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Ruling

Subject: The control test as in defined in section 165-12 of the ITAA 1997

Question 1

Do you meet the conditions in section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will subsection 165-15(1) of the ITAA 1997 operate to deny you a deduction for tax losses in respect of the conditions in section 165-12 of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

1 July 2010 to 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You made tax losses in multiple financial years. You wish to deduct the tax losses in financial year ended 30 June 2011.

Company A holds greater than 50% of your shares in its capacity as trustee for Trust A.

Company B holds the remainder of your shares in its capacity as trustee for the Trust B.

Both trusts are discretionary trusts.

The ownership structure of Company A and Company B did not change during the ownership test period.

Your ownership structure did not change during the ownership test period.

The trustee of the Trust A resolved to distribute 100% of income and capital to the same persons in all years.

The trustee of the Trust B resolved to distribute greater than 50% of income to one person, and the reminder to another in financial year ended 30 June 2011. Trust B has not distributed in any other year.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 165-12

Income Tax Assessment Act 1997, subsection 165-15(1)

Income Tax Assessment Act 1997, subsection 165-150(1)

Income Tax Assessment Act 1997, subsection 165-155(1)

Income Tax Assessment Act 1997, subsection 165-160(1)

Income Tax Assessment Act 1997, subsection 165-215

Income Tax Assessment Act 1936, section 267-20 in Schedule 2F

Income Tax Assessment Act 1936, subsection 267-30(2) in Schedule 2F

Income Tax Assessment Act 1936, section 267-35 in Schedule 2F

Income Tax Assessment Act 1936, subsection 267-40(2) in Schedule 2F

Income Tax Assessment Act 1936, section 267-45 in Schedule 2F

Reasons for decision

Question 1

Deducting tax losses of earlier income years

Section 165-10 of the ITAA 1997 provides that a company cannot deduct a tax loss unless either:

(1) it meets the conditions in section 165-12 of the ITAA 1997 (the continuity of ownership test (COT), or

(2) it meets the condition in section 165-13 of ITAA 1997 (the same business test.

Section 165-15 of ITAA 1997 provides that even if either of the above tests are satisfied, the control test may prevent a loss from being deducted.

Continuity of ownership test

Section 165-12 of the ITAA 1997 provides that the ownership test period for the COT is the period from the start of the loss year (the year in which the loss arose) to the end of the income year (the year in which the company wishes to deduct the loss).

The test is applied to three types of interest or rights that are attached to the shares of the company: voting power, rights to dividend distributions, and rights to capital distributions.

The test is satisfied if, at all times during the ownership test period, there were persons who beneficially owned shares that had the right to more than 50% of the voting power, dividends and capital (subsections 165-150(1), 165-155(1), and 165-160(1) of the ITAA 1997).

Application of the COT

ATO ID 2003/508 discusses who the beneficial owners of shares in a company that are held by a corporate trustee of a non-fixed unit trust are for the purposes of section 165-12 of the ITAA 1997. It states that whilst a corporate trustee may be the legal owner of shares in the company, neither it nor its shareholders in their capacity as shareholders in the corporate trustee are the beneficial owners of those shares. The existence and identification of the shareholders of the corporate trustee is irrelevant for determining whether the company has satisfied section 165-12 of the ITAA 1997, as the primary tests to be applied in subsections 165-150(1), 165-155(1) and 165-160(1) are all referable to the identification of beneficial owners of shares in the company.

For the purposes of the tests in Subdivision 165-A of the ITAA 1997 it is not possible to trace through a non-fixed trust arrangement in order to establish the beneficial owners of the shares in the company held by the corporate trustee. Consequently, you do not meet the COT.

Section 165-215 of the ITAA 1997

Subdivision 165-F of the ITAA 1997 contains special provisions relating to the ownership of entities by non-fixed trusts. Section 165-215 provides an alternative for the COT.

It states:

(1) If a company does not meet the conditions in section 165-12, it is nevertheless taken to meet the conditions if it meets the conditions in this section.

First condition

(2) At all times during the ownership test period:

(a) both:

(i) persons must have held fixed entitlements to all of the income and capital of the company; and

(ii) non-fixed trusts, other than family trusts, must have held fixed entitlements to a 50% or greater share of the income or a 50% or greater share of the capital of the company; or

(b) both:

(i) a fixed trust or a company (which trust or company is the holding entity) must have held, directly or indirectly, fixed entitlements to all of the income and capital of the company; and

(ii) non-fixed trusts, other than family trusts, must have held fixed entitlements to a 50% or greater share of the income or a 50% or greater share of the capital of the holding entity.

