Corporation Tax Loss Relief Reform: A Thoroughly Modern Measure?

Alan Pink finds a mixed message – and a mixture of motives – in the new company loss relief rules that have been announced.

It brought a bit of a nostalgic lump to the throat to read the HMRC stated ‘Policy objective’ behind changing the company tax loss carry forward rules; where it says that the new measure ‘will modernise the UK’s loss relief regime...’ In the field of architecture, at least, a lot of people are now questioning the assumption that ‘modern’ equals ‘good’ - not in tax law pronouncements, though, it seems! 

The proposed provisions, described below, are certainly a good example of modernisation in two respects: they are very complicated (coming in at an eye-watering 95 pages of draft legislation), and they raise more tax! The cynic in us suggests that the real driver behind this ‘reform’ is ignorant media attacks on companies which pay little tax despite showing a large profit – because they’ve made losses in the past for which the rules (quite reasonably, in my view) give relief. But let’s get down to the detail of the new rules. 

The changes were first announced last year and there was a consultation period over the summer of 2016. The result is draft legislation, which will be included in Finance Bill 2017, with a view to taking effect on 1 April 2017. The cut-off point of 1 April 2017 refers generally to the time the losses in question were incurred, with pre-April 2017 losses continuing to be dealt with under the old rules, even when they are carried forward into the post April 2017 period; and the new rules applying to losses incurred from 1 April 2017 onwards. 

The changes won’t just affect trading losses, but will also apply to loan relationship debits, management expenses of investment companies, property losses, and non-trading intangible asset losses – basically almost anything that results in a red figure at the bottom of the company’s profit and loss account. 

Following a trend that has been a feature of HMRC announcements in recent years, the changes are given a positive ‘spin’, with the measures that will benefit some companies being set out first, followed by the not so good news later on. 

The good news, to start off, is that post-1 April 2017 carried forward losses won’t be subject to the previous restriction as to what they can be offset against. At present, and before these new rules come into effect, there is a very restrictive provision that allows trading losses, carried forward to a subsequent period, only to be offset against profits from the same trade. This restriction has given rise to a considerable amount of dispute between HMRC and taxpayer, because of the difficulty, in some cases, of interpreting what is meant by the phrase ‘the same trade’. 

For example, suppose you are a property development company and you complete a development showing a loss in your last period. 

The company then lies fallow, perhaps just carrying forward a certain amount of land held in stock, for a year or two, and then undertakes a new development, which is nothing to do with any of the old ones. Are the profits from this new trade eligible for loss offset, or is it, on the contrary, a new trade? If the company diversifies or substantially changes the way it does business, is this a new trade, or a continuation of the old one? And so on, and so on. The big plus point of the new changes is that this sometimes tricky point of definition will no longer be relevant for working out a company’s tax bill. 

Another restriction, which applies currently, but will be done away with if these new rules come in, is the rule that says that you can’t bring forward losses from an earlier accounting period and then ‘group relieve’ those losses against the profits of other companies. This again is proposed to be done away with, with brought forward losses being available to surrender to other companies within the same 75% group.

This seems an eminently reasonable relaxation. The general tenor of the tax rules as they apply to groups of companies is that the division of the overall group business into a number of separate companies should not disadvantage the taxpayer, as contrasted with a scenario where all of the same activities were carried out within a single company. 

In our wish to be scrupulously fair to HMRC (what, you hadn’t noticed?!), we should first of all express the view that the bad side of the reformed rules won’t affect the vast majority of companies. 

The first such change will obviously only affect the big boys, and HMRC estimates that only the top 1% of companies will come into this category. Although it is expressed slightly differently in the draft rules, what this consists of is a restriction of the amount of profits against which you can offset brought forward losses to 50%: but only where these profits are more than £5 million (this £5 million ‘allowance’ applies across the whole group, where there is a group of companies). 

This was what was meant earlier on in this article by the suggestion that these proposals are motivated by the media, rather than sensible analysis of the economic effect of the tax law. For some reason, which I have to say escapes me, the sight of a company paying no corporation tax, even though it has substantial profits in the current period, is regarded as objectionable – even where the reason for this lack of a tax charge is because the company has made substantial losses in earlier periods. After all, by definition these will be valid, allowable losses that the company has incurred in its laborious upward climb into profit. In economic terms, what we have here is a strong disincentive to large companies to start initially loss-making trades whose future profits it is hoped will justify the initial pain. Media 1: UK economy Nil! 

The other item on the debit side of the changes is a special rule discouraging the purchase of companies because they have brought forward trading losses. 

Where a company, which has losses arising after 1 April 2017, is bought by an acquirer, the draft Finance Bill 2017 provisions will not allow relief for any of these losses for a five-year period. This restriction may affect much smaller companies than the 50% rule mentioned above. 

However, it has to be said that prudent purchasers have always been inclined to discount the benefit of brought forward losses in a company they were purchasing. HMRC already had weapons in their armoury that they could direct against ‘loss purchasing’: for example, the requirement that the acquired company shouldn’t have any major change in their nature or conduct of its trade following the change of ownership. If the way the company was previously being run gave rise to losses, then clearly some kind of change, perhaps radical change, was needed – but this would have the danger implicit in it, even under the old rules, of meaning that the brought forward losses couldn’t be used.