Temporary loss carry-back rules - What you need to know

17 May 2021

In brief

The temporary loss carry-back rules were a welcome announcement by the Government in the Federal Budget handed down on 6 October 2020. These rules are designed to provide temporary cashflow support to companies that were previously in a tax paying position but who now find themselves in a tax loss position due to the COVID-19 pandemic and/or through obtaining faster deductions for depreciation under the new instant asset write-off measures.

The business support that can be offered by the loss carry-back rules is to monetise the value of revenue losses generated by companies, rather than deferring this until when a company returns to profitability and a taxpaying position.

In detail

Amending legislation to give effect to the loss carry-back Budget measure was quickly introduced to Parliament (Treasury Laws Amendment (A Tax Plan for the COVID-19 Economic Recovery) Bill 2020) on 7 October 2020. The regime, as originally announced, was to be in place for three years. In the 2021-22 Federal Budget, the Government announced it would be extended for an additional year.

The loss carry-back regime will broadly allow corporate tax entities with ‘aggregated turnover’ of up to AUD5 billion to choose to ‘carry-back’ tax losses made in the 2019-20, 2020-21, 2021-22 and now for the 2022-23 income years to be offset against tax paid in relation to the 2018-19 or later income years (see our Insights for the concept of aggregated turnover).

The benefit of the offset is limited by the fact that tax losses cannot be carried back earlier than the 2018-19 income year. From a timing perspective, the offset cannot be claimed until the time of lodging the 2020-21, 2021-22 or 2022-23 income tax return (i.e. the claim year), even if the company generated a tax loss in the 2019-20 year and is seeking to carry it back to offset tax paid in relation to the 2018-19 year. It is not entirely clear as to the reason for delaying the ability to claim the offset for the first year, especially when cashflow is a primary concern for most businesses already adversely impacted by COVID-19, however it does ensure that from an administrative perspective, relevant Company tax return forms can suitably deal with the new offset.

On a positive note, unlike the short-lived loss carry-back rule introduced back in 2012-13 (which capped the tax offset at AUD300,000 per annum), there is no monetary cap on the amount of the tax offset that can be claimed. The tax offset is essentially only limited to the amount of tax paid in relation to the previous income year(s) (i.e. 2018-19, 2019-20, 2020-21 and/or 2021-22 income years), and capped at the amount of the franking account surplus at the end of the year the claim is made.

The Government anticipates that eligible companies may use other Budget measures to potentially create or increase a tax loss which can then be carried back to claim a cash refund through the offset mechanism. The example below as outlined in the Budget fact sheet highlights this:.

Bogong Builders Pty Ltd has aggregated annual turnover of $60 million for the 2021–22 income year. On 1 July 2021, Bogong Builders Pty Ltd purchases a truck-mounted concrete pump for $1 million, exclusive of GST. The company’s taxable income for 2021–22 was $600,000 before the purchase. Without temporary full expensing, Bogong Builders Pty Ltd would claim a tax deduction of around $300,000, resulting in a taxable profit of $300,000, and a tax bill of $90,000.

Under temporary full expensing, Bogong Builders Pty Ltd will instead deduct the full cost of the asset of $1 million, resulting in a tax loss of $400,000. Under temporary loss carry-back, Bogong Builders Pty Ltd offsets this tax loss against profits in 2018–19, resulting in a tax refund of $120,000. Without the refund, the company may have had to defer the investment until their cash flow position recovered, or may not have purchased the new pump at all.

The additional year to access the loss carry back as announced in the 2021-22 Budget ensures that the end date for these measures is in line with the extended end date for the availability of temporary full expensing.

There are a range of considerations to take into account in applying the loss carry-back regime, including the interplay with the existing loss carry forward rules.

What are the key issues?

• Corporate tax entities (i.e. companies or entities taxed like companies) with ‘aggregated turnover’ of up to AUD5 billion are the only taxpayers that can access the loss carry-back measures. There is no loss carry-back relief for individuals or other entities.
• The loss carry-back regime operates as a refundable tax offset, effectively providing a loss company with a cash refund for the tax that was paid in a prior year(s).
• The rules are flexible in the sense that a company can choose to either carry-back or carry forward any available tax loss made in the 2019-20, 2020-21, 2021-22  and/or 2022-23 income years to be offset against tax paid in relation to the 2018-19 or later income year. There is no compulsion that a loss be applied as a carry-back instead of using it in future income years and there are no ordering rules requiring it to be applied to the earliest taxable year.
• A company must have taxable income in one or more of the preceding income year(s) that is no earlier than the 2018-19 income year. Start-up companies or companies who have only generated tax losses during this period will not be eligible to claim the offset as they will have no prior income tax liabilities against which to offset losses.
• The maximum amount of the refundable tax offset that can be obtained in a year that the loss carry-back offset is claimed is limited to the entity's franking account balance at the end of the year in which the offset is claimed, and of course, the tax liability for the prior year(s) to which it is carried back.
• The different tax rates that apply to companies should also be factored into the equation, specifically noting that not all companies have a corporate tax rate of 30 per cent with a ‘base rate entity’ (that is, broadly, an entity with ‘aggregated turnover’ of less than AUD50 million and which derives certain passive income that represents no more than 80 per cent of its total assessable income) subject to a reduced rate of tax, i.e.:
  • 27.5% for the 2019-20 income year
  • 26% for the 2020-21 income year
  • 25% for the 2021-22 and 2022-23 income years.

