Today, the Government has announced three major tax reforms to assist businesses struggling with COVID-19.
- The introduction of a temporary loss carry-back rule to allow refunds of prior year tax paid by businesses that have or will incur tax losses in either the 2020 or 2021 income years. This will eventually be replaced by a permanent loss carry-back scheme.
- A commitment to introduce “same or similar business test” for the carry forward of tax losses with effect from the 2021 income year. This will provide an alternative to the current 49% shareholder continuity test.
- The introduction of temporary powers to allow the Commissioner of Inland Revenue to modify tax obligations for taxpayers impacted by COVID-19; in a taxpayer favourable way only.
We expect to see legislation in the week beginning 27 April for items 1 and 3, with further detail of the same or similar business test expected later in the year and applying with retrospective effect.
Loss carry-back rule
Today’s announcement will be well received by ordinarily profitable businesses who are finding themselves in, or anticipating being in, a tax loss position as a result of business disruption from COVID-19. The ability for businesses to be able to carry-back a loss against a prior year profit has the potential to provide much needed cash for businesses. From a tax policy standpoint, a loss carry-back rule makes sense when viewing an entity over a wider lens than a 12 month income year basis; this is something that the OECD has also recommended as an action which governments could take to soften the blow of COVID-19.
There are some important details that businesses need to be aware of:
- A 2020 or 2021 tax loss will only be able to be carried back to the immediately preceding income year. That is, a 2020 loss can only offset profits in 2019, and a 2021 loss can only offset profits in 2020. It will not be possible to carry a loss from 2021 back against 2019 profits.
- It should be possible to make this adjustment to tax positions to gain access to losses as soon as legislation is enacted (this is expected to occur in the week beginning 27 April 2020).
- Taxpayers will be able to estimate an anticipated tax loss in either the 2020 or 2021 income year, and as a consequence make a re-estimate of the tax payable in the immediately preceding income year. Effectively, this will be a process where provisional tax can be re-estimated downward (beyond normal timeframes) and a refund obtained of the excess tax.
- Taxpayers who use this process will be exposed to use of money interest (currently payable at 8.35%) if losses are overestimated. We’d strongly recommend that taxpayers who expect to find themselves in a loss position for the 2020 income year (typically the year ending 31 March 2020) get to work on preparing the 2020 tax return in order to confirm the exact quantum of any tax loss available for carry-back to the 2019 year.
- A loss will only be able to be carried back and the tax refunded to the extent a business operating through a company holds sufficient imputation credits. This is consistent with the existing rules for companies obtaining tax refunds.
- For SME companies that transfer their profits to shareholders by means of shareholder salaries, the new loss carry-back rules need to be considered in more detail. This loss carry-back rule would not currently apply to shareholders of companies who receive shareholder salaries and pay provisional tax in their own name. As a result, consideration needs to be given to estimating what the company’s taxable income will be in 2020 with an estimated loss carry-back from 2021 and no, or a reduced, shareholder salary in 2020. If the shareholder salary will be nil or significantly reduced, shareholders should look to make a provisional tax estimate before the third instalment due date (next date is 7 May 2020 for March year ends) and get refunds of provisional tax already paid in 2020 by the shareholder. Any change to shareholder salaries may have flow on impacts to shareholders which should be considered before making decisions in this area; for example interest on overdrawn shareholder current accounts, the impact on banking arrangements etc.
- The application of the loss carry-back rule does not appear to be restricted to particular legal forms (e.g. only companies) or business size.
- The Government is proposing a permanent loss carry-back rule which will apply from the 2022 income year. This will be consulted on later in 2020.
