Making a start. I should be share sharing my screen, so you should be able to see, my screen on yours. And you've got both the title of the session there which is Tax Losses, and also my name. So as it says, my name's Phil Sparks, and I've been a trainer at FE for a couple of years now. And specialize in valuations accounting. I'm an accountant by background and also transactions.

LBOs those sort of issues. And inevitably, tax can be a fairly big part of some of those transactions. And it's certainly relevant for valuations. So let's kick off. Yeah, I make that four minutes past. So, we've got a few people online. So let's kick kickoff. So starting point is normally of course, in a trading business, losses are bad news. We'd much rather make profits, even if you have to pay tax at 20 or 30% on our, the profits that we make, you're still better off to have 70 or 80%, rather than making a loss.

But this session is about what happens when you go, when things go wrong, what happens when you make a loss, and there might be good reasons for that loss. Often businesses in their early stages, in their startup phases are loss making as they spend a lot of money on marketing, on developing new products. And also in the early days, of course, they may not have that many customers, takes a while to actually build up the, the customer base. And therefore it takes the profits might not be so good for the first few years. So what happens, when we make a loss? Excuse me. What happens when we make a loss? What does the tax man do? Does the tax man give us a refund? And of course the answer is he doesn't. We pay tax on profits but when we make a loss the tax fund doesn't give us some money. Excuse me. I do need to have a a drink of water to clear my throat. Apologies about that.

That's better. So what happens when we make a profit, when we make a profit, we pay tax. But when we make a loss we don't pay tax. But also the tax mandate very rarely gives us a refund. Now, as we, where's my mouse scroll down a little bit, And I think I'm gonna make, a few comments before we start looking at some of the detail. I think there are a few sort of very general points I would make about tax before we start, to have a look at some of the detail here. I think the first thing I would say is tax is complex. And even if you're a finance specialist, even if you're a qualified accountant, even if you spend a lot of time working in investment banking, it's unlikely that you are a tax expert. Tax is complex. Tax has got lots and lots of rules. It's obviously written in a very black and white, very objective way to catch people. Well, not really to catch people out, but basically to make sure that people comply and do the right thing so that people have some certainty over, the tax treatment. Secondly, tax is different in every jurisdiction. So every country the local tax authorities have their own view and their own rule on what's on the relevance, rules and what, on what you're allowed to do and what you're not allowed to do, and how much tax you're gonna have to pay and so on.

Therefore, I would say if you are involved in a transaction and tax is a significant or a material amount, take advice it's extremely unlikely that even if you are a high quality, very experienced tax professional, it's extremely unlikely you will know all of the rules about the territory in which you are operating. So what what we're gonna do here is we're gonna look at some broad principles of how tax losses arise how those tax losses can give us some value, what tax authorities will routinely do with those tax losses, and particularly how tax losses, can influence an M&A transaction. So we're gonna look at some very broad rules. We'll look at some of the specific aspects on what happens in different countries, but of course in one hour we can't do any more than just skim the surface a little bit. So if you are involved in a significant transaction, and it's relevant to what we're talking about here, then what you really need to do is to make sure you talk to a tax specialist on that particular transaction in that particular country to make sure that you are not missing anything to make sure you understand exactly the detail of what's going to happen. So, start with the basics. In general, if you make a profit, then you pay tax, and that's fairly straightforward fairly clear. Even that's a little bit different. You know, when exactly do you pay tax? Do you pay tax as you go along? Do you pay tax in arrears? Of course, what's the tax rate? What's the definition of those profits? All of those things are all subtly different in different countries. But generally when you make profits, you pay tax. When you basically make a loss, what tends to happen is in most jurisdictions, the tax man, the tax authorities don't give you a refund, but they don't make you pay tax if you make, if you make a loss. So that's sort of good news. But when you've incurred those losses, um, are they gone well? The answer is no. Often when you incur those losses, you can get value for them. You can get value for them by either looking backwards. So if we're in 2023 today and you made a loss in 2023, you might be in a position where you could say, but I made a profit in 2022. Can I somehow take my losses this year and offset them against the profit last year to give me a lower, um, overall or average profit, and therefore, a lower amount of tax to pay in relation to last year? And that's called carrying back the losses carrying back. And you might be able to do that. Again, I'm gonna talk about that in a little bit of a little bit more detail and we'll look at some of the rules that are relevant for this. But more common, much more common and in general, much more flexible, is the ability to take those losses. And you don't make a take a payments in tax today, but you take those losses that you made today and you offset them against profits in the future. You take those forward, you carry those losses forward, and therefore gimme a loss of a hundred this year, and you make a profit of 200 next year. It might be feasible to say, well, I'm only going to pay profits on the net of the net profit of 100 next year, which is next year's profit of 200 minus this year's profit of this year's loss of 100. The overall average or the total of profit in those two years is only a hundred, and therefore I pay less tax next year. The downside of that, of course, is time. We have to wait for that to value. We have to wait for that to benefit until next year. And again, just think about this how this is working. I've made a loss this year. Well, it's, it's probable that if I've made a loss in my income statements, then if I go and look at my cashflow, I might, well, I may well have a cash outflow this year as well, so I could really do with some cash this year. But yes, I have to wait until next year until I get the profits from trading next year and the lower tax charge next year. And obviously I do need to make sure that I'm in a position to finance my business until eventually I may start making those profits and get that benefit of that lower tax payment. So, that's the basics of how we're gonna deal with this. Now, I'm gonna make a a few other comments here. The tax regimes, again, depending on where you are, can be quite restrictive. And one of the things I'm just going to mention, um, is operating losses and capital losses.

