Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)CHANGE OF TITLE - TAX LAW IMPROVEMENT BILL (No. 1) 1998 - SENATE - Explanatory Memorandum.
Chapter 2.25 - Company net capital losses
Overview
This segment covers the rules for company net capital losses in Divisions 165, 170 and 175 of the 1997 Act.
Part A summarises these rules.
Part B explains the changes to the 1936 Act.
Part C explains why some provisions of the 1936 Act have not been rewritten.
A. Summary of the new law
Subdivision 165-CA: Applying net capital losses of earlier income years
Subdivision 165-CA makes the ability of a company to set off a net capital loss of an earlier income year against capital gains in a later year subject to the same conditions that it must satisfy to deduct a tax loss of an earlier income year.
A company cannot apply a net capital loss of an earlier year unless:
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- it has the same majority ownership and control throughout the loss year and the income year; or
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- it carried on the same business and did not enter into new kinds of business or transactions.
[subsection 165-96(1)]
Subdivision 165-CB: Working out the net capital gain and net capital loss for the income year of change
Subdivision 165-CB requires a company to work out its net capital gain and net capital loss differently for a year in which it has not had the same majority ownership and control and does not satisfy the same business test.
A company must work out its net capital gain and net capital loss under this Subdivision
- •
- if it is required to calculate its taxable income and tax loss under the special rules for the income year of change (Subdivision 165-B); or
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- if it would have been required to do so except for its not having made a notional loss in any of the periods into which the year was divided.
[section 165-102]
Did the company have a notional net capital loss in a period?
The year is divided into periods according to the same rules as those that apply for working out the companys taxable income and tax loss for the year of change.
A company has a notional net capital gain for a period if the capital gains it makes during the period exceed its capital losses. If the capital losses exceed the capital gains, it has a notional net capital loss. [sections 165-105 and 165-108]
A company makes a net capital gain
equal to the excess of its notional net capital gains for the year over any available net capital losses of earlier years. [section 165-111]
A company makes a net capital loss
equal to the sum of its notional net capital losses for the year. [section 165-114]
Subdivision 170-B: Transfer of net capital losses within wholly-owned groups of companies
Subdivision 170-B has rules that apply where a company transfers an amount of net capital loss to another company.
A resident company with a net capital loss (the loss company) can transfer all or part of it to another resident company (the gain company) if the companies are members of the same wholly-owned group during:
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- the income year in which the net capital loss was made; and
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- the income year for which the net capital loss is transferred; and
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- any intervening year.
[sections 170-110 and 170-130 and subsections 170-135(1) and 175-140(1)]
The gain company is taken to have made the net capital loss in the year in which it was made by the loss company. [section 170-120]
The gain company must apply the net capital loss immediately. [subsection 170-115(1)]
Companies that have share or debt interests in the loss company or the gain company, including interests acquired indirectly through other companies, will have the cost bases of those interests adjusted in specified circumstances. [sections 170-175 and 170-180]
Limits on the amount transferred
The amount to be transferred cannot exceed:
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- the amount the loss company would otherwise carry forward to the next year;
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- the amount that the gain company can apply in the year of the transfer; or
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- the sum of the cost bases of the share and debt interests of members of the wholly-owned group in the loss company.
[section 170-145]
The order in which net capital losses may be transferred
Capital losses are transferable in the order in which they were made. [section 170-155]
Any payment made for the transfer:
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- is not assessable income, exempt income or a source of a capital gain to the loss company; and
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- is neither a deduction nor a source of a capital loss to the gain company. [section 170-125]
A transfer can only take place under a duly made written agreement. [section 170-150]
Subdivision 175-CA: Tax benefits from unused net capital losses or earlier income years
Subdivision 175-CA specifies circumstances in which the Commissioner may disallow the application of a net capital loss of an earlier year.
The Commissioner can do this if:
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- a capital gain was injected into the company because the net capital loss was available (but not if the continuing shareholders benefit); or
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- someone would obtain a tax benefit in connection with a scheme entered into because the net capital loss was available (unless the benefit is fair and reasonable in view of the persons shareholding).
[sections 175-45 and 175-50] his sanction is not applied if the company fails to maintain the same majority ownership but satisfies the same business test. [subsection 175-40 (2)]
Subdivision 175-CB: Tax benefits from unused capital losses of the current year
Subdivision 175-CB deals with situations where the Commissioner may disallow the application of some or all of a capital loss made during the year.
The Commissioner can disallow the application of some or all of a capital loss made during the year if:
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- a capital gain was injected into the company because the capital loss was available (except to benefit continuing shareholders);
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- the capital loss was injected because a capital gain was available to absorb the loss (except where continuing shareholders benefit);
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- someone would obtain a tax benefit from a scheme entered into because the company had made a capital loss (unless the benefit is fair and reasonable in view of the persons shareholding); or
- •
- someone would obtain a tax benefit from a scheme entered into because the company had made a capital gain before it made the capital loss (again unless the benefit is fair and reasonable based on the persons shareholding).
[sections 175-60, 175-65 and 175-70]
B. Discussion of changes
Section 170-125 Tax treatment of consideration for transferred loss
A subvention payment made by the gain company will be neither assessable income nor exempt income of the loss company. Nor will it cause a capital gain to be made by the loss company.
Under the existing law, such a receipt is specifically prevented from being income or the source of a capital gain only where the loss company is a shareholder in the gain company.
The change aligns the treatment of subvention payments for net capital losses with that of subvention payments for tax losses.
Section 170-135 The loss company
Section 170-140 The gain company
These sections state conditions that must be satisfied by the companies between which the loss is transferred.
Clarify that the loss company must be an Australian resident throughout the loss year and that the gain company must be an Australian resident throughout the year for which the loss is to be applied.
The existing law requires these companies to be Australian residents but is not explicit as to when they must be Australian residents.
Section 170-150 Transfer by written agreement
This section will set out the requirements for an agreement transferring a net capital loss.
The time for making an agreement has been extended to include the day on which the gain company lodges its income tax return for the year in which the transferred net capital loss is applied.
The existing law requires the agreement to be made before that date. It is usual for such deadlines to conclude on or before the specified date.
It has been made explicit that the agreement must specify the amount being transferred.
It is implicit in the existing law that an amount will be specified in the transfer agreement. The change aligns with the specified requirements for agreements to transfer revenue losses.
Section 170-170 The gain company cannot transfer a previously transferred net capital loss
It has been made explicit that the gain company cannot transfer to another company any part of a net capital loss that is transferred to it.
This condition is implicit in the existing law.
C. Provisions of the old law that have not been rewritten
The following provision of the existing law have not been rewritten:
| Provision | Subject | Reason for omission |
|---|---|---|
| Section 160JA | Interpretative provisions for company net capital losses. | The 1997 Act uses its own terms. |
| Subsection 160ZP(5) | Definition of agreement for the purpose of determining whether a company may be disqualified from being a member of a wholly-owned group. | Covered by the definition of when a person is in a position to affect rights of a company in the 1997 Act. |