Edited version of private advice

Authorisation Number: 1052195976382

Date of advice: 9 February 2024

Ruling

Subject: Carry forward company losses

Question 1

Will Company be entitled to deduct the carried forward taxation losses against its other assessable income because it satisfies the continuity of ownership test (COT) under section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

If Company were to fail COT, would Company satisfy the business continuity test under section 165-13, section 165-210 of the ITAA 1997 (the same business test (SBT)) or section 165-211 of the ITAA 1997 (the similar business test (SBiT), such that it can deduct tax losses?

Answer

Yes.

This ruling applies for the following period:

30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

Company was registered on XX XX 20XX. Following the construction of the complex, Company commenced trading in the year ended 30 June 20XX.

The Company's principal activity since registration to date is the operation of a Business Activity in the xxx xxx in xxxx. This operation has been expanded since registration to include another activity, Activity 1.

Activity 1

•         commenced in XX 20XX.

•         customers are the General public.

•         Activity 1 and the other Business Activity operate within the same industry.

General

All the above operations are conducted within the same legal entity (Company) and managed by Company's General Manager. For internal reporting purposes, the activities are divisionalised and separately reported.

Company has registered the Trade Marks "XX XX" and "XX XX".

All activities are start-ups as opposed to purchasing established enterprises.

All funds for the operation were provided by family members and related entities.

No advertising agent is used.

All activities use the same/shared administration resources - all activities are under the control of the Company general manager and accounted for by the Company's bookkeeper from an administration office.

Neither XX as Trustee for the XX Trust (XX XX Trust) or XX as Trustee for the XX Trust (XX XX Trust) have made distributions of income or capital in the six earlier income years.

For each of the income years there have been:

a. no changes to the trustees of the trusts.

b. no changes to the appointer or guardian of the trusts.

c. no changes to the shareholders or directors of the corporate trustee.

d. no new beneficiaries appointed.

e. no amendment to either of the trust deeds.

f. no changes to the trusts.

The income injection test

For any income year there is no person not relevantly connected with the trusts (an outsider to the trust) that directly or indirectly provided a benefit to the trustees or a beneficiary (or an associate of either).

The trustee or a beneficiary (or an associate of either) has not directly or indirectly provided a benefit to the outsider to the trusts (or an associate of the outsider to the trusts).

There is no scheme under which all the following things happen (in any order):

•         the trusts have derived assessable income ('scheme assessable income').

•         a person not relevantly connected with the trusts (an outsider to the trusts) has directly or indirectly provided a benefit to the trustee or a beneficiary (or an associate of either) of the trusts.

•         the trustees or a beneficiary (or an associate of either) have directly or indirectly provided a benefit to the outsider to the trusts (or an associate of the outsider to the trust).

Current structure

XX Trust and XX Trust each own a 50% interest in Company.

Proposed restructure

a)    A new company will be incorporated, NewCo. NewCo will have no assets or liabilities (other than capital of $2) at the date of NewCo's interposition.

b)    NewCo will be interposed between Company and Company's shareholders

Company

There have been no changes to the shareholding of Company since the initial registration of the Company. No changes are proposed or are likely in the foreseeable future.

As at 30 June 20XX Company has tax losses of $XX.

The revenue from the Business Activity in the years since opening were as follows:

•         Year ended 30 June 20XX $XX

•         Year ended 30 June 20XX $XX

•         Year ended 30 June 20XX $XX

Relevant legislative provisions

Income Tax Assessment Act 1997 section 36-17

Income Tax Assessment Act 1997 section 36-25

Income Tax Assessment Act 1997 Subdivision 165-A

Income Tax Assessment Act 1997 section 165-10

Income Tax Assessment Act 1997 section 165-12

Income Tax Assessment Act 1997 subsection 165-12(1)

Income Tax Assessment Act 1997 subsections 165-12(2)

Income Tax Assessment Act 1997 subsection 165-12(3)

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

Income Tax Assessment Act 1997 subsection 165-12(5)

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

Income Tax Assessment Act 1997 section 165-13

Income Tax Assessment Act 1997 subsection 165-13(2)

Income Tax Assessment Act 1997 subsection 165-13(2)

Income Tax Assessment Act 1997 subsections 165-150(1)

Income Tax Assessment Act 1997 subsection 165-155(1)

Income Tax Assessment Act 1997 subsection 165-160(1)

Income Tax Assessment Act 1997 section 165-207

Income Tax Assessment Act 1997 Subdivision 165-E

Income Tax Assessment Act 1997 section 165-210

Income Tax Assessment Act 1997 subsection 165-210(1)

Income Tax Assessment Act 1997 subsection 165-210(2)

Income Tax Assessment Act 1997 paragraph 165-210(2)(a)

