Edited version of your written advice

Authorisation Number: 1051372656837

Date of advice: 11 May 2018

Ruling

Subject: Recoupment of losses

In order to protect the privacy of the taxpayer, the following summary is provided.

The taxpayer sought a ruling on deductibility of losses pursuant to section 165-12 of the Income Tax Assessment Act 1997 (ITAA1997).

Continuity of Ownership Tests (COT)

Section 165-12 specifies conditions that a company must satisfy in order to deduct a tax loss. Broadly, section 165-12 provides that the company must maintain more than 50% continuity of ownership throughout the ownership test period. These tests are applied either as a primary test or as an alternative test.

According to subsections 165-12(2) to (4), a company will be able to deduct losses if at all times during the ownership test period ‘there must be a person who 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.

The voting power is worked out under section 165-150, the rights to dividends under section 165-155 and the rights to capital distribution under section 165-160. Each section provides for the primary test and the alternative test.

Subsection 165-12(5) provides that the primary test will apply for a condition unless subsection 165-12(6) requires that the alternative test applies.

Subsection 165-12(6) stipulates that the alternative test applies if one or more other companies beneficially owned shares or interests in shares in the test company during the ownership test period.

In this case, the alternative test was applied to test whether continuity of ownership has been satisfied.

The alternative tests are listed in subsections 165-150(2), 165-155(2) and 165-160(2).

In applying the continuity of ownership test, a company must trace its ownership through to its ultimate beneficial owners to determine whether the conditions in section 165-12 are satisfied.

Pursuant to section 165-202, some specific entities are to be treated as if they are a person and not a company. Consequently, in applying the continuity of ownership test, a company will be able to treat the following entities in its ownership structure as if they are a person:

● government entities, including of a foreign country or of part of a foreign country

● non-profit bodies and charitable entities

● a complying superannuation fund

● a superannuation fund that is established in a foreign country and is regulated under a foreign law

● a complying approved deposit fund

● a special company, or

● a managed investment scheme.

Ownership test period

The ownership test period is defined in subsection 165-12(1) and is the period from the start of the loss year to the end of the income year, that is the year in which the loss is sought to be deducted. In this case there were a number of ownership periods.

Same shares or interests rule

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) specifically 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 must hold exactly the same shares or interests in shares for the entire ownership test period. In this case, the same shares or interests rule has not been satisfied.

Saving provision

Subsection 165-12(7) provides that where a condition in subsection 165-12(2), 165-12(3) or 165-12(4) is not satisfied, those conditions can be taken as being satisfied if they would have been satisfied except for the operation of section 165-165, and:

the company has information from which it would be reasonable to conclude that less than 50% of the *tax loss has been reflected in deductions, capital losses, or reduced assessable income, that occurred, or could occur in future, because of the happening of any *CGT event in relation to any *direct equity interests or *indirect equity interests in the company during the *ownership test period.

* denotes a term defined in subsection 995-1(1) of the ITAA 1997

In this case, the saving provision was satisfied.

Where a company has different classes of shares with unequal rights to voting power, it may have difficulty in satisfying the continuity of ownership test even though there is no significant change in underlying beneficial ownership during the ownership period.

Division 167 improves the operation of the continuity of ownership test by modifying the test for companies that have shares with unequal rights to dividends, capital distributions or voting power.

In this case, as there were persons who held more than 50% of the voting rights, more than 50% of the rights to dividends and more than 50% of the rights to capital distributions, the conditions in subsections 165-150(2), 165-155(2) and 165-160(2) have been satisfied.

Therefore, the taxpayer satisfies the conditions in section 165-12 for the relevant ownership periods.