Edited version of your private ruling

Authorisation Number: 1012443555546

Ruling

Subject: Carried forward losses

Question 1

Will the company pass the same business test to utilise its carried forward losses that were accumulated prior to date X in accordance with section 165-13 of the ITAA 1997?

Answer

Yes

Question 2

Is the loss made on the fixed assets considered to be an eligible deduction under subdivision 40-D of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commences on:

1 July 2011

Relevant facts and circumstances

· The company has prior year losses.

· In mid 2011 the company was placed into voluntary administration and administrators were appointed.

· A deed of company arrangement (DOCA) was entered into on date X and terminated on date Y.

· The administrators continued to operate the company during the period the company was under the DOCA.

· The company operates a transport hire business.

· As a result of the DOCA, on date T there was a change in the ownership of the company.

· Before the change in ownership, the company had three large contracts, hiring out their transport assets.

· After the change in ownership and during the recoupment period, the three main contracts continued to be performed.

· The company was operating during the DOCA as a transport hire business and carried out activities associated with this business.

· Recoupment period: 2012 and 2013 year

· Comparing 2012 and 2013 year with immediately before the test time - date T:

· No expansion or contraction of the business

· No change in suppliers or clients

· No change in the scale of the business

· No discontinuance, cessation or sale of a significant part of the business

· No discontinuance of business activity

· The company did not change the direction of the business

· Company did not enter into any new contracts that have fundamentally changed the business

· No change in trade names, trademarks, patents or any other intellectual rights of the company

· Maintained the existing board of directors

· Differences when comparing the 2012 and 2013 year with immediately before the test time - date T:

· Review existing contracts and renegotiated them as they were poorly priced.

· Capital investment made to make one of its existing contracts compliant.

· The company had an existing contract in place to hire out two of its transport assets. However, it only had one transport asset operating. This meant the company was at risk of having their contract terminated due to non-performance. After the change in ownership a second transport asset was purchased. The second asset was not purchased before the change in ownership because negotiations were not completed in time. After the change in ownership, the new company completed negotiations with the supplier and purchased the second asset.

· Downsize staff to sufficient levels

· Tender for more contracts consistent with company operations

· Move location of the business to the company's original tenancy

· Reduce various overhead costs and implement cost saving activities

· Although the 2013 year has not passed, the applicant has advised that no changes to the business operations will occur except for the above

· As a result of the DOCA, the secured creditor took back certain fixed assets of the company in full satisfaction of a debt owed to them.

· The assets were taken back for an amount less then their adjustable value

· The assets are depreciating assets

· The assets were used for taxable purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 165-10

Income Tax Assessment Act 1997 section 165-13.

Income Tax Assessment Act 1997 section 165-201.

Income Tax Assessment Act 1997 paragraph 165-210(2)(a)

Income Tax Assessment Act 1997 paragraph 165-210(2)(b)

Income Tax Assessment Act 1997 section 118-24

Income Tax Assessment Act 1997 subsection 40-85(1)

Income Tax Assessment Act 1997 subsection 40-285(2)

Income Tax Assessment Act 1997 section 40-305

Reasons for decision

Question 1

The company traded with significant trading losses. In mid 2011, the company was placed into voluntary administration and a Deed of Company Arrangement (DOCA) was entered into on date X.

In order to deduct prior tax losses in later years certain requirements in Subdivision 165-A of the ITAA 1997 must be satisfied.

Under section 165-10 of the ITAA 1997 a company cannot deduct a tax loss unless:

a) it meets the conditions in section 165-12 (continuity of ownership test); or

b) it meets the condition in section 165-13 (same business test)

The continuity of ownership test (COT) is set out in section 165-12 and requires that shares carrying more than 50% of all voting, dividend and capital rights be beneficially owned by the same persons at all times during the ownership test period. The ownership test period is the period from the start of the loss year (the year in which the loss is incurred) to the end of the income year in which the loss is to be deducted (subsection 165-12(1)).

The execution of the DOCA resulted in a new shareholder on date T, therefore the COT is failed. Consequently, the same business test must be passed to utilise the tax losses.

