House of Representatives

Tax and Superannuation Laws Amendment (2013 Measures No. 1) Bill 2013

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 6 - The loss carry-back tax offset

Outline of chapter

6.1 This chapter explains how the loss carry-back tax offset rules operate.

6.2 All legislative references in this chapter are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.

Summary of new law

6.3 The loss carry-back rules give a corporate tax entity the choice of carrying back all or part of a tax loss from the current income year, or from the preceding income year, against an unutilised income tax liability for either of the years before the current year. The measure applies to assessments for the 2012-13 and later income years. A transitional one year carry-back period applies for the 2012-13 income year.

6.4 If the loss carry-back conditions are satisfied, a corporate tax entity can get a refundable tax offset for the losses it chooses to carry back.

6.5 The tax offset the entity can get is the lowest of:

·
the tax value of the amount of the loss the entity chooses to carry back;
·
the entity's franking account balance at the end of the current year;
·
$1 million multiplied by the corporate tax rate for the current year [1] (currently $300,000); and
·
the entity's tax liability for the income year(s) it carries a loss back to.

6.6 A corporate tax entity that has net exempt income in an income year it carries a loss back to must reduce the loss it carries back by that net exempt income before it works out its offset for the remaining loss.

6.7 The loss carry-back rules deny entitlement to the tax offset where there is a scheme for the disposition of membership interests in the corporate tax entity that changes who controls or is able to control the entity. The offset will be denied only if a purpose of the scheme (whether or not the dominant purpose but not including an incidental purpose) is to obtain a financial benefit calculated by reference to a loss carry-back tax offset.

Comparison of key features of new law and current law

New law Current law
Tax losses can either be:

·
carried forward and deducted against income derived in later income years; or
·
carried back against income of earlier income years to produce a refundable tax offset.

Tax losses can be carried forward and deducted against income derived in later income years.

Detailed explanation of new law

6.8 The loss carry-back refundable tax offset allows a corporate tax entity to carry back a tax loss against income tax payable for the two preceding income years.

6.9 The objective of loss carry-back is to reduce the tax disincentive for corporate tax entities to undertake sensible investment risks. It does this by providing a corporate tax entity with access to its tax losses sooner than is the case under the existing loss carry-forward arrangements. [Schedule 5, item 2, section 160-5]

Entities eligible for loss carry-back

6.10 Loss carry-back is only available for corporate tax entities (broadly, entities that are taxed like companies). [Schedule 5, item 2, paragraph 160-10(a)]

6.11 A 'corporate tax entity' is defined in section 960-115 to be an entity that is:

·
a company;
·
a corporate limited partnership;
·
a corporate unit trust; or
·
a public trading trust.

6.12 Some of those entities may be corporate tax entities at some times but not at others. An entity can claim the loss carry-back tax offset for an income year only if it was a corporate tax entity throughout that income year. [Schedule 5, item 2, paragraph 160-10(a)]

6.13 It must also have been a corporate tax entity throughout the income year the loss is carried back to and throughout any intervening income year. [Schedule 5, item 2, section 160-25]

Loss carry-back gives rise to a refundable tax offset

6.14 A corporate tax entity can choose to utilise a tax loss to obtain a loss carry-back tax offset if:

·
it has an unutilised tax loss for the current income year or for the preceding income year (called 'the middle year');
·
it has an unutilised income tax liability for the middle year or for the income year before that (called 'the earliest year'); and
·
for the current income year and each of the previous five income years, it has lodged an income tax return, or was not required to lodge a return, or has been assessed for income tax purposes by the Commissioner of Taxation (Commissioner).

[Schedule 5, item 2, paragraphs 160-10(b) to (e)]

6.15 The loss carry back offset is a refundable tax offset. [Schedule 5, item 1, section 67-23]

Losses eligible for loss carry-back

6.16 Corporate tax entities can carry their tax losses back to produce a tax offset as an alternative to carrying them forward as a deduction for future income years.

6.17 Only tax losses can be carried back. Capital losses cannot be carried back because the capital gains tax regime operates on a realisation basis. Allowing capital losses to be carried back to produce a tax offset would mean that entities could choose to realise their capital losses to get an offset but defer their capital gains.

6.18 Generally speaking, an entity makes a 'tax loss' for an income year if its deductions exceed its assessable income for that income year.

Tax losses of the current income year

6.19 The most common case involves an entity carrying back a tax loss it makes in the current income year. [Schedule 5, item 2, subparagraph 160-10(b)(i)]

6.20 Such a loss can be carried back against a tax liability of either or both of the two previous years (the middle year or the earliest year). The entity could choose to carry back some of its current year tax loss to the middle year and some of it to the earliest year. [Schedule 5, item 2, paragraphs 160-10(c) and (e) and subsection 160-20(1)]

Example 6.21 : Losses of the current income year Super Syed Pty Ltd has the following outcomes:

Income year Taxable income / (loss) Tax liability Refundable offset Loss carried forward
2013-14 $500,000 $150,000
2014-15 $2 million $600,000 0 0
2015-16 ($5 million) 0 $300,000 $4 million
In 2015-16, Super Syed incurs a $5 million tax loss. Super Syed carries back $1 million of the loss with a tax value of $300,000 against its 2014-15 income tax liability or against its 2013-14 liability, or some against one year and some against the other. It chooses to carry $500,000 back to each of those years, producing a maximum offset of $300,000 and leaving $4 million of its 2015-16 losses still unused.

Tax losses of the middle year

6.21 The less common case involves an entity carrying back an unutilised tax loss from the middle year against its tax liability from the earliest year. There is no choice about which year to carry such a loss back to because losses can only be carried back two years before the current year. [Schedule 5, item 2, subparagraph 160-10(b)(ii)]

Example 6.22 : Losses of the middle year Continuing the previous example:

Income year Unused taxable income/ (loss) Unused tax liability Refundable offset Loss carried forward
2014-15 $1.5 million $450,000 0 0
2015-16 ($4 million) 0 $300,000 $3 million
2016-17 0 0 $300,000
In 2016-17 Super Syed Pty Ltd can carry back $1 million of its remaining $4 million tax loss from 2015-16 (which is now the middle year) against its unused tax liability of 2014-15 (the earliest year) to gain the maximum $300,000 tax offset in 2016-17. It will still have $3 million of its 2015-16 loss left that it can carry forward to deduct against future income years' assessable income.

Tax losses from both years

6.22 A corporate tax entity can carry back losses from both the middle year and the current year at the same time. Both would have to be carried back to the earliest year. The entity would choose how much of each year's loss to carry back. [Schedule 5, item 2, subsection 160-20(1)]

Example 6.23 : Losses of both years Kathryn Joyce Inc. has the following outcomes:

Income year Unused taxable income / (loss) Unused tax liability Refundable offset Loss carried forward
2014-15 $2 million $600,000 0 0
2015-16 ($700,000) 0 0 0
2016-17 ($2 million) 0 $300,000 $1.7 million
In 2016-17, Kathryn Joyce can carry back its loss from the current year, or its loss from 2015-16, or some from each year. It decides to carry back the whole loss from 2015-16 and $300,000 from 2016-17. That will produce the maximum $300,000 tax offset and leave it with $1.7 million of its 2016-17 loss to carry forward to deduct against the assessable income of future years.