Income Tax Assessment Act 1997 paragraph 165-210(2)(b)

Income Tax Assessment Act 1997 subsection 165-210(3)

Income Tax Assessment Act 1997 section 165-211

Income Tax Assessment Act 1997 subsection 165-215(1)

Income Tax Assessment Act 1997 subsection 165-215(2)

Income Tax Assessment Act 1997 subsection 165-215(3)

Income Tax Assessment Act 1997 subsection 165-215(4)

Income Tax Assessment Act 1997 subsection 165-215(5)

Income Tax Assessment Act 1997 section 165-245

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1936 section 267-20 in Schedule 2F

Income Tax Assessment Act 1936 subsection 267-30(1) in Schedule 2F

Income Tax Assessment Act 1936 subsection 267-30(2) in Schedule 2F

Income Tax Assessment Act 1936 section 267-35 in Schedule 2F

Income Tax Assessment Act 1936 subsection 267-40(2) in Schedule 2F

Income Tax Assessment Act 1936 section 267-45 in Schedule 2F

Income Tax Assessment Act 1936 section 269-50 in Schedule 2F

Income Tax Assessment Act 1936 section 269-50(1) in Schedule 2F

Income Tax Assessment Act 1936 section 269-50(2) in Schedule 2F

Income Tax Assessment Act 1936 subsection 269-95(5) in Schedule 2F

Income Tax Assessment Act 1936 section 269-50 in Schedule 2F

Income Tax Assessment Act 1936 section 269-60 in Schedule 2F

Income Tax Assessment Act 1936 subsection 269-65(1) in Schedule 2F

Income Tax Assessment Act 1936 subsection 269-65(3) in Schedule 2F

Income Tax Assessment Act 1936 section 269-70 in Schedule 2F

Income Tax Assessment Act 1936 section 272-75 in Schedule 2F

Income Tax Assessment Act 1936 subsection 272-5(1) in Schedule 2F

Income Tax Assessment Act 1936 section269-95 in Schedule 2F

Income Tax Assessment Act 1936 paragraph 269-95(d) in Schedule 2F

Income Tax Assessment Act 1936 section 318

Question 1

Summary

Company is entitled to deduct the carried forward taxation losses against its other assessable income because it will satisfy the COT under section 165-12 of ITAA 1997.

Detailed reasoning

A company is entitled to claim a deduction for an undeducted tax loss of the loss year, subject to certain conditions, against its assessable income in a subsequent income year under section 36-17 of the ITAA 1997.

In section 36-25 of the ITAA 1997, a special rule in Item 2 concerning tax losses of companies provides that a company must satisfy conditions in Subdivision 165-A of the ITAA 1997 in order to deduct a tax loss.

Subdivision 165-A of the ITAA 1997 provides the rules around deductibility of tax losses of earlier income years.

Section 165-10 of the ITAA 1997 provides that a company cannot deduct a tax loss unless either:

(a) it meets the conditions in section 165-12 (which is about the company maintaining the same owners) (COT); or

(b) it meets the condition in section 165-13 (which is about the company satisfying the business continuity test).

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 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 (subsection 165-12(1) of the ITAA 1997).

Primary test

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

Subsection 165-12(5) of the ITAA 1997 provides that 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.

These 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, as a result of XX Trust and XX Trust, being non fixed or discretionary trusts, each owning a 50% interest in Company the primary test applies because no companies can be traced to have fixed interest or beneficial ownership of Company's shares during the ownership test period.

Accordingly, the primary tests in subsections 165-150(1), 165-155(1) and 165-160(1) of the ITAA 1997 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) the Company's 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 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 a family trust election (FTE) in respect of the trust is in force (see sections 995-1 of the ITAA 1997 and section 272-75 of Schedule 2F of the ITAA 1936).

In this case no FTE is in force for the discretionary trusts. Therefore, for the reasons outlined above in relation to tracing through discretionary trusts the requirements of subsections 165-150(1), 165-155(1) and 165-160(1) of the ITAA 1997 have not been met and consequently the COT in section 165-12 of the ITAA 1997 is not passed in respect of the ownership test period for each of the loss years.

However, even if a company does not meet the conditions in section 165-12, it may nevertheless be taken to meet those conditions if it meets the relevant conditions set out in Subdivision 165-F of the ITAA of the 1997 - subsection 165-215(2) to subsection 165-215(5) of the ITAA 1997:

SECTION 165-215 Special alternative to change of ownership test for Subdivision 165-A

165-215(1) If a company does not meet the conditions in section 165-12, it is nevertheless taken to meet the conditions if it meets the conditions in this section.

