In the case of an ordinary limited liability company, losses can be carried forward and be used to offset against future profits, thus reducing future tax payable. Losses might also be used to justify commercially prudent risk taking behaviour in regard to potential tax liabilities since they can be used to pay penalties.
A key factor is to ensure that there is 49% or greater continuity of shareholding from the beginning of the year of loss until the end of the year when they are used (various other rules also apply). Losses must be used on a first in first out (FIFO) basis.
If you breach the continuity requirement your losses will be gone forever. If you do not use your losses on a FIFO basis this will impact on available losses and it may also create a tax and penalty liability.
A simple scenario is as follows:
Jill and her father Mark form an ordinary company called Jillmark Limited which they use to buy an investment property. Mark owns 75% of the shares in Jillmark Limited, and Jill owns 25%. In the first year Jillmark Limited makes losses of $10,000. In the second year Jillmark Limited makes losses of $20,000.
After two years Mark decides he needs to sell his shares in Jillmark Limited as he needs the money. He sells half of his 75% holding to a friend John and the other half to Bert who is unconnected. The shareholdings are now:
The sale of Mark’s shares means that Jill is the only continuing shareholder and therefore that shareholder continuity = 25%. This is less than the 49% required so the taxable losses are lost and they cannot now be used against future income of the company.
Taxable losses have real value. Even if the company that has incurred the losses has no prospect of future income against which to offset the losses, there may be other ways to benefit from them. Before making any changes to shareholders, or their rights, you need to consider the impact on the company. Doing so after changes have been made may be too late.