Wendy’s travel and tourism business Holidays R Us Limited (‘HRUL’) organises holidays abroad for New Zealanders looking to travel. The busiest time of the year for HRUL is between November and March where New Zealand customers look to travel around and during the Christmas and New Year end of year break. HRUL has a 31 March balance date. During 2019 HRUL had a successful year, deriving taxable income of $800,000. The tax paid on this taxable income was $224,000. During the 2020 income tax year, due to the COVID-19 outbreak, many people decided not to travel which heavily impacted HRUL’s busiest months of January and February 2020. As a result HRUL incurred a tax loss of $500,000. Using the loss carry-back rules, HRUL can carry back the $500,000 loss to offset against the $800,000 taxable income derived in 2019. This would lower the taxable income of HRUL in 2019 to $300,000 on which tax of $84,000 would be payable. Therefore $140,000 of tax paid in 2019 can be refunded to HRUL. The details of how the refund would be accessed is unclear at this stage, but we recommend that HRUL should prepare and file its 2020 income tax return as soon as possible.
JD Tractors Limited (‘JDTL’) sells tractors to a range of customers across New Zealand. JDTL’s income is typically earned evenly throughout the year. JDTL has a 31 March balance date. During the 2019 income tax year, JDTL had a successful year making $2m of taxable income. During the 2020 income tax year business started to slow, due to the COVID-19 outbreak, however only the last 3 months of the 2020 income tax year was affected. As a result, JDTL’s taxable income was reduced to $1.5m for the 2020 income tax year. The tax paid on this taxable income was $420,000. As a result of the COVID-19 outbreak, business confidence is down and JDTL’s financial accountant, Jayesh, predicts that people will be unlikely to purchase new tractors during this economic downturn. Jayesh carefully forecasts the company’s income and expenditure for the 2021 income tax year which shows an expected tax loss of $300,000. This means JDTL will be able to carry-back the predicted loss in 2021 of $300,000 to offset against the taxable income in 2020 of $1.5m. This would lower the taxable income of JDTL in 2020 to $1.2m on which tax of $336,000 would be payable. Therefore $84,000 of the $420,000 tax that was paid in 2020 can be refunded to JDTL.
Buttons Limited has a March balance date and profit in the 2020 income year of $200,000. Buttons Limited would normally pass through the profit to its shareholder Benjamin as a shareholder salary. Benjamin had paid provisional tax evenly over the 2020 year based on the anticipated $200,000 shareholder salary ($18,974 paid at each P1 and P2 instalment based on personal tax rates). The estimated loss to carry back from 2021 is going to be more than the 2020 profit before shareholder salary. Buttons Limited may be able to determine not to allocate a 2020 shareholder salary. If this is the case, Benjamin will need to estimate his own 2020 provisional tax down to nil (either by 7 May 2020 or a later date, to be confirmed once there is more detail). Benjamin will then be able to request a refund of the $37,948 provisional tax already paid. Note that other commercial and tax impacts such as ACC cover and overdrawn current accounts should be considered.
Same or similar business test
Reform of tax losses has been on the tax policy agenda for some time, with a commitment by the Government last year to review the loss continuity rules to help high growth companies raise more capital. The position in 2019 was very different to the position we now find ourselves in, with many businesses needing to seek additional capital in order to survive and thrive in a COVID-19 world. In recognition of this, the Government has made a commendable decision to bypass its previous commitment to undertake a detailed consultation process and instead making a decision to follow the lead of Australia and implement a “same or similar business test”.
Ordinarily a company needs to maintain 49% shareholder continuity in order to carry forward any tax losses. Under a same or similar business test, tax losses can be carried forward regardless of the magnitude of shareholder change provided that the business being operated pre- and post- change is the “same” or “similar”. A same or similar business test provides protection that taxpayers are not just entering into loss trading arrangements as there is a requirement for the business to remain largely the same.
