A business generally makes a tax loss when the total deductions it can claim for an income year exceed the total of that business’s assessable income for the year. Then of course there are deductions that you can’t count as tax losses, such as donations, gifts and personal super contributions.
But remember, a tax loss is different from a capital loss. A capital loss can only be offset against any capital gains in the same income year or carried forward to offset against future capital gains – it cannot be offset against income.
Companies can generally carry forward a tax loss indefinitely, and use it when they choose, provided they have either substantially maintained the same ownership and control or carried on the same business since the tax loss was made.
Losses however must be deducted in the order in which they were incurred. That is, if you have incurred tax losses in more than one year, you must use the entire loss from the earliest year before you can use all or part of the loss from a later year.
Remember however that partnership income is taxed in the hands of each partner. If a partnership makes a tax loss, each partner has a proportionate share of the loss, and treats it like a loss from any business activity.
Individuals generally must treat losses from business activities separately from income and deductions from non-business activities (such as salary and wages and investments). However there are limited circumstances where it is possible to offset a loss from a business activity you carry on as an individual (either as a sole trader or in partnership) against assessable income from other sources.
At least one of the following conditions need to be satisfied:
- your business is a primary production or professional arts business and your income from other sources is less than $40,000 for the income year (excluding any net capital gains)
- the Tax Office has exercised its discretion to allow you to claim the loss
- the loss is solely due to a deduction claimed under the small business or general business tax break, or
- your income for non-commercial loss purposes is less than $250,000 and your business activity passes at least one of four tests – it produces assessable income of at least $20,000, it has produced a profit in three of the past five years (including the current year), it uses real property or an interest in real property worth at least $500,000 on a continuing basis, or it uses other assets worth at least $100,000 on a continuing basis.
(Note that the above applies only from the 2009–10 and later income years, with different rules applying to earlier income years.)
If you do not meet any of these requirements in an income year, you cannot offset your business loss against any of your other assessable income for that income year, but you can defer it. Then if your business makes a profit in the future, you can offset the deferred loss against the profit.
Subject to this and satisfying the continuity of ownership and control tests or the same business test, companies can generally carry tax losses forward indefinitely and use them in the year of their choosing. This means, for example, that a company can choose not to utilise prior-year losses in a particular year in order to pay sufficient tax to be able to distribute franked dividends.
Of course it is very important to keep all relevant records to make sure you can back-up claims made for losses in future income years. Consult your tax professional, or find out more information about using tax losses, before taking the plunge.