The new rules about the Corporation Tax loss relief have dramatically changed the scenario for the Spanish companies for 2015 onwards.
Traditionally, the rules governing this important tax issue, especially in the last years due to the impact of the financial crisis, were pretty simple:
- Tax losses where offsetable against future tax profits regardless the source of said losses. For instance, a capital loss could be freely offset against normal trading profits. No distinction whatsoever was made in this respect.
- There was a carry forward period for tax losses of 18 years. Tax losses were not allowed to be carried back to offset prior years taxable profits.
- Some limits were in place to avoid the double computation of losses when a substantial change in the ownership of a non-active company took place.
The new regulations have introduced substantial changes in this respect. The main change is that the tax loss relief cannot exceed 70 % of the current year’s taxable profits but, on the other hand, the carry forward period has been extended indefinitely (not just 18 years). Furthermore, in any case companies can offset prior year’s tax losses up to one million Euro. There is a transitional period so that in 2015 there are further limits depending on the previous year’s turnover and in 2016 the limit will be 60 % of the current year’s taxable profits.
The computation of the 70 % (60% in 2016) limit has some complexities
Haircut arrangements or debt release agreements
If the company has entered with its creditors a haircut arrangement or debt release agreement, the tax loss relief limit does not apply to the income registered as a consequence of these arrangements.
Example: Company ABC has in 2016 a taxable profit of 3 million Euro. During this year the company reached a debt release agreement with her creditors for 1.2 million Euros, which was registered as income in the books. In 2015 ABC had a tax loss of 2.5 million Euro. What would be the 2016 taxable profit after applying the 2015 tax loss relief?
Answer: the 2016 taxable profits must be split in two parts: the general one to which the limit applies and the one corresponding to the debt release agreement, which is not subject to any limitation. The income for the debt release agreement is EUR 1.2 million and the remaining taxable profits would therefore be 1.8 million (3 – 1.2).
Then the tax loss relief will be:
Tax loss relief applicable to the general taxable base: 1,800,000 * 60 % = 1,080,000
Tax loss relief fully offsetable (debt release): 1,200,000 * 100 % = 1,200,000
Tax loss relief for the year: 2,280,000 (1,080,000 + 1,200,000)
2016 taxable base: 3,000,000 – 2,280,000 = 720,000
Note that the 2015 tax loss which has not been offset against the 2016 taxable profits (2,500,000 – 2,280,000 = 220,000) can be carried forward and be offset in the future without any time limit. Moreover, since this amount is below the one million threshold, which is always allowable, it could be offset in the future without any limit.
Startups are not subject to this limitation so that all the tax losses incurred before the first year of profits can be fully offset against that year’s taxable profits and the following two profitable years. After that period, the general limit would apply. This feature is quite interesting together with the reduced tax rate applicable of 15 % applicable to the two first profitable years.
It is also important to remark that the tax loss relief limit is applied to the current year’s taxable profits before computing the deduction for the “reserve of capitalization”. Therefore, the application of said tax deduction will not cause the harmful side-effect of reducing the tax loss relief. See our post about the reserve of capitalization.
Change of ownership
Before 2015, when a substantial change of ownership in an inactive company took place, the offsetable tax losses were reduced by the amount of the losses suffered by previous shareholders on the disposal of the shares of said company. The purpose of the rule was to avoid a so called “double dip”, that is, the double computation of losses: once in the hands of the sellers and once in the company being sold.
The new rules approved have changed that in two important aspects from 2015 onwards. Now, if a company experiences a substantial change in his controlling interest AND some circumstances exist, then the right to offset previous year’s losses is completely disallowed.
The circumstances that trigger the disallowance of the tax loss relief have in common that the acquisition of the company seems to lack any valid economic reason. These circumstances are:
- The company being sold has been inactive during the three months preceding its acquisition by the new shareholders. This was the only reason that existed before to reduce the tax loss relief.
- The company is an asset holding company not engaged in any active trading
- During the two years following its acquisition by the new shareholders, the company changes his business or trade to a different activity.
- The Tax Office has revoked the license of the company for not filing the Corporation Tax for three consecutive years.
The “tax levelling” reserve
Spain has never allowed the carry back of tax losses and this principle remains unchanged. However, the new Corporation Income Tax Law has created a new tax allowance, called tax levelling reserve (“reserva de nivelación”), which to certain extent has a similar effect. Thus, Small and Medium size companies (“SME”), that is, companies with a turnover the previous tax year below ten million Euros, are allowed to deduct 10 % of the taxable profits and allocate them to that special reserve. This reserve must be used to offset the losses incurred by the company within the five years period following its creation. When this reserve is released the tax deduction must be recaptured diminishing, or even cancelling, the tax losses of that year. If during the five years period the company does not incur in any losses, then the reserve must be released – and the tax deduction recaptured – at the end of the period. The deduction is limited to an annual limit of one million Euro.
Example: Company ABC, a SME, has in year “n” a taxable profit of EUR 2,500,000.Calculate (i) the tax levelling reserve in year n (ii) the taxable base in year n and (iii) if in year n+4 the company has a loss of EUR 100,000 and in year n+5 has a loss of 50,000, explain the effect on these years taxable base.
The tax levelling reserve of year n would be of EUR 250,000, that is, 10 % of the taxable profit of 2,500,000. Therefore, the taxable base of year n would be of 2,250,000. In year n+4 the company has losses, so it is obliged to release the reserve and recapture the tax deduction. Then, the taxable loss will be reduced by the amount of the tax levelling reserve; so the taxable loss would be cero (100,000 – 100,000 out of the tax levelling reserve). In year n+5, the company has a loss of 50,000. Since this is the final year of the period, the unused part of the tax levelling reserve of year n – 100,000 – , must be fully released. Then, the taxable base of year n+5 would be a positive taxable base of 50,000: (50,000) + 100,000.