{"id":3089,"date":"2024-03-11T19:33:03","date_gmt":"2024-03-11T17:33:03","guid":{"rendered":"https:\/\/nowium.com\/?p=3089"},"modified":"2024-07-16T18:24:05","modified_gmt":"2024-07-16T16:24:05","slug":"limiting-the-recovery-of-tax-losses-starting-2024","status":"publish","type":"post","link":"https:\/\/nowium.com\/en\/limiting-the-recovery-of-tax-losses-starting-2024\/","title":{"rendered":"Limiting the recovery of tax losses starting 2024"},"content":{"rendered":"

Limiting the recovery of tax losses on corporate income tax: a “brake” on company’s investments<\/span><\/h2>\n

In a recent interview with Alexandru Boiciuc from avocatnet.ro<\/a>, I had the pleasure to discuss the challenges brought by the new limitations introduced in 2024 regarding the recovery of tax losses, a “brake” on company’s investments.<\/p>\n

These changes, introduced by Emergency Ordinance 115\/2023 starting January 1, 2024, include two major limitations: losses can only be recovered up to 70% of the tax profit (the first limitation)<\/strong>, and this can be done over a period of 5 consecutive years (reduced from 7 years)<\/strong>.<\/p>\n

In our discussions with our colleagues at avocatnet.ro<\/a>, we addressed questions about the practical implications of these measures, the main businesses affected, a comparison with tax loss recovery systems in other countries, and many more.<\/p>\n

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  1. \n

    Why is the loss recovery mechanism useful for corporate income tax?<\/strong><\/span><\/h4>\n

    Valentin Alangiu:<\/span><\/strong> “The tax loss recovery mechanism is useful from several perspectives. Firstly, it serves as a way to stimulate investments, as their costs are very difficult to be fiscally recovered in the immediate period following the investment. Thus, the costs generated by investments can be fiscally deducted by recovering them from the profits of future periods when these investments start generating revenue. This category also includes costs generated by research and innovation, which are stimulated by the possibility of deducting them from future profits. Furthermore, the loss recovery mechanism ensures fiscal equity. A company facing operational or financial difficulties can recover its losses by carrying them forward and deducting them from profits in subsequent periods. Such a company is not disadvantaged compared to a profitable company that pays taxes. Additionally, during recession or economic crisis periods, such as the pandemic, many companies can incur losses. The tax loss recovery mechanism can help mitigate the economic impact by reducing the tax obligations of companies in the following years, allowing them to recover and contribute to economic recovery.<\/p>\n

    The tax loss recovery mechanism is also crucial for small companies at the beginning of their journey, which need to initially invest significant amounts to operate. In the early development stages, most companies incur losses. The possibility of recovering tax losses can have a significant effect on maintaining company liquidity and minimizing bankruptcy risk. Lastly, the aspect of tax compliance is encouraged by the possibility of recovering tax losses, discouraging tax evasion behavior. In conclusion, the tax loss recovery mechanism is essential for stimulating investments, maintaining fiscal equity, reducing the bankruptcy risk for small businesses, encouraging tax compliance, and contributing to economic stabilization during crisis periods.”<\/li>\n

  2. \n

    What are the concrete effects of limiting the recovery of tax losses on corporate income tax?<\/strong><\/span><\/h4>\n

    Valentin Alangiu:<\/span><\/strong> “Limiting the recovery of tax losses by shortening the recovery period from seven to five fiscal years and, more importantly, limiting it to 70% of the taxable profits, will mainly affect large investments in the Romanian economy. A serious investment cannot produce profit immediately and, in limited cases, allows for rapid recovery. Usually, especially when discussing production investments, a significant period is necessary for the actual investment to be realized and the production to reach an optimal level to ensure operational profit. We are not even discussing the financing costs of the investments, which can significantly diminish a company’s profit.<\/p>\n

    However, let’s not forget that many companies generate recurring losses and operate through shareholder financing. Recurring losses represent a fiscal risk factor. Nonetheless, the Tax Authority has not managed to investigate the large number of companies producing recurring losses and still operating. Thus, by limiting the recovery of tax losses introduced by Emergency Ordinance 115\/2023 at the end of 2023, a double measure is considered: on one hand, shortening the period in which a company is allowed to recover tax losses (from seven to five years) and, on the other hand, the state seeks a method to tax something even for those recovering losses.<\/p>\n

    In this context, the measure was introduced that only 70% of the taxable profit of a fiscal year, starting in 2024, can be offset by tax losses brought forward from the previous period. The remaining 30% of taxable profit will generate a corporate income tax liability, regardless of the value of the tax losses carried forward. The concrete effect will be a decrease in the attractiveness of the Romanian economy, especially for large investments. Currently, the only retained advantage remains the flat tax rate, but nothing is certain in Romania’s tax regime in the coming years.”<\/li>\n

  3. \n

    Are there specific categories of companies that could be more affected than others by the limitation introduced in 2024?<\/strong><\/span><\/h4>\n

