Loss carry-backs
LOSS CARRY-BACKS
(Clauses 5, 6, 7, 8, 9, 11, 12, 13, 18, 19)
Summary of proposed amendment
This Bill introduces a temporary tax loss carry-back measure that would allow businesses that are or anticipate being in loss, to carry-back some or all of that loss to the immediately preceding income year.
Application date
The proposed amendment would apply from 15 April 2020.
Key features
The Bill proposes a temporary measure that would apply for losses incurred in the 2019–20 or 2020–21 income years. It would allow for refunds of previously paid tax before the loss year is finished. Taxpayers would generally access this provision by changing their estimated provisional tax. The deadline for re-estimating provisional tax would be extended from the final instalment date until the date the tax return is due or filed, whichever is the earlier. Taxpayers would be able to choose whether to use this facility.
Almost all types of taxpayers – companies, trusts and individuals – would be eligible to carry back losses. The majority of individuals who are taxed through the PAYE system do not have losses so would be unaffected by this measure but those that operate businesses through partnerships, limited partnerships, and look-through companies would be able to benefit.
Standard late payment use of money interest would apply if the loss carry-back is overestimated. Ownership continuity, grouping, and imputation rules would also apply.
Background
Businesses in New Zealand pay tax on their income when they are profitable while losses are deductible. Under existing tax loss continuity rules, these losses can be carried forward to reduce taxable income in future years.
Loss carry-forwards and carry-backs are intended to prevent systematic over-taxation over time. If taxpayers always pay tax when they earn income, but never get relief when they have a loss, they will pay more than the statutory rate of tax over time. Loss carry-backs are one way to address this. The Government has also announced policy changes relating to the loss carry-forward rules, but these are not part of this Bill.
The economic impacts of COVID-19 have made it more likely that taxpayers will be in loss in the 2019–20 or 2020–21 income years. Carrying a loss forward postpones the benefit of being able to claim losses and means that a taxpayer would still incur a tax liability for previous profitable years. The proposed loss carry-back measure in the Bill is intended to provide fast cash flow relief for businesses in loss during the period affected by COVID-19. The measure would enable tax refunds to be paid before the loss year has finished and before an income tax return has been filed for the loss year.
The proposed measure is intended to be temporary. The Government has indicated its intention to develop a permanent loss carry-back mechanism to apply from the 2021–22 tax year, which would replace the proposed temporary measure in this Bill.
Detailed analysis
Establishing the proposed loss carry-back involves amendments to the Income Tax Act 2007 and the Tax Administration Act 1994.
The main features of the proposal are set out in clause 9 of the Bill that introduces a new section IZ 8 to the Income Tax Act 2007.
This proposed section introduces the concept of the offset years – the pair of years affected by the carry-back. The first of these years is named the taxable income year and the second is named the net loss year.
To be eligible to use proposed section IZ 8, a taxpayer must have made, or estimate that they will make, a loss in 2019–20 or 2020–21 – the net loss year. It must also have had taxable income in the previous year – the taxable income year. Losses would 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; and
- losses from the 2020–21 year could be carried back to the 2019–20 year.
Example 1
Armstrong Architects Limited (Armstrong) is a well-known architectural firm based in Christchurch and is known for its innovative designs and earthquake resistant buildings. It has been having a boom in business for the last two years but because most of its current projects are under construction its work has dropped off because of the Level 4 COVID-19 restrictions preventing work on the projects. In the 2019–20 income year it is predicting it will have taxable income of $5.6 million but because it has a number of high fixed costs to cover during the COVID-19 period and has no future projects in the pipeline it anticipates that for the 2020–21 income year it will make a loss of $3.2 million.
Armstrong elects to carry back that anticipated loss to the 2019–20 income year. Armstrong has already paid $1.2 million in provisional tax over the first two provisional tax instalment dates for the 2019–20 income year and was due to pay another $368,000 on 7 May 2020. Armstrong re-estimates its provisional tax for the year to take account of the carry-back loss which will mean its taxable income will only be $2.4 million ($5.6 million − $3.2 million) with the tax liability on that being $672,000 ($2.4 million × 28%). The refund Armstrong will receive is $528,000 ($1,200,000 − $672,000) which will give it funds to meet its ongoing costs.
