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VI. Recoupment of Losses

8.155. The overriding principle that income tax should be levied on ‘true’ profits from a business during the whole period of its operation is an administratively impossible ideal. Annual tax accounting is clearly necessary if tax is not to be indefinitely deferred and the flow of revenue made uneven. Where a loss is suffered in one year, some expression of the overriding principle will be achieved if the loss is carried forward and applied against income of subsequent years. Carry-forward of losses is allowed by the present law for seven years, and, in the case of primary producers, for an indefinite period. But a full expression of the overriding principle would only be achieved if losses could be indefinitely carried back to earlier years and applied against the income of those years, generating tax refunds to the taxpayer. A workable tax system requires that an assessment must at some time be treated as final: the physical problem of record-keeping is the ultimate control.

Carry-back of Losses

8.156. For many years carry-back of losses has been permitted in a number of overseas countries. In the United States losses may be carried back for three years; in Canada, the Netherlands and the United Kingdom (in effect) for one year. Currently there is no provision for carry-back of losses in New Zealand, France, West Germany or Sweden. In some countries special rules apply on cessation of business operations: in Sweden and the United Kingdom there is provision for carry-back of losses in these circumstances for two and three years respectively.

8.157. Carry-back of losses was considered by the Spooner Committee and again by the Ligertwood Committee. Many submissions requesting an amendment to the Act to permit losses to be dealt with in this way have been made to the present Committee. The Spooner Committee, while acknowledging that loss carry-back had much to commend it, foresaw formidable practical difficulties and recommended against amending the Act. These difficulties were principally the problem of collecting adequate tax revenue in periods of depressed incomes, the prevention of the early finality of assessment due to the increase in amended assessments of prior years resulting from the operation of carry-back provisions, and the inherent complications


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of amended assessment of private companies and trust estates. The Ligertwood Committee agreed with the findings of the Spooner Committee and again rejected the proposal that carry-back of losses be permitted.

8.158. In the years following the reports of these two committees it seems that the problems of business arising from the absence of any carry-back provisions for losses have increased and this view is supported by the submissions received. To some extent the difficulties flow from the inability to obtain deductions for accrued employee benefits such as long-service leave and holiday pay. In the income year in which a business activity ceases, the profits of that income year are frequently insufficient to meet the deductions which become available from the payment of employee benefits. In addition, an anomalous situation can arise in respect of private companies. For example, a private company may incur a profit for, say, the year ending 30 June 1973, which will give rise to a liability for undistributed profits tax if a sufficient distribution of that profit is not made prior to 30 April 1974. Suppose now that the company incurs heavy losses in the year to 30 June 1974 which make the payment of a dividend imprudent and in breach of company legislation. From a practical viewpoint the company has no profits available to distribute. However, it incurs a liability for undistributed profits tax at the flat rate of 50 per cent because it has failed to make a sufficient distribution of its profits for the year ended 30 June 1973. The Act takes no cognisance of the fact that the company is incapable of paying a dividend.

8.159. The Committee's recommendations relating to a deduction for accrued employee benefits will overcome some of the problems arising from the absence of provisions for carry-back of loss, but as a result of the phasing-in proposals it will be some years before a full deduction is available. The recommendation in Chapter 16 on transfer of losses between companies will in some instances also assist in the recoupment of losses.

8.160. The difficulties foreseen by the earlier committees do not appear to be sufficiently formidable to justify the continued absence of any loss carry-back. Loss carry-back will, it is true, involve some dislocation to Revenue; but this dislocation should be comparatively minor having regard to the total revenue from taxation now flowing to the Australian Government. The degree of lack of finality in assessment depends largely on the period for which losses may be carried back: a short carry-back period should not cause undue administrative difficulty.

8.161. Apart from ensuring much greater regard for the overriding principle that the tax base should reflect ‘true’ profits, carry-back has advantages in terms both of the cash-flow of business and of government economic management. The refund of tax which will result from the operation of loss carry-back should provide a business with cash funds at a time when they are most needed. Also where a downturn in the fortunes of the business coincides with a general business recession, the cash funds will provide a source of spending which should assist in stimulating economic recovery.

8.162. The absence of any provisions for carry-back of losses is partly responsible for the practice, described in paragraph 16.142, of selling the shares of ‘loss-companies’. The Committee, in Chapter 16, expresses its agreement with the measures that have been adopted to control this practice. The proposal to allow a carry-back of losses, in removing the unfairness which the practice sought to overcome, strengthens the case for the measures directed against the sale of loss companies.




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8.163. The Committee recommends that the law allow a carry-back of losses for all taxpayers other than trust estates and it believes that a period of two years should not cause undue administrative problems. It does not favour these carry-back provisions being made available to trust estates: to do so would require lengthy and complicated special provisions to ensure that the benefit of any loss carried back was in fact received by persons entitled to the benefit.

Carry-forward of Losses

8.164. Currently the Act restricts the allowance of losses to those incurred by a taxpayer in the seven years following the year of income (section 80(2)). There is one exception to this general rule in that primary producers may carry losses forward indefinitely (sections 80AA to 80 AC).

