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Claiming Tax-Loss Deductions

claiming tax loss deductions

Future earnings can generally be offset by taking advantage of tax losses, if your enterprise can satisfy certain conditions related to ownership, shareholdings and business activities. There are three main tests that must be satisfied, but they are complex and require professional help. Here are the guidelines for whether your organisation can deduct its tax losses.

If your company suffers a tax loss, it may carry that loss forward indefinitely to offset future taxable income, provided certain conditions are met.To use the losses in later years, your enterprise must meet these tests in this order:

1. Continuity of ownership and control tests, where you show that ownership and shareholder structure have remained the same.

2. Same business test, showing that your organisation has carried on the same activities since the loss was incurred.

The tests must follow that order because the outcome of the ownership test determines the way the same business test is applied. If your enterprise cannot satisfy the requirements, it will not be able to use the tax losses. Here is how the tests work:

Continuity of Ownership Test

The same people must hold more than 50 percent of the right to vote and the right to receive dividends and capital distributions during the ownership period. That is the time that extends from the start of the year of the loss until the end of the year the loss is used. Some complex issues related to how the rights are held determine how the rule applies. Among the critical issues are:

  • Whether the rights are held legally or beneficially;
  • Whether the rights are held directly or indirectly; and
  • If the rights are held indirectly, how the entities are interposed.

Control Test

Your enterprise may fail the control test if, during the ownership period, one shareholder becomes a controlling holder in order for that individual or someone else to get a tax benefit.

Same Business Test

If your company fails the continuity of ownership and control tests, it may still use the loss if it satisfies the same business test. To do that, the organisation must:

  • Carry on the same business as before the ownership change. This means the businesses retains its essential character;
  • Not engage in and derive income from new businesses that are generally different from the company’s other activities; and
  • Not enter into new transactions from which income is generated. For instance, the enterprise must not enter into transactions that are unusual in relation to the operations carried on before the ownership change.

The legal interpretations of some of these phrases have been the subject of much debate. Keep in mind that the time at which you compare whether your business has changed varies depending on the outcome of the continuity of ownership test.

When your business deducts tax losses, they must be taken in the order they were incurred. In other words, the oldest losses must be used first. Your organisation doesn’t have to use the losses in a year when it would make no sense. For example, if your company wants to pay out franked dividends, it would make sense not to use the losses that year.

Tax losses can arise when deductions exceed income. But some deductions, such as those for charitable donations, cannot be uses to create a tax loss. And keep in mind, a tax loss is not the same as a capital loss, which can be used only to offset capital gains.

Tax loss rules are complex. Be sure to consult with your adviser, who can help determine how the regulations might affect your business liabilities and how to appropriately time the deductions.

For more details on this topic, contact Jolyon Quessy.