Private ruling: Modified small business test
Date of advice: 10 March 2016
Published: May 2016

Ruling: Q1: In respect of tax losses incurred by the Taxpayer in the year ended 31 March 20XX, does the Taxpayer satisfy the modified Same Business Test (SBT) under section 707-125 of the Income Tax Assessment Act 1997 (ITAA 1997) such that it is able to transfer these losses to itself as the head company of a proposed Multiple Entry Consolidated (MEC) group at the joining date? | A1: Yes. | Q2: Will the discontinuation of a distinct part of the Taxpayer's business just after the start of the trial year adversely impact its ability to satisfy the SBT throughout the trial year pursuant to subsection 165-210(2) of the ITAA 1997 and as modified by subsection 707-125(1) of the ITAA 1997, given this business had been substantially discontinued prior to the start of the trial year? | A2: No.

Relevant facts and circumstances: The scheme, subject of this ruling, is described below: The Taxpayer is an Australian tax resident company. The principal activity of the Taxpayer is currently the wholesale distribution of specialised solutions for a specific sector including livestock tools and other products and systems designed to enhance farmer productivity and profitability. At the test time, the business of the Taxpayer in addition to the principal activity as described above also included limited manufacturing activities. Prior to the test time, due to challenging environmental factors, a decision was made to cease manufacturing activities. The employees were notified that although the factory will cease manufacturing the Taxpayer will continue to sell manufactured product as stock allows and beyond this time will support their customers through the relevant warranty periods and endeavour to carry spare parts for up to 2 years. Apart from the closure of the Taxpayer's manufacturing facility, there have been no other changes to the business conducted by the Taxpayer at the test time compared to the trial year. The Taxpayer has post 1999 carried forward tax losses. The Taxpayer is considering forming a MEC group with the second taxpayer (Taxpayer 2). The primary business activity of Taxpayer 2 is the sale of agricultural and related technology products which are distributed directly to farmers.

Relevant legislative provisions: Section 165-12 of the Income Tax Assessment Act 1997 (ITAA 1997) | Section 165-13 of the ITAA 1997 | Section 165-210 of the ITAA 1997 | Subdivision 707-A of the ITAA 1997

Reasons for decision: Summary: Detailed reasoning When an entity becomes a member of a tax consolidated group (TCG), its unused carry-forward tax losses are transferred to the head company if the tax losses satisfy modified versions of the usual tests for deducting and applying them i.e. the continuity of ownership test (COT) in section 165-12 or the same business test (SBT) in section 165-13. Broadly, the tests are applied as though the 12 months prior to the joining time were the loss claim year (known as the trial year). The tax loss is transferred to the head company of the group if the joining entity could have utilised the tax loss in the trial year assuming it had sufficient income or gains of the relevant type. Subdivision 707-A provides the rules for the 'transfer' of unutilised tax losses of a joining entity to a head company of a consolidated group. These rules apply to tax losses incurred after 30 June 1999. This Subdivision is applied to each tax loss that the joining entity seeks to transfer, separately, and not the total amount of all the tax losses carried forward at the joining time. In the current circumstances, the Taxpayer has tax losses at the time the TCG will be formed. The modified versions of the COT and the SBT must therefore be considered for the tax loss to determine whether these unutilised tax losses can be transferred to the Taxpayer as the head company of the multiple entity consolidated (MEC) group. Broadly a company can only deduct prior year losses if they satisfy the conditions in section 165-10 which require the company to pass COT, or if COT is failed, the SBT. In the present case the COT was failed. | Detailed Reasoning - SBT: Where a company does not meet the conditions in section 165-12 or it is not practical to show that it meets these conditions, the company must satisfy the same business test found in section 165-13. It states: 165-13(1) This section sets out the condition that a company must meet to be able to deduct the tax loss if: (a) the company fails to meet a condition in subsection 165-12(2), (3) or (4); or (b) it is not practicable to show that the company meets the conditions in those subsections. Note: Other provisions may treat the company as meeting, or failing to meet, the conditions in subsections 165-12(2), (3) and (4). The 'test time' is determined by the table provided by subsection 165-13(2) as follows: 165-13(2) The company must satisfy the same business test for the income year (the same business test period). Apply the test to the business the company carried on immediately before the time (the test time) shown in the relevant item of the table. | Detailed Reasoning - The test time is:: 1 It is practicable to show there is a period that meets these conditions: (a) the period starts at the start of the ownership test period or, if the company came into being during the loss year, at the time the company came into being; (b) the company would meet the conditions