Edited version of your written advice

Authorisation Number: 1051394325995

Date of advice: 16 July 2018

Ruling

Subject: Tax loss

Question 1

Can the company apply subdivision 165-B of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

In applying section 165-45 of the ITAA 1997, is the first period from 01/07/2017 to XX/XX/2017 and the second period from XX/XX/2017 to 30/06/2018?

Answer

Yes.

Question 3

Would trading income from a discretionary trust to which the company is made presently entitled at the end of the 2017-18 income year be attributed to periods on a reasonable basis under subsection 165-60(2) of the ITAA 1997?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2018

The scheme commenced on

1 July 2017

Relevant facts

The company was incorporated and purchased a business.

Later, the company sold the business having incurred considerable losses during the period of operation.

The company has ceased trading and is managing payments of the remaining creditors. The company has not made a decision on whether it will continue with a new business.

Trust B operate a separate business. Trust B is a discretionary trust.

In accordance with the Trust Deed, the company is a general beneficiary of Trust B. Under the Trust deed, the Trustee may determine whether to pay, apply or set aside income of the Trust, or any part of the income of the Trust, to, or for the benefit of, beneficiaries, or any one or more of them exclusive of the other, or others, in such proportions and from such categories of income as the Trustee may in its discretion determine.

Trust B did not make any distributions of income to the company in the 2016-17 income year.

As at XX/XX/2017, the shareholding composition of the company was as follows:

Shareholder No. of ordinary shares held Percentage of ownership

Entity C xxx XX%

Entity D xxx XX.XX%

Entity E xxx XX.XX%

On XX/XX/2017, entity C transferred all their shares in the company to entity D resulting in entity D holding XX.XX % and effectively becoming the controller of the company. Both entity C and D are Australian residents for tax purposes.

The company has only ever had ordinary shares on issue, with dividend, capital and voting rights being the same for all shares. That is, the percentage of ownership corresponds to the percentage of dividend, capital and voting rights.

As the same shareholders did not hold more than 50% of the company at all times during the ownership test period, the share transfer on XX/XX/2017 resulted in a change in majority ownership of the company.

Accordingly, the company does not satisfy the ordinary Continuity of Ownership Test (“COT”) for the 2017-18 income year.

As the company’s business was sold during the year, the company did not carry on the business from just prior to the change in ownership (that is, XX/XX/2017) throughout the remainder of the 2017-18 income year. Accordingly, the company will not be able to satisfy the Same Business Test (“SBT”).

It is proposed by 30 June 2018, the Trustee will exercise its discretion to distribute all trust income of the Trust for the period to the company. There will be no requirement for the company to repay the distribution back to Trust B nor any other conditions placed on the payment of the distribution.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 4-15

Income Tax Assessment Act 1997 Division 165

Income Tax Assessment Act 1997 section 165-12

Income Tax Assessment Act 1997 section 165-13

Income Tax Assessment Act 1997 section 165-15

Income Tax Assessment Act 1997 section 165-40

Income Tax Assessment Act 1997 section 165-45

Income Tax Assessment Act 1997 section 165-55

Income Tax Assessment Act 1997 section 165-60

Income Tax Assessment Act 1997 section 165-165

Income Tax Assessment Act 1997 section 165-210

Reasons for decision

A company cannot deduct a tax loss unless it satisfies either the continuity of ownership test (COT) under section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997), or the same business test (SBT) under section 165-13 of the ITAA 1997 and does not fail the change of control test under section 165-15 of the ITAA 1997.

Continuity of ownership test

You meet the conditions set out in section 165-12 of the ITAA 1997 if during the ownership test period there are persons who:

(i) had more than 50% of the voting rights in the company; and

(ii) had rights to more than 50% of the company’s dividends; and

(iii) had rights to more than 50% of the company’s capital distributions.

The ownership test period is the period from the start of the loss year to the end of the income year. In this case, the ownership test period for the loss year is 1 July 2017 to 30 June 2018.

Under section 165-15 of the ITAA 1997, the same people must control the voting power, or the company must satisfy the same business test.

The same share rule in section 165-165 of the ITAA 1997 ensures that the same persons considered for continuity of ownership testing for the recoupment of tax losses must hold exactly the same shares, or interests in shares, for the entire ownership test period.