There are ownership continuity requirements that match those that apply to loss carry-forward provisions. 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 is to prevent the use of losses to eliminate tax on income that was not connected with the loss-making business when it was earned.
Example 2
Buzz Autos Limited (Buzz) is a car dealership specialising in American muscle cars from the 1960s. Being in a very specialised market Buzz relies on steady custom from month-to-month. With the Level 4 lockdown Buzz is struggling to stay afloat. For the 2019–20 income year Buzz estimates that it will have taxable income of $268,000 on which it has already paid $75,040 in tax. Buzz has a standard 31 March balance date.
Collins Cars Limited (Collins) is a car dealership that specialises in American muscle cars from the 1970s. It has been having a great 2019–20 year and its business model has lower fixed costs than Buzz so it has significant cash reserves.
The owner of Collins knows Buzz very well and offers to assist it get through the COVID-19 situation by purchasing 52% of Buzz, which they do on 1 May 2020.
Because of the lack of ability to trade, Buzz is anticipating that for the 2020–21 year they will have a tax loss of $341,000. However, because Buzz has not met the 49% continuity rule it will not be able to carry back that loss to the 2019–20 year. It will, however, be able to carry that portion of the loss arising after 30 April forward to the 2021–22 income year.
The part year continuity rules will allow Buzz to carry back a portion of the 2020–21 loss for the year (from 1 April 2020 to 30 April 2020), which Buzz estimates as $160,000. Buzz will need to meet the requirements to use a part year loss such as preparing part year accounts to the date of the breach in continuity.
The amount that could be carried back would 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; or
- an amount determined by the taxpayer.
Example 3
Tranquillity Limited (Tranquillity) is an online media site that publishes daily news articles and lifestyle stories with a focus on holistic lifestyles. It proved to be very popular for the year ended 31 March 2019 and made a taxable profit of $140,000.
However, Tranquillity has suffered a number of setbacks in the 2020 income year, both as a result of COVID-19 and also because of unrelated pressures facing the media industry. For the year ended 31 March 2020 Tranquillity is estimating a tax loss of $180,000.
As 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, Tranquillity Ltd is only able to carry back $140,000 of the loss. The $40,000 excess loss balance can be carried forward to the 2021 year to offset against future profits of the company.
If the company is within a wholly owned group of companies, the amount that could be carried back is only the amount that cannot be offset against profits within its wholly owned group in the loss year.
Example 4
Apollo Supplies Group (ASG) is a 100% wholly owned group that manufactures and supplies hospitality and kitchen equipment to a range of commercial operators in New Zealand. Some companies within the group focus on manufacturing while Apollo Distribution Limited (Apollo) is responsible for sales within New Zealand.
In the year ended 31 March 2019, Apollo made a taxable profit of $420,000. It grouped its profits with the losses of other members within the ASG which, overall, made a group taxable profit of $2.5 million.
All companies within the ASG faced a downturn in revenue in the 2020 income year because of COVID-19. Apollo has been the most significantly affected company within the group and, in the year ended 31 March 2020, Apollo made a tax loss of $120,000 largely because of making virtually no sales in the last quarter of the 2020 income year. Apollo wishes to carry back its loss to the 2019 income year and offset it against other companies in the ASG.
Before Apollo carry back its loss to the 2019 year it must first make maximum use of the ability to group the loss in the 2020 year itself with its other 100% wholly owned companies in the ASG.
Together, the other members of ASG (excluding Apollo) made a taxable profit for the year ended 31 March 2020 of $90,000. As a result, the tax loss available to carry back to the 2019 year is $30,000. Apollo can group the remaining $90,000 of the 2020 loss with the profit of other group companies or carry it forward.
Apollo can carry back $30,000 of its 2020 tax loss and offset this against its 2019 year profit. If it did not have sufficient profit, it could group the loss against the profits of other companies in ASG in the 2019 income year.