Second condition

(3) The persons holding fixed entitlements to shares of the income, and the persons holding fixed entitlements to shares of the capital, of:

(a) in a paragraph (2)(a) case-the company; or

(b) in a paragraph (2)(b) case-the holding entity;

at the beginning of the loss year must have held those entitlements to those shares at all times during the ownership test period.

Third condition

(4) At the beginning of the loss year:

(a) individuals must not have had (between them), directly or indirectly, and for their own benefit, fixed entitlements to a greater than 50% share of the income of the company; or

(b) individuals must not have had (between them), directly or indirectly, and for their own benefit, fixed entitlements to a greater than 50% share of the capital of the company.

Fourth condition

(5) It must be the case that, for each non-fixed trust (other than an excepted trust) that, at any time during the ownership test period, held directly or indirectly a fixed entitlement to a share of the income or capital of the company, section 267-20 in Schedule 2F to the Income Tax Assessment Act 1936 would not have prevented the non-fixed trust from deducting the tax loss concerned if it, rather than the company, had incurred the tax loss.

First condition

As at all times during the ownership test period (OTP) persons held fixed entitlements to all income and capital of the company, and Trust A (a discretionary trust) held more than 50% of fixed entitlements, this condition is met.

Second condition

As you have stated your ownership structure did not change during the OTP, the persons holding fixed entitlements have held those entitlements at all times during the OTP. Therefore, this condition is met.

Third Condition

Company A in its capacity as trustee for Trust A holds more than 50% of your shares. Company B in its capacity as trustee for Trust B holds the remainder of your shares. After reviewing the trust deeds of these trusts, we consider that both trusts are discretionary trusts. Subsequently, individuals have not held between them, directly or indirectly, for their own benefit, fixed entitlements to greater than 50% of your income or capital. The third condition is met.

Fourth condition

Section 267-20 in Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) provides that a non-fixed trust may be denied a tax loss deduction if it does not meet the conditions in subsection 267-30(2), section 267-35, subsection 267-40(2), and section 267-45, where applicable.

As both Trust A and Trust B held a fixed entitlement to a share of your income or capital, the conditions will need to be considered in light of both trusts.

Subsection 267-30(2) in Schedule 2F to the ITAA 1936

A trust must meet this condition if the trust distributed income or capital in the relevant income year (financial year ended 30 June 2011) or within 2 months after its end, and in at least one of the six earlier income years.

The condition is that the trust must pass the pattern of distributions test in the relevant income year.

Only Trust A has distributed income or capital in the relevant income year or within 2 months after its end, as well as in at least one of the six earlier income years, and subsequently must meet this condition.

Subdivision 269-D of the ITAA contains the pattern of distributions test, and states:

A trust passes the pattern of distributions test for an income year if, before the end of 2 months after the end of the income year:

(a) the trust distributed directly or indirectly to the same individuals, for their own benefit, a greater than 50% share of all test year distributions of income (see subsection 269-65(1)); and

(b) the trust distributed directly or indirectly to the same individuals (who may be different from those in paragraph (a)), for their own benefit, a greater than 50% share of all test year distributions of capital (see subsection 269-65(3)).

Section 269-65 of the ITAA 1936 defines what a test year distribution of income or capital is:

Test year distribution of income

(1)  A test year distribution of income is the total of all distributions of income made by the trust in any of the following periods, provided the period does not start more than 6 years before the start of the income year:

(a)  the period from the start of the income year until 2 months after its end;

(b)  if the trust distributed income before the trigger year (see subsection (2))-the income year, before the trigger year, that is closest to the trigger year;

(c)  if paragraph (b) does not apply and the trust distributed income in the trigger year-the trigger year;

(d)  if neither paragraph (b) nor paragraph (c) applies-the income year, closest to the trigger year, in which the trust distributed income;

(e)  each intervening income year (if any) between the one in paragraph (a) and the one in paragraph (b), (c) or (d).

Trigger year

(2)  If this Subdivision is being applied for the purposes of section 267-20, the trigger year is the loss year mentioned in that section. If it is being applied for the purposes of section 267-25, the trigger year is the year in which the debt mentioned in that section was incurred.

