Tax loss carry-back scheme: Important considerations

Tax loss carry-back scheme: Important considerations

Tax loss carry-back scheme: Important considerations 1200 630 Lee Stace
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Standard imputation (ICA), ownership continuity and grouping rules still apply under the new tax loss carry-back scheme, while anyone who overestimates their loss will face IRD interest (UOMI) from the date of their first provisional tax instalment for the previous year.

Moreover, company profits already paid out via shareholder-employee salaries or dividends are unable to be reversed to take advantage of the scheme.

A basic overview of the scheme

Under the temporary scheme, taxpayers who expect to make a loss in either the 2020 or 2021 tax year will be able to estimate that loss and use all (or a portion of it) to offset any profit made in the previous year.

This allows those who need cash urgently to receive a refund of any income tax paid in the previous year.

It applies to companies, trusts, and individuals (other than those deriving only PAYE income) and those that operate through partnerships and look-through companies.

The legislative reference is sIZ8 Income Tax Act 2007.

Here are some of the things you need to consider before electing to use the scheme.

The ICA rules

Be mindful that standard ICA rules apply as part of the tax loss carry-back.

That means in order to obtain a refund of income tax, a taxpayer must have an ICA credit balance at the end of the most recently ended tax year (i.e. 31 March 2020) that is at least equal to the refund amount.

Alternatively, they can complete an interim ICA return up to the date of their refund request.

Provisional tax deposits held in a tax pooling account that are refunded under the loss carry-back scheme will be subject to the imputation debit rules that normally apply for pooling.

Given the potential exposure to imputation penalty tax of 10 percent and UOMI, the timing of tax pooling refunds due to a loss being carried back should be considered on an ongoing basis to mitigate this risk. 

The results can be catastrophic if they’re not.

We strongly encourage you to contact us before you refund any balances from the pool.

Ownership continuity and grouping rules

The ownership continuity requirements that relate to the loss carry-forward provision, and the normal grouping rules, also apply under the tax loss carry-back scheme.

This means a company must have maintained at least 49 percent common ownership throughout the loss year and preceding profit year.

For entities part of a group, the group must have retained 66 percent common ownership throughout the loss year and the preceding year.

That said, there are provisions in the tax loss carry-back legislation that deal with part years in the ownership continuity period.

IRD has examples of this in its commentary for the COVID-19 Response (Taxation and Other Regulatory Urgent Measures) Bill.

Time bar rule

IRD can reassess both the loss year and the preceding profit year at the same time – even if the preceding profit year is time barred.

That is something to keep in mind.

Situations where the scheme cannot be used

A taxpayer must have taxable income in the previous year.

Given that, a company that has already paid out its profit via shareholder-employee salaries will not have any taxable income to which they can apply future losses they wish to carry back.

This is also the case if the taxpayer has already distributed its profits as a dividend or made a subvention payment.

Therefore, they cannot use the scheme.

Taxpayers who have ringfenced rental losses will not be able to carry back losses either.

It’s the same with multi-rate PIEs. This is because they have a cash-out for losses that provides immediate tax relief in this situation.

Situations where it will offer limited benefit

A taxpayer can only carry back losses one year (e.g. from the 2021 tax year to the 2020 tax year).

As such, there will be situations where the scheme will only free up a small refund of income tax.

Example one

Tax yearTaxable income
2019Massive profit
2020Modest profit
2021Huge loss forecast

Someone can only carry back the huge forecast loss for 2021 to the extent of the taxable income in 2020. As you can see, this is considerably lower in comparison to the 2019 tax year.

This will result in a very small refund of tax under the scheme.

Example two

Tax yearTaxable income
2019Massive profit
2020Small loss
2021Huge loss forecast

Someone can only carry back the small loss from 2020 to the 2019 year. The huge forecast loss from 2021 cannot be utilised as part of the scheme.

Once again, this will result in a small refund of tax.

Here’s another thing to remember.

If the taxpayer is part of a wholly owned group of companies, the loss amount they can carry back is limited to the amount that cannot be offset against the profits within that group during the loss year. In other words, the loss must be used within the group first during the loss year.