In this case, the company had three shareholders holding XX%, XX.XX% and XX.XX% of the shares up to XX/XX/2017. On XX/XX/2017 shareholder one transferred all their ownership to shareholder two resulting in shareholder two holding XX.XX % of the shares in the company.

Applying the same share rule to the present circumstances, the same shareholders did not maintain more than 50% of the shares during the whole ownership test period. Therefore, the continuity of ownership test is not met.

As such, for the company to be able to claim the losses incurred, it must satisfy the SBT.

Same business test

The SBT is set out in section 165-210 of the ITAA 1997 and comprises a positive test and two negative tests, as follows:

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 (the same business test, subsection 165-210(1));

2. However, the company does not satisfy the same business test if at any time during the same business test period the company derives assessable income:

(a) from a business of a kind that it did not carry on before the test time (the new business test, paragraph 165-210(2)(a)); or

(b) from a transaction of a kind that it had not entered into in the course of business operations before the test time (the new transactions test, paragraph 165-210(2)(b)).

Taxation Ruling TR 1999/9 Income tax: the operation of sections 165-13 and 165-210, paragraph 165-35(b), section 165-126 and section 165-132 provides the Commissioner’s view on the application of the SBT and provides guidelines to assist with determining whether the SBT is satisfied. To satisfy the SBT you must be able to show that you carried on the same business, in the sense of the identical business, at all times during the income year as the business you carried on before the change in ownership occurred (paragraph 38 of TR 1999/9).

In Case Y45; AAT Case 7,272 (1991) 22 ATR 3395; 91 ATC 426 Dr Grbich of the Administrative Appeals Tribunal determined that the taxpayer did not satisfy the SBT as the taxpayer had ceased to carry on part of its business that comprised an agency for selling an agricultural machine, notwithstanding that the taxpayer continued its agricultural consulting business at all times. This decision indicates that the discontinuance, whether by way of cessation or sale, of a significant part of the business carried on by a taxpayer is likely to result in the taxpayer not being able to satisfy the SBT.

As outlined in paragraph 47 of TR 1999/9, if, before the end of the period of recoupment, the taxpayer completely ceases to carry on the business it carried on immediately before the change-over, it necessarily fails the same business test. Any other business it may thereafter carry on must be a new business that it has commenced.

In this case the company sold the business during the income year and ceased trading. As the business is dormant, the Commissioner considers that the company does not satisfy the SBT in the 2017-18 income year.

Subdivision 165-B of the ITAA 1997

Subsection 4-15(2) of the ITAA 1997 requires a company to calculate its taxable income for an income year using rules in subdivision 165-B if it “does not maintain continuity of ownership and control during the income year and does not satisfy the same business test”.

That is, where there is a change of ownership or control of a company during a loss-making year and the company does not maintain the same business, the general loss utilisation rules may be overridden by the current year loss rules. The company must work out its taxable income and tax loss under subdivision 165-B of the ITAA 1997.

Without these rules, a company that had incurred losses at the beginning of an income year could be acquired and then have income injected into it, in order to absorb those losses for tax minimisation purposes.

Under subdivision 165-B of the ITAA 1997, losses incurred before the change of ownership are effectively extinguished. However, the company may be able to carry forward that part of the tax loss that was incurred after the change of ownership for utilisation in a later year, subject to the usual restrictions. However, the application of those restrictions may be modified by section 165-20 of the ITAA 1997 (see ATO Interpretative Decisions ATO ID 2003/720 and ATO ID 2004/949).

To calculate the loss under the current year loss rules of subdivision 165-B of the ITAA 1997, the following steps apply:

1. Divide the income year into periods bounded by the time of each change in ownership or control

If there is only one disqualifying change in ownership or control during the income year, there will only be two periods for that income year. The last period in the income year ends at the end of the income year (section 165-45 of the ITAA 1997).

2. Calculate notional loss or notional taxable income for each period

Treat each of these periods as an income year, attributing assessable income and deductions to each to arrive at a notional taxable income or notional loss for each period. Income and deductions cannot be attributed on a simple pro rata basis. Sections 165-55 and 165-60 set out the rules for attributing deductions and assessable income respectively.

Attributing assessable income

Where the company is a beneficiary of a trust, net income assessable to the company under section 97 of Income Tax Assessment Act 1936 (ITAA 1936) is attributed to periods within the income year so far as the net income is reasonably attributable to a period (subsection 165-60(2) of the ITAA 1997).

