Edited version of your private ruling

Authorisation Number: 1051702843582

Date of advice: 24 June 2020

Ruling

Subject: Continuity of ownership test

Question 1

Will Company A be entitled to deduct the carried forward losses against its other assessable income in the 20XX income year on the following basis:

(a)          Company A satisfies the continuity of ownership test (COT) under section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997) as modified by Division 167 of the ITAA 1997; and

(b)          The Commissioner does not disallow the deduction of the carried forward losses under section 175-10 of the ITAA 1997?

Answer

Yes.

Question 2

Will the proposed trust income distribution made from Trust B to Company A in the 2020 income year be subject to the family trust distribution tax (FTDT) under section 271-15 of Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 3

Will the Commissioner apply section 100A of the ITAA 1936 to the proposed trust income distribution from Trust B to Company A in the 2020 income year?

Answer

No.

This ruling applies for the following period(s)

Income year ended 30 June 20xx

The scheme commences on

1 July 20xx

Relevant facts and circumstances

Company A

Company A is a private company that was incorporated in 19XX. It was previously carrying on a business.

The Memorandum and Articles of Association of Company A has been provided and forms part of the facts of this ruling.

Company A has an amount of carried forward tax losses as at 30 June 20xx, arising under Division 36 of the ITAA 1997. The losses were incurred over a number of years while the business was being carried on.

In previous years, Mr C contributed significant funds required to keep the business going, including playing off some liabilities of Company A.

Ms D also contributed funds into Company A in 20XX, along with Mr C contributing more funds.

There were no written loan agreements in place and the arrangements were informal. The loans were used to keep the business going and pay off some of the liabilities of Company A. Company A was not on-lending or making loans to any entities or associates.

The business was eventually wound up, with assets being sold to pay liabilities.

The loan from Ms D was repaid in 20XX from the sale of assets.

The loan from Mr C has been progressively reduced since, by way of any funds received by associated entities or income from investments.

As at 30 June 20xx, the remaining loan balance outstanding to Mr C was $X.

The financial statements of Company A for the years ended 30 June 20XX - 20xx have been provided and form part of the facts of this ruling.

The shareholders of Company A as at 1 July 20XX were as follows:

1 a Class share Trust B

1 b Class share Ms D

1 c Class share Ms D

xx% of Ordinary shares Ms D

xx% of Ordinary shares Trust B

Pursuant to Company A's Constitution the a, b and c class shares hold no rights to vote at any general meeting of the company.

Pursuant to Company A's Constitution the a, b and c class shares have a right to payment of dividends at the directors' discretion.

Pursuant to Company A's Constitution the a, b and c class shares have a right of return of capital not exceeding the nominal value of each shares, but no right to further participate in the surplus profits or assets of the company.

The Ordinary class shares hold the right of voting at the general meeting of the company, right of dividends and right of return of capital in the surplus assets of the company.

Company A's Constitution allows for other classes of shares, but these have never been issued.

The shareholders of Company A held the same shares during the period between 1 July 20XX and July 20XY.

The shareholding of Company changed on July 20XY with Trust B becoming the sole shareholder of all Company A shares on issue.

Company A's Constitution provides the methodology for the transfer of shares. Essentially, the clause provides that the transfer will occur at a fair value.

Ms D's b class, c class and ordinary shares were all transferred to Trust B at their respective par values.

Trust B has retained these shares to the current date and will hold them until 30 June 20xx.

Company A has never paid any dividends to the former or current shareholder of the a, b and c class shares.

The current directors of Company A are Mr C and spouse. Ms D and Mr C are related.

Trust B

Trust B is a discretionary trust established by way of deed in 19XX.

The trust deed of Trust B has been provided and forms part of the facts of this ruling.

Trust B made a family trust election (FTE) effective from 1 July 20XX with Mr C as the specified individual of the trust.

Company A has not made an interposed entity election (IEE) to be included as a family member of Trust B, but will make a valid interposed entity election (IEE) in the 2020 income year if the Commissioner considers it necessary as part of this Ruling.

Trust B will distribute part or all of its income in the 20xx income year to Company A.

The 20xx distribution would then be offset against the carried forward losses of Company A.

Trust B will make a cash payment in satisfaction of the resulting unpaid present entitlement owing to Company A on or before the lodgement due date of Company A's 20xx income tax return.

Company A will then use the cash to repay the unsecured loan outstanding to Mr C.

