Tax losses deductions are an essential part of corporate tax systems. A tax loss occurs when the total tax expenses are greater than the total tax revenue, under the tax reporting rules of an applicable jurisdiction. The tax loss is not lost, as can be offset against future tax liability, under a set of rules, unfortunately, these rules have been in a constant state of uncertainty over the past years.
Based on PwC Tax Guide, we have prepared a roadmap to describe the Portuguese tax losses regime from 2010 until 2023.
Starting, the tax losses generated in tax years prior to 1 January 2010 could be carried forward for 6 years, then from 1 January 2010 until 31 December 2011 the tax losses could be carried forward for 4 years and then again from 1 January 2012 until 2013 tax losses could be carried forward for 5 years.
Within the Corporate Income Tax Reform, carried on in 2014, tax losses generated from 1 January 2014 onwards could be carried forward for 12 years. However, the deduction of tax losses carried forward, even if the tax losses were generated before 2014, were limited to 70% of the taxable profit assessed in the relevant fiscal year.
In 2017, another change, tax losses generated from 1 January 2017 onwards could be carried forward only for 5 years, on the other hand, the carryforward rule revoked the First In, First Out (FIFO) method. However, companies considered micro, small or medium (the so-called “PME”) dispose of a 12 years period to carryforward their tax losses.
With the COVID-19 pandemic, taxable losses generated in 2020 and 2021 could be carried forward for 12 years and this period applies not only to PME companies but also to large companies. In these years, the cap deduction of taxable losses was increased to 80%. In addition, these tax years are disregarded for computation of the carryforward period of existing taxable losses, concerning the first day of the 2020 tax year.
For 2022, the taxable losses can be offset against a taxable income during a 5 years period, although there is a 12 years period in the case of PME companies. The tax losses are again capped at 70% of the taxable profit assessed in the tax year in which the taxable losses are used, although it is possible to deduct first the taxable losses, which the carryforward period ends first.
At this point, it’s time to look at the 2023 Budget Law – which is a game-changer – because it establishes that the tax years starting on or after 1 January 2023 can now be deducted against a taxable profit generated in future taxable years for an unlimited period. This new rule also applies to tax losses assessed in tax years prior to 1 January 2023, which carryforward period is still running as of that date, although now, the deduction of carried forward tax losses is capped at 65% of the taxable income.
Tax losses carryback is not allowed in Portugal, although it would be an effective and beneficial measure for companies, especially the ones still recovering from the COVID-19 crisis. The main benefit of this rule is that it results in a refund of taxes paid in previous tax years and thus provides additional liquidity.
Several OECD countries implemented or expanded tax losses carryback rules and, in May 2021, the European Commission recommended that EU member states should allow tax losses carryback to at least the previous fiscal year. Despite this, the European Commission also suggests a limit of 3 million euros per loss-making fiscal year.
A Tax Foundation article (Fiscal Fact No.770, June 2021), which analysed 37 countries that included Australia, Canada, Israel, Japan, Mexico, the United Kingdom and the United States besides EU countries, shows that there is a significant variation in how businesses can offset their losses.
The mentioned study, also observed that 20 of the 37 countries, allowed companies to carryforward losses indefinitely. Although, 11 of these countries restrict the amount of taxable income that can be offset by the previous-year losses. On the remaining 17 countries, i.e., the ones with time limits, the average carryforward period is 9,4 years. Another conclusion of the article is that EU countries tend to be more restrictive with loss carryback provisions than with carryforward provisions.
In the end, we reach five major conclusions:
- the unlimited deduction period for tax losses is a trend, especially among EU countries;
- to increase Portugal’s tax attractiveness we should have considered a cap of more than 65%;
- to increase liquidity, especially for PME companies, a tax losses carryback regime should have been established;
- since this is a period of high inflation (the highest over the last 20 years), tax losses should have been indexed to inflation; and
- it should have been established a specific rule to clarify the period for keeping the tax documentation (i.e. there is a 4 years period regarding the statute of limitation – which could be extended to 12 years in some cases – at the same time it is established that all records and supporting documents should be kept for 10 years, but with this new rule the tax documentation may have to be kept much more than 10 years).
Nuno Jacinto
February 2023