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Ruling

Subject: Net capital losses and application of the modified continuity of ownership test

Question 1

Is Company B able to apply its previously unapplied net capital losses from earlier income years to reduce the amounts remaining after the reduction of the capital gains under step 1 of the method statement contained in section 102-5 of the Income Tax Assessment Act 1997 (ITAA 1997) by virtue of having maintained the same owners for the purposes of section 165-12 of the ITAA 1997 as modified by Division 166 of the ITAA 1997 for the year ended 31 December 2011?

Answer

Yes

This ruling applies for the following periods:

XX/XX/XXXX to XX/XX/XXXX

The scheme commences on:

XX/XX/XXXX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The description of the scheme is based on the documents provided by Company B.

Company B is an indirectly wholly owned subsidiary of Company H.

Company B is an indirectly wholly owned subsidiary of Company H's Annual Reports state that Company B is an indirectly wholly owned subsidiary of Company H was listed on a Company B is an indirectly wholly owned subsidiary of Company H.

The foreign stock exchange is an "approved stock exchange" within the meaning of subsection 995-1(1) of the ITAA 1997 and regulation 995-1.05 of Schedule 5 to the Income Tax Assessment Regulations 1997.

Therefore, Company B is an indirectly wholly owned subsidiary of Company H is a "widely held company", as defined in subsection 995-1(1) of the ITAA 1997, for the whole of the relevant income years.

Company B is an indirectly wholly owned subsidiary of Company H's share capital consists of XXXX shares with a nominal value of $X each. The XXXX shares are bearer shares and as such Company B is an indirectly wholly owned subsidiary of Company H does not maintain a register of shareholders.

All of Company H's bearer shareholders are entitled to vote at each annual general meeting and have the same entitlements to dividends and capital distributions. The bearer shares, being listed on the foreign stock exchange, do not carry a right to a fixed rate of dividend.

7 Company H also has on issue XXXX non-voting equity securities that are not part of the share capital and confer no voting rights. However, each non-voting equity security confers the same rights as each bearer share to participate in the available earnings and in any surplus proceeds from liquidation.

Bearer shares

8 Based on the Company H Annual Reports for the relevant income years, a shareholders' group with pooled voting rights (pooled shareholders' group) has owned at least XX% of the issued bearer shares.

The pooled shareholders' group was comprised of ten individuals at XX/XX/XXXX. X of those same individuals were members of the group for the relevant income years.

10 In addition, Company D has disclosed that it owned XXXX (XX%) of Company H's issued bearer shares for each of the relevant income years. Company D is a company whose shares were listed for quotation on the foreign stock exchange for the whole of the relevant income years.

Taxation information

11 Company B has a net capital loss of $XXXX for the year ended XX/XX/XXXX, a portion of which it wishes to apply against capital gains it made in the year ended XX/XX/XXXX from the sale of some of Company B's assets.

The estimated gross capital gain and the amount of the net capital losses Company B wishes to apply in the calculation of its XX/XX/XXXX taxable income will be $XXXX.

This would reduce Company B net capital losses to $XXXX.

Corporate change

Company B advises that no corporate change (listed in subsection 166-175(1) of the ITAA 1997) took place in the test period (the relevant income years).

Company B advises that at all times during the test period (the relevant income years) that Company H has maintained 100% ownership of Company B. Company B has provided extracts from Company H's financial reports which summarise the major corporate activities during the test period.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-5,

Income Tax Assessment Act 1997 Division 165,

Income Tax Assessment Act 1997 section 165-12,

Income Tax Assessment Act 1997 subsection 165-12(1),

Income Tax Assessment Act 1997 Division 166,

Income Tax Assessment Act 1997 Subdivision 166-A,

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 subsection 166-15(1),

Income Tax Assessment Act 1997 section 166-145,

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 166-175(1),

Income Tax Assessment Act 1997 section 166-230,

Income Tax Assessment Act 1997 section 166-240,

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

Income Tax Assessment Act 1997 subsection 166-240(3),

Income Tax Assessment Act 1997 section 166-255,

Income Tax Assessment Act 1997 section 166-265 and

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

Reasons for decision

Section 165-12 of the ITAA 1997 specifies conditions that a company must satisfy in order to deduct a tax loss. Broadly, section 165-12 of the ITAA 1997 provides that the company must maintain more than 50% continuity of ownership throughout the ownership test period.

