There are a number of action items you can undertake prior to 30 June 2021 relating to the loss carry back tax offset. This Bulletin covers various considerations for entities as part of year-end tax planning.
The Government enacted a temporary loss carry back regime for corporate tax entities with an aggregated turnover below $5 billion in the October 2020-21 Federal Budget. Broadly, the regime allows entities that paid income tax in the 2019, 2020, or 2021 income years, and make a tax loss in a subsequent income year (2020, 2021 or 2022 income years) to carry their loss back to a prior year and obtain a cash refund of some or all of the income tax paid. Eligible entities can claim this refundable tax offset by making a choice in their 2021 or 2022 income tax return. Importantly, as a tax loss can only be utilised once, entities may have to choose between claiming the offset and carrying forward the tax loss as a deduction in a subsequent year.
In the recent 2021-22 Federal Budget, the Government also announced its intention to extend the current loss carry back measures by an additional year, to allow eligible entities to also carry back a tax loss in the 2023 income year against tax payable in any of the four prior income years.
Is your entity eligible for the tax offset?
To be eligible for the tax offset, an entity must:
- Be a corporate tax entity in the loss year (e.g. 2021 or 2022 income year)
- Carry on a business
- Have aggregated turnover of less than $5 billion in the relevant loss year (or the prior year)
- Make a tax loss in any of the 2020, 2021 or 2022 income years
- Have an income tax liability in any of the 2019, 2020 or 2021 income years
- Have a surplus franking account balance* at the end of the income year they are claiming the tax offset; and
- Have lodged the last 5 income tax returns prior to the claim year
* This requirement need not be satisfied by non-resident companies other than New Zealand resident companies that have elected to be franking entities.
Entities cannot claim the offset for:
- Capital losses
- Tax losses that have already been used
- Tax losses created by the conversion of excess franking credits; and
- Tax losses that were transferred to tax consolidated groups, including where the head company transfers the loss to itself on formation
Subject to the above criteria, you can identify entities that may be eligible for the tax offset where they had a tax liability in:
- 2019 and then make a tax loss in either 2020*, 2021 or 2022
- 2020 and then make a tax loss in either 2021 or 2022
- 2021 and then make a tax loss in 2022
* Claims relating to 2020 losses can only be made in the 2021 income tax return (e.g. the 2021 tax return may include a choice to carry back both a 2020 and 2021 year tax loss).
Note also that the loss carry back offset was included as one of the tax benefits subject to the general anti-avoidance rules (Part IVA) and a specific integrity rule was included in the loss carry back measures involving companies being acquired with the purpose of obtaining the offset.
Comparison between applying losses in a future year, and carrying them back
The following examples illustrate the consequences of offsetting prior year tax losses against taxable income under the ordinary carried forward losses rules, as well as the consequences of choosing to use the loss carry back tax offset instead.
For simplicity, it is assumed that the entity’s tax rate is 30% in all years and all amounts are in million dollars and no PAYG instalments are paid. Where differences arise between the two examples, they are bolded.
The following basic examples show the cash flow benefits that may be available to a company choosing to carry the loss back. While the overall tax position is the same, the loss carry back provides $600,000 of cash to the company to help fund its activities.
Example 1 – Loss carry back tax offset not chosen
Franking account balance |
Tax losses available |
Taxable income before losses |
Prior year losses applied |
Taxable income / (loss) |
Loss carry back tax offset |
Tax payable / (refundable) |
|
|---|---|---|---|---|---|---|---|
2020 |
– |
10.0 |
10.0 |
3.0 |
|||
2021 |
3.0 |
(2.0) |
(2.0) |
– |
|||
2022 |
3.0 |
(2.0) |
3.0 |
(2.0) |
1.0 |
0.3 |
|
2023 |
3.3 |
7.0 |
7.0 |
2.1 |
|||
2024 |
5.4 |
N/A |
N/A |
N/A |
N/A |
N/A |
|
Total |
18.0 |
5.4 |
Example 2 – Loss carry back tax offset chosen
Franking account balance |
Tax losses available |
Taxable income before losses |
Prior year losses applied |
Taxable income / (loss) |
Loss carry back tax offset |
Tax payable / (refundable) |
|
|---|---|---|---|---|---|---|---|
2020 |
– |
10.0 |
10.0 |
3.0 |
|||
2021 |
3.0 |
(2.0) |
(2.0) |
(0.6) |
(0.6) |
||
2022 |
2.4 |
– |
3.0 |
– |
3.0 |
0.9 |
|
2023 |
3.3 |
7.0 |
7.0 |
2.1 |
|||
2024 |
5.4 |
N/A |
N/A |
N/A |
N/A |
N/A |
|
Total |
18.0 |
5.4 |
Paying dividends in the 30 June 2021 year
It is important to note that cash refunds received from this offset reduce an entity’s franking account balance. The franking account balance must be in credit on the last day of the income year for which the entity is claiming the offset. That is, the franking account balance must be in surplus on 30 June 2021 or 30 June 2022 for entities with a 30 June year end. These two amounts represent the maximum amount of loss carry back available to be claimed.
