Article by Peter Norman and Christine Hutchinson
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.
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