Edited version of private advice

Authorisation Number: 1051664407182

Date of advice: 30 April 2020

Ruling

Subject: Losses - same business test

Question

Does the taxpayer satisfy the business continuity test under section 165-210 of the Income Tax Assessment Act 1997, such that it can deduct tax losses incurred in previous income years for an income year, to the extent that its total assessable income exceeds its total deductions (except tax losses) for that year?

Answer

Yes

This ruling applies for the following period:

An income year

The scheme commenced:

During an income year

Relevant facts and circumstances

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

Background

      1.      The taxpayer is an Australian tax resident company and not a member of a tax consolidated group.

      2.      Since its incorporation, the taxpayer has been wholly owned by a foreign company (Parent Company).

      3.      During an income year, 100% of the shares of Parent Company were acquired by another entity which became the new parent company of the taxpayer. As such, the taxpayer failed the continuity of ownership test (COT) under section 165-12 in respect of all carried forward losses (COT failure date).

      4.      The taxpayer had tax losses carried forward to later income years which was comprised of tax losses carried forward from a number of income years. The taxpayer has not accrued any tax losses on or after 1 July 2015.

      5.      The COT was not failed at any stage between the start of the income year that the earliest losses that are the subject of the private ruling were incurred and the COT failure date.

The taxpayer's business operations

      6.      The principal activities of the taxpayer as at the COT failure date were the importation and wholesale distribution of a range of electronic products in a number of segments.

      7.      All finished goods and spare parts were imported from Parent Company and its related entities and Company A, a foreign company.

Cessation of product distributorship

      8.      During the income year following the COT failure date, Company A notified the taxpayer that the distributorship for its products would cease in several months' time and that a new company would be appointed as the new Australian distributor of Company A's products (cessation date).

      9.      The reason for Company A's decision to cease the distributorship with the taxpayer was due to commercial reasons which resulted in a change to its approach and strategy for the distribution of its products.

The taxpayer's business operations after cessation of the distributorship

     10.     Upon being notified of the cessation of the Company A distributorship, the taxpayer experienced the following changes to its business operations over several months:

·                     The winding down of marketing activities relating Company A's products

·                     The cessation of the importation and distribution of Company A's products

·                     The implementation of a restructure plan which entailed a reduction in employees by 30%

·                     Some changes in directors and executive management

·                     A reduction in gross assets

     11.     Apart from the above changes, the following business activities of the taxpayer remained the same as immediately before the COT failure date (i.e. the test time for the purposes of the same business test), including:

·                     The importation and distribution of its other products in the electronics market

·                     The identity of its customers

·                     Employee functions

·                     Business premises

·                     Capital and working capital

·                     Business name

     12.     No other changes occurred in the business of the taxpayer during the income year in which the distributorship with Company A ceased other than as described in this ruling.

     13.     The taxpayer did not derive income from any source or transaction that it did not carry on before the COT failure date.

     14.     The taxpayer was not in a net exempt income position for the income year in which the distributorship ceased.

Relevant legislative provisions

Section 36-25 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 165-10 of the ITAA 1997

Section 165-12 of the ITAA 1997

Section 165-13 of the ITAA 1997

Section 165-210 of the ITAA 1997

Reasons for decision

All subsequent legislative references in the Reason for decision are to the Income Tax Assessment Act 1997, unless otherwise specified.

Section 36-25 sets out the special rules for deducting tax losses. Item 2 in table 2 of section 36-25 refers to the relevant tests in Subdivision 165-A.

Section 165-10 of Subdivision 165-A provides that a company cannot deduct a tax loss unless either it meets the conditions in section 165-12 (which is about the company satisfying the continuity of ownership test) or section 165-13 (which is about the company satisfying the business continuity test).

The taxpayer failed the continuity of ownership test on the COT failure date in respect of losses incurred in previous income years ended. Therefore, it can only carry forward losses incurred in the previous income years if it satisfies the business continuity test.

Section 165-13 defines the business continuity test period and the 'test time'. Subsection 165-13(2) states that the business continuity test period for a company is the income year in which the company wishes to deduct tax losses of earlier income years. For present purposes, the business continuity test period is the income year in which the distributorship ceased.

The 'test time' is determined by the table provided by subsection 165-13(2). Item 1 of the table states that, where practicable, the test time is the latest time that the company can show that it has satisfied the continuity of ownership test in subsections 165-12(2), (3) and (4) (regarding the company maintaining the same owners).

The latest time that the taxpayer is able to show that subsections 165-12(2), (3) and (4) were able to be met was the COT failure date. Therefore, the test time for the losses subject to this ruling is the COT failure date.

A company can satisfy the business continuity test by carrying on either the same business (section 165-210) or a similar business (section 165-211).

