The temporary loss carry-back scheme, announced on 15 April 2020, was enacted as part of the COVID-19 Response (Taxation and Other Regulatory Urgent Measures) Act 2020, passed under urgency on 30 April 2020. That Act gives effect to a number of measures designed to stimulate the economy and assist businesses struggling as a consequence of the global COVID-19 pandemic.
Under the temporary scheme, businesses expecting to make a loss in either the 2019-20 year or the 2020-21 year can use that loss to offset profits they made in the year before. The economic impacts of COVID-19 have made it more likely that taxpayers will be in loss in the 2019–20 or 2020–21 income years. Carrying a loss forward postpones the benefit of being able to claim losses and means that a taxpayer would still incur a tax liability for previous profitable years. Conversely, the loss carry-back scheme is intended to provide immediate cash flow relief for businesses in loss during the period affected by COVID-19.
Commentary to the Bill introducing the scheme highlights that almost all types of taxpayers – companies, trusts and individuals – will be eligible to carry back losses. The majority of individuals who are taxed through the PAYE system do not have losses so would be unaffected by this measure but those that operate businesses through partnerships, limited partnerships, and look-through companies will be able to benefit.
However, while the scheme will be welcomed by many businesses, as highlighted in an earlier note on this topic, it will not assist businesses that, although suffering serious downturn in revenues, do not actually move from profit to loss, as in such a case there will be no loss to carry back.
Mechanics of the scheme
The enabling provisions for the scheme are set out in the unfortunately complex new section IZ 8 of the Income Tax Act 2007 (“ITA 2007”). This section introduces the concept of “offset years” – the being the “taxable income year” and the “net loss year”.
To be eligible to use the scheme, a taxpayer must have made, or estimate that they will make, a loss in 2019–20 or 2020–21 – the net loss year. It must also have had taxable income in the previous year – the taxable income year. Losses would only be carried back for one year.
The scheme is subject to limitations. If a claimant company is within a wholly owned group of companies, the amount that may be carried back is limited to the amount that cannot be offset against profits within its wholly owned group in the loss year. Similarly, company ownership continuity requirements apply that match those that apply for the purposes of the loss carry-forward provisions. Also, a company must have an imputation credit account credit balance of at least the amount of the claimed refund at the end of the most recently ended tax year.
Shareholder-employees will also not generally be able to benefit from a loss arising in the 2019-20 year. This is because owner-managed companies tend to remunerate the owner with all the profits of the company, and in such situations the company has not paid any tax. Inland Revenue have confirmed that where profits have been distributed by way of shareholder-employee salaries, this cannot be reversed to take advantage of a loss carry-back. Notwithstanding this, Inland Revenue have highlighted that shareholder-employees who have paid provisional tax on the basis they would receive a shareholder salary which is not in fact paid because the company’s pre-salary income is offset by a loss carry-back may re-estimate their provisional tax. Any overpaid provisional tax will be refunded, affording these business owners at least some of the intended benefit of the scheme.
Interestingly, an amendment to section RM 10(4) of the ITA 2007 provides that if the taxpayer owes a debt on other tax types, Inland Revenue will not apply any of the refund arising from the loss carry-back to satisfy tax debt. This is contrary to Inland Revenue’s normal approach and highlights the Government’s commitment to support New Zealand businesses. However, where use of money interest applies because of an overestimate of the loss carry-back, the taxpayer cannot use the COVID-19 related remission of interest provisions in section 183ABAB of the Tax Administration Act 1994.
Although this measure is temporary, the Government has signalled its intention to develop a permanent loss carry-back mechanism to apply from the 2021–22 tax year. Inland Revenue has suggested that the longer-term regime may be more traditional, such as not allowing a refund before the loss has been established. With the application of the generic tax policy process and the thorough consultation that accompanies that, we can also expect any future provision to be less complex and more user-friendly.
© 2020, G D Clews and S J Davies