6.23 Tax losses not used for loss carry-back in the current income year are available to reduce any taxable income in that income year or a future income year, according to the usual rules for deducting prior-year losses in Division 36.

Tax losses ineligible for carry-back

6.24 Some tax losses cannot be carried back.

6.25 An entity cannot carry-back losses that have been transferred under:

·
Division 170 - transfers between companies in the same foreign banking group; or
·
Subdivision 707-A - transfers to the head company of a consolidated group by an entity joining the group.

[Schedule 5, item 2, paragraph 160-30(a)]

6.26 In addition, the part of a tax loss that is deemed to exist when a corporate tax entity has excess franking offsets for an income year (see section 36-55) is not eligible for carry-back because it does not represent an economic loss. Allowing it to produce a tax offset would mean that a past payment of tax could give rise to a refund of that tax without any effect on the entity's willingness to take sensible investment risks. The real part of the income year's tax loss would still be able to be carried back. [Schedule 5, item 2, paragraph 160-30(b)]

The loss carry-back period

6.27 For the 2013-14 and later income years, a loss carry-back refund can be claimed against tax liabilities of either of the two income years preceding the current income year. [Schedule 5, item 6, section 160-1 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A 1997)]

6.28 As a transitional measure for the 2012-13 income year, a loss carry-back refund can only be claimed against the tax liability for 2011-12 income year. [Schedule 5, item 6, section 160-5 of the IT(TP)A 1997]

The choice to carry-back losses

6.29 Loss carry-back is optional, mirroring the existing choice corporate tax entities have about whether to deduct their tax losses (see subsections 36-17(2) and (3)). An entity can choose to carry a tax loss back or not as it sees fit. That is, the entity can choose:

·
how much of its tax loss for the current year is to be carried back to the earliest year;
·
how much of its tax loss for the middle year is to be carried back to the earliest year; and
·
how much of its tax loss for the current year is to be carried back to the middle year.

[Schedule 5, item 2, subsection 160-20(1)]

6.30 Therefore, as well as choosing whether or not to claim a loss carry-back tax offset, an entity can also choose which tax loss to carry back (if it has a loss in both the current year and the middle year). It could choose to carry back losses from both years.

6.31 It can also choose which years to carry a tax loss back to (if it has a tax liability for both the middle year and the earliest year). It could choose to carry its loss back to both of those years.

6.32 Finally, an entity can choose how much of a loss to carry back (subject to the limit on the total amount of the offset it can produce for any given year). An entity might normally choose to carry back the maximum amount it can but there could be some cases where it would not do so. For example, a company might only wish to debit its franking account by less than the maximum refund in order to retain its capacity to pay a fully franked dividend.

6.33 The choice to claim a loss carry-back tax offset is made by notifying the Commissioner in the approved form. The choice must specify that the entity wishes to claim the offset and:

·
each loss year that it wishes to carry an amount back from;
·
the amount of the loss it wishes to carry back; and
·
each year it wishes to carry the loss back to.

[Schedule 5, item 2, subsection 160-20(2)]

6.34 The choice must be made by the time that the entity lodges its tax return for the current income year, or within such further time as the Commissioner allows. [Schedule 5, item 2, subsection 160-20(2)]

6.35 The approved form would usually be the corporate tax entity's income tax return, so the claim would normally be made at the same time as the tax return is lodged. However, there might be cases where the claim is not made in the return. For example:

·
an entity that is not required to lodge a return might claim the offset in a separate form; or
·
an entity might wish to claim the offset when one of its assessments is amended after it has lodged its return, making loss carry-back possible for the current year or changing the maximum amount of the offset available - in such a case, the Commissioner would have to allow the choice to be made after the date for lodging the income tax return.

How the loss carry-back tax offset is calculated

6.36 The amount of an entity's loss carry-back tax offset is worked out in a series of steps.

Step 1: Work out the amount of the loss to be carried back

6.37 The first step is to work out the amount of the tax loss that the entity is carrying back to each of the two years before the current year (the middle year and the earliest year). These will be the amounts the entity has chosen to carry back to those years. [Schedule 5, item 2, step 1 in subsection 160-15(2)]

Example 6.24 : Choosing the amounts to carry back Quigley Enterprises Ltd makes a $400,000 tax loss in the 2016-17 income year. Its franking account balance at the end of that year is $120,000. In 2014-15, it had a tax liability of $48,000 and, in 2015-16, it had a tax liability of $21,000. It also had net exempt income of $4,000 in 2015-16. The corporate tax rate is 30 per cent in each of those years.Quigley chooses to carry back $160,000 to 2014-15 and $74,000 to 2015-16. The remaining $166,000 is available to deduct against future taxable income.

Step 2: Reduce the step 1 amount by net exempt income

6.38 The second step reduces the step 1 amount by the net exempt income of the year the loss is carried back to. This ensures that, for the purposes of the loss carry-back tax offset, net exempt income is applied in the same way as it is applied when working out the amount of deductible losses in an income year. [Schedule 5, item 2, step 2 in subsection 160-15(2)]

Example 6.25 : Reduction for net exempt income Continuing the previous example, the amount Quigley carried back to 2015-16 is reduced by the $4,000 net exempt income, leaving $70,000. The amount carried back to 2014-15 is not reduced because there was no net exempt income for that year.

Step 3: Convert the step 2 amount to a tax equivalent amount

6.39 The third step converts those reduced amounts into tax equivalent amounts by multiplying the step 2 amount by the corporate tax rate for the current year. [Schedule 5, item 2, step 3 in subsection 160-15(2)]

Example 6.26 : Converting amounts to 'tax equivalents' Continuing the previous example, the $160,000 carried back to 2014-15 is converted into a tax equivalent amount by multiplying it by the 30 per cent corporate tax rate, producing a result of $48,000. The reduced amount carried back to 2015-16 is converted into a tax equivalent amount in the same way, producing a result of $21,000.

Step 4: Reduce the step 3 amount so that it does not exceed the relevant tax liability

6.40 The fourth step reduces the converted amount so that it does not exceed the amount of the tax liability available for the income year the loss was carried back to. The result of this step, for each income year an amount is carried back to, is the loss carry back tax offset component for that income year. [Schedule 5, item 2, step 4 in subsection 160-15(2)]

Example 6.27 : Reducing amounts to reflect tax liability Continuing the previous example, neither amount carried back, after conversion into its tax equivalent amount, exceeds the tax liability for the income year it was carried back to. Therefore, neither amount is reduced. The loss carry back tax offset component for 2014-15 is $48,000 and for 2015-16 is $21,000.

6.41 If amounts were carried back to both the earliest year and the middle year, the loss carry back tax offset components for those two years are added together to produce the amount of the tax offset. [Schedule 5, item 2, paragraph 160-15(1)(a)]

Limits on the loss carry back tax offset

6.42 The loss carry back tax offset for the current income year cannot exceed:

·
the balance in the entity's franking account at the end of that current income year; or
·
the tax payable on $1 million taxable income ($300,000 at the current corporate tax rate).

[Schedule 5, item 2, paragraphs 160-15(1)(b) and (c)]

Example 6.28 : Working out the offset amount Continuing the previous example, the two loss carry-back tax offset components are added together to produce a total of $69,000. This is less than Quigley's franking account balance and less than the $300,000 maximum offset, so is not reduced. Therefore, Quigley's tax offset for 2016-17 is $69,000.

