The policy of the regime is to provide cash flow support to encourage businesses which are currently accruing tax losses due to the adverse economic circumstances associated with the COVID-19 pandemic. MinterEllison explore the loss carry back rules and what it means for business.

Eligibility for the loss carry back regime

A corporate tax entity with an aggregated turnover of less than $5 billion has the option to carry back a tax loss incurred in the 2019/20, 2020/21 or 2020/22 income years and will be able to utilise that tax loss (i.e. as a refundable tax offset) against profits which gave rise to a tax liability in the 2018/19, 2019/20, and 2020/21 income year.

As the carry back period is limited to as far back as the 2018/19 income year, its effectiveness may be limited for entities that have been trading at a loss for an extended period. The Commissioner's practice is to first apply the refundable tax offset amount towards any outstanding debt of the entity before providing a refund.

A corporate tax entity will need to make a choice to claim the refundable tax offset when it lodges its income tax return for the 2020/21 or 2021/22 income year. The choice must be made in the approved form and specify the year the tax loss was made, the amount of the tax loss carried back, and the year the tax loss is carried back to. In addition, in order to claim the loss carry back tax offset the corporate tax entity must have lodged an income tax return for the current year and the immediately preceding 5 income years (unless the entity was not required to lodge an income tax return for a year, for example if the entity was not yet in existence).

Where a loss is not chosen to be carried back, it will be available to reduce any taxable income in that year or in a future income year, according to the usual rules for deducting prior-year losses.

The loss carry back rules are temporary and will cease to apply after the 2021/22 income year.

The key restrictions

The following restrictions apply for a corporate tax entity seeking to carry back tax losses.

Use of the tax loss offset

A tax loss can only be utilised once and therefore carried back once. If the tax loss is carried back, that tax loss must be applied and may not subsequently be carried forward and deducted in a later income year.

Where a loss is carried back, the resulting tax offset forms part of the tax assessment of the current year and does not alter the tax liability of the year to which the loss is carried back. This means a carried back loss will not give rise to interest on overpayments of tax nor will it reduce any general interest charge or shortfall interest charge arising from a potential late payment of the tax liability for that previous year.

Amount of the loss carry back offset

While there is no explicit monetary cap on the carry back, it is limited to the lesser of the loss carry back tax offset component for the relevant income year and the entity's franking account balance at the end of the current income year. It follows that the carry back will have limited application for companies that have previously distributed prior year profits as fully franked dividends.

There is a further limitation that the tax loss offset cannot exceed the tax equivalent amount for the applicable tax loss year. That is, the tax loss offset is not able to exceed the income tax liability for that particular income year.

Franking

Limiting the loss carry back tax offset for an income year to the surplus balance of the corporate tax entity's franking account is intended to ensure that the offset cannot exceed the value of past taxes paid by the entity that have not yet been distributed to shareholders as franking credits. The refund from a loss carry back tax offset will generate a franking debit which will need to be considered in order to ensure that a franking deficit tax liability does not arise.

Ineligible losses

Losses transferred between companies in the same foreign banking group, losses transferred to the head entity of a consolidated group or MEC group as a result of an entity joining the group, or tax losses arising as a result of an excess franking offset are not able to be carried back.

Further, the carry back loss regime does not apply to capital losses.

Integrity rules

The existing loss carry forward rules do not appear to apply to the carry back rules. However, a specific integrity rule does apply. This integrity rule bears the hallmarks of Part IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936). It requires that the following elements be present:

• there is a scheme for the disposition of membership interests in the corporate tax entity;
• the result of that scheme must be a change of control;
• an entity would be entitled to a financial benefit associated with the loss carry back tax offset;
• one of the entities entering into the scheme had the requisite purpose of enabling a corporate tax entity to obtain a loss carry back tax offset having regard to the relevant circumstances, including the activities and assets of the corporate tax entity, together with the relevant circumstances in section 177D(2) of the ITAA 1936. 

If the integrity measure is failed the corporate tax entity cannot carry back the tax loss but is able to carry forward the tax loss (under the usual loss carry forward rules). The ability to carry forward the tax loss is useful but assumes that the business remains viable and becomes profitable in future years in order to deduct the tax loss. A relaxation of the integrity requirement would have a stimulatory effect and assist businesses to recover earlier.

This integrity rule will broadly prevent schemes to acquire loss companies.

The integrity rule may also have limited application in respect of purchasers of profitable entities prior to its announcement, meaning that a purchaser can access the benefit of the loss carry back regime in respect of entities that it had acquired previously.

Applicable entities

Importantly, only entities that are taxed like companies are eligible to carry back tax losses. For example, a limited partnership is not able to deduct a tax loss in a year in which it is a VCLP, ESVCLP, VCFOF or VCMP as it is not a corporate tax entity. However, if a limited partnership stops being a VCLP, ESVCLP, VCFOF or VCMP and becomes a corporate tax entity it may be able to carry back tax losses.

As a foreign hybrid limited partnership is taxed as a flow through entity for Australian income tax purposes it is not able to carry back a tax loss. However, if the partner in a foreign hybrid limited partnership is itself a corporate tax entity, that partner may be able to carry back its share of the partnership tax loss.

Observations

The tax loss carry back rules provide an opportunity for further welcome relief for corporate tax entities. Distressed entities looking to restructure their debt may benefit from the ability to carry back their tax losses, however given the election to carry back losses can only be made when an entity lodges its income tax return in the 2020/21 or 2021/22 income year, it may not provide an immediate cash benefit to assist companies experience cashflow issues due to COVID-19.

It is important that corporate tax entities consider whether their commercial objectives are best served through the application of the tax loss carry back rules or by carrying the tax loss forward to future income years.

In addition to the examples provided in the Explanatory Memorandum, it would assist with corporate tax entity compliance if the ATO would provide additional practical examples given the numerous possibilities that arise as a result of the tax offset and the large number of businesses expected to apply this measure.