Some business owners and finance managers (usually those without a tax specialist on their team) aren’t aware that companies can use past year losses to reduce taxable income, provided the company maintained the same majority ownership from the time the loss was made until the time it is utilised. In this article we provide an overview of the Continuity of Ownership Test and the Similar Business Test.
The Continuity of Ownership Test (COT) is one of the tests used to determine whether a company can utilise its tax losses from previous years. COT, as the name suggests, is primarily concerned with significant changes in ownership of shares.
To pass the test, the same persons must have more than 50% of the voting power, rights to dividends and rights to capital at all times throughout the loss period and until the end of the income year in which the company wants to deduct the loss.
The underlying principle is to ensure that the ultimate owners who bore the loss are the same ones who seek to benefit from its future offset.
An Example of the Continuity of Ownership Test in Action
Widget Wizards (our hypothetical company) suffered a significant loss in the 2022 income year but has turned a profit in the 2024 income year. To apply the Continuity of Ownership Test, we examine the company’s ownership from 1 July 2021 (being the start of the loss year) to 30 June 2022 (being the end of the recoupment year).
On 1 July 2021, the company’s shares were owned by John (40%), Sarah (40%) and Pam (20%). Some time throughout the 2024 income year, Pam sold her shares to Beatrice resulting in the shareholding at 30 June 2024 being John (40%), Sarah (40%) and Beatrice (20%).
Despite this change in ownership, Widget Wizards should still pass the COT because John and Sarah who together own more than 50% of the shares in the company have maintained that shareholding throughout the period.
Of course, tax is never that simple! Special tracing rules and modifications apply where the shareholder is a company or a trust . In those circumstances we strongly recommend you speak to a tax expert to assist you in determining whether the COT can be satisfied.
Is the Continuity of Ownership Test the Same as the Similar Business Test?
The Similar Business Test (SBT) is often mentioned in the same breath as COT, yet is a different and alternative test for recouping losses. While COT focuses on the continuity of share ownership, SBT focuses on the business carried on by that company. Specifically, the SBT applies when a company fails the COT but still wishes to utilise its tax losses. A key thing to note here is the Similar Business Test applies only to losses from 1 July 2015 - all earlier losses must satisfy the more narrow Same Business Test.
Specifically the SBT allows companies to claim tax losses against income derived from a business that is ‘similar’, not necessarily ‘same’, to the one generating the loss. The comparison looks at various factors such as the assets used to generate income, the activities, and any changes to business operations.
Unlike the COT, the SBT requires a full examination of all the facts and circumstances with no single factor being determinative to the outcome. In these circumstances we strongly recommend you speak to our tax consultants to assist you in determining whether the SBT can be satisfied.
Reporting Requirements for Prior Year Tax Losses
Companies with prior year tax losses (including capital losses) exceeding $100,000 are required to complete and attach a Losses Schedule to their Company Tax Return . Included in the Losses Schedule are details of the carry forward losses and the loss recoupment tests satisfied by the company in relation to those losses (i.e. the COT or the SBT).
It’s critical that the Losses Schedule is completed correctly and that any losses recouped during the year satisfy the company tax loss rules.
Get Tax Advice on the Continuity of Ownership Test
If the COT criterion is met, along with the other stipulations we’ve covered, then a company can freely carry forward losses. But tax laws, with their complexity, almost always means that getting advice tailored to your business’ unique circumstances is a smart investment.
Consult with our experienced tax advisors to ensure your business is optimising all tax and finance processes.
Disclaimer: The above information is for general informational purposes only and is not intended to constitute professional advice. For advice tailored to your specific circumstances, consult a professional.