Taxpayers would be able to claim a refund for a loss carry-back by re-estimating provisional tax (where the 2019–20 is the taxable income year) or amending their tax return (where 2018–19 is the taxable income year). The Bill proposes that the deadline for re-estimating provisional tax would be extended from the final instalment date until the date the tax return is filed (or the due date if this is earlier). This would allow taxpayers to have 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 taking into account 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; or
- the day the 2019–20 tax return is due.
Provisional tax already paid could then be refunded. The proposed provision also extends to shareholder-employees of a company who may have paid provisional tax on the basis that 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.
Example 5
Dorothy and Mary own Hidden Figures Limited (HFL) a company that makes model spacecraft. They have had a pretty good year to 31 March 2020 overall but had a terrible month of March because their main customer base is overseas visitors. Given the current COVID-19 situation and the expected worldwide decline in travel Dorothy and Mary do not see the financial position of the business improving until they get their on-line sales up and running or the tourist market gets back to previous levels.
They sit down and work out that even by cutting costs HFL will probably make a loss to 31 March 2021 of at least $120,000. In the 2019–20 income year HFL used the standard method to pay provisional tax. Its instalments for the year were $24,000 on both the 28th of August 2019 and 15th of January 2020. Dorothy and Mary have calculated that, pre-COVID, they think HFL was likely to make taxable income of $267,000 with tax payable on that of $74,760 and they were planning to make a final instalment of provisional tax on 7 May 2020 of $26,760.
They elect to carry back the anticipated loss from the 2020–21 income year to the 2019–20 income year. This will give them a revised taxable income of $147,000 ($267,000-$120,000) and tax liability of $41,160. At the third instalment they decide to estimate HFL’s tax liability at $41,160 via myIR. This means there is no payment required at the third instalment date and Inland Revenue will issue HFL a refund of $6,840 ($48,000 − $41,160).
In October 2020 Dorothy and Mary realise that the business has been doing worse than expected and now anticipate the 2020–21 loss to be $170,000. When they are preparing HFL’s 2019–20 income tax return they reflect this increased loss in the return and when they file they receive an additional refund of $14,000.[1]
However, when completing the 2020–21 tax return for HFL Dorothy and Mary calculate that the loss for the 2020–21 income year will only be $110,000 given the quick recovery of the tourist industry in the first quarter of calendar year 2021. They complete the 2020–21 return and then amend the 2019–20 return for HFL. The reduced loss will mean that HFL has taxable income of $157,000 ($267,000 − $110,000) and a tax liability of $43,960 in 2019–20. It has only paid tax of $27,160 so will have tax payable of $16,800 (that is, $5,600 at each instalment date). It will need to pay use-of-money interest on this amount over the three provisional tax instalment dates.
If the tax return for the profit year has already been filed, the taxpayer would be able to request a reassessment and refund because of the loss carry-back.
Example 6
Eagle Beach Kayaking Ltd (Eagle) operates kayaking tours in Abel Tasman National Park and makes the majority of its income for the year in the summer months. The company experienced a significant reduction in bookings and a number of cancellations from early December 2019 as a result of COVID-19 which has resulted in it making a loss for the year ended 31 March 2020 of $70,000. In the prior year the company made a taxable profit of $95,000 and paid tax of $26,600. Eagle filed its 2018–19 tax return in December 2019.
Eagle is eligible for the loss carry-back scheme and is entitled to carry its 2020 loss back to the 2019 year. To do so Eagle will need to amend its tax return for the year ended 31 March 2019 to receive a refund of the overpaid tax in 2019. Eagle amends its 2019 tax return via myIR and receives a refund of $19,600 (($95,000 − $70,000) × 28% less tax paid of $26,600). Alternatively, Eagle could request the Commissioner accept a section 113 of the Tax Administration Act 1994 adjustment in writing, requesting the amendment of its 2019 tax return.
