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Ruling

Subject: Company Losses - Modified Continuity of Ownership Test - Saving rule

Question 1

Will subsection 166-272(8) of the Income Tax Assessment Act 1997 be satisfied in relation to the proposed transfer of shares in Loss Company from Company A to Subsidiary A?

Answer

Yes

Question 2

For the purposes of subsection 166-272(8) of the ITAA 1997, can CGT events that happen during the test period in relation to any direct equity interests or indirect equity interests held in Loss Company, other than CGT event A1 happening when Company A disposes of its interest in Loss Company, affect the quantum of Loss Company's tax loss that is attributable to non-economic deductions?

Answer

No

This ruling applies for the following periods:

2010 Income Year to 2020 Income Year

The scheme commences on:

2010 Income Year

Relevant facts and circumstances

Loss Company is the head company of the income tax consolidated group.

Loss Company is an Australian incorporated and resident company.

Loss Company has one class of share on issue. Each share carries the same rights to exercise voting power, receive dividends and receive capital distributions.

All of the shares in the Loss Company are currently held in equal proportions by Company A and Company B.

Company A is a non-resident entity that is 100% indirectly held by Stakeholder A through a wholly-owned non-resident interposed entity.

The shares in Stakeholder A are traded on an approved stock exchange. None of the listed shares of Stakeholder A are shares that carry a right to a fixed rate of dividend.

The Loss Company shares held by Company A are taxable Australian property within the meaning of section 855-15 of the ITAA 1997.

Company B is a resident entity that is 100% indirectly held by Stakeholder B through non-resident interposed entities.

The shares in Stakeholder B are traded on an approved stock exchange. None of the listed shares of Stakeholder B are shares that carry a right to a fixed rate of dividend.

Loss Company had a tax revenue loss in the loss year.

The tax loss was primarily due to the reset and attribution of tax base to certain assets as part of a tax consolidation process.

The calculation of Loss Company's tax loss includes a taxation deduction.

Loss Company forecasts that it will start to deduct some or all of its tax loss in a future income year (recoupment year).

Company A proposes to dispose its interest in Loss Company to its wholly-owned Australian resident subsidiary, Subsidiary A, for market value consideration.

Company A expects to make a capital loss on the disposal of its interest in Company A to Subsidiary A.

Company A expects to defer any capital loss made on the disposal of its 50% interest in Loss Company pursuant to Subdivision 170-D of the ITAA 1997.

Assumptions

Loss Company will deduct some or all of its tax loss of the loss year starting from the recoupment year.

Other than CGT event A1 happening on Company A's proposed disposal of its interest in Loss Company to Subsidiary A, no other CGT event will happen in relation to any direct equity interests or indirect equity interests held in Loss Company by the stakeholders (being Stakeholder A and Stakeholder B as widely held companies mentioned in section 166-240 of the ITAA 1997), or an entity interposed between a stakeholder and Loss Company, during the test period.

Company A will make a capital loss on the proposed disposal of its interest in Loss Company to Subsidiary A.

No more than one less than the number of shares currently on issue will be issued by Loss Company during the test period.

Any changes to the class of shares on issue and/or the rights attached to the shares in Loss Company during the test period will be a change of no more than 50%.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 165

Income Tax Assessment Act 1997 section 165-10

Income Tax Assessment Act 1997 subsection 165-150(2)

Income Tax Assessment Act 1997 subsection 165-155(2)

Income Tax Assessment Act 1997 subsection 165-160(2)

Income Tax Assessment Act 1997 Division 166

Income Tax Assessment Act 1997 section 166-5

Income Tax Assessment Act 1997 subsection 166-5(1)

Income Tax Assessment Act 1997 subsection 166-5(2)

Income Tax Assessment Act 1997 subsection 166-5(3)

Income Tax Assessment Act 1997 section 166-145

Income Tax Assessment Act 1997 subsection 166-145(1)

Income Tax Assessment Act 1997 subsection 166-145(2)

Income Tax Assessment Act 1997 subsection 166-145(3)

Income Tax Assessment Act 1997 subsection 166-145(4)

Income Tax Assessment Act 1997 subsection 166-145(5)

Income Tax Assessment Act 1997 section 166-220

Income Tax Assessment Act 1997 section 166-235

Income Tax Assessment Act 1997 subsection 166-235(1)

Income Tax Assessment Act 1997 subsection 166-235(2)

Income Tax Assessment Act 1997 subsection 166-235(3)

