Skip to main content
Inland Revenue

Tax Policy

Business continuity test

Home > Publications > 2021 > Supplementary Order Paper No 23 to the Taxation (Annual Rates 2020–21, Feasibility Expenditure, and Remedial Matters) Bill > Business continuity test

Supplementary Order Paper No 23 to the Taxation (Annual Rates 2020–21, Feasibility Expenditure, and Remedial Matters) Bill

Commentary on the proposed amendments

Hon David Parker
Minister of Revenue

March 2021


Business continuity test

Business continuity test

(Clauses 16B, 25B, 28, 37E, 37F, 37H, 37I, 44DB to 44DU, 44FB, 44FC, 45B, 58(2B), 58(5CB), 58(CC), 58(10BA), 58(10BAB), 58(10BAC), 58(12BA) and 58(12C))

Summary of proposed amendment

The proposed amendments would introduce a business continuity test to the Income Tax Act 2007 to loosen the loss continuity rules to help stimulate growth and innovation in the economy. The business continuity test would act as a secondary test permitting loss carry forward if there is a breach in ownership continuity of a company as long as there is no major change in the nature of the business activities of the company. The test would be accompanied by measures to support the policy objective:

  • A purpose provision setting out the objective of the test (promote growth and innovation while preventing loss trading).
  • Exclusion of dormant companies from the rules.
  • Anti-injection rules to prevent schemes that would permit the purchaser of a company to use up losses by diverting income into the company or by reducing expenditure of the company.
  • A rule to stop pre-emptive changes to the business being made before the change in ownership to defeat the purpose of the business continuity test.
  • Maintaining the current approach to loss grouping.

Application date

The proposed amendment would apply to breaches of ownership continuity occurring in the 2020–21 and later income years and to losses arising from the 2013–14 income year onwards.

Key features

Subpart IA of the Income Tax Act 2007 sets out the rules for when tax losses may be carried forward to a later income year to offset future income (the “loss continuity” rules) by requiring at least a 49 percent continuity of ownership from when a loss arises to when it is used. Proposed new subpart IB would provide an alternative loss continuity rule by introducing a business continuity test modelled on Australia’s “similar” business test. This would allow a company to carry losses forward after a breach of the 49 percent shareholder continuity rule as long as the business fundamentally continues without major change.

Australia’s similar business test compares the similarity of the business immediately before the change in ownership to the business at the time losses are used. This comparison is made by evaluating the extent to which the assets, activities, operations, and identity of the business remain the same throughout this period. Some allowance is made for changes in these factors through natural development (changes which are normal and expected of a business seeking to maximise profits).

The business continuity test proposed as subpart IB starts with the presumption that a company can carry forward losses following a change in ownership unless there is a major change in the nature of its business activities, having regard to the assets used, within five years (or less if losses are used earlier) of the change in ownership. The proposal carves out changes which are just a consequence of natural development. As a whole, the test is intended to focus on the inputs a company employs and not its outputs to allow a business to pivot. The test specifically requires reference to assets as these are a key resource which a company uses to generate income and a significant change in the asset base could be a good indication that the fundamental business activities are not being continued post acquisition and there has been a major change.

If a company is carrying forward losses comprising 50 percent or more bad debt deductions claimed under section DB 31(3) of the Income Tax Act 2007 the five-year rule will not apply. Instead, the continuity period for these companies will run from the time immediately before the breaching change in ownership until the time the loss is used up. This feature is designed to prevent failed finance type companies from being acquired for loss trading purposes.

To support the test and ensure it is not manipulated to enable loss trading the following measures are proposed:

  • A purpose provision setting out the objective of the test (that is, permit capital raising while preventing loss trading).
  • Exclusion of companies where the scale of activities in its business have reduced to nothing or almost nothing (dormant or “zombie” companies) from the rules.
  • Anti-injection rules to prevent schemes that would permit the purchaser of a company to use up losses by diverting income into the company or by reducing expenditure of the company.
  • A rule to stop pre-emptive changes to the business being made before the change in ownership to defeat the purpose of the business continuity test.
  • Maintaining the current approach to loss grouping. Companies acquired as part of a corporate group may continue to offset losses within that group, however, a company cannot be purchased and have its losses made available within a new group.


Loss continuity rules in subpart IA 5 of the Income Tax Act 2007 determine whether a company can carry tax losses forward to offset income in a future year. New Zealand’s current loss continuity rules require 49 percent continuity of ownership. This was designed to guard against loss trading but can be an impediment to businesses obtaining capital to innovate and grow because, in doing so, they can breach the 49 percent threshold. While this is particularly an issue for start-ups, some businesses recovering from the economic impacts of COVID-19 may look to recapitalise and innovate in order to survive.

Example 7: Anonymised real-life example

Starting Today Limited (STL) was founded in 2003 and operates in the electronics industry. In 2006, a venture fund invested $2 million for a 40% interest in the company.

The investment was used by STL to fund further development to advance to the commercialisation stage. At the same time, 20% of STL’s shares were set aside for employees as part of an employee share plan in order for the company to retain those employees and align their interests and rewards with those of other shareholders. The founder retained a 40% shareholding.