First condition

165-215(2) At all times during the *ownership test period:

(a) both:

(i) persons must have held *fixed entitlements to all of the income and capital of the company; and

(ii) *non-fixed trusts, other than *family trusts, must have held fixed entitlements to a 50% or greater share of the income or a 50% or greater share of the capital of the company; or

(b) both:

(i) a *fixed trust or a company (which trust or company is the holding entity) must have held, directly or indirectly, fixed entitlements to all of the income and capital of the company; and

(ii) non-fixed trusts, other than *family trusts, must have held fixed entitlements to a 50% or greater share of the income or a 50% or greater share of the capital of the holding entity.

Second condition

165-215(3) The persons holding *fixed entitlements to shares of the income, and the persons holding fixed entitlements to shares of the capital, of:

(a) in a paragraph (2)(a) case - the company; or

(b) in a paragraph (2)(b) case - the holding entity;

at the beginning of the *loss year must have held those entitlements to those shares at all times during the *ownership test period.

Third condition

165-215(4) At the beginning of the *loss year:

(a) individuals must not have had (between them), directly or indirectly, and for their own benefit, *fixed entitlements to a greater than 50% share of the income of the company; or

(b) individuals must not have had (between them), directly or indirectly, and for their own benefit, fixed entitlements to a greater than 50% share of the capital of the company.

Fourth condition

165-215(5) It must be the case that, for each *non-fixed trust (other than an *excepted trust) that, at any time during the *ownership test period, held directly or indirectly a *fixed entitlement to a share of the income or capital of the company, section 267-20 in Schedule 2F to the Income Tax Assessment Act 1936 would not have prevented the non-fixed trust from deducting the *tax loss concerned if it, rather than the company, had incurred the tax loss.

Note:

See section 165-245 for when an entity is taken to have held or had, directly or indirectly, a fixed entitlement to a share of income or capital of a company.

Section 165-245 of the ITAA 1997 provides:

165-245 When an entity has a fixed entitlement to income or capital of a company

For the purposes of this Act, an entity is taken to have held or had, directly or indirectly, a *fixed entitlement to a share of income or capital of a company at a time if and only if the entity held or had, directly or indirectly, that fixed entitlement at that time for the purposes of Schedule 2F to the Income Tax Assessment Act 1936.

Fixed Entitlement

The definition of the term 'fixed entitlement' in subsection 995-1(1) of the ITAA 1997 relevantly provides that:

an entity has a fixed entitlement to a share of the income or capital of a trust if the entity has a fixed entitlement to that share within the meaning of Division 272 in Schedule 2F to the ITAA 1936.

Subsection 272-5(1) of Schedule 2F to the ITAA 1936 provides that 'if under a trust instrument, a beneficiary has a vested and indefeasible interest in a share of income of the trust that the trust derives from time to time, or of the capital of the trust, the beneficiary has a fixed entitlement to that share of the income or capital'.

The word 'interest' is a word that is capable of many meanings. In the absence of a definition, one must infer its meaning from the context in which it is found (Gartside v Inland Revenue Commissioner [1968] AC 553 at 602-603 and 617-618; Commissioner of Stamp Duties (Queensland) v Livingston (1964) 112 CLR 12 at 28-29; and CPT Custodian Pty Ltd v Commissioner of State Revenue (Vic) (2005) 224 CLR 98). There may be circumstances in which the word 'interest' could be interpreted broadly to include any right or advantage that a person might be able to claim with respect to the income or capital of the trust and/or in respect of the trustee, whether present or future, ascertained or potential.

In the context of Schedule 2F to the ITAA 1936, however, it is clear that for an interest to be recognised as a 'fixed interest' it must be a right with respect to a share of the income or of the capital of the trust that is susceptible to measurement. To adopt the words of Lord Wilberforce in Gartside v Inland Revenue Commissioners, the right must have 'the necessary quality of definable extent'.

The term 'vested and indefeasible' is not defined in the taxation legislation. The Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997does discuss its ordinary meaning, at paragraphs 13.4 to 13.6.

In the context of Schedule 2F to the ITAA 1936, the meaning of the term 'vested and indefeasible' has not been judicially considered, other than a discussion in Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 in the limited context of amending the constitution of a registered MIS under section 601GC of the Corporations Act 2001.

However, the term 'vested and indefeasible' does appear in subsection 95A(2) of the ITAA 1936 and has been considered in that context by the courts - refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4525; Walsh Bay Developments Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4378; Dwight v Commissioner of Taxation (1992) 92 ATC 4192; Harmer v FC of T (1991) 173 CLR 264; 91 ATC 5000.

Also relevant are MSP Nominees Pty Ltd v Commissioner of Stamps (SA) (1999) 198 CLR 494; 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54 at 63; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490.

