Companies pay corporation tax on their profits but they are able to claim relief for any losses arising, for instance, from trading activities, property lettings, or disposals of capital assets. Relief is given by offsetting the loss against profits or gains in the same accounting period, or in some cases a claim to carry back the loss can be made. Any remaining loss will be carried forward to potentially be relieved in future accounting periods.
As many will be aware, there have been several changes to relief for carried forward losses introduced in recent years, most prominently by F(No.2)A 2017 which introduced a package of increased flexibility alongside new restrictions from 1 April 2017. Most recently, however, has been Budget 2018 in which the government announced plans to reform rules for relief of corporate capital losses. The new rules are planned to take effect from 1 April 2020 and propose to extend the corporate loss restriction to include carried forward capital losses.
Corporate capital losses
Any capital losses arising to a company in an accounting period are netted off against the capital gains which arise in the same period. The company will have overall chargeable gains that are subject to corporation tax when gains exceed losses. Where losses exceed gains, the remaining amount may be carried forward and set against capital gains that arise in the future periods. The section of the legislation that effects this is now s2A of the Taxation of Chargeable Gains Act 1992; the whole of the Part 1 which contains this section was rewritten as part of changes introduced for non-residents in Finance Act 2019.
An election can be made to transfer gains or losses arising in companies that are within a group for capital gains purposes in an accounting period to another company within that group.
Changes to corporation tax relief
Key changes were introduced to corporation tax income losses from 1 April 2017:
- Losses arising from 1 April 2017 can be carried forward and set against the total profits of a company or another company within the same group via group relief; and
- From 1 April 2017, the amount of profit that can be relieved by carried forward losses is limited to 50%, subject to an annual deductions allowance of £5 million per group.
These reforms did not cover capital losses, however. The original consultation document noted that “Capital losses are ring-fenced for corporation tax purposes meaning that they can only be relieved against chargeable gains… This reflects the fact that companies have greater discretion over the point at which capital losses are recognised for tax purposes… The government believes that the distinct treatment of capital losses remains appropriate and does not intend to change it as part of these reforms.”
The government has now changed its mind and in late 2018 ran a new consultation on changes that sought to remedy this by bringing capital losses into the restriction.
Budget 2018 reform
As we have seen, the loss relief rules are already advantageous for capital gains by allowing carried forward capital losses to be set off against capital gains. However, without any restriction on the amount of capital gains that can be relieved by carried forward capital losses the government believes that the Exchequer will be negatively affected due to losses incurred from historic disposals made by businesses who are now making substantial capital gains over many years and so may not pay any corporation tax.
At Budget 2018, the Chancellor announced the government’s intention to reform the rules for the relief of corporate capital losses from 1 April 2020. It is proposed that Finance Bill 2019-20 will include changes that extend the restrictive element of the corporate income loss restriction (CILR) to capital losses. It does this by adding a new s269ZBA to Part 7ZA of the Corporation Tax Act 2010 to apply a restriction on the use of carried forward capital losses, helping to create a more balanced loss relief regime in the UK.
In the same way as the current CILR, the proposed changes will restrict the use of carried forward capital losses to 50% of the capital gains arising in an accounting period, subject to the existing £5 million deductions allowance which a company will now have to allocate between capital as well as trading and non-trading streams of income. This applies to gains arising on or after 1 April 2020 (and will apply to the post-31 March 2020 portion of an accounting period straddling 1 April 2020) but the restriction will apply to all carried forward capital losses, whenever arising.
The provisions will not apply to current year capital losses; a company will still be able to set these against gains in the same year without any restriction.
Good and bad news
As mentioned above, the CILR was not all bad news. It also extended the categories of profits which could be relieved by carried forward trading losses and non-trade loan relationship deficits, as well as introducing group relief for carried forward losses. There is no equivalent relaxation for carried forward capital losses; they will only be available to relieve capital gains in future years, not income profits.
The new restriction however will not apply to:
- Carried forward losses against the shareholders’ share of basic life assurance and general annuity businesses (BLAGAB) gains;
- Ring-fenced allowable capital losses arising in certain UK extraction activities of oil and gas companies; or
- Real estate investment trusts (REITs) where the capital losses are attributable to the property rental business.