6.43 The maximum amount of an entity's loss carry-back tax offset for a year is limited by the surplus balance of its franking account at the end of the year so that the offset cannot exceed the value of past taxes paid that have not yet been distributed to shareholders as franking credits.

6.44 A company may have a surplus in its franking account because it has paid tax, or received franked dividends, and has retained its profits.

6.45 Limiting the loss carry-back tax offset to the amount in the franking account at the end of the current year avoids a double benefit arising from the past payment of tax. This double benefit could otherwise arise because shareholders could receive an imputation credit in relation to company tax that, because of loss carry-back, had effectively no longer been paid.

6.46 Another reason that loss carry-back is limited by the surplus balance of the franking account is to minimise the possibility of an entity's franking account going into deficit (which would create a liability to franking deficits tax) when it gets a refund as a result of the offset. This reduces administrative churn in the tax system from companies that receive a refund from their loss carry-back offset having to return some or all of it as franking deficits tax.

6.47 Since the debit from getting a refund of tax will occur after the end of the relevant year, the balance in the entity's franking account may have changed, so the debit could still put the account into deficit. If that deficit is not made up by the end of the year, the entity would be liable for franking deficits tax to make good the excess of its franking debits over its franking credits.

6.48 The franking account balance limit does not apply to a foreign resident entity with a permanent establishment in Australia. This ensures that loss carry-back does not discriminate against foreign residents that are not within the Australian imputation system and so will usually not have a franking account balance to support the offset. [Schedule 5, item 2, subsection 160-15(4)]

6.49 However, the franking account balance does limit the loss carry-back tax offsets of New Zealand franking companies. These are companies resident in New Zealand that have chosen to be within the Australian imputation system.

6.50 Payments of Australian income tax by a New Zealand franking company does result in a credit arising in the company's franking account. Accordingly, the franking account limit applies to those companies to prevent them from obtaining an effective refund of tax that they have already passed on as a credit to their shareholders by paying a franked dividend. [Schedule 5, item 2, subsection 160-15(4)]

6.51 Any debit to the franking account of a foreign resident entity (other than an New Zealand franking company) for a refund of tax arising from a loss carry-back tax offset can only reduce the account balance to nil; it cannot put it into deficit. [Schedule 6, item 59, table item 2A in subsection 205-30(1)]

There must be a tax liability in the middle or earliest year

6.52 A corporate tax entity can only get a loss carry-back tax offset if it has an income tax liability for the year it carries a loss back to. That is, the company must have been assessed as owing an amount of income tax for either the middle or earliest year. [Schedule 5, item 2, paragraph 160-10(c) and step 4 in subsection 160-15(2)]

6.53 If a tax loss is carried back two years, the tax value of the amount carried back to each year is limited by the available tax liability of that year. A tax liability of one of the years cannot be used to support carrying back an amount to the other year. [Schedule 5, item 2, step 4 in subsection 160-15(2)]

6.54 The 'income tax liability' is not the amount of unpaid tax for that year. Payments of tax (whether by pay-as-you-go (PAYG) instalments or otherwise) do not affect the tax liability used to work out the offset. Rather, the income tax liability is the amount of income tax assessed to the entity for the year the loss is carried back to. [Schedule 5, item 3, definition of 'income tax liability' in subsection 995-1(1)]

6.55 The Commissioner's usual practice is to apply any refund amount arising from an offset towards paying another amount the entity owes to the Commissioner before an actual refund would be paid.

6.56 Each part of a tax liability can only be used once to support a loss carry-back. This ensures that the tax value of the loss carried-back utilises the corresponding amount of the tax liability of the year it is carried-back to. [Schedule 5, item 2, subsection 160-15(3)]

Example 6.29 : Difference between basic and final tax liability Neversink Corp has the following outcomes:

Income year Taxable income / (loss) Basic tax liability Offsets Final tax liability
2014-15 $1 million $300,000 $120,000 $180,000
2015-16 ($1 million) 0 0 0
In the 2015-16 income year, Neversink can carry-back some of its loss against its 2014-15 tax liability. Even though Neversink's $300,000 basic tax liability for 2014-15 was the same as the tax value of the maximum $1 million it can carry-back, its final liability was reduced to $180,000 because it had available a $120,000 tax offset in that year for some R & D expenditure.Therefore, Neversink only carries back $600,000 of its 2015-16 loss because the tax value of that loss ($600,000 x 30 per cent corporate tax rate = $180,000) matches the liability available. The remaining $400,000 of Neversink's loss can be deducted against taxable income of later income years.

Example 6.30 : Using up a tax liability - single year shock Proudnose Pty Ltd has the following outcomes:

Income year Taxable income / (loss) Tax liability
2014-15 $600,000 $180,000
2015-16 ($1 million) 0
2016-17 $3 million $900,000
In the 2015-16 income year, Proudnose can carry-back some of its loss against its 2014-15 tax liability. It would not carry-back the maximum $1 million because the tax value of that amount ($300,000) is more than the 2014-15 tax liability. Instead, Proudnose might choose to carry-back $600,000, using the whole 2014-15 tax liability ($600,000 x 30 per cent = $180,000).In the 2016-17 income year, the remaining $400,000 of the 2015-16 loss can be used as a deduction against the taxable income of that income year. It cannot be carried-back to 2014-15 because there is no unutilised tax liability left in that income year.

Example 6.31 : Using up a tax liability - two year shock Cavendish Pty Ltd has the following outcomes:

Income year Taxable income / (loss) Tax liability
2014-15 $5 million $1.5 million
2015-16 ($1.5 million) 0
2016-17 ($2 million) 0
In the 2015-16 income year, Cavendish can carry-back up to $1 million of its loss for that year against its 2014-15 tax liability. It decides to do so, producing a loss carry-back tax offset of $300,000 ($1 million x 30 per cent corporate tax rate) and using up $300,000 of its 2014-15 tax liability. Since it has no tax liability for 2015-16, the $300,000 is refunded to it.In the 2016-17 income year, Cavendish can carry-back the remaining $500,000 from 2015-16 or $1 million of its 2016-17 loss, or some of each (to a total of $1 million), against the remaining 2014-15 tax liability. It chooses to carry-back $500,000 from 2015-16 and another $500,000 from 2016-17. This again produces a $300,000 offset that is refunded to it.The loss from 2015-16 is fully used up and there is still $1.5 million left of the 2016-17 loss that can be used as a deduction for later income years. The loss can no longer be used as a carry-back loss because there is no year left that it can be carried back to (2014-15 being more than two years back from 2017-18).

Effect of net exempt income

Net exempt income in the current year

6.57 In working out a year's tax loss, the raw loss is reduced by any amount of net exempt income in the year (see subsection 36-10(3)). 'Net exempt income' is a taxpayer's exempt income, less the amounts that would become deductible if the exempt income had been assessable income (see section 36-20). Loss carry-back does not alter this calculation.

6.58 If an entity has net exempt income in the current year and an unutilised loss from an earlier year, it must apply that unutilised loss against the current year's net exempt income (see subsection 36-17(7)). This reduces the unutilised amount of the loss. Loss carry-back does not alter this operation. However, it does mean that a tax loss from the middle year that might otherwise be available for loss carry-back might first have to be reduced by any net exempt income in the current year.

