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HMRC internal manual

Capital Gains Manual

HMRC guidance on avoidance through the creation and use of capital losses by companies

HMRC guidance (PDF 112KB) on avoidance through the creation and use of capital losses by companies.

The Statement setting out the principles, published on 5 December 2005, is as follows:

HMRC Statement: Avoidance through the creation and use of capital losses by companies

Purpose of the statement

  1. This statement sets out the principles underlying the new Targeted Anti- Avoidance Rules (TAARs) which are aimed at preventing the ‘artificial’ creation and use of corporate capital losses where there are arrangements and one of the main purposes of those arrangements is to secure a tax advantage. It also details the repeal of certain sections of legislation.
  2. How the legislation is intended to operate, and the types of arrangements to which it will apply, are set out below. We will be consulting with business on whether the draft legislation and draft guidance properly captures and explains the purpose and principles set out in this statement, but not on the principles themselves.

Who is likely to be affected?

  1. Most companies do not use schemes or arrangements to create capital losses “artificially”, nor do they generally use capital losses in ways unintended by the legislation and so avoid corporation tax. The schemes and arrangements that this legislation is designed to address can be complex and will have tax avoidance as a main purpose; therefore it will not apply to the majority of companies who enter into transactions for purely commercial purposes. And it is particularly unlikely that this legislation will affect small and medium sized enterprises as there is little evidence to suggest that they undertake, or are likely to undertake, the type of arrangements that are targeted by this legislation.
  2. The legislation addresses three types of behaviour with three separate TAARs:
* The contrived creation of corporate capital losses;
* The buying of capital gains and losses; and
* The conversion of income streams into capital gains, and the creation of a capital gain “matched” by an income deduction. In both scenarios the gain is wholly or partly franked by capital losses.
  1. All three TAARs will only apply where there is a main purpose of obtaining a tax advantage. In addition, the legislation countering the conversion of income into capital gains and capital losses into an income deduction requires the issue of a notice by HMRC directing that the legislation applies.
  2. This package of measures also includes the repeal of certain parts of the Taxation of Capital Gains Act 1992 (‘TCGA 1992’). The ‘bed and breakfasting’ rules in Section 106 are being repealed, as is Schedule 7AA, which is replaced by TAAR 2.

Why the provisions are necessary

  1. The provisions are necessary because; there is evidence from disclosures and other sources showing that avoidance using capital losses is becoming more widespread; companies are finding ways around the existing anti-avoidance provisions and there has been a substantial increase in the amount of unused corporate capital losses available for carry forward.
  2. Taken together this gives rise to a significant risk to corporation tax on future capital gains and potentially to corporation tax on companies’ income profits. The Government is therefore acting now to prevent the further creation and utilization of capital losses in circumstances unintended by the legislation.
  3. The Government will monitor the impact of the new TAARs and their effect on company behaviour and if necessary it will consider whether further action is required.

Principles underlying the TAARs

  1. The existing corporate capital gains legislation generally reflects the following principles:
* Relief for capital losses should only be available where a group or company has suffered a genuine commercial loss and made a real commercial disposal;
* Unless there is a continuation of a trade and certain detailed conditions apply, relief for a company’s capital losses should only be available against its own capital gains or those of companies that were under the same economic ownership both when the capital loss was accrued and when the capital loss is utilized;
* Except in certain restricted circumstances, capital loss relief is only available against capital gains, not income profits.
  1. However, companies are using schemes and arrangements in such a way as to contravene these principles. Therefore this anti-avoidance package is necessary to ensure that the corporate capital gains legislation more closely reflects these principles.

General description of the measure

Contrived creation of capital losses (TAAR 1)

  1. This provision applies to “contrived” capital losses arising on disposals made on or after 5 December 2005.
  2. Any capital loss arising on a disposal made on or after that day will not qualify as an allowable capital loss when it arises in connection with arrangements that have the obtaining of a tax advantage as one of the main purposes.
  3. A further explanation of tax advantage and main purpose is set out in the guidance (see the link below), along with examples of the type of schemes caught.
  4. Genuine commercial transactions that give rise to a real commercial loss, as a result of a real commercial disposal will not be affected by this TAAR.
  5. Alongside TAAR 1, it has been possible to repeal S106 TCGA 1992 (the “bed and breakfasting” rules) which no longer appear to be necessary or performing a useful function.