in subsections 165-12(2), (3) and (4) if the period were the ownership test period for the purposes of this Act The latest time that it is practicable to show is in the period 2 Item 1 does not apply and the company was in being throughout the loss year The start of the loss year 3 Item 1 does not apply and the company came into being during the loss year The end of the loss year For the same business test: see Subdivision 165-E. | Detailed Reasoning - Elements of the SBT: The details of the SBT are in Subdivision 165-E. To satisfy the SBT in respect of its prior year losses, the Taxpayer must be able to satisfy a positive test, two negative tests and an anti-avoidance test is section 165-210 which states: 165-210(1) A company satisfies the same business test if throughout the same business test period it carries on the same business as it carried on immediately before the test time. 165-210(2) However, the company does not satisfy the same business test if, at any time during the same business test period, it derives assessable income from: (i) a business of a kind that it did not carry on before the test time; or (ii) a transaction of a kind that it had not entered into in the course of its business operations before the test time. 165-210(3) The company also does not satisfy the same business test 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 same business test period the same business as it carried on immediately before the test time. | Detailed Reasoning - Transfer of loss from joining entity to head company: Subdivision 707-A governs the transfer of losses to the head company of a TCG. Section 707-120 contains the test for transfer of losses from joining entity to the head company of a TCG. Relevantly the section states: 707-120(1) Subject to subsection (1A), the loss is transferred at the joining time from the joining entity to the head company of the joined group (even if they are the same entity). 707-120(1A) The loss is transferred under subsection (1) only to the extent (if any) that the loss could have been utilised by the joining entity for an income year consisting of the trial year if: (a) at the joining time, the joining entity had not become a member of the joined group (but had been a wholly-owned subsidiary of the head company if the joining entity is not the head company); and (b) the amount of the loss that could be utilised for the trial year were not limited by the joining entity's income or gains for the trial year. | Detailed Reasoning - Modified SBT for TCGs: The 'SBT period' is a defined term under section 995-1, which states that the SBT period has the meaning given by a number of sections. Section 707-125 contains the modifications to the SBT for companies' post-1999 losses which becomes a member of an income tax consolidated group. The relevant section in relation to loss transfer on consolidation is section 707-125 which, at subsection 707-125(2) modifies the application of section 165-13. It states: 707-125(2) Work out whether the loss is transferred on the basis that section 165-13 required the joining entity to satisfy the same business test for: (a) the period (the same business test period ) consisting of: (i) the trial year; and (ii) the income year that included the test time worked out for section 165-13 for the joining entity (disregarding paragraph (b) of this subsection), if that income year started before the trial year; and (b) the time (the test time ) just before the end of the income year for which the loss was made by the joining entity. The trial year The 'trial year' is the notional tax loss claim year adopted in transfer testing, and represents the equivalent of the recoupment period in the 'recoupment test'. The trial year is defined in subsection 707-120(2). It states: 707-120(2) The trial year is the period: (a) starting at the latest of these times: (i) the time 12 months before the joining time; (ii) the time the joining entity came into existence; (iii) the time the joining entity last ceased to be a subsidiary member of a consolidated group, if the joining entity had been a member of a consolidated group before the joining time but was not a member of a consolidated group just before the joining time; and (b) ending just after the joining time. Additionally, subsection 707-120(3) provides: 707-125(3) When working out whether the joining entity carried on the same business throughout the trial year (or a period including the trial year) as it carried on at a particular time, assume that the entity carried on at and just after the joining time the same business that it carried on just before the joining time. Effectively, any change in the joining entity's business activities at and just after the joining time is not relevant for 'transfer' testing. The Taxpayer and Taxpayer 2 will form a MEC group. The tax losses which are the subject of this ruling are the 20XX losses. The trial year will be the period from 22 April 20YY to 31 March 20ZZ. The test time, being the time just before the end of the loss year which is year ended 31 March 20XX. | Detailed Reasoning - Modified SBT - application to the Taxpayer's circumstances: The SBT is the primary, positive test. It looks at whether the business in the trial year is actually the same business that was carried on at the test time. The Commissioner's view on the operation of sections 165-13 and 165-210 is 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). Taxation Ruling TR 2007/2 