How Small Businesses Can Leverage Carry Forward Losses in Australia

Need help with tax losses and trying to figure out how to make the most of them? 

Understanding how to carry forward tax losses in Australia can be a game-changer for your business. This tax procedure allows you to offset future profits and reduce your tax burden.

However, navigating the rules around carrying forward losses can be tricky, with strict conditions and limitations that can catch you off guard.

In this article, we’ll break down the complexities of carrying forward tax losses, explaining how they work, the eligibility criteria, and the steps you can take to optimise your tax strategy, maximise your business tax deductions, and avoid costly mistakes. 

Read on for more details on how carrying forward your tax losses can work to your advantage while remaining fully compliant with  Australian tax law.

What are carry forward tax losses?

A tax loss occurs when an individual, business, or investment’s allowable deductions exceed its income in a particular financial year. This means that the entity has spent more on deductible expenses (such as business costs, investment property expenses, or capital asset sales) than it has earned in income.

What does it mean to “carry forward tax losses”? It means that when you experience a tax loss in any year, you can deduct the amount lost from your taxable income in future years. This simple concept, when properly applied, helps reduce the amount of tax owed in profitable years by applying the losses against future earnings.

There are two main types of tax losses that can be carried forward:

• Revenue Loss: These arise from regular business or personal income activities, such as trading, services, or wages. Revenue losses can generally be carried forward and used to offset future assessable income
• Capital Loss: These occur when a capital asset (like shares or property) is sold for less than its purchase price. Capital losses can only be carried forward to offset future capital gains tax (not regular income), which is why they are not strictly categorized as tax losses by the ATO.

Everyone in business, including individuals operating as sole proprietors or in a partnership as well as incorporated companies, can carry forward taxes. However, the rules are different for each business structure.

For example, companies can carry forward tax losses indefinitely and use the privilege whenever they like as long as they pass certain tests (which we shall explore in detail later). However, individuals are required to claim a tax loss at the earliest opportunity; otherwise, they might forfeit the ability to apply the tax loss to their future earnings. 

How do carry forward tax losses work in Australia?

Tax losses in Australia are tracked and carried forward according to guidelines set by the Australian Taxation Office (ATO). The rules allow businesses and individuals to offset future income with losses from prior years under certain conditions. 

The tracking of losses begins when a business or individual lodges a tax return showing a loss. This loss is then recorded and carried forward in future tax returns. The ATO keeps track of the unused losses until they can be applied to reduce taxable income in profitable years.

So, for each financial year:

• The loss amount is recorded
• The carried-forward loss is applied automatically when future income is reported
• Unused losses continue to be carried forward until fully used.

There are strict rules regarding when a business can use carried-forward losses. The first rule for anyone seeking to use their carried forward tax losses is that there must be sufficient future income.

You can only use a tax loss to offset income in a year where you have enough taxable income to absorb the loss. The loss will be subtracted from that income, reducing the amount on which you pay tax.

Companies and individuals seeking to carry forward losses must also pass certain tests, known as the Same Business Test or Continuity of Ownership Test (for Companies ) and the non-commercial Loss rules (for individuals). More details about both tests will be provided in the next section.

Eligibility criteria for carrying forward tax losses

Carrying forward tax losses is subject to specific eligibility requirements set by the Australian Taxation Office (ATO) for different business structures :

Individuals (Sole Proprietors)

If your business operates as a sole proprietorship, you can carry forward your tax loss indefinitely but must claim a tax loss deduction at the earliest opportunity.

For example, if you experienced a tax loss in 2023 and you have sufficient income /profit in 2024, you must claim the tax loss in 2024 instead of reserving it for the future. 

Non-commercial activities

Sometimes, you might be involved in a non-commercial business activity that isn’t related to your primary source of income. 

If you experience a tax loss from such a business, you can carry forward your tax loss until you make a profit from the said business. 

In some cases, you might be able to offset the loss against other sources of income, such as your regular salary/wages. But you’ll need to meet the requirements set by the ATO’s Non-Commercial Loss rules to qualify for this option.

A registered tax agent can explain how those rules work and whether they apply to your case. 

Individuals (Partners)

Businesses that are run as partnerships can carry their business losses forward in a unique way. 

Individual partners generally absorb the liabilities of their business in proportionate shares. In the same way, each partner will receive a share of the tax loss that is proportional to their stake in the business, and the tax loss will be carried forward or offset on an individual basis, according to the ATO rules

Companies 

Incorporated companies can carry their tax losses forward indefinitely and use them at any time as long as the majority ownership and control of the business remain the same from when the tax loss arises to when the deduction is claimed.

However, if ownership and control of the company have changed by at least 50 percent within that time, the company needs to satisfy either of two tests (collectively known as the business continuity test) to be able to carry forward their tax losses:

• The same business test: This test allows a company to use tax losses if it operates the same business as it did when the losses occurred.
• The similar business test: this test allows a company to use tax losses after an ownership change provided that the current business is similar to the former ( without any significant changes in its services or goods sold)

The rules might be different if your business operates as a trust. In such cases, you should consult a registered tax agent to get personalised insights into your case. 

Types of losses that can be carried forward

As stated earlier, tax losses that can be carried forward fall into two main categories: revenue losses and capital losses. Each type of loss is treated differently under the tax law, with specific rules on how and when they can be used to offset future income or gains.

