Issue
In determining the extent that a tax loss has been 'reflected' for the purposes of applying subsection 165-12(7) of the Income Tax Assessment Act 1997 (ITAA1997), is the disposal of an indirect equity interest in the loss company during the relevant ownership test period that was previously subject to a roll-over under Subdivision 126-B of the ITAA 1997 during that period, to be taken into account where it results in a capital gain that is less than it otherwise would have been but for the tax loss?
Decision
Yes. As the capital gain made in the ownership test period in relation to an indirect equity interest in the loss company was reduced because of the loss company's tax loss, it is to be taken into account in applying subsection 165-12(7) of the ITAA 1997.
Facts
Loss Company seeks to deduct a tax loss in the year of income ended 30 June 2001 that it made 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 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 an indirect equity interest in Loss Company, as defined in paragraph 165-12(9)(b) of the ITAA 1997, to Company R, which paid arm's length market value in respect of the acquisition of the interest.
The disposal resulted in the happening of CGT event A1 under subsection 104-10(2) of the ITAA 1997, in respect of which Company K made a capital gain. That capital gain was less than it otherwise would have been because of Loss Company's tax loss.
That capital gain was rolled over under Subdivision 126-B of the ITAA 1997 such that under subsection 126-60(2) of the ITAA 1997, Company R was deemed to have acquired the relevant indirect equity interest with the same first element of cost base as it had in the hands of Company K at the time of acquisition.
Subsequently, during the ownership test period, Company R disposed of the indirect equity interest and made a capital gain under subsection 104-10(4) of the ITAA 1997, because of the happening of CGT event A1. The capital gain made by Company R was not rolled-over.
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 assume 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
For the tax loss incurred by Loss Company to be reflected in the capital gain made by Company R from the happening of CGT event A1, it must have resulted in that capital gain being less than it otherwise would have been because of Loss Company having incurred the tax loss.
In order for Company R's capital gain to be less than it otherwise would have been, the cost base of Company R's indirect equity interest must have been calculated without full regard to Loss Company's tax loss.
Due to the roll-over under Subdivision 126-B of the ITAA 1997 of Company K's capital gain, the first element of the cost base of Company R's indirect equity interest has not taken into account Loss Company's tax loss. In contrast, the capital proceeds received by Company R were less than they otherwise would have been because of Loss Company's tax loss.
Accordingly, Company R's capital gain has been reduced because of Loss Company's tax loss, and thereby has reflected that tax loss.