This 60% change of ownership resulted in the forfeiture of approximately $4 million of tax losses that had accrued since inception.

In 2008, the company expanded into the US Market and received an initial capital investment of US$10 million, followed by further capital rounds over the following four years that resulted in a 60% change of shareholding and all tax losses, $6 million, from 2006 to 2009 being forfeited.

In September 2019, the Government committed to publicly consulting on options to loosen the loss continuity rules to address the impediment with a view to increasing the productivity of the economy.

On 15 April 2020, the Government announced that it would introduce a business continuity test modelled on Australia’s “similar business” test. While the Government had planned to loosen the tax loss continuity rules following a full consultation process a decision was made to accelerate work on the business continuity test as a COVID-19 response. It was announced that the test would be introduced after consultation with private sector representatives and apply retrospectively to the 2020–21 income year onwards so that taxpayers could capital raise in reliance on being able to carry some or all of their losses forward even if the change in ownership exceeds the 49 percent loss continuity threshold.

A business continuity test works by assuming that if a business is carried on after a change in ownership the motivation for acquiring a company is a genuine commercial one. If the business is not so carried on, the motivation for acquiring the company could be loss trading (that is, acquiring a company with historic losses in order to reduce tax payable in relation to another business). The test works to prevent losses from being carried forward if loss trading could be the reason a company is acquired. The proposed changes remove an impediment to sensible business reorganisations, including recapitalisations while preventing loss trading.

The details of the business continuity test have been developed with Chartered Accountants Australia and New Zealand, the Corporate Taxpayers Group, and members of the New Zealand Law Society Tax Law Committee.

Detailed analysis


The proposed amendments would introduce the business continuity test as new subpart IB (Carrying forward companies’ loss balances: continuity of business activities) of the Income Tax Act 2007. The business continuity test is intended to loosen the current loss continuity rules so that a taxpayer can carry forward tax losses even where there has been a breach in ownership continuity.

Proposed section IB 1 sets out the purpose of the business continuity test. This is to permit loss carry forward after a change in ownership in order to remove impediments to:

  • innovation and economic growth
  • corporate reorganisations
  • changes in the direct or indirect ownership of companies
  • companies accessing new sources of share capital
  • corporate reorganisations (including changes in shareholding with no immediate sourcing of new capital), and
  • companies adapting their businesses in order to grow or be resilient.

Importantly, the proposed section also makes clear that loosening the loss continuity rules by introducing this test is not to encourage loss trading.

Loss trading is where there is little or no economic basis for the transaction in which a company is acquired. Its principal purpose is the purchase of losses that would otherwise not be used. This is done to offset income that the acquirer would otherwise have needed to pay tax on. Preventing loss trading is the reason loss continuity rules are part of the tax system.

Overall, the purpose statement is designed to provide context to support the interpretation and application of the business continuity test, it is not itself a test for loss carry forward. It is expected that the proposed purpose statement would have value in cases at the margin where it is unclear how the proposed business continuity test will apply.

Core test

Proposed section IB 3 introduces the core business continuity test. This test can be relied on to carry losses forward if a company breaches the 49 percent ownership continuity threshold, as long as there is no major change in the company’s business activities that would suggest it is not being continued post-acquisition. The test would apply to all companies with the exception of mineral mining companies. There is tailored business continuity test already available to these companies in section IS 2 of the Income Tax Act 2007. Clause 44DU makes this treatment clear.

Similar business: no major change

A company will meet the business continuity test as long as there is no major change in the nature of the business activities carried on by the company (proposed subsection (2)(c)). In determining whether a particular change is a major change in the nature of the business activities the taxpayer would need to evaluate the extent to which the same business activities are undertaken to generate assessable income. Proposed subsection (4) specifically directs the taxpayer, to consider the extent to which the same or similar assets are used to generate assessable income.

The phrase “business activities” is intended to consider the particular actions carried out by the business to generate income and the processes or methods by which they are carried out. For example, a bakery may predominantly bake its own products for sale, but may also buy in some specialty items that it resells. Likewise, the bakery may sell its products through its own retail outlet but may also sell direct to local supermarkets and cafes.

The use of the phrase “business activities” is intended to deal with the situation where a company discontinues one business and starts another. It is normal for a company to establish new businesses as part of its growth. Absent a change in ownership a company is permitted to do this while maintaining their losses and using them to offset income of both the old and the new businesses. The business continuity test also permits this as long as the starting of a new business is something that could reasonably be expected to have happened without a shareholding change. The test is not intended to be applied granularly on a business-by-business basis.

Overall, elements to evaluate include:

  • the business processes
  • the scale of business activities
  • use of suppliers or other inputs
  • the markets supplied to
  • the type of products or services supplied, and
  • the assets used.

“Assets” is intended to take an ordinary meaning and includes tangible and intangible (for example, goodwill) assets. It is accepted that some categories of asset require replacement. The phrase “same or similar assets” is used to clarify that the normal replacement of specific assets with similar assets would not be part of the assessment of whether there has been a major change.

