Should loss carry-back provisions be extended?

The 2021 Budget brought about substantial changes to the UK’s corporation tax system. One of the reforms is to temporarily allow an extension to loss carry-backs. How helpful will this be for businesses making losses in 2021 and 2022? 

In normal times, loss-making companies can either: (1) carry-back their losses to offset profits that they made one year earlier and receive a refund on the taxes that they have paid on the previous year’s profit, or (2) carry the loss forward indefinitely to set against future profit. The rules also permit a “terminal loss relief” that allows a three-year carry-back for firms that are about to close down. Normally, that tends to encourage company exits, but would not do so if the same carry-back is available to all firms.

The policy change put forward in the Budget extends the one-year limit for carry-backs to three years. The maximum amount that can be carried back is naturally capped at the amount of profits made in the previous three years. The Chancellor has set an additional cap on the amount of loss that companies can carry back beyond the regular one-year period at £2 million. What are the likely implications of this reform?

Let’s take a company with a loss of £1 million in 2021. Suppose this company made a total profit of £3 million in 2018 and 2019 combined, and broke even in 2020. Should this company carry its loss back to 2018 and 2019 and receive a refund of 19% of £1 million  = £190,000? Or should it wait until it regains a profitable position in two years’ time, when it could use the loss to reduce its tax liability then by 25% of £1 million = £250,000?

The answer depends on various factors (which I explore in the context of R&D tax credits in a recent research study1). There are at least three reasons why the company may choose to take the extended carry-back option:

  1. Does the company expect to survive until 2023, and to make a profit then? If not, carry back now.
  2. Does the company need cash for its operations (and investment) now, and is external financing too costly or difficult to find? If so, carry back now.
  3. Does the company discount future cash flows at more than 15%?2 If so, carry back now.

Companies that are confident of returning to profit within a couple of years will be better off waiting until the tax rate rises. So companies that are more likely to take advantage of the offer of the more generous carry-back are those: 

  • without good prospects of future profit, or 
  • which face financial constraints. 

The extension of loss carry-backs for those companies that do take advantage may help curb bankruptcies and layoffs at a time of immense pressure on cash flows.

In general, it could be argued that the loss relief should be generous. The convention of splitting a company’s activities into 12 month periods is rather arbitrary, and it makes sense for losses in one period to be cumulated with profits in other periods. 

However, there are two main arguments against a carry-back extension policy. The first is that it advantages some companies and sectors over other. Two companies that have the same loss in 2021 may be treated differently, depending on whether they had profits in 2018 and 2019. To the extent that these different companies are competitors, the policy gives a competitive advantage to firms with prior profits.3 

Second, and more importantly, reducing bankruptcies may encourage the survival of so-called zombie firms – companies that live on without much prospect of growth, profitability or contribution to productivity and employment. Zombie firms are much less productive than healthy businesses, and their survival is a threat to business dynamism. They do not contribute to the tax base as they persistently report losses.4 Even before the pandemic, the UK economy was struggling to increase aggregate productivity, and promoting the survival of zombie firms may exacerbate this problem.

This is not the first time the UK has allowed a loss carry-back extension during a crisis. In the 2008-2010 global financial crisis, companies were also allowed to carry back their losses to the preceding three years, but the policy was then much less generous (only up to £100,000 of loss could be carried back to earlier years) and targeted only companies with smaller profits. In a CBT research study5, we explore the likelihood of dropping out of the market after receiving extra cash through a carry-back extension.  Our preliminary findings show that loss carry-back extensions promote company survival, but the question about whether the survivors are zombies or productive UK firms remains to be answered.

So while there is a general case for generous treatment of losses, the case for simply extending loss carry-backs in a recession is less strong. Some companies may be helped and may return to profitability. But others may become zombie firms. And if a company’s problem is really one of external finance being too costly, or simply not available, then giving relief for losses is at best an indirect remedy. 


Relevant research from the Centre for Business Taxation: 

“Dynamics of financing frictions for R&D”, İrem Güçeri, CBT research paper in progress, 2021.

Discretionary fiscal responses to the Covid-19 pandemic”, Michael Devereux, İrem Güçeri, Martin Simmler and Eddy Tam, Oxford Review of Economic Policy, 2020.

“How important are company losses? Taxation of loss-makers and their responses”, Wiji Arulampalam, Stephen Bond, Michael Devereux, İrem Güçeri, CBT research paper in progress, 2021.



Guceri, I. (2021) “Dynamics of financing frictions for R&D.” CBT research paper in progress.
£190,000 invested now at a return of 15% would be worth just over £250,000 in two years’ time.
Devereux, M.P, Guceri, I., Simmler, M., Tam, E. (2020) “Discretionary fiscal responses to the Covid-19 pandemic” Oxford Review of Economic Policy, graa19.
See, for example, Caballero, R.J., Hoshi, T. and Kashyap, A.K (2008). “Zombie lending and depressed restructuring in Japan,” The American Economic Review 98 (5): 1943-1977.
Arulampalam, W., Bond, S.R., Devereux, M.P. and Guceri, I. (2019) “How important are company losses? Taxation of loss-makers and their responses” CBT research paper in progress.