Introduction

Finance Bill 2017 was rushed through Parliament and received Royal Assent on 27 April. Given that the Bill did not receive the same level of parliamentary and legislative scrutiny as previous Finance Bills, the Government decided to remove a number of key provisions from the Bill before it was enacted. One of these items was the proposed legislation to reform corporation tax losses carried forward.

During the parliamentary debate on the Bill the Financial Secretary to the Treasury commented that “there has been no policy change” and “the Government will legislate for the remaining provisions at the earliest opportunity, at the start of the new Parliament”.

This fundamental reform to relief for UK corporation tax losses carried forward was planned to take effect from 1 April 2017. The proposed legislation intends to give increased flexibility in the use of carried-forward losses arising from 1 April 2017.

However it also restricts the amount of losses carried-forward, whether pre- or post- 1 April 2017, which can be set against a company’s profits to 50 percent of profits, subject to an annual £5 million group allowance. The proposed changes will affect both standalone companies and groups of companies.

The proposed legislation does not affect current-year use of losses, for example the existing group relief rules, or use of losses carried back.

The rules are still subject to enactment and at the time of writing it is not clear when the proposed legislation will be enacted, especially in the light of the UK’s General Election on 8 June 2017.

It may be the case that these rules will feature in any second Finance Act there may be in 2017 with the potential for retrospective effect unless the commencement date is changed. This assumes that the Conservative Party are successful in the June election. However, until any second Finance Bill is published, the position is currently uncertain. For simplicity the rest of this article assumes that the postponed proposed legislation is enacted in due course and takes effect from 1 April 2017 as originally planned.

The corporation tax losses affected are trading losses, non-trading deficits on loan relationships, management expenses, UK property business losses and non-trading deficits on intangible fixed assets. The proposed reforms do not apply to capital losses.

Pre-1 April 2017 losses carried forward

Under current legislation carry forward losses could be used only by the company that incurred the loss, and not by other companies in its group. In addition, certain losses could only be set against certain types of profits, for example trade losses carried forward could be set only against future trade profits of the same trade.

These rules continue to apply to losses arising before 1 April 2017, with only minor changes proposed.

Whilst the increased loss flexibility will not apply to losses arising before April 2017, companies will normally be able to choose to use pre-April 2017 losses before or after post-April 2017 losses, where both are available.

Post 1 April 2017 trade losses carried forward

The new carry-forward loss relief proposed legislation provides greater flexibility in the use of trade losses carried-forward where these arise on or after 1 April 2017.

Post April 2017, trade losses carried-forward to subsequent accounting periods may be offset against total profits of the subsequent accounting periods or group relieved in subsequent accounting periods.

This will be a welcome increase in flexibility as it reduces the potential for trading losses to become trapped in a company, i.e. not available for offset against profits of other group companies or profits of a different type of the same company.

However the carry-forward trade losses may be offset against only 50 percent of the company’s profits subject to a £5 million annual group allowance.

Restriction on use of post 1 April 2017 trade losses carried forward

For trade losses carried forward from a loss-making period to be offset against total profits a number of conditions must be satisfied, as follows:-

• The company must continue to carry on the same trade in the later period;
• The trade must not have become small or negligible in the loss-making period or any intervening period;
• The trade must be carried on on a commercial basis with a view to making a profit or with a reasonable expectation of making a profit.

Trade becomes small or negligible or other conditions breached

In certain circumstances, if the trade of the entity has become small or negligible in the loss making period then the loss carried forward may only be offset against future profits of the same trade. This is a nod in the direction to the current legislation.

Terminal relief for trading losses carried forward

When a company ceases trading, the existing loss relief provisions allow a trading loss which is incurred in an accounting period which began no more than 12 months before the date of cessation, (the loss in respect of that period) to be carried back three years against profits of the same trade.

The new rules also allow companies to use carry forward losses which remain on ceasing to trade against profits arising in the final 36 months of the trade without restriction.

However there is now the added complication of pre and post April 2017 losses. Pre April 2017 trade losses remain to be used against trading profits of the last 36 months and the post-April 2017 losses will be offset-able against total taxable profits.

Non-trading loan relationship deficits (NTLRD)

The proposed changes to the NTLRD rules will allow companies to claim all or part of the NTLRD against specific profits and allow a carry forward of excess NTLRD against total taxable profits including trading profits of subsequent accounting periods, providing a claim is made.

This proposed relaxation is also subject to the requirement that the investment business of the company has not become small or negligible. If the investment business has become small or negligible the deficit may be set against future non-trading profits only, as it is currently.

Capital losses

No changes have been made to the use of capital losses.

Group relief increased flexibility

The new group relief proposed legislation will allow carry-forward losses arising on or after 1 April 2017 to be surrendered as group relief. This significantly increases flexibility for use of carry-forward losses, subject to the 50% percent restriction/ £5 million annual group allowance.

A number of restrictions apply to the surrender of carry-forward losses, including the following:

• non-trading deficits on loan relationships, UK property business losses and management expenses cannot be surrendered if the investment business has become small or negligible;
• losses cannot be surrendered if the surrendering company could use the losses itself; and
• losses cannot be surrendered if the surrendering company has no income-producing assets.

In the case of consortium claims, additional restrictions linked to ownership at the time the loss was realised apply.

Commencement

The new proposed legislation will apply to accounting periods beginning on or after 1 April 2017. For accounting periods straddling 1 April 2017 the proposed legislation will apply as though the period before 1 April 2017, and the period on or after that date, are separate accounting periods. Necessary apportionments will be on a time basis, subject to a just and reasonable override.

£5 million annual group allowance

The loss restriction rules apply subject to an annual £5 million group deductions allowance, which allows the first £5 million of taxable profits to be offset in full by carry-forward losses. A group can choose to allocate the annual allowance between its members at its discretion.

For the purposes of the group allowance, the definition of a group is based on the current group relief definition of a parent company and its direct or indirect 75 percent subsidiaries, but is broader in a number of ways.

A group allowance allocation statement setting out the deduction of losses will be required to be submitted by the nominated company for the group’s members.

Anti-avoidance

A. Loss-buying

Several anti-avoidance provisions will be extended and some new ones introduced. For example the new proposed legislation prevents pre-acquisition carry-forward losses being surrendered to the new group for a period of five years. This new proposed legislation is in addition to the existing loss-buying proposed legislation which disallows carry-forward of losses on a major change in the nature or conduct of the trade within three years of a change in ownership. The three-year period for comparison has been extended to five years.

B. Regime anti-avoidance rule

The new proposed legislation also includes a more general form of anti-avoidance which applies to “relevant tax arrangements”. If it applies any loss-related tax advantage will be subject to just and reasonable adjustments via assessments, amendments or disallowances of the loss claims.

Relevant tax arrangements exist if:

• the purpose, or one of the main purposes, of the arrangements was to obtain a loss-related tax advantage; and
• it is reasonable to regard the arrangements as circumventing the intended limits of relief under the relevant provisions or otherwise exploiting shortcomings in the relevant provisions.

This may include, for example, manipulation of group structures to maximise the £5 million annual group deductions allowance or artificial inflation of profits to increase the utilisation of losses.

Conclusion

The new flexibility in use of carry-forward losses will be welcomed by many. However larger groups in particular will not welcome the restriction in use of losses carried forward. The changes also introduce additional complexity which may require detailed consideration and modelling to make the best use of losses carried forward, in particular for groups.

Peter Davis a Chartered Accountant and a member of the Chartered Institute of Taxation. He is a Tax Manager in Deloitte, Belfast.

Email: petedavis@deloitte.ie