Taxation Ruling

IT 2013

Taxation (unpaid company tax) treatment of carry-forward losses and investment allowance

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FOI status:

May be releasedFOI number: I 1070340

PREAMBLE

The broad aim of the Taxation (Unpaid Company Tax) legislation is to provide a formal means for the collection of the unpaid ordinary and undistributed profits tax payable by companies stripped of pre-tax profits. The legislation seeks to do this by allocating to the vendor-shareholders and other former owners of the companies, and those who purchased the companies and their associates, a share of the unpaid company tax.

2. Sections 15 and 18 of the T(UCT) Assessment Act require that a representative class of former owners of a company which has been sold to a scheme promoter and stripped its assets be notified of the target company's liabilities under the Income Tax Assessment Act before recoupment tax assessments can be raised. This necessitates the issue of the target company's notices of assessment or copies thereof to the members of this representative class who can then choose whether they will contest the assessment. It also provides the former owners with an opportunity to prevent the raising of recoupment tax assessments by paying the outstanding company tax.

3. Not all amounts shown as payable in the company notices of assessment of ordinary and undistributed profits tax will be included in recoupment tax assessments. For instance, additional tax payable by the company under section 226 of the Income Tax Assessment Act will not be recoverable under the T(UCT) legislation (see definitions of "ordinary company tax" and "undistributed profits tax" in section 3(1) of T(UCT) Assessment Act). Moreover, additional tax payable by the company under section 207 of the Income Tax Assessment Act will also be excluded except to the extent that it is in respect of a period commencing 30 days after service of the company notice of assessment or copy thereof in accordance with sections 15 and 18 of the T(UCT) Assessment Act (see section 3(11) of T(UCT) Assessment Act). Further, certain deductions may not be allowable in the company assessment but may be able to be taken into account under the T(UCT) Assessment Act in the calculation of the recoupment tax liability. In this context branch offices have raised the question of how carry-forward losses and investment allowance claims are to be treated both in raising company assessments under the Income Tax Assessment Act and in applying the provisions of the T(UCT) Assessment Act. The purpose of this ruling is to provide guidelines regarding the approach to be taken in these matters.

RULING

4. In raising company assessments for service on the representative class in accordance with sections 15 and 18 of the T(UCT) Assessment Act the relevant provisions of the Income Tax Assessment Act are applied in the ordinary way and the company notices of assessment will reflect the allowance or disallowance as appropriate of claims in respect of carry-forward losses and investment allowance. The following general observations should however be noted.

Carry-forward Losses

The Company Assessment

5. By way of introduction, the carry-forward loss provisions of the Income Tax Assessment Act are set out in sections 80 to 80F inclusive. The basic framework of those provisions is that subject to a time limit of 7 years carry-forward losses will be deductible if the company seeking the deduction complies with either the continuity of beneficial ownership test in section 80A or the continuity of business test in section 80E.

6. To satisfy the continuity of beneficial ownership test it must be shown that shares carrying more than 50% (40% in relation to the 1972 year of income) of the voting, dividend and capital rights in the company seeking the deduction were beneficially owned at all times during the year of income in which the loss is claimed by persons who at all times during the year in which the loss was incurred beneficially owned shares in the company carrying between them rights of that kind.

7. The same business test in section 80E is drafted on the basis that a disqualifying change in ownership has occurred. Against this background it provides that carry-forward losses will be deductible where at all times during the year of income in which the loss is claimed the company carried on the same business as it carried on immediately before the disqualifying change in ownership, and did not derive income from a business of a kind that it did not carry on, or form a transaction of a kind that it had not entered into in the course of its business operations, before the change took place.

8. Where, as generally was the case, all of the shares in the target company were sold to a promoter at the same time, and prior to the end of the year of income, the continuity of beneficial ownership test in section 80A of the Income Tax Assessment Act will not be satisfied. Moreover, since target companies almost invariably were cashed up at some time prior to their sale to a promoter they will not have carried on at all times during the year of income the same business as required by section 80E of the Income Tax Assessment Act. Accordingly it is expected that, in the majority of cases, carry-forward losses will not be deductible in a target company's assessment for the year of income during which it was sold to the promoter. This cannot, however, be stated as a hard and fast rule and each case will have to be considered on its own particular facts.

