Private ruling: Income Tax: Modified continuity of ownership test - no detriment rule
Published: September 2013
Ruling period: Income year ended 30 June 2012
Date scheme commenced: 1 July 2005

Ruling: Q1: Does the Commissioner confirm that Company A has continued to satisfy the continuity of ownership test is section 165-12 of the Income Tax Assessment Act 1997 ('ITAA 1997') as modified by section 166-5 of the ITAA 1997 to 30 June 2012 in respect of its losses incurred in the 2006 to 2009 income years on the basis that: · the requirements of paragraphs 166-275(a) and 166-275(b) of the ITAA 1997 are satisfied; and · paragraph 166-275(c) of the ITAA 1997 is satisfied. | A1: Yes

Relevant facts and circumstances: Company A incurred tax losses. Company A applied tracing rules for the purposes of satisfying the substantial continuity of ownership test in Division 166 of the ITAA 1997. Company A failed the substantial continuity of ownership test. Company A and Company B merged with Company B's stake in Company A being subsequently cancelled. Company B shareholders (including an individual and the Trustee of the XYZ Trust) were issued with new direct Company A shares and became registered shareholders of Company A after the merger. Company A proposes to disregard all tracing rules in respect of stakes held by the individual and the Trustee of the XYZ Trust applied in testing for substantial continuity of ownership. In respect of the individuals stake, Company A wishes to disregard the tracing rules which attribute his/her: · stake in Company A to Company B by virtue of Company B being a widely held company · indirect stake of less than 10% to Company B by virtue of Company B being the top interposed entity · direct stake of less than 10% to the single notional shareholder Company A proposes to trace the above stake down to the individual for all test times. In respect of the trustee's stake, Company A proposes to disregard the tracing rules which attribute its: · stake in Company A to Company B by virtue of Company B being a widely held company · indirect stake of less than 10% to Company B by virtue of Company B being the top interposed entity · direct stake of less than 10% to the single notional shareholder. Company A proposes to attribute the above stake to the beneficiaries of the XYZ Trust by virtue of it being the top interposed entity at all test times. By disregarding the tracing rules the result of the modified COT would be as follows: Stakeholder % ownership maintained Single notional shareholder 48.7% Individual 0.55% Beneficiaries (XYZ Trust) 1.22% Total 50.37%

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 165 | Income Tax Assessment Act 1997 Division 166 | Income Tax Assessment Act 1997 section 165-12 | Income Tax Assessment Act 1997 section 165-150 | Income Tax Assessment Act 1997 section 165-155 | Income Tax Assessment Act 1997 section 165-160 | Income Tax Assessment Act 1997 section 165-165 | Income Tax Assessment Act 1997 section 166-3 | Income Tax Assessment Act 1997 subsection 166-5(3) | Income Tax Assessment Act 1997 subsection 166-15(1) | Income Tax Assessment Act 1997 section 165-145 | Income Tax Assessment Act 1997 section 166-225 | Income Tax Assessment Act 1997 section 166-230 | Income Tax Assessment Act 1997 subparagraph 166-230(1)(b)(ii) | Income Tax Assessment Act 1997 section 166-235 | Income Tax Assessment Act 1997 section 166-240 | Income Tax Assessment Act 1997 section 166-272 | Income Tax Assessment Act 1997 subsection 166-272(1) | Income Tax Assessment Act 1997 subsection 166-272(2) | Income Tax Assessment Act 1997 subsection 166-272(8) | Income Tax Assessment Act 1997 section 166-275 | Income Tax Assessment Act 1997 paragraph 166-275(a) | Income Tax Assessment Act 1997 paragraph 166-275(b) | Income Tax Assessment Act 1997 paragraph 166-275(c) | Income Tax Assessment Act 1997 subsection 995-1

