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5. Loss Relief Income Capital Gains And Corporation Tax Notes

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5. Loss Relief Income Capital Gains And Corporation Tax Revision

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Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

5. LOSS RELIEF - INCOME TAX, CAPITAL GAINS TAX AND CORPORATION TAX

1. Income Tax Rules Governing Losses (Individuals and Partnerships) A. Carry-Across (Sideways Relief) B. Carry-Back (Losses in Early Years of Trading) C. Carry-Back (Terminal Losses) D. Carry-Forward - "Same Trade"

2. Trading Losses and CGT (Individuals and Partnerships)

3. Corporation Tax Rules Governing Losses A. Carry-Across (Sideways Relief) and Carry-Back B. Restrictions on Carry-Back Relief when Acquiring a Tax Loss Company - "Major Change" C. Discontinuance (Reconstructions with Change of Ownership) D. Company Reconstructions without Change of Ownership (Group Loss Relief) E. Carry-Back (Terminal Losses) F. Carry-Forward

4. Capital Losses Anti-Avoidance

5. Cap on Income Tax Reliefs (Individuals SIDEWAYS RELIEF ONLY) - HMRC Cap

6. General Frameworks and Reform Proposals A. 1955 Royal Commission General Principles B. Rational Frameworks for Loss Relief (Donnelly & Young)

7. Summary of the UK Position __________________________________________________________________________________

Loss relief is an essential element of many tax avoidance schemes, especially those involving limited partnerships, and so continues to be the target of a good deal of anti-avoidance law At the same time, in the current economic climate, loss relief may be the only way some businesses can survive, and they may need to carry that loss relief back rather than forward if they can, if they have no prospect of immediate profit.

1. Income Tax Rules Governing Losses (Individuals and Partnerships) A. Carry-Across (Sideways Relief)

If a trade, profession or vocation sustains a loss, the correct figure for the profits chargeable to income tax for the year is nil because under Section 64 ITA 2007, a person who sustains trading losses may claim relief from tax by making a deduction from his net income

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Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

As the loss may be set against other income, ITA 2007 refers to it as "sideways relief", which means that loss relief is computed on an ACCOUNTS BASIS (by reference to the same basis periods as income from the same source) It also means that the income may be from any source and of any type, whether earned or unearned, or from savings

Section 64 Income Tax Act (ITA) 2007 - Deduction of Losses from General Income "(1) A person may make a claim for trade loss relief against general income if the person—
(a) carries on a trade in a tax year, and (b) makes a loss in the trade in the tax year ("the loss-making year"). (2) The claim is for the loss to be deducted in calculating the person's net income—
(a) for the loss-making year, (b) for the previous tax year, or (c) for both tax years…"

The claim must be made for the whole of the loss which can be set against the income and not merely part of the loss so as to reduce one's income to the amount of personal reliefs Thus if one has income of £10,000 and a personal relief of £7457 and a loss of £5000, one has to use the whole of the loss of £5000, thus wasting
£2457 of the personal relief (s65) Alternatively, one may choose not to use the relief at all and hope to get better value for it under another rule in another year; unused loss relief may be carried back one year and set off against the general income of that year (Section 64(2) ITA 2007, above)

B. Carry-Back (Losses in Early Years of Trading)

Section 72 ITA 2007 permits the carry-back of a trading loss where the loss arises in the year of assessment in which the trade is first carried on, or the next three years of assessment and thus apples to the losses arising in the first four years of business The loss occurred in the first four years of business can be set against income in the three years preceding the loss (Section 73) but is against earlier years before later years The effect of the relief is to revise earlier income tax computations and to obtain a tax refund, but the relief is available only to individuals/partners and not to limited companies

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Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

Thus, where early losses are envisaged, it may be worth stating as a sole trader or partnership (so as to be taxed as an individual) and then incorporate at a later stage

Worked Example F began business as a sole trader on 1 July 2011. His results for the first 12 months showed a total loss of £36,000: £27,000 of that was apportioned to be in 2011-2012 (1 July 2011 - 5 April 2012) and the other £9000 was apportioned to be in 2012-2013 (5 April 2012 - 1 July 2012) Before beginning business, he was employed as an assistant solicitor. His salaries for the years 2008-2011 were: 2008 - 2009: £20,000 2011: £10,000