The government’s consultation presented 5-steps to summarise how the objectives of the reform would be achieved. These are:
- Step 1: Allocate the deductions allowance
- Step 2: Perform the CILR computation
- Step 3: Allocate the deductions allowance to net capital gains
- Step 4: Calculate the maximum amount of carried forward losses that can be set
- against gains
- Step 5: Allocate types of carried forward losses against capital gains
The following example was also provided in the consultation document. A company has the following carried forward losses:
|Post-1 April 2017 non-trading losses
|Post-1 April 2017 trading losses
In the year ended 30 April 20X4, the company makes the following profits and gains:
|Non-trading loan relationship deficits
Step 1 – Allocation of deductions allowance
The company decides to use the entire deductions allowance against capital losses:
Step 2 – Calculate the CILR computation
Corporate income loss restriction
|Qualifying profits *
|50% of relevant profits
|Relevant maximum under s269ZD CTA 2010
* Chargeable gains nil + Property income £3 million + Trading profits £5 million – Non-trading loan relationship deficits £2 million = £6 million
Chargeable gains do not feature in this calculation. Note that the company will be able to choose whether to take the deduction of non-trading loan relationship deficits of the current period into account into account in either the CILR of capital loss restriction computation.
Step 3: Allocate the deductions allowance to net capital gains
Capital loss restriction
|Relevant capital gains
|Net chargeable gains
The net chargeable gains for the accounting period are £10 million, which excludes carried forward capital losses but does include capital losses of the current period.
The deductions allowance is deducted to arrive at relevant profits, in the same way as the current restriction calculation works.
Step 4: Calculate the maximum amount of carried forward losses that can be set against gains
The relevant maximum – again in the same way as the current calculation – is then defined as relevant profits @ 50% plus the deductions allowance:
|50% of relevant capital gains
Step 5: Allocate carried forward losses against capital gains
The consultation response document indicates that at this point, the company would be able to choose which types of carried forward losses, within the normal rules, are to be utilised against chargeable gains up to this £7.5 million limit. Post-1 April 2017 non-trade loan relationship deficits for example may effectively be set against chargeable gains as part of total profits.
However, our understanding of the draft legislation is that this limit will actually specifically apply to the deduction of capital losses carried forward against chargeable gains under s2A(1)(b) of the Taxation of Chargeable Gains Act 1992. As capital losses will main more restricted following these reforms, it makes sense to utilise these as far as possible first before post-1 April 2017 loan relationship deficits for example.
Net chargeable gains for the accounting period will be £2.5 million, and profits chargeable to corporation tax will be £5.5 million.
Whilst not present in this example, it should be noted that pre-1 April 2017 non-trading loan relationship deficits may also be offset against chargeable gains, it so can be seen that the new restriction needs to interact with the current rules in a more complicated way that in the case presently. The proposed legislation accordingly modifies the existing restriction under s269ZC to ensure that relief against chargeable gains is not allowed twice. Furthermore, the amount of the deductions allowance that was allocated to the capital gains calculation is also re-added into this restriction stream. The neat split of total into trading and non-trading amounts that we presently have will be significantly muddied.
Specific considerations that are of interest
The government estimates that fewer than 1% of companies will be financially affected by the changes in carried forward capital losses which is as a result of the £5 million deductions allowance per group. As we have already seen with the CILR however, this means that whilst those paying the additional tax as a result of these measures will be mainly larger businesses, all companies will still face the additional administrative requirements in respect of the deductions allowance even if only to ensure that the rules do not affect them.
The government intends to include relevant anti-avoidance rules to negate any tax advantage from arrangements entered before the introduction of the restriction, but which give rise to such a tax advantage after. They have also stated they will counter arrangements that seek to exploit the deductions allowance going forward, such as where there is manipulation of a group structure to maximise the amount of the annual allowance due.
Changes to Alphatax
Alphatax will be fully updated to deal with the implications of the corporate capital loss restriction.
As for the existing rules, this calculation will largely be handled automatically by the software. The Deductions allowance input statement will be amended to calculate the optimum allocation of the deductions allowance to the new capital gains stream, with an override input provided if needed. Similarly, the Qualifying profits input statement will be amended to calculate the new stream of chargeable gains qualifying, with any current period deductions considered. The main Carried forward loss restriction report statement will then be amended to present full details of the calculation of the amount of the restriction, and this will automatically determine the maximum amount of carried forward capital losses that may be utilised.
We plan to include these changes in the V20.0 edition of Alphatax which will be released around Q2 2020.