The Finance Bill 2017, published on 5 December 2016 and updated with additional drafting on 26 January 2017, contains the full draft provisions for the implementation of changes to the corporation tax carried forward losses regime first announced in the 2016 Budget.
These changes are expressed to modernise corporation tax loss relief by increasing flexibility over the profits that carried forward losses can be relieved against whilst ensuring businesses pay tax in each accounting period that they make substantial profits. These objectives are intended to be achieved by two principal reforms:
- losses arising after 1 April 2017 can be carried forward to future periods and either set against taxable profits from different activities within a company or surrendered to other group members; and
- from 1 April 2017, the amount of annual profits that can be relieved by carried forward losses (both pre and post 1 April 2017 losses) will be limited to 50%, subject to a £5m allowance per group.
While improving the flexibility of the carried forward loss regime is to be applauded and produces a fairer outcome when compared to the current restrictive regime (explained further below), a more cynical view could be that these changes are principally designed to curb the use of significant carried forward losses by large businesses to reduce or remove tax on large profits. Different types of businesses will view this reform in different ways, depending on their own tax position. However, all affected businesses are likely to consider the new regime, with its split between and pre and post April 2017 systems and detailed anti-avoidance rules, more complex and administratively burdensome.
This article is intended to provide an overview of the new regime, picking up on key aspects. The underlying draft legislation is very detailed and addresses many different specific issues and business types, so taxpayers will need to consider the legislation in detail and apply the new rules to their own factual circumstances to understand the full impact of these changes.
It is also important to note that the provisions do not include any changes to the carried forward losses regime for income tax purposes, nor do they impact capital losses. Therefore any references to losses in this article are to corporation tax income losses, unless otherwise stated.
The current regime
To put the changes to the carried forward losses regime into context, it is first helpful to summarise the current position.
In computing its corporation tax liability, a company is required to separate out ‘streams’ of profit and losses in accordance with how they are generated. These streams are categorised as follows:
- trading losses (Part 3, Chapter 3 CTA 2009);
- property losses (Part 4, Chapter 3 CTA 2009);
- non-trading loan relationship losses (Part 5, Chapter 1 CTA 2009);
- non-trading losses on intangible fixed assets (Part 8, Chapter 6 CTA 2009); and
- miscellaneous losses (Part 20, Chapter 2 CTA 2009).
To the extent losses arise from any of these activities, the rules currently stipulate that such losses can be used as follows:
- firstly, against the total profits of the company that arise in the same accounting period (as per s4 CTA 2010, total profits includes profits from all the different income streams set out above, as well as capital gains);
- secondly, carried back and used against the total profits of the company that arose within the 12 months preceding the accounting period in which the losses arise;
- thirdly, surrendered against the total profits of other companies within the same group arising in the corresponding accounting period (group relief); and
- finally, carried forward and used against profits from the same trade arising in a future accounting period (i.e. carried forward losses).
From the above it can be seen that while the rules on the use of losses in the year realised or carried back to the previous year are wide in scope (such losses can be set against the total profits of the company or group members), the carry forward rules are quite restrictive. The requirement that losses carried forward can only be set against the profits of the same trade that generated the losses means that such losses are not available to be set against future profits arising under a different income stream, nor can they be used by other group members. Further still, for companies carrying on different trades, any carried forward losses are ring-fenced to the trade that generated such losses, and major changes to trading activities or periods of inactivity can jeopardise the carry forward of losses.
In addition, the carried forward loss restrictions can often lead to companies becoming unable to utilise certain types of losses, with these losses effectively becoming “trapped” within the company. A common example of this is losses arising in respect of interest payments on debt (non-trading loan relationships) which are not fully utilised in the period in which they arise or the previous period. Such losses would then be carried forward but only be available to offset against any non-trading loan relationship profits (or excess credits) arising for the company. In many cases, such a company would not have significant non-trading loan relationship profits, leading to these losses becoming trapped and effectively useless to the company or its wider group.
