Reform of Corporation Tax Loss Relief – Finance Bill 2017

Tue 20 Dec 2016

At this year’s Budget, a significant development announced was the reform of corporation tax loss relief and a consultation document was issued in May 2016.  On 5 December 2016 HMRC issued a response to this consultation document, together with draft clauses in Finance Bill 2017.  However, this is still not the whole story as further clauses (for example on consortia) are promised by the end of January 2017, despite the rules applying from 1 April 2017.

Recap of the key areas of the reforms

There are two different aspects:

• Greater flexibility on the use of post 1 April 2017 losses (removing the current restrictions of the types of profits losses can relieve, other than capital losses);
• The imposition of a restriction on the amount of losses brought forward that can be relieved to 50% of profits, subject to an annual allowance for groups/ standalone companies of £5 million per annum (other than banks where the restriction is already, from April 2016, 25%).

Changes to the original proposals

As a result of the consultation process, a number of welcome changes have been made to the proposals. 

Simplification

The original proposals added considerable complexity to loss relief calculations.  For example, it had been proposed that pre April 2017 losses would have to be used in priority to post April 2017 losses.  Also, there were requirements for pre and post April losses to be set against particular types of income, apportionment between trading and non-trading income.

It is good news that the government has listened to the concerns raised about the level of complexity, so that simplifications have now been made.  Companies will now have total flexibility over how any current year reliefs are set off against trading and non-trading profits for post April 2017 losses. Thus all post April 2017 losses, be they trading losses, property business losses and loan relationships deficits, can be set off against total profits.

However, the distinction between pre and post April 2017 losses will be maintained, as this is seen as an integral part of the affordability of the more flexible regime (not to mention that the restriction on the relief of losses carried forward at 50% of profits is not only an affordability measure, but in reality a revenue raising measure).  However, what is changing is that there will no longer be a requirement to use pre April 2017 losses up first, giving greater flexibility.  Companies will also be allowed to make a claim for pre April 2017 carried forward trading losses to be relieved against profits of that same trade in a later accounting period as opposed to the next accounting period.

For those companies without pre April 2017 losses (or if a company elects not to use pre April 2017 losses) there will also be a simplified calculation, meaning that profits will no longer need apportioning between trading and non-trading.

Group definition

The original proposal was that the definition of the group for the purposes of the £5 million annual allowance would be based on the accounting definition in IFRS 10.   As a result of representations made, the definition of ‘group’ will now be aligned with the group relief definition.  However, in order to prevent any abuse, such as fragmenting groups to claim additional £5 million allowances, there will be additional anti-avoidance rules.

Unintended consequences

A number of changes have also been made in particular areas to remove unintended consequences.  For example, fixed term investment projects could have been adversely impacted by the loss restriction to 50% profits rules, since these would be likely to make up-front tax losses.  This would have led to the relief of these losses then being restricted in later years, and possibly left unrelieved on cessation.  This has led to an important concession where companies cease trading, whereby such a company will be able to use any remaining carried forward trading losses against profits arising in the final 36 months of the trade (referred to as ‘terminal carried forward loss relief’).  For post April 2017 losses, their offset will be totally unrestricted (i.e. against total profits).  For pre April 2017 trading losses, they will only be allowed to be offset against profits from the same trade.  This concession will benefit not only fixed term investment projects but also distressed companies.  Note that the existing terminal loss relief rules allowing trading losses of the final accounting period to be carried back against its previous three years’ profits remain.

No such concessions are made however for start–ups on the basis that the £5 million annual allowance is deemed sufficiently generous.

Additional anti-avoidance measures

No tax legislation gets to the statute books these days without a hefty dose of anti-avoidance measures. 

Loss buying

A significant worry to the government is that the new rules will present new opportunities for avoidance, such as loss buying. To prevent this, where a new company is acquired, the following new rules will apply:

• on a change of ownership, pre-acquisition carried-forward losses cannot be surrendered into the new group for a period of 5 years
• the existing loss buying rules will continue to apply so if there is a change of ownership and one of the loss buying conditions are met (e.g. a major change in the conduct or nature of a trade or investment business), any pre-acquisition losses of the relevant trade or investment business will be forfeit. The time limit for considering whether the loss buying conditions have been met will be extended to 5 years after the change of ownership
• if there is a change of ownership and in the subsequent 5 years there is a change in the nature or conduct of any trade or business against which post-April 2017 carried-forward losses could otherwise be set, pre-acquisition carried-forward losses will not be allowed against profits of the trade or business the nature of which has changed.

Rules which currently apply to prevent the transfer of latent losses (transfer of deduction rules) will also be extended to prevent such a loss from being set off against total profits or group relieved.

Cessation

Currently losses die when the business ceases.  Concerned that the new flexibility might encourage other trade or investment business to be continued artificially once a trade, property or investment business has become small or negligible, the following restrictions will apply:

• trade losses will be available only to carry forward and set against profits of the same trade
• property losses will be available only to carry forward and set against profits of the same company
• management expenses will be available only to carry forward and set against profits of the same company
• non-trading losses on intangible fixed assets will be available only to carry forward and set against profits of the same company
• non-trading loan relationships deficits will be available only to carry forward and set against non-trading profits of the same company 

However, a relaxation is that losses will no longer expire when there is ‘no possibility’ of them being used.  This had been mooted as covering liquidations, but it has been recognised that this would not be appropriate as companies can realise profits during liquidation (for example on the realisation of their assets).

Targeted anti-avoidance rule

The purpose of this will be to prevent any arrangements that aim to refresh carried forward losses so that they become current year losses.  This will extend the current rules which only apply to trading losses to loan relationships deficits, management expenses and property business losses.

Exclusions

REITS and furnished holiday lettings will be excluded from the new loss relief reforms.