Example 6.32 : Net exempt income in the current year Bukowski Inc. has the following outcomes:

Income year Unused taxable income / (loss) Net exempt income Unused tax liability
2014-15 $1 million 0 $300,000
2015-16 ($1 million) 0 0
2016-17 $2 million $40,000 $600,000
In the 2016-17 income year, Bukowski can carry-back some of its $1 million 2015-16 tax loss against its 2014-15 tax liability.However, before it does so, Bukowski must first apply that loss against 2016-17's net exempt income. That reduces the loss by $40,000 to $960,000.If Bukowski carries that amount back, it would produce a $288,000 tax offset in 2016-17 ($960,000 x 30 per cent = $288,000). The tax offset would reduce its 2016-17 tax liability to $312,000.

Example 6.33 : Net exempt income in the current year with prior year losses from outside the carry-back period Rimbaud Pty Ltd has the following outcomes:

Income year Taxable income / (loss) Net exempt income Tax liability
2013-14 ($50,000) 0 0
2014-15 $5 million 0 $1.5 million
2015-16 ($1 million) 0 0
2016-17 $2 million $100,000 $600,000
Rimbaud has a $50,000 tax loss in the 2013-14 income year, which it chooses not to utilise in 2014-15 to preserve its franking credits.In the 2016-17 income year, Rimbaud wants to claim a loss carry-back offset using its 2015-16 tax loss. Rimbaud must first use its $50,000 2013-14 tax loss against its net exempt income in 2016-17. Then it must utilise $50,000 of its 2015-16 tax loss against the remaining 2016-17 net exempt income before it is able to carry-back the unutilised $950,000 of its 2015-16 tax loss to 2014-15. That will produce a tax offset of $285,000, reducing Rimbaud's 2016-17 tax liability to $315,000.

Net exempt income in the middle and earliest years

6.59 If an entity chooses to carry a loss back to a year in which it had net exempt income, the amount carried back is reduced by the net exempt income of that earlier year before being converted into an offset. [Schedule 5, item 2, step 2 in subsection 160-15(2)]

Example 6.34 : Net exempt income in a prior year Dupont & Dupond Pty Ltd has the following outcomes:

Income year Taxable income / (loss) Net exempt income Tax liability
2014-15 $5 million $100,000 $1.5 million
2015-16 ($3 million) 0 0
2016-17 $500,000 0 0
Dupont & Dupond's 2015-16 tax loss can be carried back to offset its tax liability for the 2014-15 income year. It can carry-back the maximum $1 million in this case because there is a large enough tax liability in 2014-15.If Dupont & Dupond wants to obtain the maximum loss carry-back refundable tax offset, it will have to carry-back $1.1 million of tax losses to 2014-15 ($100,000 to absorb the net exempt income, and the other $1 million to achieve the maximum $300,000 refundable tax offset).In the 2016-17 income year, Dupont & Dupond could choose to carry-back another $1 million from 2015-16 because its unused tax liability in 2014-15 is $1.2 million ($1.5 million - $300,000). Therefore it could again get the full $300,000 offset because the net exempt income was utilised the previous year, so will no longer reduce the offset.Dupont & Dupond also has $900,000 of its 2015-16 loss ($3 million - $1.1 million - $1 million) that can be deducted against taxable income, including for 2016-17. Because 2016-17 only has taxable income of $500,000, Dupont & Dupond can deduct $500,000 for the loss, reducing its tax liability to nil and leaving $400,000 to be deducted in future years.

6.60 If there is net exempt income in the middle year or the earliest year but not both, an entity may choose to carry a current year loss back to only the year without net exempt income. If it does so, the loss is not reduced by the other year's net exempt income.

The relationship between loss carry-forward and loss carry-back

6.61 Corporate tax entities must deduct losses from prior years in the order in which they arose (see subsection 36-17(7)). No similar ordering rules apply to using losses for the loss carry-back tax offset. That is, there is no requirement that an eligible loss must be carried back to the earliest year first, or that the earliest loss must be carried back first.

6.62 However, prior year tax losses are deducted before the loss carry-back refundable tax offset can be worked out because the deduction occurs as part of working out an entity's taxable income for the current year (see section 4-10). The loss carry-back tax offset is then applied after the corporate tax entity has calculated its basic income tax liability on that taxable income for the current year (see subsection 4-10(3)).

Utilising tax attributes

6.63 Each part of an entity's tax losses, its net capital losses, and its net exempt income, can only be used once in working out an amount for an entity under the income tax law (including an amount of the entity's loss carry-back tax offset). This has been a long standing principle in the income tax law but this measure makes it explicit. [Schedule 6, item 34, subsection 960-20(1)]

Tax losses can only be utilised once

6.64 If some part of a tax loss is carried-back to an income year, that part of the loss (not just the amount remaining after reduction by net exempt income) cannot be carried-back again to that or any other income year. Nor can it be used as a deduction under Division 36. Similarly, if some part of a loss is used as a deduction under Division 36, that part of the loss cannot be carried-back to produce a loss carry-back tax offset. [Schedule 6, item 34, subsections 960-20(1) and (2)]

Example 6.35 : Loss utilisation Bostle Co Pty Ltd has the following outcomes:

Income year Taxable income / (loss) Tax liability
2013-14 ($1 million) 0
2014-15 $5 million $1.5 million
2015-16 ($3 million) 0
2016-17 $2 million $0
In the 2015-16 income year, Bostle Co could choose to carry-back $1 million of its loss against its 2014-15 tax liability. It chooses to do so, producing a loss carry-back tax offset of $300,000 ($1 million × the 30 per cent corporate tax rate). Since it has no tax liability for 2015-16, that amount would be refunded to it.In the 2016-17 income year:

·
$1 million of the remaining $2 million of the 2015-16 loss could again be carried back; or
·
the whole $2 million could be deducted in 2016-17 (or a later year).

Bostle Co chooses to carry-back $1 million to 2014-15, generating a $300,000 tax offset for 2016-17, and deducts $2 million of its prior year losses in that year.Because of the ordering rule in subsection 36-17(7), Bostle Co has to deduct the carry-forward loss from 2013-14 first, leaving the last $1 million from 2015-16 to be deducted as well. It has reduced its 2016-17 taxable income to nil, so its tax liability is also nil, allowing its offset to be refunded.If instead Bostle Co chose in 2016-17 not to carry anything back to 2014-15, it would not have got a refund but it would still have $1 million of its loss left from 2015-16 that could be deducted in future years. By 2017-18, it would be too late to use it as a carry-back loss.

6.65 An entity utilises a tax loss to the extent that it deducts the tax loss against an amount of assessable or net exempt income, carries it back to produce a loss carry-back tax offset, or reduces it by applying a total net forgiven amount under the commercial debt forgiveness provisions in Division 245. [Schedule 6, item 34, subsection 960-20(2)]

Net exempt income and net capital losses can only be utilised once

6.66 An entity utilises net exempt income when it:

·
is taken into account in calculating a tax loss;
·
reduces the amount of a tax loss that can be deducted;
·
reduces a loss carried back to a year; or
·
reduces an amount under subsection 26-47(8) (about losses from boating activities), subsection 35-15(2) (about losses from non-commercial business activities) or subsection 65-35(3) (about tax offsets carried forward from earlier years).

