It now awaits Royal Assent, expected next week. See our previous Taxmail here on the Government announcement proposing the measures.
In short, it confirms taxpayers can carry back a 2020 or 2021 tax year loss one year to reduce the prior year’s taxable income. It also provides the Commissioner with a time limited power to relax the requirements of the Tax Acts.
Both of these measures are welcome. Although they will not help everyone, the loss carry back rules will provide some cash to business. The Commissioner’s power, if used appropriately, will allow some compliance relief to taxpayers.
Loss carry back
Those with losses will be entitled to a refund of the prior year tax paid. The taxpayer will not have a loss to carry forward so will pay tax in the future.
The loss carry back can be based on filed returns or estimates. If an estimate of the loss is made, use of money interest will apply from the first provisional tax instalment for any shortfalls in that estimate year. The safe harbour rules for using the standard uplift basis for calculating provisional tax will not protect taxpayers from interest.
If the profit year return has not been filed, an estimated loss can be carried back by estimating provisional tax and having that refunded. A provisional tax estimate can be made until the return is filed or the return due date, whichever is earlier.
To carry back a loss, a company taxpayer must:
- Satisfy the 49% shareholder continuity test in both the loss and profit years (part year rules will allow a part loss carry back and an anti-avoidance rule also needs to be satisfied);
- If a member of a group of companies:
- First offset any losses to the extent of group profits in the loss year (subject to rules which allow non-refundable credits to be claimed); and
- Satisfy the 66% shareholder commonality group test to offset carried back losses against profits of another group company;
- Have an imputation credit balance equal to the refund.
For closely-held companies which pay profits to shareholder-employees, the expectation is that 2020 salaries can be adjusted to account for 2021 losses. Shareholder-employees will also be able to re-estimate provisional tax until their return is filed. However, companies will not receive FBT or dividend relief if shareholders have overdrawn current accounts as a result of receiving a lower than anticipated salary.
Partners in limited partnerships and members of look through companies are entitled to have tax losses carried back. Sole traders and partners are also able to carry back tax losses.
Ring-fenced residential property tax losses and life insurance policyholder tax losses cannot be carried back.
The rules legislated are for the 2020 and 2021 years only. Permanent loss carry back rules will be considered and legislated later in the year.
In essence, the Government is providing taxpayers with a limited recourse loan. The refund of prior year tax will only be repaid if and when future taxable income is derived. It means cash will be provided to some of the businesses that need it. (It does not help those businesses which remain profitable).
Using the regime is not entirely without risk especially, if as is likely to be most useful, estimates of losses are used to request refunds. If the estimate is excessive, use of money interest applies. This risk may be managed by making a number of estimates through the 2021 year as the position becomes clearer.
COVID-19, just as it does not respect borders, does not respect tax years. When a tax loss arises it will depend on a business’s balance date. It is likely that some businesses will have significant 2021 year tax losses and small 2020 year profits or losses. Unfortunately, the rules do not allow them to access a 2019 refund.
For company groups, the position will be even more complicated. They will need to estimate the position of each company to ensure the group has a net loss that can be carried back. Groups which have not historically offset losses will need to reconsider their policy to best use the new rules.
A loss carry back will mean that income tax is payable possibly sooner than under current rules, as losses will not be available to offset future income. The complexities of the provisional tax payment rules will also need to be considered so that future year tax underpayments do not attract interest.
Finally, as these rules are brand new and can be complex, particularly where there are multiple taxpayers involved, care needs to be taken. This is not a case of claim now and deal with the consequences later.
The Commissioner will have the ability to:
- Extend a due date, deadline, time period or timeframe; or
- Vary a procedural or administrative requirement of the Inland Revenue Acts and the Unclaimed Money Act.
This power will last until 30 September 2021 (but can be extended by Order in Council). It is intended to apply in favour of taxpayers to allow them to meet their obligations.
The Commissioner’s ability to allow taxpayers to do things that the tax law says they cannot has been a matter of debate and controversy. The Commissioner has taken a restrictive view of her ability to vary the requirements of the tax rules. This reluctance is based on the view that Parliament is sovereign in the making of tax laws. Inland Revenue has no power to change the rules. The Commissioner can only decide where to allocate her resources. In other words, she can turn a Nelsonian blind eye to not find something, but having found something, she cannot ignore it.
The new rule provides an explicit power to vary legislated dates and procedures. This is welcome. It should allow the tax system to operate more smoothly.
Exactly how far the power goes is still unclear, but the dividing line seems to be that a substantive tax rule imposing tax will not be varied by the Commissioner. Some examples illustrate:
Possibly able to be varied
Possibly unable to be varied
The timing of writing off of bad debts.
Employer requirement to advise an employee that a motor vehicle cannot be used privately.
Due dates for payments.
Whether an account holder is a passive or active entity for FATCA/CRS purposes because of changes in its income profile.
This means that taxpayers are unlikely to be able to rely on the power as a general “get out of jail free” card. However, they can look forward to some relaxation of certain rules.