Businesses can carry forward their losses to adjust against future taxable profits

The profit and loss are part of the business. In one tax period, companies may make profits, and in the second, they may get into losses. The losses may be due to changes in circumstances like Covid-19 and various other factors. The start-ups are usually subject to losses in the beginning.

In most tax jurisdictions, these losses can be carried forward to adjust against the future taxable profits. In addition, the taxable persons can carry forward their losses for a specific period like six years, 10 years etc. or an indefinite period, which varies from jurisdiction to jurisdiction.

Carried forward losses is a technique where businesses can carry forward their losses to adjust against future taxable profits. Due to the current period loss, taxable persons would be paying the lessor tax in the future period. The fundamental principle behind this technique is that businesses should pay tax on the taxable profits earned over their entire life instead of taxable profits made in a specific period.

The technique proposed in the corporate tax public consultation document (the document) is based on global best practices, and it has been proposed in the document that:

“a business will be able to offset a loss incurred in one period against the taxable income of future periods, up to a maximum of 75% of the taxable income in each of those future periods”.

The above-proposed treatment implies that businesses can carry forward their losses for unlimited time as the time has not been specified in the document. Moreover, an upper limit has been proposed in the document, which is 75% of the available future taxable income to adjust the previous period’s losses. This implies that every profit-making business would be liable to pay tax on the remaining twenty-five per cent after adjustment of losses or full profit if there are no previous losses, while loss-making businesses will carry forward their losses for an unlimited time.

The proposed treatment of carrying forward losses is subject to some conditions. If these conditions are not being fulfilled, then the taxable person would not be able to adjust the carried forward losses against the future taxable profits, and these conditions can be classified into (i) continuity of business and (ii) continuity of the ownership, which has been described as under:

Continuity of Ownership Test:

Continuity of the ownership requires that at least fifty per cent of shares of the company should be held by the same person from the date the losses were started till the date losses were adjusted. For example, Mr. Alex was holding hundred per cent shares of the company since its inception, and if he sells 30 per cent shares of the company. Still, the company would be able to adjust the carried forward losses against the future taxable profits, since Mr. Alex still holds 50 per cent shares of the company.

Continuity of Business Test:

Continuity of the business requires that the same or similar business can adjust its losses against the future taxable profits, and it doesn’t matter who is the business owner. This means that even if the ownership has changed by more than fifty per cent still, a business can adjust its losses against 75 per cent of the future taxable profits.

For example, XYZ Ltd was initially owned by Mr. A, and the company was in losses. Now, Mr. B is the new owner of XYZ Ltd with the same business activity, still, XYZ Ltd can adjust its losses up to 75 per cent of the future taxable profits since the company is in the same business.

If there is any change in the ownership by more than fifty per cent and the company is not in the same or similar business, then the taxable person would not be able to adjust its previous tax losses against the future taxable profits.

Moreover, the above conditions of continuity of the business or the continuity of the owners do not apply to the companies listed on the recognized stock exchanges. Companies listed on the recognized stock exchanges would still be able to adjust their losses, even if there is a change in ownership or change in the business activity. We need to wait for the law to have a detail about the recognized stock exchanges.

Exceptions of the Carried Forward Losses:

The above is the requirement of the law, but there are exceptions, and tax loss relief would not be available for the losses in the following cases:

•Losses incurred before the effective date of corporate tax.

•Losses incurred before a person becomes a taxpayer for UAE corporate tax purposes.

•Losses incurred from activities or assets which generate income that is exempt from UAE corporate tax; or

•Losses incurred by a free zone person that are not attributable to a PE in the mainland.

The business owners of loss-making units need to be very vigilant to change the ownership and business activity, as it can have an impact on the adjustment of previous period losses. If the above the requirements of the law are not being satisfied, then businesses will not be able to carry forward its losses to adjust against the future taxable profits.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official but a personal opinion of the writer based on the public consultation document on corporate tax. For any queries/clarifications, please write to him at compliance@kresscooper.com.