Loss carry-back “trap” could mean that many businesses will fail to get tax refund

Tax experts have warned of yet another hurdle for businesses to overcome in attempting to claim the loss carry-back tax refund announced in last week’s federal budget.

Many businesses have already found they are ineligible to claim the loss carry-back measure because they are set to make a loss rather than a profit this financial year or because they are not structured as a corporation. 

Mark Molesworth, tax partner at accounting firm BDO, told SmartCompany the idea behind loss carry-back was if a business makes a profit and pays tax in 2012 it can carry up to $1 million of losses back and get a refund on the tax paid.

“That general statement is subject to a restriction in that companies will only be able to get that refund if they have sufficient franking credits in their franking account in the 2013 year,” says Molesworth.

“The way a company puts franking credits in its franking account is by paying tax and those franking credits are reduced or removed from the franking account when the company pays a franked dividend.

“The issue is that for many small businesses the owners need to take the profits each year in order to be able to live.

If they have already paid the profits from 2012 to themselves as a franked dividend then when it comes to 2013 and they want to carry back its losses, they will not get the refund tax because there will be no franking credits in its franking accounts.

“It is certainly a trap in relation to the loss carry-back measure.”

Molesworth says business owners need to talk to their accountants about the franking credit requirement.

“My message would be to those people in small business who may be eligible for loss carry-back, they need to plan how and when they pay their dividends to themselves,” he says.

“Each circumstance is going to be individual, there is no panacea but it is good practice for companies to think about how they pay their dividends and frank them anyway.”

Molesworth warns that many businesses are unaware of the requirement for franking credits.

“When I speak to people about it they are not aware of the limitation, I don’t think it I has been covered in the media.”

Robert Jeremenko, senior tax counsel at the Tax Institute, agrees with Molesworth that one of the limitations on the loss carry-back scheme is that the amount of loss that can be offset against a previous year’s profit is limited to balance in franking account.

“The reason the Business Tax Working Group has suggested that, and the government has adopted it, is that they describe the complex interaction with the franking deficit tax, which applies if your franking account goes into negative; which would result in a lot of money churning back and forwards and create extra compliance costs,” says Jeremenko.

“What that may mean is that some companies may reduce the dividend level paid out to ensure they have a franking credit reserve and that is something the Business Tax Working Group acknowledges, but that is a side effect they are willing to live with.

“I don’t believe this will cause a problem because, at the end of the day, this is designed to give business in that loss position some relief and eventually carry it back up to two years. The benefit of doing that I think far outweighs the limitation that this franking account balance account rule has.

“This is not going to be a make or break issue for this policy; it is still a positive policy announcement and something that will benefit business that meets those requirements.”

This story first appeared on SmartCompany.