Subsection 165-210(1) of the ITAA 1997 states:

a company satisfies the same business test if throughout the same business test period it carries out the same business as it carried on immediately before the test time.

Section 165-13 of the ITAA 1997 provides the meaning of the 'same business test period' and 'test time'.

Subsection 165-13(2) of the ITAA 1997 states that the 'same business test period' for a company is the income year which the company wishes to deduct the tax losses of earlier income years. In this case, the company will be recouping its tax losses in the 2012 and 2013 year.

The 'test time' is determined by the table provided by subsection 165-13(2) of the ITAA 1997. Essentially, the test time is the time when the applicant failed the COT or if it not practicable to determine when the COT is failed, the test time is the start of the income year when the loss was incurred where the applicant has been in existence at all times during the loss year.

In this case, the test time is when the company failed the COT which is date T. Therefore, for the company deduct prior year losses in 2012 and 2013, it must compare the business carried on during the year 2012 and 2013 with the business carried on immediately before the test time when the COT was failed.

The small business test is set out in section 165-201 of the ITAA 1997. It provides:

165-201(1) A company satisfies the same business test if throughout the same business test period it carries on the same business as it carried on immediately before the test time.

165-210(2) However, the company does not satisfy the same business test if, at any time during the same business test period, it derives assessable income from:

a) a business of a kind that it did not carry on before the test time; or

b) a transaction of a kind that it had not entered into in the course of its business operations before the test time.

165-201(3) The company also does not satisfy the same business test if before the test time, it:

a) stated to carry on a business it has not previously carried on; or

b) in the course of its business operation, entered into a transaction of a kind that it had not previously entered into;

and did so for the purpose, or for the purposes including the purpose, of being taken to have carried on throughout the same business test people the same business as it carried on immediately before the test time.

Taxation Ruling 1999/9 explains further what is meant by the 'same business' at paragraph 13:

13. 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, in the sense of the identical business. However, this does not mean identical in all respects: what is required is the continuation of the actual business carried on immediately before the change-over. 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 so changed that it could no longer be described as the same business. The analysis of whether the same business continues after the change-over may give rise to questions of degree and ultimately depends on the facts of the case. In making the analysis it needs to be acknowledged that a company may expand or contract its activities without necessarily ceasing to carry on the same business. The organic growth of a business through the adoption of new compatible operations will not ordinarily cause it to fail the same business test provided the business retains its identity; nor would discarding, in the ordinary way, portions of its old operations. But, if through a process of evolution a business changes its essential character, or there is a sudden and dramatic change in the business brought about by either the acquisition or the loss of activities on a considerable scale, a company may fail the test.

Same business test: subsection 165-210(1)

To determine whether the company satisfies the same business test, the same business needs to be conducted immediately before the test time and in the year of recoupment. 

In the period immediately before the test time, the company's business consisted of:

· Transport hire business

· 3 main transport hire contracts

During the same business test period, 2012 and 2013, the company's main business consisted of:

· Transport hire business

· 3 main transport hire contracts

The company's business activities immediately before the test time and during the same business test period have not altered. The focus of its activities is, and always has been providing a transport hiring service and the peripheral activities associated with this service.

This applicant provides that during 2012 and 2013 there was:

· No expansion or contraction of the business

· No change in suppliers or clients

· No change in the scale of the business

· No discontinuance, cessation or sale of a significant part of the business

· No discontinuance of business activity

· The company did not change the direction of the business

· Company did not enter into any new contracts that have fundamentally changed the business

· No change in trade names, trademarks, patents or any other intellectual rights of the company

· Maintained the existing board of directors

This does not mean there were not any changes in how the business was operated. The following are some of the differences when comparing the 2012 and 2013 year with immediately before the test time, date T:

· Review existing contracts and renegotiated them

· Capital investment to acquire another transport asset

· Downsize staff to sufficient levels

· Tender for more contracts consistent with company operations

· Move location of the business to the company's original tenancy

· Reduce various overhead costs and implement cost saving activities

Although the 2013 year has not passed, the applicant has advised that no changes to the business operations will occur except for the above.

