The Government has announced that it will reform the rules which determine whether companies can use past year losses to reduce its taxable income.
This reform will relax the existing 'same business test' and introduce a new, more flexible, 'similar business test'.
This reform was considered as part of the 2012 Business Tax Working Group review into losses, and was raised as an area for potential reform in the Government's tax discussion paper 'Re:think'.
Loss utilisation rules are necessary and important. They maintain the integrity of Australia's tax system by preventing the activity of loss-trading whereby companies are able to buy losses from or sell losses to other entities.
A company is entitled to use past year losses to reduce taxable income provided the company maintained the same majority ownership from the time the loss was made until the time it is utilised (the 'continuity of ownership test' (COT)).
Where the majority ownership has changed, past year losses may still be accessed provided the company passes the 'same business test' (SBT). This test allows companies to use losses from past years to reduce taxable income provided the company has conducted the same business from the time the COT is failed until the time the past year loss is utilised. During this period of time, the company cannot enter into new types of transactions or new business activities.
What is the problem?
The SBT is considered to be restrictive, stifling innovation in the economy. This stemmed from the term 'same business' being interpreted very narrowly.
It has been held that 'same' does not mean 'similar'. The inability to utilise losses where a company has entered into new types of transactions or business activities inhibits a company's ability to grow.
This discourages companies which have made losses from seeking new investors or exploring new profit-making activities because they may lose access to these valuable past year losses.
This in particular can disadvantage start-ups and smaller companies, who may only have one income stream. Larger and more established companies can often use the losses from one business activity to offset profits from another activity in any given year, removing the need to carry-forward losses. A smaller company or a start-up may not have this opportunity, meaning they need to carry the loss forward and apply the restrictive tests.
The current rules can also impose significant substantiation requirements which can result in increased compliance costs for taxpayers as they seek out expert advice or ATO rulings.
Changes to loss rules
The Government will introduce a 'similar business test' for losses made in the 2015-16 and future income years. This test will be based on qualitative factors, which could include:
- The extent to which the same physical and intangible assets are used for generating income
- The extent to which the company continues to generate income from the same source
- Whether the changes to the company are of a kind that would reasonably be expected to be adopted by a similarly placed company (e.g. to take advantage of unforseen business opportunities)
The 'no new transactions or business activities' aspect of the SBT will be removed. This new test will allow companies which have adapted and changed their business as their environment changed to continue to access prior year losses as a tax deduction.
The new 'similar business test' will generally be accessed by companies. However, the new rules will extend to the other situations where the SBT is currently used.
The reform will be extended to unit trusts which have securities listed on the ASX which are widely held ('listed widely held trusts'), and when determining the availability of bad debt deductions.
These changes are intended to foster increased innovation by allowing companies to remain agile and adapt to new opportunities without about tax penalties.
The Government is committed to hearing the views of interested stakeholders on the measures included in the National Science and Innovation Agenda, including the proposed loss reform.
The Government undertook consultations with stakeholders in 2016. Based on feedback received through this consultation process, the draft legislation is currently being revised.
Frequently asked questions
When do the new arrangements apply?
The new loss rules will be applied to losses made in the 2015-16 and future income years. Current loss arrangements will continue to apply to existing carried-forward losses.
Who do the new arrangements apply to?
The new rules apply primarily to companies, but will also be extended to other situations where the same business test is currently used – for unit trusts who have securities listed on the ASX and are widely held (listed widely held trusts), and in determining whether bad debt deductions are available.
How does the 'similar business test' differ from the existing 'same business test'?
The new test is intended to be more flexible and an easier test to satisfy. Basing the new test on a range of factors will allow losses to be claimed in more circumstances, where the business could not be said to be the 'same', but where the differences are minor and are such that it is appropriate for losses to be available. Including these factors in the test, and the preparation of associated guidance material, should provide companies with more certainty and a reduced need to seek expert advice or ATO rulings.
Won't relaxing these rules lead to more loss-trading and rorting of the tax system?
The new rules will increase access to losses, but will be carefully designed to ensure that it does not allow rorting of the system. Appropriate integrity measures may be required. The continuity of ownership test will also be retained as an important integrity rule to prevent loss trading.
It is not proposed that all losses be allowed – the company will still need to demonstrate the current business is 'similar', and where there has been significant change in business activities, losses would be denied. The threshold is lowered, but the essence of the test remains.
These relaxed arrangements will ensure that companies are not unfairly penalised for engaging with risk, and for seeking to improve their business, whilst discouraging harmful tax practices.
Why isn't the continuity of ownership test also being reformed?
Loss reform was raised as an area of potential reform in the Government's tax discussion paper 'Re:think'. Submissions to Re:think highlighted that the same business test was a higher priority area for reform than the continuity of ownership test, and would deliver more compliance cost savings and better support innovative businesses.
Loss rules are an important integrity measure, and retaining the continuity of ownership test helps prevent loss trading, even where the same business test is relaxed. This approach is also consistent with International trends – many comparable jurisdictions have a similar continuity of ownership test, without the need for an equivalent to the same business test.