COVID-19: Loss carry-back rules – fine in theory, but watch for fishhooks
Important considerations for new COVID-19 response tax legislation - 22 May 2020
By Robyn Walker and Veronica Harley
On 30 April 2020, the Government fast tracked new legislation to introduce further tax changes in response to the impacts of the COVID-19 outbreak. The key tax component of the COVID-19 Response (Taxation and Other Regulatory Urgent Matters) Act 2020 is a temporary tax loss carry-back measure. Broadly, this will allow businesses that anticipate being in a loss for the 2020 or 2021 tax years, to carry some or all of the loss back to the preceding year to enable an immediate cash refund of prior tax paid.
To be eligible, a taxpayer must have made or anticipate they will make a loss in either of the 2020 or 2021 tax years. The taxpayer must have a profit in the year prior to the loss year. This means:
- Losses from the 2020 year may be carried back to the 2019 year; or
- Losses from the 2021 year may be carried back to the 2020 year.
Taxpayers can claim a tax refund for provisional tax paid by re-estimating 2020 provisional tax where the 2020 return is not yet filed, or by amending their 2019 tax return to factor in the loss carry back. The rules will apply to companies, trusts and individuals (other than those deriving only PAYE income) and those that operate through partnerships and look-through companies.
Overall, this is a very positive initiative, and one the Government should be commended for. However, because of its rushed implementation, it’s not perfect, not necessarily as straightforward as it seems and will not suit all businesses. Each business will have different circumstances and each will need to consider whether this mechanism is the right option for them. Inland Revenue’s systems went live in early May with the changes so taxpayers can make elections to carry back losses via the “I want to” section of MyIR.
A few considerations and scenarios below to reflect on are outlined below
- Beware UOMI: Most business will be looking to use this mechanism in relation to a loss incurred in the 2021 year and carry this back to the 2020 income year which may still be profitable given COVID-19 may have only affected the last quarter of this year. A business that needs cash urgently will want to elect to carry back its anticipated loss as soon as possible; however, a business will need to be fairly confident of the level of loss and think carefully about how the rest of the year will play out. This is because, if a business over estimates its 2021 loss which results in tax payable, use of money interest (UOMI) will apply from 28 August 2019 (for a March balance date taxpayer), which is the first instalment date of 2020 provisional tax. Further, it will not be possible to apply for relief from UOMI imposed under the remission rules recently enacted.
To minimise potential exposure to UOMI, the business might want to take a conservative position initially given we are only one month into the new tax year and re-estimate the loss later or as the year progresses. However, holding off, may not provide the much needed cash now which could force some businesses to take some risks in this regard. Timing of electing, filing the return and monitoring losses will be key. It will be possible to re-estimate the 2021 loss to carry back at any time prior to the earlier of the date the 2020 return is filed or the due date for filing.
- Pattern of income and losses: The rules require the immediately preceding year to have taxable income. There will be some companies where the pattern of income and losses is such that the carry-back mechanism won’t be much, or any benefit. For example, taxable income in the 2019 year might have been high under normal trading conditions and so 2020 provisional tax paid to date is based on residual income tax for this year. Taxable income in the 2020 year (particularly if it is a late balance date) might have dropped, but may have only dropped to a lower taxable income and so it not yet a loss. Even if there are large losses anticipated in 2021, these will only be able to be carried back to the extent of the lower taxable income in the immediately preceding year, which may not release that much tax paid. Likewise a company with a small loss in 2020 and a larger loss in 2021 will be constrained to only being able to use the smaller loss in 2020 to amend only the 2019 tax return, such that the company is unable to carry back the larger loss incurred in 2021.
- Refunds might be limited or trapped: For taxpayers that are companies, any refunds will be limited to the credit balance in its company imputation credit account at the date of the most recently ended tax year (i.e. 31 March 2020 although some timing exceptions apply). Therefore if a company has been in the habit of paying most of its profits as dividends to shareholders and attaching imputation credits, it may find access to cash refunds is limited. The policy rationale for this rule is that the company’s tax has been paid to shareholders already via imputation credits. Any trapped refunds may be applied to income or provisional tax liabilities, if any will exist.
- Shareholder salaries: If the company has traditionally paid out its profits for the year as shareholder salaries, the company won’t have any taxable income to carry future losses back to. The shareholders and not the company in this case have paid the provisional tax. Therefore an option might be for the shareholders to estimate 2020 provisional tax to nil and have the company elect to not pay any shareholder salaries for the 2020 tax year if losses are forecast for 2021 if this is possible. However, this could then expose the company to an FBT liability if there are outstanding current accounts, so care is required. Other options may be feasible in this scenario. The important point to note is that companies will need to do some work and determine what the approach to paying shareholder salaries should be in light of these rules.
- Anti-avoidance measures: The new Act contains an anti-avoidance measure, which could apply if shares in any company have been subject to an arrangement so that a loss company falls into the rules if the purpose of the arrangement is to defeat the intention of the rules. It is possible any cute “tax planning” of this nature to deliberately take advantage of the rules would be scrutinised down the track.
- The legislation is complex: We acknowledge the Government has brought these rules in under urgency to provide assistance for businesses in need of cash flow. It has endeavoured to strike a balance of giving the much-needed assistance, accommodating the need for part year and grouping rules, while still maintaining some integrity measures. Unfortunately, doing all these things inevitably leads to complex legislation. It’s possible, issues will come to light post enactment that are not clear or that will need a remedial fix. Already we have seen an amendment introduced via a supplementary order paper post enactment to ensure the rules do not adversely affect associated persons’ provisional tax interest treatment.
Given the rushed legislation, it is hoped that Inland Revenue apply the rules in the spirit that they were intended. Particularly since the request to re-open returns for reassessments is subject to the Commissioner’s discretion.
This mechanism could be described as a “be kind” temporary measure, which will be replaced in the longer term with more robust rules for the 2022 income year onwards.
The decision to use this mechanism will be heavily fact dependent on each business’s circumstances. There are policy design features that mean the rules will not be that useful to some of the SME businesses targeted. It is clear it will not be the panacea for every business and could in some cases expose a taxpayer to significant UOMI or other taxes unless care is taken.
The content of this article is accurate as at 22 May 2020, the time of publication. This article does not constitute professional advice. If you wish to understand the potential implications of current events for your business or organisation, please get in touch. Alternatively, our COVID-19 webpages provide information about our services and provide contacts for relevant experts who can help you navigate this quickly evolving situation.