Income tax: application of the same business test to consolidated and MEC groups - principally, the interaction between section 165-210 and section 701-1 of the Income Tax Assessment Act 1997 at paragraph 14 states that the principles set out in TR 1999/9 in respect of the application of the SBT to a single company apply equally to the head company of a TCG. With regard to the positive test, paragraph 13 of TR 1999/9 states: In the same business test, the meaning of the word 'same' in the phrase 'same business as' imports identity and not merely similarity; the phrase 'same business as' is to be read as referring to the same business, in the sense of the identical business. However, this does not mean identical in all respects. What is required is the continuation of the actual business carried on immediately before the test time. It is not sufficient that the business carried on after the test time meets some industry wide definition of a business of the same kind, nor would it be sufficient for there to be mere continuance of business operations from immediately before the test time into the SBTP, if the business had so changed that it could no longer be described as the same business. The analysis of whether the same business continues after the test time may give rise to questions of degree and ultimately depends on the facts of the case. It needs to be acknowledged that a company may expand or contract its activities without necessarily ceasing to carry on the same business. The organic growth of a business through the adoption of new compatible operations will not ordinarily cause it to fail the same business test provided the business retains its identity; nor would discarding, in the ordinary way, portions of its old operations. But, if through a process of evolution a business changes its essential character, or there is a sudden and dramatic change in the business brought about by either the acquisition or the loss of activities on a considerable scale, a company may fail the test. Before the test time, the Taxpayer's business activities as well as wholesale distribution of specialised solutions for the agri-tech sector including livestock tools and other products and systems designed to enhance farmer productivity and profitability, included limited manufacturing activities. However, due to challenging environmental factors a decision was made to cease manufacturing activities. Apart from the closure of the Taxpayer's manufacturing facility, there have been no other changes to the business conducted by the Taxpayer at the test time compared to the trial year. TR 1999/9 TR 1999/9 contains various paragraphs which consider what the impact that the discontinuation of an ongoing business may have on the satisfaction of the SBT. Paragraph 38 of TR 1999/9 states: A business may be the same even though there have been some changes in the way in which it is carried on, provided the identity of the business is not changed. TR 1999/9 goes on to say at paragraph 39 that: Mere expansion or contraction of the taxpayer's business may not result in a change to the identity of the business carried on by the taxpayer. Paragraph 40 of TR 1999/9 further states: However, as a practical matter, expansion or reduction of business activities, if carried to a sufficient extreme, is likely to amount to more than a mere change in the scale of the business carried on by the taxpayer and so may result in a change in the identity of the business. In particular, a sudden and dramatic expansion or contraction brought about by the acquisition or loss of activities on a considerable scale could mean the same business is no longer being carried on. As Walton J observed in Rolls-Royce Motors Ltd v. Bamford: There is all the difference in the world between an organic growth of trade and a sudden and dramatic change brought about by either the acquisition or loss of activities on a considerable scale. Moreover, the evolution of a business is not necessarily the same as mere expansion and may also lead to change such that the business can no longer be described as the same business as that carried on immediately before the change-over, as was recognised in Fielder Downs (WA) Pty Ltd v. FC of T. Paragraph 42 of TR 1999/9 states that a company may expand or contract its activities without necessarily ceasing to carry on the same business. According to the ruling, expansion will not ordinarily cause the test to be failed if it constitutes the "organic growth" of the business through the adoption of new "compatible" operations and the business retains its identity. Similarly, it is considered that if portions of former operations are discarded "in the ordinary way", discontinuation of those activities will not necessarily cause the test to be failed. However, if the scale of the changes, especially over a short period, causes the essential identity of the business to be lost, the test may be failed. Paragraph 43 of TR 1999/9 provides further guidance as it specifically states: The question of whether the discontinuation of an activity will produce a change of business is, however, ultimately one of degree. Sudden and dramatic change brought about by either the loss or acquisition of activities on a considerable scale is to be contrasted with an organic growth of a business: per Walton J in Rolls-Royce (Motors) Ltd v. Bamford. As his Lordship there observed: Doubtless the trade of the company would remain the same trade even