the request for information, the company will be taken not to have satisfied the conditions set out in the alternative condition and thus:

·
the company is not entitled to deduct the tax loss [item 35 ; new subsection 165-240(4) of the ITAA 1997] ;
·
the company must calculate its taxable income or tax loss for the year of income in accordance with the current year loss rules in sections 50A to 50N of the ITAA 1936 or Subdivision 165-B of the ITAA 1997 [items 23 and 35 ; new subsection 50HC(4) of the ITAA 1936 ; new subsection 165-240(4) of the ITAA 1997] ;
·
the company must not have calculated a net capital gain and net capital loss under Subdivision 165-CB [item 35 ; new subsection 165-240(4) of the ITAA 1997] ;
·
the company cannot apply a net capital loss for an earlier income year [item 35 ; new subsection 165-240(4) of the ITAA 1997] ;
·
the company is not allowed a deduction for an amount in respect of a debt [items 28 and 35 ; new subsection 63AD(4) of the ITAA 1936 ; new subsection 165-240(4) of the ITAA 1997] .

9.92 If the company is required to work out its taxable income or tax loss under Subdivision 165-B or required to calculate a net capital gain or a net capital loss for an income year under Subdivision 165-CB, the provisions are to be applied as if they required the year of income to be divided into such relevant periods as would result in the highest possible taxable income for the year of income or as would result in the highest net capital gain for the current year. For this purpose, a period could have a minimum length of one day. [Items 23 and 35 ; new subsection 50HC(5) of the ITAA 1936 ; new subsections 165-240(5) and (6) of the ITAA 1997]

No offences or penalties

9.93 The mere fact that a company fails to provide the Commissioner with the required information so that the consequences outlined in paragraph 9.91 apply, does not mean that the company will be taken to have committed an offence or be liable to any penalty under Part VII of the ITAA 1936 for claiming a loss or debt deduction or for not working out the companies taxable income or tax loss under Subdivision 165-B or not working out a net capital gain or net capital loss under Subdivision 165-CB on lodging the return. Whether the provisions of Part VII apply would require a separate finding by the Commissioner. [Items 23, 28 and 35 ; new subsections 50HC(6) and 63AD(5) of the ITAA 1936 ; new subsection 165-240(7) of the ITAA 1997]

Recoupment of family trust distribution tax from companies that have benefited from the family trust concession

9.94 Section 271-60 of Schedule 2F contains special rules to provide that family trust distribution tax imposed by the Family Trust Distribution Tax (Secondary Liability) Act 1997 is payable in certain circumstances. The circumstances arise where a non-resident entity becomes liable for family trust distribution tax under Family Trust Distribution Tax (Primary Liability) Act 1997 and the Commissioner is unable to recover the tax because of territorial limitations.

9.95 Section 271-60 of Schedule 2F essentially provides that if family trust distribution tax is not paid by a non-resident family trust which holds an interest in a resident trust, then the resident trust will be liable for the tax. This will be the case if the resident trust has passed the continuity of ownership (50% stake) test only because the non-resident family trust holds the interest. Chapter 12 of the Explanatory Memorandum to the Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998 provides more detail.

9.96 This Bill will make a consequential amendment to section 271-60 in Schedule 2F to take into account the extension of the family trust tracing concession to companies [Part 2, Schedule 9] . The amendment will provide that if family trust distribution tax is not paid by a non-resident family trust with an interest in a resident company, then the company will be liable for the tax. This will be the case if the company was able to deduct a tax loss or amount in respect of a debt, apply a net capital loss of an earlier income year or was not required to work out its taxable income or tax loss under Subdivision 165-B or did not work out its net capital gain or its net capital loss under Subdivision 165-CB only because the non-resident family trust held the interest. [Items 17, 18, 19]

Commencement and application provisions

9.97 The amendments made by Schedule 9 will commence when this Bill commences. [Subclause 2(1)]

Application of the family trust concession

ITAA 1936

9.98 The amendments made to the ITAA 1936 to introduce the family trust concession will apply as follows:

·
in the case of the current year loss provisions (sections 50A to 50N) for the 1996-97 year of income [subitem 16(1)] ;
·
in the case of the debt deduction provisions (sections 63A to 63C) to debts incurred in the 1996-97 or 1997-98 years [subitem16(2)] .