Example 8

If I Can Dream CGI Limited (I Can Dream) is a start-up company that produces CGI effects for television and movies. It has been operating for a number of years now and has had a number of successful projects. However, it really needs a cash injection from a new investor to take the business to the next level. It is in desperate need to update its ageing computer equipment to state of the art technology. The computer equipment represents around 95% of the assets of the company.

Largely due to the initial cost of setting up a CGI effects company, I Can Dream has been in a loss position for a number of years and Kelvin, the owner, looks for a new investor. Ben has an interest in the film industry and decides to invest in the company, however, he wants to take a controlling interest due to some question as to Kelvin’s ability to run the company efficiently. After much discussion Kelvin agrees to an investment which will give Ben a 55% ownership stake in the company.

Shortly after the share subscription, I Can Dream uses the additional funds to completely replace its assets with new cutting-edge computer equipment. The equipment essentially produces the same product, but the quality has increased significantly.

Kelvin is concerned that the replacement of the assets will be a major change for the purposes of the business continuity test. For the purposes of assessing whether there has been a major change, section IB 3(4) requires a taxpayer to assess the extent to which the assets used in deriving the company’s assessable income have changed during the continuity period.

In the case of I Can Dream the company has replaced all of its assets, however, those assets are essentially the same as the old assets albeit newer and shinier. The assets do the same functions as the old ones but in a more efficient way, producing a better product and they look better in the office.

The policy intent is that such a replacement of assets with new versions of essentially the same assets should not be considered as a factor when evaluating if there has been a major change.

Not every change will be a major change. Any change in business activities (including use of assets) must be considered against the unchanged business activities (including use of assets) employed by the company to generate income to establish whether the change is “major”. Generally, this is a question of scale (in other words, how significant is the change in the context of the operations of the entire company). The test is not intended to give special weight to any particular factor.

Example 9

Flip Flop and Fly Eggs (FFF Eggs) has been producing eggs to supply to supermarkets for 20 years. The eggs have always come from battery farmed chickens. Over the last 20 years this operation has become large scale with two large sheds, containing 45,000 chickens each, occupying the land.

Consumers have started to become more conscious of the source of their food and the demand for battery eggs falls. Consumers prove to be more interested in animal welfare than in saving a few dollars per tray of eggs. FFF Eggs finds itself sustaining losses several years in a row as supermarkets buy less of their eggs and offer a lower price. FFF Eggs realises that it needs to change and decides to chase the free-range egg market. This requires an overhaul of its farm at a significant cost. A new investor is brought in who is keen to see the business become focused on animal welfare first. Ownership continuity is breached.

The battery sheds are torn down and in their place grass is seeded, a roosting barn set up and a fence erected around the land. 60,000 chickens are given to rescue centres. This leaves the 30,000 chickens the land can support free-range. This dramatically reduces the number of eggs FFF Eggs can supply, but it is able to double its price.

FFF Eggs can carry forward its pre-breach losses because, while a significant portion of the assets have changed, when weighting other factors there has not been a major change in the nature of the business activities. FFF Eggs has changed some but not all business processes, it still supplies to the same market (supermarkets and consumers of eggs), it uses the same suppliers to get chicken feed and replacement chickens, and there is no change in the type of product it is supplying.

Proposed subsection (2)(a) limits the application of the business continuity test to losses arising from the 2013–14 income year onwards. It will also not apply if the company ceases to carry on business activities during the continuity period (subsection (2)(b)).

Carve-outs from major change

The proposed test is designed around the fact that changes to the inputs used to generate income indicates that the fundamental business is not being continued. However, some changes to business activities and assets will be a consequence of natural development that could have happened absent the change in ownership. This behaviour is not about tax but about a company being able to position its resources in a way that maximises returns. Where there is no loss trading motivation and the fundamental business is continued the business continuity test should allow losses to carry forward. Tax should not be a barrier to normal business development.

To recognise this, proposed subsection (5) includes a number of carve-outs from what might be considered a “major change”. These carve-outs are intended to permit loss carry forward in spite of a major change where there is a genuine commercial reason for changing business activities or assets that is not related to the availability of losses. The carve-outs are not a list that defines what a major change is and only need to be referred to if there is a major change. In combination with the core major change test, the carve-outs ensure that the business continuity test has the intended input focus.

The first carve-out covers changes made to increase the efficiency of the business activities. This contemplates changes that are made to decrease costs (without artificially moving costs, refer to proposed section GB 3BAC) or otherwise increase the efficiency of the company.

The second carve-out covers changes made to keep pace with developing technology. This contemplates situations, for example, where companies take advantage of new technology that becomes available or switch from a physical store to online.

Example 10

Maowang Chan has developed a method to identify purebred cats from imposter breeds. This is important in the competitive world of exhibiting cats. His method uses a unique barcode that is tattooed at the base of the tail of the cat to identify the breeder of the cat and the family tree of the particular cat. This barcode is then read by a scanner and the code is located in a database of cat pedigree.

His company Go-Cat-Go Limited (GCG) supplies the cat identification service which breeders use like a virtual certificate of a cat’s pedigree. The company both tattoos the cats and maintains the database.

