How the rules apply
Determining a current year tax loss
A current year tax loss arises in an income year in which the taxpayer's allowable deductions exceed assessable income and that excess is also greater than any net exempt income for the year (for the purposes of this calculation prior year tax losses are ignored).
The meanings of 'current year tax loss' and 'loss year' have been modified for a corporate tax entity that has an amount of excess franking offsets. A corporate tax entity will have an amount of excess franking offsets to the extent that its franking tax offsets exceed its income tax. Where this is the case, the amount of that excess is converted to an equivalent amount of tax loss by dividing it by the company tax rate.
This converted tax loss is then aggregated with any current year tax loss and the aggregated amount becomes the tax loss for the income year.
The term 'excess franking offset' carries the same meaning as 'excess franking rebate' as it appears in the company tax return instruction guide.
End of attention
If a corporate tax entity has an amount of net exempt income this amount will be subtracted from the aggregate amount.
The rule for current year losses
The rule for calculating current year losses if you are not a corporate tax entity is in section 36-15 of the ITAA1997. Section 36-17 of the ITAA 1997 has been added for corporate tax entities.
There is a method statement in section 36-55 to work out the amount of the tax loss for corporate tax entities.
Work out current year tax loss as under general provisions disregarding net exempt income
Convert the excess franking offset into tax loss using the step by step approach outlined above
Total these two losses. The amount of loss under general provisions plus the tax loss from the converted excess franking offsets
Reduce this amount of loss by the entity's net exempt income
The result is the current year tax loss
Choosing to deduct a prior year tax loss
Corporate tax entities are able to choose the proportion of their prior year losses to be deducted in an income year. This applies from the income year in which 1 July 2002 falls and in later income years.
Corporate tax entities, in the past, had no choice but to use up their prior year losses against income in future years. Providing this choice enables corporate tax entities to have sufficient franking credits to be able to distribute franked dividends to their shareholders despite having large prior year losses.
A corporate tax entity will not have a choice in relation to how much prior year tax losses it can deduct if the entity has net exempt income and its total deductions exceed the entity's total assessable income.
The rule for absorbing tax losses
The rule for absorbing tax losses for a corporate tax entity, contained in section 36-17 of the ITAA 1997, means a corporate tax entity will only have a choice in relation to how much prior year tax losses it can deduct:
- where the entity's total assessable income exceeds the entity's total deductions and the entity does not have net exempt income, and
- where the entity's total assessable income exceeds the entity's total deductions and the entity had net exempt income.
There are some further limitations, as to the exercise of this choice, explained under the heading 'Limits to the rule' below.
Limits to the rule
There are two limits restricting when corporate tax entities can choose the amount of tax loss it applies. These are:
- an entity cannot choose to deduct any prior year losses where there is an amount of excess franking offsets, and
- an entity cannot deduct a loss that will result in an excess franking offset.
The entity must choose a nil amount if, disregarding tax losses, the entity would have an amount of excess franking offsets for that year. The choice is limited to a nil amount. This is because the tax on taxable income has been absorbed by the franking tax offset. If limit 1 applies, the entity will be in a nil tax payable position.
If, disregarding tax losses, the entity would not have an amount of excess franking offsets for that year, the entity must not choose an amount of prior year tax losses that would generate excess franking offsets for that year. This limit is designed to prevent the refreshing of prior year tax losses as current year tax losses.
Limit 2 will need to be considered where there is an amount of income tax payable after applying the franking tax offsets.
These restrictions are designed to prevent the refreshing of prior year tax losses into current year tax losses. This impacts on the application of the tests for deductibility of prior year tax losses, specifically the continuity of ownership tests.
Requirement to notify the Commissioner
When a corporate tax entity chooses to deduct a proportion of their prior year losses, it must notify the Commissioner regarding:
- making an initial choice, and
- where it subsequently changes the amount of losses after lodging its tax return for the year.
Notification of initial choice
The corporate tax entity must make this choice before or at the time the entity lodges its tax return. The notification of this initial choice is made in the income tax return for the relevant income year.
Changing the initial choice
Where an element of this loss calculation is subsequently altered there may be a need for the entity to alter its decision about the amount of losses that are applied. Where this choice is revised the entity must notify the Commissioner in writing.
There are three situations where the entity may revise the initial choice. These situations are where the:
- amount of tax loss an entity can deduct is recalculated
- difference between assessable income and allowable deductions is recalculated, or
- amount of net exempt income is recalculated.
Example: Changing the initial choice
Jarkeg Pty Ltd has taxable income of $500, prior year tax loss of $1,000, and exempt income of $200.
Jarkeg Pty Ltd chooses to deduct a tax loss of $500 against this taxable income in its tax return, after applying $200 of exempt income against prior year losses.
After lodging the return Jarkeg Pty Ltd revises its taxable income to $700 and in addition receives a further $200 in exempt income.
Jarkeg Pty Ltd changes its choice about the amount of tax loss to deduct from $500 to $600. Jarkey Pty Ltd, after applying $400 exempt income against prior year losses has $600 remaining which it can use to deduct.
End of example