The 2020-21 Federal Budget introduced a temporary loss carry back regime in response to the COVID-19 pandemic. The rules allow for corporate tax entities to carry back tax losses from the 2019-20, 2020-21 and 2021-22 years as far back as the 2018-19 income year to generate refundable tax offsets.
Pursuant to the 2021-22 Federal Budget handed down in May 2021, a Bill introduced into Parliament provides for a one-year extension of the measure allowing corporate tax entities to receive tax offsets in the 2022-23 year and carry back losses for up to four years, or up to four years of tax losses to the one prior taxable year.
What are the rules about?
The corporate loss carry back rules are contained in Division 160 of the Income Tax Assessment Act 1997 and provide for companies (and other corporate tax entities) converting tax losses (but not capital losses) into cash refunds by carrying the losses back to one or more prior income years in which the entity paid income tax.
This contrasts with the normal treatment of tax losses which are carried forward against any taxable income generated in future years, subject to certain integrity rules being satisfied.
Further details about the loss carry back regime and how it works more generally can be found in a previous article (see here).
What are the changes trying to achieve?
The changes are contained in Schedule 6 to the Corporate Collective Investment Vehicle Framework and Other Measures Bill 2021 (the “Bill”) and provide for a one-year extension to the loss carry back measure.
If the amendments are enacted in their current form, subject to certain eligibility criteria and integrity rules being satisfied, corporate tax entities may be entitled to claim a refundable tax offset, by carrying back a tax loss arising in the 2022-23 income year to one or more of the four prior income years (i.e. As far back as the 2018-19 income year).
The Bill coincides with other legislation providing for a one-year extension to the temporary full expensing measures (to apply to eligible assets first used in the 2022-23 income year). Temporary full expensing complements the loss carry back regime by accelerating tax depreciation: potentially, a major contributing factor to the generation of tax losses.
What is an example of how the changes will operate?
The amount of the tax offset is limited to the “unused” amount of income tax liabilities of the 2018-19 and later income years.
For example, assume a company had $5m of taxable income in the 2018-19 year and paid $1.5m in income tax. If tax losses totalling $4m, arising in the 2019-20, 2020-21 and 2021-22 years, have already been carried back to the 2018-19 year (resulting in offsets of $1.2m), only $1m of tax losses in the 2022-23 year can be carried back to the 2018-19 year to generate a further $0.3m tax offset (in the 2022-23 year). This assumes a 30% corporate tax rate applies throughout the period.
The entity’s franking account balance as at the last date of the “claim year” provides another limit to the amount that may be claimed as a loss carry back tax offset (see further below).
Flexibility of the loss carry back regime
The changes highlight the flexibility of the loss carry back regime. A key feature of the regime is that the offset to which a corporate tax entity may be entitled in a particular income year, is not limited to the tax loss generated in that income year.
That is, a corporate tax entity can carry back an unutilised tax loss made in an earlier year to another (earlier) income year, as far back as 2018-19 income year.
For example, the changes will allow a corporate tax entity to, claim a carry back tax loss offset in the 2022-23 year, by carrying back tax losses from any or all of the 2019-20, 2020-21, 2021-22 or 2022-23 income years to prior years (but not further back than the 2018-19 income year).
This could be the case even if 2022-23 is not actually a loss year. It may be the case that a company is able to generate a tax offset for the 2022-23 year by carrying back a tax loss from the 2019-20 year to the 2018-19 income year, even if it was in a taxable position for all years after the 2019-20 year (to the extent any remains after carrying any of the 2019-20 losses forward).
While this design feature of the loss carry back regime is not introduced by the amendments contained in the Bill, a one-year extension to the regime provides a further opportunity for companies to utilise tax losses where they otherwise missed out.
What if a company didn’t or wasn’t able to carry back a prior tax loss?
This flexibility is particularly helpful because the loss carry back tax offset for a year is also limited by the entity’s (other than certain non-resident entities) franking account balance at a relevant time. That is, a corporate tax entity may have been unable to claim some or all of the maximum possible loss carry back tax offset in either the 2020-21 or 2021-22 years because it did not have a sufficient franking account surplus at 30 June 2021 or 30 June 2022 respectively.
The extension of the loss carry back regime allows eligible companies an extra chance to convert tax losses from the 2019-20, 2020-21 and 2021-22 years into cash refunds where it otherwise missed out due to its franking account balance. Corporate tax entities can do this by ensuring sufficient franking credits exist as at 30 June 2023.
Carry back or carry forward?
The ability to choose which year’s loss is carried back allows companies to utilise earlier year losses first to minimise the potential for losses to be wasted due to the loss integrity rules not being satisfied in a later year.
It remains possible (subject to specific integrity rules) for a corporate tax entity to carry back a 2020-21 year tax loss to generate a tax offset in the 2022-23 year even if that tax loss would no longer be able to be carried forward to the 2021-22 or later years due to the operation of under the loss integrity tests.
Other pending legislation
The Treasury Laws Amendment (2021 Measures No. 5) Bill 2021 (still before Parliament) contains measures to allow entities to amend their loss carry back choice from a prior year for any reason. For example, this could be because a mistake was made on an earlier form, prior year tax returns were amended, or it is determined that it is better to carry forward rather than carry back tax losses (e.g. Where tax rates are changing). These proposed changes, in combination with the one-year extension, provide substantial flexibility for companies to maximise the benefits they can receive from their tax losses.
What are the next steps?
Clients should contact their Pitcher Partners representative to review their existing arrangements and determine what action is required in light of the changes. The changes may provide an impetus for corporate tax entities to review and document their overall tax loss position from both a carry back and carry forward perspective, including consideration of the same or similar business test.