GCG has enjoyed some success with cat breeders, however, some breeders don’t like this method of identification as it is invasive on the cats and the barcode can only be read by shaving off some of the fur which makes it limited to appeals from competitions where someone suspects a non-purebred cat has been awarded a prize.

Maowang wants to investigate other means of identifying the cats which are less invasive and make better use of technology. However, as the company has been incurring losses over the last few years, he needs a partner to help with funding the new ideas.

Alex is a cat lover who has previously exhibited his 12 cats and sees a great opportunity to make some money from the ideas that Maowang has. He offers to invest in GCG and Maowang sells Alex 52% of his company which breaches shareholder continuity.

In the year after the breach GCG works on developing a new technology which involves inserting a new microchip designed by GCG into the cats which can be read with a new patented scanner which GCG has manufactured. This has involved GCG replacing its old tattoo equipment with the new electronic scanners and microchip manufacturing equipment. The scanners and microchips are then sold to vets, who place the chips into client’s cats and can search them on the database on request. In that year GCG looks to use some of the tax losses brought forward after the breach.

GCG has had a major change during the year as its assets have completely changed, and although its business activities have remained similar on balance there has been a major change so it will need to rely on a carve-out to use the losses. Section IB 3(5)(b) allows a major change which is made to keep up to date with technology. As GCG has changed its assets to keep up with advances in technology it will be able to use the carve out in subsection (5)(b).

In the next year GCG discovers an even newer technology that utilises the cat’s tail as an antenna to broadcast the signal from the microchip to a central point to enable faster identification of the cats. GCG’s assets completely change again to produce the new microchip and receivers. Again, GCG has had a major change due to the change in the assets of the company being such a big part of the business, however, again GCG has made those changes to keep up with technology the underlying business of the company has not really changed. GCG will be able to rely on the technology carve-out to utilise its carry forward losses.

The third carve-out covers increases in scale, including a company entering a different market for its products or services.

The fourth and final category of carve-out covers changes in product or service type. Overall, this carve-out permits:

  • a company to pivot and drop a type of product or service and start producing or supplying another that has a close connection (for example, a restaurant operator switching to a cooking school), and
  • a company to be able to retain its existing product/service type but also add to it as opportunities arise, as long as there is a close connection (for example, a clothing manufacturer starting a range of commercial cleaning cloths using offcuts from the clothing).

Any new types of product or services need to relate to those already being produced in some way. This might be because they are made using mainly the same assets or processes, or there is some other close connection between those already being produced.

Example 11

For the Heart Flour Co. Limited (HFC) has developed a revolutionary technique for adding high levels of quality protein into flour. This creates flour which is superior for bread making. HFC has been producing and suppling this flour to artisan bread makers for several years. Despite its rising business HFC has made losses over the last few years.

Always on my Mind Foodstuffs Limited acquires 100% of HFC and continues its flour business. Three years in HFC discovers that their method of adding protein would have application in sport protein powders.

HFC starts producing the protein powder and stops producing the flour

This results in enough of a change in activities and assets to breach the major change test. Always on my Mind Foodstuffs Limited wants to know if a carve-out under section IB 3(5) will apply to allow HFC to carry forward its losses.

Proposed section IB 3(5)(d) allows HFC to change the types of products produced if that involves the company using the same or similar assets or the product is closely related to a product that was provided immediately before the start of the continuity period. The protein powder uses the same IP surrounding the special technique that HFC developed and the old and the new product have a close connection in that they centre around the use of the IP to fortify something with high quality protein. This situation should pass. Likewise, if HFC decided to produce flour and the protein powder the situation should pass under (5)(d). HFC is using its existing resources to expand its product offering.

The market for the protein powder shrinks and HFC sees an opportunity to simply sell up its assets and get into cryptocurrency mining – a new craze that the small group of shareholders have latched onto as the next big thing

When compared to the time immediately before the breach in ownership until the time the loss has been used there has been a major change. In dropping the flour and eventually the protein powder, HFC sold off all its assets and acquired computers to mine for cryptocurrency. The product it is not related to any aspect of the HFC business before the change in ownership and it does not use any of the same assets. Even though HFC can cease to make its original product and retain the losses from the earlier enterprise, the rules do not permit it to make anything that it wants following an ownership change and still access those losses. There needs to be a clear connection between the replacement product and the original product. The carve-out for technology will not apply either because this is only intended to cover situations where different technology is used within the continued business, not where a business sees an opportunity in a new technology-based industry.

Proposed section IB 3(7) provides that land (excluding fixtures to land) would be excluded from consideration when a company is looking at whether it can rely on the change in product/service carve-out. This is because land is a big enough asset to skew the way the carve-out is intended to apply.

Example 12

Nikki owns and operates All I Needed Was the Rain Limited (ANR), a deer farm in the Wairarapa. Venison prices have been falling lately and ANR is carrying forward losses from the last three years.

In 2023, Nikki sells ANR to David breaching ownership continuity.

David takes stock of his new acquisition. The assets are the land, the fencing set up around large flat paddocks, an irrigation system, water troughs, and several storage sheds for farm equipment, plus

300 head of deer.

