It’s been a difficult time for many businesses across Australia. Higher interest rates and reduced consumer confidence have hit sales whilst many costs, including rent, have often remained fixed.
The end result is that many businesses have made a loss in the last financial year and may be on course to also make a loss in the current financial year. The question then is – how can such trading losses be recouped for tax?
I run my business through a company
Companies can carry forward a tax loss indefinitely, and use it when they choose, provided they have the same majority ownership and control. Unfortunately, the previous loss carry-back scheme (which enabled a company to carry its trading losses back to previous profitable years and obtain a refund of tax already paid) has ended and is not available for periods after 1 July 2023.
Note also that there are anti-avoidance rules that can prevent current losses being applied in future where there is a change of ownership in the business and the nature of the business changes significantly. So, if you are thinking of buying a business with accumulated tax losses, and then making major changes to the way the business operates in order to increase profitability, make sure you take professional advice on how your proposed changes could impact access to the losses.
In short, if there is a change of at least 50% in the ownership or control of a company, the company needs to satisfy the similar business test. This test requires that throughout the relevant test period, a company carry on a business that is similar to the business it carried on before the relevant test time. The similar business test is generally not failed simply by the company engaging in new business activities or transactions.
In working out whether the current business is similar to the former business, regard must be had to the following 4 factors, which are not exhaustive:
- the extent to which the assets (including goodwill) used in the current business to generate assessable income were also used in the company’s former business to generate assessable income
- the extent to which the activities and operations from which the current business generates assessable income were also the activities and operations from which the former business generated assessable income
- the identity of the current business and the identity of the former business, and
- the extent to which any changes to the former business resulted from the development or commercialisation of assets, products, processes, services, or marketing or organisational methods, of the former business.
A company that has not maintained the same majority ownership will not be able to use its carried-forward tax losses if it has closed its business completely (e.g. discontinued the business previously carried on and has no intention to resume). This is because it will fail the similar business test.
If a company is still carrying on its business, it will not fail the similar business test merely because it has:
- reduced the scale of its business, including if its activities have reduced to a minimum or are almost entirely suspended
- suspended or temporarily closed its business only because of temporary adversity or due to reasons beyond its control which it intends to overcome (such as COVID-19 lockdowns or bushfires).
I don’t run my business through a company
Generally speaking, losses arising in this situation can only be offset against other income arising in the same year. So, if you run a business as a sole trader and make a loss this year, you can apply the loss against your other income, such as income from employment or investment income.
To the extent you can’t use the loss this year, it must be carried forward and can be applied against income in future years.
Similar rules apply to trust losses, with the added complication that there are complex anti-avoidance rules in place that can severely restrict the ability of trusts to access losses in future (for instance, by preventing the ‘injection’ of income into the trust with the specific aim of absorbing losses).
Revenue v capital losses
If you make a loss arising from your trading activities, it is a revenue loss. If you make a loss arising from the disposal of a capital asset (which would be subject to capital gains tax), it is a capital loss. For both companies and non-corporates, the treatment of capital losses is much less flexible.
They can only be offset against other capital gains arising in the same year and to the extent they cannot be so used, they must be carried forward and offset against the first available capital gain in future years.
Capital losses can never be offset against revenue profits (such as trading profits).
Get professional help
If your business is in a loss-making situation, talk to your accountant or a tax agent like those at H&R Block to fully understand the options available. Tax rules are complex and – as you can see above – apply differently to different entities.
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