[Schedule 6, item 34, subsection 960-20(4)]

6.67 An entity utilises a net capital loss when it applies it to reduce an amount of its capital gains or reduces it by applying a total net forgiven amount under the commercial debt forgiveness provisions. [Schedule 6, item 34, subsection 960-20(3)]

Example 6.36 : Utilising losses and net exempt income Polymorph Industrial Designs Pty Ltd has the following outcomes:

Income year Taxable income / (loss) Net exempt income Tax liability
2014-15 $1.5 million $100,000 $450,000
2015-16 ($3 million) 0 0
2016-17 $500,000 $50,000 0
2017-18 $2 million $50,000 $210,000
In the 2015-16 income year, Polymorph chooses to carry back $1.1 million of its loss to 2014-15. The amount is reduced by the $100,000 net exempt income of that year, leaving $1 million to produce a $300,000 loss carry-back tax offset. $1.9 million of the 2015-16 loss remains unutilised. The net exempt income of 2014-15 is fully utilised, along with $300,000 of that year's income tax liability.In the 2016-17 income year, Polymorph has to utilise at least $50,000 of its remaining 2015-16 tax loss because of the 2016-17 net exempt income. It can then carry back some of that loss to 2014-15 to produce a loss carry-back tax offset. It chooses to carry back $500,000. It cannot carry back any more because the rest of the 2014-15 tax liability was utilised in the previous income year. The amount it carries back is not reduced by 2014-15's net exempt income because it was fully utilised in working out the previous income year's offset.In the 2017-18 income year, Polymorph has to use up $50,000 of it unutilised 2015-16 loss because it has that much 2017-18 net exempt income. After taking into account that amount and the $550,000 utilised in 2016-17, it has $1.3 million of its 2015-16 tax loss that is unutilised and can be deducted against its 2017-18 taxable income.

Consolidated groups

6.68 Loss carry-back is available to the head company of a consolidated group or multiple entry consolidated group (MEC group), just like any other corporate tax entity.

6.69 Consolidated groups and MEC groups cannot access loss carry-back in relation to losses transferred to the group by a joining entity. To allow them do so would add considerable complexity to the loss carry-back measure and would be inconsistent with the overall principles of the tax consolidation regime. [Schedule 5, item 2, paragraph 160-30(a)]

6.70 Similarly, when an entity with prior year tax liabilities joins a consolidated group or MEC group, the group cannot carry back any tax loss against tax liabilities previously assessed to the joining entity. An entity can only carry its losses back against its own tax liabilities.

6.71 Under the existing consolidation rules, the franking account balance of a joining entity accrues to the head company immediately upon joining. No special restrictions apply to the group using those franking credits for loss carry-back purposes. The group should however be aware of the anti-avoidance rules relating to a consolidated group obtaining an imputation benefit under section 177EB of the Income Tax Assessment Act 1936 (ITAA 1936).

Transferred losses for non-consolidated groups

6.72 Loss carry-back is not available for losses transferred to an entity under Division 170. That Division allows losses to be transferred between entities in a corporate group where an Australian branch of a foreign bank is involved, so that it can compete on equal terms with consolidated groups.

6.73 The restriction on the use of these transferred losses for loss carry-back purposes ensures that loss carry-back has a consistent application to consolidated groups and to non-consolidated groups that have an Australian branch of a foreign bank, or a non-bank foreign financial entity. [Schedule 5, item 2, paragraph 160-30(a)]

Loss carry-back integrity rule

6.74 When deducting losses of earlier income tax years, corporate tax entities are subject to integrity rules (known as the continuity of ownership test and the same business test). Applying the same integrity rules to entities that wish to carry their losses back to obtain a tax offset would have minimal impact on the entities where the existing owners continue to trade and wish to undertake planned and sensible risks.

6.75 However, potential new owners who wish to acquire an existing entity and introduce new technology, business practices and product lines that will better position it to meet the commercial challenges of the future may find that they do not satisfy the continuity of ownership and same business tests in some circumstances.

6.76 The specific integrity rule for loss carry-back denies a corporate tax entity a loss carry-back tax offset it would otherwise be entitled to where there has been a change in the control of the entity arising from a disposition of membership interests and, considering all of the relevant circumstances, one or more parties entered into a scheme to obtain the tax offset.

6.77 Losses that cannot be carried back as a result of the integrity measure can still be carried forward and claimed as a deduction against the income of future years provided the requirements for doing so are met.

What happens when the integrity rule is applied

6.78 When the integrity rule for loss carry back applies, the corporate tax entity cannot carry back a tax loss. Subject to meeting the ordinary requirements, the entity would still be able to deduct those losses in a future year.

6.79 There is no direct impact on an entity that disposed of a membership interest when the corporate tax entity is denied the tax offset.

6.80 There is also no direct impact on an entity that acquires the membership interest when the corporate tax entity is denied the tax offset.

When does the integrity rule apply

There must be a scheme

6.81 There must have been a scheme for the disposition of membership interests, or of an interest in membership interests, in

·
the corporate tax entity; or
·
an entity that had a direct or indirect interest in the corporate tax entity.

6.82 'Scheme' is a widely defined term used in other taxation provisions, including Part IVA of the ITAA 1936. Where there has been no disposition of membership interests, the loss carry-back integrity rule does not apply. [Schedule 5, item 2, paragraph 160-35(1)(a)]

6.83 For these purposes:

·
a non-share equity interest in a corporate tax entity is treated in the same way as a membership interest in a corporate tax entity; and
·
an equity holder in a corporate tax entity is treated in the same manner as a member in a corporate tax entity.

This ensures that equity interests in corporate tax entities that are not shares are treated in the same manner as shares. [Schedule 5, item 2, subsection 160-35(3)]

6.84 Where there has been a scheme that does not involve a disposition of membership interests, the Commissioner is able to consider the potential application of other integrity rules in the taxation law (such as Part IVA of the ITAA 1936).

6.85 The terms 'interest in membership interest' and 'scheme for a disposition' have the same meanings as in section 177EA of ITAA 1936. [Schedule 5, items 4 and 5, definitions of 'interest in membership interests' and 'scheme for a disposition' in subsection 995-1(1)]

6.86 An 'interest in a membership interest' includes legal and equitable interests in a membership interest. Specific rules apply when the interest is held through a partnership or trust.

6.87 The term 'scheme for a disposition' includes dispositions that include issuing or creating membership interests, entering into contracts, arrangements, etc. that affect the legal or equitable interest in membership interests and other means by which control or ownership of a membership interest can be changed.

6.88 The scheme must have been entered into or carried out between the start of the year the entity seeks to carry the loss back to and the end of the year it claims the loss carry-back tax offset. [Schedule 5, item 2, paragraph 160-35(1)(b)]

The disposition must have resulted in a change in control

6.89 The disposition of membership interests must have resulted in a change in who controlled, or was able to control, (whether directly or indirectly through one or more interposed entities) the voting power in the corporate tax entity. [Schedule 5, item 2, paragraph 160-35(1)(c)]

6.90 When determining whether control of the entity has changed, dispositions of membership interests and interests in membership interests can be considered. The magnitude of the disposition of membership interests is not decisive.