David spends the rest of the 2023–24 year farming the herd of deer but not replacing any. In the

2024–25 year he sends off the last of the deer and buys sheep to start producing wool. At this point ANR has experienced a major change, the deer have been switched out for sheep, the product type has changed from meat to wool, the customer has changed, and some suppliers have changed. His assets have changed somewhat but not totally. ANR has also had to do-up an old shearing shed situated on the land at a cost of $100,000. He also spends $150,000 on a flock of sheep.

However, David is able to apply the subsection (5)(d) carve-out for change in the type of product. This is because, although he cannot include the land in his assessment, he uses mainly the same assets in the production of wool as he did for the venison. He leaves the fences, the troughs, and the irrigation system intact. The storage sheds still house farm equipment. All up, $1 million worth of non-land assets are still being used, while $250,000 worth of new assets have been added (including the shearing shed).

In the 2025–26 year, David decides that dairy farming is the future. He sells the sheep and converts the farm. David must look at the business activities at the time he acquired ANR and compare them to the business as it is presently. ANR has experienced a major change in the nature of its business because of the switch from being a venison farm to a dairy producer selling within a cooperative. David again looks to the carve-out for product type. However, in this case the carve-out would not apply as he is not using mainly the same assets anymore. David cannot consider the land value when coming to this conclusion, but he can include other assets. The dairy conversion required a $1.5 million automated milking shed to be installed and the fencing to be replaced to create smaller paddocks centred around a new race system that the cows would use to get to the milking shed. The fencing and raceway cost $200,000 to complete. $400,000 is spent acquiring a herd of cows.

ANR did use much of the same farm equipment and continued to use the storage sheds to keep it. However, these remaining assets only have a value of $500,000 combined. The shearing shed is no longer used. ANR will forfeit any losses carried forward after the change in ownership that were not used prior to the 2025–26 year.

Measurement period for core test

The core test must be met for the duration of the business continuity period in order for a tax loss component[3] included in a loss balance of a company to be carried forward. Proposed section IB 4 defines “business continuity period”.

For most companies, the business continuity period requires there to be no major change from the time immediately before the breaching change in ownership up until the end of the fifth income year following the change in ownership. As the point of comparison remains the time immediately before the ownership change against the time an amount of the tax loss component is to be used, gradual change can amount to a major change over time.

The five-year period is a maximum length of time that the major change test will have to be considered for most companies. When a tax loss component has been used by a company it no longer exists to be carried forward to a future year. The test therefore only ever considers whether a company can continue to carry forward existing tax loss components and has no bearing on the validity of losses already used. If all pre-ownership breach losses are used within the five years, the company will no longer have to consider the business continuity test as there are no existing tax loss components to which it would apply.

Part year loss provisions in section IP of the Income Tax Act 2007 will continue to apply.

Limiting the business continuity period is intended to reduce compliance and administrative costs while also ensuring that a business is not unduly constrained from making major changes indefinitely as this would impede innovation. It is costly to run a company as a genuine business for five years simply to access its losses. This makes loss trading less of a concern at the end of the continuity period.

Example 13

All Shook Up House Repilers Limited (All Shook Up) is a company that specialises in repiling and levelling older houses. They have been doing very well over the last number of years due to increased work from various earthquakes around the country.

Bartholomew, the owner of All Shook Up has been looking for new ways to expand his successful business and sees an opportunity in acquiring a comparable business. Steamroller Blues Contracting Limited (Steamroller Blues) is a company that undertakes land works for domestic customers. It has not been doing very well in recent years as Talia, the owner of the company, has not been pricing jobs well. As a result, Steamroller Blues has carried forward tax losses of $5 million.

Bartholomew purchases 100% of Steamroller Blues on 1 June 2021 and keeps the business operating but focuses on pricing the jobs more appropriately. In addition, the acquisition increases the customer base of the company. It is clear that Steamroller Blues has not had a major change during the business continuity period.

At the end of the company’s 2026–27 income year (31 March) Steamroller Blues has $600,000 of the original tax losses still available. In the 2027–28 income year Bartholomew sees an opportunity in school classroom construction and wants to make some changes to the company by selling all of its assets and replacing these with heavy machinery to erect buildings.

As Steamroller Blues is outside the five-year business continuity period the major change requirements will no longer need to be satisfied and therefore there are no tax restrictions on Steamroller Blues making changes to its business. The company will continue to be able to access the remaining losses.

However, if instead Steamroller Blues uses $4 million of its carried forward losses but has a major change at the end of the 2025–26 income year, it would forfeit the $1 million of unused losses.

The five-year business continuity period would not apply to all companies. For companies carrying forward losses consisting of significant deductions for bad debts claimed under section DB 31(3) of the Income Tax Act 2007 proposed section IB 4(1)(a) provides that the business continuity period will remain until the losses carried forward are utilised.

