Tax losses: savings rule - deductions and capital losses that 'could occur in future'

In determining the extent to which a tax loss has been reflected in deductions, capital losses, or reduced assessable income for the purposes of applying subsection 166-272(8) of the Income Tax Assessment Act 1997 (ITAA 1997), does the reference to deductions and capital losses that 'could occur in future' mean deductions and capital losses that are affected by the operation of Subdivision 170-D of the ITAA 1997 or another provision with a similar effect?

Yes. The phrase 'could occur in future' in paragraph 166-272(8)(b) of the ITAA 1997 refers to the situation where, as a result of the operation of Subdivision 170-D of the ITAA 1997 or another provision with a similar effect, deductions or capital losses have arisen under, and are recognised by, the income tax legislation, but are not available for utilisation until a particular event occurs in the future.

Loss Company (the tested company under subsection 166-272(8) of the ITAA 1997) made a tax loss in the 2010 income year. Loss Company seeks to deduct all of the tax loss in the 2011 income year.

Loss Company fails to satisfy the conditions in section 166-145 of the ITAA 1997 because of the operation of subsection 166-272(2) of the ITAA 1997 (often referred to as the "same share same interest rule").

Pursuant to subsection 166-272(1) of the ITAA 1997, a voting stake, a dividend stake and a capital stake in Loss Company is directly held by Company X (the stakeholder), as a widely held company mentioned in section 166-240 of the ITAA 1997.

During the relevant 'test period' (as defined in subsection 166-5(2) of ITAA 1997) for the tax loss, Company X disposed of its shares in Loss Company. This caused CGT event A1 under section 104-10 of the ITAA 1997 to happen in relation to direct equity interests (as defined in subsection 995-1(1) of the ITAA 1997) held in Loss Company by Company X. Company X made a capital loss from CGT event A1.

No other CGT events happened during the test period in relation to any direct equity interests or indirect equity interests held in Loss Company by any stakeholder mentioned in a provision listed in subsection 166-272(1).

Subsection 166-272(8) of the ITAA 1997 provides that if any of the conditions in section 166-145 of the ITAA 1997 have not been satisfied because of the operation of the same share same interest rule in subsection 166-272(2) of the ITAA 1997, those conditions are taken to have been satisfied if: ... (b) the tested company has information from which it would be reasonable to conclude that less than 50% of: (i) the *tax loss; or (ii) the *notional loss; or (iii) the bad debt; or (iv) the unrealised net loss (within the meaning of section 165-115E of the ITAA 1997); as the case requires, 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 held in the tested company by the stakeholder, or an entity interposed between the stakeholder and the tested company, during the *test period. * denotes a term defined in subsection 995-1(1) of the ITAA 1997

Subsection 166-272(8) of the ITAA 1997 is often referred to as the "savings rule". In certain circumstances, it reverses a failure of one or more of the conditions of the modified continuity of ownership test in section 166-145 of the ITAA 1997 where the failure was caused by the same share same interest rule.

The application of the savings rule in subsection 166-272(8) of the ITAA 1997 cannot be anticipated before the end of the relevant test period.

It is only once the test period has ended that Loss Company can establish with certainty the amount of deductions and capital losses 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 held in Loss Company by any of the stakeholders mentioned in a provision listed in subsection 166-272(1) of the ITAA 1997, or an entity interposed between the stakeholder and Loss Company, during the relevant test period.

Once this amount is established, it can be compared with the amount of the tax loss to determine whether less than 50% of the tax loss has been reflected in deductions or capital losses, thus satisfying paragraph 166-272(8)(b) of the ITAA 1997.

Any CGT events that happen after the end of the test period are not relevant to the application of the savings rule.

The phrase 'could occur in future' in paragraph 166-272(8)(b) of the ITAA 1997 refers to the situation where, as a result of the operation of Subdivision 170-D of the ITAA 1997 or another provision with a similar effect, deductions or capital losses have arisen under, and are recognised by, the income tax legislation, but are not available for deduction against assessable income, or application against current year capital gains or as part of a net capital loss, until a particular event occurs in the future.

Paragraph 1.126 of the Explanatory Memorandum to the Tax Laws Amendment (Loss Recoupment Rules and Other Measures) Bill 2005 states in relation to subsection 166-272(8) of the ITAA 1997: The savings provision will not apply if the loss will be duplicated in the future because of a CGT event during the period. This might occur if a capital loss has been recognised, but deferred by Subdivision 170-D.

However, the phrase 'could occur in future' in paragraph 166-272(8)(b) of the ITAA 1997 does not refer to a situation where a roll-over has been chosen by an entity in respect of a CGT event that gave rise to a capital loss.