ATO ID 2006/152: Company losses: continuity of ownership test - inter-entity loss multiplication - whether appropriate to use the non-formula method
Date of decision: 5 June 2006
Year of income: Year ended 30 June 2006
Business line: Public Groups and International

Issue
Is it appropriate to use the non-formula method in subsection 165-115ZB(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to work out the adjustment amount under section 165-115ZA of the ITAA 1997 where one company (company H) acquires firstly a non-controlling interest, and then a controlling stake in a second company (the loss company), before the loss company is subsequently liquidated and the first company makes a net capital loss that reflects tax losses incurred by the loss company?

Decision
Yes. It is appropriate to use the non-formula method in subsection 165-115ZB(6) of the ITAA 1997 to work out the adjustment amount because the net capital loss that is made on liquidation of the loss company reflects the tax losses incurred by the loss company both before and after the time that the first company gained a controlling stake in the loss company.

Facts
Company H initially acquires an interest in a second company (loss company) that does not entitle company H to exercise either directly or indirectly, or control the exercise of, more than 50% of the voting power in loss company, or confer the right to receive either directly or indirectly more than 50% of the dividends or distributions of capital of loss company. Company H then acquires a controlling stake in loss company within section 165-115Z of the ITAA 1997. After company H obtains its controlling stake in loss company, a liquidator issues a notice pursuant to section 104-145 of the ITAA 1997 declaring that shares in loss company are worthless. Loss company is a loss company within section 165-115R of the ITAA 1997 at the time that the liquidator issues the notice under section 104-145 of the ITAA 1997. Company H makes a net capital loss on the liquidation of loss company. This net capital loss reflects the tax losses incurred by loss company over the first period when company H has an interest in loss company that is not a controlling stake (the first period) and over the second period when company H has a controlling stake in loss company (the second period).

Reasons for decision
Summary: Subsection 165-115ZB(6) of the ITAA 1997 provides that: The adjustment amount to be worked out under this subsection is the amount that is appropriate having regard to: (a) the object of this Subdivision and other matters set out in section 165-115J; and (b) the extent of the affected entity's relevant equity interests or relevant debt interests, as the case may be, in the *loss company immediately before the alteration time; and (c) when, and under what circumstances, the relevant equity interests or relevant debt interests were acquired by the affected entity; and (d) the loss company's overall loss at the alteration time; and (e) the extent to which that overall loss has reduced the market values of the equity or debt; and (f) to prevent double counting, the extent of any adjustments required under this Subdivision because of any application of this Subdivision to another loss company in which the affected entity has a relevant equity interest or relevant debt interest; The declaration by the liquidator under section 104-145 of the ITAA 1997 constitutes an alteration time by virtue of section 165-115N of the ITAA 1997. Company H has a relevant equity interest within section 165-115X of the ITAA 1997 in loss company immediately before the alteration time. As the net capital loss made by company H on liquidation of loss company reflects the tax losses incurred by loss company over both the first period and the second period, it is appropriate to work out the adjustment amount for the purposes of section 165-115ZA of the ITAA 1997 under the non-formula method in subsection 165-115ZB(6) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 104-145 section 165-115J section 165-115N section 165-115R section 165-115X section 165-115Z section 165-115ZA subsection 165-115ZB(6)
Subject references: Cost base adjustments Tax loss