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Ruling

Subject: Company losses

Question 1

Are you entitled to deduct prior year tax losses incurred by the company, as long as the majority of shareholders of the company were the same shareholders for the loss years and the income year in which the loss is sought to be deducted?

Answer:

Yes

Question 2

Are you entitled to deduct prior year tax losses incurred by the company, if only one shareholder of the company is the same shareholder for the loss years and for the income year in which the loss is sought to be deducted?

Answer:

No

Question 3

Are you entitled to transfer the losses incurred by the company to a new company?

Answer:

No

This ruling applies for the following period

Year ended 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You are a company with three equal shareholders.

The directors of the company are the same shareholders.

You have only one class of shares on issue and there has been no trading in them. The shareholders for the loss years are also the current shareholders. However, a change to the shareholders is contemplated prior to receiving any future distribution as a beneficiary of a trust (as detailed below).

You ran a small business. The business was not successful and has ceased trading, with the company making a tax loss over a few years.

While the business is no longer trading, the company is still active, however, you are in the process of applying to de-register the ABN.

You intend for a trust to distribute income to you in order to take advantage of the tax losses that the company has incurred.

A director of the company is a beneficiary of a trust.

You state that the trust deed of the distributing trust allows distributions to companies that the beneficiaries are directors.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 36-17

Income Tax Assessment Act 1997 Section 165-10

Income Tax Assessment Act 1997 Section 165-12

Income Tax Assessment Act 1997 Section 165-13

Income Tax Assessment Act 1997 Subsection 165-12(2)

Income Tax Assessment Act 1997 Subsection 165-12(3)

Income Tax Assessment Act 1997 Subsection 165-12(4)

Income Tax Assessment Act 1997 Section 165-15

Income Tax Assessment Act 1997 Section 165-165

Income Tax Assessment Act 1997 Section 175-10

Income Tax Assessment Act 1997 Subsection 175-10(2)

Income Tax Assessment Act 1997 Subsection 170-30(2)

Income Tax Assessment Act 1997 Section 975-500

Reasons for decision

Summary

You are entitled to deduct a prior year tax loss if a majority of the shareholders remain the same during the loss years and the income year in which the loss will be claimed (the ownership test period), as the company will satisfy the continuity of ownership test, the control test and the same share rule. You cannot deduct a prior year tax loss if only one of the shareholders of the company remains throughout this period as the continuity of ownership test will no longer be satisfied.

You cannot transfer a tax loss to a new company as you and the new company are not members of the same wholly owned group.

Detailed reasoning

Deducting a tax loss where a majority of shareholders remain the same throughout the ownership test period

Section 36-17 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a tax loss of an entity for a loss year is deducted in a later income year if the entity is a corporate tax entity at any time during the later income year.

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

· it meets the conditions in section 165-12 (which is about the company maintaining the same owners); or

· it meets the condition in section 165-13 (which is about the company satisfying the same business test).

Only the test in section 165-12 of the ITAA 1997 is relevant to this situation. The same business test under section 165-13 of the ITAA 1997 will not apply as the company is no longer trading and therefore it is not possible for the company to be conducting the same business as it was when the losses were incurred.

The test in section 165-12 of the ITAA 1997 is applied over the ownership test period which is the period from the start of the loss year to the end of the income year in which the loss is sought to be deducted. According to subsections 165-12(2) to (4) of the ITAA 1997, in order to meet the continuity of ownership test, at all times during the ownership test period there must be persons who had:

· rights to exercise more than 50% of the voting power in the company

· rights to more than 50% of the company's dividends, and

· rights to more than 50% of the company's capital distributions.

On this basis, it is the shareholders who have these rights and not the directors of the company. Accordingly, it is necessary to look to the shareholders of the company in order to ascertain if the company meets the continuity of ownership test.

As there are three equal shareholders in the company, and there is only one class of shares, the shareholders of the company (between them) have more than 50% of the voting power and, the rights to more than 50% of the company's dividends and capital distributions, accordingly, the continuity of ownership test is satisfied.

