Among the first batch of tax legislation the government dealt with in the new year was Treasury Laws Amendment (2017 Enterprises Incentives No.1) Bill, legislation that contained changes to the “same business” test.
It sees the “same business test” supplemented with a more flexible “similar business test” to work out whether a company’s income tax losses and net capital losses from prior income years can be carried forward and used as a tax deduction in the current income year. The rationale for the change is that the same business test is considered too restrictive – stifling innovation in the economy.
In the most part, this stemmed from the test being interpreted very narrowly. Courts and the ATO generally held that “same” did not mean “similar”. The inability to utilise losses where a company has entered into new types of transactions or business activities can inhibit a company’s ability to grow. This in turn discouraged companies that had made losses from seeking new investors or exploring new profit-making activities because they may have lost access to these valuable past year losses.
This can disadvantage start-ups and smaller companies, who may only have one income stream, as opposed to larger, established businesses that may have multiple streams of income.
The new relaxed test applies to losses made in income years commencing from 1 July 2015.
The “similar business test” also helps work out whether a debt written off as bad can be deducted in an income year, and whether tax losses of listed widely held trusts can be used.
The government says the similar business test will encourage entrepreneurship by allowing companies to use losses in a wider range of circumstances and will encourage companies to “seek out new opportunities, and hopefully return to profitability”.
However the new test will still be required to meet four factors, including:
- the extent to which the assets (including goodwill) used to generate income were also used formerly
- the extent to which the activities and operations were also the same with the previous business
- the identity of the current business and the identity of the former business, and
- the extent to which any changes to the former business resulted from the development or commercialisation of assets, products, processes, services, or marketing or organisational methods, of the former business.
Note that the new measure is not a free-for-all however. Guidance issued by the ATO indicates that it will not be enough if a business is of a similar “type” to a previous business. It says a business is “similar” where there is an element of continuity, and that it has evolved or organically grown over time without changing its core identity or core source of income. It may not be sufficient that the change in business is a “reasonable” business decision or one that makes commercial sense if there is no continuity of the original business.
While entering a new business or new transaction may not necessarily cause the similar business test to fail (as it has been known to with the previous “same business” test) the new test may be more difficult to satisfy if substantial new business activities and transactions do not evolve from and complement the former business.
- More clients will now be able to carry forward losses because the similar business test – particularly the removal of the two negative limbs – is much more flexible than the same business test.
- As the law is backdated to 1 July 2015, companies and widely-held trusts that have undergone a change of ownership should review their eligibility for carrying forward prior year income and capital losses from that date onwards. They should also review whether bad debts initially incurred prior to a change of ownership or control can be written off.
- Under the new law, companies are now more free to innovate and adapt to changes in the economy or in their industry, and to enter into new kinds of transactions or businesses without disadvantaging themselves from a tax perspective.
- The similar business test, while more flexible, is more complex. It will be a challenge for tax agents to sit down and work out whether, on the facts at hand, the test is met by reference to the four factors. For this reason, tax agents may wish to seek a private ruling in complex cases.