Lilyvale Hotel Pty Ltd v Commissioner of Taxation

iNTRODUCTION 1 This is an appeal from a judge of this Court affirming an objection decision of the respondent that disallowed an objection by the appellant against the respondent's disallowance of a deduction claimed by the appellant in returning its taxable income for the 15 month period from 1 January 2002 to 31 March 2003 (in lieu of the year ended 30 June 2003). 2 The deduction claimed and disallowed was for past losses amounting to $10,579,458. 3 The basis of the respondent's disallowance of the deduction claimed, and the objection lodged by the appellant, was that the appellant did not satisfy the 'same business test': ss 165-13 and 165-210 of the Income Tax Assessment Act 1997 (Cth) ('the 1997 Act'), it being common ground that the appellant could not satisfy the continuity of ownership test: s 165-12 and Subdiv 165-D of the 1997 Act, by reason of the sale of all the shares in the appellant to Reco Harbour Grand Pte Ltd ('Reco'), a company owned by the Government of Singapore Investment Corporation Pte Ltd ('GIC') in August 2002. 4 The primary judge concluded that the business carried on by the appellant in the relevant period before the share sale was not the same as the business that it carried on in the relevant period after the sale. Consequently, the primary judge dismissed the application and affirmed the respondent's objection decision.

Statutory Context and History 5 During the 2003 year of income, Subdivs 165-A and 165-E of the 1997 Act relevantly provided: Division 165 - Income tax consequences of changing ownership or control of a company … Subdivision 165 A - Deducting tax losses of earlier income years … Operative provisions 165-10To deduct a tax loss A company cannot deduct a *tax loss unless either: (a) it meets the conditions in section 165-12 (which is about the company maintaining the same owners); or Note: See section 165-215 for a special alternative to these conditions. (b) it meets the condition in section 165-13 (which is about the company carrying on the same business). Note: In the case of a listed public company or its 100% subsidiary, Subdivision 166-A modifies how this Subdivision applies, unless the company chooses otherwise. 165-12 Company must maintain the same owners Ownership test period (1) In determining whether section 165-10 prevents a company from deducting a *tax loss, the ownership test period is the period from the start of the *loss year to the end of the income year. Voting power (2) There must be persons who had *more than 50% of the voting power in the company at all times during the *ownership test period. Note: See section 165-150 to work out who had more than 50% of the voting power. Rights to dividends (3) There must be persons who had rights to *more than 50% of the company's dividends at all times during the *ownership test period. Note: See section 165-155 to work out who had rights to more than 50% of the company's dividends. Rights to capital distributions (4) There must be persons who had rights to *more than 50% of the company's capital distributions at all times during the *ownership test period. Note: See section 165-160 to work out who had rights to more than 50% of the company's capital distributions. … 165-13 Alternatively, company must carry on same business (1) If the company fails to meet a condition in section 165-12 (which is about the company maintaining the same owners), it must instead meet the conditions in this section. (2) There must be some period (the continuity period) that satisfies these conditions: (a) it must start at the start of the ownership test period; (b) if the period were the ownership test period, each of the conditions in section 165-12 would be satisfied. (3) The company must satisfy the *same business test for the income year (the same business test period). Apply the test to the *business that the company carried on immediately before the time (the test time) when the continuity period ends. For the same business test: see Subdivision 165-E. … Subdivision 165-E - The same business test 165-210 The test (1) The company satisfies the same business test if throughout the *same business test period it carries on the same *business as it carried on immediately before the *test time. (2) However, the company does not satisfy the *same business test if, at any time during the *same business test period, it *derives assessable income from: (a) a *business of a kind that it did not carry on before the *test time; or (b) a transaction of a kind that it had not entered into in the course of its business operations before the *test time. (3) The company also does not satisfy the *same business test if, before the *test time, it: (a) started to carry on a *business it had not previously carried on; or (b) in the course of its business operations, entered into a transaction of a kind that it had not previously entered into; and did so