Mere expansion or contraction of the taxpayer's business may not result in a change in the identity of the business carried on by the taxpayer. In Avondale Motors (Parts) Pty Ltd v FC of T (1971) 124 CLR 97 at 104; (1971) 2 ATR 312 at 317; 71 ATC 4101 (Avondale) at 4105 Gibbs J said:

In some circumstances a company may expect or contract its activities, its activities may close as old shop and open a new one, without starting a new business, but the only conclusion that can be drawn from all the circumstances of the present case is that the business of the taxpayer after 15 March 1968 was different from that which it carried on before that date.

It does not, of course follow that a business will not be the same because there have been some changed in the way in which it is carried on; some cases under sec 80E may give rise to questions of degrees which do not arise in the present case.

The expansion or reduction of business activities, if carried to a sufficient extreme, is likely to amount to more than a mere change in the scale of the business carried on by the taxpayer and so may result in a change in the scale of the business. In particular, a sudden and dramatic expansion or contraction brought about by the acquisition or loss of activities on a considerable scale could mean the same business is no longer being carried on. As Walton J observed in Rolls-Royce Motors Ltd v. Bamford (1976) 51 TC 319:

There is all the difference in the world between an organic growth of trade and a sudden and dramatic change brought about by either the acquisition or loss of activities on a considerable scale.

Moreover, the evolution of a business is not necessarily the same as mere expansion and may also lead to change such that the business can no longer be described as the same business as that carried on immediately before test time…

Applying the above case law, the changes in the operations of the company are not sufficient to justify that the actual business has changed. In particular the renegotiation of existing contracts and tendering for new contracts can be attributed to the business's organic growth and does not change the character of the business. As Gibbs J said in Avondale, it does not follow that a business will not be the same because there have been some changes in the way in which it is carried on.

Paragraph 61 of TR 1999/9 provides the relevancy of a change in the location of the business for the same business test:

61. By way of illustration of the way in which the same business test applies, consider the case of a hypothetical manufacturer of widgets where there has been a change of ownership following a loss year. Each of the following matters would be relevant to consider although not necessarily significant in itself:

…

(j) Changes in the location or locations where the taxpayer carries on business and/or changes in the location of the taxpayer's customers. Location is one of the more important matters affecting goodwill and the market of the taxpayer. Note, however, that often one has to be careful to distinguish the expansion (or contraction) of an existing business, which results in a change in locale, from the commencement of a new business (or the cessation of an old business) which has the same result.

It is not evident from the changing of the company's head office that there was a change in its customer base. Further the change in location did not cause the company to cease or change its operations or preclude it from carrying out its existing contracts. The company's business remains in the income year 2012 and 2013 the provision of a transport hiring business.

Based on the above, the company will satisfy subsection 165-210(1) of the ITAA 1997 for the year ended 2012 and 2013. This is because the company carries on the same business throughout the income year ended 30 June 2012 and will continue to carry on the same business until the end of 2013 as it carried on in the period immediately before the test time.

New business test: para 165-210(2)(a) & New transactions test: para165-210(2)(b)

These tests require the company to not, at any time during the income year 2012 and 2013 to derive assessable income from a business of a kind or a transaction of a kind that it did not carry on before date T.

Paragraphs 14 and 15 of TR 1999/9 state the following regarding the new business test and new transactions test:

14. In the new business test there is a reference to 'business of a kind' that the company did not carry on before the change-over. In the new business test the word 'business' has a different meaning from the word 'business' in the small business test; it refers to each kind of enterprise or undertaking comprises in the overall business carried on by the company at the change-over and during the period of recoupment. The new business test puts a limit on the type of expansion the company may undertake if it is to retain the benefit of accumulate losses; for the taxpayer may not engage in an undertaking or enterprise of a kind in which it did not engage before the change-over and still benefit from accumulated losses

15. Generally speaking, the new transaction test is not failed by transactions of a type that are usually unmotivated by tax avoidance, namely, transactions that could have been entered into ordinarily and naturally in the course of the business operation carried on by the company before the change -over. Conversely, a transaction entered into during the period of recoupment which is outside the course of the business operations before the change-over, or which is extraordinary or unnatural, when judged by the course of the business operation before the change-over, is unusually a transaction of a different kind from the transactions actually entered into by the company before the change-over.