This condition is proposed to address concerns that a failed finance type company could be an attractive loss trading proposition. Failed finance companies may too easily satisfy the business continuity test even when they should not. A failed finance company may be acquired and, although the company is largely inactive, satisfy the test because the financial arrangement assets remain, and its activities are continued at a minimal level for five years to satisfy the business continuity test period. After five years the acquiror would be free to inject income into that company in order to use up the losses, for example, by transferring a profitable restaurant business into what was the finance company.

Losses arising as a result of bad debt deductions are the primary concern. Bad debt deductions arise when a taxpayer is in the business of “holding or dealing” financial arrangements and that taxpayer writes off a debt as unrecoverable. These are the types of deductions that can result in the large losses failed finance companies carry forward. By applying the business continuity test until the pre-breach losses have been used the losses acquired are restricted for use within the business that generated them, and Inland Revenue will be able to apply anti-avoidance rules to any loss trading type activity.

Proposed subsection IB 4(2) contains the formula to be used when calculating whether proposed subsection IB 4(1)(a) would apply, subsection IB 4(3) defines the items in the formula. In short, the calculation requires that all deductions in years a company records a loss that is included in its loss carry forward balance immediately before the breach in ownership continuity starting from the 2013–14 income year to be totalled. This total deduction amount is compared to the amount of section DB 31(3) deductions taken in those loss years. Any income derived under section CG 3 as a result of the recovery of DB 31(3) bad debts should be subtracted from the total deductions and from the DB 31(3) deductions claimed in those years. If the formula results in 50 percent or more of the loss carried forward being attributed to DB 31(3) deductions then the business continuity test applies until the losses are used.

Example 14

Always on my Mind Finance Limited (AMF) is a company that is in the business of holding or dealing in financial arrangements. It has incurred some losses relating to bad debt deductions under section DB 31(3) which relate to the amounts owing under financial arrangements.

It has incurred these losses over four years as follows:

Year  Income   Deductions (other than DB 31(3)) DB 31(3) deductions/(recoveries)  Net taxable income/(loss) 
2016–17 5,000,000 1,500,000 6,000,000 (2,500,000)
2017–18 2,000,000 3,000,000 7,500,000 (8,500,000)
2018–19 1,500,000 600,000 600,000 300,000
2019–20 1,000,000 2,000,000 (200,000) (800,000)
Total 9,500,000 7,100,000 13,900,000 (11,500,000)

Way Down Mortgages Limited (Way Down) is a mortgage lending company which is looking toward expansion and although AMF has not been performing well, Way Down thinks that with the right management this business can be turned around as the remaining portfolio of the company is promising.

AMF wants to understand how the new business continuity rules will apply to the tax losses carried forward by Way Down. It asks Lloyd the company’s accountant for some advice. Lloyd has a look at section IB 4 and also the tax returns for Way Down.

Year Deductions (other than DB 31(3)) DB 31(3) deductions/(recoveries) Total deductions
2016–17 1,500,000 6,000,000 7,500,000
2017–18 3,000,000 7,500,000 10,500,000
2019–20 2,000,000 (200,000) 1,800,000
Total 6,500,000 13,300,000 19,800,000

Lloyd advises that, because in the years that Way Down has made losses the ratio of DB 31(3) deductions to the total deductions is 67.2% ((13,300,000 ÷ 19,800,000) × 100), Way Down can carry forward its losses but the five-year rule will not apply to them. They will need to meet the requirements of the business continuity test until the losses are utilised.

Application to corporate groups

Currently, a company may offset its losses against other companies’ profits if it meets continuity of ownership requirements and has at least 66% common ownership with the companies when the loss is incurred. The loss will be made available to from the time the loss arose until the time it is used.[4]

The proposal leaves the commonality requirements unchanged. Companies in the original group that are acquired together would meet the group test (for example, they were 100% commonly owned when the loss was made and remain 100% commonly owned when the loss is to be offset). The acquired group will also form a new group with the acquiring company/group, however, because the commonality rules would fail to allow loss offsetting within the “new” group the pre-acquisition losses cannot be offset with other companies in that “new” group.

For the continuity requirements the proposal is that companies which meet commonality requirements immediately before and immediately after acquisition would be treated as a single company for the purposes of applying the business continuity test to carry forward pre-acquisition losses under proposed section IB 5. When assessing if there has been a major change the acquired group must be looked at as if it was a single company rather than separate entities.

Consequential amendments are proposed to the consolidation and amalgamation rules to incorporate the business continuity test but no changes are proposed to how these regimes operate.

Example 15

The Fame and Fortune Casino Group (FFG) is a group of companies operating a casino business. This Group is made up of a holding company and a number of subsidiaries which, as a whole, operate the casino business, one of these subsidiaries provides the finance function of the group. The finance subsidiary is carrying forward a loss.

FFG is acquired by the Money Honey Casino Group (MHG), another casino operating group of companies. MHG has a finance company and, because it is inefficient to keep two finance companies, FFG’s subsidiary finance function is wound down after the acquisition.

