Tax on a loss

Hypothetical question...

If you were looking to start a business and it did not make a profit until the second year, how would that initial loss be treated in different structures?

Ie, individual, discretionary trust and company structure.

Say you make $100, spend $200 on business expenses.

Individual and Trust -> Loss offsets other income of individual/beneficiary, if no other income, is the loss kept for the next year/until there is profit?

Company -> Loss kept until there is a profit to offset?

Is my understanding correct?

 

Thanks for the quick response.

 

Small startup businesses not being primary production often have problems with Division 35.

Basically, if you turnover is below a certain size, or business assets below a certain size, or you have not established a pattern of profits then business losses might be quarantined and carried forward to future years of business profit. You cannot set off the losses against other income in that year.

Like all simple taxation ideas, it is very complex in its application though.

Cheers,

Rob

 

Robs referrring to non-commercial losses. If the business passes one of a number of tests, then you may be able as an individual (or a partner in a partnership) to offset that loss against other income. Otherwise it is carried forward until such time as the business is profitable.

 

Thanks MattR,

I didn't do a good job of explaining did I ?

Cheers,

Rob

 

I suppose what I'm looking at is the tax implications of the following...

Say I have an idea for a product and I go and get a patent on that idea. I'm not in this alone, there are two of us. To date we've just been working on the idea in our spare time, there have been minimal costs.

We'd like a business structure to sell or licence the patent at a later date. Naturally there will be a few years of testing and small sales/licences before we could hopfully sell the patent for a reasonable sum.

Naturally there will be a few costs to setup the business/patent, are these capital in nature?

We would probably make a small loss in the first year, reasonable gain in the second year and large gain in the 3rd year + sale of patent.

Would the sale of a patent trigger a CGT event? Would a certain structure reduce the liability of this?

I'm only really looking at this in terms of forming a partnership, discretionary trust (with and without company trustee) or company.

As I mentioned earlier, this is purely hypothetical and before actually doing this I'd be looking to consult a solicitor, accountant etc. I guess I'm just thought here would be a good place to bounce some ideas around in terms of the taxation/limited liability/setup costs of the whole thing.

 

I think you should get some advice from a specialist firm in intellectual property.

It sounds like you may need external finance if you want to take out international patents or copyright (and enforce it). Also, you need to protect the property from any 'investors' that might venture capital to you. Also, you will be putting a lot of your own unpaid effort into developing the asset as well as advancing your own funds, so some security taken over the assets created may be wise.

Your advisor will need to establish whether you will be actually carrying on a business rather than merely earning income from property - being royalties, etc. This may have a bearing on qualifying for any R&D tax concessions. e.g. the way you exploit the asset is crucial, e.g. granting exclusive licenses versus generic licensing has a huge impact tax wise.

Just a very few of the factors they would need to take into account.

If you jump the gun and end up holding assets in the wrong sort of entity then it could be expensive transferring them.

Do yourself a great favour and get some specialist advice from a law firm in this area. You could ring up your local Law Society to find a specialist.

Cheers,

Rob

 

I'd say this probably isn't the "done thing" around here, however I don't really know anyone else who can help with this sort of stuff....

The reason I asked the above questions was for a tax law assignment that we have. It is supposed to be pretty basic - highlight pros and cons of different structure and advise where to hold the patent for asset protection.

From what I've read it gets very complex, especially with things like Carey’s Case (which I read about on here).

I'm still not sure what structure to use for this patent... if any of you wouldn't mind just having a quick flip through what I've written I'd be most appreciative.

I guess I'm really just curious as to if you think I'm on the right track suggesting the patent be held in trust, company as trustee and later on sell the company.

The other option I've seen is here

Any feedback would be greatly appreciated. If this isn't acceptable for the forums I apologise and the content can be removed.

 

I only had a very quick look - sorry.

Concerns:

1. Initial losses - trust and company problems in carrying forward (requirements such as continuity of business or ownership etc. - even more difficult with trusts. Partners share losses and can be set off against other income subject to Division 35.

2. Is the patent a depreciable intangible asset (intellectual property) ? In which case no CGT to the extent it is used for a taxable purpose - just balancing charge issues. ( Does this remove some incentive for holding in a trust ?)

3. How would you finance the operation ? The trust company is a passive asset holder while the trading company has no assets and is expected to initially make a loss while building up the business. I suspect the owners will be going guarantor on loans which exposes them to risk regardless of the entity (a common problem with small business). If they register a charge over assets as security this may expose trust assets to their personal creditors ???

4. If the trust is a passive asset holder and separate entity to the business then will there be any R&D concessions claimable by either entity ? (I don't know much about this area).

I don't know what level your course is pitched at ... I might just be complicating a straighforward assignment and distracting you so I won't drone on. It really needs a detailed read sometime.

