New company loss carry-back regime

The Government has released for consultation draft legislation (and explanatory material) to introduce company loss carry-back into the business tax system. Public consultation closes on 19 September 2012. The draft legislation has been prepared following consultation on the discussion paper, Improving access to company losses, which closed on 6 August 2012.

As part of loss carry-back, the proposal is that from 1 July 2012, companies will be able to carry back up to $1 million worth of losses to obtain a refund of tax paid in the previous year. From 1 July 2013, companies will be able to carry back up to $1 million worth of losses against tax paid up to two years earlier. The operative rules for the loss carry-back measure will, if enacted, be primarily contained in a new Div 160 of the Income Tax Assessment Act 1997.

The carry-back proposal was announced on 6 May 2012 and confirmed in the 2012–2013 Federal Budget.

Changes from the discussion paper

The Assistant Treasurer said the draft legislation includes a minor amendment to the definition of "tax benefit" in Pt IVA so it can apply to loss carry-back in the same way as it can for all other deductions. It also includes integrity rules, that mirror the rules used for the carrying-forward of losses, to set out how the rules are proposed to work for loss carry-back. The Assistant Treasurer said he will also oversee targeted consultation to identify and further develop alternative integrity rules for loss carry-back prior to legislation being introduced into Parliament. If this consultation can identify a simpler approach that adequately addresses integrity risks, the Government will adopt it, he said.

Rationale

As part of the rationale for the proposed measures, the Government explained that the introduction of loss carry-back would give currently profitable companies greater certainty that, if they incur a loss from undertaking an investment in order to adjust to changing economic circumstances, they will be able to utilise that loss. This reduces the asymmetry between the taxation of profits and losses. The Government also stated that restricting loss carry-back to those companies that have recently paid tax would also target the measure to companies that have had a history of being profitable, and would improve companies' cash flow by allowing access to losses in a more timely manner.

Key features

Entities eligible for loss carry-back: The loss carry-back will only be available for “corporate tax entities” as defined in s 960-115 (ie companies, corporate limited partnerships, corporate unit trusts and public trading trusts).

Loss carry-back will give rise to a refundable tax offset: A corporate tax entity will be entitled to a loss carry-back tax offset if:

• it has an unutilised tax loss for either or both the current year and the income year immediately before the current year (the “middle year”);
• it has an unutilised income tax liability for either or both the middle year and the income year immediately before the middle year (the “earliest year”); and
• either it has lodged an income tax return for the current year and each of the last five years (unless the Commissioner had determined at any stage that it did not have to lodge a return, or it did not exist at any stage during the prior five-year period such that it would not have to lodge a return), or an assessment has been made for every such year.

Carry-back optional: Claiming loss carry-back will be optional, and the corporate tax entity will be required to claim the offset by the time it lodges its tax return for the current year, or within such further time as the Commissioner allows.

Application against net exempt income first: If a corporate tax entity has net exempt income in the current year, the corporate tax entity will be required to apply prior-year unutilised losses against these amounts before loss carry-back can be claimed. If a corporate tax entity seeks to apply a tax loss against a prior year in which it had net exempt income, the tax loss will be reduced by the net exempt income of the prior year before being converted into an offset.

Utilised and unutilised tax losses: An entity will be able to utilise a tax loss to the extent that it deducts the tax loss, applies it against an amount of assessable or net exempt income, or uses it to produce a loss carry-back tax offset with relation to the loss. A tax loss will be unutilised for a given year to the extent that an entity has not utilised the tax loss.

Losses eligible for loss carry-back: In the most basic case, an unutilised tax loss will be able to be carried back from the year it arises. An unutilised tax loss from the middle year will also be able to be carried back from the current year in some cases. A corporate tax entity will also be able to carry back losses from both the middle year and the current year. In this case, eligible losses for the current year will include the current year loss (if any) and the unutilised part of the middle year's loss. As a result, a corporate tax entity will be able to choose between using the unutilised part of the middle year loss to reduce taxable income in the current year, and applying it for the purposes of carry-back.

Note: Tax losses not used for loss carry-back in the current year will be available to reduce any taxable income in that year or a future year.

Tax losses ineligible for carry-back: An amount deemed to be a tax loss because the corporate tax entity has excess franking offsets for the year will not be eligible for carry-back. The reason for this exclusion is that excess franking offsets represent payments of tax and are not economic losses. Also, tax losses transferred under Div 170 will also be ineligible for loss carry-back. Note that capital losses will also be ineligible to be carried back.

The loss carry-back period: From the 2013–2014 income year onwards, a loss carry-back refund will be able to be claimed against tax liabilities of either of the two years preceding the current year. A transitional one-year carry-back period will be provided for the 2012–2013 income year. This means that a loss carry-back refund may only be claimed for the 2012–2013 income year against tax paid for 2011–2012.

Calculating carry-back offset: By way of background, under the proposed laws the "earliest year carry-back amount" is the total amount of the unutilised tax losses from the current year and the middle year that the entity chooses to carry back to the earliest year.

The "middle year carry-back amount" is so much of the unutilised tax losses of the current year that the entity chooses to carry back to the middle year. Each of those carry-back amounts is then reduced by any unutilised net exempt income in the year it is carried back to. These calculations produce a "reduced earliest year carry-back amount" and a "reduced middle year carry-back amount". In this case, the corporate tax entity's "earliest year offset component" is the lesser of the reduced earliest year carry-back amount multiplied by the corporate tax rate, and the unutilised income tax liability for the earliest year. Likewise, the entity's “middle year offset component" is the lesser of the reduced middle year carry-back amount multiplied by the corporate tax rate, and the unutilised income tax liability for the middle year.

