Income tax
Tax losses
A tax loss arises when allowable deductions are greater than assessable income, and it can generally be carried forward to reduce taxable income in later years, subject to conditions.
A tax loss occurs when your allowable deductions for the year exceed your assessable income. It is very common for new businesses, since start-up costs and slow early sales can easily push expenses above income. The loss does not usually give you a refund, but it may be used to reduce taxable income in other years or against other income.
The treatment depends on who incurred the loss. A company that makes a tax loss carries it forward and uses it against future taxable income. A sole trader or partner may be able to deduct a business loss against other income such as wages, although the non-commercial loss rules can limit this unless the business passes certain tests. A trust cannot distribute a loss to beneficiaries, and instead holds it for use by the trust in later years.
The non-commercial loss rules apply to individuals and partners in partnerships that carry on a business. To claim a loss against other income, the business must meet one of the tests set out in the law, such as an income threshold for the individual, and one of tests relating to assessable income, profit or the assets used. If the tests are not met, the loss is deferred to be offset against future profits from the same business.
When the loss is carried forward, rules govern whether it can be used. Companies and trusts need to satisfy ownership or business continuity tests. Individuals have fewer restrictions, but a taxpayer must keep records. The order in which losses are used and how they interact with net exempt income can affect the amount available. Capital losses are separate and only usable against capital gains.
Record keeping is critical. You should maintain accounts showing how the loss arose, the carry forward figure, and the income year. These details are reported in the tax return and the ATO tracks the amount, but the burden of showing the loss is correct falls on you, including many years later when you use it to reduce tax.
GST has a separate effect. If a business is registered for GST and has a net GST refund due to heavy purchases, the BAS refund is not a tax loss, and the two are unrelated. A tax loss for income tax does not remove GST obligations. This is general information only, so confirm how losses apply to you with the ATO or a registered tax professional.
Worked example
A new company has assessable income of $60,000 and deductions of $95,000 in its first year, a tax loss of $35,000. In year two it earns taxable income of $50,000 before losses. Subject to passing the tests, it uses the $35,000 loss, leaving taxable income of $15,000, taxed at the company rate that applies. Without the loss, taxable income would have been $50,000.
Practical tips
- Keep a running record of losses and the income year they arose, since you may use them many years later.
- Check the non-commercial loss rules if you are an individual with a loss-making business.
- Remember capital losses are separate and can only be used against capital gains.