Tax Loss Carry Forward: What is it and how does it work?

What is a tax loss carry forward?

A Tax Loss Carry Forward is a tax provision that allows a taxpayer to use the losses from one year to offset the taxable income in future years.

In other words, if your business made a net loss in a particular tax year, you could apply this loss to reduce your business’s taxable income in future years, potentially reducing your tax liability.

The carry forward is usually for a specific period of time, as determined by tax laws, after which the unused loss may expire.

How does tax loss carry forward work?

Tax Loss Carry Forward works by allowing a taxpayer to apply past losses to offset taxable income in future years.

Let’s explain this further, here’s a simplified example:

Say, in the first year, you earned $100,000 in taxable income and $120,000 in business expenses. This means you had a net loss of $20,000 ($100,000 minus $120,000).

Your $20,000 loss can be applied to offset your taxable income in future years.

Now, in the next year, your taxable income is $80,000. You can apply your $20,000 tax loss from the last year to reduce your taxable income to $60,000 ($80,000 minus $20,000).

You will pay tax on your reduced taxable income of $60,000, instead of the full $80,000.

Saving you money on your tax bill!

How do you claim tax losses against assessable income?

A tax loss carry forward sounds great, but you’ll need to know how to claim your tax losses against your assessable income.

Follow these steps:

1. Calculate your taxable income: 

Determine the amount of taxable income you have earned in the current year.

2. Determine the amount of tax losses available: 

Check your records to determine the amount of tax losses you have incurred in previous years and the amount that can be carried forward to the current year.

3. Prepare your tax return: 

On your tax return, reduce your taxable income by the amount of tax losses you are claiming.

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4. File your tax return: 

Submit your tax return to the Australian Taxation Office (ATO), including the amount of tax losses you are claiming against your taxable income.

5. Wait for a response: 

The tax authority will process your tax return and determine if the tax losses claimed are acceptable.

It may be best to consult a tax professional to ensure that you are claiming tax losses correctly and in accordance with the current tax laws.

Can a sole trader claim a tax loss carry forward?

Yes! If you are a sole trader, you can use tax losses from one financial year to offset your taxable income in a future financial year.

You may even be able to claim your loss against other income, using the ‘non-commercial business loss’ rules.

Visit the ATO Non-commercial Losses page for more information on this.

Can a partnership claim a tax loss carry forward?

As for a sole trader, the same applies to a partnership, however, the loss is divided and claimed in proportion to the partnership.

Now, let’s look at the few rules that impact an individual’s or a corporation’s ability to use carry forwards to reduce tax liability.

The continuity of ownership test

Have you had a change in business ownership?

The Continuity of Ownership Test is a test used to determine if business owners have maintained a sufficient level of control over their investment to a sufficient level of same majority ownership to be able to use tax losses it has incurred.

It usually involves assessing the continuity of ownership of the investment immediately before and after the change in ownership or structure, known as the ownership test period.

An example will help you to understand this.

Your business made a loss in the financial 2019-20 year, but in the 2020-21 financial year, you made a profit.

The test will need to determine that the same majority ownership of the business has been maintained (same people owned shares with at least 50% of the voting, dividend and capital rights) from 1 July 2019 which is when the loss was recorded to 30 June 2021 (the ownership test period) when the profit was made. The business may be eligible to use its tax losses.

The same business test

The Same Business Test is a test used by tax authorities to determine if a company is eligible to use tax losses it has incurred in previous years to offset taxable income in the current year.

The same business test typically involves determining if the company’s current business is the same as or similar to the business it was conducting at the time the tax losses from earlier income years were incurred.

The same business test considers factors such as –

• the nature of the business,
• the type of products or services offered,
• the industry in which the business operates.

Here’s an example to demonstrate the same business test:

You buy an existing 24-hour gym business and continue to run the business as a gym. You will most likely pass the same business test and will be able to carry forward any losses from the previous owner.

However, if you were to buy the 24-hour gym business and change it to indoor basketball and netball courts, it is unlikely to pass the same business test. So, you may not be able to carry forward any tax losses from the original business.

The similar business test

The Similar Business Test typically involves determining if the company’s current business is similar to the business it was conducting at the time the tax losses were incurred.

This similar business test is a more flexible test than the same business test and uses factors such as the nature of the business, the type of products or services offered, and the industry in which the business operates.

Expanding on the example above, say you buy an existing 24-hour gym business and continue to run the business as a gym but not open 24 hours. You will most likely pass the similar business test and will be able to carry forward any losses from the previous owner.

It’s probably best if you speak to your accountant when applying the similar business test or get in contact with a Sleek accountant in our chat box on the bottom right-hand side of your screen.

While a loss for any business is not ideal, the tax loss carry forward is a valuable tool that can help you reduce your tax liability, keep more money in your pocket and make your investments work harder for you.

So, if you want to make the most of your capital losses, the Sleek team can help with a personalised tax strategy. Call us on +61 4 9100 0480 or contact us here.