Company executives and analysts have characterised as anti-investment, and counter-productive, government’s move to place a cap on the number of years that losses can be carried forward for future profit tax write-off. They say it could retard Jamaica’s ability to attract new capital.

At present there is no restriction on the number of years that accumulated losses may be carried forward for future tax benefit.

However, the finance ministry is pressing ahead with the proposal to place a five-year limit on the tax benefit – an idea that was first floated a few years ago, but was rejected in 2003 by the Joseph M Matalon tax committee.

Paul Lai, deputy financial secretary and head of the tax policy unit, told the Business Observer on Monday that an extension to 10 years was being considered for accumulated losses dating back to December 31, 2005.

“The plan is to cap tax losses carried forward, as of this year, for no more than five years,” said Lai. “After discussion with the Institute of Chartered Accountants of Jamaica (ICAJ) and the Tax Audit and Assessment Department (TAAD), we decided to look at allowing losses carried up to December 31 last year, for up to 10 years.”

ICAJ wants companies to continue enjoy the credit indefinitely, with its president Leighton McKnight telling the Business Observer that the five-year period represented a compromise position with the government, and that the 10-year limitation for losses to December 31, 2005, was agreed upon, to create a longer transition period for companies.

“As a compromise, we submitted that losses accumulated up to end of 2005 be crystallised and carried forward for a maximum of 10 years,” said McKnight. “Any loss thereafter we propose should be carried for six years, the same amount of time as the statute of limitation.”

It is not clear what the government’s initial position was.

McKnight, a partner at the auditing firm, PricewaterhouseCoopers, explained that under the present system, a company with accumulated loss of $500 million, and which made $100 million in profit in a particular year, could set off $100 million of the tax losses against the profit.

In this case, no profit tax would be paid that year. The company would be left with $400 million in tax losses against which it could write off future profits.

With the new proposal, if the company is not able to generate enough profit over five years to utilise the balance, it will lose the benefit.

Chartered accountant and financial analyst John Jackson believes that the time limit being proposed could impair the capital of several firms, and may give Jamaica the appearance of not being capital friendly.

“It is another indication that the government is not friendly to capital formation,” charged Jackson. “If a company makes losses, its capital becomes impaired… why should it then pay taxes on subsequent profits and go back to shareholders for fund when there has been an erosion to capital base?”

Roy Collister, vice-president of the Jamaica Chamber of Commerce, agrees with Jackson.

“Basically, it is a retrograde step, going back to where we were 20 years ago,” he lamented. “The implications for business is that if you make losses and you pay taxes on previous profits, over time you would have paid more taxes than profit made. If you are unable to set off against future profits, you won’t be able to make back money that was invested.”

The idea of the time limit apparently first surfaced via a document submitted by the technical team led by Roy Bahl and Sally Wallace of Georgia State University, to the Joseph Matalon-led committee on tax reform.

But the proposal which was put forward, ostensibly to “decrease the record-keeping burden on the tax administration and protect the corporate income tax (CIT) from tax evasion and other abuses,” was rejected by the Matalon committee.

“The tax reform committee led by Matalon considered carry forward tax losses having a five-year restrictions to be a bad idea, so we recommended the abolition of the restriction,” noted Collister.

In any event, Sterling Asset Management managing director, Charles Ross, believes that the proposed time restriction, far from simplifying company accounts, would lead to more complication in a corporate tax system.

“It is going to now cause quite complicated accounting,” Ross told the Business Observer. “Companies will have to treat tax losses as inventory to ensure they are offsetting the oldest tax losses first. Whatever tax loss you have going forward, auditors and advisors signed off with tax authorities, because they feel, in their opinion, that there is a tax loss.”

Prominent Montego Bay developer, Mark Kerr-Jarrett says the new write-off regime could have a negative impact on future investments.

“My real concern is the destructive effect it is going to have on new companies that want to start,” said Kerr-Jarrett who is also president of the Montego Bay Chamber of Commerce and Industry. “Normally it takes three to five years for a start-up to make operational profit; year seven or eight to make net profit. Now, companies will be paying taxes, after year six, on income that should be going towards paying back losses, and investors will in effect be paying taxes on losses, which will jeopardise the viability of a company.”

