House of Representatives

Treasury Laws Amendment (A Tax Plan for the COVID-19 Economic Recovery) Bill 2020

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Josh Frydenberg MP)

Chapter 2 - Temporary loss carry back

Outline of chapter

2.1 Schedule 2 to the Bill amends the income tax law to allow corporate tax entities with an aggregated turnover of less than $5 billion to carry back a tax loss for the 2019-20, 2020-21 or 2021-22 income year and apply it against tax paid in a previous income year as far back as the 2018-19 income year.

2.2 All legislative references in this chapter are to the ITAA 1997 unless otherwise indicated.

Context of amendments

2.3 The Government is supporting Australian businesses to invest, grow and create jobs.

2.4 Business investment is vital to Australia's short-term economic recovery as well as longer term productive capacity and wage growth.

2.5 The Government is providing temporary tax incentives to support new investment and increase business cash flow.

2.6 One of these tax incentives is to temporarily allow companies with turnover below $5 billion to offset tax losses against previously taxed profits to generate a tax refund. This incentive will be available to approximately one million companies employing up to 8.8 million employees.

2.7 Losses incurred up to 2021-22 can be carried back against profits made in or after 2018-19. Eligible companies may elect to receive a tax refund when they lodge their 2020-21 and 2021-22 income tax returns.

2.8 This will provide further cash flow support as well as encourage more businesses to take advantage of temporary full expensing while it is available and promote investment.

Summary of new law

2.9 The temporary loss carry back rules will allow corporate tax entities to carry back losses to earlier profitable income years as far back as the 2018-19 income year to generate a refundable tax offset. The rules are limited to corporate tax entities that:

have aggregated turnover of less than $5 billion in the year of the loss;
incur a tax loss in the 2019-20, 2020-21 or 2021-22 income years; and
have a profit in a relevant previous year as far back as the 2018-19 income year.

2.10 The amount of the refundable tax offset available to a corporate tax entity is based on the entity's tax rate in the loss year. However, the amount cannot exceed:

the amount of earlier tax paid by the entity; and
the entity's franking account balance at the end of the income year for which the refundable tax offset is claimed.

2.11 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 amount of the loss.

2.12 A corporate tax entity will need to make a choice to claim the refundable tax offset when it lodges an income tax return for:

the 2020-21 income year; and
the 2021-22 income year.

2.13 Corporate tax entities will be allowed to carry back tax losses for the 2019-20 income year but these claims will be processed when income tax returns for the 2020-21 income year and the 2021-22 income year are lodged.

2.14 The loss carry back provisions include integrity rules consistent with the integrity rules that applied under the previous loss carry back rules that applied in Australia in 2013.

2.15 The temporary loss carry back rules will cease to apply after the 2021-22 income year.

Comparison of key features of new law and current law

New law Current law
Tax losses for the 2019-20, 2020-21 or 2021-22 income years can either be:

carried forward and deducted against income derived in later income years; or
carried back against income of earlier income years as far back as the 2018-19 income year 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

2.16 Under the temporary loss carry back refundable tax offset rules, a corporate tax entity with an aggregated turnover of less than $5 billion can choose to carry back a tax loss for the 2019-20, 2020-21 or 2021-22 income year and apply it against tax paid in a previous income year as far back as the 2018-19 income year.

2.17 The choice to claim a loss carry back tax offset is an alternative to carrying tax losses forward as a deduction for future income years. Only tax losses can be carried back. Capital losses cannot be carried back because the capital gains tax regime operates on a realisation basis.

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

Entitlement to a loss carry back tax offset

2.19 A corporate tax entity can choose to utilise a tax loss to obtain a loss carry back tax offset in the 2020-21 income year or in the 2021-22 income year.

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

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

2.21 A corporate tax entity will be eligible for loss carry back in a particular income year only if:

the entity is a corporate tax entity throughout that income year;
the entity carries on a business and has an aggregated turnover of less than $5 billion in the income year that the entity incurred the loss; and
the entity was a corporate tax entity throughout the income year the loss is carried back to (disregarding any part of the year before the entity came into existence) and throughout any intervening income years.

[Schedule 2, item 2, sections 160-5, 160-20 and 160-25]

2.22 In addition, to be entitled to a loss carry back tax offset, a corporate tax entity must have lodged an income tax return for the current year and each of the five years immediately preceding it. [Schedule 2, item 2, section 160-5)]

2.23 The requirement for the corporate tax entity to 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 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. The five year period 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.

2.24 In some cases, the entity might not have been required to lodge a return for a year. This does not prevent an entity from being entitled to a loss carry back tax offset. A common example of where an entity is not required to lodge a return for a year would be where the entity did not exist in that year.

Choice to claim a loss carry back tax offset

2.25 Loss carry back is optional, mirroring the existing choice corporate tax entities have about whether to deduct their tax losses (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 an earlier year. [Schedule 2, items 2 and 34, subsection 160-15(1) and definitions of 'carry back' and 'loss carry back choice' in subsection 995-1(1)]

2.26 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 in a future income year, according to the usual rules for deducting prior-year losses in Division 36.

2.27 The choice to claim a loss carry back tax offset must be made 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 tax loss it wishes to carry back for each income year; and
each year it wishes to carry the loss back to.

[Schedule 2, item 2, section 160-15]

2.28 The choice must be made by the time that the entity lodges its income tax return for the current income year, or within such further time as the Commissioner allows. [Schedule 2, item 2, section 160-15]

2.29 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 income tax return is lodged.

2.30 However, there might be cases where the claim is not made in the income tax return. For example:

an entity that is not required to lodge an income tax return might claim the offset in a separate form; or
an entity might wish to claim the offset when an assessment for an income year is amended after it has lodged its income tax 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.

Entitlement to a loss carry back tax offset for the 2020-21 income year

2.31 If the current year is the 2020-21 income year, a loss carry back tax offset may be available to a corporate tax entity if:

the entity has a tax loss in the 2019-20 income year and/or the 2020-21 income year;
the entity has an income tax liability in the 2018-19 income year and/or the 2019-20 income year; and
for the 2020-21 income year and each of the previous five income years, either:

-
the entity has lodged an income tax return;
-
the entity was not required to lodge a return; or
-
the Commissioner has made an assessment of the entity's income tax.

[Schedule 2, items 2 and 34, section 160-5 and definition of 'loss carry back tax offset' in subsection 995-1(1)]

Entitlement to a loss carry back tax offset for the 2021-22 income year

2.32 If the current year is the 2021-22 income year, a loss carry back tax offset may be available to a corporate tax entity if:

the entity has a tax loss in the 2019-20 income year, the 2020-21 income year and/or the 2021-22 income year;
the entity has an income tax liability in the 2018-19 income year, the 2019-20 income year and/or the 2020-21 income year; and
for the 2021-22 income year and each of the previous five income years, either:

-
the entity has lodged an income tax return;
-
the entity was not required to lodge a return; or
-
the Commissioner has made an assessment of the entity's income tax.

