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Ruling

Subject: Company losses - same business test

Question 1

Does the taxpayer currently pass the same business test to be able to utilise tax and capital losses from prior years under section 165-13 of the Income Tax Assessment Act 1997?

Answer

No.

Question 2

Will the taxpayer continue to pass the same business test if certain investments are undertaken and will it be able to utilise tax and capital losses from prior years under section 165-13 of the Income Tax Assessment Act 1997?

Answer

No.

This ruling applies for the following periods:

1 July 1999 to 30 June 2010

The scheme commences on:

1 July 1999

Relevant facts and circumstances

A number of years ago the taxpayer acquired additional equity from its shareholders through an issue of shares to fund a specific project.

The taxpayer invested in the specific project by indirectly acquiring an overseas company through the acquisition of an offshore entity. The offshore entity intended to develop and operate the project in an overseas country.

The taxpayer also resolved to invest in a number of plants with the development of a concept plant, followed by a larger commercially viable plant. The concept plant was held in a wholly owned entity, with the second plant held in another wholly owned entity.

The taxpayer then entered into an exclusive licence agreement with another entity so that it could supply its expertise and technology.

A few years later an administrator was appointed to the taxpayer

A Deed of Company Arrangement (DOCA) was executed, resulting in a purchaser taking a majority shareholding of the taxpayer.

A few years later the taxpayer elected to become the head entity of a tax consolidated group with effect from an earlier period.

The tax consolidated group initially comprised the wholly owned entities and the entity that held the intellectual property.

One consequence of the consolidation was that all losses within the consolidated group were transferred to the taxpayer with effect from the earlier period.

A short while later the taxpayer placed a bid or tender for a nearby plant. The tender was withdrawn before the tender process was completed.

Shortly thereafter the taxpayer entered into an agreement with Company Group.

In the next year or so another administrator was appointed to the taxpayer.

A DOCA was entered into with another company which resulted in the sale of all of the shares in an wholly owned entity and the exclusive licence owned by another entity being sold to Company Group.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

In summary, the taxpayer has admitted that it has failed the continuity of ownership test twice over the last few years. Once the continuity of ownership test fails, the taxpayer needs to rely on the same business test to claim any pre-existing tax losses.

The first change of ownership occurred a number of years ago. Prior to the change of ownership, the taxpayer was constructing a large item of plant for its first project, and this also continued after the first change of ownership. Therefore it was considered that the taxpayer had passed the same business test at that time.

The second change of ownership occurred a few years later. The taxpayer had been placed into administration, and the taxpayer had effectively conducted no business activities from that time until the change of ownership occurred, apart from trying to sell the entity itself. Therefore, as the taxpayer was not carrying on a business for many months prior to the change, the moment that the taxpayer commences any business after the change (even if it is the same business it conducted prior to entering administration), then it will actually fail the same business test.

Also, if it actually purchases an existing plant, it will also fail the transactions of a kind test as well, as it has only ever built these large items of plant previously. That would be the case even if the business asset it purchased was exactly the same one that it had previously constructed.

Therefore, based on the information provided, the taxpayer has not yet failed the same business test or the transactions test. However, if it carries on any business, or enters into a transaction that it had not previously conducted, then it will fail one or both of these tests, which would mean that it will not be able to claim the tax losses incurred prior to the second change of ownership from that time.

Detailed reasoning

Section 165-10 of the Income Tax Assessment Act 1997 (ITAA 1997) does not allow a company to deduct a tax loss unless it satisfies either the continuity of ownership test, or the same business test.

Section 165-12 of the ITAA 1997 considers the continuity of ownership test. The test requires that persons must maintain more than 50% of either the ownership voting rights, the rights to receive dividends, or the rights to receive capital during the ownership test period, which is the period between the start of the income year where the tax loss was incurred, and the end of the income year where the tax loss is being deducted. As the facts establish that this test has been failed twice in the last few years, it is not necessary to consider this test any further in this ruling request.

Section 165-13 of the ITAA 1997 considers the same business test if the continuity of ownership test has failed. The test applies from the test time, which for most companies will commence immediately before the change in ownership occurred. There are other rules to follow if this date cannot be determined.