Set against the restrictive nature of the current carried forward losses regime, and an important point in the context of the changes, within these restrictions (other than for banks) there is currently no cap on the quantum of carried forward losses that can be used in any period or time period during which such losses remain available. Consequently, for businesses with significant pools of carried forward losses, it is possible to pay little or no corporation tax on substantial profits generated in future periods.
The new regime
The new regime essentially creates two separate carried forward losses regimes, one that applies to losses that arise before 1 April 2017 and one that applies to losses that arise after 1 April 2017.
Pre-1 April 2017 losses
Essentially, for pre-1 April 2017 losses there is no positive change to the current regime and no increased flexibility, only additional restriction. Pre-1 April 2017 losses will still only be carried forward against future profits of the same trade, but (subject to the £5m allowance described below) the profits against which such losses can be offset are restricted to 50% of the annual profits of the relevant trade in the relevant period.
Post-1 April 2017 losses
It is in relation to losses arising post-1 April 2017 that real flexibility has been introduced, although this flexibility also comes with the 50% profit restriction.
The position in relation to the current year use of losses and carry back remains unchanged, but in relation to carried forward post 1-April 2017 losses, these will now broadly be able to be used as follows:
- against the total profits of the company in future accounting periods (i.e. against profits arising under any income stream, from separate trades and also capital gains);
- against the total profits of other companies in the same group in future accounting periods (group relief for carried forward losses).
In each case, as with pre-1 April 2017 losses, the amount of annual profits that can be relieved by carried forward losses will be limited to 50% of such annual profits, subject to the £5m allowance per group described below.
The 50% profit restriction and £5m allowance
There are detailed rules set out in the draft legislation regarding the calculation of profits to which the 50% restriction applies and the interaction between pre and post 1 April 2017 losses.
In relation to the £5m allowance, while the position for a single company is straightforward, with the 50% profit restriction only applying to relevant profits that exceed £5m, for groups of companies this £5m allowance applies on a group basis and must be allocated between group members. The draft legislation contains detailed provisions in relation to the allocation of the £5m allowance with a group
– effectively groups are free to allocate the allowance as required. The definition of group for these purposes effectively follows the existing group relief definition, although slightly widening the definition to address certain specific circumstances.
Group relief for carried forward losses
The draft legislation contains detailed provisions in relation to group relief for carried forward losses. Some key points to note are as follows:
- many of the principles that apply to group relief for current year losses also apply to group relief for carried forward losses;
- the claims process broadly follows the current year group relief rules;
- consortium relief claims will be available in relation to carried forward losses, but subject to more detailed anti-avoidance provisions designed to cap a consortium member’s claim to the entitlement of that member at the time the losses arose;
- as with current year group relief, payments can be made for the surrender of carried forward losses and these will not be taxable up to the amount of the agreed loss;
- companies with no assets capable of producing income cannot surrender carried forward losses, thereby preventing the retention of otherwise dormant companies in order to access their losses.
Simple worked example
Please click here to view table.
This scenario provides a relatively straight forward example as to how the new rules would apply to a typical medium sized business.
The losses will need to have been identified based on the stream in which they arose and when they arose i.e. pre and post 1 April 2017. The company can choose whether it wants to utilise the pre or post 1 April 2017 losses first.
Use of losses for Y/E 2019
- Firstly the company could offset the current year non-trading loan relationship loss against its current year profit, reducing the taxable profit from £25 to £23m.
- Having applied all of the available current year losses, the group can then utilise the £5m group-level allowance. To do this, the entire £5m allowance could, for example, be allocated to Company A, with Company A then carrying forward £5m of its pre-1 April 2017 trading losses to reduce the y/e 2019 taxable profits from £23m to £18m.
- Under the new rules, up to 50% of Company A’s remaining £18m profit (i.e. £9m) and up to 50% of Company B’s £5m profit (i.e. £2.5m) would be available against which to offset any further available carried forward losses.
- Company A could then set off the remaining £2m of carried forward trading losses from y/e 2017 against the remaining £18m of y/e 2019 profits reducing them to £16m.
- Step 2 would leave a balance of £9.5m of profits against which carried forward losses could be applied.
