Edited version of your written advice

Authorisation Number: 1051512725275

Date of advice: 24 May 2019

Ruling

Subject: Income tax: modified continuity of ownership test - no detriment rule

Question 1

Does the Commissioner confirm that Company A has continued to satisfy the continuity of ownership test is section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997) as modified by section 166-5 of the ITAA 1997 to 31 December 20XX in respect of its losses incurred in the 20XX to 20XX income years on the basis:

● the requirements of paragraphs 166-275(a) and 166-275(b) of the ITAA 1997 are satisfied; and

● paragraph 166-275(c) of the ITAA 1997 is satisfied where the tracing rules are disregarded in respect of the stake held by stakeholder 1.

Answer

Yes

Question 2

Does the Commissioner confirm Company A has continued to satisfy the continuity of ownership test is section 165-12 of the ITAA 1997 as modified by section 166-5 of the ITAA 1997 to 31 December 20XX in respect of its losses incurred in the 20XX to 20XX income years on the basis:

● the requirements of paragraphs 166-275(a) and 166-275(b) of the ITAA 1997 are satisfied; and

● paragraph 166-275(c) of the ITAA 1997 is satisfied where the tracing rules are disregarded in respect of the stake held by stakeholder 2.

Answer

Yes

This ruling applies for the following period:

Income year ended 30 December 20XX

The scheme commences on:

1 January 20XX

Relevant facts and circumstances

Company A incurred tax losses.

Company A was a wholly owned subsidiary of company B.

Company B formed a new company, NewCo.

Company B transferred its shares in Company A to NewCo.

Company B and Company C held equal shares in NewCo.

Stakeholders 1 and 2 are shareholders in both Company B and C.

Company A proposes to disregard all tracing rules in respect of indirect stakes held by either stakeholder 1 or stakeholder 2.

In respect of stakeholder 1, Company A wishes to disregard the tracing rules which attribute the stake as follows:

● the stake attributed to company B and

● the stake attributed to Company B and Company C

By disregarding the tracing rules ownership of 50.33% is maintained.

In respect of stakeholder 2, Company A wishes to disregard the tracing rules which attribute the stake as follows:

● the stake attributed to company B and

● the stake attributed to Company B and Company C

By disregarding the tracing rules ownership of 50.47% is maintained.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 165

Income Tax Assessment Act 1997 Section 165-10

Income Tax Assessment Act 1997 Section 165-12

Income Tax Assessment Act 1997 Subsection 165-12(4)

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

Income Tax Assessment Act 1997 Section 165-150

Income Tax Assessment Act 1997 Section 165-155

Income Tax Assessment Act 1997 Section 165-160

Income Tax Assessment Act 1997 Division 166

Income Tax Assessment Act 1997 Section 166-5

Income Tax Assessment Act 1997 Subsection 166-5(3)

Income Tax Assessment Act 1997 Section 166-145

Income Tax Assessment Act 1997 Section 166-175

Income Tax Assessment Act 1997 Section 166-225

Income Tax Assessment Act 1997 Section 166-230

Income Tax Assessment Act 1997 Section 166-240

Income Tax Assessment Act 1997 Section 166-265

Income Tax Assessment Act 1997 Section 166-272

Income Tax Assessment Act 1997 Subsection 166-272(2)

Income Tax Assessment Act 1997 Subsection 166-272(8)

Income Tax Assessment Act 1997 Section 166-275

Income Tax Assessment Act 1997 Paragraph 166-275(a)

Income Tax Assessment Act 1997 Paragraph 166-275(b)

Income Tax Assessment Act 1997 Paragraph 166-275(c)

Income Tax Assessment Act 1997 Division 167

Income Tax Assessment Act 1997 Section 167-30

Income Tax Assessment Act 1997 Section 167-35

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

Reasons for decision

Question 1

Has Company A continued to satisfy the continuity of ownership test (COT) is section 165-12 of the ITAA 1997 as modified by section 166-5 of the ITAA 1997 to 31 December 20XX in respect of its losses incurred in the 20XX to 20XX income years on the basis:

● the requirements of paragraphs 166-275(a) and 166-275(b) of the ITAA 1997 are satisfied; and

● paragraph 166-275(c) of the ITAA 1997 is satisfied where the tracing rules are disregarded in respect of the stake held by stakeholder 1

Summary

1. Company A has continued to satisfy the COT in section 165-12 of the ITAA 1997 as modified by section 166-5 of the ITAA 1997 in respect of its losses incurred in the 20xx to 20xx income years

Detailed reasoning

2. The loss recoupment rules as described in subdivision 165-A require a company to satisfy either the COT or the Same Business Test (SBT) before it can deduct previously incurred losses. These loss rules apply to Company A for tax losses incurred during the 20xx to 20xx income years.

Continuity of ownership test – section 165-12

3. Section 165-12 provides the COT a company must satisfy in order to be able to deduct losses incurred in earlier income years. The test requires there to be persons who hold more than 50% of the voting, dividend and capital rights in the company at all times during the ownership test period.

4. The ownership test period is the period from the start of the loss year to the end of the income year in which the loss is to be deducted.

5. There are two mutually exclusive tests for determining whether persons hold ‘more than 50%’ of the relevant power or rights:

(a) the primary test applies if no other companies beneficially own shares or interests in shares in the loss company at any time during the ownership test period.¹

(b) the alternative test applies in any other case.²

6. As Company A is beneficially owned by one or more companies the alternative test applies for tax losses incurred during the 20xx to 20xx income years.

Concessional rules

7. Division 166 modifies the operation of the standard COT for widely held companies and eligible Division 166 companies. The modification makes it easier to apply the rules by:

● making it unnecessary for the company to prove that it has maintained the same owners throughout the period, if the company had the same owners at certain test times; and

● making it unnecessary for the company to trace through to the ultimate beneficial owners of:

● voting, dividend and capital interests in the company held by certain entities (whether directly or indirectly through one or more interposed entities); and

● small voting, dividend and capital interests in the company.

8. A widely held company is defined to include a company whose shares are listed on an approved stock exchange.

9. An eligible Division 166 company is defined to be a company where more than 50 per cent of the rights to voting, dividends or capital distributions are held by one or more of the following:

● widely held companies;

● superannuation funds;

● approved deposit funds;

● special companies;

● managed investment schemes;

● entities that are prescribed under the tracing rule that deems entities to be beneficial owners;

● non-profit companies; or

● charitable institutions, charitable funds or any other kind of charitable bodies.

10. Subsection 166-5(3) provides that a company is taken to have met the conditions in section 165-12 about a company maintaining the same owners, if there is substantial continuity of ownership as between the start of the test period and:

(a) the end of each income year in that period, and

(b) the end of each corporate change in that period.

11. Where there is no substantial continuity of ownership at each of the test times³ the company is taken to have failed the conditions in section 165-12.

12. Company A is not listed on a stock exchange and does not meet the definition of a widely held company.

13. However, Company A was a wholly owned subsidiary of Company B from incorporation until 30 June 20XX. Since 1 July 20XX, Company A has been owned indirectly in equal shares by Company C and Company B, both listed on an approved Stock Exchange.

14. Given more than 50 per cent of the rights to voting, dividends and capital distributions are held by one or more widely held companies Company A is considered to be an eligible Division 166 company.

15. As an eligible Division 166 company, Company A can choose to apply Subdivision 165-A without modification. Company A has not made this choice.

The substantial continuity of ownership test

16. Section 166-145 provides that there will be substantial continuity of ownership from the start of the ownership test period to another time in the test period if there are persons who had more than 50% of the rights to voting, dividends and capital distributions in the company⁴ and will be determined in accordance with the alternative tests contained in sections 165-150, 165-155 and 165-160 respectively and Subdivision 166-E (concessional tracing rules).

17. In addition, section 166-175 considers whether a ‘corporate change’ has occurred which includes shares issued in the company of greater than 20%. As Company A has issued shares of greater than 20% Company A will need to satisfy the substantial continuity of ownership each of the relevant test periods.

