Private ruling: Income tax: claiming prior year losses
Date of advice: 25 July 2018
Published: September 2018
Ruling period: Year ended 30 June 20XY | Year ended 30 June 20XX
Date scheme commenced: 1 July 20XZ

Ruling: Q1: Are shares that were gifted by a deceased shareholder to a testamentary trust (ie a non-fixed trust) established under the deceased's Will "beneficially owned" by the testamentary trust for the purpose of paragraph 165-205(1)(b) of the ITAA 1997? | A1: No | Q2: If the answer to question 1 is no - If a family trust election has been made in respect of a testamentary trust established under a deceased shareholder's Will, will the answer to question 1 be in the affirmative given that for the purpose of the primary test (section 165-150(1), 165-155(1) and 165-160(1) of the ITAA 1997) such an election would enable the primary test to apply to a non-fixed trust in circumstances where pursuant to sections 165-207 of the ITAA 1997 that would not be the case in the absence of such an election? | A2: No | Q3: If the answers to questions 1 and 2 are no - Are shareholders who received shares as a beneficiary of a deceased's estate taken to have acquired the shares on the date of death of the shareholder (as opposed to the date on which the shares were actually transmitted to the testamentary trust) for the purpose of the commencement of their ownership period as defined in subsection 165-12(1) of the ITAA 1997? | A3: Yes | Q4: Does a private family company that has been used as an investment vehicle (ie for investing primarily in listed and unlisted shares and some managed funds) carry on a business within the meaning of section 165-210 of the ITAA 1997? | A4: Yes

Relevant facts and circumstances: ABC Pty Ltd (ABC) was incorporated in September 19XX. ABC is a proprietary limited company that has been closely held within a family group since its incorporation ABC is a family investment vehicle which has been used by subsequent generations of the same family in the family business of investing in listed and non-listed shares in public and private companies as well as some managed funds. The investments are held on capital account (ie ABC is not a trading company). The investments are comprised of a mixture of high yield dividend stock with a smaller speculative capital growth component. ABC also has a single real estate asset held on capital account. ABC’s chronological ownership ABC currently has X ordinary shares, X A Class and X B Class shares on issue. ABC was originally owned by XX (as to X ordinary shares) and XY (as to X ordinary shares). On or around early June 19YY, XY and XX X’s children – Q,R and S – were added as shareholders (X A Class shares each) as were R’s children – U and T (X B Class shares each). Upon XX’s death in 20XT, their shares were gifted to the testamentary trusts of Q,R and S established under clause 15 of XX’s Will. As a consequence, XX’s X shares were held as follows: (a) Q Testamentary Trust - X shares (b) R Testamentary Trust - X shares (c) S Testamentary Trust - X shares (d) All X of the above as tenants-in-common - 1 share The transmission of XX’s shares occurred on or about 30 June 20XU. Upon XY’s death in 20XV, their shares were gifted to the testamentary trusts of Q,R and S established under clause [7.1] of XY’s Will. However, that clause also allowed the Executor (with the consent of Q, R or S) to elect to distribute the shares to Q, R or S (as the case may be) in their personal names instead of to their testamentary trust. As a consequence, XY’s X shares were held as follows: (a) Q Testamentary Trust No 2 – X shares (b) R - X shares (c) S – X shares The transmission of XY’s shares only occurred on 30 September 20XY. The various testamentary trusts are non-fixed trusts insofar as they have as their discretionary objects the child (either Q, R or S) and beneficiaries who stem from the respective child (eg their children, grandchildren etc). In September 20XY, after the transmission of the shares, S transferred their shares to Q and R or their respective testamentary trusts as follows: (a) The X shares held by the S Testamentary Trust: (i) Q - X shares (ii) R - X shares (iii) Q and R jointly - X share (b) The X shares held in S’s personal name: (i) Q Testamentary Trust No 2 - X shares (ii) R - X shares (c) The X share held jointly by the Q Testamentary Trust, R Testamentary Trust and S Testamentary Trust was acquired by the remaining co-owners who now hold it as to 50% each. A table setting out the changes in ABC shareholding at various testing points is provided as Annexure G to your letter dated early May 20YY. Share rights As set out above, there are Ordinary, A Class and B Class shares on issue. Clause 6 of the Articles of Association of Process Units appears to be the only Article that sets out the rights relating to the different classes of shares. It relevantly provides: (a) Voting – Ordinary shares confer the right to 1 vote per share, whereas the holders of A and B Class shares are only entitled to 1 vote for every parcel of 