Net operating loss: what happens to tax when your business makes a loss

Short answer: a net operating loss is the American name for a tax loss: a year where the costs the tax office lets you deduct are bigger than your taxable income. In Australia, New Zealand and the UK it is usually just called a tax loss or trading loss. You pay no income tax for that year, and the loss is not wasted: it carries forward and reduces the tax on later profits. A UK company can also carry it back a year and get tax it has already paid refunded. The loss on your Xero Profit and Loss is the starting point, but the tax loss is usually a different number. An Australian company whose Xero P&L shows a $40,000 loss ends up with a $44,000 tax loss, which saves it $11,000 of company tax the next year, when profit returns. Tax rules change and have conditions, so treat this guide as a way to understand the conversation with your accountant, not as tax advice.

Accounting loss vs tax loss

	Accounting loss	Tax loss (net operating loss)
Where you see it	The Net Profit line of the Profit and Loss in Xero, when it is negative	The tax return your accountant prepares
Depreciation	Your accounting depreciation	Tax depreciation or capital allowances, which can be very different
Costs the tax office does not allow (client entertainment, most fines)	Included	Added back
What it does	Reduces retained earnings on the Balance Sheet	Reduces tax in other years

So a business can make an accounting loss and still have a small taxable profit, or the other way round. The trading profit guide shows the usual adjustments from Xero’s figure to the taxable one.

Worked example: an Australian company carries its loss forward

These figures are made up. A Perth landscaping company (a Pty Ltd, taxed at the 25% base rate entity rate) lost two large council contracts in 2025-26.

2025-26	$
Sales	380,000
less all costs in Xero	(420,000)
Net loss on the Xero P&L	(40,000)
add back client entertainment (not deductible)	2,000
add back accounting depreciation	12,000
less tax depreciation the accountant works out	(18,000)
Tax loss	(44,000)

The company pays no tax for 2025-26. In 2026-27 it wins the work back and makes a taxable profit of $70,000 before losses.

2026-27	Without the loss	Using the loss
Taxable income before losses	70,000	70,000
less tax loss carried forward		(44,000)
Taxable income	70,000	26,000
Company tax at 25%	17,500	6,500

The loss is worth $11,000 (44,000 × 25%), but only when there is profit to use it against. That is why a tax loss is not cash in the bank: if the business never makes a profit again, the loss saves nothing.

The cash point most owners miss. The company had been paying PAYG instalments of $4,000 a quarter, worked out from its last profitable year. Had it kept paying them through 2025-26, $16,000 would have sat with the ATO until the return was lodged and the credit came back. Once the year was clearly heading for a loss, it could vary its instalments down, which kept that money in the business while sales were short. In New Zealand the same idea applies to provisional tax (re-estimate it), and a UK sole trader can apply to reduce payments on account.

Worked example: a UK company carries its loss back

A Bristol design studio (a limited company) made a taxable profit of £50,000 in the year to 31 March 2026 and paid £9,500 of corporation tax at 19%. In the year to 31 March 2027 a client went under and it made a £30,000 trading loss, with no other income.

Year to 31 March 2026	Before the claim	After carrying the loss back
Taxable profit	50,000	20,000
Corporation tax at 19%	9,500	3,800
Refund		£5,700

Carrying back turns the loss into £5,700 of cash once the loss year’s return is filed and the claim goes in, instead of waiting for profits that may be a year or two away. Carrying it forward instead would save the same £5,700 only if later profits stay in the 19% band, and only when they arrive. Which is better depends on the rates in each year and on cash needs, so ask the accountant to compare both.

The rules by country

These are the main rules for 2026; each has conditions and exceptions.

Australia

• Companies carry tax losses forward with no time limit. To use them, the same people must keep more than 50% of the ownership and control (the continuity of ownership test); if ownership changes, the company must instead pass the business continuity test (the same or a similar business). The temporary loss carry-back for companies covered losses up to the 2022-23 income year and has ended.
• Sole traders and partners face the non-commercial loss rules. You can only set a business loss against other income such as a salary if your income for the test (taxable income plus reportable fringe benefits, reportable super contributions and net investment losses) is under $250,000 and the business passes one of four tests: assessable income of at least $20,000; a profit in 3 of the last 5 years; real property of at least $500,000 used in the business; or other assets of at least $100,000. Otherwise the loss is deferred and can only be used against future profits of the same business.