The entity would be entitled to a loss carry-back tax offset

6.91 The loss carry-back integrity rule will apply only where, in the absence of the integrity rule:

·
an entity (other than the corporate tax entity) received or receives, in connection with the scheme, a financial benefit; and
·
that financial benefit was calculated by reference to one or more loss carry back tax offsets to which it was reasonable, at the time the scheme was entered into or carried out, to expect the corporate tax entity would be entitled.

[Schedule 5, item 2 paragraph 160-35(1)(d)]

6.92 Therefore, the loss carry-back integrity rule will not apply if:

·
the corporate tax entity does not have an income tax liability for a year that a loss can be carried back to, or
·
the corporate tax entity does not have, or expect to have, a franking credit balance.

6.93 The company is not required to consider the application of the loss carry-back integrity rule if it does not wish to carry back an eligible loss.

Purpose and relevant circumstances

6.94 The loss carry-back integrity rule will apply only if, having regard to the relevant circumstances of the scheme, it would be concluded that one or more of the persons who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not a dominant purpose but not including an incidental purpose) of the corporate tax entity obtaining a loss carry-back tax offset. [Schedule 5, item 2, paragraph 160-35(1)(e)]

6.95 To determine this purpose requires an examination of the facts and reasonable expectations of the persons at the time that the scheme was entered into. Subsequent events are not relevant except to the extent that they clarify what the true purpose of the parties was.

6.96 If at the time of entering into the scheme the expectation was that the corporate entity would not meet the requirements for getting a loss carry-back tax offset because, for example, the entity was expected to be profitable, the purpose of the entity getting the loss carry-back tax offset would not have existed. A subsequent unexpected loss would not change this.

6.97 However, an expectation that the corporate tax entity would be entitled to get the loss carry-back tax offset will not always require that the offset be denied. Consideration must be given to the purpose of the persons who entered into or carried out the scheme. This is an objective question of fact that is established by looking at all the relevant circumstances.

What are the relevant circumstances?

6.98 To objectively establish what the purpose of the persons who entered into the scheme was, the relevant circumstances surrounding the scheme of disposition must be considered. None of these circumstances is decisive by itself. The circumstances should be considered collectively to determine whether the tax offset is denied.

6.99 The first relevant circumstance is the extent to which the corporate tax entity continues the same activities undertaken after the scheme for the disposition of membership interests has been implemented as prior to implementation. [Schedule 5, item 2, paragraph 160-35(2)(a)]

6.100 Activities in this sense are referring to what the entity did to earn assessable income. The entity will be undertaking the same activities notwithstanding that it has expanded or varied its product lines. For example:

·
a restaurant that specialised in Chinese cuisine which under new ownership and control specialised in Greek cuisine would still be undertaking the business activity of being a restaurant; and
·
an entity that manufactured cosmetics that changed ownership and control would not be undertaking the same activity if it retooled to manufacture motor vehicle parts; and
·
a shop that switched from selling clothing to selling compact discs would not be undertaking the same activity.

6.101 Both the number of activities and their relative importance to the entity need to be considered. An activity may have been undertaken to such an extent and been of such importance to the entity that its continuation after the change in control was clearly the dominant purpose behind the change in control of the company. Conversely, the ending of that activity may indicate that continuing the activities of the entity was a very minor purpose of acquiring control and the entity obtaining a loss carry-back tax offset was much more than an incidental purpose.

6.102 It is a matter of judgement as to whether the extent to which the same activities have been continued indicates whether the purpose of obtaining the loss carry-back tax offset was incidental or of greater importance.

6.103 The second relevant circumstance is the extent to which the corporate tax entity continues to use the same assets. [Schedule 5, item 2, paragraph 160-35(2)(b)]

6.104 If the entity is acquired as a means to obtain control over assets of the entity, this may indicate that the purpose of the new owner was gaining control over the assets rather than the tax offset. This is more likely to be the case where the assets have unique characteristics that cannot be obtained other than through purchase of membership interests in the company. The assets do not need to be used for the same or a similar purpose as they were used by the former owners.

6.105 The extent to which the new controllers of the entity use the pre-existing assets does not preclude the replacement of those assets as part of the ordinary running of a business.

6.106 The third relevant circumstance is the matters referred in subparagraphs 177D(b)(i) to (viii) of the ITAA 1936. [Schedule 5, item 2, paragraph 160-35(2)(c)]

6.107 These matters are:

·
the manner in which the scheme was entered into or carried out;
·
the form and substance of the scheme;
·
the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
·
the result in relation to the operation of the income tax law that, but for the integrity rule, would be achieved by the scheme;
·
any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
·
any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
·
any other consequence for the relevant taxpayer, or for any person, of the scheme having been entered into or carried out; and
·
the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person.

6.108 Whether a change in the membership interests in a company was done with the purpose of gaining access to a tax offset is a matter that can only be determined on its facts. Nonetheless, the more complex or artificial the arrangements that surround the change in membership interests, the more likely it is that the tax offset will not be allowed because the form and substance of the scheme and the manner in which it was entered into indicate a purpose of getting the tax offset rather than a normal commercial purpose.

6.109 Ordinarily, it would not be expected that a change of control that arises from generational change within family owned corporate tax entities would indicate that there was a purpose of obtaining a tax benefit. Considering the financial and other consequences for the vendors and purchasers and the nature of the connection between them, the handing over of the membership interests and control of the company as the older generation retires is more likely to reflect family dynamics rather than any purpose of obtaining a tax offset. This would remain the situation notwithstanding that the younger generation may wish to introduce changes to the company's business that initially could be expected to lead to losses that could be carried back.

6.110 Similarly, the transfer of membership interests that arise from a marital breakdown is unlikely to have anything more than an incidental purpose of obtaining a tax offset. Nor is a transfer of membership interests arising from the breakdown of personal and business relationships between shareholders likely to involve anything more than an incidental purpose of obtaining a tax offset. Corporate tax entities in these situations may experience losses due to the disruption of working relationships and lack of focus on the operation of the business. In the absence of any other aggravating factors, losses could be carried back and the tax offset would be allowed.

How the integrity rule will be administered

6.111 Corporate tax entities will self-assess whether the integrity rule applies to their circumstances. In most instances, it will be clear that the integrity rule does not apply to their circumstances and they will then be able to prepare their tax return and claim the refundable tax offset from the Commissioner.

6.112 Entities that may have doubts are able to seek the advice of the Commissioner. Should the Commissioner publish a public ruling or provide a private ruling, the entities will be able to rely on it.

Examples

6.113 The following examples illustrate how the integrity rule applies.

Example 6.37 : Entity conducting similar business Visanna Flowers Pty Ltd is a profitable company. However, its profits are in long term decline. Its business activities are growing of flowers for sale of flowers from a shop. As required, flowers will be purchased from suppliers for sale from the shop.All of the shares that provide control of the company are purchased by Andrew and Melinda for $2 million. At that time, Visanna Flowers has a franking account balance of $250,000. Recent sales of nearby properties that had been used for agricultural but not floral purposes suggest that a fair market value of the flower farm and shop would be $1.85 million. The properties available do not have the arterial road access that Visanna Flowers has and would need to have new flower beds planted.In accordance with their business plan, Andrew and Melinda refurbish the shop and add a café. They also expand the products sold from the shop to include the work of local artists. Andrew and Melinda expect that Visanna Flowers will incur a loss of $800,000 in the first year of operation but become profitable afterwards. The expected availability of the loss carry-back tax offset is included in the cash flow projections provided to their banker.On the evidence available, Andrew and Melinda's purpose is to implement changes that they expect will lead to Visanna Flowers being a more profitable business than it currently is. While Visanna Flowers is undertaking new business activities, it has also continued its initial business activities of growing and buying flowers for sale. The company has retained most of its pre-existing assets albeit that some have been refurbished.While the cash flow benefit of the carry back of losses has been taken into account, in this particular instance, other factors such as the existing flower beds and arterial road access lead to the view that the carry-back of the loss was an incidental purpose of acquiring of Visanna Flowers Pty Ltd.

