Edited version of your written advice

Authorisation Number: 1013003630650

Date of advice: 2 May 2016

Ruling

Subject: Consolidation and continuity of ownership tests

Question 1:

Does Company X as head company of the Company X Consolidated Group meet the conditions in section 165-12 of the ITAA 1997 as modified by subsection 707-210 (2) of the ITAA 1997, for utilisation in the income year A of an amount of tax losses transferred at consolidation under subdivision 707-A of the ITAA 1997?

Answer:

Yes

Question 2:

Does Company X as head company of the Company X Consolidated Group meet the conditions in section 165-12 of the ITAA 1997 to utilise in the income year A tax losses incurred post-consolidation?

Answer:

Yes

Relevant facts and circumstances

Company X, an Australian resident, carries on business in Australia

Company X is wholly owned by a foreign entity, Company Y, since its incorporation. The shares held by Company Y in Company X carry the rights to:

• exercise more than 50% of the voting power in Company X;

• receive more than 50% of any dividends that Company X may pay and

• receive more than 50% of any distribution of capital from Company X.

Company Y holds ownership of Company X for the benefit of its government ('the foreign government') such that all monies invested in Company X are and will remain government monies and all returns from that investment will flow through Company Y to form part of consolidated revenue of the foreign government.

Company X is also the head company of an Australian consolidated group ('the Company X Group').

The subsidiary members of the Company X Group are wholly owned by Company X since their incorporation.

The shares held by Company X in each of the subsidiary members carry the rights to:

• exercise more than 50% of the voting power in the subsidiary member;

• receive more than 50% of any dividends that the subsidiary member may pay; and

• receive more than 50% of any distribution of capital from the subsidiary member

Ultimately, each of the subsidiary members is wholly beneficially owned by the foreign government through Company X and Company Y.

The Company X Group has carried forward losses comprised of losses transferred by the subsidiary members at consolidation and losses incurred by the group post-consolidation.

As part of a restructure proposed by the foreign government during income year A, Company Y will be replaced by Company Z as the entity holding Company X and therefore the subsidiary members of the Company X Group for the benefit of the foreign government.

Any agreement made, transaction done by or to in relation to Company Y which is in force or effective immediately before the incorporation of Company Z, is continued by company Z as if Company Z is the same person as Company Y for the purposes of the relevant law of the foreign country.

The Company X Group expects to be able to recoup some of its carried forward losses in the income year A.

Relevant legislative provisions

Subsection 165-12(1) of the ITAA 1997

Subsection 165-12(2) of the ITAA 1997

Subsection 165-12(3) of the ITAA 1997

Subsection 165-12(4) of the ITAA 1997

Subsection 165-12(5) of the ITAA 1997

Subsection 165-12(6) of the ITAA 1997

Subsection 165-15(1) of the ITAA 1997[-

Subsection 165-150(2) of the ITAA 1997

Subsection 165-155(2) of the ITAA 1997

Subsection 165-160(2) of the ITAA 1997

Subsection 165-165(1) of the ITAA 1997

Subsection 165-202(1) of the ITAA 1997

Reasons for decision

Subdivision 165-D of the ITAA 1997 governs the operation of the general loss recoupment rules for companies. Pursuant to section 165-10 of subdivision 165-D of the ITAA 1997, a company can only recoup a tax loss incurred in an earlier income year if the company:

• satisfies the continuity of ownership test (COT) in section 165-12; or

• satisfies the same business test (SBT) in section 165-13; and

• does not fail the control test in section 165-15 (i.e. experience a tainted change of control).

The COT requires that a company has maintained the same majority ownership during the 'ownership test period'.

Ownership test period

Subsection 165-12(1) of the ITAA 1997 defines the ownership test period as the period from the start of the income year in which the company made the loss (loss year) to the end of the income year in which the tax loss is recouped.

The COT

The COT is applied to three different kinds of interests or rights that attach to shares in a company, being, voting power in the company, rights to dividend distributions and rights to capital distributions of the company.

