The Bill introducing the ability for taxpayers to carry back tax losses has flown through its second reading and we expect ratification into formal legislation imminently.
The changes have been widely canvassed, but to recap:
- Tax losses in the 2019/20 or 2020/21 income years can be carried back to offset against taxable profits of the preceding year;
- It is a one year carry back;
- Application is with reference to tax year, not a point in time, therefore the ability to avail will be dependent upon balance date;
- Estimation of tax losses is permitted;
- The carry back can be utilised across group (providing there is sufficient commonality of shareholding, at least 66%);
- Legal form of business is not relevant, there are no restrictions on the type of structure a business operates from;
- However, and this is not a surprise, tax losses arising from residential rental activities are excluded;
- This is a temporary measure and a permanent change permitting the carry back of tax losses will be consulted upon publicly later in the year (a two year carry back is not off the table).
We are certainly grateful for the changes and agree it is a smart way of using the tax system to put needed cash into the hands of businesses quickly. However, we would be remiss not to point out some of the unavoidable limitations and casualties of the rules.
Companies that pay dividends
The ability to carry back losses and refund income tax previously paid for companies relies on the availability of sufficient imputation credits.
This is best explained by a quick exaggerated example:
In its first year of trading JEJ Limited earned $100 of taxable profits in the year to 31 March 2019 and paid tax of $28. The Directors determined to pay a dividend of all retained earnings, $72 ($100 minus $28) on 31 December 2019 and attached all the imputation credits.
In the year to 31 March 2020 JEJ Limited suffered and incurred tax losses of $80.
Unfortunately, as all previous tax paid by JEJ Limited was distributed with the dividend, the tax loss carry-back rules cannot achieve the desired objective of a refund of tax. This is because JEJ Limited has no imputation credit account balance.
As is often the case, owner-managed companies tend to reward the working owner with all the profits of the company, once known.
In these situations, the company has not paid any tax as the liability is that of the working owner. Unless there is a mechanism to reduce the salary in retrospect, the company has no profit against which future tax losses can be carried back to. This is relevant for the carry back of tax losses to the 2019 year.
Careful planning is recommended with respect to paying shareholder/employee salaries for the 2020 year, i.e. should they be reduced to leave the profit in the company if a tax loss is expected in the 2021 year.
This is with an eye on avoidance risk, as ordinarily the Commissioner would expect a person to be rewarded for effort. Guidelines would be welcomed from the Commissioner confirming that the non-payment of shareholder/employee salaries would not be questioned in this environment.
Consideration will also need to be given to potential overdrawn shareholder current accounts including the need to charge interest to avoid FBT and the possibility the shareholder will need to repay these loans.
Introduction of new shareholders
The existing shareholder continuity rules, at least 49%, must be maintained with respect to tax losses. Continuity must be maintained from the beginning of the target profit year to the year the tax losses are carried back from.
Care needs to be taken, or at least an “eyes wide open approach”, that the introduction of a new shareholder would not inadvertently prevent the ability to carry back tax losses.
Use of money interest
Favourable treatment is given to those taxpayers who pay provisional tax based on standard uplift with use of money interest on short payments relaxed.
If you are seeking to estimate tax losses to accelerate a carry back and ultimately get this wrong, then use of money interest and penalties may apply. Be reasonable and be able to justify your estimation here please. Using a tax pooling intermediary may help here if you get it wrong.
What we’d like to see next
To reiterate the reforms that are being put in place are truly welcome measures with the tax system playing its part.
As we continue this journey, we are starting to see more and more businesses going into hibernation (certainly in the tourism space) and closing their doors on a more than temporary basis.
As the law currently stands it is arguable that ongoing costs while in longer term hibernation are not deductible. We would like to see relief allowing the deductibility of holding costs for these businesses while their doors are closed (and have gone beyond temporary interruption).
Note the proposed introduction of a same or similar business test for the carry forward of tax losses which will help companies raise additional capital from new investors without forfeiting brought forward tax losses didn’t make this round of tax changes but remains on the agenda.