Income Tax Assessment Act 1997 subsection 166-235(4)

Income Tax Assessment Act 1997 subsection 166-235(5)

Income Tax Assessment Act 1997 subsection 166-235(6)

Income Tax Assessment Act 1997 section 166-240

Income Tax Assessment Act 1997 subsection 166-240(1)

Income Tax Assessment Act 1997 subsection 166-240(2)

Income Tax Assessment Act 1997 section 166-265

Income Tax Assessment Act 1997 section 166-272

Income Tax Assessment Act 1997 subsection 166-272(1)

Income Tax Assessment Act 1997 subsection 166-272(2)

Income Tax Assessment Act 1997 subsection 166-272(8)

Income Tax Assessment Act 1997 paragraph 166-272(8)(b)

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

(All legislative references are to the Income Tax Assessment Act 1997)

Question 1

Subsection 166-272(8), often referred to as the "saving rule", provides that if any of the conditions in section 166-145 have not been satisfied, those conditions are taken to be satisfied if:

· they would have been satisfied except for the operation of subsection 166-272(2), and

· Loss Company has information from which it would be reasonable to conclude that less than 50% of the tax loss has been reflected in deductions, capital losses or reduced assessable income that occurred, or could occur in future, because of the happening of any CGT event in relation to any direct equity interests or indirect equity interests held in Loss Company by the stakeholder (Stakeholder A or Stakeholder B by operation of section 166-240) or an entity interposed between the stakeholder and Loss Company during the test period.

Paragraph 166-272(8)(a): First requirement

The first requirement of the saving rule requires that the conditions in section 166-145 would have been satisfied but for the operation of subsection 166-272(2).

The modified continuity of ownership test in section 166-145 only applies if Loss Company is a widely held company or an eligible Division 166 company.

Loss Company is an eligible Division 166 Company because it is held indirectly through interposed entities by one or more widely held companies.

Pursuant to subsection 166-5(3), Loss Company is taken to have met the conditions in section 165-12 (which is about the company maintaining the same owners) if there is substantial continuity of ownership as between the start of the test period and:

· the end of each income year in that period; and

· the end of each corporate change in that period.

The ownership tests: substantial continuity of ownership

Under section 166-145 there is substantial continuity of ownership of Loss Company between the start of the test period and another time in the test period if, at the start of the test period and immediately after the other time in the test period:

· the same persons (none of them companies or trustees) had more than 50% of the voting power in Loss Company (the 'voting power condition').

· the same persons (none of them companies) had rights to more than 50% of Loss Company's dividends (the 'dividend rights condition').

· the same persons (none of them companies) had rights to more than 50% of Loss Company's capital distributions (the 'capital rights condition').

Loss Company's test period is the period consisting of the loss year, the income year and any intervening period.

No corporate change has happened or will happen to Loss Company during the test period.

Accordingly, the ownership test times for Loss Company in respect of the tax loss is the end of each income year between the start of the test period and the recoupment year.

Pursuant to subsection 166-145(5), there is substantial continuity of ownership at the ownership test time if it is the case, or reasonable to assume, that there are persons who collectively:

· control or are able to control more than 50% of the voting power in Loss Company at that time,

· have the right to receive for their own benefit more than 50% of any dividends that Loss Company may pay, and

· have the right to receive for their own benefit more than 50% of any capital distributions of Loss Company.

Persons: ultimate owners of Loss Company shares

Section 166-240 modifies how the ownership tests in section 166-145 are applied to a widely held company that holds a stake of 10% to 50% (inclusive) in Loss Company.

On the facts, Stakeholder A and Stakeholder B are entities mentioned in section 166-240 and therefore, pursuant to subsection 166-240(2), the conditions in section 166-145 are applied to Loss Company, as if at each relevant test time, the widely held company (Stakeholder A and Stakeholder B) were a person (other than a company) which held the voting stake, dividend stake and capital stake.

Section 166-265 provides that, because section 166-240 applies, the persons who actually held each affected voting stake, dividend stake and capital stake are taken not to have held it.

Same share same interest rule

Section 166-272 modifies how the ownership tests in section 166-145 are applied to a voting stake, a dividend stake, or a capital stake in Loss Company held (directly or indirectly through one or more interposed entities) by a stakeholder, being a widely held company mentioned in section 166-240 (under paragraph 166-272(1)(b)).