UOMI ramifications

A taxpayer can re-estimate provisional tax in the previous year as many times as they like under the scheme. They can keep doing so up until the date they file their return for the loss year (or the date by which they must legally file this return if this is earlier).

However, re-estimating provisional tax means the UOMI rules in s120KB Tax Administration Act 1994 will apply.

That means if someone overestimates their tax loss carry-back for the loss year – resulting in tax to be paid later due to receiving a larger refund to which they were entitled – they will be liable to pay UOMI from the date of their first provisional tax instalment in the preceding profit year.

Interest will be charged on the difference between the income tax they owe for the profit year and the income tax they paid in that year.

The income tax they owe for the profit year is based on the original taxable income for that year, minus the actual loss from the loss year. The tax they paid in the profit year is based on the original taxable income for that year, minus the total loss year refund they initially received due to overestimating their loss.

The amount on which UOMI is charged will be split evenly across the number of provisional tax instalments payable for the profit year.

Section 183ABAB of the Act – which gives IRD the power to remit UOMI for taxpayers who cannot make tax payments after 14 February 2020 due to COVID-19 – will not be able to assist.

TMNZ can help reduce UOMI

However, someone who is incurring UOMI due to overestimating their tax loss carry-back can use TMNZ to reduce the interest cost by up to 30 percent on the additional tax payable if they are within 75 days of their terminal tax date for the profit year (or 60 days from the date IRD issues a notice of reassessment if the profit year is a closed income year).

Flexitax® allows them to apply backdated tax paid to IRD on the date it was originally due against their liability.

As such, IRD will treat the taxpayer as having paid on time once it processes this transaction, remitting any UOMI and late payment penalties incurred.

It’s a safety net for someone who has a ‘mare forecasting their loss.

It may pay to wait and see

For many taxpayers, the most recent tax year would have ended on 31 March 2020.

Up until the start of that month, when the impacts of COVID-19 really hit, everything was running smoothly. It’s quite likely their profitability was not significantly impacted.

But there’s a strong likelihood it will be during their 2021 tax year.

However, as it’s still early days in that year, having to estimate a loss to carry back to 2020 this far out is quite difficult.

Honestly, who really knows what the landscape will look like next month – let alone by 31 March 2021 – given the clouds of uncertainty lingering above the domestic and global economies in the wake of COVID-19?

The risk of incurring UOMI if they get it wrong means they may wish to err on the side of caution with their loss estimate and then re-estimate as the year progresses once the picture becomes clearer.

The other option is to hold off until later. That’s what many appear to be doing at this stage given the low uptake.

Yet a downside of playing it safe or waiting a little longer is the taxpayer may not receive the full cashflow injection they are seeking right now.

Does their desperate need for immediate funds outweigh the potential UOMI consequences down the track, or can they afford to wait?

That’s something a taxpayer is going to need to weigh up before opting in.

Don’t forget tax pool deposits

For those holding provisional tax deposits in TMNZ’s tax pool who want access to their payments now – but don’t yet have the confidence to file a loss carry-back – there is another option.

They can take a line of credit against their deposits, for interest rates below three percent. They also have the option of restoring those deposits at their original deposit dates once their cashflow situation improves.

However, there are a couple of things to note.

For starters, the ICA position needs to considered first as the debit rules for pooling apply in this situation as well since the transaction is treated as a sale of tax.

The tax must also be paid back and transferred to IRD within 75 days after the terminal tax date for that tax period.

Nonetheless, it’s something else to think about if a taxpayer requires cash in the wake of COVID-19.

Summary

The above are some things of which to be aware when it comes to the tax loss carry-back scheme.

For business owners, this IS NOT tax advice. We recommend you speak with a tax specialist in the first instance about your particular situation. The legislation is quite complex.

You can find one of our premium accounting partners here.

Lee Stace

Lee Stace is the PR and Content Manager at Tax Management NZ.

All posts by: Lee Stace

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