Edited version of your written advice

Authorisation Number: 1051488635553

Date of advice: 10 April 2019

Ruling

Subject: Business continuity test – carrying on the same business

Question

Will unutilised tax losses that were incurred satisfy the business continuity test in section 165-210 as modified under section 707-125 of the Income Tax Assessment act 1997 (ITAA 1997) so that tax losses can be transfer to a provisional head company at the proposed joining time?

Answer

Yes.

Relevant facts and circumstances

The Taxpayer is the provisional head company of a multiple entry consolidated (MEC) group. They sought a ruling on the tax implications of an entity joining the income tax consolidated group.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 165-10

Income Tax Assessment Act 1997 section 165-12

Income Tax Assessment Act 1997 section 165-13

Income Tax Assessment Act 1997 section 165-210

Income Tax Assessment Act 1997 Subdivision 705-C

Income Tax Assessment Act 1997 section 707-125

Income Tax Assessment Act 1997 section 707-135

Income Tax Assessment Act 1997 subsection 719-5(4)

Income Tax Assessment Act 1997 section 719-77

Income Tax Assessment Act 1997 Subdivision 719-C

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

In accordance with Subdivision 705-C as modified by Subdivision 719-C, the consolidated group will be treated as if it were a single entity joining the MEC group.

Section 707-120 provides that an unused carried forward tax loss of a joining entity may be transferred to the head company of a consolidated group or, by virtue of section 719-2, a MEC group (the joined group), to the extent that the joining entity could have used the tax loss for an income year comprising of the trial year.

The trial year is a notional loss claim year for transfer testing purposes and it generally comprises the 12 months prior to the joining time. This period ends just after the joining time to ensure that:

● ownership changes that occur as part of joining a consolidated group are taken into account when determining if a tax loss may be transferred, and

● a joining entity’s business is tested for a minimum 12 month period if the business continuity test (SBT) applies.

When determining if the joining entity could have used the tax loss in the trial year, it is assumed that the joining entity has sufficient income or gains against which to apply the tax loss and that the joining entity had not become a member of the joined group. Broadly, this means that the tax loss must satisfy the general loss provisions before it may be transferred to the head company of the joined group at the joining time.

Section 165-10 provides that a company cannot deduct a tax loss unless either it meets the conditions in section 165-12 (about satisfying the continuity of ownership test (COT)) or it meets the condition in section 165-13 (about satisfying the SBT). These tests are modified, under Subdivision 166-A, for widely held companies or eligible Division 166 companies.

Division 166 provides certain concessions when applying the rules in Division 165 to a widely held company or an eligible Division 166 company. Broadly, subsection 995-1(1) provides that:

● a widely held company means a company whose shares (except shares that carry a right to a fixed rate of dividend) are listed for quotation in the official list of an approved stock exchange, and

● an eligible Division 166 company means a company where more than 50% of the voting power, rights to dividends or rights to capital distributions are held by certain entities, including a widely held entity.

The business continuity test – carrying on the same business

Section 165-13 has the effect that a company may still use its tax losses despite failing the COT provided it satisfies the SBT. The SBT is set out in section 165-210 and provides:

(1) A company satisfies the business continuity test if throughout the *business continuity test period it carries on the same *business as it carried on immediately before the *test time.

(2) However, the company does not satisfy the *business continuity test under this section if, at any time during the *business continuity test period, it *derives assessable income from:

(a) a *business of a kind that it did not carry on before the *test time; or

(b) a transaction of a kind that it had not entered into in the course co its business operations before the *test time.

(3) The company also does not satisfy the *business continuity test under this section if, before the *test time, it:

(a) started to carry on a *business it had not previously carried on; or

(b) in the course of its business operations, entered into a transaction of a kind that it had not previously entered into;

and did so for the purpose of, or for purposes including the purpose, of being taken to have carried on throughout the *business continuity test period the same business as it carried on immediately before the test time.