Ownership test times

18. For the purposes of testing Company A’s satisfaction of the COT for the 20XX income year, Company A will need to satisfy the test times from the start of the test period until the end of the test period, including when there has been a share issue of greater than 20%.

Subdivision 166-E - Concessional tracing rules

19. Subdivision 166-E provides a number of concessional tracing rules to assist in determining whether the ownership tests are satisfied.

20. Special concessional tracing rules deem entities to hold the following stakes in the company so that the company does not have to trace through to the beneficial owners of the stakes including:

● stakes of less than 10% in the company;

● stakes of between 10% and 50% that are held by widely held companies;

● stakes that are held by complying superannuation funds, complying approved deposit funds, special companies and managed investment schemes;

● stakes in interposed foreign listed companies that are held as bearer shares;

● stakes in interposed foreign listed companies that are held by depository entities.

21. The following concessional tracing rules are applicable to Company A:

● indirectly held voting, dividend or capital stakes of less than 10% in Company A to the top interposed entity,5 and

● directly and/or indirectly held voting, dividend or capital stakes of between 10% and 50% by a widely held company to the widely held company as ultimate owner.⁶

Top interposed entities

22. Section 166-230 contains a concessional tracing rule whereby an indirect stake of less than 10% is attributed to the top interposed entity (TIE).

23. The TIE is interposed between the indirect stakeholder and the tested company and is the entity in which the stakeholder with a less than 10% interest has a direct interest.

24. The TIE is taken to be a person (other than a company), and is therefore regarded as an ultimate owner for the purpose of the alternative test in Division 165.

25. The persons who actually control the voting power and have rights to dividends and capital are taken not to control that power or have those rights for the purposes of the alternative test (as per section 166-265).

26. The tested company does not need (as a consequence) to trace the beneficial owners of indirect interests in the company that carries less than 10% of the rights to voting, dividends and capital distributions.

27. From the information provided, from incorporation up to 30 June 20XX Company A was a wholly owned subsidiary of Company B.

28. Therefore, according to section 166-230, Company B would be deemed to hold all of the stakes in Company A for any of the test times prior to 1 July 20xx and no further tracing of ownership of Company B during this period would be required for the purposes of the substantial continuity of ownership.

Widely held companies

29. Section 166-240 contains a concessional tracing rule relating to stakes held by widely held companies.

30. Where a company is a widely held company for the whole of the income year in which the ownership test time occurs section 166-240 treats it as the ultimate owner of a direct or indirect stake in the tested company where the stake is between 10% and 50% (inclusive) and deems the widely held company to be a person.

31. The concessional tracing rule in section 166-240 relate to stakes held by widely held companies. Where a company is a widely held company for the whole of the income year in which the ownership test time occurs, section 166-240 treats it as the ultimate owner of a direct or indirect stake in the tested company where the stake is between 10% and 50% (inclusive) and deems the widely held company to be a person.

32. From 1 July 20XX Company B and Company C each indirectly hold 50% of Company A through their direct interest in NewCo.

33. Any interests that the shareholders of Company B and Company C have indirectly in Company A are deemed to be held by Company B and Company C under section 166-240. As such no further tracing of ownership (of Company B and Company C) during this period is required and Company B would be deemed to hold exactly 50% of Company A as a TIE after 1 July 20XX.

34. This application of the tracing rules would result in Company A failing the substantial COT for test times after 1 July 20XX as not more than 50% of the voting, dividend and capital stakes have been maintained by Company B.

Division 167 Unequal dividend and capital rights

35. Division 167 enables companies whose shares do not all carry the same rights to dividends or capital distributions to test the possession of those rights similarly to companies whose shares are all of a single class with the same rights.

36. If a condition of the continuity of ownership test cannot be worked out for a company because of its unequal share structure or because of a holding company's unequal share structure an entity can choose to reconsider that condition. The three choices in order of application are:

● disregarding debt interests in the company,

● disregarding debt interests and secondary share classes,

● disregarding debt interests and secondary share classes and then treat the remaining shares in the company as having fixed rights to dividends and capital distributions.