[Schedule 2, item 2 and 34, section 160-5 and definition of 'loss carry back tax offset' in subsection 995-1(1)]

Amount of the loss carry back tax offset

2.33 The amount of an entity's loss carry back tax offset for the current income year is the lesser of:

the sum of the entity's loss carry back tax offset components for:

-
the 2018-19 income year;
-
the 2019-20 income year; and
-
if the current year is the 2021-22 income year - the 2020-21 income year; and

the entity's franking account balance at the end of the current year.

[Schedule 2, item 2, subsection 160-10(1)]

2.34 An entity is entitled to only one loss carry back tax offset for the 2020-21 income year. However, that offset may have two components - that is:

a loss carry back tax offset component relating to the 2018-19 income year; and
a loss carry back tax offset component relating to the 2019-20 income year.

2.35 An entity is also entitled to only one loss carry back tax offset for the 2021-22 income year. However, that offset may have three components - that is:

a loss carry back tax offset component relating to the 2018-19 income year;
a loss carry back tax offset component relating to the 2019-20 income year; and
a loss carry back tax offset component relating to the 2020-21 income year.

2.36 The loss carry back tax offset is a refundable tax offset. However, 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. [Schedule 2, item 1, section 67-23]

The loss carry back tax offset component for an income year

2.37 An entity's loss carry back tax offset component for an income year is worked out by applying a number of steps. These steps are applied in relation to each tax loss to be carried back to a particular income year.

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

2.38 The first step is to work out the amount of the tax loss that the entity is carrying back to the income year. This will be the amounts the entity has chosen to carry back to the relevant year. [Schedule 2, item 2, step 1 of the method statement in subsection 160-10(2)]

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

2.39 The second step is to reduce the step 1 amount by the net exempt income for the income year to the extent that the net exempt income has not already been utilised. This ensures that, for the purposes of the loss carry back tax offset, net exempt income is broadly applied in the same way as it is applied when working out the amount of deductible losses in an income year. [Schedule 2, item 2, step 2 of the method statement in subsection 160-10(2)]

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

2.40 The third step is to convert the step 2 amount into a tax equivalent amount by multiplying the step 2 amount by the entity's corporate tax rate for the loss year. [Schedule 2, item 2, step 3 of the method statement in subsection 160-10(2)]

2.41 The method statement for determining the amount of a loss carry back tax offset component applies separately for each tax loss year carried back to each gain year. The loss year can be one or more of:

the 2019-20 income year;
the 2020-21 income year; and
the 2021-22 income year.

2.42 If the entity is a base rate entity (that is, broadly, an entity with an aggregated turnover of less than $50 million for the income year) for a loss year, the entity's corporate tax rate for the loss year will be:

if the loss is the 2019-20 income year - 27.5 per cent;
if the loss year is the 2020-21 income year - 26 per cent; or
if the loss year is the 2021-22 income year - 25 per cent.

2.43 If the entity is not a base rate entity for a loss year, the entity's corporate tax rate for the loss year will be 30 per cent.

Work out the amount of the loss carry back tax offset component for an income year

2.44 If the entity does not, in its loss carry back choice, carry back any losses to the income year, the amount of the loss carry back tax offset component for the income year is nil. [Schedule 2, items 2 and 34, paragraph 160-10(2)(a) and definition of 'loss carry back tax offset component' in subsection 995-1(1)]

2.45 If the entity does, in its loss carry back choice, carry back losses to the income year, the amount of the loss carry back tax offset component for the income year is so much of the entity's income tax liability for the income year that does not exceed:

if the entity chooses to carry back only one tax loss to the income year - the tax equivalent amount worked out at step 3 of the method statement; or
if the entity chooses to carry back tax losses for two or three loss years to the income year - the sum of the tax equivalent amounts worked out at step 3 of the method statement for each of those tax losses.

[Schedule 2, item 2 and 34, paragraph 160-10(2)(b) and definition of 'loss carry back tax offset component' in subsection 995-1(1)]

2.46 This effectively limits the amount of loss carry back tax offset component for the income year to the amount of the income tax liability for that income year.

2.47 However, a tax loss can only be utilised once. Therefore, a tax loss can only be carried back once. In addition, if a tax loss is carried back and reflected in a loss carry back tax offset for an income year or used to reduce net exempt income for that year, it cannot be carried forward and deducted in a later income year. [Schedule 2, items 32 and 33, paragraphs 960-20(2)(c) and (4)(f)]

2.48 Similarly, if a tax loss is carried back to more than one income year, the tax value of the amount carried back to each income year is limited by the available income tax liability of that income year. Each part of a tax liability can only be used once to support a loss carry back. [Schedule 2, item 2, subsections 160-10(3) and (4)]

2.49 The amount of an entity's income tax liability for an income year is the amount of income tax assessed to the entity for the year. [Schedule 2, item 3, definition of 'income tax liability' in subsection 995-1(1)]

2.50 However, for the purposes of working out the available income tax liability for an income year, the head company of a consolidated or multiple entry consolidated group must disregard an income tax liability of a subsidiary member of the group that relates to a period before it joined the group and is taken to be an income tax liability of the head company because of the entry history rule (section 701-5). [Schedule 2, item 2, subsection 160-30(2)]

Loss carry back tax offset limited to the franking account balance

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

2.52 A corporate tax entity may have a surplus in its franking account because, for example, it has:

paid tax or received franked dividends; and
retained its profits.

2.53 The loss carry back tax offset for an income year is limited to the balance of the corporate tax entity's franking account at the end of that income year. This ensures that a corporate tax entity cannot both:

apply the balance of the franking credits in its franking account to frank distributions to shareholders for an income year; and
claim a refundable loss carry back tax offset for the same income year.

2.54 Therefore, this limitation will reduce the possibility of an entity's franking account going into deficit (which would create a liability to franking deficit tax under section 205-45) when it gets a refund of tax as a result of the offset. This reduces administrative churn in the tax system from companies that receive a loss carry back tax offset refund from having to return some or all of the amount refunded as franking deficit tax.

2.55 A debit will arise in a corporate tax entity's franking account when it gets a refund of tax as a result of the loss carry back tax offset on the day that the refund is received (item 2 and 2A of the table in subsection 205-30(1)). Since this debit will arise after the end of the relevant income year, the balance in the entity's franking account may have changed. Therefore, the debit could still put the franking account into deficit. If that deficit is not made up by the end of the year, the entity would be liable for franking deficit tax to make good the excess of its franking debits over its franking credits.

