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Disclaimer

This is not advice. Items herein are general comments only and do not constitute or convey advice per se. The information contained in these articles is for guidance only and should not be relied upon without obtaining professional advice having regard to your direct circumstances.

 

Tax considerations for business losses

The following are four issues worth considering by business owners in reviewing any losses before the end of the tax year:

1. Do the non-commercial loss rules apply?

An individual or partnership carrying on a business must satisfy one of the tests in the non-commercial loss rules in order to claim a business loss against other income. A common example is professionals on high salaries who are “weekend farmers” and wish to claim farm expenses in the business against their salary.

The non-commercial loss rules were introduced to restrict the ability of individuals to claim business losses from what could have been viewed as hobbies. Possible action could be taken to make the expenses “commercial” eg selling livestock to reach the minimum revenue threshold.

2. How is an unrecoverable business loan treated for tax?

A capital loss can be claimed for the amount owing on the loan as long as it is not a trade debt (see next item). The capital loss arises when a debtor is formally released from their obligation, typically by executing a deed of release or similar document.

Before forgiving debts, especially those owed by related entities or individuals, any implications that may arise for the debtor under the commercial debt forgiveness rules in the tax legislation should be considered.

Any potential implications for individuals or trusts under the deemed dividend rules should also be taken into account.

3. What are the requirements for writing off bad debts?

A deduction can be claimed for an unrecoverable trade debt as long as:

• The amount has previously been included in taxable income
• It can be shown that all reasonable steps have been taken to obtain payment of the debt, ie it is considered genuinely unrecoverable
• The debt is written off as bad in the financial records of the business during the year of income. Raising a doubtful debt provision, or later posting a journal entry, is not sufficient – the debt should be written off in the books prior to year end, and
• The statutory tests relating to either continuity of ownership or continuity of business are satisfied.

Note that collection activity in relation to a bad debt need not (and generally should not) cease, and if any amounts are later recovered from the debtor, they are simply included as assessable income at the time of recovery.

4. What are the statutory rules affecting tax losses?

Companies wishing to claim tax losses or bad debts must satisfy either the continuity of ownership test (COT) or the same business test (SBT).

COT requires the company to show that its underlying ownership (ie tracing through interposed companies and other entities) has not changed by 50 per cent or more since the tax losses were incurred. Special rules exist to make COT easier to apply and to satisfy for widely held companies.

If COT is failed, tax losses or bad debt deductions may still be available if the company can satisfy SBT.

This can be very subjective, but requires the company to show that the business is essentially the same before and after the change in ownership, and that it has not earned income from new types of transactions since the change in ownership.

Peter Bembrick
My Business, May, 2009

 


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