37. Company C has three classes of shares. As the two classes of shares have preferred rights to dividends and capital, Company A has to consider the application of Subdivision 167-A to the shares in Company C.

38. The first and second modifications in Division 167 do not apply in determining the dividend and capital rights of Company C shareholders; the third modification is applied with the rights of all classes of shares as fixed according to their market values or where impracticable to work out market value as is reasonable in the circumstances.

39. As the price of Company C’s ordinary shares listed on an approved stock exchange is not nil and the other classes of shares can be converted into ordinary shares on a one for one basis at any time, it is reasonable to fix the dividend and capital rights according to their market value pursuant to section 167-30 or section 167-35 if impracticable to work out the market value.

Voting power of Company C

40. Company C has three classes of shares, with only certain shares carry voting rights.

41. The voting stake held by a shareholder will be more than their corresponding dividend and capital stake and where the COT is satisfied in regards to the dividend and capital stakes it will therefore be satisfied in regards to the voting stake.

Same share same interest rule & savings provision

42. The ‘same share same interest rule’ in section 166-272 only applies to voting, dividend and capital stakes held by a TIE, a widely held company, an entity deemed to be a beneficial owner or a depository entity in the tested company. It requires:

● the same shares to be held by the same persons, and

● the only interests (including shares) in any other entity that is interposed between the stakeholder and the tested company that are taken into account are exactly the same interests and are held by the same persons.

43. The same share same interest rule is subject to a savings provisions which in effect negates the same share same interest rule if there is not substantial duplication of the tax loss, notional loss, bad debt or unrealised net loss (as the case may be) through capital gains tax (CGT) events occurring in respect of direct or indirect interests in the tested company during the test period.

44. Company B wholly owned Company A from incorporation until 30 June 20XX and then held a continuous ownership interest of at least 50%.

45. On 1 July 20XX Company B transferred its shares in Company A to NewCo, which is held equally by Company B and Company C.

46. Without the savings provisions, section 166-275 would deem there was no continuity of ownership in relation to the ongoing 50% interest held by Company B. However, the savings provision overrides the same share same interest rule if the tested company can reasonably 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 the future because of the happening of a CGT event in relation to any direct equity interests held in the tested company.

47. The purpose is to ensure that a loss or deduction is not available if it has been substantially duplicated through CGT events happening to interests held directly or indirectly by top interposed entities, widely held companies, entities deemed to be beneficial owners or depository entities.

48. When Company B disposed of its shares in Company A to NewCo no loss duplication arose in relation to the disposal. Whilst Company B’s historic cost base of Company A shares were understood to exceed the market value of the Company A’s shares at the time of the disposal the application of subdivision 165-CD resulted in an adjustment to the reduced cost base of Company A shares immediately prior to the disposal.

49. This adjustment required the cost base to be reduced by various amounts including the amount of revenue and capital losses Company A had incurred immediately prior to the disposal. Moreover, if a capital loss arises, Subdivision 855-A would apply to disregard the capital loss.

50. Therefore, it is reasonable to conclude less than 50% of Company A’s tax losses at 30 June 20XX would be reflected in the capital losses which Company B may have or could incur in the future because of the disposal of the Company A shares to NewCo on 1 July 20XX.

No detriment rule

51. Section 166-275 will take a company as meeting the conditions in (relevantly) section 165-12 where:

● a tracing rule modified how the ownership tests in section 166-145 apply to the tested company in respect of a voting stake, a dividend stake or a capital stake7

● the company fails the tests (whether at the time of applying the tracing rule or at another time),8 and

● the company believes on reasonable grounds, that if the tracing rule did not modify how the tests apply to the company in respect of that stake, it would not fail the tests.⁹

52. The Explanatory Memorandum to the Tax Laws Amendment (Loss Recoupment Rules and Other Measures) Bill 2005 (the EM) provides the following guidance on how a company is to form the necessary belief, on reasonable grounds, under paragraph 166-275(c) of the ITAA 1997:

1.133 The purpose of the tracing rules is to assist a company trace its ownership interests to determine whether it satisfies the COT. However, there may be cases where these rules make it more difficult for a company to satisfy the COT. While the company could choose not to apply the modified COT, that would not allow the company to use any of the tracing rules.