Relevant legislative provisions

Division 167 of the Income Tax Assessment Act 1997

Section 165-12 of the Income Tax Assessment Act 1997

Subsection 165-165(1) of the Income Tax Assessment Act 1997

Section 165-207 of the Income Tax Assessment Act 1997

Section 175-10 of the Income Tax Assessment Act 1997

Section 271-15 of Schedule 2F of the Income Tax Assessment Act 1936

Section 272-75 of Schedule 2F of the Income Tax Assessment Act 1997

Section 100A of the Income Tax Assessment Act 1936

Reasons for decision

Question 1

Summary

Company A satisfies the continuity of ownership test and is entitled to deduct it's carried forward losses against other assessable income in the 20xx income year.

The Commissioner would not disallow the deduction of the carry forward losses under section 175-10 of the ITAA 1997.

Detailed reasoning

Under section 165-10 of the ITAA 1997, a company cannot deduct a tax loss unless it either passes the continuity of ownership test (COT) in section 165-12 or the same business test (SBT) in section 165-13. This ruling only considers 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;

·         more than 50% of the company's dividends; and

·         to more than 50% of the company's capital distributions.

Ownership test period

The tests in section 165-12 of the ITAA 1997 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. In this case, the ownership test period is July 20XX to 30 June 20xx.

Primary test applies

The three conditions under subsections 165-12(2) to (4) of the ITAA 1997 are applied as a 'primary test'.

According to subsection 165-12(5) of the ITAA 1997 the primary test will apply unless subsection 165-12(6) of the ITAA 1997 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. In this case, there is no company owning any shares in Company A and therefore the primary test applies.

Family trusts

Concessional tracing rules for the primary tests are contained in section 165-207 of the ITAA 1997 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.

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

An FTE has been made for Trust B with effect from the 20XX income year and it has been in force at all times since. Therefore Trust B has been a family trust since the 20XX income year and will be treated as a person for the purposes of the COT.

Same shares held

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.

In this case, the shareholders of Company A held the same shares during the period between xx 20XX and xx 20XY.

The shareholding of Company A changed in xx 20XY with Trust B becoming the sole shareholder of all Company A shares on issue. Trust B has retained these shares to the current date and expects to hold them for the foreseeable future. They will hold them until 30 June 20xx.

Primary test conclusion

In this case, Company A would clearly satisfy COT for the period from xx 20XY, because Trust B held all of the issued shares and thus had 100% of the rights to voting, dividends and capital of Company A.

However, because b and c class shares have a right to payment of dividends at the directors' discretion, and these shares were held by Ms D until xx 20XY, there is no clear outcome reached in applying the primary tests under Division 165 of the ITAA 1997 prior to this time, as it cannot be determined that Trust B had more than 50% of the rights to dividends.

Subdivision 167-A

A company that is unable to work out whether it satisfies the conditions for continuity of ownership for any of the provisions listed in section 167-10 because it has an "unequal share structure" can reconsider whether the relevant conditions are satisfied after disregarding certain interests in the manner permitted under subdivision 167-A of the ITAA 1997.

These rules only apply where companies are unable to work out if a condition is satisfied, and by that reason, fail to satisfy the condition (as opposed to being able to test the condition and then failing it).

The rules must be applied in the order set out in the legislation (sections 167-15, 167-20 and167-25 of the ITAA 1997).

·         The first is to disregard any debt interests.

·         The second is to disregard debt interests and secondary share classes.

·         The third is to disregard those shares and treat the remaining shares as carrying certain percentages of the rights to received dividends and capital distributions.

In this case, none of the issued shares in Company A are considered to be debt interests so the first method does not apply.

Disregarding secondary share classes

Under the second method, "secondary class shares" refers to a class of shares other than the ordinary shares of a company that represent the majority of the company's value.

Under this method, it must be reasonable to conclude that:

(a) the total market value of these classes does not exceed 25% of the total market value of all of the company's shares (excluding debt interests), and

(b) the market value of each of these classes of shares is not greater than 10% of the total market value of all of the company's shares (excluding debt interests).

Where the above requirements are met, the secondary class shares whose market values do not exceed 10% of the total market value may be disregarded along with any debt interests for the purpose of reconsidering the relevant ownership condition.

Consideration is given to the fact that all the a, b and c classes of shares on issue do not provide the holder of the shares with any right to surplus capital in the wind up of a company, no rights to vote at a company general meeting, and any dividends are only at the discretion of the Board. To date, dividends have not been paid to the owners of any shares other than ordinary shares.