Example 6.38 : Entity using existing assets in new business Sergio's Barbershop Pty Ltd is a company that owns a business premise valued at $1 million, which is well located for passing traffic. The company has a franking account balance of $300,000. Business premises are tightly held in that location and rarely come to the market. Sergio wishes to retire and insists that the company must be sold with the premises as opposed to him selling the premises separately and liquidating the company. He also requires a price that reflects the value of the franking credits.Kate has sought to purchase the few properties that have to come to market in the last year but been unable to match the prices offered by competing purchasers. Kate pays $1.15 million to Sergio for 100 per cent ownership and control of the company. Kate paid this price because Sergio had an offer of $1.1 million from a competing purchaser.The company is renamed Kate's Fashion Pty Ltd and commences to trade. Kate expects the company to trade at a small loss of approximately $20,000 in the first year of operation as she builds up a new clientele.The company under Kate's control is conducting a very different business to that when controlled by Sergio. The price paid for the company at least in part was calculated by Sergio's determination to obtain a financial benefit by reference to the franking credits. However, Kate has acquired a company where her primary objective was to gain control over business premises that she could not otherwise obtain and was at risk of losing to a competing purchaser.The relatively small loss that she expected the company to have in its first year of trading suggests that the potential loss carry-back tax offset was not a significant purpose in her planning.While there are some circumstances that suggest that the tax offset should be denied, there are also circumstances that suggest it should be allowed. In this particular situation, balancing these circumstances, the tax offset would be allowed.

Example 6.39 : Entity acquiring assets that are generic in nature Ian's Consulting Pty Ltd has a five-year lease over premises in a country town with an option to renew the lease for a further five years. There are many similar premises located within 500 metres that are available on similar terms. The company has been returning profits in excess of $500,000 in recent years and has a franking account balance of $400,000. Other than the lease and office equipment, the company has no significant assets.Jackie acquires all of the shares in the company for $150,000. Ian establishes a new company called Ian's Consulting Services Pty Ltd and trades from one of the available premises located across the road. As the office equipment is of limited value to Jackie, she permits Ian to buy what he wishes and take it with him.Jackie renames the company Jackie's Promotions Pty Ltd and refurbishes the business premises to meet her needs. As expected from the business plan, Jackie's Promotions makes a loss of $800,000 in its first year of operation. Jackie insists that her primary purpose in purchasing the membership interest in what is now her company was to obtain a valuable long term lease.Jackie is conducting a very different business to that of Ian. While the company under her control has continued to use the same leased premises, comparable alternative premises were readily available. Jackie's claim that she wanted a valuable long term lease is not convincing. The payment of $150,000 by Jackie is providing a financial benefit to Ian. Jackie will also receive a financial benefit in that the company now under her control can expect to receive a loss carry-back tax offset of $240,000 (30 per cent of $800,000) in its first year of operation and possibly a further loss carry-back tax offset should the second year's trading give rise to a loss.Accordingly, the loss carry-back tax offset would be denied.

Example 6.40 : Entity sells assets back to former owners Kelly Transport Pty Ltd owns vehicles, plant and equipment valued at $10.5 million. The company has a franking account balance of $600,000. Members of the King family acquire 100 per cent of the membership interest in Kelly Transport for $10.8 million and rename the company King Plumbing Pty Ltd.Within a matter of days, King Plumbing sells for $10.5 million all of the vehicles, plant and equipment to Kelly Transport Service Pty Ltd, a company wholly owned by the former shareholders of Kelly Transport.King Plumbing then commences a new business that in its first year of operation is expected to incur a loss of $1.5 million and $1 million in its second year, before it becomes profitable.The King family is conducting a very different business to that of the former owners of what is now King Plumbing. While very valuable assets were acquired with the company, the quick sale of those assets demonstrates that there was never any intention to use them in an income earning activity. The very substantial recoupment of the purchase price for the company by selling its assets has effectively led to a situation where the net cost to the King family was $300,000.As the King family expects the company to have trading losses of $2.5 million, they can reasonably expect to be able to carry back losses so that King Plumbing will obtain tax offsets of $300,000 in both of the first two years of operation under their control.It is probable that the availability of the tax offset over two years was a significant purpose of the transfer of membership interests. Both tax offsets would be denied.

Example 6.41 : No expectation of loss Thomson Pty Ltd has been a profitable company for many years and has a franking credit balance of $300,000. The market value of the underlying assets of the company is $2.8 million. The company's owner wishes to retire and the shares are acquired by two long standing employees for $2.9 million.Following the change of ownership in the company, minimal changes are made to its operations or assets. The new owners based on their intimate knowledge of the company were confident that it would continue to be profitable. Some months after acquisition, due to a fire, the company loses a substantial amount of stock leading to a loss for the year.Under its new owners, Thompson made minimal changes to its business and retained most of its business assets. The price for the membership interest could suggest that it was calculated with reference to a financial benefit from the franking credit balance. However, as the price paid is fairly close to market value, it could also represent the respective bargaining strengths of the parties. The new owners had a reasonable expectation that the company would continue to be profitable.As the fire could not be predicted and there was no expectation that the tax offset would be claimed, there would be no basis to deny the tax offset.

Example 6.42 : Complex or artificial arrangement Williamson Brothers Pty Ltd provides a wide range of technological services to local governments and small to medium sized business. As the successful tenderer for a major technological upgrade by a local government, Williamson Brothers has entered into eight inter-related contracts, of which seven are expected to be profitable and one will be unprofitable.Williamson Brothers acquires 95 per cent of the shares of Dormant Pty Ltd and individuals associated with Williamson Brothers acquire the remaining 5 per cent for a total payment of $50,000. Dormant's assets are $100 cash in the bank and a franking account credit balance of $300,000. Dormant had paid a substantial amount of tax in the two years prior to its acquisition by the Williamson Group. Dormant's previous business was connected with the provision of technological services.The unprofitable contract is to be performed by Dormant. The seven profitable contracts are to be performed by Williamson Brothers Pty Ltd. The long standing practice of Williamson Brothers Pty Ltd has been to undertake all the contracts and accept the losses on the unprofitable contracts as a necessary aspect of being able to obtain the profitable contracts.Even though Dormant was continuing to undertake the same business activities as prior to the change in ownership, having regard to the price paid for Dormant and the company having no assets or contracts in progress until the unprofitable contract was allocated to it, the availability of the tax offset would be a significant factor in the decision to acquire the membership interest. Therefore, the tax offset is not available.