2009 - 2010: £15,000

2010 -

Since the £27,000 loss was occurred in 2011-2012, within the acceptable three years of 2008-2009, F is able to set off against the £20,000 salary. He would have to set off against this one, and not any future salary (2010 or 2011) because of the 'earlier-year-first' rule. But if the loss (£27,000) exceeds the income (£20,000), the remaining £7,000 can be set off against the next year (2009-2010). Thus: 2008 - 2009 Salary Less 2011-12 loss Revised Liability Remaining Loss (2011-12) 2009 - 2010 Salary Less Remaining 2011-12 Loss

20,000
-27,000 0 7,000

Less 2012-13 Loss Revised Liability Remaining Loss (2012-13)

15,000
-7000 8000
-9000 0 1000

2010 - 2011 Salary Less Remaining 2012-13 Loss Revised Liability

10,000
-1000 9000

Section 72 ITA 2007 - Relief for Individuals for Losses in First 4 Years of Trade (1) An individual may make a claim for early trade losses relief if the individual makes a loss in a trade—
(a) in the tax year in which the trade is first carried on by the individual, or (b) in any of the next 3 tax years. 3

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

(2) The claim is for the loss to be deducted in calculating the individual's net income for the 3 tax years before the one in which the loss is made

Relief is denied unless it can be shown that the business was conducted on a commercial basis with a view to a profit (Section 74 ITA 2007), and the relief cannot be extended by the taxpayer transferring the business to the spouse or civil partner after first 4 years (s74(4)) IMPORTANTLY Section 72 and Section 64 are ALTERNATIVES such that the same loss cannot be relieved under both sections (i.e. twice) viz. cannot be used to set off against income in the same or previous year or both (under Section 64) AND set off against income in the three years preceding the loss which was incurred within the first 4 years of the business (s72) HOWEVER, relief under one section can result in a SURPLUS OF LOSS which can be used as relief under the other section. The following example illustrates:

Worked Example A begins trading in August 2012. His losses in the 2012-13 year are £15,000. His income in the previous three years (2009-10 onwards) amounted to £10,000. If he elects to use the Section 72 relief then he will have wasted his personal allowances in the preceding years, but will be left with a surplus of £5000 which can be relieved against any other income he might have in 2012-13 under Section 64. C. Carry-Back (Terminal Losses)

If a loss is sustained in the last 12 months of a business, the unrelieved loss of that period, so far as not otherwise relieved, may be relief by set off against business profits in the year of cessation and the three previous years of assessment (Section 89(3) ITA 2007) Relief is given as far as possible against later rather than earlier years (contrast with the position under Section 72 where the general rule is earlier years first) In contrast to Section 64, the relief is only against profits arising from trade and not from all other income; though if profits of a preceding year are insufficient to absorb the loss, trade-related interest and dividends are treated as profits for the purpose of the deduction (s85)

D. Carry-Forward - "Same Trade"

A loss that is sustained in carrying on a trade can be carried forward under Section 83 and set off against the first available of profits of the same trade without time limit, though the loss must be deducted as far as possible from the earliest subsequent profits such that the taxpayer may not be able to make use of his personal allowance

Worked Example 4

Corporate & Business Taxation (BCL)/Magister Juris (MJur) ACCOUNTING PERIOD Year to 31 Dec 2008 Year to 31 Dec 2009 Year to 31 Dec 2010 Year to 31 Dec 2011 Year to 31 Dec 2012 Section 83 ITA 2007

Bachelor of Civil Law

PROFITS (£)
+2000

TAX YEAR

-6000 (loss)
+1600

2009-2010

+3600

2011-2012

+4000

2012-2013

2008-2009

2010-2011

TAXABLE PROFIT (£) (LOSS) 2000 0 (with a 6000 loss carried forward) 0 (1600 - 6000 = 4400 loss c/f) 0 (3600 - 4400 = 800 loss c/f) 3200 (= 4000 - 800)

- Carry Forward Against Subsequent Trade Profits

(1) A person may make a claim for carry-forward trade loss relief if—
(a) the person has made a loss in a trade in a tax year, and (b) relief for the loss has not been fully given under this Chapter or any other provision of the Income Tax Acts or under section 261B of TCGA 1992 (use of trading loss as a CGT loss). (2) The claim is for the part of the loss for which relief has not been given under any such provision ("the unrelieved loss") to be deducted in calculating the person's net income for subsequent tax years (3) But a deduction for that purpose is to be made only from profits of the trade. (4) In calculating a person's net income for a tax year, deductions under this section from the profits of a trade are to be made before deductions of any other reliefs from those profits.