Subsections 165-12(2), 12(3) and 12(4) of the ITAA 1997 provide respectively that there must be 'persons' who had:

• more than 50% of the voting power in the company at all times during the ownership test period;

• rights to more than 50% of the company's dividends at all times during the ownership test period; and

• rights to more than 50% of the company's capital distributions at all times during the ownership test period.

The COT can be satisfied by applying the primary test under subsection 165-12(5) unless subsection 165-12(6) requires the alternative test to be applied. The alternative test applies where one or more other companies beneficially owned shares or interests in shares in the test company anytime during the ownership period.

The alternative test

Subsection 165-150(2) of the ITAA 1997 provides that the condition in subsection 165-12(2) is satisfied if, it is the case, or it is reasonable to assume, that there are 'persons' (none of them companies or trustees) who at a particular time control, or are able to control, (whether directly or indirectly, through one or more interposed entities) the voting power in the company (being tested).

Subsection 165-155(2) provides that the condition in subsection 165-12(3) is satisfied if, it is the case, or it is reasonable to assume there are 'persons' (none of them companies or trustees) who at a particular time have the right to receive for their own benefit (whether directly or indirectly) more than 50% of any dividends that the company (being tested) may pay.

Subsection 165-160(2) provides that the condition in subsection 165-12(4) is satisfied if, it is the case, or it is reasonable to assume, that there are 'persons' (none of them companies or trustees) who at a particular time have the right to receive for their own benefit (whether directly or indirectly) more than 50% of any distribution of capital from the company (being tested).

Persons

Subsection 165-202 of the ITAA 1997 provides that, for the purposes of a test (in subdivision 165D), shares held by government entities and charities, among others, are taken to be beneficially owned by a 'person' (who is not a company). Subsection 165-202(1) contains a list of such entities. Included in that list at item (d) is the 'government of a foreign country or of part of a foreign country'.

Control test

Even if the COT is satisfied, the control test in section 165-15 of the ITAA 1997 may prevent a loss from being recouped. Broadly, subsection 165-15(1) denies a tax loss if a person who controlled, or was able to control, the voting power in a company for some or all of the ownership test period, did not control, or was not able to control that voting power for the whole of the loss year with the purpose of obtaining a tax benefit (for that person or someone else).

Same share rule

Subsection 165-165(1) of the ITAA 1997 requires that in testing whether a condition relevant to the COT has been satisfied:

(a) the only shares in the company that are taken into account are exactly the same shares and are held by the same persons; and

(b) the only interests in any other entity (including shares in another company) that are taken into account are exactly the same interests and are beneficially owned by the same persons.

Transfer of losses at consolidation

Subdivision 707-A of the ITAA 1997 governs the transfer of carried forward losses of the joining entities to the head company at consolidation. Section 707-120 of the ITAA 1997 modifies the loss recoupment rules in section 165-12 of the ITAA 1997.

These modified loss recoupment rules are required to be satisfied for the ownership test period by each joining entity that transfers losses to the head company at consolidation.

The ownership test period commences from the beginning of the loss year of each joining entity to just after the time of consolidation.

Utilisation of losses transferred at consolidation

Subdivision 707-B of the ITAA 1997 governs the utilisation by the head company of losses transferred to it by the joining entities pursuant to subdivision 707-A.

Under section 707-205 of the ITAA 1997, a head company's ability to utilise transferred losses is determined by applying the loss recoupment tests directly to the head company with the loss year starting at the transfer time. The exception applies where the losses were transferred because the joining entity satisfied the continuity of ownership test (COT). In this situation, the loss is described as a 'COT transfer': see subsection 707-210(1A) of the ITAA 1997.

If the losses were transferred as a COT transfer to a head company, it is the joining entity that is further subject to the COT. Further, the following assumptions (modifications) are made to the COT pursuant to subsection 707-210(4) of the ITAA 1997:

• the period subject to the COT runs from the start of the loss year of the joining entity until the end of the income year for which the head company seeks to utilise the loss ('ownership test period');

• the joining entity is a wholly owned subsidiary of the head company as defined in subsection 703-30(1) of the ITAA 1997; and

• only ownership changes above the head company are considered in determining whether the joining entity passes the COT during the ownership test period.