- Company A could then choose to surrender £2.5m of its available y/e 2018 carried forward losses to Company B so that Company B’s y/e 2019 taxable profits are reduced to £2.5m.
- Company A could then choose to set off a further £7m of its remaining £12.5m carried forward trading losses from y/e 2018 against the remaining £16m of y/e 2019 profits to reduce its y/e 2019 taxable profits to £9m.
- There remains £2m of non-trading loan relationship losses which arose in y/e 2017, £5.5m of carried forward trading losses which arose in y/e 18 and £2m of non-trading loan relationship losses which arose in y/e 18 to be carried forward.
- Tax will be payable in y/e 2019 by both Company A (on taxable profits of £9m) and Company B (on taxable profits of £2.5m).
As anticipated, a range of targeted anti-avoidance measures have been included in the draft legislation. A primary concern of the government has been loss buying and a number of new and amended anti-avoidance provisions have been proposed to address this concern:
- on a change of ownership of a company with carried forward losses, pre-acquisition carried-forward losses cannot be surrendered into the new group for a period of five years;
- the existing loss buying rules will continue to apply so that if there is a change of ownership and one of the loss buying conditions are met, any losses arising pre-acquisition will be lost. However, the time limit for assessing whether the conditions are met will be extended from three to five years; and
- rules that restrict losses that arise before changes of ownership that are coupled with major changes in the business of the transferred company or a co-transferred company within a five year or, for an investment business, eight years after the change of ownership.
In addition there are anti-avoidance rules that:
- seek to prevent trade or investment businesses being continued artificially once a trade, property or investment business has become small or negligible in order to benefit from the greater flexibility;
- extend the current rules relating to ‘refreshing losses’ to cover carried forward property business losses and carried forward non-trading losses on intangible fixed assets;
- where there is a change of ownership of a company and, within 5 years of the change, there is a no gain/no loss transfer of an asset which is subsequently sold at a gain, there may be a restriction on the surrender of losses within the group to set off against the chargeable gains; and
- restrict carried forward losses which arise from arrangements which have a main purpose of obtaining a “loss-related tax advantage”.
Application to certain industries
Certain industries have been singled out in the draft legislation for different treatment:
- banks, whose carried forward losses have already been restricted to 50% of taxable profit since April 2015, will be further restricted to 25% of taxable profit;
- life insurance companies have special computational provisions that determine the impact of the new provisions to life business profits;
- creative industries such as film, TV, video game and orchestra will continue to be subject to existing specific loss carry forward provisions in relation to pre-completion losses, with the new regime only applying to completion period losses;
- oil and gas activities will continue to be subject to their own corporation tax regime; and
- REITS and furnished holiday lettings are excluded from the new rules.
Winners and losers
The primary winners under the new rules will be SME businesses with profits of less than £5m, who will benefit from greater flexibility to carry forward losses without the 50% profit restriction. It is the government’s view that this will account for 99% of all businesses.
However, for larger companies and groups, the carried forward loss rules potentially become vastly more complex. For example, a large retailer with an international group and, say, a banking division will need to separate any pre and post 1 April 2017 losses, run separate calculations for its finance activities and continue to separate out its non-UK activities. In addition, it is likely that the 50% profit restriction will lead to an acceleration of cash tax payments.
Concerns have also been raised in relation to capital intensive businesses such as infrastructure and new businesses or technology developments that require significant early stage investment. The 50% profit restriction is likely to impact financial forecasting and valuation of such businesses, although the issue for fixed term investment projects has been recognised through the introduction of an unrestricted three year terminal loss carry back.
As illustrated above, the new carried forward loss regime will benefit some businesses and disadvantage others. However, what is particularly concerning at a time of ongoing focus on reducing the complexity of the UK tax code and promoting the competitiveness of the UK tax regime is the complexity and detail of rules that on the face of it have reasonably simple objectives. The draft legislation runs to nearly 100 pages and in addition to the burden this places on businesses attempting to understand and apply the new rules, operating the new rules will for many businesses result in a significant additional compliance and administrative burden that is likely to be unwelcome, even for those businesses that also benefit from the changes.