It is an essential element of subsection 272-5(1) of Schedule 2F to the ITAA 1936 that in order to have a 'fixed entitlement' to a share of income or capital there must be a 'vested and indefeasible interest' under a trust instrument.

The EM that accompanied the Taxation Laws Amendment Bill (No. 4) 1995 at paragraph 10.239 states:

What is a fixed entitlement to income or capital of a company?

10.239 A fixed entitlement in a company is defined for both income and capital.

10.240 A person has a fixed entitlement to income of a company if the person is the beneficial owner of shares in the company that carry any right to receive dividends that might be paid by the company. The extent of the entitlement is expressed as a percentage of the total dividends that might be paid by the company. [Subsection 271-10(1)]

10.241 A person has a fixed entitlement to capital of a company if the person is the beneficial owner of shares in the company that carry the right to receive any return of capital in the company to all shareholders (e.g. in the event of winding-up, or of a reduction in the capital, of the company). The extent of the entitlement is expressed as a percentage of the total capital that would be distributed. [Subsection 271-10(2)]

In this case:

Condition 1

Up until the income year in which the restructure takes place XX Trusts, non-fixed trusts, held 100% of the shares in Company, with the consequence that the trusts have entitlement to 100% of the income and capital of the company.

For the income year and subsequent to that income year in which the restructure takes place NewCo will hold entitlement to all the income and capital of Company. All the shares in NewCo will be held by XX Trusts which provides those entities with 100% of the income and capital of NewCo.

Condition 1 is satisfied for all years in which the losses were incurred.

Condition 2

The fixed entitlements to the income or capital of the company under condition 1(a) or holding entity under condition 1(b) held at the beginning of the loss year are held at all times by XX Trusts during the ownership test period.

Condition 2 is satisfied for all years in which the losses were incurred.

Condition 3

The third condition in subsection 165-215(4) requires that at the start of the loss year, individuals must not have had between them (directly or indirectly) for their own benefit, fixed entitlements to more than 50% of the income or capital of the company.

No individuals have directly or indirectly more than 50% of the fixed entitlements to income or capital as no individual has a 'vested and indefeasible interest' under a trust instrument/s.

Condition 3 is satisfied for all years in which the losses were incurred.

Condition 4

Whether section 267-20 in Schedule 2F to the ITAA 1936 notionally prevents the non-fixed trust from deducting the *tax loss:

SECTION 267-20 NON-FIXED TRUST MAY BE DENIED TAX LOSS DEDUCTION

Type of trust to which this Subdivision applies

267-20(1)

This section applies to a trust that:

(a) can deduct in the income year a tax loss from a loss year; and

(b) was a non-fixed trust at any time in the period (the test period ) from the beginning of the loss year until the end of the income year; and

(c) was not an excepted trust at all times in the test period.

...

Conditions for deducting tax loss

267-20(2)

The trust cannot deduct the tax loss unless it meets:

•         the condition in subsection 267-30(2) (if applicable); and

•         the condition in section 267-35; and

•         the condition in subsection 267-40(2) (if applicable); and

•         the condition in section 267-45.

In this case the trusts are non-fixed trusts and are not excepted trusts in respect to the losses in each of the relevant income years, the four conditions in Subdivision 267 of Schedule 2F of the ITAA 1936 must be met if Company is to deduct, in a future year ('the income year') tax losses incurred in preceding income years.

Condition 1: Subsection 267-30(2) in Schedule 2F of the ITAA 1936

Subsection 267-30(1) states:

... the trust must meet the condition in subsection (2) if either or both of the following happened:

(a) the trust distributed income:

(i) in the income year or within 2 months after its end; and

(ii) in at least one of the 6 earlier income years; or

(b) the trust distributed capital:

(i) in the income year or within 2 months after its end; and

(ii) in at least one of the 6 earlier income years.

The condition in subsection 267-30(2)in Schedule 2F of the ITAA 1936 is the trust must pass the pattern of distributions test for the income year.

In summary, the pattern of distributions test essentially examines the pattern of income and capital distributions of the trust over a period to determine whether there has been an effective change in those who benefit under the trust.

The pattern of distributions test is contained in Subdivision 269-D in Schedule 2F of the ITAA 1936, where section 269-60 in Schedule 2F of the ITAA 1936 states a trust passes the pattern of distributions test for an income year if, before the end of 2 months after the end of the income year:

(a) the trust distributed directly or indirectly to the same individuals, for their own benefit, a greater than 50% share of all test year distributions of income (see subsection 269-65(1)); and

(b) the trust distributed directly or indirectly to the same individuals (who may be different from those in paragraph (a)), for their own benefit, a greater than 50% share of all test year distributions of capital (see subsection 269-65(3)).

