The trouble with using the tax system for business support is the lag in providing cash. The Minister of Finance announced three tax measures today (click here to see the factsheet). There is a clear focus on providing and enabling cashflow and freeing Inland Revenue’s ability to respond.

The three tax measures announced today are:

• A tax loss “carry back” rule which allow refunds of tax paid in a prior year. There will be a temporary rule for tax losses in the 2020 and 2021 tax years and a permanent rule for future years.
• A same or similar business test to allow tax losses to be carried forward. This is to help companies to raise capital.
• A temporary rule to give Inland Revenue flexibility to relax time frames and processes without the need for Cabinet approval.

These measures, which will apply to all businesses (not just small businesses, which is the focus of the Government's press release) reflect suggestions to Government and considerable hard work by Inland Revenue and Treasury. They are very welcome measures. However, they will need to be carefully assessed before businesses use them.

The temporary rule

For the 2020 and 2021 tax years, a tax loss will be able to be carried back to the 2019 or 2020 year to allow a refund of tax paid in the earlier year. Refunds cannot exceed the imputation credit account balance. Tax losses can be estimated to receive the refund. If an estimate is made, interest will be applied to any refund made in excess of the actual loss. This rule will be urgently legislated in late April 2020 so that it applies in time for the 7 May 2020 provisional tax instalment.

The temporary rule is estimated to have a $3.1 billion benefit for taxpayers which reduces to $1.6 billion over the forecast (Budget) period. This means the Government expects to provide relatively immediate refunds and to recoup those refunds as businesses recover and become profitable.

The permanent rule

For later years, the loss will need to be confirmed in a tax return. It cannot be estimated.  Further modifications to the temporary rule will be made. The permanent rule is expected to be legislated later this year after more detailed consideration is given to how the permanent rule should apply.

Our observations

Tax years vary depending on the tax balance date so when and how the proposed rules apply is not simply stated. The effect of the rules will depend on when a tax loss is made or expected.  The later a balance date occurs the more likely there will be a 2020 tax loss due to COVID-19.  Conversely the earlier a balance date, the more likely there would be a 2021 tax loss. 

A table outlines some possible outcomes:

2020 tax year result due to COVID-19	2021 tax year result due to COVID-19	Applying the new temporary rule
31 December 2019 taxable profit confirmed	31 December 2020 tax loss estimated	The 2021 tax year loss can be carried back to the 2020 tax year.  This can be estimated to claim the refund.
31 March 2020 taxable profit confirmed	31 March 2021 tax loss estimated	The 2021 tax year loss can be carried back to the 2020 tax year. This can be estimated to claim the refund.
31 March 2020 tax loss estimated or confirmed	31 March 2021 tax loss estimated	The 2020 tax year loss can be carried back to the 2019 year.  This can be an estimate or through a tax return filed early.  The 2021 tax loss cannot be carried back (as there is no taxable profit in 2020).
30 June 2020 tax loss estimated or confirmed	30 June 2021 tax profit estimated	The 2020 tax loss can be carried back to 2019 (by estimate or a return).  The business will have tax to pay for 2021 as it will have already used its 2020 tax loss.

 

The table illustrates that some thought will be required. The risk of interest being charged if tax losses are overestimated will influence the use of estimates rather than completed returns.  Those with earlier balance dates may wish to prepare their tax returns earlier than they otherwise would to protect themselves from this risk. Otherwise, a refund claim may be delayed until the position is confirmed. Although the cash will also be deferred, the rule will allow deferring tax payments with some certainty.

Importantly, companies will need to consider their imputation position. Companies that have paid imputed dividends may find the loss carry back rule does not help them. This is more likely to be an issue if the carry back is to the 2019 tax year as dividends are more likely to have been paid since.

The June example also illustrates why the cost of the proposal decreases over time. The Government expects to get the refunds as future tax payments. The risk it takes is that the business does not recover to pay future tax. However, the cash is likely to fund taxable income of others including suppliers and employees.

Finally, from a financial reporting perspective, the loss carry-back proposal may support recognition of an asset.  This may be as early as for 31 March balance dates as the legislation should be enacted in time for those financial statements to be finalised. 

The current rules require at least a 49% continuity in ultimate shareholders for a company to carry tax losses forward. The rule is intended to prevent tax loss trading.

However, it constrains particularly start-ups looking for cash. It will hamper businesses looking for new investors to help them through to recovery.

The proposed change is to allow companies to apply a “same or similar business test” from the 2021 tax year. This test applies in Australia and is intended to apply in the same way. 

The proposed rule is to be further developed and will be included in the same end of year tax bill as the permanent loss carry back rule.

Our observations

The same or similar business test is not as straight forward to apply as a percentage shareholding continuity test. The key question will be what a similar business is. This question has the potential to restrict its usefulness.

An “old world” example illustrates: is a (horse) coach building business the same as a (motor) bus building business? The business would have used the same skills and possibly similar processes and equipment but would have produced different products. We think these types of examples should meet the same or similar business test. It is important that a change in product or how a business will operate during the post COVID-19 recovery phase (e.g. shifts to having a greater online presence) qualifies. The point is to preserve and use the skills already gained.

Australia changed its rules from a same business to a similar business test. This was to broaden its application. The Australian Taxation Office’s ruling on the test (available here) suggests, in short, that a change must evolve from the earlier business carried on to meet the test. It contains several examples of business changes. It will provide some guidance while New Zealand’s rule and guidance is developed. In the meantime, care needs to be taken with business cases and other plans that companies undertake.

Tax legislation has many rules which specify deadlines and processes. Changes can be made by Order-in-Council (by Cabinet with Governor General approval). The Government is proposing a rule to allow Inland Revenue to make temporary changes to allow businesses to cope with COVID-19. The amendment will cover the Tax Acts and the Unclaimed Money Act. It will apply for 18 months and will be included in the urgent legislation for later this month.

Our observations

This is a practical and welcome measure.  Several suggestions made to Inland Revenue cannot be implemented without a law change or an Order-in-Council. Both take time which means that certainty cannot be provided to businesses. It also takes either Cabinet or Parliamentary time on matters of detail. In the current economic conditions, business certainty and more urgent priorities for Government require a quicker and easier process.

We are hopeful that this change will allow quick and practical changes to rules, without unnecessary constraints, to produce the right tax outcomes.

We are mindful the last time Inland Revenue’s powers were considered there were constitutional objections (that Parliament is sovereign in tax matters so Inland Revenue should not have powers to override tax law) and corruption concerns (that corporates would be given ‘sweetheart’ deals by Inland Revenue). This is not the place to respond in detail to those concerns as in our view they are misplaced. 

However, we expect the rule to provide sufficient protections to prevent abuse. Further, for those of us implementing the tax rules, flexibility is necessary at this time so the constitutional protection which Parliament provides needs to be relaxed. (However, to be blunt, that protection can often be missing as the very technical issues which arise are not necessarily well understood by lawmakers).

The usual consultation has not occurred, and Parliamentary oversight of these urgent measures will be reduced. However, the policies have been suggested by taxpayers and advisors (see our Taxmail of 17 March here) and are taxpayer friendly.  It is to be hoped the detail of the measures do not unduly restrict their application.

The Government and Officials have moved at pace to consider and announce the proposals.  That is welcome and appreciated.

However, these measures are unlikely to be the last. Keep an eye out for Part 3.