The applicant states that for the recoupment periods the company did not change the direction of the business and did not entered into any new contracts that have fundamentally changed the business. It does not appear that the company entered into a business that it did not enter before the change-over. Although new contracts were entered, they are not inconsistent with the company's business before the change-over.

The company does not appear to derive assessable income from a new business of a kind that it did not carry on before the change-over.

However, the company did enter into a new transaction, when it made a capital investment to become fully compliant with one of its contracts. This involved purchasing a second transport asset.

The new transactions test was considered by Sheppard J in J Hammond Investments Pty Ltd v. FC of T (1977) 31 FLR 349 (J Hammond Investments). Sheppard J said at 357-359:

… there remains the question of whether it is correct to say, within the meaning of para. (c) of the subsection, that the taxpayer did not derive income from a transaction of a kind that it has not entered into in the course of its business operations before the change took place.

…

There are of course many receipts which are not properly described as being income from a business. There is an example of such a receipt in the present case. The partnership acquired a new building with a tenant in it, who remained in occupation for a short time after the acquisition. The sum of $160 was received by way of rental. It does not seem to me that that was income derived from the business being carried on by the partnership but it was certainly income derived from a transaction enter into in the course of the partnerships business operations. Many other transaction of this general type can be imagined.

Whilst therefore, I do not regard the matter as free from difficulty, I have reached the conclusion that the second limb of the paragraph is not intended to refer to the daily transactions involved in carrying on a business but to transactions of an isolated and independent kind, which transactions have nevertheless arisen in the course of the taxpayer's business operations.

…

In the present case there is not, in my opinion, any special isolated or separate transaction to which the provision of the second limb could attach.

In Fielder Downs (WA) Pty Ltd v. FC of T (1979) 45 FLR 242, Campbell J indicated a company fails the new transactions test if the company derives income during the same business test period from a transaction that was a different kind from the transactions the company had entered into in the course of the business carried on by the company at the test time, even if the first mentioned transaction is a transaction ordinarily involved in carrying on the business of the taxpayer during the same business period. Campbell J said:

If the business carried on beforehand should properly be held to be a business of the development of pastoral land for the eventual grazing of stock and one which was at all material times the one and the same business continuing from its commencement until the land were fully developed and stocked [that is, if the same business test was satisfied], it seems to me that the transaction of selling cattle (or wool or sheep) [that is, a day to day transaction of a transaction that was entered into in the ordinary course of the taxpayers business after the test time] was a transaction of a kind that the company had not entered into in the course of its business operations of developing the property prior to the sale. There is a difference in kind between a dealing or transaction concerned with the selling of seed or cereals for income and a dealing involved with obtaining income from the sale of stock.

In J Hammond Investments, Sheppard J at 4318 expressed the view that the [new transaction test] 'is not intended to refer to the daily transactions involved in carrying on a business but to transactions of an isolated and independent kind, which transaction have nevertheless arisen in the course of the taxpayer's business operations prior to the test time. Sales of stock had not been carried on prior to that time, and indeed prior to that time the company had no stock available which it could have sold. So it seems to me, that the sale of stock was a transaction of a different character from any which had been previously entered into by the company.

Thus, Campbell J treated the reference to 'transaction of a kind' in the new transaction test as being a reference to all transactions entered into in the course of the taxpayer's business operations, regardless of whether they were transactions entered into as part of the daily or regular conduct of the business carried on by the taxpayer or were transactions that were 'independent' or 'isolated' transactions, when judged by reference to the business carried on by the taxpayer. But, importantly, it would seem he did not regard transactions as being caught by the test if they were transactions that could have been carried on in the course of the company's operations prior to the test time.

Applying the above case law, the new transaction test is not failed where a taxpayer enters into a transaction that could have been entered into ordinarily and naturally in the course of its business operations before the test time.