The same business test period applies from the test time to the end of the income year in which the tax loss is being deducted.

Subdivision 165-E of the ITAA 1997 considers the same business test further. Section 165-210 of the ITAA 1997 sets out further requirements before the same business can be satisfied. These are the business of a kind test and the transactions of a kind test. These tests compare the business operations before and after the test time.

Taxation Ruling TR 1999/9 discusses the operation of the same business test for company income tax loss purposes. Paragraph 8 provides a précis of how the same business test operates to tax losses (the 80E test in the ruling). It states the following:

8. The conditions for complying with sections 165-13 and 165-210 are set out in paragraphs 11 to 19 of this Ruling. However, broadly speaking, the 80E test is satisfied where a company, at all times during the year in which it claims a deduction for a prior year loss:

· carried on the same business (meaning the business of the company as an entirety, or its 'overall business') that it carried on immediately before the change in the beneficial ownership of shares by reason of which it ceased to satisfy the continuing ownership and control requirements described in section 165-12;

· did not carry on any business (meaning a particular undertaking or enterprise) other than a business of a kind carried on before the disqualifying change as part of the overall business;

· only derived income from transactions of a kind that it had entered into in the course of the overall business before the change of ownership; and

· the anti-avoidance provisions in subsection 165-210(3) do not apply to the company.

Paragraph 13 of TR 1999/9 indicates that the same business imports identity and not mere similarity. What is required is the continuation of the actual business that was carried on before the change in ownership.

According to the facts, there were two changes of ownership over the last few years. The first change occurred a number of years ago. The facts indicate that there was no change in the business that was being conducted by the taxpayer during the period on either side of that change of ownership. However, this particular change in ownership is not the subject of this ruling request.

The second change of ownership occurred a few years later when the deed of company arrangement (DOCA) with Company Group was completed.

By this time, the first project plant had been completed and sold and a specific project had lapsed, so there were no major assets on the books of the taxpayer at that time, apart from the intellectual property. There were a few other projects under consideration, but that was the extent of the business operations.

Prior to the second change of ownership, the major thrust of the business to date was a specific project, building a number of plants, and developing the associated intellectual property. Once the first project plant was built, the taxpayer had a choice to either operate that plant (the original plant), or sell it without operating it. The original plant was retained, which resulted in the taxpayer operating the plant for a number of years before it was sold.

The specific project lapsed, which left the only business operations prior to the second change as the building of the plants, and the sale or operation of those plants.

The only other activity noted in the facts was that a one off bid or tender was lodged to purchase an existing plant near the original plant. This tender was withdrawn before the tender process was completed.

Whether a business was carried on?

The first item to look at is whether a business is being carried on immediately prior to the change of ownership. In this case, the taxpayer was placed into administration, and the taxpayer remained in administration until the DOCA was completed when the change of ownership took place.

The facts do not indicate that any activity took place during this period of administration, which is a period of more than one year. It should be noted that the taxpayer deals with large projects, so there were only a few large projects with gaps in between them.

The same business test was considered in Avondale Motors (Parts) Pty Ltd v. FC of T (1971) 124 CLR 97; 45 ALJR 280; 2 ATR 312; 71 ATC 4101. As part of the judgement, the issue of whether the taxpayer was carrying on a business for the purposes of the same business test arose. Gibbs J cited other cases where it was held that a company could still be considered to be carrying on a business notwithstanding that its activities are reduced to a minimum or almost entirely suspended. One example was a shipping company that had lost its only ship and it was in the process of acquiring another ship, so the company activities were suspended due to circumstances outside of its control.

Gibbs J also cited South Behar Railway Company Limited v. IRC, 65 [1925] AC 476, where in his judgement, Lord Sumner said: "Business is not confined to being busy; in many businesses long intervals of inactivity occur".

In this case, the period of inactivity lasted for more than one year whilst the administrator was in charge. Therefore it could be argued that the inactivity was beyond the control of the taxpayer as the directors did not actually appoint the administrator, although they were effectively responsible for the financial state of the taxpayer when the administrator was appointed.

