One of the new measures announced in the 2020-21 Federal Budget allows corporate tax entities to carry-back tax losses from certain years and offset them against tax paid on profits. But there are some limitations that businesses and their tax advisers need to be aware of.
As contained in the 2020-21 Federal Budget tax announcements, the ‘loss carry-back’ measure allows eligible corporate tax entities to carry-back tax losses made in the 2020 to 2022 income years to offset tax paid on profits from the 2019 income year onwards in the form of a refundable tax offset.
While the loss carry-back measures apply from as early as the 2019-20 income year, corporate tax entities will need to wait until they lodge their 2020-21 and/or 2021-22 tax returns to claim the refundable tax offset. However, this may mean that corporate tax entities with a December year-end will be able to access the refundable tax offset from January 2021.
Separately, the budget’s tax measures also provide a temporary incentive that allows businesses to claim an immediate deduction for the full cost of eligible capital assets.
Both measures apply to businesses with an aggregated turnover of less than $5 billion.
The combination of the loss carry-back measure and the instant asset write-off measure can, in some circumstances, result in the corporate tax entity receiving a cash refund from the government for incurring a tax loss as a result of the capital expenditure. Companies that have the financial capacity should carefully consider these measures when setting their capital expenditure budget.
Franking account limitations
While the measures are generous and intended to be accessible by a significant portion of corporate taxpayers (with the aggregated turnover requirement capped at $5 billion), the surplus franking account requirement may nevertheless limit availability of the loss carry-back relief.
Typically, small- to medium-sized business owners tend to draw out company profits each year via fully franked dividends up to the available franking credits in the company’s franking account. As such, the franking account balance tends to be minimal year on year. As the loss carry back rules do not permit the refundable tax offset to generate a deficit in the franking account, it is likely that many businesses would not be able to access the relief. Despite this, it is also worthwhile noting that due to the reduction in corporate tax rates over the last few decades, a number of corporate tax entities have experienced trapping of their franking credits and as a result continue to maintain a surplus franking account balance. These corporate entities may now have the opportunity to consider the application of the rules.
Additionally, publicly listed companies generally maintain a healthy balance of franking credits in their franking account and, as such, the franking account limitations are unlikely to be the main barrier for these companies to access the loss carry-back relief.
Corporate tax entity limitations
Further to the franking account limitations, the corporate tax entity requirement means that not all small- to medium-sized businesses are able to directly benefit from the relief. Most small businesses operate through an unincorporated structure, such as sole traders, partnerships and trusts. Therefore, by restricting the loss carry-back relief to corporate tax entities, it means that unincorporated businesses would miss out on the relief even though the economic impact of COVID-19 may affect these unincorporated businesses the same way as those operated through an incorporated structure.
Corporate tax entities planning to access the loss carry-back relief should also be aware of the integrity measures that have been included in the loss carry-back relief.
When corporate tax entities wish to deduct losses from earlier income years, they are required to satisfy the loss recoupment tests, namely the continuity of ownership test and the business continuity test. The integrity rules targeting the loss carry-back measure would deny a corporate tax entity the carry-back tax offset if:
i there is a scheme that involves a change of control from the disposition of membership interests, and
ii considering all of the relevant circumstances, the scheme was entered into for the purposes of enabling the corporate tax entity to get a loss carry-back tax offset.
Losses transferred into a consolidated group or a MEC group are not eligible for loss carry-back.
There are also administrative requirements that the company must satisfy in order to claim the loss carry-back tax offset, including the requirement to have lodged an income tax return for the current year as well as the five years immediately preceding the current year.
Transfer pricing implications
Multinational taxpayers should also consider how the loss-making position arising from accessing the full expensing of depreciating assets would impact on its profitability analysis as part of its benchmarking studies and to determine whether the tax loss can be sustained and utilised.
On 1 November 2021, Company B purchases a truck for $1.5 million.
Under the instant asset write-off measure, Company B can deduct the full cost of the truck in the 2021-22 income year. As a result, Company B makes a tax loss of $400,000 for the 2021-22 income year.
In the 2020-21 income year, Company B had taxable income of $8 million. As Company B had an aggregated turnover of $80 million in that income year, it was liable to income tax at the standard corporate tax rate of 30%. Therefore, Company B paid income tax of $2.4 million for that income year. Company B had no net exempt income in that income year.
Company B’s franking account balance at the end of the 2021-22 income year is $1.3 million.
Company B makes a loss carry-back choice to carry-back the tax loss of $400,000 for the 2021-22 income year to the 2020-21 income year.
The refundable tax offset arising from the loss carrying back to the 2020-21 income year is $120,000 — that is, $400,000 x 30%.
As this amount is less than Company B’s income tax liability for the 2020-21 income year ($2.4 million) and its franking account balance for the current year ($1.3 million), Company B’s loss carry-back tax offset component for the 2020-21 income year is $120,000.
Therefore, when Company B lodges its income tax return for the 2021-22 income year, it will be entitled to a refundable loss carry-back tax offset of $120,000.
Company B will not have any carry forward tax losses and its franking account balance is reduced to $1,180,000 accordingly.
If you need assistance with Carry Back Tax Losses please contact TSP Accountants any time for friendly advice on 49294155 or email us at firstname.lastname@example.org
This article was written by Gary Poon, and featured in Issue 9 November/December of Outlook, the feature publication of Tax & Super Australia.