1.134 The modified COT allows a tracing rule to be disregarded in respect of a particular stake if it would cause the company to fail the ownership tests. A company is taken to satisfy the relevant conditions if the company believes on reasonable grounds that it would not fail the conditions if the tracing rule did not apply in respect of that stake.

1.135 The rule does not prevent other tracing rules potentially applying to the relevant stake or the same tracing rule applying in respect of other stakes. It merely allows tracing rules to be disregarded in these circumstances to the extent that they would cause a failure of the modified COT.

1.136 The company must hold a reasonable belief that it would not fail the tests if the tracing rule did not apply. In most cases a company would be expected to form this view by applying the test for substantial continuity of ownership in the normal way, this is without the use of that tracing rule in respect of the particular stake. However, it is recognised that in some cases, despite its best endeavours, a company may be unable to obtain sufficient information to determine with certainty that it would pass the ownership tests without the tracing rule. In such a case, the modified COT allows a company to draw a conclusion about whether it would satisfy the ownership tests based on any information that it has reasonably been able to obtain

53. In respect of Stakeholder 1’s stake Company A is seeking to disregard all tracing rule concessions that attributed the stake as follows:

● prior to 1 July 20XX; the stake attributed to Company B, and

● post 1 July 20XX: the stake attributed to Company B and Company C

54. As per section 166-230 Company A proposes to apply the tracing rule to the indirect stake held by stakeholder 1, therefore the TIE for this stake is Stakeholder 1.

55. Stakeholder 1 has maintained a minimum indirect stake as follows:

● prior 1 July 20XX stake held 1.39% (in Company B), and

● post 1 July 20XX stake held 1.03% (Company B 0.69% and Company C 0.34%)

56. By disregarding the tracing rules in relation to the stakes held by stakeholder 1, will allow Company A to have maintained more than 50% of the same owners to the end of the test period. The total ownership maintained is 50.33%.

Conclusion

57. Company A continued to satisfy the continuity of ownership test in section 165-12 as modified by section 166-5 in respect of its losses incurred in the 20XX to 20XX income years on the basis:

● the requirements of paragraphs 166-275(a) and (b) are satisfied, and

● paragraph 166-275(c) is satisfied where the tracing rules in sections 166-230 and 166-240 are disregarded in respect of the stakes in Company B and Company C held by stakeholder 1.

Question 2

Company A has continued to satisfy the continuity of ownership test in section 165-12 as modified by section 166-5 in respect of its losses incurred in the 20XX to 20XX income years on the basis:

● the requirements of paragraphs 166-275(a) and (b) of the ITAA 1997 are satisfied; and

● paragraph 166-275(c) of the ITAA 1997 is satisfied where the tracing rules in sections

● 166-230 and 166-240 of the ITAA 1997 are disregarded in respect of the stakes in Company B and Company C held by stakeholder 2.

Summary

58. Company A has continued to satisfy the continuity of ownership test in section 165-12 as modified by section 166-5 in respect of its losses incurred in the 20XX to 20XX income years.

Detailed reasoning

59. As set out in Question 1, Company A does not meet the definition of a widely held company, but is considered to be an eligible Division 166 company. Company A has not made the choice to apply Subdivision 165-A without modification.

Substantial continuity of ownership in Company A

60. Section 166-145 provides that there will be substantial continuity of ownership from the start of the ownership period to another test time in the test period if there are persons who had more than 50% of the rights to vote, dividends and capital distributions in the company determined in accordance with the alternative tests in sections 165-150,165-155 and 165-160 and the concessional tracing rules.

