Edited version of your written advice

Authorisation Number: 1013100731289

Date of advice: 29 September 2016

Ruling

Subject: Income tax ~~ Tax losses ~~ Continuity of ownership test ~~ Modified rules

Question 1

Will the transfer of shares in the Corporate Trustee from Company A to Individual C (the Proposed Transaction) result in the Loss Company being unable to satisfy the continuity of ownership test under section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following periods:

1 July 20YY to 30 June 20ZZ

Relevant facts and circumstances

Loss Company

The Loss Company is the head company of a consolidated group for income tax purposes.

The Loss Company has substantial carried forward capital and revenue losses.

All of the issued shares in The Loss Company are held, and have been held at all times from the commencement of the year of income in which the carried forward capital and revenue losses were incurred until the date of the ruling, by the Corporate Trustee in its capacity as trustee of the Unit Trust

Unit Trust

The Unit Trust is a hybrid unit trust with income and capital units which holders of the income units will have entitlements to the income of the Unit Trust and holders of the capital units will have a beneficial interest in the capital assets of the Unit Trust.

All of the capital and income units on issue in the Unit Trust are held by the Family Trust.

A family trust election (FTE) under section 272-80 of Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936) was made in respect of the Unit Trust.

Discretionary Trust

Corporate Trustee is the trustee of the Discretionary Trust.

A FTE under section 272-80 of the ITAA 1936 was made in respect of the Discretionary Trust.

Corporate Trustee

Corporate Trustee is the corporate trustee of the Unit Trust and Discretionary Trusts.

Presently, Corporate Trustee has X directors.

Corporate Trustee has two shares on issue. One ordinary share (50% shareholding) is held beneficially by Company A. The other ordinary share (50% shareholding) is held by Company B.

The Proposed Transaction

The shares in Company B are currently held as to 50% by Individual A and as to 50% by Individual B, who are also both directors of Company B.

It is proposed that Company B will transfer its share in Corporate Trustee to Individual C (the Proposed Transaction).

Individual C is not an associate of any of the Appointors or Guardians of the Discretionary Trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 165-A

Income Tax Assessment Act 1997 Section 165-10

Income Tax Assessment Act 1997 Section 165-12

Income Tax Assessment Act 1997 Subsection 165-12(1)

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 Subsection 165-12(5)

Income Tax Assessment Act 1997 Subsection 165-12(6)

Income Tax Assessment Act 1997 Section 165-15

Income Tax Assessment Act 1997 Subdivision 165-CA

Income Tax Assessment Act 1997 Subsection 165-96(1)

Income Tax Assessment Act 1997 Subdivision 165-D

Income Tax Assessment Act 1997 Subsection 165-150(1)

Income Tax Assessment Act 1997 Subsection 165-155(1)

Income Tax Assessment Act 1997 Subsection 165-160(1)

Income Tax Assessment Act 1997 Subsection 165-165(1)

Income Tax Assessment Act 1997 Section 165-175

Income Tax Assessment Act 1997 Section 165-207

Income Tax Assessment Act 1936 Schedule 2F Section 272-75

Reasons for decision

Loss Company is the head company of a consolidated group. In order to deduct its carried forward tax losses, it will need to satisfy the general loss recoupment provisions in section 165-10 of the ITAA 1997. This requires the head company to pass the COT in section 165-12 of the ITAA 1997 and control test in section 165-15 of the ITAA 1997 or the same business test (SBT) in section 165-13 of the ITAA 1997.

The Commissioner is only considering the COT under section 165-12 of the ITAA 1997 in this ruling. In particular, the Commissioner does not in this ruling make any determination on whether the Loss Company satisfies the 'control test' or whether the capital and tax losses are deductible for a particular income year. The Loss Company will need to self-assess whether these conditions are satisfied.

Continuity of Ownership Test (COT) - section 165-12

Under section 165-12 of the ITAA 1997, a company cannot deduct a prior year tax loss unless it satisfies the COT, which is about the company maintaining the same owners. The COT consists of three conditions under subsections 165-12(2), 165-12(3) and 165-12(4) of the ITAA 1997. Broadly, this means that there must be persons who, at all times during the ownership test period had:

• 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.

Ownership test period

The tests in section 165-12 of the ITAA 1997 are 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.

Primary test applies

The three conditions under subsections 165-12(2) to (4) of the ITAA 1997 are applied either as a 'primary test' or as an 'alternative test'.

According to subsection 165-12(5) of the ITAA 1997 the primary test will apply unless subsection 165-12(6) of the ITAA 1997 requires that the alternative test applies. Subsection 165-12(6) of the ITAA 1997 states that the alternative test applies if one or more other companies beneficially owned shares or interests in shares in the company during the ownership test period.

In the current circumstances, the primary test applies because no companies beneficially owned shares or interests in shares in the Loss Company during the ownership test period. All the shares in the Loss Company are legally held by the Corporate Trustee in its capacity as trustee for the Unit Trust. However, neither the Corporate Trustee nor its shareholders are the beneficial owner of the shares in the Loss Company.