So what do you mean by these two things? Well, operating losses are sort of the opposite of operating profits. They're to do with your trading. They're to do with buying and selling, uh, your products or your services. It's to do with the normal trading activity of your business. And if you make an operating loss the tax man, the tax authorities will normally treat that in a separate way to capital losses. What I mean by capital losses, well, capital losses are the opposite to capital gains. If I buy a large building and operate it for four or five years, I bought it for 100 and I sold it a few years down the line for 200, then I make a capital gain on that transaction. That's not the same thing as operating profits. It's a capital gain and it's taxed in a different way, and the tax man may charge a different rate of tax. He may have various, other rules and regulations, things like tax writing, down allowances or tax depreciation as it's sometimes known that relates to, those capital items. And normally the tax authorities will treat these separately. So if you make operating losses, which in the US are known as net operating losses or nulls for short, if you make operating losses, they can only be offset against operating or trading profits in the future. Similarly, if you make capital losses you sell a business, sorry, you, you sell a building, you make a loss on selling that building, you can only offset those losses against capital gains in the future. That normally the tax authorities will force you to keep those two things distinct. Keep the, and, and of course there will be different tax treatments on both of those. So capital losses relates to buildings, relate to property can also relate to investments. So if you buy and sell shares in a company, then again, you may, that you, you may be stuck, stung by capital gains tax on selling those shares. Or alternatively, you might make a capital loss on selling those shares if the value of the business has gone down. And again, you can only offset those losses against, future profits. Sometimes there are property profits or property losses, and some authorities will, again, keep those separate from capital losses. So, just things to be aware of the tax regime can be quite restrictive again, depending on the, on the territory that you are operating in So, let's start by looking at carrying back. This is the best, this is the nicest thing to happen, if you make a loss, and we've got a little example here. Here's a business. It's made profits for the previous two years, years minus two and year minus one, profits of, a hundred every year. And it's paid tax. And you, the tax rate is very easy to see. It's at 30%. So basically, the tax authorities charge us 30% on those, uh, profits, and we pay in cash 30 and 30 each year. If in the following year we make a loss. Then again, you can see that we make that loss of 150, bad news and the tax rate applied to that loss, and that's not necessarily the same thing as a tax refund is 45. So 150 times 30 gives you an amount of 45. Well, what do we do with that? Well, the first thing to say state is that basically the tax man will not normally give you a tax refund of 45. However, if in a particular territory, the tax man allows you to carry back those losses to offset those losses against previous year's profits, then effectively you take that 45 and you say but I've paid 30. So basically, you need to give me a refund of 30. Now, quite often in a lot of territories, you might be allowed to carry losses back, but only for one year. Well, if that was the case, then what would happen? You'd be able to get a refund of 30 based on your previous year's tax payments, and then you would have a 15 of tax credit or fix 15 of tax losses to carry forward to offset against later years. If you are in a fortunate position or the tax authorities allowed you to carry it back for two years or more, then effectively you'd get a refund of last year's tax charge of 30, and also a refund of half of the previous year's, tax paid of 15. Now, of course, what's likely to happen is you might have been in a position, and, sorry, I'm gonna ma I'm making quite a mess of this page. What might have happened is you paid the 30, you are still in the process of negotiating and arguing and finalizing your tax payments for the previous year. And then it turns out that you make a loss this year. What might well happen is that you simply don't need to make that payment of 30 for the prior year, because you've got losses this year that will offset it. So these, you know, there can be some quite big timing sort of shifts here, but this is good news. If the tax authorities allow you to go back, allow you to carry back losses, then you can either offset against tax that is in the process of being paid and negotiated and agreed, or even get a refund from the tax authorities based on tax that you have paid in, previous years. Now, this is where the tax authorities are quite different. in the UK, and I'll put up a little map later in the UK you are allowed to carry losses back for one year in some other European territories. It's infinite in some other European territories. There's the nobilities to carry tax back at all in the USA, it used to be, there used to be a position where you could carry those losses back for a number of years but no longer, they basically got rid of that in 2017, the ability to carry those losses back and basically, therefore you can't do that. Having said all of that, actually, there's one factor that has made this a little bit unusual, and that's covid. When covid happened a few years ago, a lot of tax authorities around the world recognized that businesses that were carrying on trading were struggling inevitably because people were locked down, people were stuck at home. A lot of, things like the airline industry, people stopped traveling, and a lot of those businesses were making very heavy losses. So what happened was the tax authorities became a little more generous, and they opened up those carryback periods. So in the UK we had in the UK we had a position where you could carry back losses for three years for a period between April 2020 and March 2022. So during that period, uh, you were allowed to go back and offset current year losses against tax you'd already paid in the previous, in the prior three years, to get value to get refunds from the UK government. Something very similar happened in the US. There was something called the, uh, CARES Act, CARES, and that, again, allowed businesses to carry back and offset losses against profits in the period from the end of 2017 until, January, 2021. So again, it gave PE firms the ability to get tax refunds for current losses against previous years profitable, years where they'd already paid tax.