Subsection 269-65(1) in Schedule 2F of the ITAA 1936 states a test year distribution of income is the total of all distributions of income made by the trust in any of the following periods, provided the period does not begin more than 6 years before the beginning of the income year:

(a) the period from the beginning of the income year until 2 months after its end;

(b) if the trust distributed income before the trigger year (see subsection (2)) - the income year, before the trigger year, that is closest to the trigger year;

(c) if paragraph (b) does not apply and the trust distributed income in the trigger year - the trigger year;

(d) if neither paragraph (b) nor paragraph (c) applies - the income year, closest to the trigger year, in which the trust distributed income;

(e) each intervening income year (if any) between the one in paragraph (a) and the one in paragraph (b), (c) or (d).

For tax loss deductions, the trigger year is the relevant earliest loss year to be recouped. For debt deductions, the trigger year is the year (beginning on the day the debt was incurred) in which the relevant bad debt to be recouped was incurred.

Subsection 269-65(3) in Schedule 2F of the ITAA 1936 states that subsection (1) applies in the same way to distributions of capital made by the trust, to determine what is a test year distribution of capital.

Importantly, section 269-70 in Schedule 2F of the ITAA 1936 states, for the purposes of section 269-60 in Schedule 2F of the ITAA 1936, if the trust does not distribute to an individual the same percentage of income or capital for every test year distribution, the trust is taken to have distributed to the individual, for every test year distribution, the smallest percentage that it distributed to the individual for any of the test year distributions.

The following is an example (from the Explanatory Memorandum to the Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998) of how the test and the smallest percentage are used:

Year 7 is the current income year. A trust has a loss incurred in Year 6. The trust has made one distribution of income for Years 1, 2, 3 and 4 and two distributions for Year 7. No distributions of capital have been made for Year 7. This means it is not possible to apply the test for any distributions of capital by the trust.

In accordance with the test discussed...the end year is Year 7 (i.e. the current income year) and the start year is Year 4. Year 4 is the start year because it has a distribution made before the loss year that is closest to that loss year. To work out the test year distribution for each year, each distribution of income for the year made to any person is totalled. The percentage of the total distributed to each individual is that individual's share of the test year distribution.

The test year distributions made by the trust are as set out in Table...

Table 1: The test year distributions made by the trust are set out as such:

In this example, the trust does not satisfy the pattern of distributions condition. This is because only 30% of each test year distribution has been distributed to the same individuals, having regard to the fact that each individual is taken to have received the smallest percentage for each test year distribution. In essence, if the total worked out by adding the smallest percentage of each individual is more than 50%, the test is passed (in the above example, the smallest percentages are those in the far right column).

In this case, the condition in subsection 267-30(2) in Schedule 2F of the ITAA 1936 is not applicable since the trusts have not distributed income or capital for the relevant period.

In ATO ID 2003/174 (Withdrawn), the Commissioner stated that if a trust only has a distribution in the recoupment year but not in any earlier year, that the pattern of distributions test does not apply (Interpretative Decision ID 2003/174which has been withdrawn on the basis that it is a straight application of the law).

Condition 2: Section 267-35 in Schedule 2F of the ITAA 1936: Previously failed subsection 267-30(2)

To be allowed to deduct a prior year loss in a current income year, section 267-35 in Schedule 2F of the ITAA 1936 states the trust must not have been prevented from deducting the tax loss in an earlier income year because of a failure to meet the condition in subsection 267-30(2) in Schedule 2F of the ITAA 1936.

In this case, as the trusts have not been prevented from deducting the tax loss in an earlier income year because of a failure to meet the condition in subsection 267-30(2) in Schedule 2F of the ITAA 1936, this condition is satisfied.

The condition in subsection 267-40(2) in Schedule 2F of the ITAA 1936

In subsection 267-40(2) in Schedule 2F of the ITAA 1936:

The condition is that, during the period beginning at the test time and finishing at the end of the test period, the same individuals (who must be some or all of the threshold group) must have had more than a 50% stake in the income or the capital, respectively, of the trust.

The meaning of a 50% stake is explained in section 269-50 in Schedule 2F of the ITAA 1936 as follows:

More than a 50% stake in income

269-50(1) If there are individuals who have (between them), directly or indirectly, and for their own benefit, fixed entitlements to a greater than 50% share of the income of a trust, those individuals have more than a 50% stake in the income of the trust.

More than a 50% stake in capital

269-55(2) If there are individuals who have (between them), directly or indirectly, and for their own benefit, fixed entitlements to a greater than 50% share of the capital of the trust, those individuals have more than a 50% stake in the capital of the trust.

In this case, the condition in subsection 267-40(2) is not applicable since the trusts do not have any beneficiaries with fixed entitlements.