It is also noted that, in 20XY, when Ms D transferred her ordinary and b and c class shares, to Trust B, all transfers were done at par value, and this must have been considered by all parties as a fair value in accordance with Company A's Constitution. Therefore, the value ascribed to those secondary class shares was their par value.

It is considered that the value of ascribed to those secondary class shares is negligible.

It is reasonable to conclude that the total market value of the secondary class shares on issue (a,b and c classes) does not exceed 25% of the total market value of all of the company's shares, and no one class of those secondary class shares is greater than 10% of the total market value of all of the company's shares.

The secondary class shares can therefore be disregarded in determining if Company A satisfies COT.

For the test period of xx 20XX to 30 June 20xx, Trust B consistently held xx% of the ordinary shares (increasing this to 100% in xx 20XY).

It can therefore be established that all times during the ownership test period, Trust B had rights to:

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

·         more than 50% of the company's dividends; and

·         more than 50% of the company's capital distributions.

Company A therefore satisfies COT for the entire test period of xx 20XX to 30 June 20xx.

Section 175-10

Section 175-10 of the ITAA 1997 states:

(1)           The Commissioner may disallow the excluded loss if, during the income year, the company derived assessable income, or a capital gain accrued to the company, some or all of which (the injected amount) would not have been derived, or would not have accrued, if the excluded loss had not been available to be taken into account ...

(2)           However the Commissioner cannot disallow the excluded loss if the continuing shareholders will benefit from the derivation or accrual of the injected amount to an extent that the Commissioner thinks is fair and reasonable having regard to their respective rights and interests in the company.

In this case, the Commissioner has considered the following factors:

The Commissioner considers that as Mr C has always owned more than 50% of the shares in Company A, he is entitled to recoup those losses. The trust distribution will be used to repay Mr C's loans that he made to Company A in order to keep the business operating during the years it made those losses. Repayment of these loans by Company A is considered to be an ordinary commercial dealing, and Mr C is entitled to have those loans repaid.

The Commissioner therefore thinks that the proposed income distribution from Trust B into Company A, and the use of the carry forward losses, is fair and reasonable having regard to Mr C's rights and interests in Company A, and will not seek to disallow the losses under section 175-10 of the ITAA 1997.

Conclusion

Company A satisfies the continuity of ownership test and is entitled to deduct it's carried forward losses against other assessable income in the 20xx income year.

Mr C is a continuing shareholder and it is fair and reasonable, given the company can deduct the losses, he shares in this benefit to the company. The Commissioner will not disallow the deduction of the carry forward losses under section 175-10 of the ITAA 1997.

Question 2

Summary

The trustee of Trust B will not be liable for family trust distributions tax under section 271-15 of Schedule 2F of the ITAA 1936, as Company A is part of the family group. It is not necessary for Company A to do an interposed entity election.

Detailed reasoning

It is proposed that Trust B confers present entitlement to trust income to Company A for the 20xx income year. The question is whether the trustee of Trust B will be liable to pay FTDT in respect of this.

Section 271-15 of Schedule 2F of the ITAA 1936 provides that a trustee will be liable for family trust distributions tax where the trustee of a family trust confers a present entitlement to, or distributes, income or capital of the trust, outside of the family group.

In this case:

·         It has been established that Trust B is a family trust, with a family trust election, under subsection 272-80(1) of Schedule 2F of the ITAA 1936;

·         That Mr C is the primary individual of Trust B effective from 1 July 20XX under subsection 272-80(3) of Schedule 2F of the ITAA 1936.

·         It is proposed that the trustee of Trust B will make Company A presently entitled to trust income for the 20xx income year.

A family group is defined in section 272-90 of Schedule 2F of the ITAA 1936 as:

·         Family members of the primary individual (as defined in s272-95)

·         Certain former family members of the primary individual

·         Other family trusts with the same primary individual

·         The trust in respect of which the family trust election is made

·         Entities covered by an interposed entity election; and

·         Entities owned by the family (i.e. a company owned by the family).

Because Company A is a company, it needs to be considered under the last two of the above points, to determine whether, at the time the trustee confers the present entitlement or makes the distribution to Company A in the 20xx income year, that Company A is a member of the family group of Mr C.