What about carrying losses forwards? Now this is much more common. This is a much more common position where when you make a profit the tax authorities allow, sorry. When you make a loss, the tax authorities allow you to take that loss and offset it against later years profits. And this is pretty much universal. There are very few countries that don't allow this approach. So we're gonna do deal with this in sort of two sections. The first thing is we're just simply going to look at what happens in year zero. You make a loss, so you end up with a tax credit and what happens in future years? You basically use those losses to reduce the taxable profits and therefore reduce the tax that you are going to pay. And you have to keep a running total. You have to keep a sort of a tax balance to keep track of, of this. And I think it's worth making the point that all the time here, we're not being kind of too subtle in the difference between, accounting profits and tax profits. We're just really talking about profits in a very general term. Of course, certain things are recognized in a different way, for accounting purposes and for tax purposes, particularly things like depreciation, and amortization. So we're gonna open up a spreadsheet and have a little go at an exercise on this. So if you can go and find those resources and go and find those four spreadsheets. And I'll show you which spreadsheets we are going to open.

I apologies. I just need to find the right one and drag it down.

Here we go. So, it's the spreadsheet that says tax losses workout empty. I'm sort of waving my mouse around the title. It says, tax losses workout empty. So if you can grab that spreadsheet, if you want to kind of follow along, if you want to kind of do it at the same time. And basically, we'll complete this spreadsheet together. So, we will, of course, if you actually go and have a look you'll see that there's a version of this that says full at the end. And that's the one with the solution in so we're gonna sort of construct this so we understand how this actually works to reinforce that point. So here we are we've got a business you can see that it's making losses in the first two years, and then it makes a profit in the next three years. If you look at the total of all of these items, you can see that at the bottom of the spreadsheet it says 180. So that, so the total profit is actually a profit rather than a loss. And therefore, we're in a position where we make losses in media losses in the early years, and then we're basically gonna absorb those losses to offset later years profits. This is a position we're assuming a business here where there is no ability to carry back those losses. And maybe this is a startup business, and they don't have profits in prior years. Or alternatively, maybe the local tax authorities say you're not allowed to do that. So, how do we go about that? So the first thin we need to do is and I'll just sort of for some odd reason, I've got a opening items there. So, let's have a little look. We've got a little utilization section here, a little utilization table here. So what we're going to do is we're basically gonna capture, we're gonna keep track of the total of losses. Now this isn't quite the same thing as the total of losses. What it actually is, is it's saying, I need, when I make a loss, I need to build up that sort of credit for tax purposes. And then when I make a profit, I'm going to use those taxable losses to offset the profits that I make. Now, I'm gonna sort of just make the point here. There's an assumption here that I can do that in full. When we look at some of the restrictions in, five minutes or so we will see that often tax authorities restrict the amount of losses you can use in any given year. We're not doing that. This is a very simple situation. So I'm starting with a position where I have zero, taxable losses. I've got no NOLs brought forward. How do I actually keep track of those NOLs? So the first thing I do is I say, I'm gonna do a little base calculations, beginning ending subtraction, sorry, beginning addition, subtraction, and ending. So I'm gonna start with the brought forward position of zero. And then what I need to do is I need to add on any losses that I make in this line. But when I get to the positive profits, I need to take off the losses that I'm making use of those brought forward losses that I'm making use of to build, to offset against my profits. So I'm gonna do that with a minus min formula. So I'm gonna say equals minus min. And when there is a loss, I want to capture that loss in full. I wanna capture that loss in full. Now I'm gonna capture this loss, these losses as positive items. So if I've got a loss, then the loss in that year is always going to be more negative than the running total of losses. Because I'm gonna treat that as a positive item. So I'm gonna say I want the minimum of either the loss that I make in the year or the balance carried forward. Now that balance carried forward is nil. My loss in the year is minus 100. So in this first year, it's basically gonna add that 100 to my running total of losses. I get to the bottom, do an alt equals, and add it all up.

