New legislation has been enacted in the Finance Act 2015, taking effect from 18 March 2015, to tackle arrangements implemented by some corporate groups with the specific intention to “refresh” tax losses. As explained below in further detail, “refreshing” tax losses in this context broadly refers to arrangements that allow carried forward tax losses to be used against a wider range of taxable group profits that tax law otherwise permits. Restrictions will now apply to such arrangements, although the broad and subjective manner in which the new legislation has been cast is likely to cause some uncertainty to corporate groups seeking to comply with these new rules.
A company can carry on a number of different trades and activities for tax purposes and the UK corporation tax rules require a separate calculation of the profit or losses derived from each of these activities. To the extent losses arise from any of these activities, the tax rules can restrict how losses arising from one activity can be offset against profits from another activity of the same company or a group company.
The rules are generous regarding the use of losses in the year in which they arise. Losses can generally be offset against profits that arise in the same year from a different activity of the same company or (by way of group relief) against profits derived from activities of other group companies.
However, if losses cannot be utilised in the year they arise (the company or wider group does not have sufficient taxable profits in that year), although the tax rules allow any such losses to be carried forward into subsequent periods, the manner in which such losses can be utilised is significantly restricted. Typically, it will only be possible to off-set such losses against any future profits arising from the same activity that gave rise to those losses and it is not possible to surrender such losses to another group company.
This restriction on the use of carried forward losses often results in what is known as “trapped” losses – carried forward losses that are unlikely ever to be offset against taxable profits since the company in which the losses arise does not make any profits. A common example is a group holding company that pays interest on external or intra-group debt (and therefore generates tax losses) but has no trade of its own.
“Refreshing” tax losses
To counteract the legislative restriction on carried forward losses, some corporate groups have been putting in place arrangements (e.g. intra-group loans) that seek to generate taxable profits within a company with carried forward losses and corresponding current year tax losses in that or another group company. The profit generated by these arrangements is off-set by the carried forward losses and the corresponding losses generated can be off-set in the generous manner permitted for current year losses (i.e. against the profits of other activities or other group members), thereby effectively “refreshing” the carried forward losses and circumventing the legislative restrictions on the use of carried forward losses.
Preventing loss “refreshing”
Finance Act 2015 introduces a new Part 14B of the Corporation Tax Act 2010 that seeks to prevent arrangements implemented specifically to “refresh” carried forward losses that have no significant wider commercial purpose. For these anti-avoidance rules to apply, broadly the following conditions need to be met:
- arrangements exist for a company to receive profits from which it can deduct carried forward losses;
- the company, or a company connected with it, is entitled to bring a tax deductible amount into account as a consequence of the arrangements and it is reasonable to assume that this deduction would not have arisen to that company but for the arrangements;
- the main purpose, or one of the main purposes, of entering the arrangements is to obtain a tax advantage involving both the tax deduction and the use of the carried forward reliefs; and
- when the arrangements were entered into, it would have been reasonable to assume that the value of the anticipated tax advantage would be greater than any other economic benefit of the arrangements.
Where the conditions are met, the company will be restricted from off-setting the relevant carried forward losses against the profits derived from the offending arrangements, thereby negating the benefit of the arrangements.
These new rules apply to all profits arising after 18 March 2015 (irrespective of when the arrangements were put in place) and accounting periods current at this date will need to be apportioned into two notional periods.
While the legislation targets specific planning, it is drafted widely and is reliant upon the purpose and value assessment conditions to target the provisions against these specific avoidance arrangements.
The difficulty for corporate groups is the subjective nature of the assessment as to whether a tax advantage is obtained and that this tax advantage is more valuable than any associated economic advantage. The value assessment condition in particular is representative of a new approach to certain anti-avoidance legislation, with the consequence that its scope and application is likely to be uncertain for both taxpayers and HMRC for some time.