2.56 The franking account balance limit does not apply to a foreign resident entity with a permanent establishment in Australia that is not within the Australian imputation system. [Schedule 2, item 2, subsection 160-10(5)]

2.57 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.

2.58 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.

2.59 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 the franking account into deficit (item 2A of the table in subsection 205-30(1)).

Examples

Example 2.1 : Business benefits from temporary loss carry back Due to the impact of Coronavirus restrictions on customer demand and its ability to trade, Company A makes a tax loss of $2 million in the 2019-20 income year.In the 2020-21 income year, the reduced trading means Company A makes another tax loss of $500,000. Company A's franking account balance at the end of the 2020-21 income year is $550,000.In the 2018-19 income year, Company A had taxable income of $5 million. Company A had no net exempt income in that income year.As Company A had an aggregated turnover of less than $50 million in each of the relevant income years, it was liable to tax at the base rate entity corporate tax rate in each income year. In the 2018-19 income year, the base rate entity corporate tax rate was 27.5 per cent. Therefore, Company A paid income tax of $1,375,000 for that income year.Company A makes a loss carry back choice to:

carry back the tax loss of $500,000 for the 2020-21 income year to the 2018-19 income year; and
carry back the tax loss of $2 million for the 2019-20 income year to the 2018-19 income year.

The loss carry back tax offset component for the 2018-19 income year is $680,000 - that is, the sum of:

$130,000, being the amount worked out by applying the method statement in section 160-10 for the 2020-21 income year - that is, $500,000 x 26 per cent (the base rate entity corporate tax rate for the 2020-21 income year); and
$550,000, being the amount worked out by applying the method statement in section 160-10 for the 2019-20 income year - that is, $2 million x 27.5 per cent (the base rate entity corporate tax rate for the 2019-20 income year).

As the result of the method statement in section 160-10 is less than its income tax liability for the 2018-19 income year ($1,375,000), Company A's loss carry back tax offset component for that income year is $680,000.However, the amount of the loss carry back tax offset component exceeds the balance in Company A's franking account at the end of the 2020-21 income year ($550,000).Therefore, when Company A lodges its income tax return for the 2020-21 income year, it will be entitled to a refundable loss carry back tax offset of $550,000 - that is, the lesser of:

$680,000 - that is, Company A's loss carry back tax offset component for the 2018-19 income year; and
$550,000 - that is, the balance in Company A's franking account at the end of the 2020-21 income year.

If Company A's loss carry back choice does not reflect this position, it can modify the choice to reduce the amount of tax losses carried back. As a result, the unutilised amount of the loss ($130,000) can be carried forward and deducted in future income years.

Example 2.2 : Business benefits from temporary full expensing and temporary loss carry back On 1 November 2021, Company B purchases a truck for $1.5 million. Under the temporary full expensing measure explained in Chapter 8, Company B can deduct the full cost of the truck in the 2021-22 income year. As a result, Company B makes a tax loss of $400,000 for the 2021-22 income year.In the 2020-21 income year, Company B had taxable income of $8 million. As Company B had an aggregated turnover of $80 million in that income year, it was liable to income tax at the standard corporate tax rate of 30 per cent. Therefore, Company B paid income tax of $2.4 million for that income year. Company B had no net exempt income in that income year.Company B's franking account balance at the end of the 2021-22 income year is $1.3 million.Company B makes a loss carry back choice to carry back the tax loss of $400,000 for the 2021-22 income year to the 2020-21 income year.The result of the method statement in section 160-10 for the 2020-21 income year is $120,000 - that is, $400,000 x 30 per cent.As this amount is less than Company B's income tax liability for the 2020-21 income year ($2.4 million) and its franking account balance for the current year ($1.3 million), Company B's loss carry back tax offset component for the 2020-21 income year is $120,000.Therefore, when Company B lodges its income tax return for the 2021-22 income year, it will be entitled to a refundable loss carry back tax offset of $120,000.

Tax losses ineligible for carry back

2.60 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 or multiple entry consolidated group by an entity joining the group.

[Schedule 2, item 2, paragraph 160-30(1)(a) and subsection 160-30(2)]

2.61 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 (section 36-55) is not eligible for carry back because it does not represent an economic loss. [Schedule 2, item 2, paragraph 160-30(1)(b)]

Loss carry back integrity rule

2.62 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 business continuity test (that is, the same business test or the similar 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.

2.63 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.

2.64 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.

2.65 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

2.66 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.

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

2.68 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

2.69 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.

2.70 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 2, item 2, paragraph 160-35(1)(a)]

2.71 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.

[Schedule 2, item 2, subsection 160-35(3)]

2.72 This ensures that equity interests in corporate tax entities that are not shares are treated in the same manner as shares.

2.73 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).

2.74 The terms interest in membership interest and scheme for a disposition have the same meanings as in section 177EA of ITAA 1936. [Schedule 2, item 3, definitions of 'interest in membership interests' and 'scheme for a disposition' in subsection 995-1(1)]

2.75 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.

2.76 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.

2.77 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 2, item 2, paragraph 160-35(1)(b)]

The disposition must have resulted in a change in control

2.78 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 2, item 2, paragraph 160-35(1)(c)]

2.79 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

2.80 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 2, item 2, paragraph 160-35(1)(d)]

2.81 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.

2.82 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

2.83 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 2, item 2, paragraph 160-35(1)(e)]

2.84 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.

2.85 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.

2.86 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?

2.87 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.

2.88 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 2, item 2, paragraph 160-35(2)(a)]

2.89 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 started to provide a takeaway service would still be undertaking the same business activity; 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.

2.90 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.

2.91 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.

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

2.93 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.

2.94 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.

2.95 The third relevant circumstance is the matters referred in subsection 177D(2) of the ITAA 1936. [Schedule 2, item 2, paragraph 160-35(2)(c)]

2.96 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 connected with the relevant taxpayer, 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.

2.97 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.

2.98 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.

2.99 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

2.100 Corporate tax entities 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 are then able to prepare their tax return and claim the refundable tax offset from the Commissioner.

2.101 Entities that may have doubts are able to seek the advice of the Commissioner.

Examples

2.102 The following examples illustrate how the integrity rule applies.

Example 2.3 : Entity conducting similar business Pretty 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 are 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, Pretty 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 Pretty 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 caf é . 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 Pretty Flowers being a more profitable business than it currently is. While Pretty 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 Pretty Flowers Pty Ltd.