(4) So far as the *business continuity test under this section is applied for the purpose of Subdivision 165-B (which is about working out the taxable income and *tax loss for the income year of change of ownership or control), the company also does not satisfy the test if, any time during the *business continuity test period, it incurs expenditure:

(a) in carrying on a *business of a kind that it did not carry on before the *test time; or

(b) as a result of a transaction of a kind that it had not entered into in the course of carrying on its business operations before the test time.

Taxation Ruling 1999/9 Income tax: the operation of sections 165-13 and 165-210, paragraph 165-35(b), section 165-126 and section 165-132 (TR 1999/9) explains the Commissioner’s view on the application of the same business test. The ruling provides that subsections 165-210(1) and (2) include three tests each of which must be satisfied by the company in order for it to meet the requirements of sections 165-13 and 165-210 so that it is not prevented from deducting its prior year losses.

The first test in subsection 165-210(1) comprises the positive requirement that the company carry on at all times during the income year in which it seeks to deduct the prior year loss, the same business at it carried on at the changeover (i.e. when the change in beneficial ownership occurred that results in the company not maintaining majority ownership). The second and third tests in subsection 165-210(2) comprise the respective negative requirements that the company does not carry on certain businesses and does not enter into certain transactions during the income year in which they seek to deduct the prior year loss.

TR 1999/9 states:

12. …a company is treated as carrying on the one overall business at the change-over and during the period of recoupment since the reference to ‘business’ in the same business test is a reference to all the activities carried on by the company at the change-over and during the period of recoupment, irrespective of whether those activities constitute or are treated by the company as constituting separate or distinct activities, enterprises, divisions or undertakings carried on by the company.

13. In the same business test, the meaning of the word ‘same’ in the phrase ‘same business as’ imports identity and not merely similarity; the phrase ‘same business as’ is to be read as referring to the same business, in the sense of the identical business. However, this does not mean identical in all respects: what is required is the continuation of the actual business carried on immediately before the change-over. …In making the analysis it needs to be acknowledged that a company may expand or contract its activities without necessarily ceasing to carry on the same business. The organic growth of a business though the adoption of new compatible operations will not ordinarily cause it to fail the same business test provided the business retains its identity; nor would discarding, in the ordinary way, portions of its old operations. But, if through a process of evolution a business changes its essential character, or there is a sudden and dramatic change in the business brought about by either the acquisition or loss of activities on a considerable scale, a company may fail the test.

The business continuity test period

Subsection 707-125(4) states:

If Subdivision 166-A would apply to the joining entity for an income year consisting of the *trial year, work out whether the loss is transferred on the basis that:

(a) subsection 166-5(5) treated the joining entity as having satisfied the condition in section 165-13 if the joining entity satisfied the *business continuity test for the period (the business continuity test period) consisting of:

(i) the trial year; and

(ii) the income year described in subsection (5) of this section, if that income year started before the trial year; and

(b) subsection 165-5(6) required the business continuity test to be applied to the *business that the joining entity carried on at the time (the test time) just before the end of the income year for which the loss was made by the joining entity.

The income year described in subsection 707-125(5)

Subsection 707-125(5) states:

For the purposes of subparagraph 707-125(4)(a)(ii), the income year is:

(a) the income year in which occurred the first time mention in subsection 166-5(6); or

(b) the income year of the joining entity containing the time at which the joining entity is taken under subsection 707-210(5) to fail to meet the condition in section 165-12, if that subsection is relevant to working out whether the joining entity can utilise the loss.

In relation to paragraph 707-125(5)(a), the income year in which occurred the first time mentioned in subsection 166-5(6) is the earlier of:

…

(a) the end of the first income year; and

(b) the first time in the test period that a *corporate change in the company *ends,

for which there is no *substantial continuity of ownership of the company as between the start of the *test period and that time.

Additional test

Where a joining entity has previously had a loss transferred to it because another entity was able to transfer the loss to the joining entity because the other entity satisfied the SBT (i.e. SBT tagged losses) the additional test in section 707-135 must also be satisfied.

Section 707-135 requires the joining entity to satisfy the SBT for the trial year and the time just before the end of the income year in which the loss was transferred to the joining entity.

Has there been a change in the identity of the business?