Subsection 165-12(1) of the ITAA 1997 defines the term 'ownership test period', for the purposes of these provisions, as the period from the start of the loss year to the end of the income year.

Section 165-96 of the ITAA 1997 provides that a company can only apply a net capital loss if it satisfies Subdivision 165-A of the ITAA 1997 assuming that the net capital loss was a tax loss that the company was trying to deduct.

Division 166 of the ITAA 1997 modifies the way the rules in Division 165 of the ITAA 1997 apply to a widely held company or an eligible Division 166 company. However, the company may choose that Subdivision 165-A of the ITAA 1997 is to apply to it for the income year without the modifications made by Subdivision 166-A of the ITAA 1997 (subsection 166-15(1) of the ITAA 1997).

Company B is an "eligible Division 166 company" (as defined in subsection 995-1(1) of the ITAA 1997) for the whole of the income years from XX/XX/XXXX to XX/XX/XXXX because it is not a "widely held company" and all of the voting stakes, dividend stakes or capital stakes in it are wholly owned, beneficially and indirectly through interposed entities, by a widely held company (Company H).

Subsection 166-5(1) of the ITAA 1997 only requires a company to be a widely held company or an eligible Division 166 company during 'the income year', ie the year in which the company seeks to deduct a tax loss or apply a net capital loss. Therefore, the company must satisfy the requirements of Division 165 of the ITAA 1997 as modified by Division 166 of the ITAA 1997 (paragraph 1.13 of the Explanatory Memorandum to the Tax Laws Amendment (Loss Recoupment Rules and Other Measures) Bill 2005).

To satisfy the conditions in section 165-12 of the ITAA 1997, as modified by Division 166 of the ITAA 1997, subsection 166-5(3) of the ITAA 1997 requires Company B (an eligible Division 166 company) to satisfy the conditions for substantial continuity of ownership in section 166-145 of the ITAA 1997 as between the start of the test period and:

· The end of each income year in that period

· The end of each corporate change in that period.

Under section 166-145 of the ITAA 1997, there is substantial continuity of ownership of a company as 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 the company.

· The same persons (none of them companies) had rights to more than 50% of the company's dividends.

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

Although Company H had, throughout the test period, XXXX non-voting equity securities on issue that conferred the same rights as each bearer share to participate in the available earnings and in any surplus proceeds from liquidation, these shares are not counted for the purposes of applying the continuity of ownership test. This is because non-voting equity securities are not shares.

The company's test period is the period consisting of the loss year, the income year and any intervening period (subsection 166-5(2) of the ITAA 1997).

If there is substantial continuity of ownership under section 166-145, the effect of subsection 166-5(3) of the ITAA 1997 is that Company B will be taken to have satisfied section 165-12 of the ITAA 1997.

Under section 166-145 of the ITAA 1997, the ownership test times for Company B in respect of the net capital loss made in the year ended XX/XX/XXXX are the relevant income years.

Application of the bearer share concession - section 166-255 of the ITAA 1997

Under section 166-255 of the ITAA 1997, an indirect stake in the loss company held by way of bearer shares in a foreign listed company that is interposed between the bearer shareholders and the loss company is attributed to a single notional entity at an ownership test time if all the following conditions are satisfied:

There is a foreign listed company interposed between the bearer shareholders and the loss company at the ownership test time.

At all times during the relevant income year, the principal class of shares in the foreign listed company is listed for quotation in the official list of an approved stock exchange.

At the ownership test time, the bearer shares must carry rights to 50% or more of the voting power, rights to dividends or rights to capital distributions of the foreign listed company.

The beneficial owners of some or all of the bearer shares have not been disclosed to the foreign listed company. If a beneficial owner of bearer shares has been disclosed to the foreign listed company, those bearer shares are excluded from this tracing rule.

No other tracing rule has applied.

Company H is a foreign listed company interposed between the bearer shareholders and Company B. At all times during the relevant income years in which each ownership test time occurred, the bearer shares, being the principal class of shares in Company H, were listed on the foreign stock exchange. The bearer shares carry rights to 100% of the voting power of Company H.

