Edited version of private advice

Authorisation Number: 1051924459611

Date of advice: 7 January 2022

Ruling

Subject:Tax losses - business continuity test

Question

With respect to tax losses incurred by Entity A in previous income years, will three proposed transactions either individually or together cause Entity A to fail the business continuity test in section 165-13 and subsections 165-210(1) and (2) of the ITAA 97 if undertaken in a future income year?

Answer

No.

This ruling applies for the following period:

1 January 20XX to 31 December 20XX

The scheme commences on:

1 January 20XX

Relevant facts and circumstances

Immediately before it failed the continuity of ownership test (COT), Entity A carried on a particular business.

Entity B acquired a 100% interest in Entity A.

Entity A continues to carry on the particular business.

Entity A has carried forward losses.

Entity A must satisfy the 'business continuity test' going forward to recoup its carry forward tax losses in future income years. Although Entity A's profile after the COT failure remains the same as before, Entity A is contemplating three different transactions for which it seeks guidance prior to undertaking one or all transactions.

Relevant legislative provisions

Section 165-13 of the Income Tax Assessment Act 1997 (ITAA 97)

Subsection 165-210(1) ITAA 97

Subsection 165-210(2) ITAA 97

Reasons for decision

According to section 165-10 a company cannot deduct a tax loss unless either it meets the conditions of 'continuity of ownership' in section 165-12 (COT) or it meets the conditions of the 'business continuity test' in section 165-13.

Entity A will only be entitled to deduct it's carried forward tax losses incurred prior to the COT failure if it meets the conditions of the 'business continuity test' in section 165-13.

The 'business continuity test' is satisfied by a company meeting the conditions of the 'same business test' in section 165-210 (SBT) or the 'similar business test' in section 165-211.

In this case, Entity A seeks guidance with respect to the SBT only. Therefore the 'similar business test' in section 165-211 is not considered in this ruling.

Same Business Test (SBT)

A company satisfies the SBT if throughout the 'business continuity test period' it carries on the same business as it carried on immediately before the test time (subsection 165-210(1)). The company does not satisfy the SBT if at any time during the 'business continuity test period' it derives assessable income from:

•         a business of a kind that it did not carry on before the 'test time' (paragraph 165-210(2)(a)) or

•         a transaction of a kind that it had not entered into in the course of its business operations before the 'test time' (paragraph 165-210(2)(b)).

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 (TR 1999/9) sets out the Commissioner's view on the SBT.

Subsection 165-210(1) - same business test

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 taxpayer seeks to utilise the losses), with the business carried on immediately before the test time (i.e. the continuity of ownership test (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 goes on to explain that the word 'same' in the phrase 'same business as' imports identity and must be read as referring to the identical business.

Paragraph 30 of TR 1999/9 states:

30. For a company to satisfy the same business test, the company must be able to show that it carried on at all times during the period of recoupment the same business as the business that the company carried on at the change-over.

Paragraph 31 of TR 1999/9 goes on to say:

31. Avondale Motors, a judgment of Gibbs J sitting as a single justice of the High Court, is the leading authority on the application of section 80E of the ITAA 1936. In Avondale Motors, Gibbs J held that the reference to 'same business' in section 80E required that the taxpayer carry on the 'identical business' at all times during the period of recoupment rather than a business of the same kind or of a similar kind. Gibbs J said:

'The meaning of the phrase "same as", like that of any other ambiguous expression, depends on the context in which it appears. In my opinion in the context of the section the words "same as" import identity and not merely similarity and this is so even though the legislature might have expressed the same meaning by a different form of words. It seems to me natural to read the section as referring to the same business, in the sense of the identical business, and this view is supported by a consideration of the purposes of the section...'

The guidelines provided in subparagraph 60(c) of TR 1999/9 note that:

There is a distinction between a change of business and a 'mere change in the process by which [the business] is carried on' (see Avondale Motors and Case Y45; AAT Case, 272). The second kind of change does not, of itself, result in a taxpayer not satisfying the same business test. However, when a change in the taxpayer's business operations or processes affects the identification of the taxpayer's business by going beyond a mere change in the way in which the business is carried on, it is likely to result in a change in the business itself, e.g. Gordon & Blair Ltd v IRC.

Subparagraph 60(d) of TR 1999/9 stipulates that:

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.

Subparagraph 61(d) of TR 1999/9 notes that:

Changes in the persons to whom the taxpayer sells the widget (for example, different industrialists or wholesalers). The market for a company's products or services is an important indicator of whether the business is the same, and should be examined carefully. Consequently, it is relevant to look at the persons to whom the product is sold or the service is provided. In the case of a company with just one customer, or a very few customers, a change in the identity of that customer or those customers is often a matter of significance. Similarly, where the custom of a company is derived from a connection with another, perhaps associated, company, a sudden change in that custom following the severing of the connection often points to a change of business. On the other hand, the identity of the business of a manufacturer who sells to a multiplicity of customers in the same market, assuming the absence of any sudden or dramatic change, is unlikely to change merely on this account. Business considerations for the change in market would also be relevant.

Subparagraph 61(e) of TR 1999/9 continues that:

Changes in the mix of customers of the taxpayer (for example, selling only to wholesalers). Again, this may mean no more than a refocusing of attention on the most profitable segment of the taxpayer's market within what is obviously the same business. But, at the other extreme, the transformation of a retailer with an insignificant wholesale market into a wholesaler with an insignificant retail market, would have obvious significance for the same business test.