Entities covered by an interposed entity election

If a company makes an interposed entity election (IEE) in respect of a trust which has made a FTE, that company will be included in the family group of the test individual specified in the FTE.

Company A has not made an interposed entity election in accordance with section 272-85 of Schedule 2F of the ITAA 1936. Providing Company A passes the family control test under subsection 272-87(3) at the end of the income year, it would be entitled to make an interposed entity election.

This means that Mr C, or any of the members of his family (or trusts to which he is specified as the primary individual) must, between them, directly or indirectly, hold fixed entitlements to a greater than 50% share of the income or the capital of the company.

From the facts provided, Company A would pass the family control test in the 20xx income year, as Trust B (as part of the family group) holds all the issued shares in Company A and therefore has a 100% entitlement to all the income and capital of the company. It would also pass the test in earlier years as Ms D is also a member of Mr C's family group.

Entities owned by the family

Subsection 272-90(5) of Schedule 2F of the ITAA 1936 provides that a company is a member of the family group in relation to the conferral or distribution if, when the conferral or distribution takes place, the primary individual or any of their family members, or a family trust with the same primary individual specified, or any combination of the above, have fixed entitlements to all of the income and capital of the company.

The definition of fixed entitlement is governed by section 272-10 of Schedule 2F of the ITAA 1936 which provides:

(1)           If a shareholder in a company holds shares carrying the right to receive some or all of the dividends that may be paid by the company, the shareholder has a fixed entitlement to a share of the income of the company equal to the total dividends represented by the dividend that the shareholder has a right to receive.

(2)           If a shareholder in a company holds share carrying the right to receive the whole or part of any distribution of the paid-up share capital of the company in the event of any return of capital to shareholders, the shareholder has a fixed entitlement to a share of the capital of the company equal to the percentage of the total distribution represented by the amount that the shareholder has a right to receive.

Notwithstanding, the above definition, in the Explanatory Memorandum to the Taxation Laws Amendment Act (Trust Loss and Other Deductions) Bill 1997, it is accepted that a company in relation to a shareholding held by a family trust can be a family group member. In this regard, it is stated that a company will be a member where:

At the time of the distribution, some or all of the individuals specified in the family trust election...and family trusts of the same individual have fixed entitlements, directly or indirectly, and for their own benefit, to all the income and capital of the company (refer to table in paragraph 5.34).

In this case, at the time of conferring the present entitlement or making the distribution for the 20xx income year to Company A:

·         Trust B is a member of Mr C's family group pursuant to subsection 272-90(3) of Schedule 2F of the ITAA 1936 as the trust in respect to which the family trust election was made; and

·         Trust B is the sole shareholder in Company A. Therefore Trust B is considered to have fixed entitlements directly or indirectly, and for their own benefit, to all of the income and capital of the company under the terms of subsection 272-90(5) of Schedule 2F of the ITAA 1936.

Therefore, if the trustee of Trust B makes Company presently entitled to income of the trust in the 20xx income year, the trustee will not be liable for FTDT pursuant to 271-15 of Schedule 2F of the ITAA 1936. This is because Company A is an entity owned by the family and considered to be part of Mr C's family group.

Conclusion

Accordingly, the conferral of trust income by Trust B to Company A will not be subject to FTDT pursuant to section 271-15.

Company A may make an interposed entity election, if eligible to do so. However, Company A is already part of the Trust B's family group.

Question 3

Summary

The Commissioner considers that section 100A of the ITAA 1936 will not apply.

Detailed reasoning

Section 100A of the ITAA 1936 provides that where a beneficiary of a trust estate who is not under a legal disability, is presently entitled to trust income, and that present entitlement is linked either directly or indirectly to a reimbursement agreement, the beneficiary is deemed not to be presently entitled to the income.

Trust distributions which fall within section 100A of the ITAA 1936 are assessed to the trustee under section 99A of the ITAA 1936.

Subsection 100A(7) of the ITAA 1936 defines a reimbursement agreement to include,

...the payment of money or the transfer of property to, or the provision of services or other benefits for, a person or persons other than the beneficiary or the beneficiary and another person or persons.

Further, the term 'agreement' is defined in subsection 100A(13) of the ITAA 1936 to include any agreement, arrangement or understanding, whether formal or informal, express or implied, and either enforceable or unenforceable. However, the term does not include any agreement entered into in the course of ordinary family or commercial dealings.

The Commissioner considers that section 100A of the ITAA 1936 will not apply in this case.