Back in the May 2012 Budget there was a significant new tax concession announced that will be of help to many businesses run via companies.

This concession takes the form of companies being able to “carry back” losses in order that they can be offset against profits derived from previous years, such offset resulting in a refund of previous company tax paid. Under the existing company loss rules, tax losses made by a company can only be carried forward and offset against a future profit derived. The current treatment provides some recognition of the tax value of a loss but no immediate benefit.

These proposed changes will be of benefit to many in the racing/breeding industry who run their successful horse businesses via a company and may suffered significant losses in the ensuing years due, say, to factors like bad luck, the softening of the bloodstock market, mainly due to the advent of the GFC in late 2008 and the continuation of the natural disasters that have befallen regional Australia in the past 5 or so years.

Now that Treasury have released a discussion paper in late July 2012 as to how these rules are likely to operate, I am in a position to provide the industry with the policy design features of these rules as well as a useful example as to how these rules will operate.

Overview – Loss “carry back” rules

Access to company losses will be improved by introducing a loss carry-back measure to allow companies that have paid tax in the past, but are now in a tax loss position, to choose to claim a refund of some of the tax they have previously paid. This will allow companies to utilise the losses sooner and reduce the risk of never being able to use them. Some of the major features of these new rules are noted below.

Limited “carry back” period

A one year carry-back period will be allowed for the 2012-13 income year, followed by a two year carry-back period from the 2013-14 income year onwards.

This means that a loss carry-back refund will be able to be claimed for the 2012-13 income year against tax paid for 2011-12 This means that a loss carry-back refund will be able to be claimed for the 2012-13 income year against tax paid for 2011-12.

From the 2013-14 income year onwards, a loss carry-back refund will be able to be claimed against tax paid for the two years preceding the claim year.

$1 million cap

A cap of $1 million will apply in each claim year to the amount of losses that any company can carry-back against taxes paid in previous income years. This design feature means that loss carry-back will particularly benefit small companies, which are relatively disadvantaged by the existing loss utilisation rules.

The maximum potential refund in any year will be the tax value of the cap. With a $1 million cap and a 30 per cent tax rate, this will be $300,000.

Available to companies only Loss carry-back will only be available for companies and other corporate tax entities (which are taxed as companies).

Refunds limited to a company’s franking account balance

The maximum amount of the tax value of loss carry-back (currently $300,000) cannot exceed the surplus balance of the company’s franking account at the end of the income year for which the loss carry-back is claimed. That is, the tax value of loss carry-back cannot exceed the value of past taxes paid and of franking credits received that have not been distributed to shareholders at that time.

Choice to claim loss “carry-back”

Claiming loss carry-back will be optional.

For any potential claim year, a company will have the option to claim loss carry-back for any current year loss of that year and/or any unutilised current year loss of the previous year. The company can choose to only claim loss carry-back for a portion of a loss.

Where both of the immediately preceding income years were profit years, the company will be able to choose to apply a particular eligible loss, or portion thereof, to either or both profit years.

Date of effect

The measure will apply from the 2012-13 income year.

Example – loss “carry back” generates a huge tax refund for breeder

Understandably, many of you will find these proposed rules a little complex and hopefully my example below helps to demystify these changes.

Company Losses (Current Position)

Kentucky Pty Ltd (“Kentucky”) is a successful Australian breeding company that has generated hundreds of thousands of dollars profits over the years.

In 2010-11, Kentucky Pty Ltd generates a taxable income of $750,000 upon which tax of $225,000 is paid (i.e. 30% tax rate).

Bad luck befalls Kentucky and due to the sale of many poorly conformed foals and a very soft market, yearling sale prices plummet and it makes a tax loss of $500,000 in 2011-12.

Under current rules, Kentucky is unable to offset this $500,000 loss against previous tax paid.

Kentucky must “carry forward” these losses and can only use them to offset any future taxable income it generates.

Company Losses (Future Position with loss “carry back”)

Belmont Pty Ltd (“Belmont”) is another established successful breeding company. Belmont generates the following taxable income:

• 2011-12 Taxable Income: $750,000 ($225,000 tax paid)

• 2012-13 Tax Loss: ($500,000)

Belmont can offset its $500,000 loss incurred during 2012-13 against its 2011-12 taxable income to receive a refund of $150,000. (i.e. 30% of $500,000)

Belmont continues to trade and generates the following taxable income/(loss):

2014-15 Taxable Income: $800,000 ($240,000 tax paid)

2015-16 Taxable Income: $900,000 ($270,000 tax paid)

2016-17 Tax Loss: ($1,500,000)

Per the “$1m cap requirement” noted above, Belmont is able to offset only $1,000,000 of its 2016-17 losses against their combined 2013-14 and 2014-15 taxable income to receive a tax refund of $300,000 ($1 million @ 30%).

Belmont’s remaining losses of $500,000 must be carried forward in order to be utilised, as per the “Current Position” example above.

You are welcome to contact the writer if you wish me to clarify or expand upon any of the matters raised in this release.

PAUL CARRAZZO CPA

CARRAZZO CONSULTING CPAs
339 WILLIAM STREET, WEST MELBOURNE, VIC, 3003
TEL: (03) 9982 1000
FAX: (03) 9329 8355
MOB: 0417 549 347
E-mail: paul.carrazzo@carrazzo.com.au
Web Site: www.carrazzo.com.au