When MHG acquired FFG ownership continuity was breached. When applying the business continuity test to determine whether the losses of the FFG can be carried forward after the change in ownership the business activities of the whole group must be considered. When considered as a single company the Group carries on the same income generating business activities it did before being the casino. It also uses the same income generating assets to do so. On these facts FFG should be able to carry forward any pre-acquisition losses its members might have, and those losses will remain available to offset income within the FFG but not within the new group formed with the MHG because the commonality requirements are not met for those losses.


A number of proposals have been developed to support the core test and ensure it does not open up opportunities for loss trading. The key purpose of the loss continuity rules remains to prevent this activity.

Dormant company rule

Proposed section IB 3(3)(a) would disallow the carry forward of losses if the change in ownership occurs at any time after the business activities of the company have ceased and before any revival of the business. The proposed rule does not require assessment of whether a company is completely dormant, but it should deal with companies that are no longer viable and really only have value in their stock of tax losses. Similarly, proposed section IB 3(2)(b) would disallow any further carry forward of losses where a company ceases to carry on any business activities (in effect becomes dormant after the change in ownership).

The dormant company rule does not apply to a temporary reduction in activity. A company may be seasonal or may have to temporarily suspend trading due to Government order but as long as the income earning infrastructure remains ready to be operational there is no cessation of the business that will trigger the dormant company rule. Likewise, the proposal does not consider low activity industries to trigger the rule. It does not matter that a company is being run by receivers or liquidators as long as there remains a sufficient level of business activity.

Example 16

Golden Coins Ltd operates claw game machines to thirty shopping centres. It installs the machines and staff regularly visit the sites where they are installed to collect any money and replenish the supply of novelty stuffed animals.

Buying and installing the machines was an expensive exercise, it also proves expensive to service and stock the machines. Golden Coins incurs significant losses over the two-year period it operates.

The machines are poor quality and the claws constantly break. The number of players dwindles as the machines become known as unreliable and stingy with their prizes. Golden Coins decides not to stock or service the machines anymore and leaves them to slowly empty out. The shopping centres ask for them to be removed and they are all taken back to a warehouse that Golden Coins is leasing. After a month, the sole shareholder Jim, sells the business to his friend Rob. The machines are defunct and all that is left is the idea that maybe they could be refurbished and a lease for the warehouse where they are stored. There is otherwise no other activity happening.

The policy intent is for the dormant company rule to apply in this situation to not allow the carry forward of losses as at the time of the change in ownership the business activities carried on by Golden Coins had ceased.

Change in business activities prior to acquisition

Proposed section GB 3BA is a specific anti-avoidance rule to prevent arrangements that are made between the purchaser and seller of a company prior to a transaction that are intended to defeat the business continuity test or the dormant company rule. If taxpayers are able to avoid the intended application of the test, then avenues for loss trading schemes could arise.

Example 17: Change in assets

Milkcow Blues Boogie Cheese Limited (MBBC) is a poorly managed manufacturer of cheese with significant tax losses to carry forward. The cheese MBBC is known to produce has a terrible reputation and the shareholders have decided to sell the company rather than fix it. Spinout Limited (Spinout), a manufacturer of very good pulled toffee, hears the shareholders of MBBC are looking to sell and that the company has significant losses. The assets MBBC currently has are not very useful for toffee, but the staff can probably be retrained. Spinout knows that replacing the assets of MBBC after the change in ownership is going to breach the major change test and arranges for MBBC to dispose of speciality cheese equipment and to acquire toffee machines before the sale of shares takes place.

Section GB 3BA would apply to this situation to prevent MBBC from carrying forward its pre-acquisition losses because in the two years prior to the ownership continuity breach MBBC and Spinout entered into a verbal arrangement where the sale of shares of MBBC was made conditional on the assets being changed so that the business of Spinout could be carried out after the ownership change without breaching the core business continuity test.


Example 18: Change to a dormant company

A Little Less Conversation Limited (ALLC) was a publishing company that put out a popular political magazine. However, the operations were mothballed when the chief editor quit and the content became less popular. ALLC sustained substantial losses. After three years, Judy, a shareholder with a 10 percent stake in ALLC had an idea to start a high fashion magazine. They approached the other shareholders in ALLC offering to purchase the remaining 90 percent of the shares if ALLC’s business was restarted and produced the magazines as requested by Judy for six months. ALLC began to produce the magazines. Six months later, as agreed, the remaining 90 percent of shares in ALLC were transferred to Judy who continued on with the fashion magazine.

Section GB 3BA would apply to this situation to prevent the dormant company rule being circumvented by an arrangement to restart a business before the change in ownership.

Anti-injection rules

One way to engage in loss trading activity is to buy a loss company and inject some profitable activity or reduce its costs to soak up available losses. An acquirer may purchase a company and continue to run its business activities while also injecting amounts of income into the business or transferring costs out of the business that are small enough not to be regarded a major change. This is most likely to occur with an associated person. Proposed sections GB 3BAB and GB 3BAC are specific anti-avoidance rules and would only apply where a company is relying on the business continuity test to carry forward losses. The rules would not apply to companies more broadly.