The company's contract required two transport assets to be fitted with certain equipment. However, it only operated one asset. This meant the company was at risk of the contract being terminated due to non-performance. After the change in ownership, a second asset was purchased. This capital investment was able to save the existing contract and increase its cash-flow to help stabilise the company.

In the company's case, the capital investment could have been made prior to the change in ownership. It already had an existing contract and could have purchased the second asset if negotiations went through in time. By purchasing the second asset after the change in ownership, it produced income from a transaction of the same kind as the transactions actually engaged in before the change in ownership. That is income from hiring out its asset. Further, the transaction is not an independent or isolated transaction. Therefore, the new transaction test in paragraph 165-210(2)(b) is passed.

In consideration of the above, the company does not appear to derive assessable income from a new business of a kind that it did not carry on before or enter into a transaction which is outside the course of its business operations before the change in ownership.

Question 2

As a result of the DOCA, secured creditors took back certain fixed assets of the company. The secured creditors took back the assets in full satisfaction of the debts owed to them. However, assets were taken back at a value lower then their adjustable value.

The assets are depreciating assets and were used for taxable purposes. Therefore the capital allowance provisions in Division 40 of the ITAA 1997 are applicable.

As the secured creditors enforced their security interest against the fixed assets, a change in the ownership of the assets occurred and is treated as a disposal by the company under section 106-60 of the ITAA 1997. Therefore, CGT event A1 is triggered and a capital gain or loss will occur.

However, under section 118-24 of the ITAA 1997, a capital gain or loss is disregarded if the asset is a depreciating asset and a balancing adjustment event occurs instead.

The meaning of a 'balancing adjustment event' is explained in section 40-295 of the ITAA 1997:

A balancing adjustment event occurs for a depreciating asset if:

(a) you stop holding the asset or

(b) you stop using it, or having it installed ready for use, for any purpose and you expect never to use it, or have it installed ready for use, again; or

(c) you have not used it and:

I. if you have had it installed ready for you - you stop having it so installed; and

II. you decide never to use it

In this case, the assets are depreciating assets, and the company stops holding the asset as they are taken back by the secured creditors in satisfaction of debts owed to them.

The balancing adjustment amount is applied as follows:

· if the termination value of a depreciating asset is more than its adjustable value, the difference is included in your assessable income (subsection 40-285(1) of the ITAA 1997)

· if the termination value is less than its adjustable value the difference is an allowable deduction (subsection 40-285(2).

Subsection 40-85(1) of the ITAA 1997 provides the meaning of 'adjustable value' and states that for the first year in which you use the asset, the adjustable value is its cost less its decline in value and for later income years, it is the sum of its opening adjustable value and second element costs less its decline in value. The assets adjustable value has been provided by the company.

Section 40-300 of the ITAA 1997 provides that the termination value of a depreciating asset is worked out at the time when a balancing adjustment even occurs. The termination value is, in certain circumstances, an amount specified in the table in subsection 40-300(2) of the ITAA 1997. Otherwise, the termination value is the amount taken to have been received under section 40-305 of the ITAA 1997.

As no item in the table in subsection 40-300(2) of the ITAA 1997 applies, the termination value is worked out under section 40-305 of the ITAA 1997. Item 2 in the table in section 40-305 of the ITAA 1997 provides that the termination value of a depreciating asset, where all or part of a liability is terminated, is the amount of the liability or part when it is terminated. This was the case in ATO ID 2004/160 Capital Allowances: termination value - assigning depreciating assets to terminate a liability, where a lessor accepted a depreciating asset in complete satisfaction of any and all of the taxpayer's liabilities arising from any default and the early termination of the lease agreement. The termination value of the depreciating asset was the amount of those liabilities when terminated.

In the company's case, it did not receive a cash amount; rather the debt owed to the secured creditors was discharged. Therefore the termination value would be the amount of the debt.

As the termination value was less then the assets adjustable value, the difference is an allowable deduction under subsection 40-285(2) of the ITAA 1997.