Reforms to the corporation tax loss relief rules were originally due to apply from 1 April 2017. The announcement of the general election means that it is not clear whether the reforms will still take effect from that date. Broadly, the reforms aim to increase the flexibility in how losses can be used, particularly in relation to group relief, whilst restricting the extent to which losses can eliminate profits in a particular period, ensuring that large businesses pay tax in each accounting period in which they make profits.
Currently companies can eliminate all of their taxable profits in an accounting period by deducting carried-forward losses of the same trade, resulting in no corporation tax being paid in a year when a company has otherwise made substantial profits. The government has stated that the reforms are required to 'modernise' the current loss relief system and reflect the way that corporate groups are structured.
The reforms were first announced at Budget 2016. A consultation was then held between May and August 2016, with draft legislation first published in December 2016 and originally contained in the Finance Bill. However, the legislation was withdrawn from the Finance Bill after the general election announcement, to enable the Bill to pass through Parliament before the pre-election dissolution of Parliament. It is expected that the provisions will be included in a post election Finance Bill, but it is not clear whether they will still take effect from April 2017.
How does the loss relaxation work?
Under the new rules, a company will have more flexibility about the types of profit that can be relieved by carried-forward losses. Broadly, companies will be able to carry forward any trading losses arising after the legislation takes effect and set these against taxable profits of different income streams within the company. The carried-forward losses will also be deductible against the taxable profits generated by other group companies. This is in contrast to the current position where group relief is only permitted in the year of the loss.
How does the loss restriction work?
Going forward, a company's annual profit that can be relieved by carried-forward losses will be restricted. From the introduction of the rules, companies with profits in excess of £5m can only offset 50% of their profits against losses carried forward in a single year. This restriction applies to carried-forward losses arising at any time, meaning pre and post introduction of the rules. This change is in contrast to the previous position where carried forward losses could be offset against all future profits of the same type in that company (with no restriction). The £5m de minimis threshold applies on a group-wide basis, although groups will have discretion when deciding how to allocate the £5m allowance between group companies.
What happens to a company's restricted carried-forward losses if it ceases trading?
When the proposals were first announced there was concern that the restrictions could result in losses being permanently restricted if a company with unused carried-forward losses went into liquidation. In response to this, HMRC has introduced terminal loss relief in relation to carried forward losses, enabling a company's carried forward trading losses to be used to offset any of its profits arising three years prior to it ceasing trading. The 50% restriction does not apply in relation to terminal loss relief; however, the relief only applies to reduce profits in a 3 year period from the date the legislation takes effect.
Are anti-avoidance provisions included?
The draft legislation that was originally included in the Finance Bill included various anti-avoidance rules designed to prevent opportunities for tax avoidance made available by the extension of group relief for carried-forward losses. For example, there is an anti-avoidance rule in relation to loss-buying, whereby a group which buys a loss-making company cannot use the pre-acquisition carried-forward losses for five years. There is also an anti-avoidance provision to prevent a company artificially breaking its group relationship to gain access to a separate £5m de minimis profit allowance. There is also a targeted anti-avoidance rule (TAAR) designed to disallow any loss-related tax advantage that arises from tax arrangements, where the purpose or one of the main purposes of the arrangements is to obtain the loss-related tax advantage.
How do you see these rules interacting with the new corporate interest restriction?
The new restrictions on loss relief cannot be viewed in isolation—groups will also have to consider the impact of the new rules restricting tax relief on corporate interest payments. Companies which are affected by both these provisions may be hit with a significant increase in corporation tax. For example, a company that suffers an interest restriction and is unable to deduct substantial interest expenses will have increased corporation tax profits—it will then only be able to offset 50% of these profits with losses. Prior to the changes, that same company may have been able to achieve a greater reduction in corporation tax profits by way of loss relief.
What do you think the practical effect of these new rules will be?
The new flexibility for a company, in being able to set off losses against different income streams and having greater access to group relief, is welcome. However, the rules are long and very complicated and will create a compliance burden for companies seeking to claim the reliefs.
Some businesses may now also have to adjust their tax forecasts and profit projections to account for delays in utilising their losses. For example, the restrictions are likely to affect businesses which invest significant sums of money in research and development costs before being able to generate a profit. Take for example, a pharmaceuticals company that spends five years and £100m developing a new drug, generating a tax loss of £100m over the course of five years. In year six it gains a licence and begins to make regular profits of £50m per annum. In two years, it has recovered all its initial investment but for tax purposes it takes until the end of year nine for the £100m of losses to be fully utilised. Delays in utilising losses could make some projects simply unviable.
The new rules will be particularly burdensome for any entities that suffered substantial losses in the financial crisis of 2008 and subsequent years, many of which still have substantial carried-forward losses some nine years later and whose businesses may only now be just starting to make substantial profits in the recovery.
Indeed, HM Treasury has acknowledged the costly affect of these rules—it projects to raise over £1bn from these measures over the next three years.
The effects of these measures coupled with the new restrictions on tax relief on corporate interest payments are likely to be concerning to many UK corporate groups.
What sector specific provisions have been included?
There are specific rules in the legislation for dealing with losses in relation to: insurance companies carrying on a Basic Life Assurance and General Annuity Business (BLAGAB); oil and gas activities; and the creative industries. Banks and financial groups are already subject to their own loss restriction rules, which work with the same policy objective; although in their case the limit is now 25%.
Are there any unresolved or uncertain areas of application?
Given the fundamental shift in how losses will be treated going forwards, it will take some time for the new rules to bed down, and it is inevitable that practical problems will start to crop up and need resolution over the next few years. It is anticipated that further legislation will be needed—or desired by HMRC from the anti-avoidance perspective—to batten down the fine detail, so expect further 'tinkering' in future Finance Bills.
Eloise Walker and Penny Simmons are corporate tax experts at Pinsent Masons, the law firm behind Out-law.com. This is an updated version of a piece which was first published on LexisPSL on 12 April.