When acquiring a company that is conducting a business,
purchasers should pay careful attention to the structure of the
acquisition to ensure that any prior year losses of the
business will be available.
In this Federal Court case, Stone J upheld the
Commissioner's denial of a deduction for Lilyvale Hotel
Pty Ltd (Lilyvale) for carry forward losses from its business
operating a hotel. Stone J held that Lilyvale failed the same
business test on the date 100% of its shares were acquired by
Reco Harbour Grand Pte Ltd (Reco). An important fact
influencing the decision was that prior to the share sale the
hotel was operated by ANA Enterprises Australia Pty Ltd
(Enterprises) under a management agreement with Lilyvale - and
this management agreement was terminated on completion of the
A company is only entitled to carry forward losses from
prior years if it satisfies either the continuity of ownership
test or the same business test. In circumstances where 100% of
the company's shares have been sold, it cannot satisfy
the continuity of ownership test and will therefore only be
able to carry forward prior year losses if it satisfies the
same business test.
The same business test 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 continuity of ownership
In this case, the question was whether Lilyvale carried on
the same business immediately prior to the date in August 2002
when its shares were acquired by Reco as it did in the period
ending 31 March 2003.
The ANA Hotel Sydney was constructed by Lilyvale on land it
held under a 99 year lease. The hotel commenced operating in
September 1992 and was operated and managed by Enterprises, as
agent for Lilyvale, under a management agreement with Lilyvale.
Lilyvale's role was limited to high level supervision
and responsibility for capital expenses and finance. It had a
limited role in the day-to-day management of the hotel.
Lilyvale also entered into an agreement with another company
in the ANA group to use various trademarks of ANA in connection
with the operations of the hotel.
In August 2002 Reco acquired all the shares in Lilyvale. On
completion, the management agreement with Enterprises was
terminated, as was the employment contract of the general
manager. The general manager was on the same day hired directly
by Lilyvale and Lilyvale then managed the hotel itself.
Lilyvale retained the right to use the ANA trademarks for a
period of 12 months. It was desired that there be a
"seamless transition" in the operation of the hotel
after the share sale until a new management company was
appointed. Stone J. commented that she was satisfied on the
evidence that such "seamless transition" was
On 1 July 2003, the hotel was re-branded the Shangri-La
Hotel and a new general manager was appointed.
In the tax year ended 31 March 2003, Lilyvale had assessable
income of approximately $10.5 million and it sought to deduct
carried forward losses of the same amount. The Commissioner
denied the deduction and Lilyvale appealed to the Federal
Federal Court decision
In order for Lilyvale to satisfy the same business test, it
needed to show that the business it carried on after the share
sale was identical to that it carried on before the sale. At
issue was the characterisation of Lilyvale's
Stone J characterised the business of Lilyvale prior to the
share sale as one of property ownership and high level
supervision of the hotel operations. After the share sale Stone
J accepted that Lilyvale's business was the operation
of the hotel as it stepped into the shoes of Enterprises to
perform that role. Therefore, the business of Lilyvale before
and after the share sale was different and it failed the same
business test. Stone J rejected the proposition that the
activities of Enterprises in operating the hotel under the
management agreement could be imputed to Lilyvale because
Enterprises was an agent of Lilyvale under that agreement.
What does this mean?
In any company acquisition where the purchaser requires the
use of prior year losses and the business of the company is run
along similar lines to those in the Lilyvale case, where there
is active involvement of a manager under a management
agreement, the purchaser may need to ensure such continues.
Where the purchaser wishes to engage its own management company
it may be well advised not to terminate the current management
agreement, but to ensure it can be assigned to its own
management company. The same result may also be achieved if the
purchaser acquired the shares in the management company so that
the management agreement could continue on foot.
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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