The similar business test in section 165-211 does not apply for present purposes as it is only available for losses made in income years starting on or after 1 July 2015. The taxpayer has not accrued any tax losses on or after 1 July 2015.

To satisfy the business continuity test - carrying on the same business, in section 165-210, the taxpayer must be able to satisfy the following:

·                     A positive test - the same business test - the company must carry on the same business during the business continuity test period (i.e. the income year in which the distributorship ceased) that it carried on immediately before the test time (i.e. the COT failure date) (subsection 165-210(1))

·                     A negative test - the new business test - the company must not derive assessable income from carrying on a business of a kind that it did not carry on before the test time (paragraph 165-210(2)(a))

·                     A further negative test - the new transaction test - the company must not derive assessable income, in the course of its business operations, from a transaction of a kind that it had not entered into before the test time (paragraph 165-210(2)(b)), and

·                     The anti-avoidance test - the company did not commence certain business activities before the test time for the purpose of satisfying the same business test (subsection 165-210(3)).

The Commissioner's views concerning the application of the same business test are set out in 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.

a) The positive test - subsection 165-210(1)

The positive test in subsection 165-210(1) requires a comparison of the business carried out throughout the business continuity test period) (i.e. the income year in which the distributorship ceased), with the business carried on immediately before the test time (i.e. the COT failure date). Paragraph 8 of TR 1999/9 provides that the expression 'same business' in subsection 165-210(1) means the business of the company as an entirety, or its 'overall business'.

Paragraph 13 of TR 1999/9 further states:

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 test time. It is not sufficient that the business carried on after the test time meets some industry wide definition of a business of the same kind, nor would it be sufficient for there to be mere continuance of business operations from immediately before the test time into the SBTP, if the business had so changed that it could no longer be described as the same business. The analysis of whether the same business continues after the test time may give rise to questions of degree and ultimately depends on the facts of the case. 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 through 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 the loss of activities on a considerable scale, a company may fail the test.

Determining whether the taxpayer has carried on the same business at all times during the business continuity test period as the business the taxpayer carried on immediately before the test time, means drawing an inference of fact after considering and weighing all the factors, and then attaching the appropriate weight to each factor, having regard to all the circumstances. The application of the same business test to each case requires close analysis of the facts of each case.

In the present case, the business carried on by the taxpayer immediately before the test time was the importation and distribution of consumer electronic products.

Company A notified the taxpayer during the income year of its decision to cease its distributorship with the taxpayer.

Thus, the main issue that will determine whether the taxpayer satisfies the positive limb of the same business test is the impact of the cessation of the Company A distributorship on the taxpayer's business.

The taxpayer experienced a number of changes, as outlined in the facts, during the business continuity test period as a result of the cessation of distributorship which directly affected its business activities.

It needs to be determined whether any of the above changes experienced by the taxpayer, or a combination of them over time, will cause the taxpayer to fail the positive limb of the same business test under subsection 165-210(1).

TR 1999/9 contains guidance on what impact the discontinuation of a segment of a business may have on the satisfaction of the same business test.

Paragraph 38 of TR 1999/9 states:

... A business may be the same, even though there have been some changes in the way in which it is carried on, provided the identity of the business is not changed.

Paragraph 39 of TR 1999/9 states that:

Mere expansion or contraction of the taxpayer's business may not result in a change in the identity of the business carried on by the taxpayer ...

Paragraph 40 of TR 1999/9 further states:

However, as a practical matter, expansion or reduction of business activities, if carried to a sufficient extreme, is likely to amount to more than a mere change in the scale of the business carried on by the taxpayer and so may result in a change in the identity of the business. In particular, a sudden and dramatic expansion or contraction brought about by the acquisition or loss of activities on a considerable scale could mean the same business is no longer being carried on. As Walton J observed in Rolls-Royce Motors Ltd v. Bamford:

'There is all the difference in the world between an organic growth of trade and a sudden and dramatic change brought about by either the acquisition or loss of activities on a considerable scale.'

Moreover, the evolution of a business is not necessarily the same as mere expansion and may also lead to change such that the business can no longer be described as the same business as that carried on immediately before the change-over, as was recognised in Fielder Downs (WA) Pty Ltd v. FC of T.

Accordingly, the expansion of business activities will not ordinarily cause the same business test to be failed if it constitutes the 'organic growth' of the business through the adoption of new 'compatible' operations and the business retains its identity. Similarly, it is considered that if portions of former operations are discarded 'in the ordinary way', discontinuation of those activities will not necessarily cause the test to be failed. However, if the scale of the changes, especially over a short period, causes the essential identity of the business to be lost, the test may be failed.

