Edited version of private advice

Authorisation Number: 1051640194242

Date of advice: 17 March 2020

Ruling

Subject: Tax losses - continuity of ownership test

Question

Will the transfer of one share in Company A Pty Ltd from Company B Pty Ltd to Individual A result in you being unable to satisfy the 'continuity of ownership' test (COT) under section 165-12 of the Income Tax Assessment Act 1997 (ITAA 97)?

Answer

No.

This ruling applies for the following period(s)

1 July 2019 to 30 June 2020

The scheme commences on

XX July 20XX

Loss Company

You are the head company of a consolidated group for income tax purposes.

You have carried forward capital and revenue losses which were all incurred after the 20XX income year.

Some of the revenue losses have been transferred to you under Subdivision 707-A of Part 3-90 of Income Tax Assessment Act 1936 (ITAA 36). There has not been a change of ownership in your shares since the year of income in which the joining company made the transferred loss.

All your shares have been held by Company A Pty Ltd (Company A), in its capacity as trustee of the Unit Trust from the commencement of the income year in which the carried forward capital and revenue losses were incurred until the date of the ruling. At all times the shares:

·        have been the exact same shares as per section 165-165, and

·        carry XX% of the voting power, XX% of the rights to dividends and XX% of the rights to the capital distributions.

Unit Trust

The trustee of the Unit Trust is Company A.

The Unit Trust is a unit trust with income and capital units:

·        holders of the income units will have entitlements to the income of the Unit Trust, and

·        holders of the capital units will have a beneficial interest in the capital assets of the Unit Trust.

All of the capital and income units on issue in the Unit Trust are held by the trustee of the Discretionary Trust. There are no other beneficiaries of the Unit Trust.

A family trust election (FTE) under section 272-80 of Schedule 2F of the ITAA 1936 was made in respect of the Unit Trust on X June 20XX with 20XX as the specified income year. The FTE has been validly made and has remained effective since it was made.

The trust deed does not contain any restrictions on changing shareholders of the corporate trustee.

Discretionary Trust

The trustee of the Discretionary Trust is Company A.

The Discretionary Trust is a discretionary trust.

General beneficiaries include eligible corporations.

A FTE under section 272-80 of Schedule 2F of the ITAA 1936 was made in respect of the Discretionary Trust on XX Month 20XX with XXXX as the specified income year. The FTE has been validly made and has remained effective since it was made.

Company A

Company A has two ordinary shares on issue. One ordinary share (X% shareholding) is held beneficially by Company B Pty Ltd (Company B). The other ordinary share (X% shareholding) is held by Individual B.

The Proposed Transaction

The directors of Company B have advised that they wish to cause the company to be deregistered and accordingly wish to transfer its share in Company A.

It is proposed that Company B will transfer its share in Company A to Individual A ("Proposed Transaction").

Individual A is known to the directors of Company A although they are not an associate as defined in section 318 of the ITAA 36.

No other event has occurred that has caused you to fail the 'continuity of owners' test in section 165-12 of ITAA 97.

The Proposed Transaction will neither involve any change to the terms of the trust deed of the Unit Trust, nor any change to the identity of the trustee, nor any changes to the trust property nor changes to the beneficiaries of the Unit Trust.

Relevant legislative provisions

Reasons for decision

All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated

Issue 1

Question 1

Summary

The Proposed Transaction does not alter the continuity of ownership of your shares and will not have any impact on you passing the COT in section 165-12 in respect of the ownership test period.

Detailed reasoning

Under section 165-10, a company cannot deduct a tax loss unless it either passes the COT in section 165-12 or the same business test (SBT) in section 165-13.

This ruling only considers whether the Proposed Transaction will cause you to fail the conditions for the COT in section 165-12.

COT

The COT consists of three conditions under subsections 165-12(2), 165-12(3) and 165-12(4) of the ITAA 1997. Broadly, this means that there must be persons who, at all times during the ownership test period 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.

Ownership test period

The tests in section 165-12 are applied over the 'ownership test period' which is the period from the start of the loss year to the end of the income year in which the loss is sought to be deducted.

