By Max Newnham
When a business is commenced, one of the most important decisions that must be made is what type of legal structure to use? Each of the choices – sole trader, partnership, family discretionary trust, and company – has advantages and disadvantages with regards to income tax.
One of the main areas of income tax that differs between each structure is the way losses can be claimed. For sole traders and a partnership of individuals, when the non-commercial loss tests are passed, the loss can be used to reduce the taxable income of the owners in the year it is made.
When a loss is made that exceeds the income earned, this can be carried forward to later years and offset against net income earned then. If the non-commercial loss tests are not passed, the loss cannot be used to decrease other income earned by the owners in the year the loss is made, but must be carried forward to later years when the tests can be passed.
When a business loss is made by a company or a family trust, it can be used to reduce any other income made in the financial year, without any non-commercial loss tests needing to be passed. If there is no other income, the loss is carried forward to later years.
When a loss is made by a family trust or a company, and carried forward to later years, one of two tests must be passed to offset the loss against income. The first is the same ownership and control test, and the second is the same business test.
The ways these tests are applied differs between a company and a trust.
Q. Can family trust losses be claimed by a prospective new owner of a business sold by a trust if the same business test is satisfied, where the original owner has lodged a family trust election?
A. When a family trust sells a business, the accumulated tax losses remain with the trust and cannot be passed on to the new owner of the business. This principle also applies to all types of entities including sole traders, partnerships, and companies.
The only way accumulated losses can be claimed by the new owner of a business is when the company operating the business is sold. When the ownership of a company changes, the continuity of ownership test cannot be passed, but the same business test must be passed. This means the business operated by the company must remain the same and cannot be changed.
To my knowledge, it is virtually impossible for business losses to be passed on to a new owner of a business when it is operated through a family trust. The only time this would work is when a family member, such as a son or daughter, takes over the running of a business operated through the family trust.
If this occurred, there could not be a change in the pattern of distributions of income or capital from the trust by more than 50 per cent. The pattern of distributions test legislation is complicated and takes into account trust distributions for of up to six previous years, and the percentages of income distributed in each of those years.
This means if a son or daughter took over the running of a business operated through a trust, which had accumulated losses, there cannot be a change in the distributions they receive from the trust by more than 50 per cent.
Given the complexities related to selling a business operated through a trust, you should seek professional advice before taking any action.
Source: The Age