Example 2.4 : Entity acquiring assets that are generic in nature Gabrielle'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. Gabrielle establishes a new company called Gabrielle'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 Gabrielle to buy what she wishes and take it with her.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 Gabrielle. 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 Gabrielle. 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 2.5 : Entity sells assets back to former owners Tally 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 Tally 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 Tally Transport Service Pty Ltd, a company wholly owned by the former shareholders of Tally 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 2.6 : No expectation of loss Summertime Sun 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. Based on their intimate knowledge of the company, the new owners 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, Summertime Sun 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.

Interest on overpayments and late payments

2.103 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.

Consequential amendments

The general anti-avoidance rule

2.104 The amendments modify the income tax general anti-avoidance rule in Part IVA of the ITAA 1936 so that it applies to schemes entered into with the purpose of obtaining a loss carry back tax offset.

2.105 The general anti-avoidance rule works by identifying a scheme and a tax benefit that is produced for a taxpayer by the scheme. The Commissioner can cancel the tax benefit if it can be concluded (after examining eight listed factors) that someone entered into the scheme for the dominant purpose of providing the taxpayer with the tax benefit.

2.106 A tax benefit is defined to include an amount not being included in the taxpayer's assessable income, a deduction or capital loss being incurred by the taxpayer, or a foreign income tax offset being allowable to the taxpayer. The amendments extend that definition to include a loss carry back tax offset being available to the taxpayer. [Schedule 2, items 4 to 6, the definition of 'loss carry back tax offset' in subsection 6(1), paragraphs 177C(1)(baa) and (ea) of the ITAA 1936]

2.107 As with the existing tax benefits, the tax benefit from gaining a loss carry back tax offset does not apply if the offset arises from making a choice expressly provided for by the income tax law unless the scheme was entered into for the purpose of enabling the choice to be made. [Schedule 2, items 7 to 10, subsections 177C(2) and (3) of the ITAA 1936]

2.108 In this regard, if a scheme is entered into to inflate the amount of a loss carry back offset, subsection 177C of the ITAA 1936 does not prevent Part IVA from applying to the scheme. Therefore, if a taxpayer is entitled to make a loss carry back choice for an amount that is lesser than the amount specified in the choice but inflates the amount under a scheme to which Part IVA applies, the Commissioner will be able to make a determination to cancel that part of the amount of the loss carry back offset that is the result of the scheme.

2.109 The bases for identifying tax benefits are also being extended to include whether or not the whole or part of a loss carry back tax offset is allowable to the taxpayer. [Schedule 2, item 11, paragraph 177CB(1)(ca) of the ITAA 1936]

2.110 If Part IVA is satisfied, the Commissioner can make a determination to cancel the tax benefit. The possible determinations, which separately cover each type of tax benefit, are extended to include determinations in relation to tax benefits from a loss carry back tax offset. [Schedule 2, item 12, paragraph 177F(1)(ca) of the ITAA 1936]

2.111 When the Commissioner makes a determination to cancel a tax benefit, he or she can also make any compensating adjustments needed to put any taxpayers into the tax position they would have been in if the scheme had not been entered into. The amendments allow the Commissioner to make compensating adjustments to provide taxpayers with the loss carry back tax offset that would have been available apart from the scheme. [Schedule 2, item 13, paragraph 177F(3)(ca) of the ITAA 1936]

Pooled development funds

2.112 A company that makes a tax loss in an income year that it ends as a PDF can only deduct that loss in a later income year in which it is a PDF for the whole year.

2.113 The amendments extend the same treatment to the loss carry back tax offset. They prevent a corporate tax entity carrying back a tax loss that arose in a year it ended as a PDF, unless it was a PDF throughout both the current year and the year the loss was carried back to. [Schedule 2, items 19, 20 and 24, sections 36-25 and 195-37]

2.114 As with the current law treatment of deductions for tax losses, there is no restriction on a PDF carrying back any tax loss that arose in a year it did not end as a PDF. Nor is there any restriction on carrying back a tax loss that arose in the part of a year before the company became a PDF. [Schedule 2, items 22 and 23, subsection 195-15(5)]

Venture capital and similar limited partnerships

2.115 The current law prevents a limited partnership from deducting a tax loss in an income year in which it is a venture capital limited partnership, an early stage venture capital limited partnership, an Australian venture capital fund of funds, or a venture capital management partnership.

2.116 These entities cannot be corporate tax entities and so cannot claim the loss carry back tax offset. However, if a limited partnership stops being one of these venture capital entities and becomes a corporate tax entity, it might claim the offset by carrying a loss back to a year in which it was one of those entities. That would provide the entity with an offset based on a year in which it was not a corporate tax entity and so would not have been able to deduct a tax loss. To preserve the symmetry with deducting tax losses, the amendments prevent a limited partnership carrying a tax loss back to a year in which it was a venture capital entity. [Schedule 2, items 21 and 25, sections 36-25 and 195-72]

2.117 Each partner in a venture capital partnership usually gets his or her share of the partnership's loss (subsection 92(2) of the ITAA 1936). However, a limited partner can only deduct its share of partnership losses to the extent of its contributions to the partnership (subsection 92(2AA) of the ITAA 1936). The remaining part of a limited partner's share of partnership losses is its 'outstanding subsection 92(2AA) amount' (subsection 92A(2) of the ITAA 1936). That amount can be deducted under some circumstances but can never be used to produce a tax loss for the limited partner (subsections 92A(1) and (3) of the ITAA 1936).

2.118 As the outstanding subsection 92(2AA) amount of a limited partner in a venture capital partnership cannot be part of a tax loss for the partner, it cannot be used to produce a loss carry back tax offset the limited partner might claim if it is itself a corporate tax entity. [Schedule 2, item 14, subsection 92A(3) of the ITAA 1936]

Life insurance companies

2.119 For income tax purposes, life insurance companies carry on two broad categories of business: complying superannuation business and ordinary business. The earnings on complying superannuation business are taxed in broadly the same way, and at the same rate, as earnings made by complying superannuation funds. Earnings on the ordinary business are taxed at the corporate tax rate.

2.120 To ensure that the tax treatment of the complying superannuation business of life insurance companies continues to be the same way as that of complying superannuation funds, loss carry back tax offsets are not available in respect of that complying superannuation business. They are available in respect of ordinary business. [Schedule 2, item 30, paragraph 320-149(2)(aa)]

Foreign hybrids

2.121 Foreign hybrid limited partnerships are entities that are partnerships under foreign law but would normally be treated as companies for the purposes of Australia's income tax law. A special regime ensures that they are generally treated as ordinary partnerships for purposes of the income tax law (Division 830).

