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Lilyvale Hotel Pty Ltd v Commissioner of Taxation
[2009] FCAFC 21
The Full Federal Court has allowed Lilyvale Hotel Pty Ltd
(Lilyvale) to bring forward losses in reliance on the same business
test where Lilyvale previously ran a hotel business using a
manager. Following a sale of all shares in Lilyvale, the management
arrangement was terminated and Lilyvale directly managed the
business. In the decision at first instance, this aspect caused a
failure of the same business test and a denial of a deduction for
the carry forward losses. This decision has now been overturned by
a decision of the Full Federal Court that clarifies the operation
of the same business test where managers are involved in a
business.
Relevant Law
In order for a company to carry forward losses from prior years
it must satisfy either the continuity of ownership test
(COT) or the same business test
(SBT). In circumstances where a majority of the
shares in a company have been acquired, it cannot satisfy the COT
and must pass the SBT or it will not be entitled to carry forward
losses. The SBT requires the company to have carried on the same
business at all times during the income year as it did immediately
before it failed the COT.
Federal Court decision
The fact that Lilyvale did not pass the COT was not in dispute.
All the shares in Lilyvale had been acquired by a third party in
August 2002.
Last year we reported that a single judge of the Federal Court,
Stone J, denied Lilyvale the right to carry forward its losses, on
the basis that Lilyvale was previously engaged in the business of
property ownership and high level supervision of the hotel
operations and this was a different business to that of running a
hotel directly. Stone J had rejected the proposition that the
activities of the manager in operating the hotel could be imputed
to Lilyvale because the manager was an agent of Lilyvale. [
click here to see the full update]. This decision has now been
overturned by the Full Federal Court.
Full Federal Court Decision
The Full Federal Court found that even though the management of
the Hotel was executed in different ways at different times, the
identification of the business had remained the same throughout the
same business test period. The Full Federal Court found that the
operation of the business by Lilyvale and the operation of the
business on behalf of Lilyvale by its manager was "a
distinction without a difference". The management company was
carrying out its activities as an agent of Lilyvale and so,
according to the law of agency, this meant that Lilyvale itself had
been carrying out those activities. Accordingly, the activities of
the manager in managing the hotel could not be excluded from
consideration in the characterisation of Lilyvale's business
before the share sale.
What does this mean?
The decision of Stone J had caused concern where companies were
acquired in circumstances where there were prior year losses and
the business of the company involved the active involvement of a
manager. With the Full Federal Court overturning the decision of
Stone J, many of these concerns have now been allayed.
Nevertheless, the decision is a salutary warning for persons
considering acquiring a majority stakehold in a company that has
prior year losses. The SBT is strictly construed and care must be
taken to ensure the test can be satisfied if those losses are
sought to be utilised. If there are plans to terminate or appoint a
manager in respect of the business carried on, tax advice should be
sought to ensure that access to prior losses will not be denied.
Whether the manager acts as agent for the business owner may well
be a relevant factor in this analysis.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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On 11 May 2011, the ATO issued draft Ruling TR 2011/D2 (Draft Ruling) and a Decision Impact Statement (Decision Impact Statement) setting out their views in relation to the Aid/Watch case