Test year distribution of capital

(3)  Subsection (1) applies in the same way to distributions of capital made by the trust, to determine what is a test year distribution of capital.

The relevant trigger year in this case is financial year ended 30 June 2011.

Trust A in all test year distributions attributed 100% of income and capital to the same persons. Applying the test in subdivision 269-D of the ITAA 1936, in all test years the trust distributed directly or indirectly to the same individuals a greater than 50% share of capital and income. Therefore Trust A passes the pattern of distributions test and meets the condition in Subsection 267-30(2) in Schedule 2F to the ITAA 1936.

Section 267-35 in Schedule 2F to the ITAA 1936

This section provides that that the trust must not have been prevented from deducting the tax loss in an earlier income year because of a failure to meet the condition in subsection 267-30(2).

After applying the test in subdivision 269-D of the ITAA 1936 in respect of the previous loss year (financial year ended 30 June 2010), we do not consider either trusts have been prevented from deducting the tax loss in an earlier income year because of a failure to meet the condition in subsection 267-30(2). Therefore both trusts meet the condition in Section 267-35 in Schedule 2F to the ITAA 1936.

Subsection 267-40(2) in Schedule 2F to the ITAA 1936

A trust must meet this condition if at any time during the test period individuals had more than a 50% stake in the income or capital of the trust.

Subdivision 269-C of the ITAA 1936 provides that individuals will have more than a 50% stake in the income or capital of the trust if between them they have fixed entitlements to more than 50% of the income or capital of the trust.

We have considered the trust deeds of both Trust A and Trust B, and have found that no individuals have fixed entitlements to more than 50% of their income or capital and therefore they do not need to meet this condition.

Section 267-45 in Schedule 2F to the ITAA 1936

Section 267-45 in Schedule 2F to the ITAA 1936 states that:

A group must not, during the test period, begin to control the trust directly or indirectly.

A group for the purposes of this condition is defined in subsection 269-95(5) of the ITAA 1936:

(a)  a person; or
(b)  a person and one or more associates; or
(c)  2 or more associates of a person.

A group controls a trust if (subsection 269-95(1) of the ITAA 1936):

(a) the group has the power, by means of the exercise of a power of appointment or revocation or otherwise, to obtain beneficial enjoyment (directly or indirectly) of the capital or income of the trust; or

(b) the group is able (directly or indirectly) to control the application of the capital or income of the trust; or

(c) the group is capable, under a scheme, of gaining the beneficial enjoyment in paragraph (a) or the control in paragraph (b); or

(d) the trustee is accustomed, under an obligation or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the group; or

(e) the group is able to remove or appoint the trustee; or

(f) the group acquires more than a 50% stake in the income or capital of the trust.

After considering the circumstances, we do not consider that a group began to control the trusts during the test period. Ownership or control of neither the trusts nor the corporate trustees changed. You meet the condition in section 267-45 in Schedule 2F to the ITAA 1936.

Section 267-20 in Schedule 2F to the Income Tax Assessment Act 1936 both would not have prevented Trust A or Trust B from deducting the tax loss concerned if they, rather than the company, had incurred the tax loss. Therefore, they meet the fourth condition.

Conclusion

There was not, at all times during the ownership test period, persons who beneficially owned shares in you that had the right to more than 50% of the voting power, dividends and capital (subsections 165-150(1), 165-155(1), and 165-160(1) of the ITAA 1997). However, as you meet the conditions in section 167-215 of the ITAA 1997 you are taken to have met the conditions in section 165-12 of the ITAA 1997 and you pass the continuity of ownership test.

Question 2

Control test

Subsection 165-15(1) of the ITAA 1997 states that even if a company meets the tests in sections 165-12 or 165-13, it cannot deduct a tax loss if a person who controlled, or was able to control, the voting power in the company for some or all of the ownership test period did not control, or was not able to control, that voting power for the whole of the loss year, and began to control, or became able to control, the voting power with the purpose or purposes of obtaining a tax benefit (for that person or someone else).

As your ownership, nor the ownership of the entities which hold your shares, changed during the loss year, we do not consider that you fail the control test.

Subsequently, subsection 165-15(1) of the ITAA 1997 will not operate to deny you a deduction for tax losses in respect of the continuity of ownership test.