ATO ID 2003/534: Deducting tax loss: saving rule - reduced capital gain made during ownership test period due to agreement involving payment of a contingent amount
Date of decision: 5 June 2003
Year of income: Year ended 30 June 2002
Business line: Public Groups and International

Issue
Is the happening of CGT event C2 under section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) resulting from the disposal of a direct equity interest in a loss company, to be taken into account in applying subsection 165-12(7) of the ITAA 1997 where the disposal agreement involved payment of a contingent and unascertainable amount?

Decision
No. The contractual right to receive that contingent amount was the relevant CGT asset involved in the happening of CGT event C2 under section 104-25 of the ITAA 1997, and not an equity interest in the loss company, as required by subsection 165-12(7) of the ITAA 1997.

Facts
Loss Company seeks to deduct in an income year (the income year) a tax loss that it had incurred in an earlier income year (the loss year). Company K disposed of shares (the shares) in Loss Company to Company R at the beginning of the loss year. The shares constituted a direct equity interest in Loss Company for the purposes of paragraph 165-12(9)(a) of the ITAA 1997. Loss Company failed the continuity of ownership test in section 165-12 of the ITAA 1997 as the conditions in subsections 165-12(2), (3) and (4) were not satisfied, only because of the operation of section 165-165 of the ITAA 1997. The disposal resulted in CGT event A1 happening and Company K made a capital loss under subsection 104-10(2) of the ITAA 1997. Pursuant to the contract for the disposal of the shares, Company R undertook to pay two amounts to Company K. The first amount was a fixed amount (the lump sum) that Company R immediately paid upon the execution of the contract. The second contracted amount was a contingent and then unascertainable amount (the contingent amount) that was potentially payable at a specified time (the specified time) and was made referable to the market value of shares in Loss Company as at the specified time. Under subsection 116-20(1) of the ITAA 1997, the capital proceeds in respect of CGT event A1 was the total of the lump sum and the then market value of the contingent amount. The contractual right to receive the contingent amount is property, and a CGT asset in the hands of Company K. The receipt of the contingent amount at the specified time resulted in CGT event C2 happening under section 104-25 of the ITAA 1997, during the relevant ownership test period. The lump sum and the resultant contingent amount in respect of CGT event C2 were less than they otherwise would have been because Loss Company had incurred the relevant tax loss that it now seeks to deduct.

Reasons for decision
Summary: Subsection 165-12(7) of the ITAA 1997 provides that where a condition in subsection 165-12(2), 165-12(3) or 165-12(4) is not satisfied because of the operation of section 165-165 of the ITAA 1997 that the condition can be taken as being satisfied where: the company has information from which it would be reasonable to conclude that less than 50% of the *tax loss has been reflected in deductions, capital losses or reduced assessable income, that occurred, or could occur in future, because of the happening of any *CGT event in relation to any *direct equity interests or *indirect equity interests in the company during the *ownership test period. *denotes a term defined in subsection 995-1(1) of the ITAA 1997. The relevant CGT asset involved in the CGT event C2 was not an equity interest in Loss Company, as required by subsection 165-12(7) of the ITAA 1997, but rather the contractual right to the contingent amount. Accordingly, the reduced gain that Company K made upon the happening of CGT event C2 is not taken into account in determining the extent that the tax loss has been reflected for the purposes of subsection 165-12(7) of the ITAA 1997. [HISTORY: This ATO ID has been amended to include the (*) asterisk when reference is made to subsection 165-12(7) of the ITAA 1997 that is a minor amendment to the provisions providing useful interpretation with reference to direct equity interests and indirect equity interests by making them defined terms under subsection 995-1(1) of the ITAA 1997. The amendment also removes from the ATO ID any reference to subsection 165-12(9) of the ITAA 1997 repealed by the Tax Laws Amendment (2007 Measures No 4) Act of 2007 with effect from 24 September 2007 and any reference to Taxation Ruling TR 93/15 withdrawn with effect from 17 October 2007.]

Legislative references: Income Tax Assessment Act 1997 subsection 104-10(2) section 104-25 section 116-20 section 165-12 subsection 165-12(2) subsection 165-12(3) subsection 165-12(4) subsection 165-12(7) section 165-165 subsection 995-1(1)
Subject references: Capital losses Company losses Continuity of ownership Saving rule