Article on the Value of Tax Losses - AXL are experts
How a company's losses can be an asset Wednesday, March 04, 2015 DAVID MILSTEAD Print this article A number of former income trusts have been in an ongoing squabble with the Canada Revenue Agency over the way they’ve used past losses to offset profit. In recent months, a number have settled, avoiding coughing up back taxes – but losing the ability to use their tax-saving techniques in the future. Today, we’ll skip any analysis of who’s right in the disputes. Instead, I’d like to focus on the valuable thing the companies are losing – the boring-sounding “deferred tax assets” – and highlight some Canadian companies who still have plenty of them. At the risk of gross oversimplification, corporations that lose money in a given year (and have no taxable income) have the right to use that loss in future years. When the profit returns, corporations can use the past losses to reduce their taxable income. These accumulated losses, then, go on the balance sheet as an asset – a deferred tax asset – because of their value in reducing future tax bills. (Finance is funny sometimes.) The losses have a limited life – they can’t be used indefinitely, at least in Canada and the United States, according to the Canada Revenue Agency, the Internal Revenue Service and the tax laws of the two countries. And, at times, companies have to write down the value of these deferred tax assets. Most of the time, they’re engaging in an exercise, under accounting rules, to determine the likelihood of using them. A profitable company, after all, is much more likely to use these tax assets than an unprofitable one. But even when the value of the losses is written down on the balance sheet as per accounting rules, they still exist under tax law for future use, if the company surprises itself and becomes more profitable than expected. Confusing? Sure. Here’s an example that may help. Paramount Resources Ltd., a Calgary energy concern, had $150-million in losses recorded on its balance sheet at the end of 2013. But the company “owned” just more than $600-million in losses, expiring between 2023 and 2025, at the end of 2013. (The company has not yet filed its 2014 annual report with more current disclosures.) The difference comes, as the company notes, because its estimate of its probable future taxable profit isn’t big enough to use all the losses. Similarly, Quebec-based packaging and tissues company Cascades Inc. had $759-million in accumulated losses as of Dec. 31, 2013, most of which don’t expire until 2030 or later. The figure includes $290-million in losses in Europe that never expire. The company recorded $593-million of the $759-million as a tax asset, determining that amount is only what is “probable” to be realized. The company produced $48-million in earnings before taxes in the past 12 months, according to S&P Capital IQ, meaning it has more than 15 years of tax-free earnings, roughly, at this rate. Certainly, there’s a speculative element to the numbers; management has some judgment about future profitability, and if things get worse, the value of some or even most of these tax assets could wither away. But Indigo Books & Music Inc. is an illustration of how a company may ultimately achieve even more than what the balance sheet suggests. At the close of its year ended in March, 2014, the company had $23.6-million in tax losses it could use against future income. It then applied international accounting standards for income taxes, and wrote down the value of its deferred tax assets by $11.6-million. But the company tells shareholders in its annual report that the time period allowed in the accounting standards is “significantly shorter” than Canada’s expiration period for the tax losses. So, Indigo says, it expects to use all its deferred tax assets before they expire, so they have economic value above and beyond the numbers on the balance sheet. The company’s effective tax rate in the year ended last March? Negative 15.2 per cent. The analysts who cover these companies include their estimates of the tax assets’ value, but it’s not as clear that all investors consider them. Cascades’ losses, for example, work out to $8.06 a share, or $6.30 a share if you use the figure recorded on the balance sheet; the stock closed Wednesday at $8.07. That’s an extreme example; Indigo’s full amount of losses works out to nearly $1 a share on a stock that closed Wednesday at $11.71. This means it can pay for investors to keep a close eye on companies that have a history of losing money. After all, it can be an asset.