Where, however, trust net income is not reasonably attributable to a particular period, it is treated as a “full year” amount and is taken into account at Step 3 (subsection 165-60(7) of the ITAA 1997).

Where an amount is actually distributed to the company during the income year, then this amount is generally attributable to the relevant period.

However where no amount has been paid or the beneficiary is not presently entitled to an amount during the year, then a distribution paid at the end of the income year is generally regarded as a full year amount.

Discretionary trusts and present entitlement

The beneficiaries of a discretionary trust do not have a fixed entitlement or interest in the trust funds. The trustee has the discretion to determine which of the beneficiaries are to receive the income and capital of the trust and how much each beneficiary is to receive.

The beneficiaries of a discretionary trust do not have an interest in the assets of the trust. They merely have a right to be considered or a mere expectancy until such time as the trustee exercises its discretion to make a distribution.

Section 101 of the ITAA 1936 provides a beneficiary shall be presently entitled where a trustee exercises their discretion to apply income of a trust estate for the benefit of the beneficiary.

There is no definition of the term 'presently entitled' in the ITAA 1936 or the ITAA 1997. It is therefore necessary to refer to the meaning which has been given to the term by the courts.

The principal cases on the concept of present entitlement are the High Court decisions of Federal Commissioner of Taxation v Whiting (1943) 68 CLR 199 and Taylor v Federal Commissioner of Taxation (1970) 119 CLR 444. A summary of the main principles emerging from these cases are:

A beneficiary will be presently entitled if:

(a) the beneficiary has an indefeasible, absolutely vested, beneficial interest in possession in trust law income; and

(b) the beneficiary has a present legal right to demand and receive payment of the trust law income (or would but for a legal disability), whether or not the precise entitlement can be ascertained before the end of the year of income and whether or not the Trustee has the funds available for immediate payment.

In a discretionary trust it is not possible for a beneficiary to be presently entitled until the trustee makes a resolution as to which beneficiaries, if any, will receive a distribution from the trust.

3. Calculate taxable income and the tax loss for the income year

As a notional loss of one period cannot be offset against the notional taxable income of another period, you can potentially have both a taxable income and a tax loss for the same income year.

The taxable income for the year of change is worked out by adding up: (a) each notional taxable income; and (b) any full -year amounts (that is, amounts of assessable income not taken into account at Step 2), then subtracting any full-year deductions (that is, deductions not taken into account at Step 2). A notional loss is not taken into account when calculating taxable income, but counts towards the company's tax loss.

A company's tax loss for the loss year is the total of each notional loss and excess full-year deductions of particular kinds.

4. Carry forward any tax loss for the income year

You can carry forward any notional loss and offset it against net assessable income in a future income year, provided it then satisfies the COT and control test or, failing that, the SBT. As mentioned previously, regard should be had in the future income year to section 165-20 of the ITAA 1997 which may allow a deduction for a loss or part of a loss that was incurred during the period after the change in ownership.

Treatment of taxable income

You cannot offset any taxable income derived in the period before or after the change in ownership against any current year tax loss, or prior-year tax loss. You cannot offset any prior-year losses against current year taxable income because the usual test requirements have not been met.

Treatment of a tax loss

A tax loss incurred in the period before the change in ownership cannot be utilised in a later income year.

A tax loss incurred in the period after the change in ownership may be carried forward and utilised in a later income tax year, provided the usual test requirements as modified by section 165-20 of the ITAA 1997 are then met.

For those expenses that are spread over a number of income years (for example depreciation costs) these are to be allocated on a proportional basis across the periods.

Current situation

In this case, the company does not satisfy the continuity of ownership test or the same business test. Therefore, the rules contained in subdivision 165-B of the ITAA 1997 apply.

In applying the rules of section 165-45 of the ITAA 1997, the company’s first period is from 1 July 2017 to XX/XX/2017 and the second period is from XX/XX/2017 to 30 June 2018.

In calculating the assessable income of the company it is not considered that trading income from Trust B can be reasonably attributed to the above two periods.

Although Trust B may have derived the income throughout the year, the company, as beneficiary of a discretionary trust cannot be said to have derived their distribution throughout the year. The company was not presently entitled to a trust distribution during the 2017-18 income year prior to the trustee of Trust B distributing income to the company at the end of the income year. Such a distribution is regarded as a full year amount.