Reforms to corporation tax loss relief: A two-way stretch
Forthcoming changes to corporation tax loss relief will be far-reaching, explains Donald Drysdale.
Three key reforms
On 26 May, HM Treasury and HMRC published a joint consultation entitled ‘Reforms to corporation tax loss relief: consultation on delivery’. This expands on Budget proposals to reform the rules for corporation tax relief for carried-forward losses.
There are three main elements to these proposals. Potentially, two of them are beneficial and the third is restrictive.
First, losses arising on or after 1 April 2017 and carried forward are to be available to set against taxable profits from different activities. This represents a fundamental move away from the existing rules under which losses from particular activities may be carried forward only against future profits from similar activities.
Second, in a significant extension of group relief, losses arising on or after 1 April 2017 and carried forward are to be available to set against profits of other members of the same group. For this purpose the familiar group relief definition of group relationships based on beneficial ownership will apply.
Third, from 1 April 2017 the amount of annual taxable profits that can be relieved by carried-forward losses will be limited to 50% of the taxable profits in excess of £5m. This £5m threshold or ‘allowance’ will apply on a group-wide basis, with the group having full discretion as to how it is allocated, and for this purpose a different definition of group will apply – possibly based on control as defined in IFRS 10 (Consolidated Financial Statements).
The reforms will be confined to revenue losses – that is, trading losses (including a company’s share of a partnership trade loss), non-trading loan relationship deficits, management expenses, UK property losses, and non-trading losses on intangible fixed assets. The rules for relieving capital losses will be unaltered.
So that no-one feels left out, I should mention a further proposal which ensures that there will continue to be a more restrictive treatment for historic carried-forward losses of banks, with the amount of profit that a bank can relieve with these losses now restricted to 25% from 1 April 2016. However, I won’t address specialist banking issues further.
Impact of the reforms
The good news is that, as a result of the reforms, companies and groups will enjoy increased flexibility over the profits against which future carried-forward losses can be relieved. To limit the cost of these measures to the Exchequer, losses arising before 1 April 2017 will retain their character and remain subject to the existing restrictions on how they may be used.
The bad news is the 50% limit on profits that can be relieved by carried-forward losses arising on or after 1 April 2017. This restriction will add further complexity to the tax computations of larger businesses. The government asserts that the £5m allowance will ensure that the restriction affects only the largest 1% of companies. Even for them it shouldn’t permanently deny relief for carried-forward losses, but it will affect the timing of relief: where a company’s carried-forward losses are restricted, it will be able to carry forward any unused losses and claim relief for them against profits arising in future periods – subject to possible reiteration of the restriction.
The government aims to ensure that the restriction on using carried-forward losses will not cause a group to pay corporation tax in a year of loss. Furthermore, the restriction won’t apply to the carry back of losses, thus helping to provide cash-flow support to businesses in periods of financial difficulty.
Profits will still be computed separately for different types of income, under the ‘schedular system’, at least until the Office of Tax Simplification completes its review of the corporation tax computation. Although allowing companies to set carried-forward losses from one activity against profits of another brings greater flexibility, the categorisation of profits will still be needed in relation to the treatment of carried-forward losses from before 1 April 2017. It is also relevant for other aspects of corporate tax such as double tax relief, Northern Ireland corporation tax and the controlled foreign company regime.
Under the new corporation tax loss relief regime, as at present, unused trading and property business losses will expire on cessation of the activity in which they arose. Subject to some technical changes, existing anti-avoidance and change of ownership rules will continue to apply. New rules may be introduced to counteract profit-shifting that might otherwise be used to accelerate the use of losses.
The consultation paper sets out a proposed structural model for delivering its objectives. The government is inviting views on this model, and on whether any alternative proposals could achieve the objectives more effectively.
The model goes into significant detail but, in outline, it defines three steps for calculating the allowable corporation tax relief:
- Step 1: Calculate the amount of profits to which the restriction applies.
- Step 2: Allow up to 50% of remaining profit to be relieved by pre-April 2017 carried-forward losses subject to the existing streaming rules.
- Step 3: Allow post-April 2017 losses to be relieved against the profits of different activities and/or different companies within the group.
The paper includes worked examples illustrating how the new rules might affect:
- a standalone company with profits over £5m;
- a loss-making group;
- a group with taxable profit up to £5m;
- a group with taxable profit of more than £5m and post-April 2017 carried-forward losses;
- a group with taxable profit more than £5m and a mix of pre- and post-April 2017 carried-forward losses; and
- (for the specialist) a banking group with pre- and post-2015 carried-forward losses.
Draft legislation on the proposals is to be published this autumn, allowing for a period of technical consultation ahead of its inclusion in the Finance Bill 2017.
The rate of corporation tax is being progressively reduced and will be down to 17% by April 2020. While this is an essential part of the government’s plan to make the UK corporate tax system competitive, it may be foolhardy to overlook the possibility that other changes being made to the tax regime at the same time could create uncertainty and instability and might discourage companies from doing business in the UK.
The proposed reforms to corporation tax loss reliefs fall into this category, and the government is causing further waves by consulting too on changes to the tax deductibility of corporate interest expense and the substantial shareholdings chargeable gains exemption. It would be unfortunate if these substantial modifications to the structure of corporation tax were to deter foreign investment.
Any significant change to tax law may have unintended consequences. There is a risk that details within the loss relief proposals might disadvantage not only large companies and groups or prospective inward investors but also other, smaller businesses who might need to understand the new regime and maintain separate records detailing their pre- and post-April 2017 carried-forward losses. Businesses and their tax advisers would be wise to study the consultation paper and assess how they might be affected.
Concerns raised early are always the most likely to be heard. ICAS intends to respond to the current consultation, which ends on 18 August. If you have views on the proposals and would like ICAS to take them into account, please email them to firstname.lastname@example.org.
Article supplied by Taxing Words Ltd