Private ruling: Consolidations - transfer of losses
Date of advice: 7 November 2016
Published: March 2017
Ruling period: Income year ended 30 June 20ZZ
Date scheme commenced: 1 July 20YY

Ruling: Q1: Can the losses incurred by Subsidiary B for the income years ended 30 June 20XX and 20YY be transferred to the Head Company at the joining time pursuant to section 707-120 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Can a loss incurred by Subsidiary A for the income year ended 30 June 20ZZ be transferred to the Head Company at the joining time pursuant to section 707-120 of the ITAA 1997? | A2: Yes | Q3: Can a loss incurred by Subsidiary B for the income year ended 30 June 20ZZ be transferred to the Head Company at the joining time pursuant to section 707-120 of the ITAA 1997? | A3: Yes

Relevant facts and circumstances: The relevant entities in the “Group” (as referred to for the purpose of this ruling) includes: the Head Company, Subsidiary A, Subsidiary B, X Pty Ltd, Y Pty Ltd, A and B. The Head Company was incorporated as an investment company vehicle to invest in other entities by way of supplying capital and expertise. The Head Company is not a wholly owned subsidiary and its shareholders are X Pty Ltd and Y Pty Ltd. X Pty Ltd owns A% of the shares and Y Pty Ltd owns B% of the shares in the Head Company. X Pty Ltd is C% owned by A and Y Pty Ltd is C% owned by B. In and from 20XX, the Head Company beneficially owns C% of the ordinary shares in Subsidiary A. Prior to 20XX the Head Company owned D% of the shares in Subsidiary A and Z Pty Ltd owned E%%. The Head Company purchased the E%% shareholding from Z Pty Ltd. Z Pty Ltd does not have any relationship with any persons or entities associated with the Group. Subsidiary A was incorporated to purchase all of the shares in Subsidiary B. Subsidiary A beneficially owns C% of the ordinary shares in Subsidiary B. All shares issued by the Group are ordinary shares, and all shares have equal voting, dividend and capital distribution rights. The constitutions of the relevant entities in the Group have not been amended to alter these rights. The right to vote is attached to ordinary shares held and the total voting power in an entity in the Group is limited to the voting power attached to those shares. The ordinary shares issued by each of the entities in the Group carry an absolute entitlement to any dividends paid by the relevant entity (being the issuer of the shares). All entities have had the same business since incorporation. The Head Company, Subsidiary A and Subsidiary B are Australian resident companies and are not prescribed dual residents (as defined in subsection 6(1) of the Income Tax Assessment Act 1936 ). The Head Company, Subsidiary A and Subsidiary B intend to consolidate for income tax purposes. The Head Company will be the 'head company' of this group in accordance with subsection 703-15(2) of the ITAA 1997. Subsidiary A and Subsidiary B will be 'subsidiary members' of this consolidated group in accordance with subsection 703-15(2) of the ITAA 1997. The consolidation year will be the income year ended 30 June 20ZZ. Subsidiary A and Subsidiary B incurred taxable losses for the income years ended 30 June 20XX and 20YY. Assumptions 1) The Head Company will make the choice to consolidate the group as required by subsection 703-50(3) of the ITAA 1997. 2) A and B will continue to have a collective indirect ownership interest of more than F% of the shares in both Subsidiary A and Subsidiary B until the end of the ownership test period, being the end of the income year in which the losses are to be utilised by the Head Company.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 6(1) | Income Tax Assessment Act 1997 Division 165 | Income Tax Assessment Act 1997 section 165-12 | Income Tax Assessment Act 1997 subsection 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 section 165-13 | Income Tax Assessment Act 1997 section 165-15 | Income Tax Assessment Act 1997 subsection 165-15(1) | Income Tax Assessment Act 1997 Subdivision 165-D | Income Tax Assessment Act 1997 subsection 165-150(1) | Income Tax Assessment Act 1997 subsection 165-150(2) | Income Tax Assessment Act 1997 subsection 165-155(1) | Income Tax Assessment Act 1997 subsection 165-155(2) | Income Tax Assessment Act 1997 subsection 165-160(1) | Income Tax Assessment Act 1997 subsection 165-160(2) | Income Tax Assessment Act 1997 section 165-210 | Income Tax Assessment Act 1997 subsection 165-165(1) | Income Tax Assessment Act 1997 section 165-210 | Income Tax Assessment Act 1997 Part 3-90 | Income Tax Assessment Act 1997 section 701-1 | Income Tax Assessment Act 1997 subsection 703-15(2) | Income Tax Assessment Act 1997 subsection 703-50(3) | Income Tax Assessment Act 1997 Division 707 | Income Tax Assessment Act 1997 Subdivision 707-A | Income Tax Assessment Act 1997 section 707-105 | Income Tax Assessment Act 1997 section 707-120 | Income Tax Assessment Act 1997 subsection 707-120(1) | Income Tax Assessment Act 1997 subsection 707-120(1A) | Income Tax Assessment Act 1997 subsection 707-120(2) | Income Tax Assessment Act 1997 section 707-140 | Income Tax Assessment Act 1997 Subdivision 707-C