New Zealand

• Companies carry losses forward if at least 49% of the shareholding stays the same from the loss year to the year it is used, or, for ownership changes since the 2021 income year, if the business passes the business continuity test.
• Sole traders: a business loss generally reduces other income in the same year, and anything left over carries forward. Losses from residential rental property are ring-fenced and cannot be used against other income.

United Kingdom

• Companies can set a trading loss against other profits of the same year, carry it back against the previous 12 months’ profits, or carry it forward against future total profits. Carried-forward losses can cover the first £5 million of profit a year in full.
• Sole traders can set the loss against all their income for the tax year or the year before (sideways relief, capped at the greater of £50,000 or 25% of income), carry it forward against future profits of the same trade with no cap, and, in the first four years of trading, carry it back against income of the previous three tax years.

How to find the figures in Xero

1. The accounting loss. Run Accounting › Reports › Profit and Loss for the financial year. A negative Net Profit is the accounting loss. Check bank reconciliation and year-end adjustments are done first, or the number will move.
2. The trend before the year ends. Run the Profit and Loss by month for the year to date. A loss that shows by month six or seven is the moment to talk about varying PAYG instalments or provisional tax, not after year end. The year to date profit and loss guide shows how to project the rest of the year without being misled by seasonal months.
3. The Balance Sheet. The loss reduces Current Year Earnings, and from next year Retained Earnings. If losses since the start are bigger than profits, retained earnings go negative; see retained earnings for what that means for dividends.
4. The tax loss itself. Xero’s accounting reports do not track tax losses carried forward. The figure is in the tax return (and in your accountant’s tax workpapers), so ask for it each year and note it in your year-end file, because you will need it the first profitable year.

Menu names move between Xero releases and regions, so search Xero Central for the report name if your screen differs.

Common mistakes

• Treating the tax loss as cash. It saves tax later, at the tax rate, and only if profits return. A $44,000 loss is worth $11,000 at 25%, not $44,000.
• Keeping up last year’s instalments. PAYG instalments, provisional tax and payments on account are worked out from the last profitable year. In a loss year they can be reduced, within the rules, so the cash stays in the business.
• Changing owners without checking. Selling more than half of an Australian company, or more than 51% of a New Zealand one, can make carried-forward losses unusable unless the business continuity test is passed. Ask before the sale, not after.
• Using the Xero figure as the tax loss. Depreciation and non-deductible costs make the tax loss different. Use the figure from the return.
• Assuming a sole trader’s loss always reduces salary tax. In Australia the non-commercial loss rules often defer it instead.

Common questions

What is a net operating loss? It is a year where a business’s tax-deductible costs are bigger than its taxable income, so taxable income is negative. Net operating loss is the US term. In Australia, New Zealand and the UK it is usually called a tax loss or trading loss, and it can reduce tax in other years.

Is a net operating loss the same as a net loss? Not quite. A net loss is the bottom line of the Profit and Loss when costs are bigger than sales. A net operating loss or tax loss is worked out for tax, after adding back costs the tax office does not allow and swapping accounting depreciation for tax depreciation, so the two figures usually differ.

How long can you carry forward a tax loss? In Australia, New Zealand and the UK, business tax losses can generally be carried forward with no time limit, as long as the conditions are met, such as the ownership tests for companies and, for UK sole traders, the loss being used against profits of the same trade.

Can I get a tax refund for a business loss? A UK company can carry a trading loss back 12 months and get back corporation tax paid on the previous year’s profit. A UK sole trader can set it against income of the year before. Australian companies cannot carry losses back since the temporary rules ended, but excess PAYG instalments paid during a loss year are credited back when the return is lodged.

Can a sole trader offset a business loss against wages? In the UK, generally yes, through sideways relief, within a cap. In New Zealand, generally yes, except for ring-fenced residential rental losses. In Australia, only if the income requirement is met and the business passes one of the four non-commercial loss tests; otherwise the loss is deferred to future years of the same business.

Does Xero track tax losses carried forward? No. Xero’s Profit and Loss shows the accounting loss for the year, and the Balance Sheet shows it in retained earnings, but the tax loss carried forward is worked out in the tax return. Ask your accountant for the figure each year.

Know when the year is turning into a loss

ReportPilot reads your Xero figures and sends a short plain-English email every Monday. It covers sales and profit against last month and the same month last year, the cash in the bank against the end of last month, money owed to you that is past due and by whom, and bills due in the next two weeks against your cash. It does not work out tax or tax losses, but it shows early when profit is falling, which is when a change to instalments or a plan for the loss is worth discussing with your accountant. It asks Xero for read-only access, and there is a 14-day free trial with no card.