If your business has not paid income tax for the past four years due to perpetual tax losses, then this article is for you. The rules of the game are changing. You may be required to pay income tax earlier than you anticipated That is despite that huge credit of unrelieved tax losses in your balance sheet
It is crucial (especially for non-tax experts) to point out that the way a taxable profit or loss is determined is prescribed by the income tax law. The 'taxable profit' may not necessarily equal the accounting profit. Accounting profit is determined by the accounting rules. Almost always, the tax profit or loss differs from accounting profit or loss.
So, technically, a company can have an accounting loss but a taxable profit. Especially when some business expenses are not accepted deductible expenses for tax purposes. Vice versa is also true. An entity can have an accounting profit but still record a tax loss. This happens, for example, when there are investment incentives such as accelerated capital deductions, investments credits, or sometimes, 100 percent capital deduction. Or due to huge investments in machinery or equipment at the beginning of business operations (where revenue is still small), a business may also experience a prolonged period of tax losses. The good thing is that taxpayers can, indefinitely, carry forward tax loss in one period to the next period until it is fully exhausted. But there is a myriad of other reasons for a business to find itself in a prolonged loss position. Some are very legitimate. But some of can also be artificial. For example, because of various tax avoidance schemes.
In a simple way, for businesses, income tax is a tax on 'profit'. Generally, no income tax is payable when a business has made no taxable profit Of course, th.is rule is not without exceptions. Businesses in perpetual tax loss, for example, maybe taxed on their turnover. This is called an alternative minimum tax (AMT). Originally, AMT was to apply to entities that were in perpetual loss due to tax incentives. But later, this was widened to cover all perpetual loss-making regardless of the reasons.
The Finance Act, 2020 has brought in yet another rule to deal with perpetual income tax losses (ie. Introduction of section 19(2) into the Income Tax Act, Cap 332).
If your business has unrelieved tax losses for the four previous consecutive years of income, then the new rule restricts the deduction of previous tax losses in your fifth year if, in the absence of the unrelieved tax losses, you would have a taxable profit That is, in the fifth year your taxable profit cannot be reduced below 30 percent by the unrelieved tax losses. A simple example may be useful here:
Before adjusting for unrelieved tax losses of Sh250 million accumulated in the last four years, Company X has a taxable profit of Shl20 million in the year 2021. In the absence of the new rule, Company 'X' would not pay income tax in 2021. Because the losses (Sh250 million) wipe out the entire taxable profit for the year 2021 (Shl20 million) and still unrelieved loss of Shl30 million remains to be carried to subsequent periods. But with the new rule, Company 'X' will pay tax in 2021. How? The new rule says, Company 'X' cannot adjust its taxable profit (Shl20 million) in 2021 by the unrelieved losses to below 30 per cent of that taxable profit (i.e. 36 million, which is 30 percent of 120 million). Therefore, Company ‘X' would pay Shl0.8 million in 2021 as income tax (i.e. apply a tax rate of 30 percent on 36 million).
The new rule does apply to corporations undertaking agricultural business or providing health or education services.
By Shabu Maurus, Tax Partner, Auditax International.