Reasons for decision: Summary: Section 166-275 of the ITAA 1997 will take a company as meeting the conditions in (relevantly) section 165-12 of the ITAA 1997 where: · a tracing rule modified how the ownership tests in section 166-145 of the ITAA 1997 apply to the tested company in respect of a voting stake, a dividend stake or a capital stake (paragraph 166-275(a) of the ITAA 1997); and · the company fails the tests (whether at the time of applying the tracing rule or at another time) (paragraph 166-275(b) of the ITAA 1997); and · the company believes on reasonable grounds, that if the tracing rule did not modify how the tests apply to the company in respect of that stake, it would not fail the tests (paragraph 166-275(c) of the ITAA 1997). The term 'tracing rule' is defined by reference to specific provisions within Subdivision 166-E of the ITAA 1997 (relevantly) sections 166-225, 166-230 and 166-240 of the ITAA 1997. Company A proposes to apply the no-detriment rule in section 166-275 to stakes held by an individual and a trustee and trace down to the individual and the beneficiaries of the trust. By doing so, the individual would maintain 0.55% and the beneficiaries 1.12% ownership of Company A at all relevant times. The tracing rules listed below applied to the stake held by the individual at the following relevant times: · indirect stake held by a widely held company attributable to the widely held company (section 166-240 of the ITAA 1997) for test times prior to December 2009 (excluding December 2008) · indirect stakes of less than 10% attributed to top interposed entity (section 166-230 of the ITAA 1997) for the December 2008 test time; and · direct stake of less than 10% attributed to a single notional entity (section 166-225 of the ITAA 1997) for test times from December 2009 to 30 June 2012. The tracing rules listed below applied to the stake held by trustee at the following relevant times: · indirect/direct stake held by a widely held company attributable to the widely held company (section 166-240 of the ITAA 1997) for test times prior to December 2009 (excluding 10 December 2008) · indirect stakes of less than 10% attributed to top interposed entity (section 166-230 of the ITAA 1997) for the December 2008 test time; and · direct stake of less than 10% attributed to a single notional entity at December 2009, 30 June 2010 and November 2011 test times. It is clear from the text of section 166-275 of the ITAA 1997 and in considering subdivision 166-E of the ITAA 1997 as a whole that the intent is to maintain the concessionary operation of the tracing rules and ensure their application is not detrimental to the satisfaction of substantial continuity of ownership. The Explanatory Memorandum to Tax Laws Amendment (Loss Recoupment and Other Measures) Bill 2005 ('the EM') supports this. It states the following in respect of the no detriment rule: · the no detriment rule does not prevent other tracing rules from applying to the relevant stake(s) or the same tracing rule from applying to a different stake [1.135] · the no detriment rule merely allows tracing rules to be disregarded to the extent they cause a modified COT failure [1.135] · the belief on reasonable grounds will usually be formed by applying the substantial COT in the normal way without the use of that tracing rule in respect of that particular stake [1.136] · circumstances where the operation of a tracing rule could cause the ownership tests to be failed and, therefore, might trigger the no detriment rule include where variations in shareholders interests in the tested company raise above or fall below the relevant threshold in the test period (for example, a direct shareholder's interest in the tested company raises above or falls below 10%) [1.137]. | Detailed Reasoning - Paragraphs 16-275(a) and (b) of the ITAA 1997: A tracing rule has modified how the ownership tests in section 166-145 of the ITAA 1997 applied to Company A in respect of a voting stake and Company A has failed the ownership tests. The first two requirements of the no detriment rule are satisfied at this time. Should Company A have reasonable grounds to believe that by disregarding the tracing rules, they would have passed the ownership tests; the no detriment rule will be satisfied. | Detailed Reasoning - Paragraph 16-275(c): Under paragraph 166-275(c) of the ITAA 1997, if a company were to disregard a concessional tracing rule, it would have to demonstrate that it believes on reasonable grounds that, if the rule did not apply, it would not fail the COT in section 165-12 of the ITAA 1997. In establishing these reasonable grounds, Company A can apply the concessional tracing rules. Further, Company A can disregard not only a tracing rule that applies in relation to a particular stake, but also the same or a different concessional tracing rule that applies in relation to one or more other stakes. Subsection 166-5(3) of the ITAA 1997 provides that the conditions in section 165-12 of the ITAA 1997 will be met where Company A has maintained substantial continuity of ownership. The substantial continuity of ownership test is provided in section 166-145 of the ITAA 1997 and requires the use of the alternative tests in section 165-150, 165-155 and 165-160 of the ITAA 1997. To establish the reasonable grounds that it would not fail the ownership tests if the tracing rules did not apply, Company A has identified the stakes held by an individual and a trustee. In respect of the individual's stake, Company A wishes to disregard all tracing rule concessions that applied for the relevant period and trace through to the individual. In respect of the trustee's stake, Company A wishes to disregard all tracing rules concessions. This therefore requires consideration of the ultimate owner of the shares, which in this case would be the beneficiaries. By doing so, Company A has calculated that substantial continuity of ownership, determined in accordance with the alternative tests, has been maintained as follows: | Detailed Reasoning - Stakeholder % ownership maintained: Single notional shareholder 48.7% Individual 0.55% Beneficiaries (XYZ Trust) 1.12% | Detailed Reasoning - Total 50.37%: By disregarding the tracing rules that applied to the individual's stake (i.e. sections 166-225, 166-230 and 166-240), Company A has calculated the individual maintained a 0.55% stake over the test period. In respect of the Beneficiaries stake, Company A can disregard a tracing rule that applies to a stake if it has reasonable grounds to believe that if the tracing rule did not apply to the stake, it would not fail the ownership tests. By disregarding the tracing rule concessions that applied to trustee's stake (i.e. section 166-225, 166-230 and 166-240), and treating the Beneficiaries (XYZ Trust) as the top interposed entity under section 166-230(1)(b)(ii) of the ITAA 1936, the Beneficiaries (XYZ Trust) maintained a 1.12% stake. Company A has demonstrated on reasonable grounds that, if the tracing rules did not apply, it would not fail the COT in section 165-12 of the ITAA 1997. Paragraph 166-275(c) of the ITAA 1997 is satisfied. Same share same interest rule - section 166-272 As previously stated, the same share same interest rule in Division 166 of the ITAA 1997 applies in limited circumstances. Relevantly, it applies to the trustee's stake as a top interposed entity. Broadly stated, the rule in subsection 166-272(2) of the ITAA 1997 requires only the same shares/interests to be taken into account when determining substantial continuity of ownership. The savings provision in subsection 166-272(8) of the ITAA 1997 will apply to take the substantial continuity of ownership as being satisfied.