2.122 Foreign hybrid limited partnerships are not eligible for loss carry back tax offsets (which are only available to corporate tax entities). However, a partner in such a partnership would get a share of the partnership loss and could, if it were itself a corporate tax entity, seek to claim a loss carry back tax offset. There are limits on the extent to which partners can claim a deduction for a tax loss flowing to them from a foreign hybrid limited partnership. To preserve symmetry with deducting tax losses, the amendments ensure that the same limits apply to the partner's use of that loss for loss carry back. [Schedule 2, item 31, subsection 830-65(3)]

Other minor amendments

2.123 Other minor amendments are made to:

update the non-operative lists of relevant provisions about tax offsets and tax losses are amended to include references to the loss carry back tax offset;
update notes to provisions; and
make minor technical corrections to the law.

[Schedule 2, items 15 to 18, 26 to 29, 35 and 36, sections 13-1, 36-25, 205-35 of the ITAA 1997, section 175 of the ITAA 1936 and section 45-340 in Schedule 1 of the Taxation Administration Act 1953]

Application and transitional provisions

2.124 The loss carry back tax offset rules apply to assessments for:

the 2020-21 income year; and
the 2021-22 income year.

2.125 The provisions in Schedule 2 to the Bill commence on the first day of the first quarter after Royal Assent. [Section 2 of the Bill]

SCHEDULE 2 - REGULATION IMPACT STATEMENT - TEMPORARY LOSS CARRY BACK

Background

2.126 The current treatment of losses does not contribute to companies' cash flow in an economic downturn, as they cannot access the tax value of a loss until they return to profitability. Additionally, the introduction of Temporary full expensing will generate large tax deductions for companies that invest in depreciable assets. In some cases this will create tax losses that would normally have to be carried forward and used to offset tax on future profits.

2.127 Individual taxpayers, including businesses operating as sole traders, can offset current year business losses against other income sources such as salary and wages and investment income. For large companies and consolidated groups that conduct a range of business activities, losses in one activity may be offset against profits from other activities, which provides some ability to utilise current losses.

2.128 However, companies that undertake only one business activity or suffer losses on the majority of their activities may not have other sources of income against which to offset their losses. These companies are required to carry that loss forward. Australia is not unique in this respect; it is common practice in other jurisdictions to require a loss to be carried forward, although various forms of loss carry back are available in a number of OECD countries, including Canada, France, Germany, Ireland, New Zealand, Singapore, the United Kingdom and the United States.

2.129 Tax loss carry back allows companies that paid tax in previous years to utilise their current losses rather than carry them forward. Conceptually, the loss is carried back to reduce the earlier profit and the corresponding reduction in tax is refunded to the company.

2.130 Tax loss carry back was introduced as a 2012-13 Budget measure. It was available for 2012-13 and was repealed after one year in 2014. It was designed to provide a permanent two year carry back, limited to a carry back amount of $1 million.

2.131 The economic analysis included in this RIS was made available to decision makers prior to a final decision being made. This RIS was finalised as part of the preparation of legislation after the final policy decision was made.

1. The problem

2.132 The Government has introduced a number of initiatives to support businesses withstand and recover from the economic effects of the Coronavirus. However, the current tax treatment of company losses will limit the effectiveness of some of those initiatives. Furthermore, for companies that suffer tax losses due to the economic effects of the Coronavirus, the requirement to carry those losses forward will delay access to the loss's tax value.

2.133 A key initiative aimed at helping businesses recover from the economic effects of the Coronavirus is Temporary full expensing. This time limited incentive allows companies to deduct the entire purchase cost of depreciating assets, rather than deducting this amount over time as the asset depreciates in value. By bringing these deductions forward, the after-tax cost of assets is reduced which creates an incentive for businesses to invest. This investment will boost Australia's productive capacity over the longer run, leading to higher wages and living standards for all Australians. This investment will increase long-term productivity in the economy providing support for wage growth. Temporary full expensing will be available until 30 June 2022, creating an incentive to make investments before the measure terminates to qualify.

2.134 This tax treatment will change the timing of deductions significantly which will have the apparent effect of moving profits and losses between years. In general, profits will move out of years where eligible investment are made and towards subsequent years. In some cases this movement will generate tax losses and in other cases losses under the counterfactual policy will simply become larger. The current company tax treatment of these losses will dilute the economic incentive provided by Temporary full expensing.

Example 1 Quaternion Construction Limited purchases a piece of equipment for $1 million. Under Temporary full expensing the entire purchase price is deductible in the year of the purchase so if Quaternion Construction's taxable income before the purchase was $1 million then the purchase would reduce its taxable income to zero, saving $300,000 in tax that year (at the 30 per cent company tax rate). However, if Quaternion Construction's taxable income was only $600,000 before the purchase, its tax outcome would be a tax loss of $400,000. The related tax saving would only be $180,000 because without loss carry back the tax value of the loss would have to be carried forward to offset future tax liabilities rather than being immediately accessible. The full tax value of the loss will eventually be realised if Quaternion Construction goes on to make sufficient profits but the delay in realising this value will reduce the attractiveness of Temporary full expensing and make the company less likely to change its decisions in favour of making new investments under the policy.

2.135 Temporary full expensing also changes tax outcomes in subsequent years because there are no depreciation expenses in those years for qualifying purchases. However, this does not eliminate the problem. The consequences of requiring tax losses to be carried forward still reduce the economic incentive created by Temporary full expensing because of the delay in accessing the tax value of the loss.

2.136 The other problem associated with loss carry-forward during an economic downturn is that while profits are taxed in the year they are realised, the tax value of losses generated by the downturn is not immediately available to affected companies. This asymmetry reduces the degree of economic stabilisation provided by the corporate tax system. With a more symmetric treatment of losses, corporate taxation would provide more support to the economy during downturns, and this support would be targeted towards firms that have been more seriously affected.

2. Why Government action is needed

2.137 The problems identified in the previous section occur within a regulatory system (the tax system). As a result, they can only be addressed by Government action. The objective of any reform to address these problems should be to provide earlier access to the tax value of losses for the period that Temporary full expensing is available at an acceptable fiscal cost without introducing further problems.

2.138 The main problems created by providing earlier access to the value of tax losses are related to the integrity of the tax system. Providing early access to tax losses significantly increases the difficulty of denying dishonest claims before they are processed under self-assessment and recovering amounts that have been paid out inappropriately.

2.139 More broadly this proposal is consistent with a number of policies the Government has introduced that aim to support the economy recover from the effects of the Coronavirus. The aim of supporting companies recover is consistent with the broad thrust of policy and it specifically complements Temporary full expensing by preserving the incentives it provides in certain cases.

