I cautiously welcome draft legislation aimed at addressing issues with some companies carrying forward and claiming income tax losses.
This is an issue particularly faced by early stage companies – especially those focused on innovative products and services – that frequently experience significant changes in shareholders in the early years of their existence in response to continuing capital needs, which has previously resulted in them failing the 50% continuity of shareholders test.
The Government’s response is a step in the right direction, but problems still remain.
The existing same business test is very restrictive and can lead to the stifling of innovation in order to ensure that existing losses remain available.
Any steps to liberalise the same business test would be good for the economy and for taxpayers.
However, the means by which this has been done may increase compliance costs for such businesses and may not have the desired effect.
In particular, the requirement that changes made to the business are ones that would be reasonably expected will mean ATO officers – and taxpayers – will need to obtain evidence of what such businesses would do.
This requires either a large degree of business experience – which ATO officers may not have – or a potentially expensive and time-consuming evidence collection exercise. Furthermore, what others may – or may not – do may not necessarily be relevant to assessing the outcomes for a particular company’s circumstances.
It may make the task too hard or too costly and lead businesses down the path of least resistance – don’t innovate and be certain the tax losses remain available.
The current legislation says that, in order to claim tax losses from past years against current year income, a company must have more than 50% continuity of shareholders.
Where this continuity of ownership test is failed, under the current test a company must:
- carry on the same business; and
- not derive income from a new business or new kind of transaction.
Once it fails both of these tests, the past year losses are not available.
This is perceived as a problem for businesses focused on innovation and continuing capital requirements in order to prove their products and services and grow. That is, they often make losses in the early years, get new investors and therefore fail the continuity of ownership test. The company may then move in a new – but related – direction. However, because the same business test requires an identical business and not merely a similar business, they often fail the same business test.
The draft legislation tries to overcome this by saying that a company that fails the continuity of ownership test can continue to use its tax losses if it passes either:
- the existing same business test; or
- a business continuity test.
The new business continuity test requires that the continuing business be similar, but not necessarily the same. It focusses on:
- whether the same assets are used before and after the change in ownership
- whether the sources of income for the company are the same before and after the change in ownership
- whether the changes to the business – from before to after the change in ownership – are ones that would reasonably be expected from similarly placed businesses.
Mark Molesworth, Tax Partner, BDO Australia