ITAA 1997

9.99 The amendments made to the ITAA 1997 to introduce the family trust concession will apply as follows:

·
in the case of amendments that affect the prior year loss rules (Subdivisions 165-A and 166-A) where the loss year is the 1996-97 income year or any later income year and the income year is the 1997-98 income year or later income year [subitem16(3)(a))] ;
·
in the case of amendments made to the current year loss rules (Subdivisions 165-B and 166-B) where the income year is the 1997-98 income year or any later income year [subitem 16(3)(b)] ;
·
in the case of amendments that affect the application of net capital losses of an earlier income year or the calculation of net capital gains or losses of an income year (Subdivisions 165-CA and 165-CB) where the current year or income year referred to is the 1998-99 income year or later income year [subitem 16(3)(c)] ;
·
in the case of amendments that affect the debt deduction provisions (Subdivision 165-C) where the debts were incurred in the 1996-97 income year or any later income year and the income year referred to is the 1998-99 income year or any later income year [subitem 16(3)(d)] ;
·
in the case of amendments that affect provisions that deal with tax benefits from unused losses (Subdivision 175-A) where the loss year is the 1996-97 income year or any later income year and the income year is the 1997-98 income year or any later income year [subitem 16(4)(a)] ;
·
in the case of amendments that affect provisions dealing with tax benefits from unused deductions (Subdivision 175-B) where the income year is the 1997-98 income year or any later income year [subitem 16(4)(b)] ;
·
in the case of amendments that affect provisions dealing with tax benefits from unused net capital losses of earlier years or unused capital losses of a current year (Subdivision 175-CA or 175-CB) where the income year is the 1998-99 income year of any later income year [subitem 16(4)(c)] ;
·
in the case of amendments that affect the provisions dealing with tax benefits from unused bad debt deductions (Subdivision 175-C) where the debts were incurred in the 1996-97 income year or any later income year and the income year referred to is the 1998-99 income year or any later income year [subitem16(4)(d)] ;
·
in the case of information gathering rules for Subdivision 165-A (paragraph 180-5(2)(a)) where the loss year is the 1996-97 or later income year and the income year is the 1997-98 income year or any later income year [subitem 16(5)(a)] ;
·
in the case of information gathering rules for Subdivision 165-B (subparagraph 180-5(2)(b)(i)) where the income year is the 1997-98 income year or any later income year [subitem 16(5)(b)] ;
·
in the case of information gathering rules for Subdivision 165-CA or 165-CB (subparagraph 180-5(2)(b)(ii) or paragraph 180-5(2)(c)) where the income year is the 1998-99 income year or any later income year [subitem 16(5)(c)] ;
·
in the case of information gathering rules for Subdivision 165-C (paragraph 180-5(2)(d)) where the debt was incurred in the 1996-97 income year or any later income year and the income year referred to is the 1998-99 income year or any later income year [subitem 16(5)(d)] ;
·
in the case of information gathering rules for Subdivision 175-A (paragraph 180-15(2)(a)) where the loss year is the 1996-97 income year or any later income year and the income year is the 1997-98 income year or any later income year [subitem 16(6)(a)] ;
·
in the case of information gathering rules for Subdivision 175-B (paragraph 180-15(2)(b)) where the income year is the 1997-98 income year or any later income year [subitem 16(6)(b)] ;
·
in the case of information gathering rules for Subdivisions 175-CA or 175-CB (paragraph 180-15(2)(c) or (d)) where the income year is the 1998-99 income year or any later income year [subitem 16(6)(c)] ;
·
in the case of information gathering rules for Subdivision 175-C (paragraph 180-15(2)(e)) where the debt was incurred in the 1996-97 income year or any later income year and the income year referred to is the 1998-99 income year or any later income year [subitem 16(6)(d)] .

Application of the alternative condition

ITAA 1936

9.99 The amendments to the ITAA 1936 to introduce the alternative condition will apply as follows:

·
in the case of the current year loss provisions (sections 50A to 50N) the 1996-97 year of income [subitem 36(1)] ;
·
in the case of the debt deduction provisions (sections 63A to 63C) to debts incurred in the 1996-97 or 1997-98 years of income [subitem 36(2)] .