Then what I'm gonna do is I'm gonna copy this to the next row and just see what happens. So, oops so now I've got 100 of losses brought forward from my first year, and I've got another loss of 70 that I make in the year. So I'm not using, I don't have the ability to use that loss. So I add on the minus 70 is clearly lower than the positive 100. So the min statements grabs the minus 70 flips it round because it's minus min turns it into a positive 70 of loss that I'm using to add, to my running total and end up with 170. Now, what about the following year? What happens the following year when I make a profit? What happens here? Well, now that I'm making a profit, basically I am dealing with positive numbers, and the profit that I've got is 50 and the amounts, my brought forward loss that I've got to the ability to use is 170. Now, obviously I can't, if I've got a profit of 50, I can't get a tax refund. The best that I can possibly do is basically use as all of, use, as much of my losses brought forward to offset fully against the profits in that year. And that's what happens here. It based, the min formula says that the 50 of profits in the year is lower than the 170 of brought forward losses that I've got to use. And so it uses up, because it's a minus min formula, it uses up 50 of those losses brought forward. The same thing happens in the following year. I've got 120 brought forward of losses. My losses in my profit in year four is only 100. So therefore, it's gonna fully offset the 100, of profits, by using some of my brought forward losses. Now, what's gonna happen in the following year, this is the kind of quite cute one. So this basically says in the following year, I've got 20 of losses to bring forward so I can reduce my profit by 20. And then the minus min formula says, well, what have I got? I've either got 20 of losses to use, or I've got profit in the air of 200, therefore I'm gonna use up all of the 20, and that's gonna leave my losses basically empty. So that clever little minus min formula is really very working very hard here. Basically, it has a different impact in the years when the profit is negative compared to when the profits is positive. So you can see how, how, how useful that is. That that's really, really a great really great formula here. So that basically gives me the profits that I'm using the losses. I'm just gonna finish this section off by saying, well, okay, what would actually be my profits my taxable profits and the tax that I'm actually gonna pay? Well, my taxable income is gonna be equal to the 100 of loss that I make offset by the fact that I am, taking that, building it up as a credit for future years. So I'm gonna add those two numbers together, and therefore I end up with taxable profit of nil, which is exactly what we expected from making a loss. Basically, you would anticipate that I'm not gonna pay any tax at all. So how much tax am I gonna pay? Well, I'll multiply the profits by the 30%. Where am I? And I need to do function F4 to lock that number in.

And the answer is, I don't pay any profits at all. What happens in subsequent years? Well, in subsequent years, basically, because in the first two years, I don't make any profits at all, but then by the time I get to year three, I'm making a profit of 50, but I'm using, I'm offsetting that with those brought forward losses of 50, and therefore my net profits that my next actual taxable profit is zero. And it's only when I get to the final year out here. It's only when I get to the last year when I've got only 20, I brought forward losses to offset against the 200 that I start to have a taxable profit of 180 multipy by 30%, gives me 54 of tax, to be paid. I'm actually just gonna just change this a little bit just for the next section. I'm just gonna say, just to make it clear, I'm gonna multiply by minus one because this actually is a tax payment rather than a tax receipts. Okay? Let's go back to our notes.

