Coronavirus – Tax Loss Scheme
The government has announced details on the changes to tax losses as part of a suite of measures to assist with the economic downturn caused by the COVID-19 lockdown.
The scheme will allow entities to offset a loss in a particular tax year against a profit in a previous year.
In addition, the government will relax laws on the shareholder continuity rules.
Tax loss carry-back scheme
The tax loss carry-back scheme will allow firms to offset losses in a given income year against profits made in previous income years.
The scheme will appeal to any company that is anticipating making a loss in the 2021 income year (the year ended 31 March 2021).
Directors should already be modelling financial scenarios for the year ahead. Simply put, Directors should model how they will continue trading if they suffer a loss in income of say 20%, 40% or 60%. We wrote about that recently and you can read our commentary here.
Once Director’s have formed a view on the likely outcome for their business, they may discover that the business will make a loss. In order to continue trading, cash flow will need to be managed carefully. In many instances, additional capital will need to be introduced to the business. The government’s announcement will allow overpayment of provisional tax to be refunded and potentially allow relief on the usual provisional tax payment due on 7 May 2020.
An example prepared by Inland Revenue appears below:
Wiki Wiki Hospitality Limited (Wiki) has had a profitable year for the year ended 31 March 2020. It has not yet finalised its tax return, but it is expected to return $2m net income. Its final provisional tax payment for the expected $2m income is coming up on May 7, where it expects to pay $250,000 in tax (it has already paid $310,000 in early provisional tax instalments).
However, because of COVID-19, it is not operating at the moment, and does not know when it will be allowed to resume operating. It is still paying its staff (supported by the wage subsidy scheme) and rent. It seems inevitable that it will make a loss in the year ended 31 March 2021. In early May, the directors meet with the CFO and forecast some scenarios. In all the scenarios, Wiki will make a loss of $1.5m for the year-ended 31 March 2021, although some scenarios sees it making a $2m loss.
Knowing it will face use-of-money-interest charges if it over-estimates its loss, Wiki decides to carry-back the more certain loss of $1.5m to the 2019/20 year, and re-estimate its income for that year to $500,000 (down from $2m). Because it has already paid $310,000 in tax, it pays nothing on May 7, and receives a refund of $170,000 from its earlier provisional tax payment.
In short, for the 2019/20 year, Wiki returns $500,000 of income and pays $140,000 tax, receiving back its earlier payments as refunds.
The proposal has yet to become law. It is anticipated that it will be introduced to Parliament once it resumes sitting after April 28. Inland Revenue have yet to consult with tax advisors about the intricacies of the scheme and so little information is available by way of administrative guidance.
Inland Revenue’s website notes that taxpayers “do not need to rush to re-estimate their provisional tax before 7 May. Part of the proposed law change would make it possible for them to re-estimate it after the date of the final instalment. This will give them more time to work out any estimated loss for the 2020/21 income year.”
We’ll update clients once this guidance is available.
Shareholder continuity and tax losses
Under existing tax law, companies have significant changes to shareholding can forfeit tax losses.
For stand alone companies at least 49% of shares should be held by the same shareholders throughout the period. This is called the Shareholder Continuity Test. If continuity was less than 49%, all tax losses would be forfeited.
In a group of companies, the threshold is higher. One company can distribute the loss to a related company which is part of the same group so long as shareholder continuity exceeds 66%.
The government has announced that it will relax these rules. So long as the company is in a “same or similar” business when the shareholding changes, prior year’s losses will carry forward to future tax years.
Guidance has yet to be issued, and this is certain to be a temporary change to the Income Tax Act. Nevertheless, it is a welcome change and one that early stage businesses, or “start-ups”, will benefit from. The software industry is an obvious candidate where large losses are incurred in bringing a product to market. It will enable owners of start-up businesses to seek additional capital by offering equity in their companies.
It should be noted that both are proposals at this stage, and not law. Directors should be mindful that changes may be made to these proposals during the consultation period.
The tax working group advised that these rules should be relaxed back in 2019 with the caveat that there might be an impact on revenue collected. Current estimates put it at $60 million.
You can read more about the proposed changes by clicking on the link here.
Inland Revenue has a full list of tax changes (both proposed and recent) on their site here.