In the ruling request, the taxpayer has advised the following:

The taxpayer has maintained a focus on investing in specific projects, even though most have not made to fruition and there have been no recent projects progressing past the 'consideration' phase.

There have been periods where projects have been delayed or put on hold due to funding and other issues. Similarly, some of those projects ultimately did not come to fruition and were abandoned due to funding and other influences. Ideally the taxpayer would have pursued the investments to completion if circumstances allowed.

The explanation provided in the ruling request does not directly relate to the period of over a year whilst the taxpayer was under administration were there was little or no activity. The administration would have stopped any major decisions being made if that decision involved the spending of large amounts of money.

The facts indicate that the major activities undertaken during administration were various steps to try and sell the taxpayer and its major asset which was the intellectual property. On their own, these activities would not be sufficient to conclude that the taxpayer was still actually carrying on a business of building and operating the plants. The sale of the taxpayer was actually achieved at the time the DOCA was completed.

Therefore, little or no activity took place in the period prior to the change of ownership after the original plant was sold. As such, there was little or no business activity occurring at the time immediately prior to the change of ownership. This would give the indication that the business was effectively dormant during the period of administration.

Whether the same business is conducted?

In relation to the first change a number of years ago, the taxpayer was conducting the same business on both sides of the change of ownership. There are no issues with the same business test in relation to this change of ownership. Also, this particular change in ownership is not the main subject of this ruling request.

The second change of ownership occurred a few years later. Immediately prior to this change of ownership, the taxpayer was under administration, and so was conducting little or no business immediately prior to the change of ownership. The major asset held was the intellectual property relating to the construction and operation of the plants.

This asset was sold as part of the ownership transfer, so that will mean that this part of the business no longer exists in the hands of the taxpayer. This will mean that even if the taxpayer does decide to construct another plant, it won't be on the basis as the holder of the intellectual property, so it would need to obtain the use of the intellectual property again before the plant could be built. As it is currently owned by another entity within the overall second company group, this should be able to be achieved.

This effectively means that if another plant was to be built, it would not be on the basis of the owner and developer of the intellectual property, which was the case with the original plant. Rather it would be on the basis of using technology owned by another entity. After the first change of ownership, the technology was owned by another entity which then entered the consolidated group shortly after the first change, so the taxpayer was the overall owner of the intellectual property at the time that the original plant was completed. This won't be the case on the next occasion.

At present, there is little or no activity being carried on at the moment, so the same business test hasn't been failed as yet. However, the taxpayer is not earning any income which would allow the tax loss to be deducted either. The same business test will only need to be applied once there is an income stream against which the tax losses could be deducted.

The ruling request has put up two scenarios relating to potential future activities conducted by the taxpayer. The first of these is to repurchase and operate the original plant. The taxpayer has previously operated that particular plant, so if operating this type of plant was the sole test, then that business operation would not be stopped by the 'business of a kind' test .

What the taxpayer hasn't done before is actually purchase a plant to operate. It has only ever built them. So if the same business test incorporated how the plant was acquired, then this would be failed. The major part of the taxpayer's business operations for a number of years was the actual construction of the plant, which was then operated for a period of time.

The taxpayer did put in a tender on one occasion to purchase a plant, but that was withdrawn part of the way through the process. However the plant was not actually purchased, so that one withdrawn attempt can't be translated to indicating that the taxpayer is in the business of acquiring this type of plant.

According to TR 1999/9, the business conducted must be identical, and not just similar. The repurchase of the original plant and operating it would be a similar business, but is it an identical business. The previous business was the construction of, and operation of the plant, not the purchase of, and operation of the plant. Therefore it would not be an identical business.

The purchase of the existing plant near the original plant is the second investment under consideration. If the taxpayer acquired this plant, it would be treated in the same way as the acquisition of the original plant above. Therefore the acquisition would be treated as a similar business, but not an identical business.

Additional transactions.

The second change of ownership occurred a few years ago. Immediately prior to this change of ownership, the taxpayer was under administration, and so was conducting little or no business immediately prior to the change of ownership. The major asset held for the last few years was the intellectual property.