And we need to deal with one more section on this, which is deferred tax, which is deferred tax. So deferred tax is basically where we store that future benefit. So as it says here we basically have, I'm just gonna move that out of the way. It says, we create a tax credit, which is matched by a deferred tax asset on the balance sheet. So what we do is when we basically have a loss on our income statements, and we don't have to pay any tax, what we do is we know that in the future that's gonna give us some value. So we take that loss, we multiply by our tax rate, and we store that as a deferred tax asset on the balance sheet. So it's a positive amount, and that's because we know, or we hope that basically the business will turn the corner from loss making into profits. And when it does, we will get value from that asset in the con, in the terms of a reduction in the tax that we are going to have to pay in later years. So it satisfies the definition of assets. So that's what we do. We make those losses and we basically park, um, 30%, if that's a tax rate of that loss on the balance sheet as a deferred tax asset. And gradually, as we make profits in the future, and we use that tax credit, we will run down that deferred tax assets, until it gets to nil. So let's just go back to our example and let's add add on the deferred tax elements. So I'm gonna start here again. If we start the year, start the period with zero, brought forward losses zero brought forward NOLs, then we have zero deferred tax assets. So gonna do oops, gonna do another one of those little base analysis, and we're just gonna track the deferred tax assets. So we're gonna say the opening deferred tax asset is the same as the closing deferred tax assets. And then what we need to do is we're basically gonna say, I am going to take, and it's gonna look exactly the same as this formula up here, this minimum formula, but we're basically gonna say we're gonna put the deferred tax, sorry, we're gonna put, put the de fact the tax rates in. So I'm gonna say equals minus min. And I'm gonna take the profits of which is somewhere up here, which is D8. I'm gonna take the profits of D8 but then I'm going to multiply by the tax rates function F4 to lock that in, and it's gonna be the min of that or the brought forward deferred tax assets balance.

I'm hoping that works. Yes, that gives me 30% of 100 of loss. So I'm building up my deferred tax assets, building up my deferred tax assets on the balance sheet, I do an alt equals at the bottom, and then I just copy all of that to the right.

And you can basically see that as I go along each year, ha effectively reflects 30% of that, those nls, 30% of that tax loss balance. So when I get to the end, it's zero. When I get to here to the end of year four, 30% of 20 is 6. So this is the deferred tax asset that would be on my balance sheet. So go back to my notes and let's move forward a little bit. And we're gonna jump a little bit forward and then come back on the these next two slides here.

So I've mentioned a little bit about restrictions on using these NOLs. So, restrictions on using, these NOLs and that's what this is referring to here. There are various restrictions on going on using these NOLs. Now I'm gonna look just on the next page and then we'll come back to, to this page. So it talks about restrictions on using NOLs. Now the first thing I would say, NOLs versus capital.

We know already that the tax authorities tend in most jurisdictions to separate operating losses from capital losses and they force the businesses to keep those separate. And you can only offset capital losses against capital gains and operating losses NOLs against operating profits. So that's one restriction. You have to be careful with different companies. Normally, those losses are stuck within one company. Now in the UK we have a concept of something called group relief, and other territories have something similar to that. So you make a loss in one company and you can offset that against profits in another company. But that doesn't necessarily hold true for historic NOLs. So again, what it says here is be very careful. Profits in profits from one form of trade, from one business may not be offset against pro, sorry, losses from one area may not be offset against. Another one, certainly countries very difficult to use losses in one country to offset against future profits in another country. Most tax authorities are very sort of blinkered about the country that they're in, and they don't really care what's happening anywhere else in your company, in your group. They only really care about what happens in the territory. And then finally do losses, equal losses? Well, again you may well have a loss in your income statement. That doesn't necessarily mean that you have a taxable loss. You know, there are different treatments, and a really, and a really obvious one is depreciation. You may well have a depreciation rate in your business. That doesn't necessarily mean that the tax authorities will give you the same rate of depreciation. Depreciation on things like goodwill as well can be very different between the tax treatments and the accounting treatments. And then finally this one here, time juris, time restrictions. Different countries have different time periods that are available for you to use, to offset those losses. And I've got just quite a nice little couple of pictures here. So carry back provisions in Europe. Mentioned already that you're not allowed to carry losses back in the US at all. In Europe, a little bit more flexible. You can see that the pinky color allows you to carry, losses back for a year. So you can see that that's the case for France, Germany Hollands and Netherlands and and the UK some countries Estonia and Latvia that you carry those forward in an unlimited way. And the remain remaining countries, Spain, Italy, and et cetera, don't let you carry losses back at all. What about carrying losses forward? What we tend to have a lot of, a lot of these countries basically have unlimited carry forward, so you can carry them forward, as long as you'd like. But, you might certain countries, have a time limit. And you can see Finlands has got 10 year limits, Poland's got five year limits, and so on. Are there any other restrictions? Oh, lost my, lost my mouse. My mouse has disappeared. Are there any other restrictions? There's one other restriction that I want to mention, and it's a percentage restriction. In the USA, basically you are limited to using, losses to offset 80% of profits. Whereas in the UK there is a 5 million limit. And then for profits beyond 5 million, you are limited for to using losses to offset five 50% of the profit beyond 5 million.