8.165. As a result of representations made to it, the Spooner Committee considered the question of the removal of the seven-year limit and made a qualified recommendation in favour of the indefinite carry-forward of losses. The qualifications were, firstly, that a deduction would not be allowed for a loss incurred in a year of income prior to the year of income ended 30 June 1944; and secondly, that a taxpayer claiming a loss incurred more than seven years before the year of income should be required to establish the amount of any loss and also establish that it had not been allowed as a deduction from assessable income in any intervening year or been offset by exempt income. The point was also considered by the Ligertwood Committee, which dismissed the issue with the brief comment: ‘No evidence was presented to us that the seven year period is generally inequitable or inadequate, and in the absence of cogent reasons to the contrary, we consider the period of seven years now provided should be retained.’

8.166. Overseas practice varies considerably. In the United Kingdom, South Africa and New Zealand losses may be carried forward without restriction; Norway permits ten-year carry-forward, the Netherlands and Sweden six-year; Canada, France, West Germany and the United States allow a five-year period. According to the Carter Commission, the existing five-year period applying in Canada was insufficient for new businesses that required long periods to develop and a liberal carry-forward of losses was essential to overcome limitations of the annual period of measurement. It therefore recommended that losses be allowed to be carried forward indefinitely.

8.167. Numerous submissions have been received by this Committee requesting either that there should be an indefinite carry-forward period or alternatively the existing period should be extended to ten years or more. One reason given was that in the chemical, mining and other capital-intensive industries losses incurred during establishment years and in times of continuous expansion frequently cannot be recouped within the present limited period of seven years. Another reason was that the trend to larger manufacturing operations, combined with the development of new products and processes, are having the effect of extending the period of initial losses. Closely related is the claim by general insurance companies that in providing the greatly increased total covers required in a growth economy and in an economy experiencing heavy inflation, insurance companies stand to incur substantial losses which require periods in excess of seven years to recoup.

8.168. The Committee recommends that the Act be amended to permit all taxpayers to carry losses forward indefinitely. In implementing this change, it should be provided that losses qualifying for allowance on the indefinite basis be limited to losses incurred subsequent to a date seven years prior to the first year of application.




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Exempt Income

8.169. The present law requires that in calculating both the amount of a loss available for carry-forward and the income against which a loss may be applied, exempt income must be brought to account. Bringing to account exempt income in this way has been criticised on the ground that it partly neutralises the concession intended to be given by the exemption.

8.170. In one situation the exemption of income is given not by way of concession but as a means of preventing double taxation of income. There is a general provision whereby income derived from a foreign source which is taxed in the country of source is exempt from Australian tax. The provision is considered in Chapter 17. Bringing this income to account in applying the provisions in regard to carry-forward of losses could be seen as, in effect, taxing the same income a second time without any allowance for the tax already paid. If, of course, the income has only been subject to modest taxation abroad, there may be thought to be reason why it should not be relieved from taxation in Australia; but the loss carry-forward provisions do not differentiate in terms of the amount of tax paid abroad.

8.171. In Chapter 17 the Committee has proposed that the method of preventing double taxation of foreign-source income be replaced by a system under which the Australian resident brings that income to tax but receives credit for the foreign tax. If this system is adopted there can of course be no objection to the income being brought to account in the operation of the loss carry-forward provisions. And the new system will overcome another criticism of the existing system. A loss which has been suffered in operations that would have generated a tax liability abroad had they been profitable, is not available for application against income subject to Australian tax. The existing system thus requires a foreign profit to be brought to account in the operation of loss carry-forward but not a foreign loss. The system proposed by the Committee will allow the bringing in of a foreign loss.

Effect of Dividend Income

8.172. One further point remains to be dealt with. It concerns the provisions of the Act aimed at preventing the double taxation of dividends flowing through intermediate companies. The Act provides (section 46) that a rebate of company tax is allowable in respect of dividends received by one company from another. The section generally operates to render dividends received by one company from another virtually free of tax in the hands of the receiving company. However, the dividends received form part of the net income of the receiving company; and in the event of the receiving company incurring a trading loss, this loss is applied against dividend income and is not available for deduction against trading profits of other periods.

8.173. There are two ways in which the result may be viewed, both of which suggest that the tax payable by the company is excessive. The first view is that to the extent to which the loss is offset against dividend income, the dividends ultimately bear double taxation. The second view is that to the extent to which the losses are so offset, no allowance in made for that proportion of the loss in computing company tax and in fact the loss is never recouped.

8.174. The Committee believes that it ought to be a fundamental principle of company tax that dividends flowing through intermediate companies should not incur double taxation and, further, that the full benefit of trading losses should be available for offsetting against other trading profits. Accordingly, it recommends that in computing the recoupment of losses of companies, amounts representing dividends


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received from other companies should be excluded from the net income of the relevant years. There would continue, of course, to be need to counter dividend-stripping opportunities.

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