Accordingly, the primary tests in subsections 165-150(1), 165-155(1) and 165-160(1) of the ITAA 1997 are to be applied in relation to the Loss Company.

Applying the primary tests, the COT is satisfied for the Loss Company if there are persons who, at all times during the ownership test period, beneficially own (between them) shares that carry (between them):

• the right to exercise more than 50% of the voting power in the company;

• the right to receive more than 50% of the dividends the company may pay; and

• the right to receive more than 50% of the capital distributions of the company

Company owned by a discretionary trust cannot satisfy COT

In the current circumstances, all the shares in the Loss Company are held by the Corporate Trustee in its capacity as trustee for the Unit Trust. All the units in Unit Trust are held by the Corporate Trustee in its capacity as trustee for the Discretionary Trust.

In the absence of the special rules under section 165-207 of the ITAA 1997, the Loss Company will not be able to satisfy the COT since tracing through interposed entities to underlying beneficial owners cannot occur through a discretionary trust as beneficiaries of a discretionary trust do not have fixed interests in the income or capital of the company or interposed entity.

Section 165-207 - concessional tracing rules

Section 165-207 of the ITAA 1997 states:

(1) This section applies if one or more trustees of a family trust:

(a) owns shares in a company; or

(b) controls, or is able to control, (whether directly, or indirectly through one or more interposed entities) voting power in a company; or

(c) has a right to receive (whether directly, or indirectly through one or more interposed entities) a percentage of a dividend or a distribution of capital of a company.

(2) For the purposes of a primary test, a single notional entity that is a person (but is neither a company nor a trustee) is taken to own the shares beneficially.

(3) Omitted

(4) Omitted

Section 165-207 of the ITAA 1997 contains measures designed to ensure that concessional tracing rules are available for companies which are held by 'family trusts' (as defined by section 272-75 of Schedule F of the ITAA 1936). A trust is a 'family trust' at any time when a FTE in respect of the trust is in force (see sections 995-1 of the ITAA 1997 and section 272-75 of Schedule 2F of the ITAA 1936).

Under section 165-207 of the ITAA 1997, for the purposes of the primary tests, the trustee of a trust which has made a FTE is taken to be a single notional entity that is a person and is taken to beneficially own shares in a company. This is evident in paragraph 9.31 of the Explanatory Memorandum to Taxation Laws Amendment Bill (No.8) 1999 which states:

….Broadly, the concession will apply for the purposes of the company rules so that where the relevant interests in a company are held by a family trust, the trustee of the family trust will be taken to own the interest as an individual.

In the current circumstances, the Corporate Trustee as trustee of the Unit Trust has made a FTE. The Unit is a 'family trust' throughout the ownership test period. As the Unit is a 'family trust' and the trustee of the Unit Trust owns all the shares in the Loss Company, paragraph 165-207(1)(a) of the ITAA 1997 is satisfied, resulting in subsection 165-207(2) of the ITAA 1997 applying. The effect of subsection 165-207(2) of the ITAA 1997 is that, for the purposes of the primary test, a single notional entity that is a person (but is neither a company nor a trustee) is taken to own all the shares in the Loss Company. As a result, the Loss Company is able to satisfy the COT.

'Same share - same interest' rule - section 165-165

A further requirement of the COT is that exactly the same shares or interests must be held during the relevant test time. Subsection 165-165(1) of the ITAA 1997 relevantly states:

For the purpose of determining whether a company has satisfied a condition or whether a time is a changeover time or an alteration time in respect of a company:

(a) a condition that has to be satisfied is not satisfied; or

(b) a time that, apart from this subsection, would not be a changeover time or alteration time is taken to be a changeover time or alteration time, as the case may be;

unless at all relevant times:

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

(d) 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.

The purpose of this rule is to ensure that the same people under consideration for the COT must hold exactly the same shares or interests in shares for the entire ownership test period.

Based on the information provided, all the issued shares in the Loss Company held by Corporate Trustee as trustee of the Unit Trust have been exactly the same shares for the entire ownership test period.

The requirements of section 165-165 of the ITAA 1997 have been met and consequently section 165-165 of the ITAA 1997 will not cause the COT to be failed.

Capital losses

Subdivision 165-C of the ITAA 1997 deals with the ability of companies to deduct carried forward capital losses. In particular, subsection 165-96(1) of the ITAA 1997 provides that a company cannot apply a net capital loss for an earlier income year if Subdivision 165-A of the ITAA 1997 would prevent it from deducting the loss if the loss was a hypothetical revenue tax loss.

As determined above, the Commissioner is of the view that the Proposed Transaction alone will not cause the Loss Company to fail the COT such that Subdivision 165-A would prevent it from deducting the tax losses in the year ended 30 June 20YY. Therefore, on the assumption that the capital losses were tax losses of an earlier income year, the Proposed Transaction alone will not cause the Loss Company to fail the COT such that it would be prevented from deducting the capital losses in the year ended 30 June 20YY.