50 shares held by a shareholder in that class. (b) Dividends – Each of the three share classes appear to entitle the holders thereof to dividends. Dividends can be declared on one class to the exclusion of the other classes (see Article 6(d)). (c) Capital – The Articles do not set out the rights to capital in respect of each share class. Excess franking credits and losses ABC had excess franking credits as follows: (a) Year ended 30 June 2015: $XXX (b) Year ended 30 June 2016: $XXX (c) Year ended 30 June 2017: $XXX which convert into losses under section 36-55 of the ITAA 1997 as follows: (a) Year ended 30 June 2015: $XXX (b) Year ended 30 June 2016: $XXX (c) Year ended 30 June 2017: $XXX. ABC also has a carry forward capital loss of $XXX from the year ended 30 June 20XX. For the year ended 30 June 20XX, ABC provided the following income tax information: Details Total dividend income $XXX Franking credits received $XXX Gross interest $XXX Other assessable income $XXX All other expenses $XXX Taxable income $XXX Tax on the taxable income of $XXX amounts to $XXX, however, this amount was reduced to nil by franking credit offsets.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 128-15 | Division 165 | Subdivision 165-F | Section 165-10 | Section 165-12 | Section 165-13 | Section 165-150 | Section 165-155 | Section 165-160 | Section 165-205 | Section 165-207 | Section 165-210

Reasons for decision: Summary: As the ABC shares are held by the trustees for the benefit of the beneficiaries, they are not "beneficially owned" by the testamentary trusts for the purpose of paragraph 165-205(1)(b) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Under Division 165 of the ITAA 1997, the continuity of ownership test (COT) operates to prevent the deduction of a company loss if there is a change of ownership of the company during the ownership test period, that is: ● from the start of the year when the loss was incurred, ● to the end of the year when it is sought to be claimed as a deduction. It is noted that ABC did not have a recoupment year during any period to which this Ruling applies. Although it was suggested that the year ended 30 June 20XX was a relevant income year, for this year franking credit offsets reduced the tax payable to nil (with excess franking credits remaining). As such, ABC cannot deduct losses in this year. Consequently, this Ruling does not consider whether ABC can deduct any tax losses during the Ruling period. This decision only considers how section 165-205 of the ITAA 1997 applies in relation to the relevant shares up to 30 June 20XX. | Detailed Reasoning - Section 165-205: Section 165-205 of the ITAA 1997 provides a concession for the purpose of the COT test in relation to the death of a shareholder. Under section 165-205 of the ITAA 1997, where shares in a company are beneficially owned by a person when they die, the deceased is taken to continue to beneficially own the shares and retain the relevant ownership rights, if and while the shares: ● are owned by the trustee of the deceased's estate (subsection 165-205(1)(a) of the ITAA 1997); or ● are beneficially owned by someone who receives them as a beneficiary of the deceased's estate (subsection 165-205(1)(b) of the ITAA 1997). The word ‘someone’ is not defined for the purpose of subsection 165-205(1)(b) of the ITAA 1997. The Macquarie Dictionary provides the ordinary definition of ‘someone’ is ‘some person’. The term ‘beneficially owned’ is not defined in the ITAA 1997. Lord Diplock in Ayerst (HMIT) v C & K (Construction) Ltd ( Ayerst ) (1976) AC 167 at p 177 explained that the concept of ‘beneficial ownership’ owes its origin to the Court of Chancery, and said: “The archetype is the trust. The 'legal ownership' of the trust property is in the trustee, but he holds it not for his own benefit but for the benefit of the cestui que trust or beneficiaries. Upon the creation of a trust in the strict sense as it was developed by equity the full ownership in the trust property was split into two constituent elements, which became vested in different persons: the 'legal ownership' in the trustee, and what came to be called the 'beneficial ownership' in the cestui que trust." The term was considered in Avon Downs Pty Ltd v FC of T (1949) 78 CLR 353 and Dalgety Downs Pastoral Co Pty Ltd v FC of T (1952) 86 CLR 335 ( Dalgety ). The following is an extract from the judgment of Webb, Fullagar and Kitto JJ in Dalgety , commencing at CLR 341-2; AITR 389 explains: ‘Dixon J, so held in Avon Downs Pty Ltd v Federal Commissioner of Taxation (1949) 78 CLR 353, basing his conclusion upon the view that, in the terminology of company law shares are said to be “held” by the person who is registered as a shareholder in respect thereof, and that s 80(5), being concerned with voting power, should be treated as using that terminology. We share this view. Indeed, it is not too much to say that the verb “hold” and its variants, when used in relation to shares in companies, normally refers to the legal ownership of the shares according to the register of members. The Companies Acts of the United Kingdom and of the several States of the Commonwealth have uniformly used the word in this sense, and common usage has followed their example. Before a different meaning is accepted, some justification must be found in the context, or the subject-matter. No such justification is provided by the fact that “held” is modified by the adverb “beneficially”. This word serves more naturally the purpose of excluding the case of a holding for the benefit of others than the purpose of so broadening the meaning of the word “held” beyond the particular significance which it normally has in relation to shares as to make it equivalent to “owned” in the most general sense of that word.’ Gartside and Another v . Inland Revenue Commissioners [1968] 1 All ER 121 and Re Weir's Settlement MacPherson and Another v . Inland Revenue Commissioners [1970] 1 All ER 297 provide authority for the proposition that beneficiaries of a discretionary trust do not have any interest, either individually or collectively, in the property or income of a trust estate. It is for the trustee to determine, firstly, whether such beneficiaries will benefit at all under the terms of the trust and, secondly, to what extent the beneficiaries will benefit. Such beneficiaries have no more than a right to have the trust duly administered. This right does not constitute beneficial ownership. Applying the above, where shares are held by the trustee of a discretionary trust, the better view is that the shares are not beneficially owned by any persons. As you state in your application, it is relevant to note that section 165-205 of the ITAA 1997 was preceded by sections 50K(2) and 80B(3), and former section 160ZNR of the ITAA 1936 (for current year losses, prior year losses and capital losses respectively). The wording of these former provisions is consistent with the wording in section 165-205, requiring the shares be ‘beneficially owned’ by a person who received the shares as a beneficiary in the deceased estate. You contend that it is incorrect that a beneficiary of a deceased estate that is a non-fixed trust will not satisfy the requirements of section 165-205 of the ITAA 1997 for the following reasons: ● The term ‘beneficially owned’ is not used in Explanatory Memoranda (EM) discussing the concession relating to the death of a shareholder, but merely refer to shares received by ‘a beneficiary of’ a deceased estate. ● The specific absence of a reference to the term ‘beneficially owned’ in relation to the death of a shareholder in the EM to the Income Tax Assessment Bill 1996, in contrast to specific inclusion of the term for the purpose of the ‘primary test’, suggests the term was not intended for the purpose of the concession. ● The commentary in the EM to the Income Tax Assessment Amendment Bill (No.4) 1978 , in respect of subsection 50K(2) of the ITAA 1936, states ‘The section will thus preserve an entitlement to a current year loss which might otherwise be lost as a result of events quite beyond the control of the company or its shareholders’, which suggests that the section is designed to prevent the failure of the continuity of ownership test by events beyond the control of the company or its shareholders. ● That it is reasonable to conclude that the purpose of section 165-205 of the ITAA 1997 is to ensure that the death of a shareholder will not result in company losses being unable to be recouped solely because of the death of a shareholder and transfer of those shares to the decease’s beneficiaries. ● Confinement of the section to a particular type of beneficiary would lead to an irrational result. It is accepted that the EMs discussed in your private ruling application provide minimal guidance as to why the drafters of section 165-205 of the ITAA 1997, and the preceding provisions, included the terms ‘beneficially owned by’ in the relevant sections. However, the words ‘beneficially owned by someone’ as used in section 165-205 of the ITAA 1997 are clear and unambiguous. By those words, under the section, the shares must be beneficially owned by the beneficiary who is a person. Where the literal meaning of the words used is clear, it is not open to the Commissioner to add or remove words in interpreting and applying that legislation, to give effect to what may have been the purpose or intention of the Government when the provision or provisions were introduced. As determined in the facts, various shares in ABC are owned by the trustees of testamentary trusts, which are discretionary trusts. As explained in Ayerst, the trustee of a trust legally owns the trust property, but he holds it for the benefit of the beneficiaries. As such, the ABC shares that were gifted by deceased shareholder’s to testamentary trusts established under the deceased's Will are not "beneficially owned" by the testamentary trust for the purpose of paragraph 165-205(1)(b) of the ITAA 1997. NOTE: This ruling does not consider the Commissioner’s view as to whether or not section 165-205 of