The transactions test stops the tax losses from being deducted if the taxpayer enters a transaction which it has not undertaken before. The taxpayer had withdrawn a tender to purchase an existing plant before the last change of ownership. However, the preparation and submission of a tender to purchase an existing plant, (it was withdrawn before the consideration stage), is not necessarily the same as actually purchasing an existing plant via a fully completed tender process. The preparation and submission of the tender is one of the preliminary steps required to purchase the plant. However, the submission of a tender is not a guarantee that the plant would ever actually be purchased, so the submission of the tender does not in itself indicate that the taxpayer is actually in the business of buying existing plants. Also, there may be more steps in the process that the taxpayer did not do last time due to the early withdrawal, and these steps have not been completed before.

The result is that if the taxpayer actually put in another tender to purchase the plant, then this would not be a transaction of a kind that the taxpayer had not entered into previously, and so would not fail the test.

However, if the tender process went through to the final stages which resulted in the taxpayer actually purchasing the plant, then this event has never occurred before, and so would be a transaction of a kind that the taxpayer had not completed previously, and so the taxpayer would fail the transaction of a kind test at that point in time.

Effect of consolidation

The consolidation rules need to be considered as the taxpayer is the head entity of a consolidated entity. There are some modifications to deducting tax losses where there is a consolidated group involved.

Section 707-140 of the ITAA 1997 states that if a loss is transferred from any entity to the consolidated group upon entry to the consolidated group, in accordance with section 707-120 of the ITAA 1997, the head entity is deemed to have made the loss, which allows it to deduct the tax loss, subject to the other conditions being satisfied.

Section 707-410 of the ITAA 1997 states that if the head company of a consolidated group makes a loss, and an entity ceases to be a subsidiary member of the group, then the subsidiary entity is taken not to have incurred the loss under section 701-40 of the ITAA 1997 when they exit the consolidated group.

It does not matter whether the loss was made whilst the group was consolidated or was transferred into the consolidated group under Subdivision 707-A of the ITAA 1997.

In this case, when the original plant and intellectual property was sold, the subsidiary entities within the consolidated group that held these assets left this consolidated group to join the purchaser's consolidated group. Therefore these provisions needed to be considered, as some entities have exited the consolidated group during the period that the tax losses were incurred.

The operation of section 707-410 of the ITAA 1997 means that the head entity is the only entity that can actually utilise the tax loss in the event of a subsidiary entity exiting the group, as the subsidiary entity exiting the group is not able to ever utilise the tax loss that is available to the consolidated group.

The taxpayer is actually the head entity of the consolidated group, and the consolidated group is actually still in existence. Therefore the amount of losses that the taxpayer could potentially claim is unchanged as the head entity is the only entity that can claim the consolidated tax losses due to the operation of sections 707-140 and 707-410 of the ITAA 1997.

Summary

In summary, the taxpayer has admitted that it has failed the continuity of ownership test twice over the last few years. Once the continuity of ownership test fails, the taxpayer needs to rely on the same business test to claim the tax losses.

The first change of ownership occurred a number of years ago. At that time the taxpayer was constructing their original plant, and this continued after the first change of ownership as well. Therefore it is considered that the taxpayer had passed the same business test for that period.

The second change of ownership occurred a few years later. The taxpayer had been placed into administration, and the taxpayer effectively conducted no business activities from that time until the change of ownership occurred, apart from trying to sell the entity. Therefore, as the taxpayer was not carrying on a business prior to the change, the moment that the taxpayer commences any business after the change (even if is the same business it conducted prior to entering administration), it will actually fail the same business test.

Also, if it actually purchases an existing plant, it will also fail the transactions of a kind test as well, as it has only ever built plants previously. That would be the case even if the plant it purchased was the same one that it had previously built (i.e. the original plant).

Therefore, based on the information provided, the taxpayer has not yet failed the same business test or the transactions test. However, if it carries on any business, or enters into a transaction that it had not previously conducted, then it will fail one or both of these tests, which would mean that it will not be able to claim the tax losses incurred prior to the second change of ownership.