On 30 March 2017, the Federal Government released the Treasury Laws Amendment (2017 Enterprise Incentives No 1) Bill 2017 (the "Bill"). The Bill introduces the "similar business test" to supplement the existing "same business test". Together these tests will be known as the "business continuity test".
The Bill is the finalised version of Exposure Draft Legislation released in April 2016 as part of the National Innovation and Science Agenda and is designed to encourage innovation and entrepreneurship by companies and listed widely-held trusts to return to profitability without sacrificing access to their carried-forward tax losses.
The new test, which combines the same and the similar business tests is proposed to apply in relation to income years starting on or after 1 July 2015. It applies to all companies regardless of size.
Previously, a tax loss for an income year could only be carried forward where the company passes either:
- The continuity of ownership test ("COT"); or
- The same business test.
Broadly speaking, a company will fail the COT if it undergoes a substantial change in ownership or control. The same business test requires the company to carry on the "same" business at certain test times and will be failed where a company derives income from a new kind of transaction or a new kind of business.
The rigidity of the same business test has deterred many loss-making companies from seeking new opportunities and innovations, as doing so could result in failing the same business test and forfeiting tax losses.
The "similar business test" enables companies and trusts that have failed the COT, to "pivot" without forfeiting the tax losses they have accrued. As noted above, the Bill does not remove the same business test, but rather adds the similar business test as a supplement. If a company passes the same business test, it will also pass the similar business test. However now a company that has failed the COT and the SBT can apply the "similar business test" to determine whether tax losses can be carried forward and deducted.
In addition to working out whether tax losses can be carried forward, the same business test is also used for other purposes including determining whether a debt written off as bad can be deducted in an income year and whether a company with tax losses that joins a tax consolidated group can transfer its losses to the head company. The similar business test will also be used to supplement the same business test for all the purposes that previously applied to the same business test.
There are four key (non-exhaustive) factors that must be considered to determine whether a company is carrying on a "similar business", which are:
i. The extent to which the assets (including goodwill) that are used in the company's current business to generate assessable income were also used in the company's former business to generate assessable income;
ii. The extent to which the activities and operations (i.e. the types of products or services the business offers) from which the current business generates assessable income were also the activities and operations from which the former business generated its assessable income;
iii. The identity of the current business and the identity of the former business (i.e. which characteristics of the former business have been retained, which have changed or disappeared, and which are new additions specifically forming part of the new business); and
iv. The extent to which any changes to the former business resulted from the development or commercialization of assets, products, processes, services, or marketing or organizational methods of the former business.
The focus of the similar business test is on the identity of the business. This goes beyond characterizing a business merely as being of the same `kind' or `type' and instead looks at all of the commercial operations and activities carried on by the former business and compares them to the extent to which they continue in the new business. The above factors are weighed against one another according to the facts and circumstances of each case, with no one factor conclusive in determining whether or not the similar business test is satisfied.
While the similar business test will apply to all companies (as well as widely-held trusts), we anticipate that it will be especially beneficial to start-ups that accumulated tax losses in their formative years and obtained new investors over time, as they will have a greater ability to seek new and diverse business opportunities throughout their lifecycle without jeopardizing those losses.