the ITAA 1997 applies in circumstances where the change of ownership which occurs when shares are transferred to beneficiaries of a deceased estate occurs prior to the loss year. | Summary: If a family trust election is made in respect of a testamentary trust, section 165-207 of the ITAA 1997 will not operate to treat the trustee of the trust, or the trust itself, as the ‘beneficial owner’ of the shares for the purpose of paragraph 165-205(1)(b) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Section 165-207 of the ITAA 1997 provides concessional tracing rules that apply if the trustee of a family trust (as defined in Schedule 2F of the ITAA 1936): (a) owns shares in a company; or (b) controls, or is able to control, (whether directly, or indirectly through one or more interposed entities) voting power in a company; or (c) has a right to receive (whether directly, or indirectly through one or more interposed entities) a percentage of a dividend or a distribution of capital of a company (subsection 165-207(1) of the ITAA 1997). Under section 165-207 of the ITAA 1997, a single notional entity that is a person (but is neither a company nor a trustee) is taken: ● to own the shares beneficially for the purposes of a primary test (subsection 165-207(2) of the ITAA 1997), or ● for the purposes of an alternative test, is taken: (a) to control, or have the ability to control, the voting power in the company; or (b) to have the right to receive (whether directly or indirectly) the percentage of the dividend or distribution for the entity's own benefit. The provision formerly operated to treat the trustee of a family trust as the beneficial owner of the shares, however, was amended to introduce the concept of a ‘single notional entity’ in 2005. As stated in section 165-207 of the ITAA 1997, for both the primary and alternative tests, ‘a single notional entity’ is a person, but is neither a company nor a trustee. It is a notional entity, created for tax purposes, and as such was not a beneficiary of the deceased shareholder’s Will and cannot be said to have received the shares ‘as a beneficiary of the deceased’s estate. Further, it is the Commissioner’s view that it is unlikely and improbable that the drafters intention was for one concession to be applied to take one entity as the ‘beneficial owner’, then a second concession to treat a second person as the ‘beneficial owner’ of the same shares at the same time. As such, if a family trust election was made in respect of a testamentary trust, section 165-207 of the ITAA 1997 will not operate to treat the trustee of the trust, or the trust itself, to be the ‘beneficial owner’ of the shares for the purpose of paragraph 165-205(1)(b) of the ITAA 1997. | Summary: The shareholders who received shares as a beneficiary of a deceased's estate are taken to have acquired the shares on the date of death of the shareholder for the purpose of the commencement of their ownership period. | Detailed Reasoning - Detailed reasoning: Timing of the acquisition of shares is not discussed in Division 165 of the ITAA 1997 for the purposes of the COT. In the absence of a provision specifically for this purpose, the Commissioner accepts your reasoning and application of subsection 128-15(2) of the ITAA 1997, in relation to CGT assets. Amongst other things, section 128-15 of the ITAA 1997 sets out that where a person who owns a CGT asset dies and the asset passes to a beneficiary of a decease persons estate, the beneficiary is taken to have acquired the asset on the date of death of the deceased. As such: ● the trustees of the testamentary trusts that received shares from the deceased estate of XX are taken to have acquired the shares on the date of XX’s death, and ● the trustees of the testamentary trusts that received shares from the deceased estate of XY are taken to have acquired the shares on the date of XY’S death. Consequently, the following table shows the owners of shares of ABC as at 1 July 2014: | Detailed Reasoning - Shareholders: ORD X XY Q Testamentary Trust (QTT) X XX R Testamentary Trust (RTT) X XX S Testamentary Trust (STT) X XY QTT, RTT, and STT (jointly) X XY Q Testamentary Trust no.2 (QTT2) X XX R X XX S A X X Q X XX R X XX S B X X T X XX U and the only change in ownership of ABC during the ownership test period was in relation to the exit of XY S, resulting in the following shareholdings as at 30 June 20XX: | Detailed Reasoning - Shareholders: ORD X XY Q Testamentary Trust (QTT) X XX R Testamentary Trust (RTT) X XY Q X XX R X XY Q and XX R (jointly) X QTT, and RTT (jointly) X XY Q Testamentary Trust no.2 (QTT2) X XX R A X XY Q X XX R B X XY T X XX U Please note: As discussed in question 1, a company with discretionary trust shareholders may not be able to satisfy the COT as the beneficiaries interests are not fixed and indefeasible but are at the discretion of the trustee. Special provisions in relation to non-fixed trusts and the COT are provided in Subdivision 165-F of the ITAA 1997. Also a trustee may be able to make a family trust election (FTE) in relation to a discretionary trust to satisfy the primary or alternative tests under section 165-207 of the ITAA 1997. However, it is important to note that if a trustee makes a FTE in relation to a trust, there is only limited ability to vary or revoke the FTE within 4 years from the commencement date of the FTE section 272-80(6B) of schedule 2F to the ITAA 1936. Further, any distributions made from a family trust to entities outside the family group of the primary individual specified in a FTE will be subject to family trust distributions tax. | Summary: ABC, as an investment vehicle is considered to ‘carry on a business’ within the meaning of section 165-210 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: If a company fails the COT, it will not be able to claim a deduction in respect of prior year losses unless it satisfies the same business test (SBT) under subsection 165-13 and Subdivision 165-E of the ITAA 1997, including section 165-210. Draft Taxation Ruling TR 2017/D7 Income tax: when does a company carry on business within the meaning of section 23AA of the Income Tax Rates Act 1986? TR 2017/D7 sets out the Commissioner’s preliminary, but considered, views in relation to companies carrying on a business, and may be applied similarly in relation to other income tax provisions. TR 2017/D7 explains that companies are typically formed for the purpose of carrying on a business. Where a company aims to make, and has a prospect of profit, it is presumed that the company intends to, and does in fact, carry on a business. However, the presumption can be rebutted if it can be shown that, on the facts, the company had no aim or prospect of making a profit (paragraph 11). Further, whether a company is carrying on a business ultimately depends on an overall impression of the company's activities. Where a limited or No Liability company is established and maintained to make a profit for its shareholders, and invests its assets in gainful activities that have both a purpose and prospect of profit, it is likely to be carrying on a business in a general sense and therefore to be carrying on a business. In these circumstances, it is likely the other indicia of carrying on a business will support this conclusion. This is so even if the company's activities are relatively limited, and its activities primarily consist of passively receiving rent or returns on its investments and distributing them to its shareholders (paragraph 44). The test in section 165-210 of the ITAA 1997 requires a decision as to whether the ‘same’ business is being carried on throughout the same business test period (SBT period), as it carried on immediately before the test time. Subsection 165-210(2) of the ITAA 1997 defines the SBT period as the ‘income year’, being the year in which the company wishes to deduct the losses. There are three options provided in subsection 165-13(2) of the ITAA 1997 to determine the relevant ‘test time’: ● Where the company can show that it can satisfy the continuity of ownership test for some period of time but not all the ownership test period, the "test time" is the time when the company first fails to meet a condition of the continuity of ownership test. ● If it is impractical to show that the owners of the company has maintained continuity for any period since the start of the loss year, the "test time" for the start of the SBT is the start of the loss year. ● If it is impractical to show that the owners of the company has maintained continuity for any period since the start of the loss year and the company came into being during the loss year, the "test time" is the end of the loss year. In the current circumstances, ABC is in the business of investing, primarily in listed and unlisted shares (including some speculative capital growth investments) and some managed funds (as well as a small amount of real property). In considering the indicia of carrying on a business, as discussed in paragraph 12 of TR 2017/D7),: ● ABC’ investment activities have a significant commercial nature and are conducted in a commercially viable manner. ● The company was incorporated to manage and control the investment activities, and make a profit for the shareholders. ● ABC’ investment activities have been carried on regularly and repeatedly over time and continue in that manner. ● ABC keeps detailed records of income, holds regular Board meetings where the Directors actively consider its investments, seeks professional advice and is otherwise subject to the requirements of the Corporations Act 2001 (Cth) . From the above, it is the Commissioner’s view that ABC is carrying on a business for the purposes of the SBT in subsection 165-210(2) of the ITAA 1997. NOTE: As discussed above, ABC does not have an ‘income year’ or recoupment year during the period of this Ruling. As such, this Ruling does not determine: ● whether or not ABC has passed or failed the COT, and therefore ● whether the SBT can be applied in ABC’ circumstances. ● whether the SBT is satisfied during the Ruling period.