Even if a company would otherwise be able to recoup a tax loss because it passes the continuity of ownership test, the recoupment may be denied by the overriding operation of the control test in section 165-15 of the ITAA 1997. This provision denies 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 (starting at the end of the loss year) did not control, or was not able to control, that voting power for the whole of the loss year with the purpose or purposes of obtaining a tax benefit (for that person or someone else).

In addition, the same share rule in section 165-165 of the ITAA 1997 ensures that the same persons considered for continuity of ownership testing for the recoupment of tax losses must hold exactly the same shares, or interests in shares, for the entire ownership test period.

As the shareholders of the company (between them) held the voting power in the company for the whole of the ownership test period and held exactly the same shares for the whole of the ownership test period, both the control test and the same share rule is satisfied.

Section 175-10 of the ITAA 1997 provides that the Commissioner may disallow a deduction for a prior year tax loss in an income year in which the company derives income or capital gains (the injected amount) which it would not have derived if the loss had not been available. However, subsection 175-10(2) of the ITAA 1997 explains that the Commissioner cannot disallow the loss if the continuing shareholders will benefit from the derivation of the injected amount to an extent which the Commissioner considers is fair and reasonable.

In your case, you provide that the shareholders of the company have not changed and there has been no trading of shares. Therefore, the shareholders were the only shareholders in the company during the years in which the losses occurred and continue to be the only shareholders. As such, while you have stated that the injection of income into the company by a trust will be to take advantage of the tax losses incurred by the company, the fact remains that the continuing shareholders will benefit from the injection of income into the company.

Accordingly, subsection 175-10(2) of the ITAA 1997 will apply and the Commissioner will not disallow the loss.

In a situation where only two of the original shareholders remain in the company for the income year in which the loss is sought to be deducted it needs to be considered whether the continuity of ownership test, control test and same share rule will still be satisfied.

As the remaining two continuing shareholders held more than 50% of the voting power and rights to dividends and any capital distribution during the loss years (approximately 66% between them) and continue to hold more than 50% of voting power and rights to dividends and any capital distribution during the income year in which the loss is sought to be deducted (100% between them), the continuity of ownership test is satisfied. In addition, the remaining continuing shareholders will also satisfy the control test and same share rule as while there has been a change in the shareholding of the company (one shareholder is not continuing), the remaining shareholders have continued to hold their original shares which (between them) amounted to more than the 50% of the required rights during the ownership test period. In this situation, majority ownership has not changed.

Accordingly, as long as two of the continuing shareholders of the company remain the same, and they continue to hold exactly the same shares throughout the ownership test period, subsection 175-10(2) of the ITAA 1997 will apply and the Commissioner will not disallow the loss.

Deducting a tax loss where only one shareholder remains the same throughout the ownership test period

In the situation where only one of the original shareholders remains in the year in which the loss is sought to be deducted, the company will be unable to satisfy the continuity of ownership test. This is because the shareholder only held 33% of the voting power and rights to dividends and any capital distribution in the loss years and not the required 50% or more.

Accordingly, as a sole shareholder cannot satisfy the continuity of ownership test, section 165-10 of the ITAA 1997 will apply and the company will not be entitled to deduct a prior year tax loss.

Transferring a tax loss

The requirements to enable a tax loss to be transferred from a loss company to an income company include a requirement that both companies be members of the same wholly-owned group during the relevant period: subsection 170-30(2) of the ITAA 1997.

Section 975-500 of the ITAA 1997 defines 'wholly-owned group' as follows:

· 'Two companies are members of the same wholly-owned group if:

one of the companies is a 100 per cent subsidiary of the other company; or

each of the companies is a 100 per cent subsidiary of the same third company.'

As the shareholders of both the loss company and the income company are individuals, it follows that neither company can be a 100 per cent subsidiary of another company, and they cannot be members of the same 'wholly-owned group' as defined.

For that reason, the requirement of subsection 170-30(2) of the ITAA 1997 is not satisfied and no tax loss can be transferred from the loss company to the income company.