Companies carrying forward tax losses from a prior year must satisfy the ATO’s “continuity of ownership test” (COT) or, if unable to do so, the “same business test” (SBT) for losses to be deductible against assessable income of future years.
The SBT provisions contained in Division 165 of ITAA97 are drafted narrowly and therefore companies subject to the SBT are often required to interpret “same” in circumstances where there is limited guidance by way of case law and ATO commentary is general in nature. The most detailed SBT comments provided by the ATO are contained in tax ruling TR 1999/9.
For a company to satisfy the SBT requirements, it is necessary that the same business be carried on during all of the income year of recoupment (the same business test period) as was carried immediately before the “test time”. The test time is defined in s165-13 (2) as:
- the time at which COT is first failed, or
- where the time at which COT is failed cannot be identified, at the start of the loss year, or
- if the company came into being during the loss year and the time at which COT is failed cannot be identified, at the end of the loss year.
Elements of the test
There are three elements to the SBT, all of which must be satisfied:
- the same business test – at all times during the income year, the company must carry on the same business as was carried on immediately before the test time
- the new business test – the company must not, at any time during the income year, derive assessable income from a business of a kind not carried on before the test time
- the new transaction test – the company must not, at any time during the income year, derive assessable income from a transaction of a kind not entered into in the course of its business operations before the test time.
The ‘same’ business test
There is no legislative direction as to the meaning of “same” and therefore the term takes on its ordinary meaning. In tax ruling TR 1999/9, the ATO has expressed the following view:
… the meaning of the word ‘same’ … 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 change-over.
Nevertheless, it is not sufficient that the business carried on after the change-over meets some industry wide definition of a business of the same kind; … the analysis of whether the same business continues after the change-over may give rise to questions of degree and ultimately depends on the facts of the case.’
It is clear that no precise rules can be laid down to assist with interpretation of the term “same business”. Observations made by the ATO in TR 1999/9 provide insight into the Commissioner’s approach.
Expansion or contraction of activities
The 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; nor would discarding, in the ordinary way, portions of its old operations.’
However, these general views should be approached with caution as the ruling contains reference to a number of scenarios where expansion or contraction may in fact lead to a failure of SBT.
There is no guidance in TR 1999/9 as to the extent of expansion or contraction that might occur without failing SBT.
Example 14 in the ruling deals with a company that operates a chain of hamburger stores. The company experiences financial difficulties and, after becoming subject to SBT, “is obliged to close all but a few of its stores”. The ruling indicates that SBT would be failed as the ongoing business is only a “minor component” of the original business. As typically occurs in SBT cases, the taxpayer must do their best to assess whether the degree of change that has occurred to a business is sufficient for SBT to be failed.
Other factors that might be relevant
The ruling acknowledges that changes may occur to a business; it does not have to be identical in every respect. However, the ATO view is that “the identity of the business” must not change (refer paragraph 38 of TR 1999/9).
A key aspect of the analysis is to identify the business that is being carried on at the “test time” in order to ascertain whether the same business is being carried on during all of the “same business test period”. The ruling emphasises that in order to identify the business, it is necessary to consider all activities carried on, rather than just the core activities (refer paragraph 34).
By way of illustration, the ruling notes many factors that may require consideration in order to determine SBT compliance, including:
- any changes in products or services supplied
- any change in manufacturing activities, eg some outsourcing
- the market into which products or services are sold
- changes in the methods of selling
- changes in location of the business
- changes in intellectual property utilised by the business, and
- reductions or increases in the number of employees and changes in the services they perform.
It is important that a company seeking to satisfy SBT is not dormant at any stage during the test time and the same business test period. If this were to occur, it is likely that SBT would be failed due to the same business not being carried on at all relevant times (refer Avondale Motors (Parts) Pty Ltd v FCT 71 ATC 4101 and Northern Engineering Pty Ltd v FCT 80 ATC 4025).
