Issue
In applying subsection 165-12(7) of the Income Tax Assessment 1997 (ITAA 1997), does the amount of a 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 where the non-inclusion of a capital gain that otherwise would have been made under that event could mean that a lesser or no net capital gain is included in assessable income for an income year.
Facts
Loss Company seeks to deduct a tax loss that it had incurred in an earlier income year.
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 the same share or interest rule in 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 subsection 995-1(1) of the ITAA 1997. The disposal resulted in CGT event A1 in section 104-10 of the ITAA 1997 happening.
Applying the cost base provisions in Division 110 of the ITAA 1997, the cost base and reduced cost base of that equity interest, as at the time of the CGT event, was $800
The proceeds received by Company K from the disposal were $100.
The economic loss that produced the tax loss incurred by Loss Company has also caused a decrease in the market value of Company K's direct equity interest in Loss Company from $1,000 to $100.
Company K made a $700 capital loss under subsection 104-10(4) of the ITAA 1997 on the disposal of the equity interest.
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: (b) 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 equity interests 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 economic loss that produced 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, for subsection 165-12(7) of the ITAA 1997 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 fully reflects the tax loss of $900. This is through the $700 capital loss that occurs in the income year of the CGT event, and the $200 reduced assessable income that results, or could result in the future, from the exclusion of the $200 capital gain in working out a net capital gain or net capital loss for the income year under the method statements in sections 102-5 and 102-10 of the ITAA 1997.
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