Background Note
71.Depreciation of fixed assets charged in the commercial accounts of a business is not allowed as a deduction in computing the taxable profits. Instead capital allowances may be given at prescribed rates on certain assets, including plant and machinery. The annual investment allowance provides an annual 100 per cent allowance for the first £100,000 of investment in plant and machinery to all businesses. There are also 100 per cent first-year allowances available for certain types of expenditure. Otherwise expenditure on plant and machinery attracts writing-down allowances (WDA).
72.Qualifying expenditure has to be allocated to the appropriate pool for the purpose of determining entitlement to WDA. A pool may cover a single asset (for example ships or short-life assets) or a class of assets (special rate pools and overseas leasing pools are examples of class pools). Any expenditure qualifying for plant and machinery allowances that does not fall to be allocated to a single asset pool or a class pool is allocated to the main pool. The rate of WDA for expenditure in the special rate pool is 10 per cent per annum, otherwise WDA is given at 20 per cent per annum.
73.Pooling works by keeping a running total of available qualifying expenditure in a pool. WDA is given on the balance of expenditure incurred in previous periods as yet unrelieved, plus any new expenditure in the period less any disposal proceeds to be brought into account for that period. This is the reducing balance basis. Plant and machinery allowances are broadly intended to give relief for the reduction in value of an asset while a company owns it. It is unlikely that WDA alone will achieve exactly this and balancing allowances or balancing charges are given to adjust the relief to give this result.
74.Capital allowances are deducted from profits and they may create or enhance a loss. Trading losses may be utilised in several ways. They may be surrendered as group relief, and so used to reduce the profits of companies other than the one that incurred the expenditure. They may also be set sideways against other profits (of the company incurring the losses) of the same year or carried backwards to reduce the profits of the company for an earlier year. Any remaining losses are carried forward to reduce the company’s profits from the same trade in subsequent years; they cannot be set against other profits of the company or against the profits of other companies in these subsequent years.
75.A company does not have to claim its maximum entitlement to capital allowances in any period, but instead may preserve the amount on which they may be claimed for a later period. This allows the company, and indeed its group, to decide when to make a claim in order to maximise the value of the capital allowances in reducing other profits.
76.There have been a number of transactions in which companies with large pools of unclaimed capital allowances have been sold into a new group principally to enable the new group to access the allowances in the form of group relief. While there is flexibility in the capital allowances code over the timing of a claim as described above, (paragraph 31) it is not the intention that tax assets in the form of unclaimed allowances be sold .
77.If a company claims its maximum entitlement to capital allowances each year and, in doing so, creates or enhances a loss that cannot be relieved, a group acquiring the company would not be able to access the losses as group relief, as explained in paragraph 74 above. There is also specific legislation to counter loss buying where a person buys a trading company wholly or partly for its unused losses rather than solely for the inherent value of its trade or assets; this legislation prohibits the losses being utilised against any new activities introduced into the company.
78.The legislation introduced by this Schedule is consistent with the rules to deter loss buying transactions and will restrict the way in which capital allowances can be utilised following a transfer of entitlement to benefit from those capital allowances. Capital allowances or any loss attributable to a capital allowances claim will only be available to reduce the profits that they would have been able to reduce before the transaction took place. The legislation will, however, only apply where the main purpose or one of the main purposes of the transaction is to obtain a tax advantage.
79.There are three other conditions that must be met for the legislation to take effect (that is, in addition to the unallowable purpose test). A company must carry on a trade or carry on a trade in partnership with others, that company (or that partnership) must have an excess of capital allowances and there must be a qualifying change in relation to the company.
80.Broadly, a qualifying change is either the sale or partial sale (to create a consortium) of a company, a change in the ownership proportions of a consortium company, a change in the profit sharing ratio of a partnership or a transfer of the trade (with the excess of allowances) in circumstances such that the Transfers of a trade without a change of ownership provisions (in Chapter 1 of Part 22 of CTA 2010) apply. Any of these transactions could be used to transfer an entitlement to capital allowances.
81.If a company has not claimed its maximum entitlement to capital allowances it is likely that the tax written down value (that is, the expenditure in a pool unrelieved) of the plant and machinery will be greater than its value shown on the balance sheet. The amount by which the tax written down value exceeds the balance sheet value is the excess of allowances.
82.The legislation operates by allocating an amount of expenditure equal to the excess of allowances in each pool to a new separate pool of the same type (i.e. a new single asset, class or main pool). WDA are calculated on the old and the new pools separately but at the same rate. If, however, in respect of another pool the balance sheet value of plant and machinery is greater than its tax written down value, then this difference can be used to reduce the excess of allowances in a pool. There are anti-avoidance rules to prevent the manipulation of the tax written down value and the balance sheet value used in the calculation to contrive a reduced excess of allowances.
83.To enable the excess of allowances to be calculated the company’s (or the partnership’s) accounting period is brought to an end on the day of a qualifying change and a new accounting period begins on the following day.
84.Capital allowances claimed in respect of expenditure in the new pools may only be used to reduce the profits (or increase the losses) from the trade as it was carried on, and to the extent that it was carried on, before the qualifying change. Any trading activities transferred in to the company or the partnership will be treated as a separate trade for these purposes.
85.Any losses attributable to capital allowances on new pool expenditure may not be surrendered as group relief or set against other profits of the company for the year, unless they could have been used to reduce those profits before the qualifying change.
86.There are special capital allowances rules for ships that allow capital allowances to be claimed and then postponed so that the capital allowances are given in a subsequent year. Postponed allowances that have not yet been relieved will be subject to the same rules as the amounts of excess allowances.
87.In summary, this legislation is designed to prevent a company or group acquiring a company, or an increased share in a company or partnership, or a trade for the purpose of accessing the capital allowances, actually obtaining relief for those capital allowances against its existing profits. Relief for the capital allowances can, however, still be given after the change in ownership transaction but only to reduce the same profits and to the same extent that they could have reduced before the change. The benefit of the avoidance transaction is thus removed in a fair and proportionate way.