There are legitimate ways to manage tax exposure by using previously incurred tax losses. However, business owners should be wary of stories suggesting that tax losses can be bought.
David Rowley and Barrie Skinner are a couple of Wellington accountants that the profession can do without. They were recently found guilty of fraud, tax evasion and perverting the course of justice.
Their swindle was fairly simple, and was a variation on one I’ve seen before. A profitable business (with a resulting large tax bill) is promised tax savings by their adviser. This is achieved by the adviser invoicing a large amount for services that are never provided. The amount is recorded as a deduction, reducing the tax bill. Most of the money paid is refunded, and recorded as a non-taxable deposit. The difference is kept by the adviser as a fee for fabricating the tax saving. Rowley and Skinner instructed their clients to tell anyone who asked that the payments were deposits for property developments. In other cases, clients are told that they are buying the tax losses of other clients.
There are a number of victims in this sort of fraud. Obviously there’s Inland Revenue, who miss out on tax. And anyone trying to illegitimately fiddle the tax system makes victims of us all. The client is also a victim, as they face Inland Revenue scrutiny and exposure to interest and penalties.While it might be easy to say that they should have known better, the tax system is complex and full of complicated rules that do not always have intuitive outcomes. Taxpayers should be able to place trust in their adviser to guide them through what is permissible and what is not, including the use of tax losses.
Tax losses occur when a person’s allowable deductions exceed their assessable income in a year. Like a lot of tax rules there are exceptions but, generally, tax losses can be carried forward by the person to offset income earned in future years.
A company’s ability to carry forward losses is restricted by a rule that requires “continuity of shareholding” of at least 49%. The rationale is that the people who were shareholders at the time the losses were incurred should be the same people who get the advantage of them later. The rule also prevents “corporate raiders” from buying up companies solely for the purpose of using their losses.
Unlike the sort of scams perpetrated by Rowley and Skinner, a loss company can legitimately offset its losses against the profits of another company – but only if at least 66 per cent of the shareholding is the same. Losses can be offset by subvention, which involves the profit company making a payment (which is recorded as an expense) to the loss company (which records it as income). Alternatively, the loss can be transferred by making an election in the companies’ tax returns. Each method has different consequences and these should be clearly understood before proceeding, especially if the shareholding of the companies is not 100 per cent in common.
Losses incurred by partnerships are automatically taken by the partners as they are deemed to have incurred them. The new “look through company” structure passes excess deductions through to shareholders, although there are limitations as to how much of those losses can be used in each year. Other entities, such as trusts and individuals, cannot transfer their tax losses to others.
There are lawful and appropriate ways of managing tax exposure. That is generally achieved through appropriate structuring, and ensuring that assessable income is correctly calculated and that all allowable deductions are properly taken. Avoid the scams.
Geordie Hooft
Partner, Tax
Grant Thornton New Zealand Ltd
T +64 (0)3 379 9580
E geordie.hooft@nz.gt.com