Reasons for decision: Summary: The losses incurred by Subsidiary B for the income years ended 30 June 20XX and 20YY can be transferred to the Head Company at the joining time pursuant to section 707-120 of the Income Tax Assessment Act 1997 on the basis that Division 165 would not apply to deny a deduction to Subsidiary B for those losses and, but for becoming a member of the consolidated group, Subsidiary B could have utilised the losses in the relevant 'trial year'. | Detailed Reasoning - Single-entity rule and the transfer of losses to the head company: Section 701-1 states that if an entity is a subsidiary member of a consolidated group for any period, it is taken to be a part of the head company of the group, rather than a separate entity during that period. Subdivision 707-A provides the rules for the 'transfer' of unutilised losses of a joining entity to a head company of a consolidated group. These rules apply to losses incurred after 30 June 1999. This Subdivision is applied to each loss that the joining entity seeks to transfer separately, and not the total amount of all the losses carried forward at the joining time. In accordance with the overarching single entity rule, section 707-105 provides that if a loss made by an entity before the time it becomes a member of a consolidated group is transferred to the head company of the group at that time, it is the head company that is treated for income years ending after the transfer as having made the loss. Consequently, the head company can utilise the loss to the extent permitted by the legislation (i.e. the general rules (outside the consolidated groups regime of Part 3-90) about an entity utilising a loss it has made; and the special rules about transferred losses in Division 707 which supplement and modify those general rules). An unused carry-forward loss made by an entity before the time it becomes a member of a consolidated group (for an income year before the joining time) is transferred to the head company at the joining time if the joining entity could have utilised the loss (had it not become a member of the group) in the 'trial year', assuming it had sufficient income or gains of the relevant type against which to offset the loss, and assuming, rather than become a member of the group, it remained a separate entity that was a subsidiary member of the head company (see subsections 707-120(1) and 707-120(1A)). Broadly, the relevant trial year is as prescribed by subsection 707-120(2) and, in this case, would be the period starting 12 months before the joining time and ending just after the joining time. The general loss recoupment rules to be considered when determining whether the joining entity could have utilised a loss (had it not become a member of a consolidated group) are set out under Division 165 and are considered below. | Detailed Reasoning - General loss recoupment rules - Division 165: A company cannot deduct a tax loss unless: ● it satisfies the continuity of ownership test in section 165-12, or ● it satisfies the same business test in sections 165-13 and 165-210, and ● it does not fail the control test in section 165-15. | Detailed Reasoning - Continuity of ownership test (the COT): Pursuant to subsections 165-12(2) to (4), the COT requires that there 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. The 'ownership test period' is the period from the start of the income year in which the loss was incurred to the end of the income year in which the loss is utilised. The concept of beneficial ownership of shares is central to the COT. The expression 'beneficially owned' is not defined, and therefore bears its ordinary meaning. In broad terms it means ownership for one's own benefit, rather than for the benefit of others. Subdivision 165-D provides primary and alternative tests to determine who has more than 50% of the voting power and rights to dividends and capital distributions. The 'primary test' applies to persons who directly have an interest in a company (see subsections 165-150(1), 165-155(1) and 165-160(1)). The 'alternative test' applies where any shares in the company are beneficially owned by other companies and is directed at the powers or rights which it is reasonable to assume are held by the non-corporate beneficial owners (either directly or indirectly through interposed entities) (see subsections 165-150(2), 165-155(2) and 165-160(2)). When applying the primary or the alternative test, a person's shares in a company may be counted only if the person owns the same interests in the same shares throughout the ownership test period, and 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 (subsection 165-165(1)). | Detailed Reasoning - Control test: Pursuant to subsection 165-15(1), the control test will be failed such that a company cannot deduct a loss if: (a) for some or all of the part of the *ownership test period that started at the end of the *loss year, a person controlled, or was able to control, the voting power in the company (whether directly, or indirectly through one or more interposed entities); and (b) for some or all of the *loss year, that person did not control, and was not able to control, that voting power (directly, or indirectly in that way); and (c) that person began to control, or became able to control, that voting power (directly, or indirectly in that way) for the purpose of: (i) getting some benefit or advantage in relation to how this Act applies; or (ii) getting such a benefit or advantage for someone else; or for purposes including that purpose. | Detailed Reasoning - Applying the COT to Subsidiary B: Subsidiary B incurred losses for the income years ended 30 June 20XX and 30 June 20YY. Therefore the ownership test period in relation to these losses would be from 1 July 2013 to the end of the income year in which the losses are to be utilised. During that ownership test period: ● Subsidiary A beneficially held all the shares in Subsidiary B (the relevant joining entity), and ● the Head Company beneficially held D% of the shares in Subsidiary A until October 20XX and, from that time, has beneficially held C% of the shares. | Detailed Reasoning - COT in or prior to October 20XX: Based