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What is a Tax Loss and How Can it be Turned to Good Use? - 7th June 2017
You generally make a tax
loss when the total deductions that can be claimed for a financial year exceed
the total of assessable and net exempt income for the year.
If
you operate a business that makes a loss you can generally carry forward that
loss and claim a deduction for it in a future year. If you're a sole trader or
in a partnership, you may be able to claim business losses by offsetting them
against your other personal income (such as investment income) in the same
income year.
Certain deductions that would otherwise be allowable cannot be claimed as deductions where doing so would give rise to a tax loss. They are:
- payments of pensions, gratuities or retirement allowances to employees, former employees, or their dependents
- gifts or contributions made to deductible gift recipients
- payments made under conservation covenants, and
- personal superannuation contributions.
Only
sole traders or individual partners in a partnership who meet one of the
non-commercial losses requirements (see below) can offset business losses
against other income (such as salary or investment income) in the same income
year.
If
you do not meet any of these requirements, or if you operate through a company
or a trust, you can still carry it forward to future years. If your business
makes a profit in a following year, you can offset the deferred loss against
that profit.
Note that a tax loss is different
from a capital loss. A capital loss occurs when you dispose of a capital asset
for less than its tax cost base. A capital loss can only be offset against any capital
gains in the same income year or carried forward to offset against future capital
gains - it cannot be offset against income of a revenue nature.
Your business structure can
affect how you can claim tax losses. For example, companies can generally
choose the year in which they claim a deduction for a carried forward tax loss.
This can be useful as it means, for example, that a company can choose not to
utilise prior year losses in a particular year in order to pay sufficient tax
to be able to distribute franked dividends. However, if you operate as a sole
trader, partnership or trust, you cannot choose the year or years in which you
claim a deduction for your prior-year tax losses.
Sole traders
Individuals can generally carry
forward a tax loss indefinitely, but must claim it at the first opportunity
(that is, the first year that there is taxable income). You cannot choose to
hold on to losses to offset them against future income if they can be offset
against the current year’s income.
Carried forward tax losses are
offset first against any net exempt income (such as pension income, government
allowances and so on) and only then against assessable income. Losses must be
claimed in the order in which they were incurred.
Non-commercial losses
If you're in business as an
individual, either alone or in a partnership, and your business makes a loss,
you must check the non-commercial loss rules to see if you can offset the loss
against your income from other sources, such as wages.
You can ask us about the
non-commercial loss rules, but briefly these rules dictate that you can't claim a loss for
a business that is little more than a hobby or lifestyle choice (based on the
legal tests, not on your intentions). Even if it has business-like
characteristics, if it is unlikely to ever make a profit and doesn't have a
significant commercial purpose or character, you generally can't offset the
loss against your other income.
In these cases, if you are
thinking of ramping up your efforts and are sure you will make a profit in the
future, you might decide to defer the loss until you realise that profit from
the business.
The non-commercial business loss requirements are:
- your business is a primary production business or a professional arts business and you make less than $40,000 (excluding any net capital gains) in an income year from other sources
- your income for non-commercial business loss purposes is less than $250,000, and either
- your business has produced a profit in three out of the past five years (including the current year)
- your business uses, or has an interest in, real property worth at least $500,000, and that property is used on a continuing basis in a business activity (this test excludes your private residence and adjacent land)
- your business uses certain other assets (excluding motor vehicles) worth at least $100,000 on a continuing basis.
If you fail all of the
tests but you believe that you should be allowed to claim the loss due to
special circumstances, you can apply to the ATO for the "Commissioner's
discretion" to apply, which would allow you to utilise the loss (we can help
you with this application).
Companies
Companies can carry forward a tax loss indefinitely, and use it when they choose, provided that since the loss was incurred they have either:
- maintained the same majority ownership and control, or
- carried on the same business once the ownership test is failed.
If there is a change of ownership
or control of a company during an income year and the company does not maintain
the same business, it must work out its taxable income and tax loss. In broad
terms, a company in this situation has both a taxable income and a tax loss for
the same year. In some circumstances, the loss may be carried forward and used
in later years, subject to the usual restrictions.
Also note that with tax losses, you
must keep proper records relating to your tax affairs for at least five years. If
you use information from those records in a later tax return, you may have to
keep records for longer. So, if you carry forward a tax loss, you must keep the
records until the end of any period of review for the income tax return in
which the loss is fully deducted.
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