Tax benefits from unused company tax losses

Will section 175-10 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to deny a deduction to a company for losses carried forward against distributions of income received from a discretionary trust that is controlled by the shareholders (individuals) of the company?

No. Pursuant to subsection 175-10(2) of the ITAA 1997, it is considered to be fair and reasonable for the Commissioner to allow a deduction to the company for losses carried forward against distributions of income from a trust which is controlled by the shareholders (individuals) of the company.

All shares of the company have been held equally by two individuals since its incorporation. All shares on issue carry the same rights.

The company recently sold its business to a non-related purchaser and presently has carried forward losses.

The property from which the company formerly conducted its business is owned by a related discretionary trust (Trust) that is controlled by the same two individuals. This property is now rented to the purchaser of the business and generates the main income of the Trust.

The shareholders of the company have been the only beneficiaries of the Trust. The trustee is to distribute all future net income of the Trust to the company which is to claim a deduction for carried forward losses against this income.

The existing shareholders rights and interests in the company are to remain unchanged.

Subdivision 175-A of the ITAA 1997 contains various anti-avoidance rules relevant to prior year losses.

Section 175-10 of the ITAA 1997 outlines the first case for denying a deduction where income is injected into company because of the available tax loss

Subsection 175-10(1) of the ITAA 1997 provides that the Commissioner may disallow a deduction for a prior year tax loss in an income year in which the company derives income which it would not have derived if the loss had not been available.

The company has prior year losses and will claim deductions to the extent of these losses against distributions of income from a related trust.

However, under subsection 175-10(2) of the ITAA 1997 the Commissioner cannot disallow a deduction for a prior year tax loss if the continuing shareholders will benefit from the derivation of the injected amount to an extent which the Commissioner considers is fair and reasonable. In determining this, the Commissioner must have regard to the continuing shareholders respective rights and interests in the company.

There is to be no change in either the shareholders themselves or their 100 per cent continuous holding of shares in the company. The benefit from this injection of income will flow only to persons who were shareholders during the years in which the losses were incurred by the company (i.e., the continuing shareholders). This continuous shareholding is to remain unchanged for the period in which deductions for losses will be claimed.

The Commissioner has determined that it is fair and reasonable to accept that the continuing shareholders will benefit from the injection of funds in proportion to their respective rights and interests in the company. Therefore subsection 175-10(1) of the ITAA 1997 cannot apply to enable the Commissioner to disallow a claim by the company for prior year tax losses. (Note : Subdivision 175-A sets out two cases where the Commissioner may disallow a tax loss. This ATO ID deals only with section 175-10. Section 175-15 of the ITAA 1997 must also be considered. See the related ATO ID on the operation of section 175-15 of the ITAA 1997.)