Kerr-Jarrett echoed the concerns of Jackson who noted bluntly that “the other fact that is being ignored is that people do not have to keep their capital in Jamaica”.

“The restriction will ensure no new business will survive if it is financed by legitimate means,” he said. “It may drive more people outside the net and be a disincentive for young entrepreneurs to start business, which in turn provides new employment.”

The MoBay-based developer cited the case of companies that survived the 1990s by “using up capital reserve to stay afloat, (and) also had to borrow money at high interest rates,” but were now “in the process of replenishing capital reserves”.

He added: “So if the government puts a cap on it (tax losses), a lot of companies will never recoup their losses.”

Jamaica Producers, is one example of a group of companies which suffered significant banana crop losses and deficit at its banana division, due to bad weather over 2004 and 2005. As at December 31, 2004, it held $579 million in tax losses.

But the problem with this specific case is that to benefit from the losses, enough further profit would have to be generated specifically within the banana division because profitable entities in a group can’t make charge against losses by sister companies.

“If you could set off against group profit you would be better off,” noted PWC’s McKnight. “It can affect investing decision. The government should introduce group loss, so investors can get a group consolidated position as it relates to tax. If a group has two companies – one making profit and the other making a loss – it will be paying tax upfront on the profitable company, while it won’t get the tax benefit for the company making loss until perhaps it moves to a profit position five years later, when it loses the benefit.”

The GraceKennedy conglomerate is another case in point.

With operation in sectors ranging from food retail to financial services, the Grace group reported recognised tax losses of $198 million and unrecognised losses of $140 million attributable to a subsidiary, at the end of December 2004.

But the real concern of the company’s finance director, Don Wehby, is the potential impact of the new rule, on new ventures that Grace may consider.

“Our tax losses are being carried in respect of a subsidiary in the retail and trading division, but what will really affect GraceKennedy in the future, is the impact on start-ups,” said Wehby. “Experience has shown it takes three to four years until a company can get into a profit position. That is going to impact us negatively.”

The finance ministry’s Lai told the Business Observer that an extension to six years was now being considered – following discussions with the JCC – but Wehby remained unimpressed. “We won’t be able to get the full tax refund going forward… the length of time (six years) seems inadequate,” he said.

Those discussions with the JCC in fact led to several changes in the original proposal and a delay of the implementation date.

The measure was tabled in a ministry paper presented by finance minister, Omar Davies, at the beginning of the 2005 to 2006 fiscal year. It included a number of initiatives to rationalise the corporate income tax structure, including measures to simplify capital allowances to firms by reducing the number of asset types to five. All these which were to be implemented at the beginning of 2006.

Lai said that consideration was now being given to implement the plan on April 1 – the beginning of the upcoming fiscal year.

“We are looking to see if it is feasible for April 1, 2006,” he said. “The legislation is not yet in place.”

ICAJ’s McKnight noted that the harmonisation of taxation system across the Caricom, in which several countries including Barbados, had a limit, was among the rationale for the restriction.

Kerr-Jarrett believes that the real issue for the tax authorities is compliance.

“Trinidad and Tobago went on a massive clamp down on tax evasion, and now its revenue is so enhanced that it is able to reduce actual rates,” he said. “You are going to break the backs of compliant companies, the gains from implementing are negligible in the way of tax earnings, and the administrative costs may become more significant.”

Added Jackson: “The government needs to recognise that the engine of economic growth is the private sector, which provides employment, among other things. This will drive up the cost of capital. In order for people to make a determination to go into business the rate of return they will have to make up front has to be greater, and a number of business will not get off the ground because it makes no economic sense.”

The finance ministry estimates Jamaica’s tax compliance rate at 58 per cent, as at the end of November last year, but failed to “quantify the revenue gain” of the new proposal, based, according to Lai, on the difficulty in determining the revenue over the long term.