So and those sorts of restrictions are not at all uncommon. And they obviously mean it takes a while for you to actually get your money back in terms of a tax refunds, if the amounts are limited. So you can see, particularly in the UK, the tax authorities are more bothered about smaller companies that are gonna find themselves more diff more gonna find it a little bit more difficult to finance themselves and raise finance whereas the bigger companies, companies make with profits, well beyond 5 million, there's an assumption that these guys can actually look after themselves and they can raise finance to cope to take take them through, a period where they're waiting for the, the tax to come back. Now, what I'm gonna do, I think we've just about got enough time for this. I'm gonna go back to this tax losses, and I'm just going to make a little adjustment to this. I'm just gonna say, well what would happen and I just need to get my notes, need to move.

I just need to just remind myself of what I was, what, what was gonna do here. I'm basically gonna a adjust this, and I'm gonna say, what if this was a US business and we had a limitation of 80% of future profits. So I'm gonna put, gonna put a little restriction on here. I'm gonna say that there is a restriction of using, losses to offset up to 80% ALT HP for percentages. There's a restriction,of using losses, brought forward losses to offset up to 80% of the profit. Now, can we adjust our model here to show that? And I think the answer is probably yes. So effectively what's gonna happen in these first two years, we're going to build up losses, the little loss total exactly the same way as we did before. But then when we get to here, we're only gonna be able to offset those losses against 80% of these profits. So in the first year, in year three, we're basically just going to offset by foot, we we're only gonna be able to reduce the profits down to 40. Not to kneel. So can we make that adjustment? So I've got quite a neat little way of doing this. And basically I just adjust my min statement. Now, you might remember my minus min, my minus min statement said minus min. And the min, the minus min was either the brought forward loss net operating loss or the profit before tax or the loss before tax. And I'm just gonna add one extra term in there. And I'm basically gonna say, I'm gonna take the loss, or profit before tax, and I'm going to multiply by the 30% function, F4 hit return, and then do an alt equals at the bottom. Now, what's happening here? Well, in the first just gonna copy that down into the previous year as well. You can see that in the first couple of years, it doesn't seem to make any difference. It doesn't seem to make any difference at all. We're still in both of these early two years capturing all of those losses in full, which is what you'd expect to happen. That 8% restriction only comes in when we start to try and use those profits those losses against, trading profits. So what's, what happens the following year? Well, the following year, that's hasn't worked. Ah, sorry, I multiply apologies about that. I multiplied by the tax rate, not by the restrictions. I just need to adjust that.

