Edited version of your written advice

Authorisation Number: 1051193375228

Ruling

Subject: Deductibility of a loss incurred from an isolated transaction under section 8-1 of the ITAA 1997

Question

Is the loss incurred by Company A on the transfer of its shares in Company B acquired under the Transaction deductible to Company A under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. The loss incurred by Company A on the transfer of its shares in Company B acquired under the Transaction will be deductible to Company A under section 8-1 of the ITAA 1997.

This ruling applies for the following periods:

Year ending 30 June 2017

The scheme commences on:

2016 Income year

Relevant facts and circumstances

Background

Company A operates a business in a particular industry.

Company B participates in the same industry as Company A.

Company A wanted to acquire a subsidiary of Company B.

Company A made a one-off acquisition of shares in Company B (the Transaction).

Apart from the shares acquired in Company B, Company A has not acquired shares in listed companies in recent times.

Company A's Intentions in entering into the Transaction

Company A's primary intention was to acquire all or part of a subsidiary of Company B to achieve synergies in its business. However, this was not Company A's sole intention.

In the alternative, Company A intended to sell its shares in Company B at a profit.

Due to specific conditions agreed to under the Transaction and prevalent market conditions at the time of entering into the Transaction, it was perceived that the likely outcome from the sale of shares in Company B would result in a profit.

Company A never intended to hold its shares in Company B for long term dividend yield and capital appreciation.

Company A incurred a loss on the sale of its shares in Company B within a 12 month period.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 51(1)

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

All references to legislation within this ruling are to the ITAA 1997 unless otherwise specified.

Section 8-1

Section 8-1 relates to general deductions and provides:

8-1(1)

You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

8-1(2)

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your *exempt income or your *non-assessable non-exempt income; or

(d) a provision of this Act prevents you from deducting it.

8-1(3)

A loss or outgoing that you can deduct under this section is called a general deduction.

In Federal Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR 199 (Myer), the Court considered the concepts of capital and revenue within the circumstances of an isolated transaction as there is no statutory definition of 'revenue' or 'capital'.

The Commissioner has considered the principles outlined in the Myer case in Taxation Ruling TR 92/3 Income Tax: whether profits on isolated transactions are income and Taxation Ruling TR 92/4 Income Tax: whether losses on isolated transactions are deductible and provided guidance in determining whether profits from isolated transactions are assessable as ordinary income or losses on isolated transactions are deductible.

TR 92/3 should be read in conjunction with TR 92/4.

Isolated Transactions

Taxation Ruling TR 92/3 provides guidance on the Commissioner's views in regard to isolated transactions.

Paragraph 1 of TR 92/3 provides that the term 'isolated transactions' refers to:

(a) Those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

(b) Those transactions entered into by non-business taxpayers.

It is accepted that Company A's purchase of shares in Company B is outside the ordinary course of its business and is therefore considered to be an isolated transaction.

Profits or losses on isolated transactions

Paragraph 3 of TR 92/3 details the Commissioner's view as to the application of the decision in the Myer case:

The Court relied on 2 strands of reasoning in holding that the amount received by the taxpayer was income:

(a) The amount in issue was a profit from a transaction which, although not within the ordinary course of the taxpayer's business, was entered into with the purpose of making a profit and in the course of the taxpayer's business.

(b) The taxpayer sold a mere right to interest for a lump sum, that lump sum being received in exchange for, and as the present value of, the future interest it would have received. The taxpayer simply converted future income into present income.

More recently, the elements established in the Myer case were considered in Visy Packaging Holdings Pty Ltd v Commissioner of Taxation [2012] FCA 1195 (Visy).

In Visy, Middleton J stipulated at paragraph 9 that:

As is the subject of further analysis later in these reasons for judgment, these proceedings do not raise any novel or overly complex principles of law. The determination of these proceedings principally turns on the facts. It is useful at this stage to briefly set out some of the key legal concepts in issue, in order to frame the forthcoming discussion of the relevant facts and the parties' submissions.

Middleton J further elaborated at paragraphs 185 to 187 that:

185. The principle of law which is at the centre of this case is clear: if the intention or purpose of the relevant entity in entering into a transaction or upon acquiring an asset was to make a profit or gain, that profit or gain will be income, even if the transaction was extraordinary by reference to the ordinary course of that entity's business: see Westfield Ltd v Commissioner of Taxation (1991) 28 FCR 333; Commissioner of Taxation v Cooling (1990) 22 FCR 42; Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199; Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355; and Visy Industries USA Pty Ltd [2012] FCAFC 106. Similarly, if the intention or purpose was to make a profit or gain but a loss was ultimately in fact sustained, then a deduction in the amount of that loss would be permitted.

186. It is not necessary that the sole or dominant purpose of entering into the relevant transaction is to make a gain or profit. It is enough if a “not insignificant purpose” of the relevant transaction was to obtain a profit or gain: see eg Cooling (1990) 22 FCR 42 at 56-57.

187. Accordingly, in these proceedings, if the intention or purpose of acquiring the relevant shares (in the context in which that occurred), was to make a profit or gain, then the losses ultimately incurred are deductible. If that intention or purpose did not exist, then in the circumstances of these proceedings the losses incurred would be of a capital nature for the purpose of s 8-1 of the 1997 Act, and no losses could be deducted as sought by the taxpayers.

