Loss multiplication: equity or debt interests in loss company held by non-resident entity

When an alteration time happens in respect of the Australian resident loss company, are the reduced cost bases of shares in the loss company held by the taxpayer, a non-resident company that is wholly owned directly or indirectly by non-resident individuals, and which has no debt owing to Australian residents, subject to adjustment under Subdivision 165-CD of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. No other entity (including any individual) with an interest in the non-resident company has obtained, or can obtain, a capital loss or deduction for a direct or indirect equity or debt interest that reflects any part of the loss company's loss. The reason is that the non-resident company that holds shares in the loss company is wholly owned by non-resident individuals. So the reduced cost bases of the non-resident company's shares in the loss company are not adjusted under Subdivision 165-CD of the ITAA 1997.

The taxpayer, (a non-resident company) owned 51% of the shares in Company P, an Australian resident company. The remaining 49% was held by other resident entities.

The taxpayer has been at all times wholly owned by non-resident individuals. An arrangement was entered into after 11 November 1999 in which the taxpayer transferred shares in Company P to Subsidiary C. This resulted in a change in the ownership of Company P and an alteration time under section 165-115L of the ITAA 1997. Company P had an unapplied net capital loss from the income year ending 30 June 1999.

No Australian residents have a direct or indirect interest in any debt owed by the taxpayer.

An alteration time occurs in respect of a loss company when there is a change in the control or ownership of the company. It can also occur if the liquidator of the loss company declares that shares in the company are worthless.

Subdivision 165-CD of the ITAA 1997 requires adjustments to be made in relation to the equity and debt interests that entities (affected entities) have in a loss company, if an alteration time occurs for the loss company. The purpose of the adjustment is to prevent the multiplication of the loss company's realised and unrealised losses when any of those interests are disposed of. Loss multiplication would occur because the loss company's losses are reflected in the values of the interests.

An affected entity is one that alone, or with associates, has a controlling stake in the loss company, and either has a direct or indirect equity interest of at least 10% in the loss company, or is owed a debt of at least $10,000 by the loss company or by another company with such an equity or debt interest.

A special rule exists under subsection 165-115X(3) of the ITAA 1997 to prevent adjustments being made to interests that an affected entity has in the loss company. If no person or other entity that has equity or debt interests in the affected entity has obtained or becomes entitled to a capital loss or deduction that reflects any part of the loss company's loss, and no such person or other entity could make a capital loss or obtain a deduction at a later time that reflects that loss, then no adjustments are required for interests the affected entity has in the loss company. Examples of where this exception may apply include interests held in the loss company by a discretionary trust, a superannuation fund or an entity whose members are not subject to income tax in Australia.

Company P is the loss company as it had an unapplied net capital loss from an earlier income year. The taxpayer had a controlling stake as well as an equity interest of 10% or more in Company P immediately before the alteration time. As all equity and debt interests in the taxpayer are held by non-resident individuals, no loss would arise under the Australian taxation system if any person or other entity with a direct or indirect equity or debt interest in the taxpayer disposed of their interest. Also, no person or other entity has previously made a loss under the Australian taxation system as a result of disposing of a direct or indirect interest in the taxpayer. Therefore the exception in subsection 165-115X(3) of the ITAA 1997 applies.

No adjustments are required to the reduced cost bases of the taxpayer's shares in Company P because no other entity (including an individual) with an interest in the non-resident company has obtained, or can obtain, a capital loss or deduction for a direct or indirect debt or equity interest that reflects any part of Company P's loss.