Accordingly, if the joining entity in question ceases to be a subsidiary member of the consolidated group after the transfer of its losses to the head company, this exit from the group is ignored for the purposes of determining whether it satisfies the COT.

If the joining entity passes the modified COT in subsection 707-210(4) of the ITAA 1997, the head company is treated as the entity that has passed the test.

Utilisation of post-consolidation losses

In order to utilise post-consolidation losses, the head company of the group will need to satisfy the COT rules in section 165-12 of the ITAA 1997 for the relevant ownership test period post-consolidation.

Application in the present circumstances

Losses transferred at consolidation

The subsidiary members of the Company X Group are eligible to transfer their carried forward losses to Company X as the head company of the group. This is because each of them satisfies for the period commencing the start of its loss year to just before the formation of the Company X Consolidated Group (ownership test period):

• the modified continuity of ownership tests (COT) in section 707-120 of subdivision 707-A;

• the control test in section 165-15 of the ITAA 1997; and

• the same share rule in subsection 165-165(1) of the ITAA 1997

Utilisation of transferred losses

Continuity of majority ownership of Company X during the ownership test period

The relevant ownership test period commences from the beginning of the loss year of each subsidiary member to the end of income year A.

The foreign government has 100% beneficial ownership of Company X, and the Company X Group, through Company Y, from the commencement of the loss year of each subsidiary member and until just before the proposed restructure in the income year A.

Following the restructure, when the shareholding in Company X is transferred from Company Y to Company Z, the foreign government will continue to beneficially own Company X and the Company X Group through Company Z. This is explained by the fact that the moneys invested in Company X are monies of the foreign government and will remain as government monies so that all returns from the investment flows to the foreign government through either Company Y or Company Z to form part of consolidated revenue of the foreign government.

Consequently, the foreign government will continue to beneficially own 100% of Company X until the end of income year A during which the losses in question may likely be recouped.

Therefore, for the purposes of subsections 165-12(2), 165-12(3) and 165-12(4) of the ITAA 1997, the foreign government, a person, had during all times in the ownership test period:

• control of more than 50% of the voting power in Company X;

• rights to more than 50% of Company X's dividends; and

• rights to more than 50% of Company X's capital distributions

It is considered that the control test in subsection 165-15(1) of the ITAA 1997 is not failed as based on the facts and circumstances of the case, there is no basis to conclude that the foreign government relinquished control in respect of its voting power in Company X for some or all of the loss year/years, and subsequently assumed that control with the purpose of obtaining a tax benefit for itself or someone else.

Same share, same interest rule

For the purposes of subsection 165-165(1) of the ITAA 1997, the shares held by either Company Y or Company Z in Company X and the shares held by Company X in the subsidiary members that are taken into account, are exactly the same shares that are beneficially owned throughout the ownership test period by the same person, being the foreign government.

As both the COT and same share rules are satisfied, Company X as the head company of the Company X Group is eligible to utilise against income and gains in the income year A, tax losses carried forward in the nature of transferred and post-consolidation losses.

Utilisation of post-consolidation losses

The utilisation of post-consolidation losses by Company X at the end of income year A requires that Company X satisfies the COT post-consolidation and until the end of income year A.

As explained in relation to the utilisation of transferred tax losses, the foreign government beneficially owns 100% of Company X post-consolidation and until the end of income year A. Additionally, the control test is not failed. As the COT and the same share rule is satisfied in respect of the ownership test period, Company X is eligible to utilise post-consolidation tax losses in the income year A.

In conclusion, Company X, as the head company of the Company X Group, is eligible to recoup in the income year A carried forward losses transferred at consolidation, and tax losses incurred post-consolidation pursuant to subdivisions 165-D and 707-B and of the ITAA 1997 respectively.