Loss changes in the wind
Dec
20
Written by:
Tuesday, December 20, 2011
The Treasurer has released for comment the Business Tax Working Group's Interim Report on the Tax Treatment of Losses. The interim report is on the Treasury website.
The report sets out 4 possible reform elements, which could be pursued individually or in combination:
1) Replacing the current integrity rules (ie the continuity of business test (COT) and the same business test (SBT)) restricting access to losses. The report notes that removing the COT and SBT would increase the potential for a company to use its carry forward tax losses to reduce its current year taxable income, regardless of whether it experiences a change in ownership or a change in the nature of business it conducts. This means that, for example, companies that seek new equity partners, restructure their ownership arrangements, embark on new commercial ventures and cease unviable or unprofitable components of their business, would not be denied access to past tax losses. The report notes, however, that improving tax loss utilisation could also undermine the integrity of the tax system if it allows businesses to derive benefits from artificial tax losses. An option to partially address this concern would be to apply the integrity rules that currently apply to tax losses brought into a consolidated group eg apply the available fraction rule more broadly or apply a dominant purpose test.
* The report sees as potential benefits that removal of the COT and SBT would be broad in its application, theoretically benefiting all companies, regardless of their size or their profit or loss profile. In practice, the report considered it would likely be most beneficial (relative to the status quo) for small businesses and those that are not part of a consolidated group as they may not have income from a range of activities to spread deductions across in the first instance. Consolidated groups would, however, also benefit as the COT and SBT rules still restrict the use of tax losses derived within the consolidated group from year to year.
* On the downside, the report said that making it easier for companies to utilise tax losses relative to other jurisdictions could create international arbitrage opportunities. Attracting loss generating or utilisation activity into Australia on this basis would impose a substantial absolute reduction in Government revenue from the business tax base, the report noted.
2) Allowing immediate loss refundability - the report says a purely symmetrical tax treatment of losses and profits would require tax losses to be refunded in the income year in which the tax loss occurs. Therefore, a company in taxable profit would pay 30% of the taxable profit as company tax, and a pure symmetrical tax treatment would allow a company in tax loss to be refunded 30% of the tax loss. However, immediate refundability would involve a significant cost to revenue and for the purposes of the interim report, immediate loss refundability was not proposed as a viable reform for the foreseeable future. Nonetheless, the Working Group said the proposed reform elements outlined in the report are assessed against the benchmark of immediate loss refundability, which theoretically provides perfectly symmetrical treatment of profits and losses.
3) Allowing losses to be carried back and offset against previous years' profits. Under this proposal, loss carry back would allow companies to carry current year tax losses back to be offset against previous year's profits, resulting in a refund of tax previously paid. As such, loss carry back would be limited to the taxes paid in previous income years. That is, the maximum refund under a one-year loss carry back would be the taxes paid in the previous income year. The proposal is to limit loss carry back to a period of 1 to 3 years. A company's capacity to carry back a current year loss would also be restricted to its franking account balance.
4) Allowing losses carried forward to be uplifted by a determined benchmark rate. The report says the current tax system allows tax losses to be carried forward and deducted against future income, but the real value of the tax loss carried forward erodes over time. It suggests an uplift factor could be applied to tax losses as they are carried forward. The long term (10-year) Government bond rate is often used as a risk-free rate of return and may be appropriate as an uplift rate, the report said.
The report also notes that the suggested loss reform elements could be implemented individually or in combination. For example, the COT and SBT could be removed and replaced with an alternative integrity test at the same time as 2-year loss carry back is introduced with an uplift factor applied to any losses carried forward.
The report said the exact benefits derived by companies under the different combinations of the loss reform elements would be determined by a company's individual facts and circumstances. Broadly, it said that removing COT and SBT would impact on all businesses, loss carry back would impact on previously profitable companies, while loss uplift would help start-up companies and those companies making investment involving long lead times until profits are made.
To support the consultation process and assist in responding to the ideas in the interim report, the Working Group has put together a set of consultation questions eg:
How does the current tax treatment of losses affect decisions about your business or businesses that you are familiar with?
How do the current integrity provisions (continuity of ownership test (COT) and same business test (SBT) affect decisions about your business or businesses you are familiar with?
What would be the impacts of a one-year carry back (or a 3-year carry back) on your business (including impacts on decision making and cash flow)?
Following the Tax Forum in October, the Government established the Working Group to look at how the tax system could best help businesses increase productivity and respond to the pressures of a changing economy. The Working Group's final report on the tax treatment of losses is expected in March 2012.
In the longer term, Mr Swan said the Working Group will focus on business tax reform options such as a further lowering in the corporate tax rate or moving towards a business expenditure tax by, for example, providing an allowance for corporate equity.