ITAA 1997

9.100 The amendments made to the ITAA 1997 apply as follows:

·
in the case of amendments affecting the prior year loss rules (Subdivision 165-A) where the loss year is the 1996-97 income year or any later income year and the income year mentioned in that Subdivision is the 1997-98 income year or any later income year [subitem 36(3)] ;
·
in the case of amendments affecting the current year loss rules (Subdivision 165-B) where the income year is the 1997-98 income year or any later income year [subitem 36(4)] ;
·
in the case of amendments affecting the application of net capital losses of earlier income years (Subdivision 165-CA) where the current year is the 1998-99 income year or any later income year [subitem 36(5)] ;
·
in the case of amendments that affect the working out of a net capital gain and net capital loss of an income year (Subdivision 165-CB) where the income year is the 1998-99 income year or any later income year [subitem 36(5)] ;
·
in the case of amendments affecting the debt deduction rules (Subdivision 165-C) to debts incurred in the 1996-97 income year or any later income year and the current year referred to is the 1998-99 income year or later income year [subitem 36(6)] .

9.101 The amendments to the recoupment provisions will apply in the same way as section 271-60 in Schedule 2F will for a trust covered by subsections 271-60(3) and (4), ie. in respect of any family distribution tax that becomes payable under section 271-15. However, the changes will only apply where the determination by the Commissioner that the tax must be paid is made after the commencement of the amendments. [Item20]

Regulation Impact Statement

Specification of policy objective

The purpose of these amendments is to extend to companies 2 concessional tracing rules (the family trust concession and the alternative condition ) that are available to trusts under the trust loss measures.

9.103 The amendments will improve the equity and efficiency of the taxation system as trusts and companies will be treated on a similar basis for the purpose of tracing interests. The amendments will also create certainty in the application of the law to companies in respect of tracing interests through non-fixed trusts.

Implementation

Nature of the amendments

9.104 The implementation of this measure involves amending the company loss and debt deduction rules in the tax law to make the 2 special tracing rules that are available to trusts under the trust loss measures available to companies.

9.105 Companies need to satisfy certain tests before prior year losses can be recouped in a later income year. Broadly, a company cannot deduct a loss incurred in a prior income year unless it satisfies a continuity of majority beneficial ownership test in both the loss year and the recoupment year.

9.106 If a company fails the continuity of ownership test, it may nevertheless be able to deduct the loss if it continues to carry on the same business as it carried on at the time of change. There are also additional rules to prevent the carry forward of a loss in certain circumstances.

9.107 Similar tests apply to limit the deductibility of a companies current year losses or bad debt deductions (including certain debt/equity swap deductions).

9.108 In applying the ownership tests, it may be necessary to trace through interposed entities to the underlying individuals who beneficially own interests in the company. This is also a necessary requirement in applying the ownership tests contained in the trust loss measures.

9.110 In applying the ownership tests that apply to trusts under the trust loss measures, there are 2 special tracing rules. These rules are the family trust concession and the alternative condition.

·
The family trust concession applies where a fixed interest in a loss trust or an entity interposed between the loss trust and underlying individuals is held by a family trust. The family trust is treated as an individual holding the interest for its own benefit.
·
The alternative condition applies for the purpose of the ownership test (50% stake test) that applies to fixed trusts. If the fixed trust is held by non-fixed trusts such that it is not able to pass the 50% stake test, the fixed trust can still deduct its losses if certain conditions are satisfied.

9.111 The company loss rules will be amended so that these tracing rules will be available to companies in the same way that they apply to trusts. For example, if a company is held 50% or more by discretionary trusts it will be able to carry forward its prior year losses if the tests contained in the alternative condition are met.

9.112 The concessions will be made available for the purpose of the company prior year loss provisions, the current year loss provisions and the debt deduction provisions.

Identification of implementation options

9.113 The amendments were considered to be the only viable option for implementing rules, consistent with those in the trust loss measures, to allow companies held by discretionary trusts to deduct losses and debts in appropriate cases.

Assessment of impact (costs and benefits) of the measure

Impact group identification (the following groups will be affected by the proposed amendments)

9.114 Persons who use companies to operate businesses or to carry on investment activities will be affected by the proposed amendments. Some trusts that have interests in companies will also be affected.

9.115 The companies that will be affected are those which have deductions including prior year losses and earlier year net capital losses. The total number of companies with prior year losses in the income year 1996-97 was 162,364 and those with earlier year net capital losses 17,983.

9.116 The measures will also affect the Australian Taxation Office (ATO) which will administer the measures.

Assessment of costs

Compliance costs

9.119 The family trust concession will result in some initial compliance costs as trusts wishing to be a family trust will need to make a family trust election. These costs will be minimal as many such trusts will have made the election for the purposes of the trust loss measures.

