Issue
In applying subsection 165-12(7) of the Income Tax Assessment 1997 (ITAA 1997) does the amount of capital loss made in respect of a CGT event, in relation to an equity interest in the Loss Company, constitute an upper limit on the extent that the particular CGT event may have 'reflected' the tax loss?
Decision
No. The CGT event may also further reflect the tax loss through reduced assessable income resulted from the tax loss due to a capital gain that otherwise would have been made not happening because of the tax loss incurred by the Loss Company.
Facts
Loss Company seeks to deduct a tax loss that it had incurred in an earlier income year.
The tax loss cannot be deducted as the conditions in subsections 165-12(2), 165-12(3) and 165-12(4) of the ITAA 1997 are not satisfied, only because of the operation of section 165-165 of the ITAA 1997.
During the relevant 'ownership test period' as defined in subsection 165-12(1) of the ITAA 1997, Company K disposed of a direct equity interest in Loss Company, as defined in paragraph 165-12(9)(a) of the ITAA 1997. The disposal resulted in CGT event A1 happening under section 104-10 of the ITAA 1997.
The reduced cost base of that equity interest, as at the time of the CGT event, was $800 for the purposes of section 110-55 of the ITAA 1997. The cost base of the equity interest was also $800 for the purposes of section 110-25 of the ITAA 1997.
The proceeds received by Company K from the disposal were $100.
Due to the tax loss incurred by Loss Company, the market value of Company K's direct equity interest in Loss Company was decreased from $1,000 to the $100 received by Company K in respect of the CGT event.
Company K made a $700 capital loss as per subsection 104-10(4) of the ITAA 1997 in respect of the disposal of the equity interest.
That capital loss is not taken to be disregarded under Subdivision 170-D of the ITAA 1997 or any other provision.
Reasons for Decision
Subsection 165-12(7) of the ITAA 1997 provides that where a condition in subsection 165-12(2), 165-12(3) or 165-12(4) is not satisfied because of the operation of section 165-165 of the ITAA 1997 that the condition can be taken as being satisfied where: the company has information from which it would be reasonable to conclude that less than 50% of the *tax loss has been reflected in deductions, capital losses or reduced assessable income, that occurred, or could occur in future, because of the happening of any *CGT event in relation to any direct or indirect equity interests in the company during the *ownership test period. * denotes a term defined in subsection 995-1(1) of the ITAA 1997.
As a result of the tax loss incurred by Loss Company, the $200 assessable capital gain that Company K would otherwise have made from the disposal of its interest in Loss Company, changed to a $700 capital loss.
As provided by ATO ID 2003/535, the extent that a tax loss has been reflected is determined by taking into account the combined extent that the tax loss has or will be reflected by way of capital losses, reduced assessable income and deductions.
Accordingly, the disposal of Company K's interest in loss Company has reflected the tax loss by $900, through the $700 capital loss and $200 reduced assessable income.
This is the case even if a single CGT event in relation to an equity interest causes both a capital loss and reduced assessable income.