Cheers,

Rob

 

Thanks

1. It seems they do not have any other income, does this mean they can use the loss next year?

2. The patent would be intellectual property but I would have thought since it is going to be sold for millions that you wouldn't be able to depreciate it. It is being used for a taxable purpose though, any idea which div I could find more info on the 'no CGT' comment you made?

3. We've been told they are using their savings for finance.

4. I have read about being able to claim 125% for R&D in some cases, I'll include a note about this.

Thanks again for the help, do you think having a trust with company as a trustee and the assets held in the trust will protect the assets to a certain degree and allow for the company/trust to be sold off with ease?

Or would you have a company hold the asset and a rental agreement with a partnership and simply sell the company when the time comes?

 

OK the simple answer is that you probably want to hold your valuable assets in a trust with a corporate trustee that does not participate in any risky business. (we ignore trading trusts ?). Additionally the discretionary trust can distribute concessional income items by streaming, and can vest proceeds of the ultimate disposal of the capital without CGT problems, unlike unit trusts or companies.

The risky operation is conducted by a company that has limited liability and can soak up excess income at 30%. The problem is getting the deferred income out again - franked dividends are a 'top-up tax' but if there are concessional deductions then these are unfranked. If the assets qualify for CGT concessions then you still have to get them out as a dividend. Best options are to sell shares in the company (CGT discount) or wind it up (liquidator's dividends generally don't get taxed on items that are not profits).

If you gift the patent to the trust and then the company purchases a license to use and develop this as a product then *MAYBE* the company can claim the costs under the R&D concessions. This may mean that up to 100% of the cost of acquisition 1st year might be claimed along with up to 1/3 of related activities, and some this might be a REFUNDABLE TAX OFFSET for small startups - even though you make a loss !! (Eligibility is quite strict).

If no R&D concessions then the license will be a depreciable asset of the company (Div 40), written off over the duration of the license - and not a refundable deduction, meaning carry forward losses.

Note there are R&D tax clawback problems when the business is sold.

The trust, by granting the license, will be deemed to have part-disposed of its assets, giving a balancing adjustment - but acquisition was by gift and disposal may be to a related party? However, if the time frame between acquisition and disposal is small then there might not be an issue. Further fees derived will likely be royalties, the revenue income of the trust for distribution.

I am not sure how detailed your assignment should be, and I am only venturing information on the basis that this is a purely theoretical plan. There are always other solutions based on circumstances.

Be sure to acknowledge the InvestED forum owners as they have copyright to material posted here (even though they deny any liablitiy for the content - eh Sim ?).

Cheers,

Rob

 

Forgot a couple of useful readings.

Division 40, ITAA97

TR 2002/19

Good luck,

Rob

 

And it looks like I have omitted the initial costs of taking out the patent ! This has a flow-on effect. Issues to consider:

A mere idea or unregistered design is a capital asset of the owner.

Getting the idea into the trust may have CGT problems, deeming provisions ??

The Trustee incurs expenses to register it (with no income to pay - gifting to trust after being slugged with CGT?), upon which it then ceases to be a CGT asset (how would you handle this ??).

It might be better to patent in the original owners name & then promptly transfer ownership to the trust ??

Too many questions & too little time ... that's why advice costs I guess.

Cheers,

Rob

 

Thanks heaps for your help.

Just one last question, am I right in thinking, if a loss from a partnership is distributed to an individual, and they have no other income. Is that loss availiabe to offset income in a future year?

 

Isnt it accountant busy season? Anyway thank you for providing such detailed responses for someone who is not a client of yours...

As an accountant myself i feel its discusting that universitys dont teach this type of stuff, its up to the individual to learn it and at our uni Tax Law is an elective.

 

Hi Dave,

I have to agree, it is very humbling to come out of Uni with straight HD's and not have a clue about how to run a business or do a tax return.

I guess in the past, Accounting was progressively studied as professional qualifications while you worked in a practice and you picked things up by 'osmosis' from the world of business & commerce.

The content of most uni courses is dictated by the profession, but it is taught as full time academic study without hands-on practice. In fact some of my colleagues would regard the practicalities as a bit 'TAFE' which is very snobby in my opinion, and denies an important opportunity.

Its not the kid's fault that they have never owned property, drawn a salary or run a business and yet you need that understanding to put the teaching in context.

Far from making work placement compulsory, the pressure is on to drop content and churn Accountants out faster to meet the national shortfall. Not to mention the turf war between the professional associations which is lowering the standards of conversion courses from other disciplines (down to 6 months in some cases !).

And what about the expectations of the students ? They come out of uni feeling all accomplished only to find they have just started at the foothills of a great mountain of learning for such a broad subject. Not surprising many abandon the discipline and follow other paths.

Those that want to continue have to throw themselves on the mercy of an employer who is prepared to train and pay for their further professional learning. That is a big drain on the resources of a small firm, and a big risk given the person is straight from uni with no work history.

There has to be a better way ...

Cheers,

Rob