Running a small business can be both challenging and rewarding, but one aspect that can be particularly confusing is taxes. Specifically, what do you do when your business expenses are greater than your income, resulting in a tax loss? This is a common scenario for many small businesses, but it doesn’t have to be a source of stress.
A tax loss occurs when business expenses exceed income or when total deductions exceed total assessable and net exempt income for a given tax year. If a tax loss is incurred, it may be claimed in the current year, carried forward, or carried back to previous tax years depending on the business structure and business tests. Using a tax loss to your advantage can help to reduce your overall tax burden and increase your cash flow.
Pro Tax Tip: It is essential to properly claim all expenses that you are eligible for before claiming a tax loss. It’s also crucial to correctly allocate expenses, so only the portion of the expense that pertains to the business is claimed, and not any personal component. Maintaining accurate and comprehensive records will aid in monitoring tax losses, prevent any errors while carrying back or carrying forward tax losses to deduct in future years.
How you claim a business tax loss depends on your business structure.
Sole traders and partnerships
As a sole trader or an individual partner in a partnership, you have to offset your business losses against other types of taxable income in the same tax year. If the tax loss exceeds all other types of taxable income and still results in a loss, this leftover loss will be carried forward to offset the next years income.
Pro Tax Tip: A capital loss is different to a tax loss ̶ it can only be offset against current and future capital gains but not against income.
As a sole trader or an individual partner in a partnership, if you meet at least one of the non-commercial loss requirements, you can offset your business losses against other taxable income (such as salary or investment income) in the same tax year. The non-commercial loss requirements include:
- Your business is engaged in primary production or professional arts and you earn less than $40,000 from other sources (excluding net capital gains) in a tax year.
- Your individual income is less than $250,000 (excluding any taxable amount released through the First Home Super Saver Scheme) and either:
- Your taxable business income is at least $20,000 in the tax year
- 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 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.
- You have been granted a Commissioner’s discretion allowing you to offset the loss.
If you do not pass at least one of these tests, your business losses are deferred to the following year to offset business income in that next year first. If a loss in the business is still generated the following year and one of the above tests is not passed, the loss will again be deferred until one of the tests is passed or the future business income has absorbed all the unclaimed losses.
For a company, the option to carry forward a tax loss indefinitely is available where there is insufficient income. This allows the company to select the tax year in which they want to claim the deduction. In case your business has incurred more than one tax loss in a year, it is necessary to evaluate each loss separately.
Companies can carry forward a tax loss indefinitely and use it at their discretion, as long as the company has either:
- Retained the same majority ownership and control since the loss was incurred, or
- Continued the same business activities after the failure of the ownership test.
However, if there is a change in the ownership or control of the company during a tax year and the company does not continue the same business activities, the company must calculate its taxable income and tax loss. In general terms, a company in this situation will have both a taxable income and a tax loss for the same year. In certain cases, the loss can be carried forward and used in future years, subject to the usual restrictions.
A company incurred a tax loss in the 2019 financial year. However, the business made a large profit in the 2021. The company decided that they want to claim a deduction for the 2019 tax loss in the 2021 tax return.
The ownership test period begins on 1 July 2018 as this was the year the loss was incurred, and finishes on 30 June 2021, as this was the end of the financial year in which the large profit was made. For that period, the company must prove that the same people own shares carrying at least 50% of all voting, dividend and capital rights. If they can prove this, the continuity test is satisfied, and they can claim a deduction for the tax loss.
Loss carry back tax offset
Loss carry back allows eligible corporate entities to claim a refundable tax offset through their 2020-2021, 2021-2022, and 2022-2023 company tax returns after the end of those respective income years.
Eligible entities can claim this offset by electing to carry back losses to previous years where they had income tax liabilities. The offset represents the tax savings the eligible entity would have received if they were able to deduct the loss in the previous year using the loss year tax rate. This offset can result in a cash refund, a reduced tax liability or a reduction of a debt owed to the government.
The eligible entity does not need to amend their previous income years to claim the offset.
If the entity does not choose to carry back the loss, it can be carried forward to use in a future income year.
Entities can use the loss carry back tax offset tool to determine if they are eligible to claim the refundable tax offset and to calculate the maximum amount they can choose to claim if they are eligible. The process of claiming business tax losses can be complex and it is essential to have a clear understanding of the rules and regulations that apply. To ensure that you are taking advantage of all the deductions to which you are entitled, and to avoid any errors or oversights, it is highly recommended to work with a tax agent.
A tax agent has the knowledge and expertise to help you identify the deductions that apply to your specific situation and to ensure that your claims are accurate and comply with the regulations. They can also provide valuable advice and guidance on how to claim business tax losses, and how to maximize your potential tax refund.