for the purpose, or for purposes including the purpose, of being taken to have carried on throughout the *same business test period the same business as it carried on immediately before the test time. (4) So far as the *same business test is applied for the purpose of Subdivision 165-B (which is about working out the taxable income and *tax loss for the income year of change of ownership or control), the company also does not satisfy the test if, at any time during the *same business test period, it incurs expenditure: (a) in carrying on a *business of a kind that it did not carry on before the *test time; or (b) as a result of a transaction of a kind that it had not entered into in the course of its business operations before the test time. 6 The precursor to s 165-210 of the 1997 Act was s 80E of the Income Tax Assessment Act 1936 (Cth) ('the 1936 Act'), introduced into that Act by Act No. 103 of 1965. Section 80E of the 1936 Act was introduced as a 'safety net' to overcome the harsh consequences of the application of s 80A (which had been introduced the previous year to deny the deductibility of carry forward losses unless there was a requisite continuity of beneficial ownership of shares in the loss company) where there was a takeover of a company for reasons unassociated with its carry forward tax losses. This policy is acknowledged in the Treasurer's Second Reading Speech to Income Tax Assessment Bill 1965 which became Act No. 103 of 1965: The final matter covered by the Bill is income tax deductions for company losses. Honourable Members will recall that in October last year, the income tax law was amended to provide a counter to the buying-up of shares in companies with accumulated losses deductible for income tax purposes so that the purchasing company could divert its income to the loss company. The diversion of the income in this way resulted in the purchasing company escaping tax on income up to an amount equal to the unrecouped losses incurred by the loss company in the seven years prior to the year of income. Under the legislation introduced last October, losses of a previous year are not, for 1965-66 and subsequent years, allowable as deductions against the income of a year of income of any company unless there is found to be, during both years, a beneficial ownership by the same shareholders of shares in the company that carry at least 40 per cent of the voting and dividend rights and 40 per cent of entitlements to distributions of capital in the event of the company being wound up. It is proposed to retain this basic principle but to modify its application in a number of ways. One amendment proposed will ensure that a major, or even a total, change in the shareholdings of a company will not operate to disturb a deduction for a prior year loss incurred by the company if, at all times in the year of income in which the deduction may be claimed, the company is carrying on the same business as it carried on immediately prior to the change in its shareholdings. For this purpose, a company is not to be treated as qualifying for the deduction if, after the change in its shareholdings occurred, it begins to carry on a business, or enters into transactions, of a kind that it did not carry on or enter into before the change occurred. The Government considers that this amendment will satisfactorily meet cases of mergers and takeovers of companies that are carried out for sound economic purposes and with which there is not associated any transfer of profitable business from one company to another so that income which would otherwise be taxed is derived free of tax. (Emphasis added) 7 It is also acknowledged in the reasons for judgment of Gibbs J in Avondale Motors (Parts) Pty Ltd v Federal Commissioner of Taxation (1971) 124 CLR 97 at 105 where his Honour said: The relevant sections of the Act show an intention on the part of the legislature to impose, in the case of companies, a special restriction on the ordinary right of a taxpayer to treat losses incurred in previous years as a deduction from income. The company cannot take the losses into account if there has been a change in the beneficial ownership, of its shares or of the shares in the company of which it is a subsidiary, of the kind mentioned in s. 80a or s. 80c. This restriction is imposed to prevent persons from profiting by the acquisition of control of a company for the sole purpose of claiming its accrued losses as a tax deduction. However the restriction if imposed absolutely would lead to injustice in cases where a company, notwithstanding substantial changes in the ownership of its shares, continued to carry on the same business. (Emphasis added) 8 This is no doubt what led the appellant to submit: The present is a paradigm example of the case which it was the policy of sec 165-210, and before it sec 80E of the 1936 Act, to relieve from the consequences of a change in the shareholding in the company.