9.118 For the alternative condition, there will be some costs for companies in monitoring whether the non-fixed trusts which hold interests in the company will pass the tests that apply to non-fixed trusts under the trust loss measures.

9.119 The initial and recurrent costs of compliance associated with the company tracing rules is estimated to be minimal.

Administrative costs

9.120 The additional administrative costs to the ATO will be minimal.

Estimated costs

9.121 The cost to revenue of extending the family trust tracing concession to companies is estimated to be in the order of $10 million per annum.

9.122 It is estimated that the loss in revenue associated with the alternative condition will be negligible.

Assessment of Benefits

9.123 As indicated above, the proposed measures will not result in any gains to the revenue.

9.124 The benefit is that the changes will allay taxpayer concerns about whether companies held by discretionary trusts can deduct losses and debts. Also, the changes will create consistency between the trust loss provisions and the company loss provisions.

Consultation

9.125 It was not considered necessary to consult on the company tracing rules as extensive consultation took place on the same tracing rules contained in the trust loss measures.

9.126 The concessions were developed in response to taxpayer concerns that it was not possible to trace through discretionary trusts. The submissions received during the consultation process on the trust loss measures were taken into account in developing the rules. Submissions on the trust loss proposals were received from industry and professional bodies, and individual tax professionals and taxpayers.

Conclusion

9.127 The ATO and Treasury will monitor this taxation measure on a continuing basis. The Ato's existing consultative arrangements include the National Tax Liaison Group.

Appendix : meaning of terms taken from the trust loss measures
control a non-fixed trust Under the trust loss measures, control refers to control by a group (see group below). A group is taken to control a non-fixed trust under the criteria listed in subsection 269-95 in the trust loss measures. These criteria include having regard to matters such as having the power to obtain beneficial enjoyment (or control the application) of the income or capital of the trust (including the capacity to do so) and being in a position to control the trustee (including the ability to remove or appoint the trustee).
directly or indirectly Under the trust loss measures, the term directly or indirectly is relevant for the purposes of the continuity of ownership and control tests. For example, for the purpose of the ownership test for fixed trusts the concept of fixed entitlement (see fixed entitlement below) is used to measure an individuals ownership interest in a trust.
A person can hold a fixed entitlement in a trust, directly or indirectly, through interposed trusts, companies or partnerships (see section 272-20 in the trust loss measures). These terms also have a meaning affected by sections 272-25 and 272-30 in the trust loss measures. These provisions contain special tracing rules where fixed entitlements have to be traced through certain types of entities, for example, superannuation funds.
fixed trust Under section 272-65 in the trust loss measures, a fixed trust is a trust where all of the income and capital of the trust is the subject of fixed entitlements held by persons (see fixed entitlement below). For example, if some part of the income or capital of the trust may be distributed at the discretion of the trustee or other person, the trust is not a fixed trust.
excepted trust Under the trust loss measures, there are 6 kinds of trusts that are excepted trusts. These are family trusts; complying superannuation funds, complying approved deposit funds and pooled superannuation trusts; fixed unit trusts if all the direct and indirect fixed entitlements to income and capital of the trust are held by bodies exempt from tax under section 23 of the ITAA 1936 or Division 50 of the ITAA 1997; and deceased estates within a reasonable administration period (see section 272-100 in the trust loss measures).
fixed entitlement The concept of fixed entitlement in the trust loss measures is used to determine whether a trust has continuity of ownership (and, in the case of certain non-fixed trusts, control) of a trust. Subdivision 272-A in the trust loss measures sets out when a fixed entitlement is held in the income or capital of a company, trust or partnership.
In the case of a company, a shareholder who holds shares carrying the right to receive some or all of the dividends that may be paid by the company has a fixed entitlement to a share of the income of the company equal to the percentage of the total dividends represented by the dividends that the shareholder has a right to receive. Similar rules determine whether a shareholder has a fixed entitlement to a share of the capital of the company (see section 272-10 in the trust loss measures).
group For the purposes of the control test (see control of a non-fixed trust above) a group is defined in subsection 269-95(5) in the trust loss measures as a person; or a person and one or more associates; or 2 or more associates of a person.
more than a 50% stake The meaning for this is set out in subsection 269-50(1) in the trust loss measures and refers to individuals who have (between them), directly or indirectly, and for their own benefit, fixed entitlements to a greater than 50% share of the income or capital of the trust.
non-fixed trust A non-fixed trust has the meaning given by section 272-70 in the trust loss measures which is that a trust is a non-fixed trust if it is not a fixed trust.


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