The anti-injection rules would apply if all of the following conditions are met:

  • The company is party to an arrangement.
  • The effect of the arrangement is that the company derives assessable income or is allowed a deduction for an amount of expenditure or loss that, but for the arrangement, an associated person would have derived or incurred, would in all likelihood have derived or incurred, or might have been expected to derive or incur.
  • The sole or main purpose of the arrangement is tax avoidance.

It would not apply where, for example, employment contracts are shifted to a group member and there is a recharge to the loss company or where efficiencies are made by using other group employees to now provide services to the acquired company rather than, say, use consultants that were previously providing the services (for example, a loss company uses a firm as tax advisors but the acquirer has a tax division who would now undertake that task).

In the case of income injection, section GB 3BAB applies to deem the amount of injected income to be schedular income of the loss company. This results in tax to pay on that income (plus any associated shortfall penalties). In the case of cost shifting, section GB 3BAC applies to disallow the deduction for expenditure or loss in the profit company resulting in tax to pay on the income it offset (plus any associated shortfall penalties). The loss company is then treated as having incurred the amount of expenditure or loss.

Example 19

Moody Blue Boat Ltd (Moody Blue) is a failing manufacturer of fish finding equipment for boats. It has sustained significant losses over the last five years due to mismanagement. It’s Midnight Music Ltd (Midnight) buys and licences songs for use in events. It is a profitable business with no tax losses available to offset any income it derives.

In August 2020, Midnight acquires Moody Blue and carries on manufacturing the standard fish finding equipment it is known for and ensures the business is properly managed. There is no major change in the activities or assets of Moody Blue and so it is able to carry forward its losses relying on the business continuity test.

Midnight also sees an opportunity to assign some of its income to Moody Blue Co in order to take advantage of the available losses and reduce overall tax paid on the business of Midnight. In November 2020, an arrangement between Moody Blue and Midnight is entered into whereby some of Midnight’s licences are assigned to Moody Blue. This becomes a very small part of Moody Blue’s business and does not reach the threshold of major change.

However, the section GB 3BAB anti-injection rule applies to prevent the injected income from being offset with any remaining losses in that year. This applied because Moody Blue had a tax loss component it was carrying forward in reliance of the business continuity test, and but for the arrangement Midnight would have derived the income from the licencing activity, and the income was injected with the sole purpose of tax avoidance – Midnight entered the arrangement to reduce tax on its own business activities.


Example 20

Patch It Up Paint Ltd (Patch It Up) does painting and decorating for domestic clients. In recent years it has run into difficulty – it is poorly managed, and staff do not work efficiently or neatly. The client list slowly begins to shrink and Patch It Up suffers significant losses from 2016–2019. Patch It Up has found itself on the edge of failure and Barbara, the owner of the business, starts looking for a buyer.

Di owns and operates Rip It Up Decorators Ltd (Rip it Up). Rip It Up also does painting and decorating for domestic clients and has been very successful. In the 2020 year, Di secures the ownership interests in Patch It Up for a bargain price. This breaches ownership continuity but Di relies on the business continuity test to carry Patch It Up’s losses forward. Di thinks there is an opportunity to unlock the value of the losses by moving some costs to Rip It Up.

It seems logical to Di for Rip It Up to secure all the paint for both companies. A deduction for the paint arises in Rip It Up, Patch It Up no longer incurs this cost. In addition, Patch It Up has a loan with a bank that is resulting in deductions for interest payments. Di arranges for Rip It Up to pay the loan back on behalf of Patch It Up, but funds this repayment with a loan from another bank. Deductions for interest payments now arise in Rip It Up. The combination of these two arrangements results in Patch It Up returning to profit and therefore using its losses.

Rip It Up wants to use the deductions for interest payments and paint acquisition to reduce its own tax. However, Rip It Up’s accountant notes that section GB 3BAC applies to disallow these deductions. This is because there has been an arrangement between related parties which resulted in deductions that would have been incurred by Patch It Up being incurred by Rip It Up. Tax avoidance was the main purpose because Di entered these arrangements in order to access the losses of Patch It Up. GB 3BAC applies to treat Patch It Up as having incurred the expenditure that gave rise to the deductions. Rip It Up is reassessed and has tax to pay once the deductions have been taken away, shortfall penalties are also imposed.

Previously forfeited losses

Proposed sections IB 3(3)(b) and (c) are incorporated to confirm a taxpayer cannot revive a tax loss component:

  • that has previously been subject to a change in ownership followed by a major change, or
  • that was subject to a change in ownership before the 2020–21 income year.
Consequential amendments

Other proposals are consequential amendments to sections of the Income Tax Act 2007 which reference the loss continuity rules to ensure that, where appropriate, reference is made to the proposed business continuity test. These include amendments to rules relating to the carry forward of certain tax credits which are intended to mirror the rules for the carry forward of losses. These are research and development tax incentive credits, attributable controlled foreign company income tax credits, and tax credits for supplementary dividends.


[3] Tax loss component is defined in section IA 2(7) of the Income Tax Act 2007 as an amount included in a tax loss for the tax year (a net loss for the year and any additional amounts for the year). Section IA 5 provides that a tax loss component carried forward includes any unused tax loss component from an earlier year.  

[4] Subpart IC of the Income Tax Act 2007.