That's to the right. There we are. So nothing's changed, except in this year. What's happened is, and I'll just make the formula obvious. In this year, what's happened is that the min function has said, well, I still need to choose the lowest amount. It's a profitable year. Now, in the loss making years, the loss is going to be lower than anything else. The loss is gonna be lower than 80% of the loss. The loss is gonna be lower than the positive loss sub total brought forward. Because that's a positive amount. But when I get to here and I start looking at the I start looking at using my losses, then I've got either a profit of 50 or a restricted profit of 80% times 50, which is 40, or the loss brought forward, which is that number. And so the min function is actually gonna pick the right number, which is the restricted profit number, and that's why it's 40 rather than 50. I copy that off to the right and what do I see? I see the same thing happening in the following year. I'm restricted to using only 80% of only being able to offset 80% of 100, i.e. 80. And that's what happens here. And then I get to the final year, well, 80% of 200 would be 160, so I'd be restricted to only setting off my losses, my NOLs against 160. But the point is, I only have 50 of NOLs brought forward, so therefore I can only use all of those 50. And then after that, my, uh, n NOLs balance has disappeared. So it works. And then you can see what's then happening is I have a profit, a taxable profit in these, last three years. Which is actually means that I do pay a little bit of tax. It's only relatively small in these first two years. It's only 20% of the taxable profits multiplied by the tax rate of 30%. But you can see I am actually making tax payments in those, in those first two years. Okay. So that works quite well, right? Let's go back to our notes and we've got one last little thing to do, which is we're gonna go back and just look at this slide here, and say what about when there's an acquisition? What about when there's an acquisition? And there's a little bit of theory I just need to draw your attention to, and then it will go off and say, how do we value those losses. Now, I think it's worth making the point, first of all, that those losses are valuable. It's an asset on the target company's balance sheet. So if we were gonna go and buy that business the fact that there's a deferred tax asset, which in last example was something like 170 million at the point where we took the business over after two years of losses those losses do have value because if we buy the business, we will basically reduce the future profits of future taxable profits of that target company, and therefore that target company will pay less tax. Paying less tax is obviously a cash benefit. So again, those assets reflect the definition of, a real asset. Now, I need to just look at a couple of bits of theory, however. So, we need to be a little bit careful with the structure of the deal. There are broadly two ways of buying a business. The first way you can buy a business is on what we call an outside basis. And what we're doing with an outside basis is we are looking at the business in its entirety, and we're buying the shares. So here we are, we're buying the shareholders' equity, but actually what's happening here, that's on the next page actually, what's happening here as far as the tax authorities are concerned the tax authorities do recognize and are interested in the sale and purchase of the shares. However, once you look inside the business, nothing has changed. It's just the external ownership of the business that has, that has changed. So the tax authorities to some extent, don't really care about the fact that the ownership of the shares has changed hands within the business, the tax, the everything is the same within the business. Everything is the same. It's still the company that owns the assets, and therefore it is still the company that owns the NOLs. And therefore, if you buy the shares of a business, then you acquire the NOLs really important points. So if you buy the shares of a business, you acquire the NOLs, and therefore you can use those NOLs to offset future profits from that particular business. There's a slightly subtle point that gets wrapped up in this, which is if you buy this business and you assume there are going to be synergies by bolting this business together with your existing business, and the profitability of that business increases, then actually that's gonna make those NOLs even more valuable because you've got bigger profits to offset those NOLs against. Quite subtle, but quite an important point. So if you are basically buying a company, if you buy the shares, you acquire the NOLs, that's gonna improve your, your cash flows going forward because you basically take advantage of those NOLs. If the business, if you manage to make the business trade even better because of management action that you take, or because of synergies, then those NOLs become even more valuable because basically you've got bigger profits and more rapid profits, I profits that are arising quickly, to offset those NOLs, against and get that cash benefit in terms of reduced tax quicker.

However, what about the alternative? Well, the other way of buying a company sometimes called the inside basis, is that you buy the assets only of the business. So you buy the PP&E you buy the accounts receivable, you buy their cash balance. But if you basically don't buy the shares, then those NOLs stay with the original target company. They don't basically transfer with the underlying assets of the business. So if you buy the assets, normally the NOLs don't transfer really important points, really important points. If you buy the assets of a business, it's fairly unlikely that those brought forward losses will transfer.

Second, gonna look at one more thing. So if we go and buy a business and we buy the shares of a business, then we've said that those NOLs have value. So how do we value them? And also where do they sit within the valuation of the business? Now, given that the business, if the business has shares, we've said that the NOLs have value, they therefore will be included within the equity value of the business. Those NOLs basically reduce assuming the business becomes profitable, the NOLs reduce the cash payments in the future, and therefore if those, that's a cash benefit, therefore the equity should, the equity value should have value to the purchaser. So this is just a standard EV to equity bridge. So were actually are those NOLs? There's a temptation to think that they are part of the enterprise value because they're a result of the trading performance of the business. But they're not, they're not part of EV because they're to do with historic trading performance, not the business that you are buying today. Secondly, if you did something like a multiples based valuation of the business to work out its enterprise value, you'd start with EBIT or you start with EBITDA, that's before tax, and therefore a multiples based valuation of EV based on an EBITDA or EBIT multiple will give you an enterprise value, the underlying trading valuation of the business, that should not include the value of those NOLs. So where are those NOLs basically a financial asset. They are another asset, that is not necessarily part of the current trading activity of the business. It's is absolutely something that has value. So we would park it as a financial asset in our EV to equity bridge. So to wrap this up, we're gonna do one final little example. And if you can basically drag the other, if you can get hold of the other spreadsheets, which is value, it's called valuing deferred tax and losses, sorry, is it? Yes, valuing deferred tax and losses workouts empty. Sorry about that. I missed the title at the very top. So valuing deferred tax and losses workouts empty. So if you can grab that as a copy grab that as a copy. And we'll just work through this. This is how you would value the NOLs of a business. So here we've got a business up here. You can see, that it's forecast to make profits. You can see that it has NOLs. So basically has a loss brought forward at the point of acquisition of 400. How do we value that? Well, the answer is we don't pay 400 for it, because that 400 isn't necessarily gonna generate cash today. It's gonna generate cash over the next few years as we make use of that of the those NOLs. So, let's do a little calculation of this, and I'm just gonna get my spreadsheets up.