Condition in section 267-45 in Schedule 2F of the ITAA 1936

The condition in section 267-45 in Schedule 2F of the ITAA 1936 is a group must not, during the test period, begin to control the trust, directly or indirectly.

In summary, the control test must be passed for all non-fixed trusts in order to claim a deduction for a prior year or current year loss or debt deduction. This is in contrast to the pattern of distributions test and 50% stake test, which only need to be applied if certain conditions are met.

The control test essentially measures whether a group began to control the trust, either directly or indirectly during the test period. A group is taken to be a person and/or their associates.

Subsection 269-95(5) in Schedule 2F of the ITAA 1936 defines 'a group' as: (a) a person; or (b) a person and one or more associates; or (c) 2 or more associates of a person.

Section 318 of the ITAA 1936 includes as associates of an entity ('the primary entity') that is a natural person (otherwise than in the capacity of trustee) a relative of the primary entity.

For example, Trust B has a tax loss in the 2007-08 income year which it seeks to deduct in the 2008-09 income year. At the start of the 2007-08 income year the trustee of Trust B is AusCo. During the 2008-09 income year the trustee of Trust B changes to SubCo (a 100% owned subsidiary of AusCo). The directors of AusCo and SubCo are the same. In this case, even though there is a change in the corporate trustee, there is no change in the control of Trust B as the individuals who make the decisions have not changed.

Section 269-95 in Schedule 2F of the ITAA 1936 explains a group (see subsection (5)) controls a non-fixed trust if:

(a) the group has the power, by means of the exercise of a power of appointment or revocation or otherwise, to obtain beneficial enjoyment (directly or indirectly) of the capital or income of the trust; or

(b) the group is able (directly or indirectly) to control the application of the capital or income of the trust; or

(c) the group is capable, under a scheme, of gaining the beneficial enjoyment in paragraph (a) or the control in paragraph (b); or

(d) the trustee is accustomed, under an obligation or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the group; or

(e) the group is able to remove or appoint the trustee; or

(f) the group acquires more than a 50% stake in the income or capital of the trust.

For example, Trust A has a tax loss in the 20XX-XX income year which it seeks to deduct in the 2008-09 income year. At the start of the 20XX-XX income year Trust A is a non-fixed trust. During the 2008-09 income year, under an arrangement between the original settlor of the trust and a group, 60% of the income of the trust becomes the subject of a fixed entitlement held by the group. Here, the group begins to control the trust in the test period and the control test is not satisfied. The prior year loss is not deductible.

In this case, a group will not, during the test period, begin to control the trusts directly or indirectly as there is no change to the original controlling group, namely, the family.

As stated in paragraph 269-95(d) in Schedule 2F of the ITAA 1936, a trustee per se does not control a trust but, instead, the group that controls the trustee controls the trust.

In short, the trusts will meet the condition in section 267-45 in Schedule 2F of the ITAA 1936 because the trusts will continue to be controlled by the same group, namely, members or associates of the family.

Conclusion

As previously stated, the control test must be passed for all non-fixed trusts in order to claim a deduction for a prior year or current year loss or debt deduction. This is in contrast to the pattern of distributions test and 50% stake test, which only need to be applied if certain conditions are met.

In this case, as long as the controller of the trusts remain the same, Company will be able to deduct prior year tax losses.

Question 2

Summary

If Company were to fail COT, Company will satisfy the business continuity test under section 165-13, section 165-210 of the ITAA 1997 (the same business test (SBT)) or section 165-211 of the ITAA 1997 (the similar business test (SBiT), such that it can deduct tax losses.

Detailed reasoning

The Business Continuity Test

A company can satisfy the Business Continuity Test by satisfying one of two 'limbs' being:

• carrying on the same business under the test in section 165-210 of the ITAA 1997 (SBT) or
• carrying on a similar business under the test in section 165-211 of the ITAA 1997 (SiBT).

The same business test

Section 165-210 of the ITAA 1997 states:

The business continuity test--carrying on the same business

(1) A company satisfies the business continuity test if throughout the *business continuity test period it carries on the same *business as it carried on immediately before the *test time.

(2) However, the company does not satisfy the *business continuity test under this section if, at any time during the *business continuity test period, it *derives assessable income from:

(a) a *business of a kind that it did not carry on before the *test time; or

(b) a transaction of a kind that it had not entered into in the course of its business operations before the *test time.

(3) The company also does not satisfy the *business continuity test under this section if, before the *test time, it:

(a) started to carry on a *business it had not previously carried on; or

(b) in the course of its business operations, entered into a transaction of a kind that it had not previously entered into;

and did so for the purpose, or for purposes including the purpose, of being taken to have carried on throughout the *business continuity test period the same business as it carried on immediately before the test time.

