Company tax loss: whether the Commissioner can be prevented from disallowing any part of a tax loss following an injection of income

Where assessable income or a capital gain has been injected into a company because of an available tax loss and the 'continuing shareholders' (as defined in subsection 175-10(3) of the Income Tax Assessment Act 1997 (ITAA 1997)) of the company benefit wholly or mainly from the injected amount, can the Commissioner be prevented from disallowing any part of the deduction of the tax loss pursuant to subsection 175-10(2) of the ITAA 1997?

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 this situation, the Commissioner cannot disallow any part of the deduction of the tax loss.

Company A has a tax loss available 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' (as defined in subsection 175-10(3) of the ITAA 1997) owned shares that carried 70% of the voting power in Company A, and rights to 70% of the dividends and capital distributions of Company A, during the whole of the loss year.

The 'continuing shareholders' owned shares that carry 100% of the voting power in Company A, and rights to 100% of the dividends and capital distributions of Company A, during the whole of the income year.

For the purposes of the company loss deduction rules, Company A satisfies the conditions of the continuity of ownership test (COT) in section 165-12 of the ITAA 1997.

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

The predecessor to section 175-10 of the ITAA 1997 was paragraph 80DA(1)(a) of the Income Tax Assessment Act 1936 (ITAA 1936) (expanded upon in subsections 80DA(2) and 80DA(6) of the ITAA 1936).

The Explanatory Memorandum (EM) to the Income Tax Assessment Bill 1973, which introduced section 80DA of the ITAA 1936, states that: The effects of the amendments proposed in clauses 8 to 13 will be - (a) to strengthen the [COT] - (ii) by requiring as an additional safeguard that the loss deduction will not be allowable where the benefit of the deduction will flow, to a disproportionate extent , to persons who were not beneficial owners, directly or indirectly, of an interest in the company in the year in which the loss was incurred. This safeguard is contained in the provisions of a new section - section 80DA - which is proposed by clause 11. ... The provisions of section 80DA are designed to ensure that deductions for previous years losses are not allowed to a company in circumstances where, although the [ COT ] has been technically satisfied, the benefits from the allowance of the deductions would, in fact, flow wholly or mainly to persons who were not shareholders in the company during the years in which the losses were incurred . The section is mainly intended to ensure the effectiveness of the [COT]... [Emphasis added]

Section 80DA of the ITAA 1936 was re-written as Division 175 of the ITAA 1997. Chapter 7 of the EM to the Income Tax Assessment Bill 1996 does not indicate any change in the legislative policy of Division 175. Therefore in accordance with section 1-3 of the ITAA 1997, the ideas expressed in paragraph 80DA(1)(a) of the ITAA 1936 are considered to be consistent with section 175-10 of the ITAA 1997.

Both subsection 80DA(2) of the ITAA 1936 (for the purposes of applying paragraph 80DA(1)(a) of the ITAA 1936) and subsection 175-10(2) of the ITAA 1997 require the Commissioner to consider the continuing shareholders' 'rights and interests in the company' when determining whether a tax loss is deductible to the company.

The 'continuing shareholders' referred to in both subsection 80DA(2) of the ITAA 1936 (for the purposes of applying paragraph 80DA(1)(a) of the ITAA 1936) and subsection 175-10(2) of the ITAA 1997 are defined by both provisions as the persons who have satisfied the three relevant COT conditions in the loss year and the income year.

The EM to the Income Tax Assessment Bill 1973 states in relation to subsection 80DA(2) of the ITAA 1936 that it: also provides, however, that paragraph [80DA(1)(a)] will not apply to disallow a loss deduction in a case in which the Commissioner considers that the continuing shareholders in the company will receive a benefit from the company's derivation of the income that is appropriate to their continuing beneficial interest in the company...

These different indicia suggest that the purpose of paragraph 80DA(1)(a) of the ITAA 1936 and section 175-10 of the ITAA 1997 is to counter collateral arrangements for the conferral of benefits through income injection schemes involving a company's tax losses. These collateral arrangements might otherwise be veiled by the legal shareholdings (as recorded on the company's share register) demonstrating satisfaction of the COT.

In this case, there is no evidence of such a collateral arrangement. The 'continuing shareholders' when the tax losses were incurred will benefit wholly or mainly - quoting from the EM to the Income Tax Assessment Bill 1973 - from the injected amount.

Accordingly, if the entire tax loss is deductible to the company, the 'continuing shareholders' will benefit from the derivation 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.

Accordingly, subsection 175-10(2) of the ITAA 1997 prevents the Commissioner from disallowing any part of the deduction for the tax loss available to Company A.