The new business test
This is a negative test in that the company must not derive assessable income from a business of a kind not carried on before the test time. The business of a company may consist of a number of different enterprises and therefore if a new enterprise is commenced during the same business test period, the relevant question is whether, after adding the new enterprise, the overall business of the company remains the same. Paragraph 71 of TR 1999/9 puts it in these terms:
… where a taxpayer acquires or commences a new undertaking and amalgamates it in its overall business, the question posed by the legislation . . . is whether the amalgamated business is the same business as the business carried on by the taxpayer immediately before the change-over and, second, whether the new undertaking was of the same kind as the undertakings of that business.
Example 6 in the ruling considers a company carrying on an open cut iron ore mining business. Following a substantial change in shareholding, the company discovers gold on its existing mining lease and subsequently commences to mine and sell gold. The ruling concludes that the new business test would be failed.
The new transaction test
This is a further negative test in that the company must not derive assessable income from a transaction of a kind not entered into in the course of its business operations before the test time. The provision is drafted in a manner that would give it wide application and the potential to cause SBT failure where minimal change may have occurred to the business. The ATO approach in these circumstances can be succinctly summarised from paragraph 15 of TR 1999/9:
The new transaction test includes all transactions entered into in the course of the company’s business operations and not merely those that are ‘isolated’ or ‘independent’. However, generally speaking, the new transactions test is not failed by transactions of a type that are usually unmotivated by tax avoidance, namely, transactions that could have been entered into ordinarily and naturally in the course of the business operations carried on by the company before the change-over.
While the apparent limiting of the circumstances in which the Commissioner would apply the new transaction test is welcome, care should be exercised by taxpayers as use of an expression such as “generally speaking” and the relevance of motive to a decision as to whether the test should be applied, provides the Commissioner with considerable flexibility.
The law contains no de minimus exclusion and therefore any amount of income from a “new transaction” could technically result in SBT being failed. However, in J Hammond Investments Pty Ltd v FCT 77 ATC 4311, the court disregarded an amount of $160 on the basis that amounts which are so insignificant as to be negligible should be disregarded.
An anti-avoidance provision is contained in subdivision 165-E that is designed to thwart attempts to satisfy SBT by altering, in advance of a change in ownership which will trigger a failure of COT, the business that is being carried on by the company. Such a change might otherwise result in the same business as is being carried on at the test time being carried on during the same business test time.
Subsection 165-210 (3) will apply and cause SBT to be failed, where prior to the “test time” the company:
- started to carry on a business it had not previously carried on, or
- 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 the same business to satisfy the SBT.
There is no requirement that a purpose of achieving SBT compliance be the dominant purpose behind changes that may occur to a company’s activities in advance of a change in ownership; it is merely necessary that such a purpose be identifiable, albeit ancillary to the dominant purpose.
Tax consolidated groups
The ATO approach to the application of the SBT rules to tax consolidated groups is contained in TR 2007/2. The ruling applies, in the context of a consolidated group, all of the fundamental principles adopted in TR 1999/9.
Under the “single entity rule”, the subsidiary members of a group are considered part of the head company for SBT purposes and therefore the “business” of the head company will be determined after considering all of the enterprises and activities carried on:
- at the test time – by all members of the group, and
- during the SBT period – by all entities while they were members of the group.
For the purposes of the new business test and the new transaction test, it is also necessary to compare the enterprises and activities of group members up to the test time with those occurring during the same business test period. It is not necessary, however, that a business or transaction be carried on by the same group member both before and after the test time.
The compliance challenge
The SBT legislation, while drafted in simple terms, can present difficulties for taxpayers endeavouring to apply the law in practice.
When determining SBT compliance, it is necessary to consider in detail all of the activities that make up the business of the company, and the means by which that business is conducted.
Many situations will arise where difficult judgments are required to be made. In these circumstances taxpayers might consider approaching the ATO for a private ruling, or formally developing a “reasonably arguable position” in support of deductions claimed for losses carried forward from a prior year.