Finally, the corporate tax rate used to derive the amount of the loss carry-back tax offset components will be the current year's corporate tax rate. The amount of the entity's loss carry-back tax offset will be the sum of its earliest year offset component and middle year offset component.

Limits on the loss carry-back offset: The maximum loss carry-back tax offset will be the least of:

• the chosen amount of loss carry-back offset;
• the tax value of the quantitative cap ($1 million) in any year – this means that, eg with a $1 million cap and a 30% rate, the maximum potential refund would be $300,000. More than $1 million will be able to be carried back to years that have net exempt income if the amount remaining after being reduced by that net exempt income does not exceed $1 million;
• the franking account balance at the end of the current year – in this regard, the maximum amount of the loss carry-back tax offset for a year ($300,000) will be limited by the surplus balance of the corporate tax entity's franking account at the end of the current year (ie the loss carry-back tax offset cannot exceed the value of past taxes paid that have not been distributed to shareholders as franking credits). There will also be a debit to the company's franking account balance for each loss carry-back tax offset claimed, which is recorded when the assessment of the refundable tax offset is made; and
• the sum of the unutilised tax liabilities in the years to which the losses were carried back.

Note that if the corporate tax entity is a foreign entity with a permanent establishment in Australia, the franking account balance restriction will not apply.

In addition, a corporate tax entity will also need to have an unutilised income tax liability in either the middle or the earliest year (ie it will need to have been assessed as owing an amount of income tax for either the middle or earliest year). However, the payment of tax (whether by PAYG instalments, etc) will not affect the tax liability figure of the year the loss is carried back to. Rather, the income tax liability refers to the amount of income tax to which the corporate tax entity is assessed for either year.

No ordering rules will apply to using losses for the loss carry-back tax offset, ie there will be no requirement that an eligible loss be carried back to the earliest year first, or that the earliest loss be carried back first. However, the deduction of tax losses will occur before the loss carry-back refundable offset is worked out, and the loss carry-back tax offset will then be applied after the corporate tax entity has calculated its basic income tax liability for the year. Note also that each part of a loss will only be able to be used once.

Consolidation and transferred tax losses: Loss carry-back will be available to the head company of a consolidated group or MEC group. However, consolidated groups and MEC groups will not be able to access loss carry-back in relation to losses brought into the group by a joining entity. Also, when an entity with prior-year tax liabilities joins a consolidated group or MEC group, the group will not be able to carry back any tax loss against tax previously paid by the joining entity. An entity will only be able to carry its losses back against its own tax liabilities. Note also that loss carry-back will not be available for losses transferred to an entity under Div 170.

Integrity rules

A corporate tax entity will not be able to choose to carry back an unutilised loss where it fails to satisfy the "continuity of ownership" or "same business" tests of Div 165. For loss carry-back purposes, the continuity of ownership test will be modified so that the ownership test period runs from the beginning of the year that the loss is carried back to until the end of the current year. This will ensure symmetry between the operation of loss carry-forward and loss carry-back, and that the rules will apply identically across the test period for both loss carry-back and loss carry-forward.

If a corporate tax entity fails the modified continuity of ownership test, it will still be able to claim a loss carry-back refundable tax offset if it satisfies the same business test. As with carried-forward losses, the corporate tax entity will need to have maintained the same business throughout the current year that it carried on just before it failed the continuity of ownership test. However, note that if a corporate tax entity experiences a change of ownership and fails the same business test within the current year, it will be able to carry back a loss in part of the year arising before it failed the continuity of ownership test if it could have done so had that part of the year been the whole of the year. This is intended to mitigate any disincentive associated with selling a loss-making company before the end of a loss year.

Administrative requirements

A corporate tax entity will need to have lodged an income tax return for the current year and each of the five years immediately preceding the current year in order to claim loss carry-back (unless the Commissioner has advised the entity that it did not need to lodge a return for a year).

Likewise, in view of the full self-assessment regime, the Commissioner will be able to rely on assessment for the purposes of establishing the accuracy of the corporate tax entity's losses and liabilities. Therefore, not having lodged a return for that year also does not disentitle an entity to a loss carry-back tax offset.

Claiming loss carry-back against a particular middle or earliest year will not give rise to “interest on overpayments” in relation to the tax liability assessed for either the middle or earliest year, or reduce any general interest charge or shortfall interest charge arising from a failure to pay the original assessed liability of the middle or earliest year.

A loss carry-back tax offset will be recoverable if a review of a corporate tax entity's tax affairs leads the Commissioner to conclude that the corporate tax entity was not entitled to it. On the other hand, if a corporate tax entity did not claim loss carry-back for a current year in which it could have, or claimed a smaller amount than it was potentially entitled to, it will be able to seek an amendment of its assessment accordingly, subject to the usual amendment periods. It will also be able to seek an amendment if the loss for one income period is reduced, but it could have chosen to carry back a loss from another income year instead.

Source: Treasury, Improving access to company losses – Introducing loss carry-back, exposure draft and explanatory material, 23 August 2012, www.treasury.gov.au/ConsultationsandReviews/Submissions/2012/company-losses-access-Exp-Draft