Companies incur tax losses from time to time and would benefit from being able to use these losses to reduce future income. Generally speaking, a company can carry forward a tax loss indefinitely and choose when to apply losses to taxable income. However, there are certain rules that must be satisfied before a loss can be recouped. With new legislations introduced into parliament, it is time to recap the company loss recoupment rules and how the new rules have an impact.
Companies can only use carried forward tax losses to offset current year taxable income if they satisfy one of the following tests:
Continuity of majority ownership test
Same business test
CONTINUITY OF MAJORITY OWNERSHIP TEST (COT)
The continuity of majority ownership test is satisfied when the same people between them hold more than 50% of voting power and dividend and capital rights at all time during the test period, which is between the start of the loss year and the end of the year in which losses are being deducted.
When applying this test, the company must look through any interposed companies or trusts to find the natural persons who exercise the ultimate voting control and have the ultimate right to receive the dividends and capital distributions.
SAME BUSINESS TEST (SBT)
When the continuity of majority ownership test is failed, the same business test can be used as an alternative test. This test requires that the same business is carried on by the company during the year of loss recoupment as immediately before the test time which is generally the time at which continuity of majority ownership test is first failed.
However, there is no clear interpretation of the term “same business” in the legislation. Even though the ATO ruling indicates that ‘organic growth of a business through the adoption of new compatible operations will not ordinarily cause it to fail the SBT provided the business retains its identity’, this should be relied on with caution as some expansion or contraction may lead to the failure of the SBT.
When determining whether the company is taken to be carrying on the same business, the ATO will look at factors such as the brand, products and services being supplied, manufacturing activities, the market, change in business location, the scale of the business and etc.
SIMILAR BUSINESS TEST
In order to encourage companies to explore new profit making activities without failing the same business tax and lose valuable tax losses, the government has introduced the new ‘similar business test’ to supplement the existing same business test and provide better flexibility. The new test can be retrospectively applied to losses incurred from 1 July 2015. It looks at the extent:
To which same assets are used to generate income
To which same activities and operations are used to derive income
To which identity of the business is maintained
Of development of former business
Although the similar business test has been designed as a more flexible test, there are still uncertainties in the application. It will be a question of fact and degree as to how similar the business needs to be in order to pass the test. This will require a comparison and weighing up of each of the factors. The relative importance of each of the factors will determine if the test has been met on an overall basis. Applying the similar business test is, therefore, in practice, prone to some subjectivity.
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