Primary test applies

The three conditions under subsections 165-12(2) to (4) are applied either as a 'primary test' or as an 'alternative test'.

According to subsection 165-12(5) the primary test will apply unless subsection 165-12(6) requires that the alternative test applies. Subsection 165-12(6) states that the alternative test applies if one or more other companies beneficially owned shares or interests in shares in the company during the ownership test period.

All your shares are legally held by the trustee for the Unit Trust. All the units in the Unit Trust are held by Company A in its capacity as trustee for the Discretionary Trust. There are no other beneficiaries of the Unit Trust.

General beneficiaries of the Discretionary Trust include eligible corporations.

The trustee of the Discretionary Trust has discretion in terms of the distribution of income and capital of the trust with no beneficiaries having a fixed interest to the income or capital of the trust.

Tracing rules can only be applied in circumstances where the beneficial owners have fixed quantifiable interests in the things being traced. Tracing through interposed entities to underlying beneficial owners cannot occur through a discretionary trust as beneficiaries of discretionary trusts do not have fixed interests in the income or capital of the company or interposed entity.

In the current circumstances, the primary test applies because no companies can be traced to have fixed interest or beneficial ownership of your shares during the ownership test period.

Accordingly, the primary tests in subsections 165-150(1), 165-155(1) and 165-160(1) are to be applied and will be satisfied if there are persons who, at all times during the ownership test period, beneficially own (between them) your shares that carry (between them):

·        the right to exercise more than 50% of the voting power in the company;

·        the right to receive more than 50% of the dividends the company may pay; and

·        the right to receive more than 50% of the capital distributions of the company.

Concessional tracing rules for the primary tests are contained in section 165-207 so that where the relevant interests in a company are held by the trustee of a family trust, a single notional entity that is a person will be taken to own the interests. This means that there is no need to trace past the family trust.

Relevantly, subsections 165-207(1) and (2) of the ITAA 1997 state:

(1) This section applies if one or more trustees of a family trust:

(a)   owns shares in a company; or

(b)   controls, or is able to control, (whether directly, or indirectly through one or more interposed entities) voting power in a company; or

(c)   has a right to receive (whether directly, or indirectly through one or more interposed entities) a percentage of a dividend or a distribution of capital of a company.

(2) For the purposes of a primary test, a single notional entity that is a person (but is neither a company nor a trustee) is taken to own the shares beneficially.

A trust is a 'family trust' at any time when a FTE in respect of the trust is in force (see sections 995-1 and section 272-75 of Schedule 2F of the ITAA 1936).

Under subsection 272-80(9) of Schedule 2F of the ITAA 1936, an election is in force at all times after the election commencement time if it has not been revoked. Under subsection 272-80(10), the election commencement time is at the beginning of the specified income year where the family control test is passed.

A FTE has been made for the Unit Trust with effect from the 20XX income year and it has been in force at all times since. The Unit Trust has been a family trust since the 20XX income year.

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) of the ITAA 1997 relevantly 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.

All your shares have been held by Company A, in its capacity as trustee of the Unit Trust from the commencement of the 20XX income year and at all times:

·        have been the exact same shares as per section 165-165, and

·        carry 100% of the voting power, 100% of the rights to dividends and 100% of the rights to the capital distributions.

As the Unit Trust has been a family trust for the full ownership test period, the concessional tracing rules do not require any tracing beyond it and it is taken for the purposes of the primary tests be a single notional entity that holds XX% of all your interests.

The Proposed Transaction could only impact the satisfaction of the COT in section 165-12 if it altered the continuity of ownership of your shares held by the trustee of the Unit Trust.

Continuity of a trust estate will be maintained so long as the trust is not terminated for trust law purposes. (Commissioner of Taxation v. David Clark; Commissioner of Taxation v. Helen Clark [2011] FCAFC 5; 2011 ATC 20-236; (2011) 79 ATR 550).