So we're gonna do a very simple calculation, just the same as we did before. So we're gonna say we have losses brought forward of 400. We're gonna do the same minus min formula equals minus min. And our minus min formula is either the level of profits or it's the brought forward, amount of the NOLs. And it gives us a use of one hundreds. We do an alt equals at the bottom, and then this is exactly the formula, same formula as we use before. And you can see that we are gradually using up the NOLs over the next four years. So, what's the tax benefit to us? The tax benefit to us is simply the 100 of NOLs that we are using, multiplied by the tax rate F4 to dollarize that of 30% multiplied by minus one because I quite like this is a, this is a positive amount and it's gonna be 30 every year all the way until the final year when obviously we're not, we've extinguished those, NOLs and they disappear. What is the NPV of those cash flows of the cash benefits? It's equal. I'm just gonna do it rather than manual. I'm gonna do it using the Excel NPV function. So NPV and what's the rate? 5%. And what are the cash flows? Here they are.

That gives me an end, a present value of tax losses of 106. And does that make sense? Well, it does because the total of all the cash flows is 120. So by when you discount it you reduce the value of the later years. So that makes sense that it gives me a value of 106. So we could put that into our valuation of our business. Going round the EV to equity bridge. We could basically say the enterprise value calculated on the basis of say, um, an EV to EBIT, multiple is 500. But then we have this extra value from these the present value of tax losses which is equal to the 106. We then have some debt, and so we can work round our way around the EV to equity bridge, and we can simply say the equity value is the enterprise value of 500 plus the valuation of the tax losses minus the debt of 20, which gives us a value of 586. And there's just one thing I'm just gonna do just before we close up, and that's to say this is all very good, but what if this business had really we bought this business, and we suddenly had much better synergies. We basically managed to have some great synergies, which really improved the profitability of the target company. Well, obviously we're gonna have some benefit from those synergies. But it's also gonna benefit us in terms of how quickly we get value from these nls. So remember that number 106.4, what happens if, and we just took a really big number, let's make the profitability in the first year, 500.

Well, you can see that that valuation of the NOLs goes from 106 up to 114. So we are making use of those NOLs more quickly because of the improved profitability. And that in turn improves the valuation of the business. And now of course, this is gonna be a negotiation, a negotiating point because the target company, the synergies that you are going to get by putting your business and the target company together is really a function of the combination of the two businesses. The target company isn't gonna get those by itself. And so that increase in value of those NOLs due to the synergies is really a function of you, the purchaser. So in the first, in the first instance you shouldn't really be paying, a purchaser for those, For those synergies and for the tax benefits of those synergies in terms of that early use of the NOLs. So this would absolutely be part of the negotiation with the owner of the target company. And that's it. So we're done. So I guess just standing back from this, hopefully that explains a little bit of what tax losses are, what NOLs and capital losses are, how you can use them and get value for them by, or either carrying them backwards or carrying them forward, which is much more common. It should hopefully demonstrate that they have real value if you're gonna go and buy a business. And certainly something that you would want to dig into in a great deal of detail to understand. And also not just to understand the NOLs themselves, but understand the use of them going forward. Because they obviously only have value if you can make use of them if the combined business is highly profitable and can use those NOLs. And then the final points I'm gonna make, as I think I've made lots of times already, this is a complex area. Tax rules are complex and tax rules are very different in different jurisdictions. And therefore, if you have any material tax impact on any deal that you happen to be working on, you absolutely should take specialized tax advice that or from people that really understands the situation, not just in general, but in for your particular sector, for your particular businesses in the territory in which they operate and as if by magic. That's exactly at three o'clock. So if there are no questions I'm basically gonna say thank you very much for joining. I hope that's been useful. Do have a look. You should have both the solution files to both of those spreadsheets. Do download those and the recording for this session, we'll also be pasted onto will also be uploaded onto our website as well. So thanks very much for your attention and look forward to seeing you at our next webinar. Thank you.