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Markel Tax

21 Jul 2020

Utilising corporate losses – trading losses

The coronavirus global pandemic (Covid-19) has had a significant economic impact on the performance of UK companies, with a great number realising losses as a result of the necessary lockdown imposed by the government. Cash flow management has been a fundamental challenge for companies during this uncertain time and although the country slowly begins to emerge from its hibernation, it is important that companies continue to identify opportunities to strengthen their cash flow position.

This article acts as a reminder of the available uses of corporate losses to mitigate future tax liabilities and generate cash repayments or other receipts from HMRC. It should be noted that this article primarily explores the uses of losses arising as a result of the recent economic impact Covid-19 and as such does not consider the application of pre-April 2017 loss relief.

Trading losses

Companies may suffer losses from a variety of different activities, including through its trading or investment activities, through expenses of loan relationships, through owning properties or intangible assets or as a result of a disposal of a capital asset. This article focuses on trading losses.

A company’s trading losses can be relieved in a number of different ways including being offset against profits of the current or prior year, group relieved to other members of the same group or consortium and carried forward for offset against future profits of the company, group or consortium. Following the changes effective from 1 April 2017, it is now possible to use carried forward trading losses in a more flexible way. Before this date it was only really possible to use trading losses brought forward against profits of the same trade. Further details on the more flexible rules are highlighted below.

Current and prior year loss relief

The first way in which a company may obtain relief for its trading losses is to offset them against the total profits of the current accounting period, with any remaining amounts being eligible to be carried back against the company’s total profits arising in the previous 12-month period.

The losses must be offset against the company’s current year total profits first, with any balance being eligible for relief against total profits arising in the previous 12-month period. In order to make a claim to carry back trading losses, the company must have carried on the same trade in the previous 12-month period. Where the company has already paid the tax liability for the previous accounting period, HMRC will repay the amount deemed as overpaid along with interest.

It may be the case that a company suffers a trading loss in a period but also disposes of a capital asset, in order to raise needed funds resulting in a chargeable gain. Relief may be claimed for the trading loss against the chargeable gain arising in the current year so as to reduce the current year tax liability.

In response to Covid-19, HMRC has revised its policy on carry-back claims for anticipated losses incurred by a company, allowing repayments to be made before a company submits its current period tax return or carry-back claim. Companies will be required to provide HMRC with evidence to support these claims, such as management accounts, forward-looking reports to the board of directors, and relevant public statements. This may be a welcomed cash flow opportunity for many companies that have suffered losses in the early part of 2020.

Terminal loss relief

If a company ceases to trade in an accounting period, the trading losses incurred in the final 12 months of trading may be carried back for offset against total profits over an extended period of 36 months ending immediately before the terminal loss making period. Where the final accounting period is less than 12 months, any trading losses incurred in the penultimate accounting period are apportioned on a time basis and added to the losses in the final accounting period so that relief can be given for losses incurred in the final 12 months.
Where terminal loss relief is being claimed against profits of multiple accounting periods, the losses must be offset as far as possible against the company’s total profits of later accounting periods before earlier accounting periods.

Although many companies may have temporarily ceased to trade as a result of Covid-19, HMRC have clarified that a temporary cessation of trading where trading is expected to resume after coronavirus lockdown restrictions are relaxed will not generally be treated as a cessation of trade for tax purposes so the future intentions of the directors will have to be ascertained.

Terminal loss relief may also be claimed for trading losses arising in periods after April 2017 and carried forward at the time the company’s trade ceases, see the ‘Relief for losses carried forward’ section below.

Group relief

Another way in which current year trading losses may be utilised is group relief. This is a mechanism in which current year losses of a loss-making member of a group may be surrendered for use against the current year total profits of a profitable member of the same group.

For group relief purposes, two companies are regarded as members of the same group if one is a ‘75% subsidiary’ of another or both are ‘75% subsidiaries’ of a third company. For these purposes, one company (Company B) is a ’75% subsidiary’ of another company (Company A) if all three of the following conditions are met in respect of the two companies:

  1. Company A, directly or indirectly, owns at least 75% of the ordinary share capital of Company B,

  2. Company A is beneficially entitled, directly or indirectly, to not less than 75% of the profits available for distribution to the equity holders of Company B, and

  3. Company A is beneficially entitled, directly or indirectly, to not less than 75% of any assets of the Company B available for distribution to its equity holders on a winding up.

In broad terms, the maximum amount of the group relief claim is the lower of the available losses of the surrendering company and the total profits of the claimant company for the overlapping period, being the period in common to the accounting periods of the surrendering company and the claimant company.

There are a number of complexities in calculating the amount of group relief available where companies become member of the same group part way through an accounting period or where the group members have non-coterminous accounting periods.

Group relief may also be claimed for trading losses arising in periods after April 2017 and carried forward to future accounting periods, see the ‘Relief for losses carried forward’ section below.

Consortium relief

A kind of group relief is also available between a ‘consortium company’ and its members, known as consortium relief. Broadly, a consortium exists where a ‘consortium company’ is 75% owned by ‘consortium members’, being companies which own at least 5% of the ‘consortium company’.

Trading losses may be transferred by a consortium company to its consortium members in proportion to the consortium member’s interest in the consortium company, and vice versa. A consortium member’s interest is taken as the lowest percentage of the ownership of ordinary share capital, entitlement to profits available for distribution and entitlement to assets on a winding-up.
The maximum consortium relief which is available is the lower of:

  • the consortium company's loss/profit multiplied by the consortium member’s interest in that consortium, and

  • the consortium member’s available profit/loss.