Continuity of a trust estate will be maintained if there is some continuity of property, continuity of trust obligations and membership of the trust. Relevantly, in Federal Commissioner of Taxation v. Commercial Nominees of Australia Ltd [1999] FCA 1455; 99 ATC 5115; (1999) 43 ATR 42 the Full Federal Court had stated that:

55....in order to determine whether losses of particular trust property are allowable as a deduction from income accruing to that trust property in a subsequent income year, it will be necessary to establish some degree of continuity of the trust property or corpus that earns the income from the income year of loss to the year of income. It will also be necessary to establish continuity of the regime of trust obligations affecting the property in the sense that, while amendment of those obligations might occur, any amendment must be in accordance with the terms of the original trust.

56. So long as any amendment of the trust obligations relating to such trust property is made in accordance with any power conferred by the instrument creating the obligations, and continuity of the property that is the subject of trust obligation is established, there will be identity of the 'taxpayer' for the purposes of section 278 and sections 79E(3) and 80(2), notwithstanding any amendment of the trust obligation and any change in the property itself.

The Proposed Transaction will neither involve any change to the terms of the trust deed of the Unit Trust, nor any change to the identity of the trustee, nor any changes to the trust property, nor changes to the beneficiaries of the Unit Trust.

The trust deed does not contain any restrictions on changing shareholders of the corporate trustee.

The change in shareholders of the corporate trustee of the Unit Trust as part of the Proposed Transaction will neither alter the continuity of trust property of the Unit Trust nor its trust obligations. Therefore the Proposed Transaction alone will neither alter the continuity of the Unit Trust, nor will it alter the continuity of the beneficial ownership of your shares.

Throughout the ownership test period, the Unit Trust is a family trust and has maintained continuity of ownership of all your shares which carry with them XX% of voting power, XX% of the rights to dividends and XX% of the rights to capital distribution.

The requirements of subsections 165-150(1), 165-155(1) and 165-160(1) have been met and consequently the COT is passed in section 165-12 in respect of the ownership test period.

Capital losses

Subdivision 165-CA deals with the ability of companies to deduct carried forward capital losses. In particular, subsection 165-96(1) provides that a company cannot apply a net capital loss for an earlier income year if Subdivision 165-A would prevent it from deducting the loss if the loss was a hypothetical revenue tax loss.

As determined above, the Commissioner is of the view that the Proposed Transaction alone will not cause you to fail the COT such that subdivision 165-A would prevent it from deducting the tax losses in the year ended XX June 20XX. Therefore, on the assumption that the capital losses were tax losses of an earlier income year, the Proposed Transaction alone will not cause you to fail the COT such that it would be prevented from deducting the capital losses.

Transferred losses

You have carried forward losses that have been transferred to you under Subdivision 707-A of Part 3-90. All losses were incurred after the 20XX income year.

Subdivision 707-B of Part 3-90 modifies the rules about a company maintaining the same ownership in section 165-12 for transferred losses.

For losses transferred to you as a COT transfer, section 707-210 modifies the test entity. This rule applies to a loss transferred to a head company by another company because the COT in section 165-12 was passed in respect of the loss at the transfer time (subsection 707-210(1A). The test period for passing the transfer test ends after the joining time, taking into consideration any ownership changes that occur as part of a consolidation event (subsection 707-120(2)).

For COT transfers, you (the head company) are only able to pass the COT if the test company (generally the company that incurred the loss) is able to pass the COT based on the assumptions in subsection 707-210(4). Based on these assumptions, the original loss period is reinstated and the only post-consolidation changes that are relevant are those that occur to the head company (i.e. intra-group changes, including the exit of the test company, are ignored).

There has not been a change of ownership in your shares since the year of income in which the joining company made the transferred loss.

For all other transferred losses, subsection 707-205(2) refreshes the loss year to commence at the time of transfer.

Therefore the modified tests in subdivision 707-B will only be impacted if there has been a change in the beneficial ownership of your shares.

As concluded above, the Proposed Transaction does not alter the continuity of ownership of your shares and there have been no changes to the beneficial ownership of your shares after the losses were first incurred. Therefore the Proposed Transaction will not have any impact on you passing the modified COT rules under subdivision 707-B.