Subparagraphs 61(l) and (m) of TR 1999/9 provide that:

(l) Reductions or increases in the number of persons employed by the taxpayer or who are contracted by the taxpayer to perform services for the taxpayer, and changes in the nature of services performed by persons who are employed or contracted by the taxpayer. Once again, rationalisations of staff are to be expected with the conversion of a loss making company into a profitable operation, even where the same business is being carried on, but there are many changes of staff that point to a change of business. For example, the sacking of all staff usually means a business has ceased and, if new staff are recruited from the new owner, that may mean the taxpayer is acquiring its new owner's business. A huge increase in staff devoted to what previously was a minor activity may be the result of a change in business. Contracting out of staff, as in the case of outsourcing, may range from mere efficiency gains in the same business to a change in the kind of business being carried on.

(m) Changes in the directors and/or management of the taxpayer. This was a factor considered in Avondale Motors. Generally speaking, however, it has little significance as it is usually follows a change in ownership, regardless of what business is carried on, but its absence could point to a favourable answer to the question posed by the same business test.

On a weighing up of the facts and circumstances, the Commissioner formed the view that the identity of Entity A will not change as a result of the Entity A carrying out one or all the proposed transactions. The Commissioner accepts that the proposed transactions will not affect the identity of the business.

Paragraph 165-210(2)(a) - new business test

Paragraph 14 of TR 1999/9 states the new business test refers to 'business of a kind' that the company did not carry on prior to the change-over. The word 'business' imports a different meaning from its use in the same business test, being 'each kind of enterprise of undertaking comprised in the overall business carried on at the change-over and during the period of recoupment.' The new business test limits the type of undertaking or enterprise in which a company participates, to exclude those of a kind the company did not engage in before the change-over, so that it cannot retain the benefit of accumulated losses.

Paragraph 67 of TR 1999/9 notes however that the new business test (and new transactions test) allow a business to expand and develop provided the activities by which it produces its income remain of the same kind.

Paragraph 70 of TR 1999/9 recognises that the new business test is intended to limit the expansion available under it by preventing the taxpayer from adding to its operations a business, that is, an undertaking or enterprise, or a kind it had not carried on before the change-over.

Paragraph 71 of TR 1999/9 specifies the question is, first, whether the amalgamated business is the same business as the business carried on by the taxpayer immediately before the changeover and, second, whether the new undertaking was the same kind as the undertakings of that business. Under the first question, considerations such as the relative proportions of the undertakings (which could permit a company to pass the same business test, despite having commenced an undertaking of a novel kind or character). Under the second, the test inspects whether the same business, although expanded in scale and operations, includes business activities of a kind it did not carry on before the change. Doing so will generally cause the company to fail the same business test.

Paragraph 74 of TR 1999/9 highlights that whether a new business, in terms of a particular undertaking or enterprise, is different in kind from the company's old undertakings or enterprises is a question of fact. Characterising an undertaking or enterprise involves having regard to the undertaking or enterprise as a whole, because a new undertaking or enterprise when considered in context with the other business operations of the taxpayer may disclose a different character from the undertaking or enterprise considered as a whole.

The Commissioner accepts that Entity A will not derive assessable income from carrying on a business of a kind that it did not carry on immediately before the test time (i.e. the COT failure date). It is organically maximising its business and not changing the nature of its business that it carried on before its 100% acquisition.

Paragraph 165-210(2)(b) - new transactions test

Paragraph 15 of TR 1999/9 states the new transactions test purpose is to prevent the injection of income into a loss company that has otherwise met the same business and the new business tests. Paragraph 78 notes it extends not only to daily transactions involved in carrying on a business, but also to isolated and independent kinds of transactions. Paragraph 79 also notes that a company will fail the new transactions test if it derives income during the recoupment period from a transaction of a different kind from the transactions the company had entered into in the course of the business carried on by the company at the change-over, even if the first-mentioned transaction is a transaction ordinarily involved in carrying on the business of the taxpayer during the recoupment period.

Paragraph 81 of TR 1999/9 goes on to state that a purposive approach to the new transactions test would regard it as applying to all transactions entered into the course of the company's business operations and not merely those that are 'isolated' or independent'. But transactions that would have been entered into in the course of business operations before the change-over consistently with its ordinary course, are usually transactions of the same kind as those that actually had been entered into.

Transaction:

Paragraph 82 of TR 1999/9 notes that the meaning of the word 'transaction' is broad and depends upon its context. In the context of paragraph 165-210(2)(b) 'transaction' refers to every means or event by which a taxpayer derives income. Therefore, the new transactions test ensures that a company deducts losses from income from transactions of the same kind as the operations by which it generated income before the change-over.

Entered into:

Paragraph 83 of TR 1999/9 goes on to say that the expression 'entered into' is also broad in meaning, however its function is to indicate the connection between the kind of transaction and the course of business operations before the change-over.

Business operations:

At paragraph 85 of TR 1999/9, the expression 'business operations' refers to everything that a company undertakes or performs or does in the course of the business, which is the same business, that is, the overall business of the company.

Of a kind:

Paragraph 86 of TR 1999/9 holds that the content of the word 'kind' in the new transactions test is to be derived from the course of the taxpayer's business operations before the change-over. Paragraph 86 holds that generally speaking; the new transactions test will not be failed where the transaction could have been entered into ordinarily and naturally in the course of the company's business operations before the change-over. The opposite will be held where the relevant transaction is extraordinary or unnatural in comparison to transactions entered into in the course of business operations before the change-over.

This is elaborated upon at paragraph 87 of TR 1999/9, which notes that transactions that could naturally have been entered into the course of the taxpayer's business operations before the change-over, had they been available, and which do not have the effect of changing the ordinary course or character of the taxpayer's operations, generally produce income from transactions of the same kind as those that were actually engaged in before the changeover.

The Commissioner accepts that the proposed transaction is considered a business or transaction 'of a kind' that it carried on immediately before the test time. Accordingly, Entity A will continue to derive revenue from the same business activities from the same customer base in the business continuity test period as the previous income year.