Revenue Losses

Revenue losses which are considered actual tax losses by the ATO arise from the normal operations of a business or individual’s income-generating activities. These include costs and expenses that exceed income in a given financial year.

Common revenue losses may include:

• Operational losses: Expenses from running a business (e.g., wages, rent, utilities, and other operating costs) that exceed business income.
• Investment property losses: Expenses related to managing or maintaining an investment property that exceeds the rental income earned from the property.
• Investment losses: Losses from income-generating investments, like interest from bank deposits or dividend income from shares.

Revenue losses are applied to individuals and businesses. They can be carried forward to reduce future assessable income. 

For example, if a business incurs a $50,000 loss in 2023, it can carry forward this loss to offset income in 2024 and beyond until the loss is fully used. However, revenue losses can only be used to offset assessable income, not capital gains. If an individual or business has both a revenue loss and a capital gain in a given year, the revenue loss cannot be used to reduce the capital gain.

Capital Losses

Capital losses occur when an individual or business sells a capital asset (such as property, shares, or other investments) for less than its original purchase price.

Unlike revenue losses, capital losses can only be used to offset capital gains, not other forms of assessable income. If a capital loss exceeds the capital gains in a year, the remaining loss can be carried forward to future years.

For example, if you sell shares for a $30,000 loss in 2023 but make a $50,000 gain from selling a different asset in 2024, you can carry forward the $30,000 loss and use it to offset the 2024 capital gains, paying tax only on $20,000 of the current gain.

Capital losses can be carried forward indefinitely until they are fully utilised. However, they must first be applied to capital gains in the year they occur. If there are no gains that year, the loss is carried forward to be used against future gains.

How to claim carry forward tax losses: Step-by-step guide

Wondering how you can claim deductions on your tax losses? Here’s a summary of the steps involved:

• Identify your unused tax losses: The first step is to identify your tax losses from previous years that haven’t already been deducted from your taxable income
• Ensure you meet the eligibility criteria: Depending on your business structure, you may need to pass the non-commercial activities test, same business test, or similar business test to qualify for this type of deduction.
• Document your income and expenses: You’ll need to have detailed records of your income and expenses, including:
  • Receipts, invoices, or bank statements that verify your deductions.
  • Records of your taxable income for the years when the losses occurred.
  • Any previous tax returns showing these losses.
• Complete the relevant tax forms: you can claim your previous tax losses when filing your income tax returns. If you’re filing a paper tax return, you’ll need to complete question L1 (for 2024) to report and claim revenue losses. Capital losses are claimed by completing question 18 on your form. If you use the myTax payment platform, you can claim your tax loss by ticking the appropriate tax losses box. 
• Ensure you file your tax returns on time: The due date for filing tax returns is October 31st for individuals and 28 February for companies. It is important to lodge your tax return with carried-forward losses on time to avoid penalties.

Impact of carry forward tax losses on future tax planning

The ability to carry tax losses forward is important for businesses to manage their taxable income in future years. It is particularly helpful for businesses that go through ups and downs in their profits, as it balances their tax liabilities.

However, strategic tax planning is important because it helps businesses decide the best time to use their carry-forward tax losses. For example, if a business expects to make more profits in the future, it might choose to hold off using those losses until it can offset a larger amount of income (especially for companies that can generally use their tax losses as they like). This allows them to save more in taxes when it’s most beneficial. 

Planning also helps businesses maintain cash flow, as they can keep more money in the business by paying less in taxes when they are making profits.

As a business owner, you also need to be mindful of the ATO’s eligibility rules, which must be met to utilise your losses. If the business changes hands or starts a different type of operation, the losses may no longer be available to carry forward. Planning around these rules and properly structuring any planned ownership or operations change can help you preserve your ability to use previous tax losses.

Successfully carrying forward losses over multiple years would allow you to reinvest the amount saved into growing your operations, effectively setting your business up for long-term success.

FAQ

How many years can you carry forward a tax loss in Australia?

In Australia, you can carry forward a tax loss indefinitely until it’s fully used to offset future taxable income. There’s no time limit, but depending on your business structure, you must meet certain conditions to claim it. 

Can individuals carry forward tax losses in Australia?

Yes, individuals in business can carry forward tax losses to offset future income. However, these losses can’t be applied to personal income, such as salary or wages, unless certain rules are met. 

 Can capital losses be carried forward in the same way as revenue losses?

Yes, capital losses can be carried forward in Australia, but unlike revenue losses, they can only be used to offset capital gains, not regular income. 

Final thoughts 

Carry forward tax losses can be a powerful tool for reducing future tax liabilities. Whether you’re a business or an individual with investment income, these losses can help lower the tax you owe in profitable years.

If you’re unsure how to get the most out of your tax losses, you might consider working with a registered tax agent. Tax laws can change, and the rules involved in applying losses might be difficult to understand or apply. Having expert advice can help you ensure easy compliance with the rules and make smart decisions about when and how to use your losses. This can help you maintain your business’s financial health and optimise its tax position for the future.

Lawpath’s business tax compliance services can help ensure you get the most out of this opportunity, so let us help you maximise your tax savings and strengthen your business finances!