A Loss-Making Year in Your Business: How It Is Carried Forward for Tax Purposes

Accounting Loss and Tax Loss: They Are Not the Same

The loss shown on a business's balance sheet does not always coincide with the loss recognised for tax purposes. To determine the tax result, non-deductible expenses are added to the accounting results. In a loss-making year this means that non-deductible expenses reduce the tax loss that is carried forward. For example, an accounting loss of €10,000 that includes €2,000 of non-deductible expenses leads to a tax loss of €8,000, and only that can be carried forward.

The Five-Year Rule

Under article 27 of the Income Tax Code, if the result from business activity in a tax year is a loss, that loss is carried forward and offset against business profits of the following five tax years. The following basic rules apply:

• The loss of the earliest year is offset first, before the loss of a later year
• The five-year period starts from the tax year following the one in which the loss arose
• If the loss is not used within the five-year period, it is permanently lost and cannot be offset later

What the Loss Is Offset Against

A loss from business activity is offset exclusively against future profits of the same business activity. It is not offset against other income of the individual, such as salary or rents of the same year. This means that a freelancer with a loss in their business cannot reduce the tax on a salary they may receive in parallel. A special rule applies to losses arising abroad: they are offset only against business profits that also arise abroad.

Three Examples from Practice

When the Right to Carry Forward Is Lost: Change of Ownership

The law provides restrictions on loss carryforward when a company's ownership changes significantly. If, within one tax year, the direct or indirect participation in the capital or voting rights changes by more than 33%, the losses may no longer be carried forward, subject to conditions that also concern changes in the company's activity. The exception is that the taxpayer can prove the change was made for commercial or business reasons and not for tax avoidance. In practice, the entry of a new shareholder, a share transfer or an acquisition can put accumulated losses at risk, which is why the tax review must take place before the transaction, not after.

Sole Traders and Conversions: Special Cautions

Special rules apply to sole traders and freelancers, such as those concerning the minimum imputed profit, which may limit the usefulness of loss carryforward. In addition, in cases of converting a sole proprietorship into a company or a merger, special provisions apply to the fate of losses, and transferring them to another legal entity is not automatic. In both cases, an individual assessment is needed before any decision.

The Most Common Mistakes

1. Failing to record and monitor the tax loss by year, so it is not taken into account when profits appear
2. Confusing the accounting loss with the tax loss and calculating the offset with the wrong amount
3. Inability to track the five-year period and loss of a loss that expired without being used
4. Admitting a new partner or selling shares without checking the impact on carried-forward losses
5. Expecting the business loss to reduce the tax on the owner's other income, such as salary or rent

5 Practical Tips

1. Ask your accountant for an annual register of tax losses showing the amount and expiry of each loss.
2. Plan the use of the loss: if you expect profits, there is no reason to accelerate revenue or delay expenses just to 'show' a profit.
3. Before admitting a new partner, transferring shares or an acquisition, check the impact on accumulated losses.
4. Do not let fines and undocumented expenses reduce your tax loss.
5. If you are starting a business, consider with your accountant the depreciation deferral privilege for new businesses as part of the overall tax planning of the first years.