3. Policy options

No change - option 1

2.140 While not changing the tax treatment of losses would not address the policy problem associated with delayed access to the tax value of losses, it would avoid the integrity problems associated with all of the identifiable reforms.

Loss Refundability - option 2

2.141 The first option that requires new policy would be a loss refundability measure. This would more closely resemble a purely symmetrical tax treatment of losses and profits by allowing tax losses to be refunded in the income year in which the tax loss occurs. For example, if a company makes a tax loss of $1 million, it would receive a $300,000 tax refund in their income tax assessment for the year in which the loss is realised (at the 30 per cent tax rate).

2.142 While this approach would meet the aim of providing earlier access to the tax value of losses, it would create significant integrity concerns. In particular, loss refundability raises the possibility of fraudulent taxpayers making a net profit from a tax scheme. The systems and laws used to administer the income tax system are not designed to mitigate this type of risk. For example, if a business ceases operating, there is little recourse for the Commissioner of Taxation to take action against a taxpayer to recover an inappropriately claimed refund. Other key integrity concerns include schemes to generate tax losses on paper to receive the tax refund, noting that once a refund is issued it is difficult to recoup. A related yet distinct concern is international corporations could artificially shift their losses to their Australian subsidiaries to receive the tax benefit using related party transactions. This option would also increase the risk of loss trading whereby failing businesses are acquired for the tax benefits of the losses. These integrity risks will deteriorate the existing tax base and unduly distort commercial decisions.

2.143 The level of resources required to mitigate these risks would be significant given that even with the current asymmetric treatment of tax losses, around one third of companies made a tax loss in a typical year when the economy is growing. Implementing loss refundability would require significant structural change, as it would be exceedingly difficult to implement loss refundability temporarily with sufficient integrity.

Temporary Loss Carry back - option 3

2.144 A third option is to allow companies to carry back losses incurred in a given year against taxed profits in earlier years. The primary difference compared to loss refundability is that Temporary loss carry back has a more limited application in that it requires profits in earlier years. It also raises fewer integrity issues because taxpayers can only ever claim back tax that was paid in the past.

2.145 For example, if Jamie's Coffee Pty Ltd had taxable income of $5 million and paid $1.5 million in income tax in 2018-19 but due to the impact of the Coronavirus restrictions makes a tax loss of $2 million in 2019-20. Under the treatment of losses in the current law, Jamie's Coffee Pty Ltd would carry these losses forward until it made a taxable profit. Under Temporary loss carry back it will receive a tax refund of $600,000 in recognition of this loss.

2.146 Temporary loss carry back has the advantage that it was previously designed and introduced in Australia in 2012-13 and was available until it was repealed in 2014. The previous experience with loss carry back means that many of the implementation and integrity issues were considered and the old framework provides an advanced starting point for a reintroduction. It should also be noted that when loss carry back was repealed, the repeal was part of the broad repeal of the Mineral Resources Rent Tax together with the measures that it funded, rather than identified short comings of the regime.

2.147 Temporary loss carry back also has the advantage that it is more targeted towards firms that were previously viable, reducing the risk that it supports firms that were already experiencing weakness prior to the current health crisis. Previously weak firms will have more limited access to the benefits of Temporary loss carry back due to a lack of prior taxed profits.

2.148 There are a number of design choices associated with a loss carry back regime. In this case, given the need to support Temporary full expensing, the policy should match the qualification criteria for that scheme. The key criteria are that Temporary full expensing ends on 30 June 2022 and that it is only available to businesses with turnover below $5 billion per year. The corresponding rules for Temporary loss carry back would be that it ends after the 2021-22 income year and that it has the same qualifying turnover limit.

2.149 One complicating factor associated with Temporary loss carry back is its interaction with the imputation system. This system uses tax credits to impute tax paid at the company level to domestic shareholders that receive dividends. Temporary loss carry back needs to be designed to prevent the refund of tax that has also generated imputation credits that have been distributed and claimed by shareholders. Such an outcome would effectively credit tax paid at the company level twice, resulting in net tax refunds when considered across the whole tax system. To prevent these outcomes, Temporary loss carry back can be limited to previous tax amounts that have not generated distributed credits.

2.150 The number of years that taxpayers can carry a loss back can be limited, with shorter carry back periods associated with lower fiscal costs, reduced integrity risks, and more precise targeting towards previously viable businesses. A shorter carry back period also reduces the number of companies that are limited by the imputation considerations described above. This proposal considers Temporary loss carry back to the last income year that was not affected by the economic effects of the Coronavirus, which is the 2018-19 income year. Other jurisdictions that have adopted loss carry back have opted for carry back periods of between one and three years.

2.151 Australia's previous loss carry back regime limited the amount of loss carried back to $1 million. This limit reduced the fiscal cost of the measure and managed the integrity risk. This proposal does not have a limit on the amount carried back, reflecting the aim of supporting Temporary full expensing (which is also unlimited). As there are natural limits to this measure, not having a dollar limit on the amount allowed to be carried back is not as much of a concern as with loss refundability (option 2). Its temporary imposition also limits the ability of taxpayers to create structures that exploit the regime, on top of the integrity rules that can be applied from the 2012-13 measure.

2.152 The integrity issues associated with Temporary loss carry back were largely considered during the design of the previous implementation of the regime in 2013. It would be appropriate to replicate the integrity rules that applied under the previous regime in 2013 which were designed to prevent schemes that have the purpose of claiming a tax loss carry back benefit. These schemes would work by combining, in a single entity, the three main characteristics required to claim a tax benefit. That is, a prior tax profit, a recent loss and a sufficient franking account balance. Only introducing loss carry back on a temporary basis would further limit integrity risks. Additional departmental funding to the Australian Taxation Office to upgrade internal systems would also assist in detecting integrity concerns associated with Temporary loss carry back.

Loosening Loss Integrity Rules - option 4

2.153 The final option is to temporarily amend the current loss integrity rules. The current rules limit the benefit a company receives for providing new equity or their ability to alter the goods or services or business model while retaining access to previous losses.

2.154 The two integrity rules that could be relaxed to provide an effective benefit are the Continuity of Ownership Test (COT) and the Business Continuity Test (BCT), as they limit the availability of losses through mergers or acquisitions. COT requires that 50 per cent of a company's shares carrying all voting, dividend, and capital rights are held by the same persons. The BCT requires the acquired entity to maintain the same or substantially similar business activities to those that it carried on prior to the change in ownership.

2.155 Relaxing integrity rules makes companies in a loss position more valuable to larger corporations, especially those with large franking credit balances. However, for companies to receive a benefit from the policy it requires acquisition to some extent. There is a risk that this option would not be very effective in an economic downturn as most companies would likely be financially constrained to buy other businesses.

