Income tax
Carry-forward loss
A carry-forward loss is a tax loss from an earlier year that has not yet been used and is brought forward to reduce taxable income in a later year.
When you cannot use a tax loss in the year it arises, because there is no income to absorb it, the loss is carried forward. It sits in your tax records and is applied against taxable income in future years until used up. There is generally no time limit for carrying forward revenue losses, provided the conditions to use them continue to be met.
Companies must satisfy additional tests to use carried forward losses. The main test is the continuity of ownership test, which asks whether the same people have owned more than 50% of the company's voting, dividend and capital rights throughout the period from the loss year to the year of use. If this test fails, the company may still use the loss if it satisfies the business continuity test, which looks at whether it carries on the same business or a similar business.
Trusts have their own tests, which can be complex, and depend on the type of trust. Family trusts may make an election to be a family trust, which has implications for how losses and other items are treated. Individuals and partnerships generally have fewer restrictions on carrying forward losses, but the non-commercial loss rules can defer losses until the business makes a profit.
When a loss is used, you apply it to the taxable income of the later year. If the loss is larger than that income, the unused balance continues to be carried forward. Where there are several years of losses, they are normally applied in the order they arose. A company applies the loss before working out the taxable income on which it pays tax at the company rate.
Record keeping is essential because the ATO needs evidence of how the loss arose when you use it, possibly many years later. Keep the original accounts, workings, and any evidence supporting the ownership or business continuity tests. If the business changes hands or alters its activities, consider the effect on the losses before the change takes place.
Capital losses carried forward follow different rules, and can only be applied against capital gains. Revenue losses and capital losses should not be mixed. Carry-forward losses do not change your GST position. This is general information only, so confirm whether you can use a carried forward loss with the ATO or a registered tax professional.
Worked example
A company made a tax loss of $40,000 in year one and $10,000 in year two, a total of $50,000 carried forward. In year three it has taxable income of $30,000 before losses. Provided the ownership or business tests are met, it uses $30,000 of the losses, so taxable income is nil and $20,000 of losses remains to carry forward again.
Practical tips
- Check the ownership and business continuity tests before a company uses carried forward losses, especially after a change of owners.
- Keep the workings that show how each loss arose, because you may need them years later.
- Track revenue losses and capital losses separately, since capital losses can only be used against capital gains.