61. For the purposes of testing Company A’s satisfaction of the COT for the 20XX income year, Company A will need to satisfy the test times from the start of the test period until the end of the test period.

62. As per the reasoning in question 1:

● for any test time prior to 1 July 20XX, Company B would be deemed to hold all the voting, dividend and capital distribution stakes in Company A according to section 166-230.

● For any time on or after 1 July 20XX, Company B and Company C will each be deemed to hold 50% of the voting, dividend and capital distribution stakes in Company A, according to section 166-240.

63. This application of the tracing rules would result in Company A failing the substantial COT for test times after 1 July 20XX as not more than 50% of the voting, dividend and capital distribution stakes have been maintained by Company B.

Division 167 Unequal dividend and capital rights

64. As per reasoning in question 1, Company C has applied Division 167 to its unequal share structure and determined that it is reasonable to fix the dividend and capital rights according to their market value pursuant to section 167-30 or section 167-35 if it is not practical to work at the market value.

Voting power of Company C

65. In relation to the voting power of Company C shares, and the reasoning in Question 1, the shareholder with voting rights voting stake will be greater than their dividend and capital distribution stakes and hence if the test is satisfied in relation to dividend and capital stakes it will be satisfied in regards to the voting stake

Same share same interest rule & savings provision

66. As per the reasoning in question 1, section 166-272 applies in respect of shares or other interests held by a TIE, a widely held company, an entity deemed to be a beneficial owner or a depository entity in the tested company requiring that:

● the same shares are held by the same persons and

● the only interests (including shares) in any other entity that is interposed between the stakeholder and the tested company that are taken into account are exactly the same interests and are held by the same persons.

67. As discussed in question 1 the same share same interest rule is subject to a savings provisions and without the savings provisions, section 166-275 would deem there was no continuity of ownership in relation to the ongoing 50% interest held by Company B.

68. When Company B disposed of its shares in Company A to NewCo a loss duplication did not arise in relation to the disposal and at the time of the disposal the application of subdivision 165-CD resulted in an adjustment to the reduced cost base of Company A shares immediately prior to the disposal concluding that less than 50% of Company A’s tax losses at 30 June 20XX would be reflected in the capital losses which Company B may have or could incur in the future because of the disposal of the Company A shares to NewCo on 1 July 20XX¹⁰.

No detriment rule – section 166-275

69. Section 166-275 will take a company as meeting the conditions in section 165-12 where:

● a tracing rule modified how the ownership tests in section 166-145 apply to the tested company in respect of a voting stake, a dividend stake or a capital stake11

● the company fails the tests (whether at the time of applying the tracing rule or at another time),12 and

● the company believes on reasonable grounds, that if the tracing rule did not modify how the tests apply to the company in respect of that stake, it would not fail the tests.¹³

70. In respect of Stakeholder 2’s stake, Company A is seeking to disregard all tracing rule concessions that attributed the stake as follows:

● prior to 1 July 20XX; the stake attributed to Company B, and

● post 1 July 20XX: the stake attributed to Company B and Company C.

71. As per section 166-230, Company A proposes to apply the tracing rule to the indirect stake held by stakeholder 2 to make stakeholder 2 the TIE for this stake.

72. Stakeholder 2 has maintained a minimum indirect stake as follows:

● prior 1 July 20XX stake held 1.92% (in Company B), and

● post 1 July 20XX stake held 1.46% (Company B 0.96% and Company C 0.50%).

73. By disregarding the concessional tracing rules in relation to the stakes held by stakeholder 2, will allow Company A to have maintained more than 50% of the same owners to the end of the test period. The total continued ownership is 50.47%.

Conclusion:

74. Company A has continued to satisfy the continuity of ownership test in section 165-12 as modified by section 166-5 in respect of its losses incurred in the 20XX to 20XX income years on the basis:

● the requirements of paragraphs 166-275(a) and (b) are satisfied; and

● paragraph 166-275(c) is satisfied where the tracing rules in sections 166-230 and 166-240 are disregarded in respect of the stakes in Company B and Company C held by stakeholder 2.