2.156 Obviously any relaxation of the integrity rules would raise integrity risks. In this instance some of these risks are associated with old losses that accrued before the current health crisis. Providing recognition for these losses reduces the targeting of this measure, raising its cost by supporting firms that were struggling to be viable before the health crisis.

4. Impact analysis

2.157 These options only affect corporate taxpayers. That is, companies and entities that are taxed like companies. In all cases the regulatory burden imposed by these options would either be zero (for option 1) or overwhelmingly smaller than the impact on the amount of tax paid by companies. These regulatory burdens are discussed in this statement, but the main considerations in the choice between options are the policy outcomes for taxpayer behaviour and the structure of the tax system.

2.158 The integrity risk associated with option 2 is structural in magnitude. Annual corporate tax losses over recent years (which were not affected by the health crisis) have been between 15 to 20 per cent of gross tax profits. The administrative systems that support the income tax system would not be able to scrutinise refunds at this level of losses (or greater levels in a downturn). It would also not be possible to increase the capacity of tax administration in the short time that this policy is available to support taxpayers. The introduction of further integrity rules to mitigate this risk would not only increase the level of administration required, but likely create a significant regulatory burden for taxpayers. Globally, no major economies provide general loss refundability for corporate income tax payers.

2.159 There are integrity risks associated with option 4 also, but this option has a further weakness due to its imprecise targeting. Assistance would rely on the existence of healthy companies that are interested in purchasing loss making companies to access the tax value of their losses. In a scenario where losses are concentrated in particular sectors of the economy, the pairing of loss making companies with profitable purchasers is likely to be difficult within sectors, further reducing the likelihood of a successful match.

2.160 The policy considerations associated with option 3 are the level of targeting of assistance provided, the degree of integrity issues and the associated regulatory burden.

2.161 The level of assistance provided by these policies is linked to their long-term fiscal cost, so the level of targeting is a key policy consideration. Temporary loss carry back will be available to eligible companies, with the key criteria determining eligibility being the presence of tax profits and losses in the correct years, together with having a sufficient franking balance. Sufficient franking credits at the end of the loss year is a requirement because once a company distributes their franking credit, which they receive for paying tax, their shareholders will typically use the franked dividends to offset their personal income tax liability. Without this limit, Temporary loss carry back would generate double benefits because a refund of company tax would have to be paid both to the company and to its shareholders. Further, companies that have a franking account deficit at the end of the income year would be required to pay franking deficit tax (potentially with penalties). Data suggests that a lack of franking balance will affect only a small percentage of companies.

2.162 Temporary loss carry back is being proposed in conjunction with Temporary full expensing to encourage business investment. In recent years around 40 per cent of investment in new depreciating assets by companies is from those in a tax loss position. Providing Temporary loss carry back would increase the proportion of companies that receive an immediate tax benefit under Temporary full expensing. Without Temporary loss carry back, these companies would have to wait before accessing the tax value of these deductions, potentially deterring them from making investment decisions.

2.163 The incentive created by Temporary full expensing is due to the bring-forward in timing of deductions for the purchase of a depreciating asset, which would ordinarily be spread over the effective life of the asset. Under Temporary full expensing these deductions are brought forward, which increases their present value thereby creating the incentive to invest. However, without Temporary loss carry back, companies that experience a tax loss will have to wait until the tax loss is used to offset a future profit to enjoy the tax benefit, destroying the incentive. Temporary loss carry back preserves the incentive for eligible companies.

2.164 The presence of the appropriate profit and loss years targets the benefit provided by Temporary loss carry back to companies that were viable before the current health crisis. Requiring a current tax loss targets the benefit towards two broad populations. These are companies that have been negatively affected by the health crisis and companies that receive large tax deductions because they have taken advantage of Temporary full expensing (companies could have both of these attributes). In both cases Temporary loss carry back will produce a cash-flow benefit to the company, represented by the change in the underlying cash balance. In the case of companies that have utilised Temporary full expensing, there is an additional benefit derived from the preservation of the incentive created by Temporary full expensing. These measures encourage business investment which is an important factor in Australia's economic recovery and increasing productivity and wage growth. Treasury estimates that the combined economic impact of these measures will generate an increase in GDP of $21/2 billion in 2020-21 and $10 billion in 2021-22, and will create around 50,000 jobs by the end of 2021-22.

2.165 The regulatory burden placed on taxpayers by option 3 has been quantified using the Regulatory Burden Measurement Framework. The preferred option will increase compliance costs to corporate taxpayers and intermediaries by an average of $20 million per year. This includes a one-off compliance cost associated with moving from the current taxation treatment of losses to Temporary loss carry back. There is also an increase in recurring compliance costs associated with adding new labels to record keeping systems. This would add around $115 of additional compliance cost per taxpayer based on 175,000 possible entities that may claim the Temporary loss carry back. The regulatory impacts are provided in the table below. The calculation of the compliance cost and assumptions is provided at Appendix A.

Average annual regulatory costs (from business as usual)
Change in costs ($ million) Business Community organisations Individuals Total change in costs
Total, by sector $20 $0 $0 $20

2.166 The direct costs associated with option 3 is a reduction in receipts which is estimated at $4.9 billion over the forward estimates period. This is because the Temporary loss carry back would be used to offset previous tax paid, resulting in a tax refund to the company. The Australian Taxation Office would receive $4.4 million in funding to administer Temporary loss carry back and support taxpayers to understand and claim tax benefits.

2.167 The gross benefits provided by Temporary loss carry back are due to the reduction in company tax paid. These amounts are estimated in the associated revenue costing and are orders of magnitude larger than the direct costs. The indirect cost associated with option 3 is the opportunity cost of the revenue forgone. An assessment of how the overall costs and benefits compare relies on an assessment of the fiscal and macroeconomic impacts of the proposal.

5. Consultation

2.168 Past reviews and stakeholder consultations have established that there is justification and support for introduction of a loss carry back. Stakeholders expressed general support for a loss-carry back during consultation on the 2012-13 measure. General support for a loss carry back was echoed by business community stakeholders more recently in the Coronavirus context as a mechanism to provide cash flow support to businesses.

Australian tax reviews

2.169 Australia's Future Tax System (2009) recommended that companies should be allowed to carry back a revenue loss to offset it against the prior year's taxable income, with the amount of any refund limited to a company's franking account balance.

2.170 The review noted that a loss carry back would improve the asymmetric treatment of gains and losses and automatic fiscal stabilisers.

