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Ruling

Subject: Same business test for deducting bad debts

Question 1

Is the entity carrying on the same business for the purposes of section 165-126 of the Income Tax Assessment Act 1997 (ITAA 1997) as it carried on immediately before the change in ownership in the relevant year?

Answer

Yes.

Question 2

Is the entity entitled to claim a deduction for bad debts under section 25-35 of the ITAA 1997 for the year ended 31 December 20XX?

Answer

Yes.

This ruling applies for the following period:

01 January 2010 to 31 December 2010

The scheme commences on:

01 January 2010

Relevant facts and circumstances

The entity operates as a shipping agent.

In the relevant year two bad debts owing by overseas companies were written off. This related to taxable revenue derived as agency fees taken up as revenue in 200Y. The overseas companies were related companies. The companies had gone into compulsory liquidation and bankruptcy arrangements. This was due to the global financial crisis, an oversupply of ships and management issues.

In the relevant year all the shares in the entity were transferred/disposed to new owners. This was after the date the above revenue was derived, but before the debts were written off. Thus continuity of ownership test was not passed.

In 200Y the company claimed a further bad debt write off. This was claimed as a deduction in the 200Y tax return as the continuity of ownership test was passed.

When preparing the relevant year tax return tax losses were brought forward and offset against income for that year. This relied on the same business test being passed.

The bad debt write off (and capital loss) for relevant year, however, was not claimed when the tax return was lodged.

A letter was sent to the ATO providing the information and data.

The entity concluded the same business test was satisfied. The following is information provided by the entity in the letter to the ATO:

It was concluded that the same business test was passed on the following grounds:

(a) Business Activity - The business activity remained the same after the change of share ownership.

(b) The customers the entity were working with in 200Y are predominantly the same as those of today.

(c) Staffing - Staff personnel and numbers remained the same for many months after the change of ownership. There were no new employees arising from the ownership change. All staff continued in exactly the same roles and duties

(d) Suppliers and advisors remained the same.

(e) The Business premises location and office layout remained the same.

(f) At all times the entity has retained the same basis of deriving revenue which is cost plus 10%.

Changes to the Company as a result of the ownership change include:

(a) There is a new agency agreement and principal.

(b) Appointment of overseas non-executive directors representing the new business owners. One original director remained the same. The overseas directors have minimal management and control over the operations and processes of the agency. Their approval is required for material expenditure.

(c) Change of company name.

The entity prepares tax returns using a substituted accounting period.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-35;

Income Tax Assessment Act 1997 subsection 25-35(5);

Income Tax Assessment Act 1997 section 165-126;

Income Tax Assessment Act 1997 section 165-210;

Income Tax Assessment Act 1997 Subsection 165-210(3);

Income Tax Assessment Act 1997 Subsection 165-210(4).

Reasons for decision

Issue 1

Eligibility for same business test

Question

Is the entity carrying on the same business for the purposes of section 165-126 of the Income Tax Assessment Act 1997 (ITAA 1997) as it carried on immediately before the change in ownership in the relevant year?

Answer

Yes.

Summary

The business operations of the entity during the relevant period were the same as it was prior to the change of ownership. The entity does satisfy the same business test at the relevant test time as it was carrying on the same business.

Detailed reasoning

Taxation Ruling TR 1999/9 Income tax: the operation of sections 165-13 and 165-210, paragraph 165-35(b), section 165-126 and section 165-132 expresses the ATO view regarding the interpretation of the same business test for the purpose of ITAA 1997.

Technically the same business test is itself but one of three separate, though related, tests prescribed by section 165-210 of the ITAA 1997. Those tests are the same business test, the new business test and the new transactions test.

The first test is the same business test as stated TR 1999/9 paragraph 30:

For a company to satisfy the same business test, the company must be able to show that it carried on at all times during the period of recoupment the same business as the business that the company carried on at the change-over.

TR 1999/9 at paragraphs 12 and 28-29 provides that, for the purposes of the same business test, the term business means the company's overall business.

TR 1999/9 at paragraph 13 states that:

In the same business test, the meaning of the word same in the phrase same business as imports identity and not merely similarity; the phrase same business as is to be read as referring to the same business; what is required is the continuation of the actual business carried on immediately before the changeover [i.e. the time of the disqualifying change in ownership]. Nevertheless, it is not sufficient that the business carried on after the change-over meets some industry-wide definition of a business of the same kind; nor would it be sufficient for there to be mere continuance of business operations from immediately before the change-over into the period of recoupment, if the business had changed so that it could no longer be described as the same business.