The same share same interest rule is in subsection 166-272(2). For the purpose of determining whether Loss Company has satisfied a condition in section 166-145, a condition that has to be satisfied is not satisfied unless at all relevant times:

· the only shares in Loss Company that are taken into account are the shares in existence at the start of the test period in the numbers in which they were held by Company A and Company B at that time, and

· the only interests (including shares) in any other entity that is interposed between the stakeholder (in this case, Stakeholder A and Stakeholder B under section 166-240) and Loss Company that are taken into account are exactly the same interests and are held by the same persons.

At the start of the test period, all of the voting power, rights to receive dividends and rights to receive any distribution of capital of Loss company were held by Stakeholder A and Stakeholder B through the operation of section 166-240.

At each test time after the transfer of Loss Company shares from Company A to Subsidiary A, the stake attributed to Stakeholder A will not satisfy subsection 166-72(2) because Subsidiary A was not an entity interposed between Stakeholder A and Loss Company at the start of the test period.

Only the stake attributed to Stakeholder B, being 50% each of the voting power, rights to receive dividends and rights to receive any distributions of capital of Loss Company satisfies the same share same interest rule.

Accordingly, the voting power condition in subsection 166-145(2), the dividend rights condition in subsection 166-145(3) and the capital rights condition in subsection 166-145(4) is not satisfied for each test time in the test period.

However, this is only because of the same share same interest rule in subsection 166-272(2). Except for the operation of that provision, all of the voting stakes, dividend stakes and capital stakes in Loss Company would have been held, through the operation of section 166-240, by the two widely held companies, Stakeholder A and Stakeholder B at those times.

Therefore, the requirement in paragraph 166-272(8)(a) is satisfied.

Paragraph 166-272(8)(b): Second requirement

Paragraph 166-272(8)(b) requires that Loss Company has information from which it would be reasonable to conclude that less than 50% of the tax loss has been reflected in deductions, capital losses or reduced assessable income that occurred, or could occur in future, because of the happening of any CGT event in relation to any direct equity interests or indirect equity interests held in Loss Company by the stakeholder (Stakeholder A or Stakeholder B by operation of section 166-240) or an entity interposed between the stakeholder and Loss Company during the test period.

Paragraph 1.124 of the Explanatory Memorandum to the Tax Laws Amendment (Loss Recoupment Rules and Other Measures) Bill 2005 states, in relation to subsection 166-272(8), that:

A loss can only be reflected in ownership interests to the extent that it represents an economic loss.

On the facts, the component of the tax loss that relates to the taxation deduction is a non-economic deduction.

The amount of the tax loss that represents the non-economic deduction cannot be reflected for the purposes of paragraph 166-272(8)(b).

Other than CGT event A1 happening as a result of the transfer of shares from Company A to Subsidiary A, no CGT events will happen in relation to any direct equity interests or indirect equity interests held in Loss Company by the stakeholders (Stakeholder A and Stakeholder B) or an entity interposed between the stakeholder and the Loss Company during the test period.

Accordingly, Loss Company has information from which it would be reasonable to conclude that less than 50% of the tax loss has been reflected in deductions, capital losses or reduced assessable income that occurred or, could occur in future, because of the happening of any CGT event in relation to any direct equity interests or indirect equity interests held in Loss Company by the stakeholders during the test period.

The requirement in paragraph 166-272(8)(b) is therefore satisfied.

Conclusion

The requirements of subsection 166-272(8) are satisfied and the provision applies to the proposed transfer of an interest in Loss Company from Company A to Subsidiary A.

Question 2

Tax loss for the purposes of subsection 166-272(8) is defined in subsection 995-1(1) to relevantly mean:

a tax loss worked out under section 36-10 ….

Broadly, a tax loss is worked out under section 36-10 by adding up allowable deductions for an income year (except tax losses for earlier income years) and subtracting total assessable income and net exempt income (worked out under section 36-20).

Loss Company's allowable deductions are determined under the relevant provisions of the income tax legislation.

For purposes of applying subsection 166-272(8), CGT events that happen during the test period in relation to any direct equity interests or indirect equity interests held in Loss Company will not affect:

· the quantum of the tax loss of Loss Company; or

· the nature and quantum of deductions that have a bearing on the calculation of the tax loss of Loss Company.

Accordingly, the quantum of Loss Company's tax loss that is attributable to non-economic deductions is not affected by any CGT events (other than CGT event A1 happening when Company A disposes of its interest in Loss Company) that happen in relation to any direct equity interests or indirect equity interests held in Loss Company during the test period.