Tax Losses

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The tax treatment of Case I, Case II, Case V, and capital losses are areas that will require the attention of many accountants in the coming months as the income tax filing deadline approaches. This review does not deal with the tax treatment of specified reliefs as they only impact a minority of high income individuals.
Case I losses
At the outset, it is worth noting the changes made in the Supplementary Budget to the taxation of persons engaged in dealing in, or developing, residential development land. The 20% income tax rate for dealing in, or developing, residential land was abolished. With effect from 1 January 2009, all profits will now be taxed at the marginal rate. For all tax returns submitted after 7 April 2009 (e.g. income tax returns up to and including 2008), residential land losses will generally only be relievable (on a value basis) up to a maximum of 20%. Losses forward from previous years will also be treated on a value basis. This represents a dangerous precedent in our tax system as it is effectively introducing retrospective taxation.
Where an individual has an accounting year ended say 31 March 2009, all the profits from residential land will be subject to the higher rate of tax. This differs somewhat from the tax treatment of companies: where companies have an accounting period straddling the year end, they will be treated as having two tax periods in their accounting year.
S381 TCA 1997 allows a person to offset losses from a trade, profession or employment against, firstly, other income of the individual (e.g. rents, dividends, employment income) or, in a case where the individual is married, against the income of their spouse. The losses of a trade are to be computed in the same manner as profits. Capital allowances can be used to create or augment a loss.
Any claim for relief under S381 TCA 1997 must be made within two years of the end of the year of assessment.
S382 TCA 1997 allows a person to carry forward excess losses from a trade or profession not already utilised under S381 TCA 1997 to future years, to offset against profits of the same trade or profession. It is not possible to offset losses carried forward against, say, investment income or employment income. Relief under S382 TCA 1997 is to be given against profits of the first year of assessment. It is not possible to carry losses forward and save them for a period in which income would be taxable at the marginal rates (41%), rather than only use them against income in an earlier period taxable at the standard rate (20%). Losses forward cannot be offset between spouses.
There are specific provisions relating to losses arising from a farming trade. Where a farmer incurs losses for three consecutive periods, any losses arising in the fourth period can only be carried forward to offset against future profits of the same farming trade and cannot be offset against other income under S381 TCA 1997.
Terminal loss relief is available where a trade or profession is permanently discontinued and the person carrying on the trade has incurred a loss. The relief allows a person to carry back the loss to the three preceding years of assessment, and receive a refund of tax paid on the profits in those periods to the extent that the losses allow. Where there is a cessation of a trade, accountants should be cognisant of the cessation provisions with regard to the change of the prior period to the actual basis of assessment where profits are not already assessed on the actual basis (31 December year end). These rules only apply where taxable profits on the actual basis in the prior year would exceed the profits originally assessed.
In this regard, it is also worth noting the special provisions for short-lived businesses, i.e., where a business commences and ceases within three tax years. Under these provisions, the aggregate taxable profits for the three years of assessment may not exceed the profits actually earned in the period. An election for this treatment must be made before the specified return date for the year of cessation.
Case II losses
Partnership profits and losses are taxed under Case II. The rules relating to loss relief under Case I detailed above apply to Case II with some exceptions. Where a partnership incurs a loss, the loss cannot be apportioned so as to give any partner a profit for tax purposes, irrespective of the provisions of the partnership agreement. Furthermore, loss relief cannot be claimed by the individual partners for more than the total partnership loss. Similarly, where a partnership makes a profit, no partner can claim relief for any loss, nor can partners be taxed on more than the total partnership profits. Different partners may use their share of a partnership loss in different ways for the purposes of relief. For example, one partner might claim relief under S381 TCA 1997, while another might claim to have his/her share of the partnership loss relieved under S382 TCA 1997.
Anti-avoidance legislation exists to prevent the use of losses incurred by certain partners in a partnership under S1013 TCA 1997. The legislation restricts the right of limited partners and general partners, who are not active partners (as defined by S1013 TCA 1997), to offset losses, interest, and capital allowances of the partnership against non-partnership income. The use of losses by non-active partners in a partnership was covered in the article ‘Tax planning in a recession’ in the spring issue of Accounting Matters and may be referred to for guidance.
Case V losses
S384 TCA 1997 deals with Case V losses. Case V losses are those arising from Irish rents, and are specifically described as: “the aggregate of the deficiencies computed in accordance with S97 TCA 1997 which exceed the aggregate of the surpluses as so computed”. This can be taken as meaning the excess of rental expenditure over rental income.
All Case V income is treated as arising from one source, therefore where there are a number of let properties, losses arising on one property may be netted against profits arising on another property. There is no provision in tax law where Case V losses incurred by one spouse may be set against the profits of the other spouse. This contrasts with excess capital allowances, which are specifically provided for under S305 TCA 1997. Although historically, some tax districts allowed the set-off of losses, Revenue are of the view that they are precluded by the legislation from granting the set-off. However, Revenue may be issuing some guidance reaffirming this position in the coming months. S305 TCA 1997 provides that Case V income is reduced by capital allowances forward in priority to current year capital allowances. Accordingly, this would increase the amount of current year capital allowances available to set against total income.
Losses carried forward are to be deducted from the profits on which the person is assessed under Case V. The argument is that capital allowances are made in charging the income and, therefore, it is only the assessed profits, i.e., after capital allowances, which fall to be relieved in the computation.
Consequently, losses carried forward are the last in the sequence to be relieved. The Revenue view is that Case V losses carried forward are available for offset against the Case V income after capital allowances (carried forward and current year). The alternative view is that the losses carried forward should be set against the current year Case V income in priority to capital allowances. The legislation is far from clear in this area and is open to interpretation.
Capital gains tax losses
A loss is calculated in the same manner as a gain. The same rules apply as to the consideration chargeable and the expenditure allowable. There are, however, restrictions on the use of indexation in computing a loss, and also in computing a loss on certain non-wasting chattels. Indexation is still available for expenditure incurred prior to 2003. It cannot be used to either create or increase a loss. If a gain on the disposal of an asset would not be chargeable, then a loss arising on the disposal of that asset is not allowable. In addition, where the person making the disposal is an individual, and is not domiciled in Ireland, any losses accruing to him on the disposal of assets situated outside Ireland are not allowable losses for capital gains tax purposes whether the proceeds of sale are remitted into Ireland or not.
Unused capital gains tax losses are carried forward and must be set off in the next earliest possible year against any net gains of that year, and any unused balance carried forward to the next year, until all losses forward are used up against gains of those future years. In any year, losses may be set against gains liable at the highest rate of tax.
Except in the case of a capital gains tax loss arising to an individual in the year of his or her death, relief by way of set-off of a loss against chargeable gains cannot be given for a year of assessment earlier than the year of assessment in which the loss actually arose.
In the case of a married couple, surplus losses of one spouse may be set against gains of the other spouse. Terminal loss relief is available to the personal representatives of a deceased person. The deceased’s allowable capital losses which arise in the year of death may be set against pre-death capital gains of that year and any excess may be set back against the chargeable gains for the three years of assessment before the year of assessment in which he or she dies. Terminal loss relief only applies to the excess losses after chargeable gains of the year of death are sheltered. Terminal losses must be set against later gains first, before setting them back against gains of earlier years.
Care should be taken when dealing with losses arising on disposals to connected parties, or losses that are crystallised on share portfolios. Again, this issue was covered in the article ‘Tax planning in a recession’ in the spring issue of Accounting Matters and may be referred to for guidance.