While the carry-back tax offset is not subject to a continuity of ownership or business continuity test that apply to utilise carry forward tax losses, a specific integrity rule can apply where there has been a change of control arising from the disposition of membership interests and certain other requirements are met. In addition, the general anti-avoidance rule (Part IVA) can also apply to schemes entered into with the purposes of obtaining a loss carry-back tax offset.

What else should I know?

What losses are eligible for carry-back?

Only tax losses (i.e. revenue losses) are eligible for carry-back. The following types of losses are not eligible for carry-back:

• capital losses
• tax losses that were transferred to or from companies in the same foreign banking group
• losses transferred to a head company of a tax consolidated group by a joining entity, and
• losses generated as a result of excess franking offsets.

How does it apply to consolidated groups?

As noted above, losses transferred to the head company of a tax consolidated group are not eligible for loss carry-back. Similarly, the head company of a tax consolidated group cannot carry-back a loss to be offset against tax paid by a joining entity prior to joining the group - that is, broadly a company can only carry-back its own losses against its own tax liabilities.

The integrity rules

The new loss carry-back regime contains a specific integrity rule. A company cannot carry-back a tax loss to an income year if, broadly, there is a scheme for a disposition of membership interests held directly or indirectly in the company that result in a change in control of the company, and having regard to relevant circumstances listed in the legislation, “it would be concluded that a person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the corporate tax entity to get a loss carry-back tax offset.”

The relevant circumstances include the extent to which the company continued to conduct the same activities or use the same assets after the scheme as it did before, and also the matters referred to in the general anti-avoidance rule (Part IVA). A company will need to self-assess whether the integrity rule applies to their circumstances. The general anti-avoidance rule can apply to schemes entered into with the purposes of obtaining a loss carry-back tax offset and may be applied where the specific integrity provision does not apply - for example, where there has been a scheme that does not involve the disposition of membership interests.

There is also an inbuilt integrity requirement that determines eligibility to the loss carry-back tax offset – the company must have lodged its income tax return for the loss year and for each of the five preceding income years (where it was required to do so).

Other consequential amendments

A range of consequential amendments to the tax law are also proposed to cater for the new loss carry-back regime, including:

• a debit to a company’s franking account will arise when a refund from a loss carry-back tax offset is received – care should be taken to ensure the debit to the franking account will not put the franking account into deficit which could result in franking deficit tax liability at year end
• taxpayers have rights to object against an assessment which includes the taxpayer's refundable tax offsets - this will enable a company that claims a loss carry-back tax offset to object to the amount of any refund arising from the offset
• a loss carry-back offset can be changed by requesting an amended assessment, subject to the usual time limits for amending assessments, and
• a loss carry-back tax offset is disregarded when the Commissioner of Taxation determines the rate for the next year's PAYG instalments.

The takeaway

To carry-back, or to carry forward?

Loss carry-back is optional, similar to the existing choice available to companies to carry forward and deduct prior year tax losses.

The existing loss carry forward rules are largely undisturbed by the introduction of the loss carry-back regime. Losses, of course, can only be "utilised" once.

An entity may choose to either carry forward or carry-back part or all of a tax loss, and there are generally no restrictions to this choice. Unlike the rule which requires losses to be deducted in the order in which they arose, there are no similar ordering rules that apply to using losses for the loss carry-back tax offset.

As the loss carry-back offset results in an immediate refund, logic would suggest that a company would be more likely to choose to carry-back its losses before it carries them forward. Carrying forward losses also runs the risk of those losses being lost due to changes in ownership or business carried on by the company. But carrying losses back has its own downfalls and limitations, including the impact on the franking account and the ability to pay franked dividends in the future. A careful consideration of all the factors will need to be made before making a choice.

A choice to carry-back losses must be made by the day on which the company lodges its tax return for the year in which the offset is claimed, subject to additional time being allowed by the Commissioner of Taxation. It is expected that the annual company tax return will be the approved form to make the loss carry-back choice.