At the time it amended its return Eagle filed an interim imputation credit account (ICA) account which shows a balance in its ICA of $20,500 on the date of the refund and after the refund will have a credit balance of $900. However, if Eagle only had a balance in its ICA of $15,000, The amount of the refund will be restricted to $15,000. This will mean that Eagle will have $4,600 held in its income tax account to use towards other tax debts or future tax payments.
Almost all types of taxpayers would be eligible to carry back losses (companies, trusts, and individuals). The majority of individuals who are taxed through the PAYE system and are subject to auto-calculation (qualifying individuals) do not have losses so would be unaffected by this measure, but those that operate businesses through partnerships, limited partnerships, and look-through companies would be able to benefit. Taxpayers who have ringfenced rental losses would also not be able to carry back losses.
Example 7
For the year ended 31 March 2019 Michael paid tax of $21,940 on $94,000 of income, all of which related to wages and interest income he earned during the year. Michael was therefore a “qualifying individual” in the 2019 income year.
In the year ended 31 March 2020 Michael entered into a partnership with Gus, running a small accounting advisory firm – Michael And Gus Accounting (MAGA). Michael and Gus’s partnership made an $80,000 loss in the 2020 income year as it was still a new business with a small number of clients and it was challenging establishing itself post-COVID-19. Each partner was allocated $40,000 of the partnership’s loss to include in their 2020 tax return. After including his other income, Michael has a net loss of $25,000 for 2020.
The loss carry-back scheme does not apply to individuals who are qualifying individuals in the loss year. As Michael was not a qualifying individual in the loss year (the 2020 income year), Michael is eligible to carry his $25,000 loss back to the 2019 income year. This will now make his taxable income $69,000, with tax thereon of $13,720, Michael will receive a refund of $8,220 ($21,940 − $13,720) after amending his return through myIR.
Michael would not be eligible if he only received reportable income such as salary, wages and dividends in the 2020 loss year as it would be impossible for him to have a loss.
Example 8
Katherine owns a number of residential rental properties. In the year ended 31 March 2020 she paid $22,400 of tax on her net rental income of $80,000.
In the year ended 31 March 2021 Katherine reduced the rent she was charging her tenants as, because of COVID-19, the majority could not continue to afford to pay the same rent. Overall, Katherine only received $40,000 of rental income from tenants in the 2021 income year, however, her rental expenses largely remained the same and her total rental deductions for 2021 were $60,000. As a result, her rental properties made a loss of $20,000. Katherine wants to carry her $20,000 loss back to the 2020 income year under the new loss carry-back provision and cash out the loss she has made this year.
Under the ring-fencing of residential property rules, the amount of Katherine’s rental deductions allowed is capped at the amount of rental income received (that is, $40,000) and her excess deductions will be carried forward to the 2022 income year. Katherine cannot carry her excess rental deductions back.
Multi-rate PIEs (most unit trusts and KiwiSaver funds) may not carry back losses. Multi-rate PIEs (including KiwiSaver) have tax cash-out for losses so already benefit from immediate tax relief for losses.
Standard features from the tax system would apply and are therefore not specified within the Bill. These include:
- 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, or alternatively it can complete an interim imputation return up to the date of the refund request.
- If the loss carry-back is overestimated, resulting in tax to be paid later, standard use of money interest would apply in the normal way.
- 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 disallowed.
- 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 that all of the companies in the group are 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.
- As proposed by clause 12, the Bill would amend section RM 10(4) of the Income Tax Act 2007 so 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.
- As proposed by clause 19, the Bill proposes that where 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.
The Bill also inserts a proposed anti-avoidance provision in clause 5. This would apply where a share in a company has been subject to an arrangement which allows a loss company to meet the requirements of the new section IZ 8 and the purpose of that arrangement is to defeat the intent of section IZ 8. Any arrangement subject to this provision would not be treated as meeting the requirements of section IZ 8.
Clause 6 of the Bill also proposes that section GB 4(1)(b) and GB 4(2) which deal with arrangements for grouping tax losses for companies would also apply to section IZ 8.
1 Calculated as ($267,000 − $170,000) × 28% = $27,160 − $41,160 = $14,000.