Loss and gain buying (TAAR 2)

  1. There is evidence that companies with capital losses and gains are being sold to other companies or groups solely to obtain a benefit from capital losses, despite the existence of legislation designed to prevent this. TAAR 2 removes the incentive for loss and gain buying by preventing the offset of any losses or gains on assets from an acquired company against gains or losses of the acquiring company, or a connected company. TAAR 2 has separate provisions dealing with loss buying and gain buying.

Loss buying

  1. There is existing legislation which applies to the transfer of capital losses (or assets standing at a loss) when a company moves from one group to another. This legislation is in Schedule 7A TCGA 1992 and this remains effective in many cases. However, some companies are managing to find ways around the legislation and are acquiring capital losses from other companies and groups in order to obtain a tax advantage.
  2. The existing legislation at Schedule 7A TCGA 1992 will remain applicable in all cases that do not involve tax avoidance, but where tax avoidance is a main purpose, the new rules take effect in priority to the existing provisions.
  3. The new rules will apply whenever there is a change of ownership of a company and one of the main purposes of this change was obtaining a tax advantage.
  4. Where these conditions are met, the new rules will prevent the use of any capital losses accruing on assets belonging to the company before the change of ownership to frank capital gains that arise on assets belonging to the new owners.
  5. The legislation applies to tax advantages arising on or after 5 December 2005. It can therefore apply where a loss has accrued before that date but the loss is not set against a chargeable gain until on or after 5 December.

Gain buying

  1. The legislation designed to prevent gain buying is less effective following the introduction of the substantial shareholdings exemption. TAAR 2 therefore replaces Schedule 7AA TCGA 1992 thus enabling Schedule 7AA TCGA 1992 to be repealed.
  2. The new rules will apply where there is a change of ownership and where the main purpose, or one of the main purposes of the arrangements, is the obtaining of a tax advantage.
  3. Where the new rules apply, any gains arising on assets owned by a company at the time of its change of ownership will only be capable of being franked by capital losses deriving from assets it held before the change. The acquiring company or group will not be able to offset its capital losses against capital gains arising in its new subsidiary.
  4. There is a similar commencement rule to that for loss buying.
  5. Examples of the type of transactions that TAAR 2 is designed to catch are also set out in the guidance.

Conversion of income to capital and capital losses used to create an income deduction (TAAR 3)

  1. The new rules are designed to prevent the following types of avoidance schemes:
* Schemes that convert an income profit into a capital gain, where the gain can then be franked by capital losses. Such schemes result in income escaping the charge to tax


* Schemes that use capital losses to cover a capital gain, and as part of the arrangements there is a related deduction from income profits. These schemes result in a reduction in the amount of corporation tax payable on income profits.
  1. The new rules will apply where the following conditions are met
* There is a receipt which but for the arrangements would have been treated as income for the purposes of CT
* A chargeable gain accrues to a company in respect of the receipt
* There are capital losses which are available to be set against the gain
* The main purpose or one of the main purposes of the arrangements was to obtain a tax advantage


* A chargeable gain accrues to a company
* And a company incurs expenditure which is allowable as a deduction in computing its income profits for the purposes of CT
* There is a capital loss available to be set against the capital gain
* The main purpose or one of the main purposes of the arrangements was to obtain a tax advantage
  1. Where the conditions are met and HMRC issues a notice then the company is denied the use of capital losses against the gain. The gain will therefore remain within the charge to corporation tax.
  2. This rule applies to chargeable gains accruing on any disposal made on or after 5 December 2005.
  3. In order to ensure that the provisions are targeted only at abusive transactions, they apply a purpose test to the arrangements, so that only those designed to achieve a tax advantage are within their scope.
  4. Transactions which have a commercial, not tax motivated purpose, such as sale and leaseback arrangements should not be caught. However to provide extra certainty for these common types of financing arrangements there is an explicit exclusion for the sale and leaseback of land and property, where the transactions are with third parties.
  5. HMRC will consider requests for informal advice about the application of this third TAAR to specific cases. Requests should be made in the format detailed in draft guidance. Provided that all relevant facts are disclosed to the clearance officer, HMRC will be bound by the advice they give.