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To be precise, “tax Loss” is defined as an excess amount of deductible expense over gross income for the relevant business year in calculating the amount of income for each business year (Corporation Tax Law (“CTL”) Article 2 Item 19).
The state that deductible expense excesses over gross income means that a company does not have enough earnings for tax purpose (income) to bear tax liability.
It is quite natural that a corporation tax is not taxed for the business year in such a state, and moreover, the company is able to deduct the tax loss incurred in the business year from the income generated after the following fiscal years (CTL Article 57 Para 1).
If the income for the following years is positive, it means the company has enough tax-bearing capacity, so it seems likely that the government can impose corporation tax normally.
Why do we need to allow the company to deduct the tax losses carried over from the previous year to the taxable year?
Corporation tax is imposed on the income of each business year by “fiscal year” of a corporation (CTL Article 5).
The fiscal year of a corporation is a period artificially separated in order to calculate the business results (earnings) for certain period of time.
So a company may generate profit in one fiscal year but incur loss in the next fiscal year and vice versa.
Considering such possibility, you can not judge whether the business of the corporation is really going well or not unless you overlook profit and loss for several years.
The same way of thinking is appropriate to evaluate tax-bearing capacity of the corporation tax.
If a company generates large income in the following year of tax loss but the corporation tax is imposed on all of that income based on “year by year” basis, a company have to pay the tax before it regains tax-bearing capacity lost in the previous year.
Therefore, even in the corporation tax arena, offset of tax loss against current taxable income (deduction of tax loss carry-forward) is allowed.
However, there are some conditions.
First of all, the tax loss should be incurred in the fiscal year for which the “blue” tax return was filed.
And, after that, the final tax returns are continuously filed (Article 57, paragraph 10 of the law).
If you think “there is no tax payment due to tax loss this year, so it is okay not to file the tax return” then did not file the return, you cannot carry forward the loss to the following fiscal years.
To file the “blue” return, you need to get approval from the Director of the Tax Office (CTL Article 121 Para 1).
If you are not approved but submit the blue return, it is regarded that you filed a “white” return and the tax loss carry forward will not be allowed.
Also, approval of “blue” may be revoked later.
A common reason is that the installation, recording or preservation of books and records required by the law (CLT Article 126 Para 1, Articles 53 – 59 of Ministerial Order for enforcement of the CTL (hereinafter “CTLMO”)) are inaccurate (CTL Article 127 Para 1 Item 1) or disobedience to instruction from the director of the tax office (CTL Article 126 Para 2, Article 127 Para 1 Item 2).
If the “blue” return filing is revoked, carry forward of tax loss incurred for relevant fiscal year is not allowed.
I strongly recommend that you first apply for “blue” return filing immediately after establishment of your company.
The premise of approval is “to record all transactions that affect assets, liabilities and capital in an orderly and light manner in accordance with the principle of double entry bookkeeping and to prepare financial statements based on that record” (CTLMO Article 53).
So, of course, you have to establish a system that enables proper recording and retention of books and records from the time of the application.
If you say “I cannot do it” afterward, the approval will be revoked and tax loss carry-forward is also retroactively disallowed.
It will be disaster if it turns out after your company becomes profitable and having large taxable income.
The tax loss incurred in the business year starting on or after April 1, 2018 can be carried forward for 10 years.
For instance, tax loss incurred for the fiscal year ended on March 31, 2019 can be carried forward to the fiscal year ending on March 2029.
The carry-forward period of the tax loss incurred before April 2018 is 9 years.
Tax losses that can not be used (deducted) within the carry-forward period will expire.
You can only claim deduction of the tax loss carry forward up to 50% of the income before the deduction.
In other words, no matter how much tax loss carry forward you have, half of the income generated during that year will be taxed.
In the past, there was no such limit, but in exchange for lowering corporate tax rate, the upper limit of the deduction has been gradually reduced from 80% to 65%, 60%, 55% then 50%.
It is a good thing that the carry-forward period was extended for one year, but it is anticipated that many corporations become not able to utilize the tax losses within 10 years due to tightening the limitation.
However, (i) small and medium enterprises, (ii) public interest corporations, etc., (iii) cooperatives, etc, (iv) unincorporated associations etc. are able to claim the deduction not subject to the limitation (CTL Article 57 Para 11).
Please note that for the purpose of (i) above, a wholly owned subsidiary of a large corporation (a corporation whose share capital or equity capital is 500 million yen or more) is not regarded as “small and medium enterprises” (CTL Article 66 Para 6 Item 2, 3).
Therefore, corporations that expect utilization of the tax loss carry-forward should pay attention not only to their own capital but also to the capital amount of the parent company or its affiliates.
Especially if you have any plan of capital increase, you need to carefully consider the timing and amount.
Otherwise, you may be subject to unexpected limit and end up with unexpected tax burden.
Capital is an important factor in decision making for tax purpose.
I have summarized it in my blog “Capital and tax planning”.
Please refer to the blog as well if you are interested in it.
“Refund for carry-back” is a system which refunds corporation tax of the previous year in case that tax loss is incurred in the following year.
The refund is entitled when a company paid corporation tax for the fiscal year (hereinafter referred to as the “refundable income year”) commenced within one year prior to the start date of the fiscal year in which the tax loss was incurred (CTL Article 80 Para 1).
Again the “tax loss” herein is limited to the tax loss incurred during the fiscal year for which the “blue” return was filed (blue tax loss) (CTL Article 80 Para 3).
Application of this refund has been temporarily suspended for fiscal years ending between April 1, 1992 and March 31, 2018.
During that period, only small and medium-sized corporations and legal entities under liquidation were able to apply the refund under certain conditions but finally the restriction has been lifted from the fiscal year ending after April 1, 2018.
West Japan suffered severe flood damage this year.
As for such disasters (caused by earth quake, wind and flood, fire, cold, snowing, drought, lightning strikes, volcanic eruptions and other natural phenomena and extraordinary disasters caused by artifacts, pests, noxious animal and other creature), there is a special rule of tax loss carry-forward and carry-back that does not require filing of “blue” return as a condition (CTL Articles 58, 80 Para 5).
Basic rules such as the 10-year carry-forward period, the 1-year carry-back, the 50% deduction limit (small and medium corporations, etc. are exempted) are the same as “blue” tax loss.
Any taxpayer including the “white” return filing taxpayer is able to carry forward or carry back the tax loss for casualties on its properties such as inventories and fixed assets.
I suppose the purpose of limiting the scope of the loss is to facilitate recovery from the disaster.
So I personally think the limit on the period and deduction should be more relaxed so that the damaged taxpayers surely regain tax-bearing capacity.
The tax loss naturally provides tax saving opportunity (supplement of tax-bearing capacity) but it can be schemed for tax evasion.
In the past, there were some M&A cases where the acquisition price was raised because of expected tax benefit of the tax loss carry-forward the target company had.
To restrict such “trading” of the tax loss, the tax law has been changing and providing more and more conditions for utilization of the tax loss.
That is why the corporations experienced mergers, corporate divestitures, etc. have to satisfy so many complex conditions to utilize the tax loss assumed from other companies through the corporate reorganization.