Heavy lifting

Special rules to prevent company owners carrying tax losses forward from one company to another are much more complex than they first appear. ROBERT RICHARDS explains.

By Robert Richards

Carrying over tax liabilities

Special rules to prevent company owners carrying tax losses forward from one company to another are much more complex than they first appear.

There is a general rule that taxpayers can carry losses forward indefinitely for offset against any of their assessable income.

But that general rule is subject to special rules to prevent “trafficking” in loss-making companies and trusts.

When it comes to such companies, there are two prime tests that need to be applied. The first is the “continuity of ownership” test. This requires the same people to own more than 50% of the company’s voting power, 50% of the rights to dividends the company might pay, and a right to 50% of any possible capital distributions, from the start of the loss year through to the end of the income year.

There are also anti-avoidance provisions designed to prevent people effectively disposing of shares while retaining nominal ownership of the shares. However, all is not lost where a company fails the continuity of ownership test. This is because a company will not be prevented from carrying forward losses if, having failed the continuity of ownership test, it then satisfies the “same business test”.

But if you thought this provision was relatively straightforward, think again. The same business test actually consists of two separate sub-tests. The first is that the company must have carried on throughout the year of income the same business as it carried on immediately before it failed the continuity of ownership test.

The second is that the company must not have at any time during the income year derived assessable income from a business of a kind that it did not carry on before failing the continuity of ownership test. Nor can it have derived income from a transaction of a kind that it had not entered into in the course of its business operations before it failed the continuity of ownership test.

As a matter of practice, unless a liberal interpretation is given to the word “same”, as used in the first sub-test, it might be very hard to pass the same business test. That is, once a company starts to make losses, it is hardly likely to carry on its business exactly as it did while it was making those losses. Unless it makes changes, it is likely to make further losses. Getting an unprofitable business to become profitable necessarily involves some changes.

Yet in Avondale Motor (Parts) v Federal Commissioner of Taxation (High Court, 21 May 1971) the High Court took a very strict, and one might say totally unrealistic, interpretation of the same business test. There, Justice Gibbs said: “The business carried on at all times during the year of income should be the same business; mere similarity of kind is not enough.” There the taxpayer was held not to be carrying on the same business because its name, staff, stock and franchise had all changed.

Not many “same business” test cases are considered by the courts. But there was one last July – Lilyvale Hotel v Federal Commissioner of Taxation, Federal Court, 10 July 2008.

This case illustrates that the starting point to deciding whether the same business test has been met or not is to determine the business of the taxpayer company.

Lilyvale owned a hotel at The Rocks in Sydney. Originally the hotel was known as the ANA Hotel Sydney. Following a change in the ownership of the company, which caused it to fail the continuity of ownership test, the hotel became known as the Shangri-La Hotel.

Like most taxpayers, when I see the name of a hotel change I assume that it has new managers and that despite this, and accompanying cosmetic changes, nothing else has changed. This was the case here. But it is not enough to say, in the present case, that Lilyvale’s business was the ownership of a hotel. There was more to it than that.

It came down to the question of how the hotel was managed. Before the change in the company’s ownership, the hotel was managed by ANA Enterprises Australia. After the sale of the company, Lilyvale terminated its agreement with ANA Enterprises and appointed its own general manager.

Justice Stone, who had heard the matter, concluded that Lilyvale failed the same business test. Effectively, she said that Lilyvale’s business, before the change of ownership, was not just that of owning a hotel but of contracting the management of it.

She said: “The same business test requires, however, not merely that the same business be carried on, but that it be carried on by the taxpayer, in this case Lilyvale. I accept that after the share sale, Lilyvale carried on the business of managing the hotel. The critical question remaining is whether the business that Lilyvale carried on before the share sale is properly characterised as the business of managing the hotel in the same way that the business it carried on after the share sale can be characterised.”

Accordingly, Stone concluded that while it was true that Lilyvale’s income (on which it was liable to income tax) was sourced from the hotel, it was the activities of Enterprises Australia that generated that income.

She said that Lilyvale’s involvement in the business of the hotel was so distant from the day-to-day activities of the hotel that, in her view, the course of conduct carried on in the hotel, bearing in mind the notions of continuity and repetition, could not be said to be the conduct of Lilyvale. I do not yet know whether or not that decision will be appealed, but my guess is that it will be.

However, whether the decision is right or wrong, it illustrates a stark point – the same business test is an uncommercial test.

I suspect it is because it is to the tax office’s advantage to have such imprecise legislation. In practice, imprecise tax legislation is simply another way of conferring a discretion on the taxman.

Changing the name and management of a hotel could see it fail the “same business” test.


Robert Richards CPA is a solicitor specialising in tax matters.

This article first appeared in CPA Australia’s magazine, INTHEBLACK.


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