For the purposes of the 'same business test' for the relevant income year, we need to look at the taxpayer's business immediately before the beginning of the start of the bad debt year and the taxpayer's business carried on at the change-over, extended to a point past where it can be said that the same business is being carried on. Given the information provided, we believe that it would be reasonable for us to conclude that the same business was being conducted during the relevant period.

Pursuant to paragraph 61 of TR 1999/9, the following factors were examined in applying the 'same business test'.

The entity failed the continuity of ownership test (COT) but has satisfied the same business test (SBT) based on the following:

§ The entity was conducting the same business activity;

§ The entity had the same client relationships;

§ The entity had the same employees;

§ The entity had the same suppliers and advisors;

§ The entity had the same business premises;

§ The entity had the same business model and pricing policy.

From the time the COT was failed through to the time the bad debts were incurred, the entity's business has remained the same. The entity's business activity has continued to be the same. It is also noted that there has been a minor change to the directors at the relevant test times, however, the new directors have minimal management and control over the company and one director remained the same. From the information provided there was nothing to suggest that the business carried on by the entity changed.

Therefore, it is concluded that the entity's business has not changed in the relevant income year compared to immediately before the relevant test time and meets the same business test.

Did the taxpayer enter into a new business in the relevant income year pursuant to subsection 165-210(3) of the ITAA 1997?

Paragraph 64 of TR 1999/9 states that the new business test requires that the taxpayer company did not, at any time during the period of recoupment, derive income from a business of a kind it did not carry on before the change-over.

Based on the information provided, there is nothing to indicate that the entity entered into a new business in the relevant income year.

Did the taxpayer enter into a new transaction in the relevant income year pursuant to subsection 165-210(4) of the ITAA 1997?

Paragraph 65 of TR 1999/9 further states the new transactions test requires that the taxpayer company did not, at any time during the period of recoupment, derive income from a transaction of a kind it had not entered into in the course of its business operations before the change-over.

Based on the information available, there is nothing to indicate that the entity entered into a new transaction in the relevant income year.

Therefore, based on the analysis above, the entity does satisfy the same business test at the relevant test time as it was carrying on the same business in the year ended 20XX.

Issue 2

Eligibility to claim deductions for bad debts

Question

Is the entity entitled to claim a deduction for bad debts under section 25-35 of the ITAA 1997 for the year ended 20XX?

Answer

Yes.

Summary

The entity is eligible to claim the bad debts incurred in the year ended 20XX as the debtors have been placed into liquidation and the entity is not able to recover the debts, and the entity has satisfied the same business test.

Detailed reasoning

A deduction for a bad debt may be claimed under section 25-35 of the ITAA 1997.

To qualify for a bad debt deduction under section 25-35 of the ITAA 1997, the debt must satisfy four criteria:

1) a debt must exist;

2) the debt must be bad;

3) the debt must be written off as a bad debt during the year of income in which the deduction is claimed.

4) the debt must have been brought to account as assessable income in any year.

A debt may be defined as a sum of money due from one person to another. As a general rule where a taxpayer is entitled to receive a sum of money from another either at law or in equity, it is accepted that a debt exists.

Paragraph 31 of the Taxation Ruling TR 92/18 Income tax: bad debts provides that a debt may be considered to have become bad in any of the following circumstances:

(a) the debtor has died leaving no, or insufficient, assets out of which the debt may be satisfied;

(b) the debtor cannot be traced and the creditor has been unable to ascertain the existence of, or whereabouts of, any assets against which action could be taken;

(c) where the debt has become statute barred and the debtor is relaying on this deference for non-payment;

(d) if the debtor is a company, it is in liquidation or receivership and there are insufficient funds to pay the whole debt, or the part claimed as a bad debt;

(e) where, on an objective view of all the facts or on the probabilities existing at the time the debt, or a part of the debt, is alleged to have become bad, there is little or no likelihood of the debt, or the part of the debt, being recovered.

In addition, subsection 25-35(5) of the ITAA 1997 provides that a company must satisfy either the continuity of ownership test (COT) or the same business test (SBT) before being entitled to a deduction for bad debts.

In this case, based on the facts provided:

1) There is a debt in existence.

2) The debt is bad. The companies were placed into liquidation in 200Y, and the entity was unable to recover the debt in full or in part.

3) The debt was brought to account as assessable income in 200Y.

4) The entity failed the COT, but was able to pass the SBT based on the same business activity, the same client relationship, the same employees, the same suppliers and advisors, the same business premises, and the same business model and pricing policy from the time the COT was failed through to the time the bad debts were incurred.

Therefore, based on the analysis above, the entity is entitled to claim the bad debts in the year ended 20XX.