Losses can only be carried forward under this section against future profits from the same business: thus if the nature of the business changes in a future year, there can be no carry-forward of the losses - see Gordon and Blair v IRC (brewing losses not c/f w/ bottling profit) The following cases on cessation/continuance are also relevant to corporation tax (below)

Gordon and Blair Ltd v Inland Revenue Commissioners

The taxpayer company carried on business as brewers but in October 1953 they ceased brewing, but continued to bottle and sell beer supplied to its specification by another brewery; the company claimed that it carried on the same trade before and after Oct 1953 The Special Commissioners upheld the Crown's contention that the company ceased trading as brewers and commenced a fresh trade of selling beer such that the taxpayer could not rely on the set off against future profits under what is now Section 83 ITA 2007 5

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

The Court of Session held that the SC were entitled to come to that conclusion

Lord President Clyde (Not followed - Walton J, Rolls Royce / HMRC Manual c.f. Lord Guthrie)

No beer was brewed by the taxpayers after October 1953, but the beer brewed by the other firm was distributed by the taxpayers under the same organisation to the same type of customers and in substantially the same way the taxpayer had been distributing their own…
The taxpayer argued that their trade was, before and after October 1953, the distribution and sale for profit of their own particular brand of beer whether manufactured by them or manufactured by another However, this contention mis-describes the real nature of the taxpayer's trade which was really the manufacture for sale by the taxpayer their own brand of beer; the selling and the distribution were ancillary to the main trading activity before October 1953 After 1953 their ancillary activity became the sole trading activity; Special Commissioners were entitled to reach the conclusion which they came to

Lord Guthrie (with whom Lord Carmont agreed; Followed - Walton J, Rolls Royce)

It is a question of degree whether a change in activities of a company amounts to the discontinuance of a trade and the commencement of a new one

Rolls-Royce Motors Ltd v Bamford (Inspector of Taxes)



RR was incorporated for the manufacture of motor-vehicles but its activities later expanded to aero-engines; when it ran into serious financial difficulties the receivers of debenture-holders transferred 4 of RR's 6 divisions (including the aero-manufacture) to the govt. The remaining 2 divisions (the motor manufacture) were transferred to the taxpayer company, which was a wholly owned subsidiary of RR When RR went into administration, the taxpayer claimed to carry forward losses incurred by RR to be set against its own profits; the inspector of taxes rejected this on the ground that the taxpayer company did not carry on the same trade as that in which losses were made The Special Commissioners held against the taxpayer Walton J held that they were entitled to reach that conclusion

Walton J

There is a difference between the organic growth of a trade and a sudden and dramatic change brought about by either acquisition or loss of activities on a considerable scale 6

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

If a small grocer's shop expands organically to acquire other shops, then organises a central system of bulk-buying for all of them, then starts to run its own fleet of vans, the correct assumption is that it has never discontinued one trade and commenced another But the final trade will bear little relationship to its original beginnings and if, as the result of some crisis, it has to get rid of all its activities by selling them off, leaving it with only the original shop, there would be no doubt that there had been a violent change in the trade…
This is supported by authority: in Gordon & Blair v IRC, Lord President Clyde treated the matter as being one in which the essence of the trade was different in two cases, whereas both Lords Guthrie and Carmont treated the matter as one of degree In J G Ingram v Callaghan the taxpayer argued that the essence of the trade throughout had been selling; the profitable sale of goods (relying on Lord President Clyde); whether they are made by the company itself or purchased ready-made from another, this was simply change in the means… but the end - the essence - remains the same: a profitable sale Lord Donovan in the CoA rejected this: you cannot as a rule segregate the various activities involved and select one of them as being the "essence" and the "real trade" There is an organic unity about trade which prohibits segregation; a trade differs from the individual activities which go into it; if T had been asked in one period what his trade was he would have said "making and selling"; in the second period he would have said "we have changed over now simply to selling" If, as here, there is in substance a complete division of the trade by the company into two separate parts, notwithstanding that the trade of the same general nature is carried on thereafter by each of two now separate entities, neither of them is carrying on the same trade as the composite whole formerly carried on The comparison which has to be made is between the trade actually carried on by the company in the accounting periods in which it made the losses, and the trade carried on by the taxpayer and not the historic trade of the company and that of the taxpayer If this is the correct approach, then the question of degree approach favoured by Lord Guthrie in Gordon & Blair, which was adopted by the Commissioners here, is the correct one

Robroyston Brickwords Ltd v IRC (Court of Session, Scotland)

The taxpayer company manufactured and sold bricks from Robroyston, Scotland C Ltd, a company which carried on the same trade as the taxpayer, acquired the entire share capital of the taxpayer in order to eliminate what

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