Where a consortium company has other profits against which a current year loss relief claim may be made, it is deemed that such a claim is made before consortium relief is calculated. This rule does not apply to group relief.
Consortium relief may also be claimed for trading losses arising in periods after April 2017 and carried forward to future accounting periods, see the ‘Relief for losses carried forward’ section below.

Relief for losses carried forward

Where a company incurs a trading loss in an accounting period, those losses may be carried forward provided that relief for the losses has not already been claimed and, in the case of trading losses, the company continues to trade in the next accounting period.

The tax treatment of losses carried forward were reformed by Finance Act 2017, with the aim of providing more flexibility in the relief of losses arising on or after 1 April 2017. As such, trading losses arising in accounting periods beginning on or after 1 April 2017 may be carried forward and:

  • relieved against total profits of the company of that later accounting period,

  • surrendered as group relief against the total profits of a member of the same group of that later accounting period,

  • surrendered as consortium relief against the total profits of a consortium company/consortium member,

  • relieved as a terminal loss against total profits of the prior 36 months, but not before 1 April 2017, if unrelieved in the period the trade ceases.

Although the 2017 corporate loss reform brought an element of flexibility, it also introduced a corporate income loss restriction (CILR) on the amount of profits against which carried forward losses can be offset, broadly limiting relief to 50% on a group wide basis after taking account of a £5 million deduction allowance.

The following example illustrates the restriction on the carried forward group loss relief provisions:

ABC Limited has trading losses brought forward from accounting periods beginning on or after 1 April 2017 of £7m. The company has incurred a further trading loss of £1m in the current year ended 30 June 2020.
XYZ Limited is the wholly owned subsidiary of ABC Limited and generated trading profits of £10m in the current year ended 30 June 2020.

The maximum amount available for group relief is the lower of:

  • The £8m of losses available for surrender by ABC Limited (£7m of brought forward trading losses and £1m of current year trading losses), and

  • The £10 of profit generated by XYZ Limited in the current year.

However, the maximum amount of carried forward losses that may be surrendered from ABC Limited to XYZ Limited is restricted by the CILR to £6m (£5m + 50% of the remaining amount of carried forward losses relievable, i.e. £2m)

The current year losses are not subject to the CILR and do not count towards the £5m deduction allowance.
The maximum group relief claim available from ABC Limited to XYZ Limited for the year ended 30 June 2020 is £7m, being:

  • £1m of losses incurred by ABC Limited in the year ended 30 June 2020, and

  • £6m of losses brought forward by ABC Limited

The £1m of ABC Limited losses that were restricted from use by the CILR will continue to be carried forward for relief in later accounting periods.

The following example illustrates the restriction on the carried forward group loss relief provisions:

ABC Limited has trading losses brought forward from accounting periods beginning on or after 1 April 2017 of £7m. The company has incurred a further trading loss of £1m in the current year ended 30 June 2020.

XYZ Limited is the wholly owned subsidiary of ABC Limited and generated trading profits of £10m in the current year ended 30 June 2020.

The maximum amount available for group relief is the lower of:

  • The £8m of losses available for surrender by ABC Limited (£7m of brought forward trading losses and £1m of current year trading losses), and

  • The £10 of profit generated by XYZ Limited in the current year.

However, the maximum amount of carried forward losses that may be surrendered from ABC Limited to XYZ Limited is restricted by the CILR to £6m (£5m + 50% of the remaining amount of carried forward losses relievable, i.e. £2m)

The current year losses are not subject to the CILR and do not count towards the £5m deduction allowance.

The maximum group relief claim available from ABC Limited to XYZ Limited for the year ended 30 June 2020 is £7m, being:

  • £1m of losses incurred by ABC Limited in the year ended 30 June 2020, and

  • £6m of losses brought forward by ABC Limited

The £1m of ABC Limited losses that were restricted from use by the CILR will continue to be carried forward for relief in later accounting periods.

The flexibility of group relief for carried forward losses provides an incentive to profitable companies to acquire companies with significant carried forward losses for use of those losses via group relief. As such a number anti-avoidance provisions have been introduced to counteract loss buying, including a five-year restriction on group relief claims of a company’s carried-forward pre-acquisition losses where it has undergone a change of ownership. It is worth reiterating that losses may only be carried forward to a later period if the trade continues to be carried out in that later period.

There are additional restrictions which can prevent the use of carried forward trading losses where there is also a major change in the nature or conduct of the trade in a five year period, beginning not more than three years before the change in ownership (prior to 1 April 2017, the five year period was three years).

Research and Development loss surrenders

Where a company incurs qualifying R&D expenditure in an accounting period in which it is loss-making, it may be entitled to surrender some of those losses for relief or credit under the various research and development schemes.

For loss-making SMEs this can result in a repayable tax credit of up to 14.5% of the losses surrendered and for larger loss-making companies a credit may be used to discharge the liability or result in a cash payment.

For more information on the availability of research and development reliefs, please click here.

Summary

The various uses of trading losses set out above could provide a way for many companies in distress securing a much needed cash flow benefit. However, care should be taken to balance the immediacy of the cash flow benefits with maximising the relief that can be obtained and advice should be sought where necessary.

For further information or assistance with the uses of corporate trading losses please contact Markel Tax on 0370 218 5278 and or email Martin Mann or Imran Umarji.

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Tagged Tax for entrepreneurs and corporates Tax for entrepreneurs and corporates
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