Apart from Company D's holding of XX% and the collective shareholding of the pooled shareholders' group, the beneficial owners of the other bearer shares have not been disclosed to Company H (the foreign listed company).

Therefore, the remaining indirect stake in Company B (being a direct stake in Company H) is attributed to a single notional entity under section 166-255 of the ITAA 1997.

As the single notional entity under section 166-255 of the ITAA 1997 would be attributed with a greater percentage of the rights at the ownership test time on at the end of the test period than it had at the start of the test period on XX/XX/XXXX, section 166-270 of the ITAA 1997 provides that the single notional entity is taken to have the percentage of rights that it had at the start of the test period, ie XX%.

Application of the widely held company concession - section 166-240 of the ITAA 1997

Under section 166-240 of the ITAA 1997, a direct or indirect stake in a loss company of between 10% and 50% held by a widely held company is attributed to the widely held company, which is deemed to be a person other than a company.

For the purposes of subsection 166-240(3) of the ITAA 1997, Company D is a "widely held company" for the whole of the the relevant income years. (being the test period in which each ownership test time occurs) because its shares are listed on the foreign stock exchange.

Company D indirectly held during the whole of each income year in which each ownership test time occurred, the following:

· A voting stake that carried XX% of the voting power in Company H.

· A dividend stake that carried the right to receive XX% of any dividends that Company H may pay.

· A capital stake that carried the right to receive XX% of any distribution of capital of Company H.

Under subsection 166-240(2) of the ITAA 1997, the section 166-145 of the ITAA 1997 ownership tests are applied to Company B as if, at each relevant ownership test time, Company D was a person (other than a company) which held a voting stake, dividend stake and capital stake of XX%.

Section 166-265 of the ITAA 1997 provides that, because section 166-240 of the ITAA 1997 applies, the persons who actually held each affected voting stake, dividend stake and capital stake are taken not to have held it.

Application of the "indirect stake of less than 10%" concession - section 166-230 of the ITAA 1997

Based on the bearer share concession and the widely held company concession discussed above, it has been established that the same persons held XX.XX% stakes in Company B at each ownership test time.

The substantial continuity of ownership test in section 166-145 of the ITAA 1997 requires that there must be persons who had more than 50% of the voting power, and rights to more than 50% of the company's dividends and capital distributions, at each ownership test time. In order for Company B to satisfy section 166-145 of the ITAA 1997, it needs to be established that one or more remaining bearer shareholders in Company H had at least 0.0X% of the voting power and rights to the company's dividends and capital distributions at each ownership test time.

Based on the Annual Reports for each of the relevant income years the pooled shareholders' group has owned between XX% and XX% of the issued bearer shares.

Amongst the members of the pooled shareholders' group, the same X individuals were always in the group throughout the test period.

Section 166-230 of the ITAA 1997 applies if it is the case, or it is reasonable to assume, that a stakeholder indirectly holds a stake carrying rights to less than 10% of the voting power, or rights to receive less than 10% of the dividends or capital distributions, of the loss company. In this situation, the top interposed entity is taken to hold the relevant voting stake, dividend stake or capital stake, and to be a person (other than a company).

In this case, on the basis that:

· the pooled shareholders' group owned collectively a minimum of XX% of the voting rights in, and rights to dividends and capital distributions of Company H at each ownership test time in the test period

· X individuals were always members of the group for each of the relevant income years

· it is reasonable to assume that at least one individual among those X individuals owned less than XX% of the voting power and rights to dividends and capital distributions at each ownership test time in the test period and the same individual owned at least 0.0X% of the voting power and rights to dividends and capital distributions at each ownership test time in the test period.

Accordingly, Company B satisfied the voting power condition in subsection 166-145(2) of the ITAA 1997, the dividend rights condition in subsection 166-145(3) of the ITAA 1997 and the capital distribution rights condition in subsection 166-145(4) of the ITAA 1997 during the test period during the relevant income years.

As there is substantial continuity of ownership under section 166-145 of the ITAA 1997, Company B is taken to satisfy the continuity of ownership test in section 165-12 of the ITAA 1997 in respect of the test period during the relevant income years.

For the year ended 31 December 2011, Company B will be able to apply its previously unapplied net capital losses from earlier income years to reduce the amounts remaining after the reduction of the capital gains under step 1 of the method statement contained in section 102-5 of the ITAA 1997.