CTM05280 - Corporation tax: restriction on relief for carried-forward losses: increase of deductions allowance in connection with onerous or impaired leases

CTA10/S269ZX, 269ZY & 269ZYZA

A company’s deductions allowance can be increased in certain circumstances involving a corporate rescue. These are generally where the company is a tenant under a lease of land and profits or credits arise to it from reversals of onerous lease provisions or right-of-use asset impairment losses as a result of arm’s length arrangements under which the company’s obligations under the lease are varied or cancelled. In addition, at least one of the following conditions must also be met;

  • Condition X – it is reasonable to assume that before the arrangement(s), there was a material risk that the company would be unable to pay its debts as they fell due within the next 12 months and the sole or main purpose of the arrangement was to avert that risk
  • Condition Y – the company is in insolvent administration
  • Condition Z – the company’s arrangement is, or is part of, a statutory insolvency arrangement

Without this exception to the normal loss reform rules, a company in financial distress could suffer a restriction in their use of any carried-forward losses against such reversals and may, consequently, be pushed into administration or insolvency.

Example

A retail company has several leased units across the country. The change in consumer shopping habits coupled with the impact of COVID-19 has reduced footfall significantly and led to a large drop in profits across several stores. The rental payments the company is making on those retail units are no longer commercially justifiable, so the company makes an onerous lease provision of £20 million in respect of those leases.

In a subsequent accounting period, the company gets into financial difficulty and negotiates a rent reduction with its landlords to avoid insolvency. As a result, the company reverses the £20 million onerous lease provision it previously made, giving rise to a taxable receipt. In that accounting period, the company has relevant trade profits of £22million, £50 million brought forward trade losses and a deductions allowance of £5 million. The loss restriction would, under normal circumstances, mean that the company would only be able to utilise £13.5 million of its carried forward losses against these ‘paper’ profits i.e. the sum of their deduction allowance of £5 million and 50% of the remaining £17 million profits. This gives rise to a tax liability on profits of £8.5 million and the remaining £36.5 million losses may be carried forward or surrendered as group relief if applicable.

The provisions at CTA10/S269ZX would allow the company to increase its deductions allowance by the lower of its specified profits and the sum of its relevant credit(s). Relevant credits include a relevant reversal credit, a relevant remeasurement credit and a relevant variable lease payment, these are explained further below. In this case the relevant credit (the reversal of the onerous lease provision of £20 million) is lower than the specified profits of £22 million, and so the deductions allowance is, therefore, £25 million. The company is then able to cover its profits fully without restriction and will have £28 million trade losses remaining for future use or surrender as group relief.

Meaning of relevant reversal credit

CTA10/S269ZY defines a relevant reversal credit as a credit that the company is required to bring into account for accounting purposes as either an onerous lease or a right-of-use asset impairment reversal in relationship to a lease of land under which they are a tenant.

Relevant reversals will also occur in situations where a property company sublets to another company in the same group and negotiates the release from the lease obligations with a third-party landlord.

Meaning of a relevant remeasurement credit and variable lease payment

CTA10/S269ZYZA was introduced to cover situations where IFRS 16 requires the recognition of a remeasurement amount or a negative variable lease payment.

Like a relevant reversal credit, a relevant remeasurement credit is a credit the company is required to bring into account for accounting purposes. Where the credit relates to a relevant right-of-use asset impairment loss in relationship to a lease of land under which they are a tenant, this is instead a relevant remeasurement credit.

A variable lease payment will only occur where the affected company opted for the specific COVID-19 easement to IFRS 16 that applies to rent concessions occurring as a direct consequence of the pandemic; and only to payments that would have been payable under the lease on or before 30 June 2022.

You may need the help of a HMRC accountant in ensuring the above definitions are met and in quantifying the sums involved.