A more straight forward rule would have been refreshing

Stephen Hignett, Tax Partner, CMS

Today’s budget included the stamping out of various techniques (known as “refreshing” arrangements) that allow companies to use certain types of brought forward losses which might otherwise not be used (sometimes described as being “trapped”). The losses in question are trading losses, non-trading loan relationship deficits (interest expenditure) and management expenses which, in each case, have been carried forward and so can no longer be group-relieved to other group members.

This is best explained by way of an example.

Company A has brought forward non-trading loan relationship deficits representing past accrued interest liabilities. It can no longer group-relieve these reliefs, they are only available for set off against particular future profits of the same company. In practice, such future profits are likely to be restricted to capital gains (realised anywhere in the group and elected into Company A – however, capital gains are much rarer since the substantial shareholdings exemption was introduced) and future interest income of the same company. In short, such brought forward reliefs may be expected to have little value to Company A.

However, what if Company A obtained cash from its parent by way of an equity subscription and then lent that money to its subsidiary Company B at interest? Company A would then have interest income, but that could be sheltered by its brought forward non-trading loan relationship deficits. Company B would have interest deductions which, given that they would be new “in-year” deductions, could be group-relieved elsewhere in the group. In short, the old reliefs (which had become inflexible) would have been “refreshed” and available for surrender as group relief.

This represents a very simple “refresh” arrangement; there are many more.

The new rules (which come into force today), will apply to both past and future transactions but, in relation to the past transactions, they will only apply to the consequences of those transactions arising as from today. Where the rules apply, the brought forward reliefs are no longer available to be used to be set against the “new” profits (e.g. interest income).

I find a couple of things interesting about these new rules.

First, refresher arrangements with no genuine commercial purposes are referred to in the GAAR examples as arrangements falling outside of the scope of the GAAR. If this was considered to be evidence that HMRC found such arrangements acceptable, the new rules announced today have cleared that up.

Second, is the mechanics of the “targeted anti-avoidance rule” (or “TAAR”) to be included in the new rules. This TAAR is to be a two-limbed beast, both limbs of which need to apply for the brought forward losses to be rendered unavailable. Limb one includes the familiar “main purpose or one of the main purposes” test but limb two states that the rule will only apply where “the value of the anticipated tax advantage is more than the anticipated value of any other economic benefits to the arrangement”. This is a less familiar test although it can also be found in the new DPT rules.

In the third example that HMRC provide in their technical note on the new rules, they give the example I set out above but include the additional fact that Company B is to use the funds lent to it to buy the shares in a company from a third company at arm’s length. HMRC concludes that “The main economic driver of the arrangement – and its largest anticipated benefit – is the opportunity to generate additional profits. As a result the TAAR will not apply.”

This sounds helpful, but how exactly will this test be applied and what comfort can we take from this example in practice?

– Will all genuine third party acquisitions not be caught by this new rule in these circumstances? Of course, all such acquisitions are made in the hope of deriving future economic benefits.

– Alternatively, will taxpayers have to compute – given that this would appear to be a test of pounds and pence – exactly what they anticipate to be the economic benefits of the transaction and compare that to the tax benefits of the loan arrangements to see which is greater?

– Since HMRC state that this is a “reasonable-to-assume test”, perhaps the former approach is too subjective? Consequently, perhaps taxpayers should ask a helpful objective third party (no doubt using public transport in SW4) what they think of the transaction? Given that so many M&A transactions are often ultimately considered unsuccessful, taxpayers may not get the response that they will be hoping for!

In limb 2 of this TAAR (and the insufficient economic substance test in DPT) it would appear that HMRC have a new test. However, it remains to be seen exactly how it will be applied in practice. Where taxpayers are confident that there is a genuine commercial purpose behind the transaction, applying for a non-statutory clearance from HMRC to confirm the new rules will not apply may be advisable.

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