though, as a result of organic growth in response to every factor which might influence it, the company adopted new compatible operations and discarded portions of its old. Paragraph 60(d) of TR 1999/9 also addresses such changes as it states: 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. Paragraph 61(c) of TR 1999/9 is also relevant, given that this acquisition allowed the company to manufacture products that were previously outsourced: Changes in the manufacturing activities of the taxpayer (for example, reduced manufacturing activities arising from the purchase of some parts that were previously manufactured, or the cessation of all manufacturing activities by converting to a purchasing and assembling operation). The outsourcing of some components in a manufacturing business might well be a natural step in turning a loss company's business into a profitable one which, in its context, has no particular significance for the same business test; on the other hand, the conversion of what had hitherto been a manufacturing business into one of assembling parts manufactured by others is not unlikely to result in the company failing the test, even though it, too, is a means of making the operation a profitable one. In the present case, at the relevant SBT test time, the Taxpayer had already made the decision to discontinue its manufacturing activities, a decision which had a long gestation period given the historical connection of those activities to the Taxpayer Group. Staff and customers had been notified and the only manufacturing activities that occurred were to discharge its existing obligations to old customers prior to the official close on the specified date. However, after the closure of its manufacturing operation, the Taxpayer continued to distribute a small amount of shearing accessories manufactured by third parties. All other aspects of its business operations remained the same. New Business Test For the purposes of paragraph 165-210(2)(a), a company does not satisfy the same business test, if at any time during the 'same business test, it derives income from a business of a kind it did not carry on before the 'test time'. The Taxpayer discontinued the manufacturing of equipment. However the Taxpayer did not enter into any new business, undertakings, commercial enterprise or transactions of a kind that it had not carried on before the test time. Therefore, it is concluded that the Taxpayer has merely contracted its business during the period of recoupment within the same fields of endeavour as it was engaged in before the change-over. Accordingly, paragraph165-210(2)(a) does not apply and the Taxpayer satisfies the same business test in subsection165-210(1). New Transaction Test For the purposes of paragraph 165-210(2)(b), a company does not satisfy the same business test, if at any time during the 'same business test period', it derives income from a transaction of a kind it had not entered into in the course of its business operations before the 'test time'.. The new transaction test is to ensure 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. A company fails the new transactions test if the company derives income during the period of recoupment from a transaction that was 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 period of recoupment. The new transactions test ensures that the company deducts losses from income from transactions of the same kind as the operations by which it generated income before the change-over. The Taxpayer did not enter into any new transactions that it did not already carry out before the test time as part of its ordinary business. Thus, there is no derivation of income from a transaction that was of a different kind from the transactions that the Taxpayer undertook at the change-over. Accordingly, paragraph 165-210(2)(b) does not apply and the Taxpayer satisfies the same business test in subsection165-210(1). The anti-avoidance test TR 1999/9 describes subsection 165-210(3) as the anti-avoidance test. Paragraph 91 of TR 1999/9 states: Subsection 165-210(3) is a provision designed to prevent a taxpayer company satisfying the 80E test, the 50D test, the 63C test, or the 80F test, respectively, where the company commenced to carry on new businesses or entered into a new kind of transaction prior to the change-over, in anticipation of obtaining a deduction for a prior year loss, a current year loss or a bad debt respectively. Those provisions are referred to as the 'anti-avoidance test'. The facts of this case indicate that the Taxpayer did not commence to carry on a new business or entered into a new kind of transaction prior to the change-over it had not previously entered into in order to ensure that the SBT is satisfied. Accordingly, subsection 165-210(3) does not apply and the Taxpayer satisfies the same business test in subsection165-210(1). | Detailed Reasoning - Conclusion: On the facts of the scheme, it is considered that the Taxpayer has carried on the same business during the test time, change year and trial year and thus, has satisfied the SBT. As the SBT has been passed, the losses incurred by the Taxpayer for the year ended 31 March 20XX will be transferred to the Taxpayer as the head company of the proposed TCG. | Detailed Reasoning - Question 2: This question has been addressed in response to Question 1.

Reasons for decision: All legislative references in this document are to the Income Tax Assessment Act 1997 (ITAA 1997) .