Where an entity does not have significant franking credits, this could mean that the entity must choose between paying fully franked dividends to shareholders and claiming the loss carry back tax offset. As the amount of loss carry back tax offset is limited to the franking account balance as at 30 June 2021 or 30 June 2022 (as appropriate), this may significantly impact year-end planning considerations, including management of Division 7A loans.
For example, paying a fully franked dividend to offset a shareholder’s loan account prior to 30 June 2021 to meet the minimum yearly repayment requirement may mean that the entity cannot claim the full loss carry back tax offset otherwise available with its 2021 income year return due to an insufficient franking credit balance.
Making the right choice
The amount of the loss carry back offset is based on the entity’s corporate tax rate in the loss year rather than the tax rate applicable in the year that income tax was paid. Therefore, a $27,500 income tax liability in the 30 June 2020 income year in respect of $100,000 of taxable income is only able to be refunded in full in the 30 June 2021 year, if, for that later year, there is a tax loss of $105,769 carried back (if the entity’s corporate tax rate drops to 26%) or $91,667 carried back (if the entity’s corporate tax rate increases to 30%).
Eligible entities should therefore effectively work backwards to calculate the amount of offset they are seeking and then gross this up based on the applicable tax rate in the loss year. Where the entity’s tax rate is decreasing from year-to-year (e.g. from 27.5% to 26%) it may be preferable to carry a loss back rather than forward.
Where the entity’s tax rate is increasing from year-to-year, choosing to carry the loss forward instead may provide a better outcome, but there may be risk and timing disadvantages associated with this. However, as the choice to carry back a 30 June 2020 year loss can only be made with the 2021 income tax return, entities should be in a position where they have all the relevant information at hand to make the optimal choice for any 30 June 2020 loss.
Care should be taken to ensure that a tax loss is used effectively, as a tax loss can only be utilised once. To the extent that an amount of a tax loss is specified in an entity’s loss carry back choice it is taken to be utilised and not able to be carried forward and used again.
Exposure Draft legislation to allow choice to be changed
Exposure draft legislation[1] has been released proposing to allow entities to change their loss carry back choice within the amendment period relating to the income year for which the choice was made.
This may allow entities to simply go back and amend their choice if they realise that they would obtain a bigger refund by carrying a loss forward (e.g. to reduce taxable income subject to a 30% corporate tax rate) than carrying a loss back (e.g. that was refundable at 26% of the amount of the loss). Changing the choice may also be a mechanism by which a company could pay back the refundable offset to generate additional franking credits to enable franked dividends to be paid, as a company cannot otherwise generate credits to its franking account by paying tax voluntarily.
Despite the changes proposed by the exposure draft legislation, you should still take care in ensuring that you make the loss carry back choice correctly as the proposal is not law yet and in any case the period of review for the company (which may be as little as two years) may prevent the choice from being changed.
Corporate tax entities on payment plans
Corporate taxpayers on payment plans for income tax debts may not have a significant franking account balance at either 30 June 2021 or 30 June 2022. This is because the franking account credit only arises when the payments are made (i.e. on a cash basis).
The entity may consider making repayments earlier than due under their payment plan to maximise their entitlement to the loss carry back tax offset. However, care should be taken as the Commissioner has not given any guidance about whether Part IVA could apply to such arrangements.
31 December “Early” Balancers
Taxpayers with a 31 December 2020 year end can claim their loss carry back offset now. The form required to do this has not been incorporated into their 2021 “early” income tax return yet. Instead, the offset can be claimed by lodging this form at least five days prior to lodging the tax return to avoid processing delays. Note that companies are required to calculate and disclose their aggregated turnover under this form (within one of the specified ranges), potentially adding further compliance costs.
What are the next steps?
You should contact your Pitcher Partners representative to review your existing arrangements and determine what action is required in light of these year-end items.
[1] Division 7 of Schedule 1 to the Treasury Laws Amendment (Measures for Consultation) Bill 2021: Miscellaneous and Technical Amendments.
