Question 21.

1
 
A resident company pays a fully franked dividend of $700 to a resident shareholder.
Advise the income tax implications of the shareholder if it is:
 
 an individual subject to the top marginal tax rate;
 an individual with marginal tax rate of 19%;
 a company with other assessable income of $8,000, and a carried forward loss of
$12,000;
 a company with other assessable income of $9,000 and deductions of $16,000;
and
 a partnership with two resident individual partners sharing equally partnership
profits or losses.
 
Answer
 
 
Imputation system: tax implications of resident shareholders based on the assumption
that the resident company paying the dividend has based the distribution on a 30%
company tax rate:
 
(a) Resident individual at top marginal rate:
 assessable income = $700 (s 44 ITAA 1936) + $300 (gross up) = $1,000
 tax @ 45% = $450
 tax offset = $300
 net tax payable on the dividend = $150
 
(b) Resident individual with marginal tax rate of 19%:
 same amount of assessable income as in (a)
 tax @ 19% = $190
 excess tax offset = $110, being tax offset of $300 less tax payable of $190. The
excess is refundable from the ATO
 
(c) Resident company with carried forward loss:
 assessable income = $700 + 300 + 8,000 = $9,000
 the company can choose the amount of carried forward losses to use in this
income year
 the range of losses to choose is $0 to a maximum of $8,000
 if choose $0: tax @ 30% = $2,700; net tax payable = $2,700 – 300 (tax offset) =
$2,400
 if choose $8,000: tax = $1,000 x 30% = $300 which is fully offset by the
imputation credit
to the franking account of the company of $300. Net tax payable is zero.
 
(d) Resident company with current year loss:
 tax loss = $700 + 300 + 9,000 – 16,000 = ($6,000)
 additional tax loss converted from excess tax offset = $300 / 30% = $1,000
 total tax loss carry forward to next year = $7,000
 
 
(e) Partnership with resident partners:
 net income of partnership from the dividend = $700 + 300 = $1,000
 each partner shares (i) assessable income of $500; and (ii) tax offset of $150

 

Yumyum Thai Pty Ltd is in the business of running a Thai restaurant, serving
traditional Thai food. It has two shareholders, Gary and Matt. Gary held 75%
of the shares in company while Matt held 25%. After a decade of profitable
operation, the company incurred tax losses of $200,000 in each of the last two
income years. Gary sold two thirds of his shares to Matt on 1 July in this
income year. Gary now holds 25% of the shares in the company, and Matt
holds 75%. Gary incurred a capital loss of $300,000 in the share disposal.
 
Immediately after the share transfer, Matt introduced a new menu in the
restaurant. Instead of traditional Thai dishes, the new menu features largely
French dishes with hint of Thai flavour. The name and decoration of the
restaurant was also changed to reflect the new menu. The company also
published a cookbook in October this income year featuring the signature
dishes of the restaurant. The book was a bestseller, contributing a significant
amount of revenue to the company. The company turned around in the
income year and became profitable again.
 
Advise whether the company can use the carry forward losses in this income
year.
 

Answer
 
Yumyum Thai Pty Ltd needs to satisfy the continuity of ownership test (CoT)
or the business continuity test (BCT) in order to use the carry forward losses
from the prior two income years in this income year: s 165-10 ITAA 1997.
 
Continuity of ownership test
 
To pass CoT, the company needs to maintain the same majority owners
during the “ownership test period”. The test period commences from the start
of the loss year to the end of the current income year. The test will be satisfied
if there are the same majority owners (i.e. > 50%) in terms of voting power,
rights to dividends and capital distributions: s 165-12 ITAA 1997.
 
The issue in this scenario is that Yumyum Thai Pty Ltd appears to have the
same owners during the “ownership test period”, being Gary and Matt. Gary’s
sale of two thirds of this shares to Matt means that no new owner was
introduced. Notwithstanding, the CoT rule accounts for shareholdings based
on “exactly the same shares and are held by the same persons”: s 165-165.
Consequently, only 50% shares have been held by Gary and Matt together for
the purposes of CoT. As such, the CoT has failed. The saving rule in s 165-
12(7) does not apply, as more than 50% of the tax loss has been duplicated in
the sale of the shares from Gary to Matt.
 
Business continuity test
 
To pass the BCT, the company needs to establish that it carries on the same
business as it carried on immediately before the test time; and it does not
derive any assessable income from a new kind of business or a new kind of
transaction that it did not carry on or enter into before the test time: s 165-
210 ITAA 1997 (SaBT); or that it carries on a similar business to the one that it
carried on before the test time: s 165-211 ITAA 1997 (SiBT).
 
The issue in relation to the SaBT is whether a restaurant serving traditional
Thai dishes is the same “kind” of business as a restaurant that serves French
dishes with a hint of Thai flavour. It is likely that the “kind” of business
operating as a traditional Thai restaurant that was carried on prior to the sale
of shares catered to a different market segment, and is therefore different to a
restaurant serving French food (with a hint of Thai flavour) which would cater
for another type of market segment. In addition, the publication and sale of a
cookbook which did not previously exist reinforces the argument that the
restaurant is deriving assessable income from a new kind of business.
Consequently, SaBT would fail and the carry forward losses would not be able
to be recouped.
 
Also see: ATO Tax Ruling 1999/9.
 
The issue in relation to the SiBT involves a question of fact based also on
consideration of the 4 factors set out in s 165-211(2) ITAA 1997:
 
 extent to which assets used in the current business were also used in
the former business;
 extent to which activities and operations of current business were those
of former business;
 identity of current business and former business;
 extent to which changes in former business result from development or
commercialisation of assets, products, processes, services of former
business.
 
The restaurant business conducted after the share sale is likely to be
considered a similar business to that conducted before the share sale. The
significant revenue derived from a cookbook may be a countervailing factual
consideration in that it is not a process of the former business; it would be
necessary to argue that it resulted from development of products or processes
of the former business, which may be possible given that the signature dishes
of the current business retain a hint of Thai flavor.