Tax Loss carry-back scheme

The proposed measure

This temporary measure will permit losses incurred in either the 2020 or 2021 tax year to be carried back to the prior tax year, enabling tax losses to be refunded to the extent that tax has been paid in the immediately preceding tax year. This should have the effect of immediately freeing up cash for struggling businesses.

Although said to be targeted at small to medium enterprises (SMEs), there has been no formal indication that it will be limited to those businesses. Neither the Beehive’s fact sheet, not Inland Revenue’s commentary provides any guidance on this.

Although material details regarding the operation of the changes are yet to be released, we know that a key feature of the measure is that the 2020 or 2021 tax loss can be estimated for refund purposes. This may enable some businesses to access the benefits of the tax loss carry-back as early as 7 May 2020 when the third provisional tax instalment for 2020 is due. We also understand that use-of-money interest will be charged if a refund based on an estimated tax loss proves to be too much when the tax loss is finally calculated. This is presumably intended to discourage deliberate over-estimates by businesses.

Apparently the temporary mechanism will be included in a bill to be introduced in the week commencing 27 April 2020. Between now and then Inland Revenue will be undertaking consultation with tax advisors to make the law and administrative guidance as clear as possible. Inland Revenue has also indicated that a permanent tax loss carry-back scheme will be developed later this year and will be expected to apply for 2022 and later tax losses.

It will be interesting to see what steps are taken by Inland Revenue to ensure the integrity of the tax system is maintained when the measure is introduced, should some businesses seek to game the system. For example, Inland Revenue will want to ensure that businesses that are not forecasting current losses are not incentivised to inflate expenditure (such are remuneration to owners) to access taxes paid in previous years. A specific anti-avoidance rule may well be introduced as part of the measure to deal with this.

Other jurisdictions

It is worth noting that New Zealand’s proposed tax loss carry-back scheme is not unique. Immediately prior to the current economic crisis, Canada, France, Germany, Ireland, the Netherlands, Singapore, the United Kingdom and Japan all operated loss-carry back schemes in some form. The Japanese scheme was limited to SMEs, while the French, German, Dutch, Singaporean and United Kingdom schemes limited carry back to the preceding year. Both France and Germany capped carry-back at €1m. The most generous scheme was Canada, which allowed losses to be carried back three years.

In response to the COVID-19 emergency, to date the Czech Republic, Poland, Norway and Sweden have all introduced some form loss-carry back scheme. Singapore has extended its carry back to three years and the United States has reintroduced a scheme which had been abolished in 2017 to fund proposed tax cuts.

Like New Zealand, there is not much information available about these proposed schemes. However, from a review of existing schemes, there are various limitations that have been imposed which have the effect reduce their benefit which Government’s may consider including in their measures. These include:

• Limiting the absolute value or percentage of total losses that can be carried back;
• Limiting the carry-back of capital losses;
• Ring-fencing of certain types of losses;
• Limiting the number of years losses can be carried back;
• Continuity or “same or similar business” requirements;
• Applying refunds to existing tax arrears;
• Time limits for claims

It remains to be seen what, if any, of these limitations will be introduced in New Zealand.

What is clear is that this measure ought to cushion the economic effects of the COVID-19 emergency for some businesses.

The justification for loss carry-back schemes is fairly straightforward. The Australian Treasury highlighted in a 2012 report that loss-carry back acts as an “automatic stabiliser” in a time of economic downturn:

Loss carry back allows businesses to access the tax value of their losses by providing tax refunds for loss periods. This has an automatic stabiliser effect by increasing cash flows for previously profitable companies during economic downturns when they are most needed, without the need for direct government intervention.” The report highlights some obvious problems: “not all companies will be able to access the full benefit of the tax value of their losses, for example, if the tax value of losses is greater than previous taxes paid.

With this in mind, the Government’s proposed loss carry-back scheme will be a welcome addition to the suite of measures designed to enhance business cash flow at this extraordinary time. But it will not be helpful to some businesses and has already been criticised as being cumbersome and complicated when most business principals are seeking more direct assistance. A loss carry back scheme means that a business has to have moved from profit to loss before being able to carry a loss back to the profitable period and reclaim tax otherwise due in that period. A serious downturn in revenues may still leave a profit in the business, albeit a much reduced one. In such a case there is no loss to carry back and the revenue hit is not ameliorated at all. Neither is the loss carry back scheme likely to be of help to small businesses conducted through a corporate structure, where the profit of the business is typically paid out to shareholders as remuneration. In those cases there will be no prior company tax that has been paid, against which a loss can be carried back. The position of look-through companies and their shareholders employees is also uncertain. 

The legislation, when enacted may make these things clearer but it is highly likely that small and medium businesses will need more direct support if they are to survive the crippling of their cash flows during lock down and beyond.      

© 2020 G D Clews, S J Davies, Old South British Chambers