The loss carry-back rules – here’s what you need to know

1 May 2020

As part of the Government’s response to COVID-19, the Government has introduced loss carry-back rules into parliament in the COVID-19 Response (Taxation and Other Regulatory Urgent Measures) Bill. This is expected to pass through all stages 30 April 2020.

The proposed rules would allow businesses that anticipate being in loss in either the 2019–20 or 2020–21 tax years to carry some or all of that loss back to the preceding year where profits were earned.

The loss carry-back rules are intended as a temporary measure to provide cash flow relief for businesses in loss during the period affected by COVID-19. When enacted, the loss carry-back rules will enable tax refunds for a profit year to be paid before the loss year has finished. Taxpayers will be able to estimate the loss for the year and transfer it back to the profit year. It’s important to note that a refund of tax under these rules cannot exceed an imputation credit balance at the end of the most recently ended tax year, or in an interim imputation, return to the date of the refund request.

The proposed measure provides for a one-year carry-back. The Government has indicated its intention to develop a permanent loss carry-back mechanism to apply from the 2021–22 tax year. The longer-term regime may be more traditional, such as not allowing a refund before the loss has been established.

Almost all types of business entities be they companies, trusts or individuals will be eligible to carry-back losses.

Eligibility to use the loss carry-back

To be eligible to use the loss carry-back (in proposed new section IZ 8 of the Income Tax Act 2007), a business must have made or estimate they will make a loss in 2019–20 or 2020–21. It must also have had taxable income in the previous year. Losses will only be carried back for one year. This would mean:

  • Losses from the 2019–20 year could be carried back to the 2018–19 year.
  • Losses from the 2020–21 year could be carried back to the 2019–20 year.

You cannot carry back a loss from 2020-21 to the 2019-20 year and then carry back any excess to 2018-19. It is a one-year rule.

The amount able to be carried back will be the smallest of:

  • The estimated loss (in 2019–20 or 2020–21), before adjusting for the carry-back.
  • The taxable income in the previous year, again before adjusting for the carry-back.
  • An amount determined by the business proprietor or director.

Example

Imogen’s on-line software sales is an online supplier of software. For the year ended 31 March 2019 it made a taxable profit of $120,000

Imogen’s business sales suffered a number of setbacks in the 2020 income year, both as a result of COVID-19 and also from unrelated pressures facing her business and the industry. For the year ended 31 March 2020, Imogen is estimating a tax loss of $160,000.

The limit of the loss carry-back is the lesser of the loss made in the 2020 year and the profit in the 2019 year. Imogen is only able to carry back $120,000 of the loss. The $40,000 excess loss balance can be carried forward to the 2021 year.

Some points for companies to note:

  • There are ownership continuity requirements that match those that apply to normal loss carry-forward rules. These mean if a company has had an ownership change of more than 49% since the beginning of the profit year, the loss carry-back would not be available, except on a part year basis. This ensures those shareholders that incurred the tax on the profits will be able to benefit from the losses they bore.
  • If a company is within a wholly owned group of companies, the amount that can be carried back is only the amount that cannot be offset against profits within its wholly owned group in the loss year; that is, the loss must be used within the group first in the loss year.

The core benefit of the loss carry-back rule is the ability to claim a refund of tax paid by re-estimating provisional tax (where 2019–20 is the taxable income year) or having the assessment amended where 2018–19 is the taxable income year.

The Bill proposes the deadline for re-estimating provisional tax would be extended from the final provisional tax instalment date until the date the tax return is filed (or the due date if this is earlier). This would allow time to consider the estimate of their tax loss for the net loss year.

For example, if a company is in profit for 2019–20 and estimates it would be in loss in

2020–21, it could re-estimate its 2019–20 provisional tax by considering the estimated loss carry-back deduction. It could do this any time up to the earlier of:

  • The day the 2019–20 tax return is filed.
  • The day the 2019–20 tax return is due.

Provisional tax already paid can then be refunded. If the tax return for the profit year has already been filed, a request can be made to amend the assessment and refund because of the loss carry-back.

The proposed rules also extend to shareholder-employees of a company who may have paid provisional tax on the basis they would receive a shareholder salary from the company, which is not in fact paid because the company’s pre-salary income is offset by a loss carry-back. However, the rules will not allow a refund of shareholder employee tax paid in the 2018-19 year as the necessary resolutions for those years have already been made.

Importantly, the estimate made to carry a loss back should be robust, not just a “finger in the air” exercise. If the estimate overestimates the loss use of money, interest will be payable.

Example

Maisie owns a veterinary business that specialises in horses. Maisie has had a good year to 31 March 2020 overall but had a terrible month in March. Given the current COVID-19 situation Maisie does not see the financial position of her business improving until horse racing gets back up to the pre-COVID-19 position.

Maisie’s accountant estimates a loss to 31 March 2021 of at least $120,000. In the 2019–20 income year, Maisie used the standard method to pay provisional tax. Provisional tax instalments for the year were $24,000 on both 28 August 2019 and 15 January 2020. Maisie calculated that, pre-COVID, she was likely to make taxable income of $267,000 with tax payable of $74,760. She was planning to make a final instalment of $26,760 for provisional tax on 7 May 2020.

Maisie elects to carry back the anticipated loss from the 2020–21 income year to the 2019–20 income year. This will give a revised taxable income of $147,000 ($267,000-$120,000) and a tax liability of $41,160. At the third instalment Maisie decides to estimate her tax liability at $41,160. This means there is no payment required at the third instalment date and Inland Revenue will issue her a refund of $6,840 ($48,000 − $41,160).

In October 2020, Maisie realises her business has been doing worse than expected and now anticipates the 2020–21 loss to be $170,000. When preparing her 2019–20 income tax return, her accountant reflects this increased loss in the return and receives an additional refund of $14,000 when filed.

However, when completing the 2020–21 tax return, Maisie’s accountant realises the loss for the 2020–21 income year will only be $110,000. The 2020–21 return is completed and a request made to amend the 2019–20 return. The reduced loss will mean Maisie has taxable income of $157,000 ($267,000 − $110,000) and a tax liability of $43,960 in 2019–20. Maisie has only paid tax of $27,160 so will have tax payable of $16,800 ($5,600 at each instalment date) and will need to pay use-of-money interest on this amount over the three provisional tax instalment dates.

Additional points to consider

  • To obtain a refund of income tax, a company must have an imputation credit account credit balance of at least the amount of the refund at the end of the most recently ended tax year. Alternatively, it can complete an interim imputation return up to the date of the refund request.
  • If the loss carry-back is overestimated which results in tax to be paid later, standard use of money interest would apply in the normal way. See above example.
  • The loss carry-back must ultimately be supported by a net loss shown on a tax return filed for the loss year.
  • If the tax return for the loss year is not filed, the loss carry-back deduction could be at risk.
  • If a loss company is a member of a group of companies, its loss can be carried back to the profit year and offset against the income of those other group companies. This requires all the companies in the group to be 66% or more commonly owned from the beginning of the year of profit to the end of the year of loss, with provision made for part periods.
  • If the taxpayer owes a debt on other tax types, Inland Revenue would not apply any of the refund arising from the loss carry-back to satisfy tax debts.
  • If use of money interest applies because of an overestimate of the loss carry-back, the taxpayer cannot use the remission of interest provisions in section 183ABAB of the Tax Administration Act 1994.

If you require any assistance understanding how the loss carry-back rules apply to your business, please get in touch with the Tax Advisory team today.

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May 2020

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