    Valentin Alangiu:<\/span><\/strong> “Certainly, the most affected categories of companies will be those operating in industries that require significant initial investments, which cannot be recovered within five years. Moreover, considering that only 70% of taxable profits can be used in subsequent years to deduct tax losses from the initial years, it is clear that many companies will only partially recover their initial tax losses, generating additional corporate income tax liabilities. Companies operating in low-margin industries requiring start-up investments (such as manufacturing, agriculture, or distribution and commerce sectors) will be most affected.”<\/li>\n

  4. \n

    Can you provide a theoretical example comparing the situation applicable until December 31, 2023, and the situation applicable from January 1, 2024?<\/strong><\/span><\/h4>\n

    Valentin Alangiu:<\/span><\/strong> “We can take as example a company that made a significant investment in a construction materials production unit, an investment worth 50 million euros. The first two years of operation (N-2 and N-1) of the company generate cumulative tax losses of 100 million lei. For simplicity, we assume the fiscal result equals the accounting result, and all expenses are deductible (ideal case). Starting from year N, the company begins to record a profit (the example can be studied in the file attached to this interview – in Romanian)<\/a><\/p>\n

    We observe a model that produces favorable results as the company optimizes its production capacity, and the losses incurred in the first two years of activity are covered only in the seventh year of operation. Under the model existing until December 31, 2023, the company fully recovers its tax losses by the seventh and eighth years, and the remaining profit recorded in the eighth year generates a tax of 4,960,000 lei.<\/p>\n

    Under the modified model applicable from January 1, 2024, the company does not fully recover the tax losses of 100 million lei\u2014only 42.7 million are recovered, and the remaining 57.3 million lei remains unrecovered. The company pays 14,128,000 lei in corporate income tax\u20149,168,000 lei more than under the model existing until December 31, 2023. The difference represents the 16% rate applied to unrecovered losses.<\/p>\n

    It must be noted that the theoretical example above assumes a gradual positive evolution of a company. In practice, there are often periods of economic downturn and other turbulences that can affect a company’s ability to recover its investment. The model does not consider the minimum turnover tax\u2014it would further distort the presented results.”<\/li>\n

  5. \n

    How do you anticipate this change will influence the fiscal behavior of companies and groups in the medium and long term?<\/strong><\/span><\/h4>\n

    Valentin Alangiu:<\/span><\/strong> “The changes made to the tax loss recovery mechanism will negatively impact investments in the economy. Companies will be more reluctant to make large investments in Romania due to an unstable tax environment. A business plan considered in previous years is already significantly affected by these unannounced fiscal changes. It is possible that many large companies will prefer to invest in regions with more legislative stability and better economic infrastructure. Romania’s disadvantage of having insufficiently developed transport infrastructure (both road and especially rail transport), combined with not being part of Schengen Area and this fiscal instability, leads to a decrease in investors’ appetite for coming to Romania.<\/p>\n

    Additionally, the new minimum turnover tax and the special tax in the energy sector are two elements that further increase the fiscal impact on large companies in Romania. Moreover, the lack of a real fiscal consolidation system is an impediment to investments in research, innovation, and development. Romania has implemented a fiscal consolidation system, but it is very limited and almost completely nullified by the new minimum turnover tax.”<\/li>\n

  6. \n

    Are there practical problems related to this change?<\/strong><\/span><\/h4>\n

    Valentin Alangiu:<\/span><\/strong> “In principle, there are no major problems in implementing this change\u2014conceptually, it seems simple. In practice, any transition from one system to another generates problems, and potential implementation norms can be useful in this context.”<\/li>\n

  7. \n

    How aligned is our limitation on loss recovery with practices in other countries?<\/strong><\/span><\/h4>\n

    Valentin Alangiu:<\/span><\/strong> “Indeed, many countries have introduced these limitations for tax loss recovery, but many of them have economic maturity and a stable environment where companies can develop their businesses (see the situation in the file attached to this interview<\/a>). Romania could have chosen such a policy, but it needs to offer business predictability and time for companies to prepare for the new regime. Furthermore, these new provisions are not accompanied by any policy to attract investments to Romania. The state should be interested in this aspect as the entire burden of covering the budget deficit is borne by the business environment.”<\/li>\n

  8. \n

    What do you recommend to companies in the context of this measure?<\/strong><\/span><\/h4>\n

    Valentin Alangiu:<\/span><\/strong> “Firstly, companies need to adjust their budgets already prepared for the coming years, quantify the effect of legislative changes, and find solutions to navigate the new fiscal environment. There is no one-size-fits-all solution, but regardless of how we look at things, the bill will be paid by all of us, because, sooner or later, it will be reflected in prices. More seriously, we might see withdrawals of major companies from the local market. Let’s not forget that, besides corporate income tax and minimum tax, these companies are the primary employers in the country. And labor taxation in Romania is currently at a high level.”<\/li>\n<\/ol>\n

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    Valentin Alangiu is Accounting & Tax Partner at Nowium Tax&Finance<\/a><\/p>\n

    Valentin ALANGIU<\/a><\/p><\/blockquote>\n