In this article we will discuss about the treatment of various tax losses:- 1. Revenue or Trading Losses 2. Capital Losses 3. Foreign Branch Losses 4. Group Taxation.
Revenue or Trading Losses:
Most countries in the world allow the carry-over of losses of residents and permanent establishments of non-residents for either an unlimited or a specified period. Few countries also provide for the carry-back of losses for offset against past taxable profits.
Some examples of carry-forward/back period for revenue losses include:
(a) Carry-forward period for trading losses:
ii. Up to five years:
1. 1 year:
2. 3 years:
Albania, Angola, Congo, Costa Rica, Dominican Republic, Ethiopia, Gabon, Guinea, Honduras, Kazakhstan, Lebanon, Macau, Macedonia, Moldova, Myanmar, Nicaragua, Paraguay, Philippines, Qatar, Senegal, Tunisia, Uruguay, Venezuela.
3. 4 years:
Cameroon, Mauritania, Morocco, Nepal, Nicaragua, Nigeria, Peru, Yemen
4. 5 years:
Argentina, Aruba, Azerbaijan, Botswana, Bulgaria, Cambodia, China, Colombia, Croatia, Czech Republic, Ecuador, Egypt, El Salvador, Georgia, Ghana, Greece, Hungary, Indonesia, Italy, Ivory Coast, Japan, Latvia, Libya, Liechtenstein, Lithuania, Monaco, Montenegro, Mozambique, Oman, Panama, Poland, Romania, Rwanda, Seychelles, South Korea, Slovak Republic, Slovenia, Solomon Islands, Sudan, Taiwan, Tanzania, Thailand, Turkey, Ukraine, Vietnam, Yugoslavia, Zambia.
iii. Over five years:
1. 6 years:
Bangladesh, Brunei, Jordan, Pakistan, Palestine, Portugal, Zimbabwe.
2. 7 years:
Papua New Guinea, Puerto Rico, Sri Lanka, Suriname, Switzerland.
3. 8 years:
Colombia, Fiji, India.
4. 9 years:
5. 10 years:
Canada, Finland, Iceland, Mexico, Netherlands Antilles, Norway, Russia, Serbia.
6. 15 years:
7. 20 years:
Guam, the United States.
Australia, Austria, Belgium, Bolivia, Brazil, British Virgin Islands, Chile, Cyprus, Denmark, Djibouti, France, Germany, Gibraltar, Guernsey, Guyana, Hong Kong, Hungary, Iran, Ireland, Isle of Man, Israel, Jamaica, Jersey, Jordan, Kenya, Kuwait, Lesotho, Luxembourg, Malaysia, Malta, Mauritius, Namibia, Netherlands, New Zealand, Saudi Arabia, Singapore, South Africa, Swaziland, Sweden, Tanzania, Trinidad and Tobago, Uganda, Ukraine, the United Kingdom.
Ernst & Young – Worldwide Corporate Tax Guide Some countries have different loss treatment for operating losses and tax losses due to timing differences. The latter may be carried forward indefinitely. (Examples: Bangladesh, Belgium, Cameroon, Congo, India, Malta, Monaco, Morocco, Pakistan, Senegal, Sri Lanka).
Most countries require that the tax losses be used as early as practicable. Few countries allow the taxpayer to defer the loss carry-forwards for use in a later tax year (Examples: Belgium, Canada).
Certain countries grant a longer or indefinite period for losses incurred during the start-up period. For example, in Italy and Suriname the losses during the first three years of operations may be carried forward indefinitely. The losses within the first five years may be carried forward for seven years in Japan.
India allows the start-up costs to be capitalized against the assets and depreciated for tax purposes. Portugal requires that the start-up costs are capitalized and written off over three years. In Norway, the shareholders may take a tax deduction over five years for the cash contributions made to a Norwegian company engaged in a new activity.
Besides the time limitation on carry-overs, other limitations may prevent the use of tax losses. For example:
Operating losses in the first four tax years of a company’s existence may be carried forward indefinitely. Losses in subsequent years may also be carried forward indefinitely, provided 50% of the annual turnover exceeds all costs and expenditures and the company does not incur operating losses for two consecutive years. If these conditions are not satisfied, the approval to carry forward the losses has to be obtained from the tax authorities.