2.171 The 2011 Business Tax Forum and 2012 Business Tax working group undertook further work that developed the original 2012-13 policy. This culminated in the Final Report on the Tax Treatment of Losses (2012).

2019-20 Stakeholder views of loss carry back

2.172 A number of stakeholders have made recent representations to the Government supporting the introduction of loss carry back. The various proposals offered differed in detail but at least a two year carry back was most commonly proposed. There was some interest expressed in loss refundability, but as a larger structural change rather than a temporary recovery measure. A summary of these views is presented in the table below.

Stakeholder and source Summary
BDO

Pre Budget Submission 2020 21

20 December 2019

Recommends the reintroduction of a tax loss carry back to improve cash flow of affected companies and help them adjust to changing economic conditions. The loss carry back period should be two years, available to companies that are eligible small business entities and restricted to those companies that have paid tax in the previous two years.
Business Council of Australia

Pre-Budget Submission 2020-21

4 September 2020

A tax loss carry back could support investment by allowing companies to offset current losses against previously paid taxes. This would support the cash flow of previously profitable businesses in the current downturn. It would also support cash constrained businesses as well as investment by reducing the bias against investing in riskier projects, particularly for SMEs.
John Durie, 'Back to the future on tax'

The Weekend Australian

5 September 2020

The Federal Government should revive the company tax carry back provisions of 2012 that allows companies to make tax losses to get refunds for taxes paid in previous years.

Tom Seymour (PwC Chief Executive) said from the government's perspective the tax take would be a timing issue: instead of a drop in tax receipts next year the fall would come from last year's receipts, which could be covered with borrowings.

Stakeholder views of the 2012-13 measure

2.173 Prior the passage of the loss carry back in 2012-13, the Business Tax Working Group conducted extensive consultation with stakeholders and the business community. There were 24 submissions over the course of this consultation from representative bodies and companies. The summary of these views are:

Association of Mining and Exploration Companies: supports loss reform, however wants a targeted exploration credit instead of loss carry back.
Australian Chamber of Commerce and Industry: supports loss carry back but want it extended to all businesses, not just companies.
Australian Financial Markets Association: broadly supports loss carry back.
Australian Property Group: supports loss carry back with a three year carry back period because it isn't likely that a business will have one year in loss followed by a year in profit and so on. Cap on loss carry back is not mentioned.
BDO: rank loss reform as its highest priority. It prefers a carry back period of three years, with limit to carry back determined by franking account balances.
Associate Professor Dale Boccabella: refers to his article, "A loss carry back rule for business losses in Australia: Some initial thoughts", Weekly Tax Bulletin, Thomson Reuters, No 47, 11 November 2011 at paragraph 1770. Notes the importance of tax losses to the integrity of the tax system and recommends a higher onus of proof rule, particularly for trusts.
Business SA: supports loss carry back with a three year carry back period.
Corporate Tax Association: support a one year loss carry back, with exceptions for certain circumstances (e.g., GFC) and supports a cap on the losses carried back as in the European model.
CPA Australia: supports loss carry back for a two year period, with a modest cap as businesses are not prepared to give up much to fund loss carry back.
Ernst & Young: support a loss carry back limited to two years, but do not support a cap other than the franking account balance.
Grant Thornton: supports loss carry back with a two year carry back period.
Institute of Public Accountants: supports loss carry back with a one to three year carry back period. It supports a restriction to small businesses for the measure.
Master Builders Association: support loss carry back with a longer carry back period to support large capital investments.
National Tourism Alliance: supports loss carry back with a carry back period of more than one year.
Pennam Partners: notes that loss carry back will not benefit start-up companies.
Property Council of Australia: strongly prefers a loss carry back to other loss reforms, with a three year carry back period and be available to all businesses.
Real Estate Institute of Australia: supports loss carry back with a carry back period of three years.
The Institute of Chartered Accountants Australia: supports loss carry back, with a carry back period of two years, as a measure to support smaller businesses in better accessing their losses and supporting them during downturns.
The Tax Institute: support a limited loss carry back as outlined in the Australia's Future Tax System report.
Tourism and Transport Forum: strongly support loss carry back, with a three year carry back period, as it will provide a cushion against the shocks regularly experienced by this industry (weather and other natural events, transport shocks, etc).
Tourism Accommodation Australia: support loss carry back in some form as it will support capital investment in their industry.
Yarrawa Management Pty Ltd: Broadly support a loss carry back, with a three year carry back period, as the horticultural industry have longer peaks and troughs.

6. Option selection/Conclusion

2.174 The significant integrity issues associated with option 2 prevent its practical application to address the policy priorities identified in section 2. Policy considerations also suggest that option 4 is not preferred given the very conditional nature of support it provides firms in loss positions requiring the acquisition of other companies that are in a loss position and/or have large franking credit balances. However in an economic downturn, it is possible this support would not be readily accessible.

2.175 The key consideration is between options 1 (no policy change) and 3 (Temporary loss carry back). Option 3 is preferred on the basis of its contribution to the economic recovery from the Coronavirus.

7. Implementation and evaluation

2.176 The temporary nature of this proposal will mean there is limited opportunity for review whilst it is in operation. However, it will naturally be considered as part of the review of the Government's response to the Coronavirus that will also consider the associated Temporary full expensing policy.

2.177 Furthermore, the previous implementation of loss carry back was repealed to fund other spending priorities rather than because of the identification of any weaknesses in any historic evaluations.

Appendix A to the Regulation Impact Statement - Calculation of compliance cost assumptions

Option name: Loss carry back
The proposal would allow companies to carry back losses between the 2020 and 2022 income years against tax paid from the 2019 income year onwards.
Select affected client groups Non-business individuals Businesses
Overall impact: This proposal is expected to result in a low overall compliance cost impact, comprising a low implementation impact and low impact in ongoing compliance costs.
Potential compliance costs Total Per client
Implementation $12,000,000 $70
Ongoing (p.a.) $14,000,000 $80
Aggregate impact over 2 year duration $40,000,000
Per year (2 years) $20,000,000
The level of confidence of the assessment
Supporting evidence is weak. Data is not available, limited or unreliable.

Double ended arrow, labelled from left to right as Low Medium High, with radio buttons checked under Low and Medium

Supporting evidence is strong. Data is comprehensive and relevant.
Key issues and assumptions

The number of possible entities claiming the proposed loss carry back regime is approximately 175,000. This may be higher or lower but cannot be readily determined given the current economic support packages available that distort population figures. In addition, the 2020 income year lodgements are far from complete.

The above calculation has assumed that all eligible taxpayers will opt for the loss carry back. However, based on previous experience (2012-13 measure) only a percentage of the eligible population opted for the loss carry back.


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