- A startup that is pre-revenue, or has lots of setup costs
- A business run through a company, where shareholders receive excessive remuneration, leaving no profit in the company
- A business that has temporarily or permanently ceased operations, leaving no income but still having costs to cover
- A change in business operations such as opening or closing a store
- Significant external events (2020 anyone?)
- A business experiencing hardship
Of course, you’d prefer your business to be profitable. However, if it’s in a loss situation, there are certain tax relief options that may be available.
If your business is showing a loss for tax purposes, there is a small upside. Inland Revenue allows you to carry your losses forward, to offset against profits in future years. This means if you make a loss of $10,000 in one year, and make a profit of $10,000 the next, your tax position is $0, and there is no tax to pay despite that year being profitable.
When this doesn’t work
With a company, Inland Revenue is of the opinion that losses (and profits) belong to the people who owned that business (the shareholders) at the time those losses were generated. Should there be shareholding changes greater than 49%, built-up losses are forfeited (taken away by Inland Revenue) and cannot be offset against future profit. The tax advantage is lost.
The reasoning is as follows. If you had a very unprofitable company with millions of dollars of losses, you might think you can sell that company to someone with a profitable business – they could offset the profits with the losses so they would not have to pay tax. This is called Tax Avoidance and the rules we’ve mentioned above are in place to prevent exactly this.
Proposed upcoming changes to legislation – when the 49% won’t apply
The Government has proposed to widen the rules and allow companies with major shareholding changes to retain losses if they can prove that they are operating the “same or similar business”. This change hasn’t been passed in Parliament yet, but once the Bill is introduced and passed, it will retrospectively apply from 1 April 2020, for the 2021 tax year and forward.
Businesses will be able to retain their losses if they have a shareholding change over the 49% threshold, but there has been no “major change” to business operations. The test will look at factors such as business assets and processes, products, suppliers and markets served. It will exclude major changes that were undertaken to keep pace with technological changes, rationalise the product or service mix, or to increase business efficiency.
This is a complex area of tax law and requires detailed records of changes that go back to the creation of the Company. If you’re thinking about changing shareholdings please get in touch with us at [email protected], first so we can work out the best way for you to do this.
We’ve talked about losses carried forward – but there are also losses carried back. As a result of the uncertainty caused by Covid, the Government enacted a temporary provision to allow businesses to carry losses back and offset against a previous profitable year. Part (or all) of the tax paid in that previous, profitable year can be refunded. Businesses that make a loss in either the 2020 year or the 2021 year can carry the loss back only one year.
When your accountant prepares your tax return they will look at whether this provision will affect you and work out the best tax position for you. However if you want to find out more about this please get in touch with us at [email protected]
In some circumstances, where there is common ownership (66% of the shares in both companies are held by the same group of people), losses can be transferred between two entities. The amount available to be transferred is limited to the profits available for the financial year in question. If one company has a loss of $15,000 and the other has a $10,000 profit, the loss-making company can only transfer $10,000.
There are also very specific conditions that have to be satisfied. If this applies to you, then this is something that your accountant will consider at year-end.
If you make a loss from owning a residential rental property, you can carry that loss forward but you can’t offset it against any other income that you earn. So if you earn $10,000 from salary and wages in a year, and make a $10,000 loss on your residential rental property, you still have to pay tax on that $10,000 income. The residential property losses are carried forward and can only be offset against rental profits in future years, or against any taxable profit made from the sale of the rental property.
Residential property losses can be applied on a property by property basis, or on a portfolio (combined) basis and this is something that your accountant can discuss with you at tax time.
If your business has been making losses over the past few years, or you have concerns while being currently profitable, feel free to get in touch with us. We may be able to identify problem areas and provide advice. After understanding the issues, we would provide you with a fixed fee before we start work, so there are no surprises.