New temporary loss carry-back regime – will it help small businesses?

  • New temporary loss carry-back regime –  will it help small businesses?
  • The inherent flaw in the foreign investment fund regime; and
  • The rules around claiming deductions for working at home

Transcript

In today’s podcast, will the latest government tax measures help small businesses? The inherent flaw in the foreign investment fund regime. And we look at claiming deductions for working at home.

The temporary loss carry-back scheme announced by the Government last Wednesday was one of the most significant tax measures yet.

It enables businesses that were expecting to make a loss in either the 19/20 income year or the 20/21 income year to estimate the loss and use it to offset profits in the previous tax year. In other words, they could carry the loss back one year.

Now, this is a measure I’ve seen before and used when I was working in the United Kingdom. That measure was introduced in the wake of a fairly severe recession in the late 80s, early 90s. It’s a promising measure which is expected to cost up to about $3.1 billion over a two-year period.

However, my tax agent colleagues are concerned that we’ve only just ended the year end 31 March 2020. And right up until 1st March, everything was running reasonably smoothly before the effects of Covid-19 landed with a big thump. Companies with a standard balance date of 31st March 2020 won’t actually have been significantly affected by the Covid-19 pandemic, but it’s quite likely that in the year to 31 March 2021 they will be.

The issue we have is that that’s a long way out to be predicting losses. And what if we get those estimates wrong?  The position is that use of money interest would still apply.  Although the temptation would be to make a guess at an estimated loss for the coming financial year and then carry that back to the 2020 tax year, it comes with the caveat that use of money interest – currently 8.35% – will apply on any underpaid tax. It’s a very much a dual-edged sword.

So, the main concern that my colleagues have about the loss carry-back proposal is that it’s really not terribly helpful for small businesses that have a standard 31 March balance date because they’re being asked to predict too far ahead and with too many variables.

The better option is, as I’ve said previously, would be to postpone or cancel the 7 May provisional tax payment coming up, let things settle down a bit and then work forward from that.

The loss carry-back measure is going to be introduced as a permanent feature with effect from the start of the 2021/2022 income year and the Government will take consultation later this year on the proposal. It is a measure that I’ve thought for some time would be useful.

The problem is its timing is not terribly convenient for many small businesses right now. And this points to a dichotomy in our tax legislation and tax policy.

The majority of taxpayers and small businesses prepare their financial statements, their tax returns to 31 March. But the majority of provisional tax, however, is paid by bigger companies, and many of those have different balance dates.  The Government SOEs have a 30 June balance date and then overseas companies might have a 31 December or 30 September balance date.

Now, if you’ve got a 31 December balance date, you’ve got to wait a bit of time ahead, but you’ll probably get a better handle on what’s going to be happening. That’s even truer of those with a 30 September balance date because this has happened halfway through their tax year.

So larger businesses are probably going to be the primary beneficiaries of this measure. It’s not to say it’s of little use to small businesses. It’s just that they’re going to need to proceed with caution because the use of money interest provisions will apply.

I think that this measure will need to be fine-tuned. As I said earlier, I do wonder whether it might just be easier to simply say forget about paying provisional tax on 7 May.

Alternatively, maybe do as the Canadians have done. They’ve introduced a measure where a business can borrow up to 40,000 Canadian dollars from the Government, and if they repay it by 31 December 2022, 25% of the amount borrowed will be written off.  Such a measure will help companies with their cash flow, which is the critical matter for small business at the moment.

But still this loss carry-back measure is going to be of use. It’s something that will become part of the tax landscape and we should never look a gift horse in the mouth.

There’s a couple of other things the Government measures announced as well, which are also important for small businesses. One is the changes to tax loss continuity rules.

Currently, if you have a tax loss and you want to continue to carry forward that loss, you must maintain 49% of the same shareholders, what we call the shareholder continuity rule. What has been an issue for some time for growing businesses is that a significant investor wants to come onboard and they want to have more than 51% of the company, maybe a 60- 70% stake. If they do that, then under the current rules, the losses accumulated to that point are forfeited.