Paragraph 43 of TR 1999/9 explains that:

The question of whether the discontinuation of an activity will produce a change of business is, however, ultimately one of degree. Sudden and dramatic change brought about by either the loss or acquisition of activities on a considerable scale is to be contrasted with an organic growth of a business: per Walton J in Rolls-Royce (Motors) Ltd v. Bamford. As his Lordship there observed:

'Doubtless the trade of the company would remain the same trade even though, as a result of organic growth in response to every factor which might influence it, the company adopted new compatible operations and discarded portions of its old.'

Paragraph 60 in TR 1999/9 provides specific guidelines on what factors need to be considered in determining whether a taxpayer has satisfied the same business test. Paragraph 60(d) of TR 1999/9 addresses the effect of expansions or contractions of business activities as follows:

An expansion or contraction of the taxpayer's business activities may not, in itself, result in a change in the identity of the business carried on by the taxpayer: Gibbs J in Avondale Motors. However, the expansion or contraction of activities may result in a change in the identity or character of the business, taking into account the nature and extent of the expansion or contraction. In particular, the organic growth of a business through the adoption of new compatible operations in the ordinary way and, similarly, the discarding of old operations in that way, may not cause a taxpayer to fail the same business test, but a sudden and dramatic change brought about by the loss or acquisition of business operations on a considerable scale is likely to do so: Walton J in Rolls-Royce (Motors) Ltd v. Bamford.

Having regard to the facts, the Commissioner considers that the cessation of the distributorship with Company A will not amount to a sudden and dramatic change of a considerable scale as the changes experienced by the taxpayer reflect a winding down and contraction in its business operations. The changes and subsequent impact from the cessation of the distributorship did not result in a change to the identity of the taxpayer's business given that the taxpayer continued to carry out the same business activities during the business continuity test period, albeit at a reduced scale. As such, the taxpayer satisfies the positive limb of the same business test under subsection 165-210(1).

b) The negative tests - paragraphs 165-210(2)(a) and 165-210(2)(b)

The negative tests in paragraphs 165-210(a) and 165-210(2)(b) require the taxpayer to not, at any time during the business continuity test period, derive assessable income from a business of a kind or a transaction of a kind that it did not carry out before the test time (respectively, the new business test and new transaction test).

Paragraph 14 of TR 1999/9 states the following in relation to the new business test:

'...In the new business test there is a reference to 'business of a kind' that the company did not carry on before the change-over. In the new business test the word 'business' has a different meaning from the word 'business' in the same business test; it refers to each kind of enterprise or undertaking comprised in the overall business carried on by the company at the change-over and during the period of recoupment. The new business test puts a limit on the type of expansion the company may undertake if it is to retain the benefit of accumulated losses; for the taxpayer may not engage in an undertaking or enterprise of a kind in which it did not engage before the change-over and still benefit from accumulated losses.'

In paragraph 15 of TR 1999/9, the Commissioner makes the following comments about the new transactions test:

'...Generally speaking, the new transactions test is not failed by transactions of a type that are usually unmotivated by tax avoidance, namely, transactions that could have been entered into ordinarily and naturally in the course of the business operations carried on by the company before the change-over. Conversely, a transaction entered into during the period of recoupment and which is outside the course of the business operations before the change-over, or which is extraordinary or unnatural, when judged by the course of the business operations before the change-over, is usually a transaction of a different kind from the transactions actually entered into by the company before the change-over.'

Given the cessation of the distributorship with Company A, the taxpayer will no longer derive income from the importation and distribution of Company A's products from the cessation date. However, all the revenue to be derived by the taxpayer during the business continuity test period will be from the same source of importation and distribution of electronics as was derived before the test time. The taxpayer will have derived revenue from the same business activities and from the same customer base in the business continuity test period as the previous income year. As such, the cessation of the Company A distributorship will not cause the taxpayer to fail the new business or new transaction tests.

c) The anti-avoidance test - subsection 165-210(3)

This subsection is designed to prevent a taxpayer satisfying the business continuity test by commencing a new business or entering into a new transaction prior to the test time, in anticipation of obtaining a deduction for a prior year loss, a current year loss or a bad debt in the claim year.

Where the taxpayer commenced to carry on the same business or entered into a transaction in the course of its business operations before the test time for a variety of purposes, the anti-avoidance test nevertheless operates to prevent a taxpayer from satisfying the relevant tests, where one of the purposes was to satisfy the business continuity test.

According to the facts in the present case, the taxpayer did not commence any businesses or enter into any transactions of a kind that had not been previously carried on for the purpose of satisfying the business continuity test under section 165-210 and as such, the anti-avoidance test has no application.

Conclusion

Based on the above analysis, the taxpayer will satisfy the business continuity test under section 165-210 for the income year such that it is able to deduct some or all of the tax loss made in previous income years to the extent that its total assessable income exceeds its total deductions (except tax losses) for that year.