Application of the Formula A-(L+T)

9. The T(UCT) legislation only applies where the consideration paid for the sale of the shares in a target company was greater than the net assets of the company taking into account all existing and potential liabilities for ordinary and undistributed profits tax, it being obvious in those circumstances that the tax liabilities of the company would not be met. This test is encapsulated in the formula A - (L + T) where A represents the total assets, L represents the total liabilities and T represents the existing and expected tax liabilities (sections 5(1) (d) and 5(2)(d) of the T(UCT) Assessment Act). Sections 5(7) and 5(9) have the effect that in applying the formula the tax payable for the year in which the company was sold to a promoter is to be ascertained on the basis that the year of income ended immediately before the last parcel of shares was sold to the promoter. Given that, generally speaking, all of the shares in target companies are sold to the promoter at the same time, and assuming there have been no disqualifying changes in beneficial ownership prior to that sale, the continuity of beneficial ownership test in section 80A of the Income Tax Assessment Act will be met during the abbreviated year of income contemplated by section 5(9)(c). Further, where the shares were sold in parcels and the last parcel represented at least 50% of the voting, dividend and capital rights (40% is the relevant percentage for the 1972 year of income) the continuity of ownership test would also be met. Accordingly it can be expected that in the vast majority of cases carry-forward losses will be taken into account in applying the formula.

10. Where the continuity of beneficial ownership test is not met regard will have to be had to the continuity of business test in section 80E of the Income Tax Assessment Act. The cashing up characteristic of pre-tax profit stripping would result in target companies failing to satisfy the same business test even in relation to the abbreviated year of income. Exceptional cases may arise, however, where companies were not cashed up prior to sale to the promoter and these will have to be considered on their own particular facts.

11. In applying the continuity of beneficial ownership test it may also be necessary in a very exceptional case where the requirements of section 80A of the Income Tax Assessment Act have been met to also consider sections 80B(5) and 80DA.

The Basis for the Calculation of Recoupment Tax

12. Section 3(10) of the T(UCT) Assessment Act has the effect that in selecting the basis for recoupment tax in any given case a comparison is made between the amount of tax payable for the whole of the year of income and the amount payable in respect of the year of income abbreviated to immediately prior to the sale of the last parcel of shares to a promoter. The lesser amount will be the basis for recoupment tax.

13. For the reasons set out in paragraph 8 above it is expected that carry-forward losses will generally not be available in ascertaining the tax liability for the full year. In relation to the abbreviated year of income it is considered that, for the reasons mentioned in paragraph 9 above, in the majority of cases carry-forward losses will be available. Again it must be stressed that this is a generalisation and specific cases may, on their facts, warrant a different conclusion.

Investment Allowance

The Company Assessment

14. Section 82AG(1) of the Income Tax Assessment Act provides that the investment allowance is not available if, inter alia, before the expiration of 12 months after the property was first used, or installed ready for use, the taxpayer disposed of the property. It is typical of pre-tax profit strips that the operating assets of a trading company are sold to a new trading entity as part of the cashing up of the target company. Where the operating assets include property eligible for investment allowance and those assets are sold to a new trading entity within 12 months of the eligible property first being used or being installed ready for use, section 82AG(1) of the Income Tax Assessment Act would withdraw the entitlement to investment allowance unless section 82AJA applies. Since section 82AJA only applies to public companies and their subsidiaries, in the vast majority of cases where the eligible property is sold within the 12 month period the target company will not be entitled to a deduction for investment allowance in its assessment.

Application of the Formula A-(L+T)

15. The abbreviation of the year of income to immediately prior to the sale of the last parcel of shares in a target company to a promoter will not affect the operation of section 82AG(1) of the Income Tax Assessment Act. This is due to the specific terms of section 82AG(1) which refer to the sale of eligible property within 12 months of it first being used or installed ready for use. Whether or not the investment allowance is to be taken into account in the application of the formula will depend on whether the eligible property was sold within the statutory 12 month period. The comments expressed above in relation to the operation of sections 82AG(1) and 82AJA in the context of raising company assessments (paragraph 14) are equally applicable here. Consequently, where section 82AG(1) applies the investment allowance will not be taken into account in the application of the formula A-(L+T).

The Basis for Calculation of Recoupment Tax

16. The matters discussed in paragraph 15 in relation to the application of the formula apply with equal force to the determination of the basis for the calculation of recoupment tax with the result that, unless section 82AJA applies, investment allowance cannot be taken into account in ascertaining the recoupment tax liability.

17. The fact that the application of the carry-forward loss provisions will produce different results in relation to the company assessment on one hand and the basis for recoupment tax on the other means that Branch Offices must ensure that the covering letters issuing to vendor shareholders with the company notice of assessment (or copy thereof) include an explanation in this regard.

COMMISSIONER OF TAXATION
4 February 1983

References

ATO references:
NO J 209/110/1 P2 F27
BO SYD 13/SCCUAF 4064/5/1

Subject References:
T(UCT)
CARRY FORWARD LOSSES
INVESTMENT ALLOWANCE

Legislative References:
T(UCT)AA 5
T(UCT)AA 3(10)