Trade losses - restriction of relief: first year allowances and annual investment allowances
S76-S79 Income Tax Act 2007 (ITA 2007)
These provisions were originally introduced in 1976 to counter avoidance schemes. Other changes in legislation since then have made them largely redundant. They are aimed at arrangements whereby a person claims capital allowances to reduce his overall tax liability and subsequently transfers the relieved assets to others to avoid tax on the future income or a balancing charge.
Bob has substantial investment income and is liable to higher rate tax. He goes into partnership on 1 January 2012 with Jim, who has no other income. The partnership trades as fencing manufacturers. It is agreed that the first accounts will be drawn up to 5 April 2012 and that the partnership profit sharing ratios for that period will be Bob 95%:Jim 5%. After that they will be Bob 10%:Jim 90%.
In the period 1 January 2012 to 5 April 2012 the partnership spends £100,000 on plant and machinery qualifying for the full amount of annual investment allowance of £100,000. The partnership claims the AIA. Its expenses match its income and so there is a loss of £100,000 created by the capital allowances for that period allocated in accordance with the profit sharing ratios. Bob’s share of the loss is £95,000 and he sets that against his investment income. Profits in future will be shared Bob 10%:Jim 90% and so Bob will not pay much higher rate tax on the profits earned by the equipment.
S76 ITA 2007 restricts loss relief which derives from First Year Allowances (FYAs), and Annual Investment Allowances (AIAs) on plant or machinery. It does not apply to other capital allowances such as 100% enterprise zone allowance, or writing down allowances or small pools allowance on plant and machinery.
The legislation refers to a ‘qualifying activity’. A qualifying activity is wider than a trade. It also covers:
- a profession or vocation
- an employment or office
- a property business
- a furnished holiday lettings business
- an overseas property business
- the management of an investment company
- special leasing
- mines, quarries and other concerns as listed in S12 Income (Trading and Other Income) Act 2005.
‘Qualifying activity’ is defined in S15 Capital Allowances Act 2001 (see CA20010).
First kind of scheme S77 ITA 2007
If a person carries on a qualifying activity in partnership with a company and the partnership incurs expenditure on plant or machinery for leasing, the person may not have sideways loss relief for a loss created by FYAs or AIAs on the plant and machinery. For these purposes treat letting a ship on charter as leasing.
Sideways loss relief is relief against general income under S64 or S72 ITA 2007.
Sideways loss relief is also denied if a scheme is effected or arrangements are made before or after the FYA or AIA expenditure is incurred for the qualifying activity to be carried on in partnership with a company. This means that an individual cannot start a leasing business, incur expenditure on plant, and claim loss relief if the individual has entered into an agreement that a company will join the qualifying activity later on.
Second kind of scheme S78 ITA 2007
Sideways loss relief is not available to an individual for a loss created by FYAs or AIAs on plant and machinery acquired for a qualifying activity if:
- the individual carries on or will carry on the qualifying activity in partnership, or
- the capital allowances were given on an asset which is transferred to a connected person or sold at a price below market value, and
- a scheme or arrangements are made the sole or main benefit of which might be expected to be the obtaining by the individual of sideways loss relief.
Use the normal definition of connected person in S993 ITA 2007.
If you find that loss relief needs to be withdrawn, do it by making an assessment under S79 ITA 2007.