Business Continuity Test Period and the Test Time

To apply the business continuity test, including the SBT, the business continuity test period and the test time need to be established. Section 165-13 of the ITAA 1997 defines the business continuity test period and the test time.

Subsection 165-13(2) of the ITAA 1997 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 any of the income years for which the ruling applies (or claim income year).

The Test Time is determined by the table provided by subsection 165-13(2) of the ITAA 1997. 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) of the ITAA 1997 (regarding the company maintaining the same owners). Whilst in this case BBC was able to show that subsections 165-12(2), (3) and (4) of the ITAA 1997 were met for the relevant period the following is provided for completeness were Company not to meet the requirements for the same owner test.

Item 2 provides that if it is not practicable for the company to show that it has maintained the same owners for any period since the start of the loss year.

Item 3 provides that if it is not practicable for the company to show that it has maintained the same owners for any period since the company came into existence in the loss year, being the first year of operation of Company, the test time is the end of the loss year.

The Explanatory Memorandum to Taxation Laws Amendment Bill (No. 5) 2003 provides some guidance about what 'practicable' means for the purpose of section 165-13 of the ITAA 1997:

When is it not practicable for a company to show that it fails the COT?

4.17 Impracticability may arise where the necessary information on the beneficial ownership of shares does not exist or where the information cannot reasonably be obtained.

4.18 Also, a company may be able to identify the beneficial owners of its shares such that it may know that it has not satisfied the COT as between, say, the beginning of the loss year and the end of the income year. However, it may be impracticable to point to the time it actually failed the test.

To satisfy the SBT in section 165-210 of the ITAA 1997, the taxpayer must be able to satisfy the following sub-tests:

• The Same Business Test (a positive test) - the company must carry on the same business during the Business Continuity Test Period that it carried on immediately before the Test Time (subsection 165-210(1) of the ITAA 1997)
• The New Business Test (a negative 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) of the ITAA 1997)
• The New Transactions Test (a negative 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) of the ITAA 1997), and
• The Anti-Avoidance Test - the company did not commence certain business activities before the Test Time for the purpose of satisfying the SBT (subsection 165-210(3) of the ITAA 1997).

The first three of the above sub-tests form a descending hierarchy that first tests the business of the company as an entirety (its 'overall business'), then the component undertakings or enterprises, if any, of that business and, finally, the individual transactions by which the business is carried on.

The Commissioner's views concerning the application of the SBT and each of the sub-tests 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 (TR 1999/9).

Paragraphs 59 and 60 of TR 1999/9 set out the relevant considerations:

Whether the same business is being carried on is a question of fact and degree. Significant weight is given to changes after the change-over in the income producing product or service of the taxpayer, how it is produced, acquired or provided and/or changes in the market for that product or service. But even these are a question of fact and degree often to be decided in the context where some expansion or contraction would be expected.

The following factors are relevant in determining whether a taxpayer has satisfied the same business test:

(a) Identifying the business carried on by the taxpayer at the change-over involves identifying with specificity the actual business activities carried on and transactions entered into by the taxpayer at the change-over.

(b) The business carried on by the taxpayer is not characterised by reference to business activities or transactions that the taxpayer intended to carry on or enter into before the change-over, or that the taxpayer had power or expressed the intent to carry on or enter into under its constituent documents before the change-over, if the evidence discloses the taxpayer did no, in fact, carry on those activities or enter into those transactions at or before the change-over.

(c) There is a distinction between a change of business and a 'mere change in the process by which [the business] is carried on'. A change in the taxpayer's business operations or processes that 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.

(d) 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. 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.

(e) The discontinuance during the period of recoupment, whether by way of cessation or sale, of a significant part of the business that was carried on by the taxpayer at the change-over, is likely to result in the company failing to satisfy the same business test.

(f) The commencement or acquisition, by merger or otherwise, of new undertakings (including going concerns and similar or complementary undertakings) may cause a company to fail the same business test, e.g., if the result is to alter the character of the overall business.

(g) Other factors relevant to the issue of whether the same business is being carried on after the change-over include the name of the taxpayer, the location of the business, the existence of a period or periods of dormancy, and the circumstances accounting for the inactivity and in which activity is resumed, the extent to which there is continuity of, or change in, custom and goodwill.

(h) Where the taxpayer's activities have wound down to the extent that justifies a finding of fact that the taxpayer had ceased to carry on a business, either at the change-over or before or during the period of recoupment, the taxpayer does not satisfy the same business test.

(i) Whilst the business carried on by one company in a commonly owned or controlled corporate group is not characterised by reference to the business of the group as a whole, changes in the businesses or identities of other companies in the group may result in a change of business.

