Keeping track of tax losses

18 Jun 2020

calculator and paperwork

In such a challenging economic climate, a company’s focus could easily stray from good compliance and accounting processes. However, it is important that UK companies keep an accurate track of their losses arising during the Coronavirus pandemic to ensure that they can maximise their claims for tax relief.

 

Following the 2008 financial crisis, the Treasury allowed an extended three-year carry-back period for trading losses (rather than the usual one-year period) and HM Revenue & Customs (HMRC) would look to accept provisional loss carry back claims in circumstances where trading companies could clearly demonstrate that sufficient current period losses would be available to carry-back against taxable profits of an earlier period, prior to submitting a corporation tax return for that current period. This provided valuable cashflow benefits to UK trading companies.

The cashflow benefits of provisional loss carry back claims can be compared to HMRC’s usual position where they will not allow tax losses to be carried back until the later period’s corporation tax return has been filed with them. By way of illustration, if a trading company makes a taxable profit in its year ended 31 December 2019, but anticipates a substantial trading loss in its year ended 31 December 2020 due to coronavirus, then it would usually need to pay its 2019 corporation tax liability in full by 1 October 2020 and then separately claim a corporation tax repayment sometime in 2021 once the 2020 corporation tax return showing the tax losses has been submitted to HMRC. This should be compared to the position where HMRC accepts a provisional loss carry back claim such that the corporation tax payment otherwise due on 1 October 2020 would be reduced by the anticipated and supportable 2020 losses which would provide the company with a clear cashflow benefit.

Whilst the Chancellor has not currently introduced measures in the current crisis to extend the loss carry back period, or specifically allow provisional loss carry back claims, professional bodies have made recommendations for such measures to be adopted It will therefore be important that UK trading companies are able to quickly quantify supportable tax losses in order to be in a position to take advantage of any changes to tax loss reliefs as and when they arise.

Companies that wish to seek a provisional loss carry back claims can still approach HMRC with appropriate supporting evidence of current period losses, which is likely to be (as a minimum) draft accounts and draft corporation tax computations clearly supporting these losses. Whilst there is no guarantee that HMRC would accept a provisional loss carry back claim, if there was sufficiently clear evidence that sustainable tax losses would be made in the current period then HMRC may accept a provisional loss relief claim.

There are other factors that UK companies should consider which can provide cashflow advantages in respect of their corporation tax position:

  • Extend periods of account. Using the example above of a trading company with a 31 December 2019 year-end, if the period of account was to be extended to 30 June 2020 (maximum 18-month period) then six months of the 2020 loss could be used to reduce the corporation tax payment due on 1 October 2020. The commercial and company secretarial implications of seeking a change to the period of account would need to be considered and understood in advance.
  • Large companies seek repayment of quarterly corporation tax instalments payments previously made where the company has grounds for believing that the circumstances since the instalments were paid have changed and rendered its earlier calculation of its total corporation tax liability excessive.
  • Maximise claims for tax reliefs. In particular, innovative companies should consider making claims for R&D tax credits where tax losses can be surrendered for a tax repayment of up to 33% of the qualifying R&D cost spent, provided the relevant qualifying conditions are met.

Trade cessation and change of activities

There are also concerns that HMRC may look to argue that certain companies have ceased trading as a result of coronavirus, which could prevent the offset of trading losses.

This could be particularly pertinent for companies in the leisure and hospitality sectors that have been forced to shut down their operations temporarily, with most of their staff being furloughed.

HMRC have recently published guidance which states that they would not treat such temporary breaks in trading activities as amounting to a permanent cessation of trade for tax purposes, provided that there was an intention for the company to continue trading after the restrictions are lifted and, on the resumption of activities following the break, the trade carried on by the company was the same, or similar, to that carried on before the break.

Whilst it is clearly dependent upon the facts, demonstrating that throughout the temporary break there was an intention for the company to continue trading after the restrictions are lifted is likely to be based upon the work undertaken by the company’s directors in considering, evaluating and developing all potential opportunities for the company to continue to carry on its existing trade.

Accordingly, it will be important that the message that the company is continuing to trade is accurately, clearly and consistently reflected in all information circulated by the company during the temporary break; from less formal press releases and social media postings to more formal board minutes, accounts and tax returns.

Where a company starts to carry on an entirely new activity during Coronavirus, which is unrelated to its previous trading activities, HMRC are likely to treat this as the commencement of a separate new trade. This can result in additional administrative and compliance burdens for the company during the period it carries on two separate trades (as the results for each trade would need to be separately streamed) and the potential for tax losses to become irrecoverable should either of the trades cease after lockdown ends.

This should be compared to the situation where the company starts to carry on a new activity that is similar to its existing trade, which would not normally be expected to represent a new separate trade, with the profits or losses from the new activity being merged with those of the existing trade.

This can be demonstrated by the following example taken from recent HMRC published guidance:

  • If a company carrying on a restaurant trade starts manufacturing gowns and face masks then this should be treated as the commencement of a separate new trade.
  • If a company carrying on a clothing manufacturing trade starts manufacturing gowns and face masks, using the same staff and premises, this should be treated as an extension of the existing trade and not the commencement of a separate new trade.

However, where a company carries on a new activity during Coronavirus which is similar to the existing trade (the clothing manufacturer that starts manufacturing gowns and face masks per the example above), there are anti-avoidance provisions that can prevent the offset of trading losses where there was a change of ownership in the last five years and there is also a major change in the nature or conduct of the trade. Whilst this may appear unjust in the current environment, it does represent a tax risk for companies that have experienced both a change of ownership in the last five years and a change in their trading activities due to Coronavirus.

Recommendations

Companies should be able to quickly quantify their tax losses arising from coronavirus so that they can be in a position to take advantage of cashflow benefits available from tax loss reliefs as and when they arise.

Companies that have been forced to shut down their operations temporarily due to Coronavirus should carefully consider the work undertaken by their directors during this period to justify that it is continuing to carry on the same trade and this should be reflected in all information circulated by the company.

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