This is something we in the Small Business Council recommended be reviewed. It’s therefore good to see this proposal. With effect from this income year – 1 April for most people – if you can show that you’re continuing to carry on a same or similar business as that prior to the change of shareholding, you can continue to carry forward losses. This is a test modelled on what happens in Australia. It’s a welcome move for fast growing companies who want to attract capital but don’t want to lose the value of the tax losses.

The other tax measure announced gives Inland Revenue discretion to temporarily change due dates and other procedural requirements outlined in the various Inland Revenue acts. This is for businesses and individuals affected by Covid-19.  This will enable Inland Revenue to extend the filing date for elections and filing tax returns or defer the due date for payment of tax.

This is a good move. It gives Inland Revenue flexibility, which it probably should’ve always had, but it never really managed to see a need for such a measure beforehand. That said, I still think there’s one or two other things that legislative changes will be needed around. For example, accidental overstayers becoming tax resident. But on the whole, this proposal is a good move, and we’ll look forward to seeing that in operation very quickly.

KiwiSaver and the Foreign Investment Fund regime rules

Moving on, the foreign investment fund regime was introduced with effect from 1 April 2007. Those who know this rule should also know it applies to KiwiSaver account holders if their KiwiSaver fund is invested overseas.

Basically, the rules say that for KiwiSaver funds, the income to be determined is calculated using what is called a fair dividend rate, that is 5% of the portfolio’s opening market value at the start of the tax year.

Now for individuals, they have the option to take the actual accrued gains/losses over the tax year. And that means that when there was a significant fall in the markets, individuals are protected against that and don’t have to pay tax on a portfolio which has just suddenly depreciated in value.

But unfortunately for KiwiSaver accounts, they don’t have an alternative. And this is also a big problem for the New Zealand Superannuation Fund, the country’s largest taxpayer, because it has a huge portfolio of overseas investments.

Now, the FIF regime has been in place, as I said, for 13 years now. And Covid-19 is the second such financial crisis to have hit financial markets since the regime was introduced. The flaw in the regime is it’s predicated on markets continually going up or being stable.

Events such as we are seeing right now and in the Global Financial Crisis are anomalies which the FIF regime really doesn’t manage well. Particularly if portfolios are significantly devalued for a period of time to come, and if you look at the overall economic return, sometimes too much tax will be paid.

The Tax Working Group recommended reviewing the 5% fair dividend rate and possibly reducing it perhaps to maybe 3 or 4%. And I think that’s something the Government really need to look at. But – there’s always a but – it’s going to need the revenue going forward. So, whether in fact that measure, which I believe is needed and the Tax Working Group recommended, will actually come to pass, we’ll have to wait and see.

Home office deductions

And finally, many listeners and readers will be working from home and will continue to do so when we go to alert Level 3. So what are the rules around claiming expenses for working from home? Well, I did an article on this. The basic rules are as an employee, you can’t claim a deduction.

Instead you are able to be reimbursed by your employer who can make a reasonable estimate of the amount that you should be claiming based on a number of factors such as area of the place you’re working in – your home office – rates, power, Internet usage, etc. A reimbursement based on this is tax free to the employee and deductible to the employer.

If the employer decides to simply pay a flat rate, it might in fact be more than what is actually a reasonable calculation of expenses. Instead, PAYE will apply.

What was interesting to see about that article was the reaction to it – several employers are applying the rules clearly. Others are completely oblivious to it, and others are simply ignoring the fact that their employees have an expense and are just simply expecting them to bear the costs. It will be interesting to see how this shakes down.  All employers will need to be looking at this matter and determining some form of allowance to help their employees.

Well, that’s it for this week. Thank you for listening. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you find your podcasts. Please send me your feedback and tell your friends and clients. Until next time Kia Kaha. Stay strong and be kind.