Paragraph 6 of TR 92/3 provides the Commissioner's view regarding profit on isolated transactions:

Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, a profit from an isolated transaction is generally income when both of the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

In conjunction, paragraph 4 of TR 92/4 provides the Commissioner's view regarding losses on isolated transactions:

A loss from an isolated transaction is generally deductible under subsection 51(1) if:

(a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income; and

(b) the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

Accordingly, to determine whether the loss will be deductible on an isolated transaction under section 8-1, Company A must have had an intention or purpose to make a profit at the time of acquisition of the Company B shares and the acquisition must have been in the course of carrying on a business or carrying out a business operation or commercial transaction.

Intention or purpose to make a profit

As established in the Myer case, and repeated in paragraph 6(a) of TR 92/3, a profit from an isolated transaction will generally be income when the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain.

Relevantly, paragraphs 7 to 10 of TR 92/3 provide:

7. The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

8. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

9. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

10. If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

As further elaborated in Visy, when trying to determine the intention to make a profit, Middleton J provided at paragraphs 200 to 203 that the minds of the directors who are in control are relevant as to whether they represented that of the taxpaying entity. Therefore, the fact that a taxpayer made a loss from a particular transaction is not important to the characterisation or assessment of the profit making intention. Rather, what matters most is whether the taxpayer, based on the directing minds of the company, had an opportunity for profit.

Also in Visy, Middleton J at paragraphs 195 and 196 did not accept that the proper characterisation of the divestment assets were part of wider scheme for the acquisition of a synergistic business. This view provides that rather than looking at the acquisition of a company as a whole forming part of a wider scheme of capital acquisition, those assets that were acquired for the purpose of divestment at a profit, would be regarded as doing more than realising an asset in an enterprising way.

Therefore, a taxpayer's sole purpose does not need to be the making of a profit in order for the taxpayer to have the requisite profit making intention. A taxpayer may have a dual purpose for the acquisition of the asset. In the case of Visy, this dual purpose was to acquire and control a business with synergistic benefits while also seeking to gain a profit on the divestment of unwanted assets.

Provided that the taxpayer can establish that one of those purposes is achieving a profit, this will be sufficient to render that profit as ordinary income. Accordingly, it stands that should a loss in fact be realised, the loss obtained will be deductible.

When looking at the business context of the transaction, Middleton J, in Visy, stipulated at paragraph 238 that, “[i]t is necessary to look at the whole factual matrix in which the transaction occurs”. In the current circumstances, the factual matrix to be considered will be those listed in the Relevant facts and circumstances. It is this factual matrix that will be utilised to determine whether Company A had the requisite intention or purpose when entering into the Transaction.

Company A had the requisite purpose at the time of entering into the Transaction.

In the course of carrying on a business or business operation or commercial transaction

As provided in paragraph 6(b) of TR 92/3, the other key element for a profit on an isolated transaction to be generally considered income is that the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

In this regard paragraphs 12 and 13 of TR 92/3 provide further explanation as to when a transaction is to be characterised as business or commercial in character:

12. For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character.

13. Some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following:

(a) the nature of the entity undertaking the operation or transaction;

(b) the nature and scale of other activities undertaken by the taxpayer;

(c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

(d) the nature, scale and complexity of the operation or transaction;

(e) the manner in which the operation or transaction was entered into or carried out;

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

(g) if the transaction involves the acquisition and disposal of property, the nature of that property; and

(h) the timing of the transaction or the various steps in the transaction.

With regard to the above factors and guidance from relevant case law, the Transaction undertaken by Company A was commercial in character and would therefore satisfy this element.

Example from TR 92/3

TR 92/4 contains examples of circumstances where a loss from an isolated transaction should be deductible.

Therefore, where the examples of TR 92/3 apply to a profit, they will apply equally in circumstances where the outcome was a loss to the taxpayer. Example 5 of TR 92/3 at paragraphs 80 to 82 is of particular note and is reproduced below:

80. Hungry Ltd, a public company, made a takeover bid for another public company, Morsel Ltd, in which it already held a 15% interest. Shortly after, Ravenous Ltd also made a takeover bid for Morsel. Ravenous' takeover bid was successful and Hungry's failed. Hungry sold to Ravenous the shares it had acquired in Morsel at a large profit.

81. Hungry was a holding company in a group of companies. Many of the entities in the company group had previously been involved in takeovers of other companies. Hungry had not previously been involved in a takeover attempt and had only disposed of shares in the course of restructuring the company group. From the time Hungry began to acquire shares in Morsel the directors of Hungry had hoped to acquire control of Morsel - they were not interested in a 'passive investment'. The contingency plan of the directors in the event that control could not be obtained was to dispose of the shares in Morsel at a profit.

82. The profit on the sale of the shares is income. A substantial, but not dominant, purpose of Hungry in acquiring the shares was to dispose of them at a profit because the contingency plan was to dispose of the shares at a profit. Furthermore, the acquisition and sale of the shares was effected in the course of the taxpayer's business.

Company A's situation is of a similar nature.

Conclusion

Company A objectively had a profit making purpose in relation to the acquisition and subsequent transfer of its shares in Company B, even though that purpose was not its dominant intention or purpose. Furthermore, the Transaction undertaken by Company A was commercial in character.

Based on the earlier analysis, it is also concluded that the negative limbs of subsection 8-1(2) do not apply.

Taking into consideration the Commissioner's views expressed in TR 92/3 and TR 92/4, and the application of the principles set out in Myer and Visy, the loss incurred by Company A on the sale of its shares in Company B acquired under the Transaction will be deductible under section 8-1.