In Avondale Motors (Parts) Pty Ltd v Federal Commissioner of Taxation (1971) 124 CLR 97, Gibbs J, concluded that the loss company, which was wholly acquired by Avondale Motors Pty Ltd on 15 March 1968, did not satisfy the same business test because immediately before 15 March 1968 it had not been carrying on any business. It was established that:

… in the period from 29 February 1968 to 15 March 1968, the loss company had no liabilities and, with the exception of some stationery, had no assets. It had no employees and no premises of its own. It earned no income and incurred no liabilities. It had no trade in stock and entered into no contracts… (1971) 127 CLR 97 at 102

It was found that the cessation in activity was not due to the nature of the business or to some temporary adversity which the taxpayer intended to overcome; it was due to a decision to discontinue the business previously carried on because it was unprofitable and there was no intention to resume the conduct of the business.

Gibbs J, went on to find that if wrong in concluding that the loss company had ceased carrying on a business before 15 March 1968, the loss company would still not satisfy the same business test because it had not established that the business carried on immediately before 15 March 1968 was the same as that carried on after that date. Gibbs J, noted:

Before 15 March 1968 the taxpayer carried on the business of dealer in motor parts and accessories at three different premises in conjunction with a motor dealer having franchises for certain vehicles. After that date it carried on the same kind of business but under a different name, at different places, with different directors and employees, with different stock and plant and in conjunction with a motor dealer having different franchises… In some circumstances a company may expand or contract its activities, it may close an old shop and open a new one, without starting a new business, but the only conclusion that can be drawn from all the circumstances of the present case is that the business of the taxpayer after 15 March 1968 was different from that which it carried on before that date... (1971) 127 CLR 97 at 104

Gibbs J, found:

The meaning of the phrase “same as” … depends on the context in which it appears. In my opinion in the context of the section [80E of the Income Tax Assessment Act 1936 – 1968 (Cth)] the words “same as” import identity and not merely similarity… It seems to me natural to read the section as referring to the same business, in the sense of the identical business… (1971) 127 CLR 97 at 105

In this instance, the Company has not at any time during the relevant periods ceased to carry on its business. Furthermore, the acquisition and divestment of interests do not result in there being a change in the Company’s business activities like that found in the Avondale Motors.

There has not been any sudden change in the Company’s revenues and assets, the changes that have occurred have been explained. Finally, its employee numbers are consistent with the expansion and contraction of its activities and its directors have remained constant over the years.

In Fielder Downs, WB Campbell J, in referring to Avondale Motors (Parts) Pty Ltd v Federal Commissioner of Taxation (1971) 124 CLR 97 held that the loss company did not carry on, at all times during the relevant income years, the same business as it carried on immediately before the change in its ownership. The essential character of the business had changed.

In Fielder Downs, the loss-company, prior to its change in ownership, was engaged in developing and growing clover seeds to market commercially. Other than some sheep brought onto the land for 2 months each year, there was no intention formed that it would carry on a grazing business. After the change in ownership, the loss company brought stock onto the land for grazing, and fencing and water improvements had to be made for the stock. The loss company’s income making emphasis had change from growing and harvesting clover seed for sale to grazing stock on pastures of clover and other fodder (oats); it had become a grazier.

WB Campbell J opined:

….If a business evolves it does not necessarily follow that during such process of evolution the essential character of the business is not changed. …prior to the transfer of shares, the company had not formed an intention that it would carry on a grazing business on its lands… Prior to the change it was engaged in the pursuit of developing and growing clover seed which was to be marketed commercially.

…

I do not think this is a case of the same business simply being carried on in a different fashion after the change-over. …the character of the business was completely changed. [1980] Qd R 283 at 291.

In this instance, the character of the Company’s business was not completely changed.

Income from new businesses or new transactions

The Company has not derived income from a business of a kind that it did not carry on before the change in ownership for the purposes of the new transaction test in subsection 165-210(2).

Conclusion

In light of the above, at all the relevant test times, it may be concluded that the company has carried on the same overall business such that it satisfies the SBT in section 165-210 so that its tax losses may be transferred to the provisional head company of the MEC group.