2. United Kingdom:
The United Kingdom allows trading losses to be set off against other income and chargeable gains in the current or preceding year but loss carry-forwards can only be used for an offset against future income from the same trade.
3. Other examples:
Ecuador limits the past loss offset to 25% of the year’s profits. Brazil and Russia limit the use of losses to 30% of the net income in any year. Germany limits loss utilisation to 60% of the balance taxable income for the year. Panama limits the loss offset to 50% of the taxable profits; furthermore, the allowable losses are restricted to 20% of the loss in each year.
Poland limits the loss offset to 50% of the original loss in any year within a five-year period. In Palestine, the carry-forward loss offset is limited to 50% of the current profits over six years. Austria allows 75% of the past tax losses to be offset in any year with the balance carried forward for future offset.
The losses in Guyana may not reduce the taxable income in any year by more than 50% or the tax payable to less than 2% of turnover.
Tax benefits of past losses of a company are usually denied if there is a change in the economic or legal identity. It could be the result of a change in ownership or control or a change in the nature or conduct of the trade due to a reorganization, such as a merger, division or liquidation.
Several jurisdictions also have special rules for the transfer of losses on mergers and acquisitions. Certain countries restrict the carry-over of losses when a company is liquidated, or its debt is restructured. There are very few countries that do not insist on some continuity of ownership or trade (Examples: Austria, Brunei).
(b) Carry-back period for trading losses:
i. One year:
Germany, Guernsey, Ireland, Isle of Man, Japan, the United Kingdom
ii. Two years:
Guam, Jersey, the United States
iii. Three years:
Canada, France, Monaco, Netherlands
Revenue losses may be carried back in certain countries and offset against past profits to claim a refund of the taxes already paid. Ireland grants an optional carry-back of trading losses for one year. Germany permits a one-year optional loss carry-back up to EUR 511,500 for corporate income tax (but not trade income tax).
The United States allows corporate taxpayers to elect a loss carry-back for two years, but the loss must be carried back fully against past profits. France permits an optional carry-back for three years. The amount may be used for the payment of corporate taxes in the following five years, and the tax benefit of any remaining unused losses is refunded to the taxpayer in the sixth year.
Chile grants unlimited carry-back of losses to the extent that a taxpayer has retained profits. Some countries allow carry-back of losses when the company ceases its business activities. (Examples: two years – Norway; three years – Ireland, Sri Lanka).
Capital tax losses arise on the disposal of capital assets. In countries where capital transactions are included in ordinary income, no distinction is normally made between revenue and capital losses. In other countries, the trading losses may often be set off against capital gains, but the capital losses can be relieved only against present or future capital gains.
Some countries allow the capital losses to be offset against current trading profits. In Brazil, the capital losses are offset against ordinary income in the year they arise, but any capital loss carry-forwards can only be deducted from future capital gains. There are also a few jurisdictions that do not allow any tax relief for capital losses (Examples: Czech Republic, Myanmar, Russia).
The carry-forward period for offset of capital losses against future capital gains varies. For example, Canada, Ireland and the United Kingdom allow an indefinite carry-forward of capital losses. Canada also permits carry-back for three years. France permits long-term capital losses to be carried forward for ten years for offset against future capital gains.
India provides eight years. Israel provides for a seven year carry-forward. Pakistan grants six years. Guatemala, United States and Puerto Rico allow capital losses to be carried forward for five years.
In Denmark and Finland, the capital loss on non-business assets can only be deducted from similar gains within the following three years. Russia allows deduction for capital losses on disposal of a depreciable asset over the remaining useful life of the asset.
Foreign Branch Losses:
Generally, foreign branch losses cannot be relieved against the domestic profits of an enterprise, which is taxed under the territorial tax regime. In countries that tax their residents on their worldwide income, the results of the foreign branches are normally included in the combined accounts of the enterprise.
The profits and losses of the enterprise are aggregated on a current basis and a tax exemption or credit is given for any foreign taxes paid on the branch income. Thus, they grant an expense deduction for the foreign branch losses, unless the foreign branch profits are tax-exempt.
The branch losses are also available for offset against the future profits of the branch itself.
Therefore, these losses are tax-deducted twice, namely:
(i) Against the taxable income at home when they arise, and then
(ii) Against the future profits of the branch through loss carry-forwards.