A same or similar business test will include some degree of subjectivity and uncertainty as to just how similar a business needs to be in order to satisfy the test; i.e. how far can a business pivot into new opportunities while still remaining sufficiently the same or similar to its original form? New Zealand will be looking to Australia for guidance on this, as Australia enacted a “similar business test” in March 2019 to supplement its existing “same business test” which had been criticised as being too inflexible. Courtesy of Deloitte Australia, we outline four factors which are considered when applying the similar business test:
- The extent to which the assets (including goodwill) that are used in its current business to generate assessable income also were used in the former business to generate assessable income. The term ‘assets’ includes physical and intangible assets. Intangible assets include goodwill, trade names, trademarks, patents, royalty arrangements, and other intellectual property rights;
- The extent to which activities and operations from which the current business used to generate assessable income also were those from which the former business generated assessable income;
- The identity of the current and former businesses—in particular, a comparison of the core functions of the current business and former business is of most significance. The comparison will show which characteristics of the former business have been retained and which characteristics have changed or disappeared. In addition, the comparison will show which characteristics of the current business are derived from those of the previous business and which characteristics are new additions. This factor requires a broad-ranging inquiry and is not limited to branding and public recognition;
- The extent to which any changes to its former business result from the development or commercialisation of assets, products, processes, services or marketing or organisational methods of the former business.
These factors are intended to identify a clear similarity between the businesses, whilst allowing for natural organic attempts to grow or rehabilitate the former business. The relative importance of each of the above factors depends on the facts and circumstances of each particular case.
It is clear there will be a degree of judgement required in order to assess whether a business is sufficiently similar to pass the test. The Australian Tax Office sets out a series of examples which do and do not satisfy the similar business test in this Law Companion Ruling from May 2019.
The 49% shareholder continuity test will remain in place for businesses who cannot satisfy the similar business test.
Jackson is the 100% shareholder of his photography company Revrac Photos Limited (‘RPL’). RPL sells packages to photograph events such as weddings and birthday parties. RPL is a relatively new business and has been loss making for the last two years because it has struggled to build a solid reputation in the market. As a result of the COVID-19 outbreak RPLs revenue has fallen even further as weddings and parties are no longer occurring and Jackson is unsure whether he will be able to continue to fund the business using his personal capital. To survive through the economic downturn, Jackson has decided to sell 60% of his company to a wealthy investor, Paul, for $100,000. Paul then begins to grow the company by setting up a shop in downtown Auckland and importing and selling photography equipment and also offering a repair service. Paul also suggests a change to the name and logo of the business to better fit with the expanded target market, the business is renamed Party Photos Equipment and Repairs Limited (‘PPERL”). As the nature of the business, its logo and name, and revenue generating structure has changed it is likely that this business post sale is not ‘similar’ to the business that Jackson was running before the sale. Since this business under new ownership is unlikely to be considered ‘similar’ and the 49% continuity test is not met, the losses will be forfeited.
Wellington Speciality Seafood Limited (‘WSS’) is a fish and chip shop in Wellington that has recently run into hardship due to a number of competitors in the market and has suffered tax losses in the last two income tax years for the first time since it started business. A majority of the shares in Wellington Speciality Seafood Limited (‘WSS’) was recently acquired by a large exporter of seafood. Under new ownership, changes were made to create a website to advertise and sell fish and chips, to introduce food delivery options using a popular food delivery service. WSS is likely to be allowed to carry forward the tax losses incurred in the previous two income tax years as the assets are being used to the same degree to generate assessable income, the core business activity of selling fish and chips has remained and the identity of the business has not changed.
The new Commissioner’s discretion to change dates, timeframes and procedural requirements
The New Zealand Inland Revenue Acts contain a number of timeframes and obligations for both taxpayers and the Commissioner. In a COVID-19 world, taxpayers are finding it more challenging to meet tax obligations, and in recognition of this, the Government will be handing more power to the Commissioner to use her discretion over the next 18 months. An amendment to the Tax Administration Act 1994 will introduce a discretionary power to allow Inland Revenue to provide an extension to due dates and timeframes, or to modify procedural requirements set out in the Revenue Acts.
This could include, for example, extending deadlines for filing tax returns and paying provisional and terminal tax. At this stage, the power will be time-limited for a period of 18 months and will apply to businesses affected by COVID-19. We understand these new powers will only be able to be used in a taxpayer favourable manner.
The content of this article is accurate as at 15 April 2020, the time of publication. This article does not constitute advice; if you wish to understand the potential implications of current events for your business or organisation, please get in touch. Alternatively, our COVID-19 webpages provide information about our services and provide contacts for relevant experts who can help you navigate this quickly evolving situation.