Example 6.43 : Generational change in an entity David and Son Tailors Pty Ltd is a company where two-thirds of the shares are owned by the trustee of David's family trust. The company has assets valued at $3 million a franking account balance of $420,000. David is ready to retire and sells all of his shares to the trustee of the family trust of his son Michael for $2.1 million, who then becomes the only owner of the company.Michael becomes the managing director of the company and immediately changes the business focus of the company in a manner that David had previously resisted. This includes selling of most of the company's assets. Michael expects that the company will be unprofitable for one to two years as the changes that he considers necessary if the company is to be able to survive in the longer term are bedded down. Michael has factored in the availability of a loss carry-back tax offset in his business plans.The business focus of the company has changed and very few of the assets have been kept. The price paid for two-thirds of the company not previously owned could suggest that a financial benefit was expected and calculated by reference to the loss carry-back tax offset. However, the generational change is a significant factor that suggests that the availability of the tax offset was at most an incidental purpose of Michael acquiring control of the company.

Example 6.44 : Breakdown of marital and personal relationships SPA Accountancy and Financial Planning Pty Ltd is one third owned by Sandra, Pep and Anthony. Sandra and Pep are a married couple and Anthony is a close friend of Pep. The company has a franking credit balance of $500,000.Following a marriage breakdown and pursuant to a Family Court order, Pep transfers his one-third interest in the company to Sandra. Pep is permitted to take his clients with him to wherever he chooses to work in the future. Anthony is now very hostile to Sandra and is no longer willing to work with her. His one-third interest is cancelled and he is permitted to take his clients with him and is released from all obligations arising from his time with SPA.Other than the goodwill associated with the client lists, much of which is lost when Pep and Anthony take their clients with them, the other valuable asset of the company is its business premises, which are subject to a substantial mortgage.Sandra renames the company as Sandra's Financial Advice Pty Ltd and changes the focus of the company away from accountancy towards financial advice, her area of expertise. She also rents that part of the premises that were previously occupied by Anthony and Pep to unrelated tenants. Sandra expects that the business will initially be unprofitable as she rebuilds what is a smaller company with a different focus and services the interest expense related to the premises.There have been significant changes in the nature of the business and other income earning activities of the company. However the two key causes for the change in control and ownership were marital breakdown and the personal hostility between Anthony and Sandra which led to the collapse of their business working relationship.Taking into account the hostile family and personal relationship, the available evidence does not indicate an intention to acquire shares so as to access franking credits via a carry back of losses. The company that is now Sandra's Financial Advice Pty Ltd would be permitted to claim the tax offset.

Other administrative rules

A corporate tax entity must have lodged returns over the past five years

6.114 A corporate tax entity must have lodged an income tax return for the current year and each of the five years immediately preceding it in order to claim loss carry-back. This covers the usual period for which the entity is required to retain its tax records under section 262A of the ITAA 1936 and the usual period in which the entity's assessments can be amended. It therefore provides a level of assurance that the entity's tax liabilities, tax losses and franking account entries for that period are likely to be accurate and able to be verified. [Schedule 5, item 2, subparagraph 160-10(d)(i)]

6.115 In some cases, the entity might not have been required to lodge a return for a year (see section 161 of the ITAA 1936). Not lodging a return for such a year does not disentitle an entity to a loss carry-back tax offset. A common case where an entity is not required to lodge a return for a year would be where the entity did not exist in that year. [Schedule 5, item 2, subparagraph 160-10(d)(ii)]

6.116 Corporate tax entities are subject to the full self-assessment regime under which an assessment is made automatically when they lodge their returns (section 166A of the ITAA 1936). However, it is still possible for the Commissioner to have assessed a corporate tax entity for an income year without it having lodged a return for that year (sections 167 and 168 of the ITAA 1936). In such cases, the Commissioner can rely on that assessment for the purposes of establishing the accuracy of the corporate tax entity's losses and liabilities, so not having lodged a return for that year also does not disentitle an entity to a loss carry-back tax offset. [Schedule 5, item 2, subparagraph 160-10(d)(iii)]

Interest on overpayments and late payments

6.117 A loss carry-back tax offset forms part of the tax assessment of the current year. Loss carry-back alters neither the tax liability of the year to which a loss is 'carried back' nor the consequences of any failure to have paid that liability by the due date. It follows that claiming a loss carry-back tax offset by carrying a loss back to a particular year does not:

·
give rise to a right to 'interest on overpayments' in relation to the tax liability assessed for that year; or
·
reduce any general interest charge or shortfall interest charge arising from not paying the liability of that year.

Amended assessments

6.118 A refund arising from a loss carry-back tax offset is recoverable where a review of a corporate tax entity's tax affairs leads the Commissioner to conclude that the corporate tax entity was not entitled to it.

6.119 Where a corporate tax entity's assessment for the current or middle year is amended, then:

·
if the amendment results in the corporate tax entity having a reduced loss or no loss (because it increases assessable income or reduces deductions) in the middle or current year, the amount of the loss carry-back tax offset that the corporate tax entity is entitled to for the current year may be reduced (potentially to nil); and/or
·
if the amendment results in the corporate tax entity having an increased loss, the corporate tax entity may qualify for a loss carry-back tax offset (or an increased offset) for the current year.

6.120 Where a corporate tax entity's assessment for either the middle or earliest year is amended, then:

·
if the amendment results in the corporate tax entity's tax liability being reduced, this could affect the loss carry-back amount for the current year and so may require the assessment for the current year to be amended to provide a lower loss carry-back tax offset; and/or
·
if the amendment results in the corporate tax entity having a higher tax liability for that year, this could increase the maximum loss that can be carried back to that year and so may allow the current year's assessment to be amended to provide a higher loss carry-back tax offset.

6.121 Subject to the usual amendment periods, a corporate tax entity can seek an amendment of its assessment for the current year in order to claim a loss carry-back offset, or to increase the amount of its offset, if:

·
it did not claim a loss carry-back offset for the current year when it could have done so once the amended assessment for the middle or earliest year is taken into account; or
·
it claimed a smaller amount than it could have once that amended assessment is taken into account.

6.122 A corporate tax entity may also request an amendment where the amount of the loss it sought to carry back from one income year is reduced, but it could have chosen to carry a loss back from another year instead. The same can also be true if the unutilised income tax liability for a gain year is reduced by an amended assessment, but the loss could instead have been carried back to another gain year with a sufficient unutilised tax liability.

6.123 In all cases, the corporate tax entity's pool of carry-forward losses would be adjusted to reflect any increase or decrease in the amount of loss carry-back used in recalculating its loss carry-back tax offset.

Application and transitional provisions

Application

6.124 The loss carry-back measure applies to assessments for the 2012-13 income year and later income years. [Schedule 5, item 6, section 160-1 of the IT(TP)A 1997]

Transitional arrangements for 2012-13

6.125 Tax losses can usually be carried back to either of the two years immediately before the year for which the tax offset is being claimed. However, they can never be carried back before the 2011-12 income year. Therefore, in the 2012-13 income year, tax losses can only be carried back for one year. [Schedule 5, item 6, section 160-5 of the IT(TP)A 1997]

6.126 This transitional rule is consistent with the recommendation of the Business Tax Working Group's 2012 Final Report on the Tax Treatment of Losses that loss carry-back be phased in with an initial one year carry-back period.


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