on the relevant facts and circumstances, A and B each hold an indirect interest in Subsidiary B. The indirect interest held by A and B in Subsidiary B prior to October 20XX was G% and H% respectively, calculated as follows: | Detailed Reasoning - % shareholding: A owns in X Pty Ltd C% X Pty Ltd owns in the Head Company A% The Head Company owns in Subsidiary A D% Subsidiary A owns in Subsidiary B C% Therefore A's indirect interest in Subsidiary B = (C% x A% x D% x C%) G% | Detailed Reasoning - % shareholding: B owns in Y Pty Ltd C% Y Pty Ltd owns in the Head Company B% The Head Company owns in Subsidiary A D% Subsidiary A owns in Subsidiary B C% Therefore B's indirect interest in Subsidiary B = (C% x B% x D% x C%) H% Therefore, prior to October 20XX, A and B collectively held D% of the shares in Subsidiary B (albeit indirectly). As all the shares held within the Group are ordinary shares with voting power and rights to dividends and capital distributions, it is reasonable to assume for the purposes of section 165-12 that Mr. A and Ms. B collectively had more than 50% of the voting power and rights to dividends and capital distributions in Subsidiary B during that period. | Detailed Reasoning - COT in or after October 20XX: As the Head Company obtained C% ownership of the shares in Subsidiary A during October 20XX, A's and B's indirect ownership interest in Subsidiary B increased as at that date to A% and B% respectively. The 'same share' rule under subsection 165-165(1) (which requires the COT alternative test to take into account only those shares in Subsidiary B that were the same shares held by the same persons throughout the ownership test period) applies such that the increase in Mr. A's and Ms. B's indirect shareholding in Subsidiary B cannot be taken into account. Nevertheless Mr. A and Ms. B continue to have a collective indirect ownership interest of more than 50% of the shares in Subsidiary B for the period in and after October 20XX to the end of the ownership test period. On the basis of the above, Subsidiary B meets the COT under section 165-12 for the relevant ownership test period. As Subsidiary B meets the COT, the same business test under sections 165-13 and 165-210 do not need to be considered. | Detailed Reasoning - Applying the control test to Subsidiary B: During no part of the ownership test period that started at the end of the loss year did A or B(or any other person) control, or were able to control, the voting power in Subsidiary B (whether directly, or indirectly through one or more interposed entities). On that basis, Subsidiary B does not fail the control test under section 165-15. | Detailed Reasoning - Conclusion: By satisfying both the COT and the control test, Subsidiary B wouldn't be denied a deduction pursuant to Division 165 for the losses it incurred for the income years ended 30 June 20XX and 30 June 20YY; and could have utilised those losses in the trial year had it not become a member of the consolidated group. It follows, pursuant to section 707-120, that Subsidiary B is able to transfer those unused losses to the Head Company at the relevant joining time and, pursuant to section 707-140 (as well as the single entity rule under section 701-1) the losses: ● will be treated as having been made by the Head Company for the income year in which the transfer occurs (i.e. 20ZZ), and ● will be treated as not having been made by Subsidiary B for the income years for which those losses were actually made. The Head Company will be able to utilise the losses transferred from Subsidiary B accordingly, subject to the operation of Subdivision 707-C which determines the amount of transferred losses that can be utilised. | Summary: Any loss incurred by Subsidiary A and/or Subsidiary B for the income year ended 30 June 20ZZ can be transferred from to the Head Company at the joining time pursuant to section 707-120 on the basis that Division 165 would not apply to deny a deduction to Subsidiary A or B for that loss and, but for becoming a member of the consolidated group, those entities could have utilised their respective loss in the relevant 'trial year'. | Detailed Reasoning - Detailed reasoning: As losses incurred by Subsidiary A and Subsidiary B for the income year ended 30 June 20ZZ are losses made before the time they become members of the consolidated group, the transferability of those losses to the Head Company, as the head company, at the joining time requires the same consideration as that applied to the losses addressed at question 1 of this ruling. In that regard, it is noted that: ● The ownership test period in relation to these losses would be from 1 July 20YY to the end of the income year in which the losses are to be utilised. ● Subsidiary A and Subsidiary B meet the COT under section 165-12 for this ownership test period as A and B have a collective indirect ownership interest of C% of the voting power and rights to dividends and capital distributions in both of the companies. ● Subsidiary A and Subsidiary B do not fail the control test under section 165-15. By satisfying both the COT and the control test, Subsidiary A and Subsidiary B wouldn't be denied a deduction pursuant to Division 165 for any loss incurred for the income year ended 30 June 20ZZ; and could utilise the loss in the trial year had the companies not become members of the consolidated group. It follows, pursuant to section 707-120, that Subsidiary A and Subsidiary B are able to transfer those unused losses to the Head Company at the relevant joining time and, pursuant to section 707-140 the losses will be treated as having been made by the Head Company for the income year in which the transfer occurs (i.e. 20ZZ).