Issue
Where assessable income or a capital gain has been injected into a company because of an available tax loss, can the Commissioner be prevented from disallowing all of the tax loss pursuant to subsection 175-10(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
Yes. The prohibition in subsection 175-10(2) of the ITAA 1997 against the Commissioner disallowing a deduction for a tax loss if the continuing shareholders will benefit from the derivation of the injected income 'to an extent that the Commissioner thinks fair and reasonable having regard to their respective rights and interests in the company' means that in some cases the Commissioner may allow some or all of a deduction for a tax loss.
Facts
Company A has a tax loss available to it from an earlier income year (the loss year) which it is now seeking to deduct.
Company A derives an amount of assessable income in the income year that it would not have derived if the tax loss had not been available for deduction.
The continuing shareholders own shares that carried 100% of the voting power in company A, and rights to 100% of the dividends and capital distributions of company A, during the whole (or the relevant part) of the loss year.
The continuing shareholders own shares that carry 60% of the voting power in company A, and rights to 60% of the dividends and capital distributions of company A, during the whole of the income year.
For the purposes of the company loss recoupment rules, company A meets the conditions of the continuity of ownership test (COT) in section 165-12 of the ITAA 1997.
Reasons for Decision
Subsections 175-10(1) and 175-10(2) of the ITAA 1997 provide: 175-10(1) The Commissioner may disallow the *excluded loss if, during the income year, the company *derived assessable income, or a *capital gain accrued to the company, some or all of which (the injected amount) would not have been derived, or would not have accrued, if the excluded loss had not been available to be taken into account for the purposes of: • Division 36 (which is about tax losses of earlier years) • Division 165 (which is about the income tax consequences of changing ownership or control of a company) • Subdivision 375-G (which is about film losses). 175-10(2) However, the Commissioner cannot disallow the *excluded loss if the *continuing shareholders will benefit from the derivation or accrual of the *injected amount to an extent that the Commissioner thinks fair and reasonable having regard to their respective rights and interests in the company. * denotes a term defined in section 995-1 of the ITAA 1997
'To an extent' and similar phrases are used in other provisions of the ITAA 1997 and also in the Income Tax Assessment Act 1936 (ITAA 1936).
Subsection 8-1(1) of the ITAA 1997 allows a loss or outgoing to be deducted 'to the extent' that it is incurred in gaining or producing a taxpayer's assessable income, or in carrying on a business for that purpose. This provision is based on subsection 51(1) of the ITAA 1936.
Subsection 51(1) of the ITAA 1936 allowed the apportionment of outgoings when determining the amount of allowable deductions. In Ronpibon Tin NL and Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 236, expenditure was incurred in the course of business activities directed in part towards the production of exempt income and in part towards the production of assessable income. Apportionment was necessary to determine the extent to which the expenditure related to assessable income, and therefore was an allowable deduction. The High Court (CLR 59; ATD 437; AITR 247) stated that subsection 51(1) of the ITAA 1936 'contemplates apportionment' of expenditure for deduction purposes.
In Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1 at 16; 91 ATC 4950 at 4957; (1949) 22 ATR 613 at 621, the High Court said that 'as the words "to the extent to which" make plain, the subsection [51(1)] contemplates apportionment.'
In Case L59 79 ATC 471; (1979) CTBR (NS) Case 66 , the Board of Review considered, amongst other things, subsection 63B(2) of the ITAA 1936. This provision, which applies to deductions for bad debts, is very similar to subsection 175-10(2) of the ITAA 1997. It provides that paragraph 63B(1)(a) of the ITAA 1936 does not apply to prohibit a deduction 'where the continuing shareholders will benefit from the derivation of the income, or the accrual of the capital gain, to an extent that the Commissioner considers would be fair and reasonable having regard to their rights and interests in the company.'
The Board of Review decided that this meant that the relevant continuing shareholders would have to 'benefit in proportion to their shareholding'.
In ATO Interpretative Decision ATO ID 2002/845, the continuing shareholders had a 100% continuous holding of shares in the company during the income years in which the tax losses were incurred, and during the income year in which the deductions for the tax losses would be claimed. As a result, the Commissioner determined that it was fair and reasonable to allow the deductions for the whole of the tax losses.
The final paragraph of ATO ID 2002/845 states that '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.' [Emphasis added]
Accordingly, subsection 175-10(2) of the ITAA 1997 prevents the Commissioner from disallowing the deduction for all of the tax loss available to company A. Instead, the Commissioner will allow a deduction for some of the tax loss in proportion to the shares in company A that the continuing shareholders own during the relevant periods.
Since the continuing shareholders own at least 60% of the shares in company A during the whole (or the relevant part) of the loss year and during the whole of the income year, 60% of the available tax loss will be an allowable deduction in the income year. The Commissioner may disallow the deduction for the remaining 40% of the tax loss.