On 26 May 2016, HMRC released a consultation paper on the reform of the rules relating to the use of losses for corporation tax purposes.
The consultation paper sets out proposals to implement the announcement made at the time of the budget in March 2016 in relation to the reform of corporation tax loss relief rules. The main objectives of the proposals are:
- to allow the carry forward of losses arising after 1 April 2017 against taxable profits of different activities (and so relax some of the effects of the old schedule rules under which losses from particular activities could only be carried forward against future profits from similar activities);
- to allow carried forward losses arising after 1 April 2017 to be made available by way of group relief to other members of a corporation tax group; and
- to restrict the amount of taxable profits that can be sheltered by carried forward losses to 50 per cent of the taxable profits in excess of £5m. This £5m allowance applies on a group wide basis.
The budget proposal also included a separate restriction on the carry forward losses of banks arising in the period before 1 April 2015 to 25 per cent of the taxable profits in any period. Banks will become subject to the rules that apply for most companies from 1 April 2017 but these rules then interact with the separate restriction on the brought forward losses of banks. Those proposals are not covered by this note.
The consultation ends on 18 August 2016.
THE PROPOSED MODEL
The consultation paper sets out a model for the design of the new rules which will be reflected in draft legislation to be published following the Autumn Statement. In broad terms, the model sets out the following three steps for determining the allowable corporation tax loss relief:
- Step One: Allow relief for unrestricted losses and calculate the amount of profit to which the restriction applies – the “Relevant Total Profits”.
Relevant Total Profits are calculated after relief is allowed for current year losses (including losses claimed by way of group relief) and any carried forward losses within the company’s allocation of the £5m allowance.
- Step Two: Allow up to 50 per cent of the Relevant Total Profits to be relieved by pre-1 April 2017 carried forward losses and any carried forward unused management expenses, non-trading losses on intangible fixed assets and UK property losses.
This is achieved by allowing up to 50 per cent of trading profits to be offset against carried forward pre-1 April 2017 trading losses and 50 per cent of non-trading profits to be offset against carried forward pre-1 April 2017 non-trading loan relationship deficits. Pre-1 April 2017 and post-1 April 2017 losses of other types (for example, excess management expenses, or non-trading losses on intangible fixed assets) may then be offset against any remaining Relevant Total Profits within the 50 per cent limit.
- Step Three: If aggregate losses relieved under Step Two are less than 50 per cent of the Relevant Total Profits then allow post-1 April 2017 carried forward losses to be relieved against the balance of Relevant Total Profits up to the 50 per cent limit.
This is achieved by allowing carried forward post-1 April 2017 trading losses and non-trading loan relationship deficits and any carried forward surrendered losses to be offset against any remaining Relevant Total Profits within the 50 per cent limit.
This model only applies to losses of a revenue nature. Relief for capital losses is unaffected by these proposals.
The flow chart at the end of this note provides more detail as to how the new model will apply in practice.
ADDITIONAL POINTS TO NOTE
When first announced at the 2016 Budget, it was anticipated that the reforms to the corporation tax loss regime purposes would, in addition to ensuring a minimum level of taxation for corporate groups generating significant profits, simplify the loss regime and give UK corporate groups greater flexibility as to how their losses could be used.
The proposed rules do encompass some relaxations of the former rules, but the detail of the proposed model reveals several unforeseen (and arguably unnecessary) complications and inconsistencies.
- Post April 2017 loss streaming
It was originaly anticipated that the existing loss streaming and hierarchy rules would be maintained for losses arising prior to 1 April 2017, but that they would not apply to losses arising after 1 April 2017. However, the proposed model preserves streaming for post 1 April 2017 losses in two notable respects. First, the model provides that the total reliefs be offset proportionately between trading and non-trading profits. Second a company’s carried forward losses arising due to excess management expenses, UK property losses and non-trading losses on intangible fixed assets for the period after 1 April 2017 must be used in priority to carried forward trading losses and non-trading loan relationship deficits.
The consultation document does not provide any explanation for retaining the hierarchy. If all post-1 April 2017 losses are expected to be available to set off against all types of income profits, it is not readily apparent why any form of streaming or hierarchy needs to be maintained for post-1 April 2017 losses, particularly in view of the general desire to simplify the existing corporation tax regime.
- Definition of “group” and interaction with wider corporation tax framework
As indicated above, it is intended that each corporate group will be entitled to a £5m annual loss allowance which can be allocated on a company by company basis between their trading and non-trading losses.
The consultation document indicates that “group” for these purposes will not have the same meaning as for group relief purposes; instead, consideration is being given to using a definition based on either control or association. The stated justification for the alternative definition is to ensure that it is not possible for multiple companies under the same economic control to benefit from separate £5m annual alowances.
It is not clear whether an entirely new definition will be used or whether the group definition will be based on an existing definition which is used within the corporation tax regime. Given that the proposals in the consultation document are being introduced as part of a suite of reforms including the new interest barrier rule (which is also currently under consultation), one option - which is not canvassed in the consultation document – should be to use the same definition of group for these purposes as for the new interest barrier rule (where the definition of group is to be based on companies whose results are consolidated for accounting purposes). To do otherwise risks creating a proliferation of definitions of “group” for corporation tax purposes without a clear need for doing so.
- New profit-shifting anti-avoidance rule
The consultation document considers the need for a new anti-avoidance rule to prevent groups artificially shifting profits from a company which has no carried forward losses to a company that has pre-1 April 2017 carried forward losses.