The New Business Continuity Test for Carrying Forward Tax Losses
The new “Business Continuity Test” which allows businesses to carry forward tax losses despite a change of ownership has now been introduced.
The test allows a company to carry forward a tax loss despite a majority share change of ownership so long as no major change in the nature of its “business activities” occurs within a defined “business continuity period”, except for a “permitted major change”. The IRD has issued some commentary on how the test is to be applied. Here we present an overview of the test and its likely application.
The “business continuity period” runs from immediately before the change of ownership to the earlier of:
- The last day of the income year in which the carried-forward tax loss is used; or
- The last day of the income year in which the fifth anniversary of the change of ownership falls.
The phrase “business activities” was deliberately chosen to ensure the broad scope of a company’s operations are taken into account. In assessing whether or not a major change in the nature of business activities has occurred, the IRD is specifically required by law to consider the extent to which the assets used in deriving income have stayed the same or similar, but the IRD has stated it will also consider other factors such as changes in business processes or in products and services supplied. Basically, the IRD just wants to know whether or not the change in ownership has resulted in one business ending and a new business beginning, and will use the extent of continuity in business activity to determine this.
“Permitted major changes” are intended to capture major changes to the business that are a consequence of natural development of the business (rather than the change of ownership), that position resources to maximise returns and are driven by commercial reasons rather than the availability of tax losses. The four permitted major changes are changes:
- Made to increase the efficiency of business activity;
- Made to keep up to date with advances in technology;
- Caused by an increase in the scale of business activity; and
- Caused by a change in the products or services provided.
Again, the purpose of the business continuity test is to permit the carry-forward of tax losses despite a change of ownership where the company remains essentially the same business, and the permitted major changes reflect this.
The new business continuity test is intended to encourage business innovation and capital investment, especially in the post-Covid economic environment. Lets hope it does so.