Loss restrictions after a change of ownership
Company trading losses
The provisions concerning the tax treatment of company trading losses are contained in Corporation Tax Act 2010. All references in this article are to that Act accordingly.
In general, where trade losses are incurred for an accounting period commencing on or after 1 April 2017, a company can choose to set these against total income of the current period ( s.37(3)(a) ), the prior twelve months ( s.37(3)(b) ) and future periods ( s.45A ). It can also choose to pass the losses to another company in the same corporation tax group.
Pro advice. Losses that are “terminal losses” (see Follow up ) can be carried back for up to three years.
Pro advice. Older losses, i.e. those arising from accounting periods commencing before 1 April 2017 are dealt with by s.45 and can therefore only be set against profits of the same trade, rather than total income.
Trade loss relief is flexible and generous. Correspondingly, there are various conditions that must be met before it can be claimed. It is also subject to several anti-abuse rules, including where a company changes ownership, especially where this is in conjunction with certain other events.
Change in ownership
A change of ownership for these purposes has occurred if:
- one person acquires more than 50% of the ordinary shares in the company; or
- two or more persons acquire a holding of at least 5% of the ordinary shares each and these holdings combined total more than 50%; or
- two or more persons acquire a further holding of ordinary shares which takes each of their holdings to at least 5%, and those holdings combined exceed 50%.
Example. Acom Ltd acquires 60% of the ordinary shares in Bcom Ltd. James and Joanna each acquire 26% of the ordinary shares of Ccom Ltd. An investment syndicate consists of ten individuals who currently own 3% of the ordinary shares of Dcom Ltd each. They each acquire a further 3%. All of these scenarios constitute a change of ownership.
Pro advice. For the purpose of the test, holdings at any two points in a three-year period, after combining holdings by connected persons, may be compared and shares acquired through inheritance are ignored per s.720(2) & (5) .
If a change of ownership has taken place, there are then several scenarios which can lead to a restriction in the use of losses.
Decline and revitalisation of trade
Where a trade ceases and a new one begins, unused losses cannot be carried forward from one trade to the other. However, what if instead the trade reduces until it has all but ceased, before a new owner takes it over and revitalises it? The potential back and forth argument between your client and HMRC could become very protracted and require interpretation by the tax tribunals.
To ensure such situations are avoided, where a trade becomes small or negligible and is then revived following a change of ownership, loss relief is restricted as follows:
- relief under s.45A cannot be claimed against profits arising after the change of ownership; and
- relief under s.37(3)(b) cannot be claimed against profits before the change of ownership in respect of that trade.
If the trade were to revive before the change of ownership, this restriction would not apply, though a different restriction still could (see below).
Example. Nish is looking to acquire A Ltd, a company that has been trading for ten years manufacturing widgets. Since the pandemic, sales have decreased by 60% with losses posted for the last three years. There have been a number of redundancies, but the trade is still being carried on. In this scenario, Nish should be able to use the losses from the three previous years if he acquires A and returns the trade to a profit-making one. The losses would be offset against the future profits accordingly.
In this example the trade, although reduced, could not be said to be negligible at the time of the acquisition and is unlikely to be considered small. However, if this was found not to be the case, the restriction will kick in.
Example. Rajesh is negotiating to purchase B Ltd. This company used to manufacture widgets, but following issues between the directors, began to make losses and eventually ceased trading 18 months ago. It is currently dormant, with no employees. Rajesh believes he can revive the trade using his know-how. If he does return the company to a profit-making position, the historic losses will not be relievable.
Change in nature of the trade
It is also necessary to consider whether the nature of the trade itself has changed. Where over a period there is a major change in the nature or conduct of a trade in conjunction with a change of ownership, loss relief under s.45A and s.37(3)(b) is again restricted.
However, for this restriction to apply, both the major change in the nature/conduct and the change of ownership must take place in a period of five years, starting not more than three years prior to the date of the change of ownership.
A change in the nature of the trade could include a major change in:
- the product or service supplied by the company
- the customer base to which the product/service is being supplied
- the market(s) in general in which the trade operates.
HMRC’s interpretation of what constitutes a “major change” for these purposes is contained in Statement of Practice 10/91 (see Follow up ).
Example. Suppose Nish from the previous example acquires A Ltd, but decides to change its activity to the manufacture of wodgets, which are completely different from widgets. Additionally, the company will be selling to completely different customers. In this case, the five-year window will begin with the date of ownership, so if the change in the nature of the trade occurs before the fifth anniversary of the acquisition, the losses will be unavailable to offset future profits.
Note that the way the five-year period is defined means that the restriction can’t be sidestepped by persuading the target company to change its trade ahead of the acquisition.
Pro advice. Both the de minimis activity and change in nature restrictions are intended to head off protracted debate between your clients and HMRC.
Group relief
So far, we have considered an individual purchasing a company. But you could also be asked to advise on the scenario where a company is acquiring another, i.e. forming a group. There is a blanket restriction on the availability of group relief for carried forward losses on a change of ownership, regardless of whether there has also been a change in the nature or scale of the business in the period surrounding the change in ownership.
Losses created in the acquired company, plus any related companies, prior to the change of ownership cannot be set against profits of other group members for a period of time following the change.
Pro advice. The restriction applies for five years following the end of the acquired company’s accounting period the change of ownership occurs in.
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