Company tax losses – similar business test or same business test lite?

The “similar business test” to make it easier for companies (and listed trusts) to deduct losses became law in March 2019.

The new law applies retrospectively from 1 July 2015.  

Under the similar business test, following a change in ownership or control, companies and listed trusts can deduct tax losses if the business carried on at the time of deduction is similar to the business carried on at the time of the loss.

In May 2019, the Australian Taxation Office (ATO) released Law Companion Ruling LCR 2019/1 (LCR 2019/1) containing the ATO views on what carrying on a similar business means. The ATO released LCR 2019/1 in draft form in 2017.

LCR 2019/1 is a reminder that the similar business test is complex involving consideration of factors that are inherently imprecise. Given this, companies looking to rely on the new test should first seek specialist advice and/or obtain a private ruling from the ATO, particularly if the company’s business is subject to change due to the market or if the company is a start-up.

The detail

Prior to the new law, companies and listed trusts could deduct a tax loss if they passed either:

  1. the continuity (greater than 50%) of ownership test (COT Test); or

  2. the same business test.

Generally, a company satisfies the same business test if it carries on the same business in the income year it wants to use the loss as it carried on immediately before the change of ownership or control that caused the company to fail the COT (the ‘test time’).

In addition, a company does not satisfy the same business test if the company:

  1. derives assessable income from a business of a kind not carried on before the test time; or

  2. derives assessable income from a transaction of a kind not entered into in its business operations before the test time.

These two extra elements of the same business test are the “negative limbs”.

Companies that failed the COT Test, and had to rely on the same business test, struggled to deduct tax losses. This was due to the rigidity of the same business test where judicial decisions, and the ATO administration of those decisions, were such that “same” meant “identical”.

In recognition of this and in line with the Government’s National Science and Innovation Agenda, the Government legislated the similar business test to give an added way for companies to deduct prior year tax losses.

In simple terms, a company can carry forward and utilise prior year losses if it carries on a business (the current business) which is ‘similar’ to the business (former business) carried on immediately before the failure of the COT Test. Unlike the same business test, the similar business test does not have negative limbs.

In working out whether a business is ‘similar’, regard must be had to the following factors:

  1. the extent to which the assets used in the current business to generate assessable income (including goodwill) were used in the former business;

  2. the extent to which the activities from the current business to generate assessable income were also activities in the former business;

  3. the identity of the current business and the identity of the former business; and

  4. the extent to which changes to the former business resulted from development or commercialisation of assets, products, processes, services, or marketing or organisational methods, of the former business.

This is a non-exhaustive list.

LCR 2019/1 draws heavily on the Explanatory Memorandum for the similar business test. While this is unhelpful in not supplying significant added guidance, it does mean the views in the Explanatory Memorandum adopted in LCR 2019/1 are legally binding on the ATO. The examples in both are simplistic.

More concerning is it appears that the ATO may consider that the similar business test is the same business test without the negative limbs. A “same business test lite” one might say. If this is the practical effect of the ATO interpretation, it would have been easier for Parliament to simply remove the negative limbs from the same business test.

Takeaway

Translating the similar business test and ATO views to real world situations is not simple. It is not clear if one factor has precedence over the other, and as LCR 2019/1 highlights, “the weight to be given to each factor depends on the facts and circumstances of each case.”

It might be said that by trying to provide a flexible test, assessing eligibility may be difficult without obtaining a private ruling from the ATO. As with any ruling request that involves weighing factors, facts, and circumstances – individual residency for example – the ruling process can be drawn-out.

Despite these criticisms, companies that could not deduct a loss in the 2016, 2017, or 2018 income years due to failing the same business test may wish to consider if they meet the requirements of the similar business test and if so, amend the earlier assessment.

Due to the fact specific nature of the similar business test, loss companies should exercise caution and seek advice to assess whether their particular facts and circumstances satisfy the test. Furthermore, as one of the key areas that attracts the ATO’s attention is the application of the loss rules, companies need to ensure there is evidence to substantiate any claims in case of audit or review.

If you have any questions with respect to the new similar business test, please contact one of our specialists:

Edward Hennebry
Associate
T +61 3 9611 0113
E: ehennebry@sladen.com.au

Daniel Smedley
Principal | Accredited Specialist in Tax Law
M +61 411 319 327|  T +61 3 9611 0105
E: dsmedley@sladen.com.au

Neil Brydges
Principal Lawyer | Accredited Specialist in Tax Law
M +61 407 821 157 | T +61 3 9611 0176
E: nbrydges@sladen.com.au

Neil Brydges