The common tax concern is to neutralize this presumed “dual benefit” of the foreign branch losses.
Under the exemption method, there is usually no duplication of loss relief. In countries that follow the credit method to avoid double taxation, the foreign loss is not ultimately deducted twice. The loss abroad reduces the combined taxable profits at home in the year of loss. If the loss is carried forward in the source country and offset against its future profits, it reduces the tax credit in that year.
The subsequent recapture of the loss only creates a tax deferral or a timing issue in the home State. If the branch losses cannot be carried forward, there is no tax loss relief in the host country and there is no subsequent tax recapture in the home State. Again, there is no double relief for the tax losses of the branch.
Several jurisdictions grant partial or full tax-exemption for foreign branch profits under their domestic law or treaties. The offset of the foreign branch loss against the profits of the head office is normally disallowed since the branch income is tax-exempt. As the branch loss is not relieved, the enterprise as a legal entity during that year pays excess taxes. Moreover, if the foreign branch fails, the losses may be disallowed forever.
A few countries with exemption relief for branch profits allow the deduction for foreign branch losses against the profits of the head office with subsequent recapture provisions when the branch becomes profitable (Examples: Austria, Belgium, Denmark, France, Germany, Netherlands, Switzerland).
South Africa taxes foreign branch profits but allows the offset of foreign branch losses only against foreign profits in future years. Foreign subsidiaries are separate legal entities. Unlike branches, the losses of foreign subsidiaries are not normally tax deductible.
In some countries, a permanent diminution in the share value of a foreign subsidiary may be written off against its book value (Examples: Austria, Germany, Italy, Switzerland).
Some countries allow a deduction for capital losses (partly or fully) on the disposal of shares in foreign subsidiaries (Examples: France, Ireland, Italy, Luxembourg, Switzerland, the United Kingdom), while others disallow them (Examples: Belgium, Germany, Netherlands, Spain). Several jurisdictions disallow any capital losses resulting from excessive profit distributions through “dividend stripping” (Examples: Austria, Belgium, Germany, Italy, Luxembourg, Netherlands).
France permits a deduction for the start-up losses of foreign subsidiaries, with recapture provisions when they become profitable. In the United States, they can be deducted only as a capital loss on the sale of the shareholding or the expected liquidation of the subsidiary. In Canada, Denmark and Sweden, a write-off requires that the foreign company be actually liquidated.
Several jurisdictions provide special rules to offset the losses and profits of companies within a group. Some of these rules allow for tax-free transfer of assets within a qualifying group of companies. The gain on the transfer of capital assets is only taxed when they leave the group (Examples: France, Ireland, Netherlands, Portugal, Spain, The United Kingdom).
These tax consolidation provisions avoid the need to operate as a single legal entity with divisions or branches for tax purposes. While many countries allow tax consolidation of resident companies, there are only four countries (e.g. Austria, Denmark, Italy and France) that currently offer worldwide tax consolidation.
Group taxation systems may be broadly divided into three main categories:
(i) Fiscal Unity system:
The group is treated as a single entity for tax purposes. It pools the profits and losses of the group members and files a joint (consolidated) tax return. Generally, the losses incurred before the consolidation period by a company cannot be applied to offset joint profits within the tax group.
Such losses may be carried over by the company for offset against its own future profits. Usually, all group companies must be tax-resident, taxable and within the prescribed level of ownership or voting control. Examples: Austria (2005), Australia, Denmark, France, Germany, Iceland, Israel, Italy, Japan, Luxembourg, Mexico, the Netherlands, New Zealand, Poland, Portugal, Slovenia, Spain, Tunisia, the United States.
(ii) Group contribution system:
A profitable company contributes to one or more loss-making companies within the group. These contributions are tax-deductible for the paying company and taxable for the receiving company. Each company files its own tax return and pays its own taxes. Both the receiving and paying companies must be resident for tax purposes.
Examples: Finland, Norway, Sweden.
(iii) Group relief system:
A loss-making resident company surrenders its current losses to the profitable resident companies in the group, with or without a subvention payment. Each company files its own tax return and pays its own taxes.
Austria, Barbados, Cyprus, Ireland, Latvia, Malta, Mauritius, New Zealand, Singapore, Trinidad and Tobago, the United Kingdom.