Chapter 2: Disallowance of trading losses
Overview
2078.Chapter 2 is the first of four Chapters dealing with variations on the theme of “loss buying”.
2079.Companies can obtain corporation tax relief for various expenses and losses in different periods from the periods in which the expenses or losses arise. They can,however, only turn these reliefs into a reduction in tax liability if they have taxable profits against which the expenses or losses can be set. The shareholders of an unsuccessful company might therefore wish to monetise these tax reliefs by selling the company to people who might be able to make use of them. Sections 768 to 768E of, and Schedule 28A to, ICTA are directed against such “loss buying”.
2080.This Part of the Act does not deal with the buying in of group relief. Section 142, which is based on section 403A(9) and (10) of ICTA, prevents companies claiming group relief in relation to expenses and losses arising before a company joined the group.
2081.The loss buying provisions of TCGA are outside the scope of this Act. See, however, the commentary on section 694.
Section 673: Introduction to Chapter
2082.This section introduces the Chapter. It is based on sections 6, 768, 768A and 834 of ICTA.
2083.Subsections (1) to (3) lay down the conditions for the Chapter to apply.
2084.Subsection (2) omits as otiose the words “either earlier or later in the period, or at the same time” in sections 768(1) and 768A(1) of ICTA.
2085.Section 767A(4)(b) of ICTA refers to a “significant revival” of activities; sections 768(1)(b) and 768B(1)(c) of ICTA refer to a “considerable revival” of a trade or business. Sections 768(1)(b) and 768B(1)(c) contrast “considerable” with “small or negligible”; in section 767A(4)(b), the contrast is not only with “small or negligible” but also with cessation. The rewrite of these provisions eliminates this variation by consistently using “significant” in subsection (3)and sections 677(2) and (4), 704(3) and 705(3).
2086.Subsection (4) defines, non-exhaustively, “major change in the nature or conduct of a trade”. The phrase “major change” has been retained in this definition, because there is case law on it: Willis v Peeters Picture Frames Ltd(1982), 56 TC 436 CA(NI)(3) and Purchase v Tesco Stores Ltd (1984), 58 TC 46 HC.(4) For the same reason, the phrase “major change” has also been retained in the similar definitions in sections 677(5), 704(10) and 705(9).
2087.Subsection (5) defines “the change in ownership”, “the company” and “trade” for the purposes of this Chapter. It defines “trade” to include an office, but does not define “trade” to include “vocation”. This is a minor change in the law. See Change 4 in Annex 1.
Section 674: Disallowance of trading losses
2088.This section restricts relief for trading losses in cases in which this Chapter applies. It is based on sections 768 and 768A of ICTA.
2089.Subsection (1) restricts relief under sections 37 and 42(relief for trade losses). It is aimed at the abuse known as “profits buying” or “loss capacity buying” whereby a trading company with large profits is sold to new owners who feed new activities into the trade which result in heavy initial losses for which early relief would not otherwise be available. The price paid to the old owners would reflect the tax benefit expected to accrue to the new owners.
2090.Subsection (2) restricts relief under section 45(carry forward of trade loss against subsequent trade profits).
2091.Section 768(1) of ICTA refers to “relief … given under section 393 [of that Act] by setting a loss incurred by the company … against any income or other profits …”. But section 393 of ICTA only gives relief for losses against “trading income” (as defined in section 393(8) of that Act). The reference to “other profits” is a missed consequential amendment. The words should have been omitted when FA1991 replaced section 393(2) of ICTA with section 393A of ICTA. Subsection (2) of this section therefore omits the reference to “other profits”.
2092.Section 768(3) of ICTA provides:
“The apportionment under subsection (2) above shall be on a time basis according to the respective lengths of those parts except that if it appears that that method would work unreasonably or unjustly such other method shall be used as appears just and reasonable. (emphasis added)”
2093.Subsection (5) omits the first instance of “appears” in section 768(3) of ICTA for the sake of consistency with sections 685(3) and 702, which are based on paragraphs 8 and 17 respectively of Schedule 28A to ICTA, and sections 704(7) and 705(7), which are based on section 768D(4) of ICTA. It also omits the second instance of “appears” in section 768(3) of ICTA to sharpen the drafting.
Section 675: Disallowance of trading losses: calculation of balancing charges
2094.This section prevents double taxation in cases in which this Chapter applies. It is based on section 768 of ICTA.
2095.If section 674(2) restricts relief for trading losses carried forward under section 45, the underlying computations of capital allowances are not affected, because the trade itself does not cease. This means that if, at the time of the change of ownership, a company owns assets on which capital allowances have been given, it can be effectively penalised twice by:
disallowance of any unused capital allowances included in the losses disallowed; and
a balancing charge when the assets are disposed of.
2096.Subsections (2) and (3) solve this problem. If an extinguished loss includes unallowed capital allowances, those capital allowances are treated as not having been given when calculating the balancing charges on an asset owned at the date of the change in ownership and disposed of later.
2097.Subsection (4) sets an identification rule. If, in any period, both losses and capital allowances were available for setting against profits, capital allowances are treated as set off before other losses. As requested by respondents, we have sharpened the drafting of this subsection.
2098.Section 768(6) and (7) of ICTA use the expression “allowance or deduction”. Since “or deduction” adds nothing to “allowance”, subsections (2) to (4) omit “or deduction” as otiose.
Section 676: Disallowance of trading losses where company reconstruction without change in ownership
2099.This section deals with the interaction between sections 674(2) and 944(3). It is based on section 768 of ICTA.
2100.When a trade is transferred from a predecessor company to a successor company, and the relevant conditions are met for a company reconstruction without a change in ownership, section 944(3) provides for the successor to be entitled to relief under section 45 for a trading loss made by the predecessor. Section 674(2) restricts relief under section 45 if there is a change in company ownership. If there is both a company reconstruction without a change in ownership (such that section 944(3) applies) and, separately, a change in ownership (such that section 674(2) applies), then this section extends section 674(2) to restrict relief given under section 944(3).
2101.Section 768(5) of ICTA refers to “section 343” of that Act. But section 768(5) only operates on section 768(1) of ICTA, and section 768(1) only restricts relief under section 393 of that Act. The only provision of section 343 of ICTA which gives relief under section 393 of that Act is section 343(3).This section refers precisely to section 944(3), which is based on section 343(3) of ICTA.
[1983] STC 453.
[1984] STC 304.