The similar business test

Section 165-211 of the ITAA 1997 sets out the similar business test, with subsection 165-211(2) of the ITAA 1997 providing the following factors that must be taken into account in ascertaining whether the company's current business is similar to its former business:

(a) the extent to which the assets (including goodwill) that are used in its current business to generate assessable income throughout the business continuity test period were also used in its former business to generate assessable income;

(b) the extent to which the activities and operations from which its current business generated assessable income throughout the business continuity test period were also the activities and operations from which its former business generated assessable income;

(c) the identity of its current business and the identity of its former business;

(d) the extent to which any changes to its former business result from development or commercialisation of assets, products, processes, services or marketing or organisational methods of the former business.

The Commissioner's views on the similar business test are discussed in Law Companion Ruling LCR 2019/1 The business continuity test - carrying on a similar business.

Paragraph 7 of LCR 2019/1 provides that

... the overall business must satisfy the similar business test. The meaning of 'similar' depends on the context in which the term arises. In the context of the similar business test, 'similar' does not mean similar 'kind' or 'type' of business. The focus remains on the identity of a business, as well as continuity of business activities and use of assets to generate assessable income. Accordingly, it will be more difficult to satisfy the similar business test if substantial new business activities and transactions do not evolve from, and complement, the business carried on before the test time. In contrast, where a company develops a new product or function from the business activities already carried on, and this development opens up a new business opportunity or allows the company to fill an existing gap in the market, the business as a whole is likely to satisfy the similar business test.

Paragraphs 9 to 14 of LCR 2019/1 discuss four factors that must be considered, and these factors require a comparison between the essential characteristics of the business before and after the relevant change in ownership or control. The weight to be given to each factor depends on the facts and circumstances of each case. The first three factors are concerned with the aspects of the business that have continued, while the fourth factor assesses the nature of any changes that have happened. Where those changes are due to an evolution or development of the business, the business is more likely to be similar to that previously carried on.

The first factor considers the extent to which the assets used to generate assessable income throughout the business continuity test period were the assets used in the business carried on at the test time. Where the same assets of the business are being used as at the test time to generate assessable income, albeit that they may be producing a different result or effect due to the development or commercialisation of some of those assets, this factor would indicate that the business remains similar to that previously carried on.

The continuing use of certain business assets to generate assessable income rather than other assets may be more relevant to the question of whether the similar business test is passed. For example, goodwill, which is the combined result of using the business' tangible, intangible and human assets in such a way that attracts custom to the business, will be more relevant than other assets, such as generic office premises, equipment and stationery, because it is closely linked to the identity of a particular business. If the goodwill that was used throughout the business continuity test period is replaced by new goodwill, it will be necessary to consider the extent to which other assets of the business have continued to be used and the amount of weight that should be given to that in comparison to other factors.

The second factor compares the extent to which the current activities and operations from which assessable income is generated were also those from which assessable income was generated previously. Where the business operator maintains the income generating activities and operations that were previously being undertaken, despite doing them in a different or more efficient way due to business improvements, this factor would indicate that the business remains similar to that previously carried on.

The third factor compares the current identity of the business with that of the business carried on before the test time. Where new activities have not resulted in the identity of the business changing, this factor would indicate that the business remains relevantly similar to that previously carried on.

The fourth factor requires an assessment of the extent to which the changes to the business resulted from the development or commercialisation of assets, products, processes, services or marketing or organisational methods of the business. As the similar business test is designed to encourage businesses to innovate, such changes will not, in themselves, cause a business to be considered dissimilar. Where changes to the business do not result from such development or commercialisation, the business is less likely to satisfy the similar business test.

The test time and test period set out in section 165-213 of the ITAA 1997 (as explained above) also applies to the similar business test.

Application to your circumstances

In Company's case, the Commissioner considers that the same or similar business tests are satisfied based on the facts and circumstances provided.

Company's:

• tangible and intangible assets, including its head office, employees, and trade mark, are used to the same degree;
• core business activity, being the provision of hospitality, continues to generate assessable income to largely the same degree as there is very little change to the activities which generate assessable income;
• Activity 1 is a relatively insignificant part of the overall business; the overall identity of the business remains sufficiently similar.

The Commissioner considers that Company satisfies all requirements of the SBT in section 165-210 of the ITAA 1997, or the SBiT in section 165-211 of the ITAA 1997 and therefore satisfies the Business Continuity Test as provided by section 165-13 of the ITAA 1997.

Even if Company were not to pass the continuity of ownership test, Company would nevertheless satisfy the requirements of the Business Continuity Test and Company is able to deduct tax losses incurred in income years prior years for the relevant income year to the extent that its total assessable income exceeds its total deductions (except tax losses) for that year.