Contributed by Cameron Blackwood, Director, Toby Eggleston, Director and Ryan Leslie, Senior Associate, Greenwoods & Herbert Smith Freehills
After much delay, the Australian Government has finally passed the changes to the company loss rules which were originally announced as part of the National Innovation and Science Agenda (NISA) as part of the “Ideas Boom” in 2015. At the time, these measures were intended to overcome the restrictions which “discourages companies which have made losses from seeking new investors or exploring new profit-making activities because they may lose access to these valuable past year losses”. Although an announcement from the NISA measures, these changes are applicable to all companies. However, for the reasons explained below it is unlikely to be of much assistance to start-ups which undertake a major pivot where the business model fundamentally changes regardless of continuation of the underlying technology.
A tax loss for an income year (the loss year) can be carried forward and deducted from assessable income in future income years if the company passes either:
- the continuity of ownership test (COT), which is failed if the company has undergone a change of more than 50% in ownership or control, or
- if it fails the COT, the same business test.
Generally, a company satisfies the same business test if it carries on the same business in the income year when it wants to use the loss (the same business test period) 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:
- derives assessable income from a business of a kind that it did not carry on before the test time (the new business test), or
- derives assessable income from a transaction of a kind that it had not entered into in the course of its business operations before the test time (the new transaction test).
The ATO has in the past sought a generally restrictive reading to these provisions, allowing for both organic growth of a business via compatible operations while retaining its identity or discontinuation of certain activities provided the scale of changes do not cause the essential identity of the business to cease.
The amendments have now supplemented the “same business test” with a “similar business test”. In essence, the company can carry forward and utilise its prior year losses if it carries on a business which is “similar” to the business carried on immediately before the failure of the COT. In working out whether a business is “similar”, regard must be had to the following factors:
- the extent to which the assets (including goodwill) that are used in the current business to generate assessable income were also used in the company’s former business to generate assessable income
- the extent to which the activities and operations from which the current business generates assessable income were also the activities and operations from which the former business generated assessable income
- the identity of the current business and the identity of the former business, and
- the extent to which any changes to the former business resulted from the development or commercialisation of assets, products, processes, services, or marketing or organisational methods, of the former business.
This is a non-exhaustive list of matters to be considered.
The examples in the explanatory memorandum and Draft Law Companion Guide LCG 2017/D6 of when a company may satisfy this new test are somewhat unrealistic, particularly for the start-up sector. What is perhaps more concerning is that the ATO considers that the similar business test in essence is the same business test without the new business or new transaction tests. Accordingly, it may allow the ATO to further restrict the application of the same business test. However, if it were the intention of Parliament to effectively replicate the “positive” part of the same business test, then it begs the question why it didn’t just delete the new business and new transaction tests rather than inserting an alternative test.
Given the genesis of the similar business test was from NISA which was primarily aimed at start-ups, it is interesting to consider whether some of the greatest start-up pivots of all time would have passed the similar business test. Some illustrations are provided below.
Instagram: Originally started life as a location-based check-in app called Burbn. Users didn’t utilise most of the features but embraced the relatively unique photo-sharing aspect. Shortly after raising venture funding but still pre-revenue the founders pivoted to re-build the photo-sharing tech adding the ability to overlay a filter into a new app called Instagram. Verdict: Fail — it is not clear how the first two factors would be applied in a pre-revenue environment. In any event given the name Burbn was ditched and a completely new app launched (although based on the same underlying tech) it would definitely fail the third factor.
Slack: Started life as a gaming company which built its own communication platform to maintain contact with its geographically distributed team while working on its game Glitch. While the game developed a small cult following, it was not enough to keep the company afloat. They closed down the game and with a last ditch roll of the dice with the remaining funds they focused on the messaging platform which became better known as Slack. Verdict: Fail — the complete shutdown of Glitch before launching Slack would be enough to fail the test.
Uber: Started out as a way of app-based on-demand booking of “black cars” with licensed chauffeur drivers before expanding into allowing anyone with a car to be a driver on the Uber platform. Later Uber expanded into delivery of food and other “atoms”, electric scooters and bikes, transforming into a mobility/transportation platform. Verdict: Potentially — at least while it related to providing drivers to passengers, as it maintained its original black car concept while adding UberX and Uber Pool. However, it is doubtful that the ATO would accept that the further expansion into food and other deliveries and e-scooter and bikes would be considered similar to the original business.
Twitter: The company originally began in 2005 as a podcasting platform company named Odeo. However, when Apple launched iTunes podcasting it made Odeo’s podcasting platform irrelevant. As a last ditch effort after asking all employees for ideas the company landed on the idea of sharing status updates ditching the Odeo software and building the Twitter tech from scratch. Verdict: Fail — completely different name, technology, effective closure of the podcasting business.
[This article was originally published in CCH Tax Week on 15 March 2019. Tax Week is included in various tax subscription services such as The Australian Federal Tax Reporter and CCH iKnow. CCH Tax Week is available for subscription in its own right. This article is an example of many practitioner articles published in Tax Week.]