CTM07550 - Corporation Tax: tax avoidance involving carried-forward losses: example arrangements

Overview of examples

These examples relate to pre-1 April 2017 periods using a simplified analysis and ignore the effect of a number of other statutory provisions which may apply to the arrangements. They are purely for illustrative purposes to demonstrate how the TAAR could apply to certain fact patterns.

HMRC will look at the facts on a case-by-case basis, and apply the legislation accordingly.

Arrangement 1: Intra-group and other hedging arrangements

The facts are as follows:

  • D Group uses intra-group derivatives to hedge their interest rate risk. D4 has substantial amounts of non-trading loan relationship deficits carried forward, and is not a banking company.
  • D1 has an external fixed rate loan liability of £1bn. The loan is a fixed-term five year loan with several years still to run.
  • D2 holds an interest rate swap with a third party, hedging the fair value risk in respect of D1’s loan. D2 receives fixed, and pays floating, interest on a notional principal of £1bn.
  • The swap and loan are linked via a third company in the group, D3, which has entered into back-to-back derivative positions with D1 and D2.
  • From D3’s perspective one of the swaps is in-the-money while the other is out-of- the-money.
  • D Group has commercial reasons to maintain the hedge but also sees the opportunity to use its derivatives to convert its carried-forward losses into current year deductions.

D Group therefore undertake the following arrangements:

Arrangement 1 (123 KB) (new)

  • D3 transfers the in-the-money derivative to company D4. D4 then realises the profit, which is covered by carried-forward non-trading deficits.
  • D3 keeps the out-of-the-money derivative and triggers recognition of the loss on it, again by realising it, thereby giving rise to a versatile in-year deduction.
  • The group then enters into a new hedging arrangement on market terms to ensure that the external loan continues to be hedged.

Analysis of Arrangement 1

The tax arrangement to be considered is:

  • Transferring the in-the-money derivative to D4, and
  • Closing out the derivatives in that year, when they were still needed.

The wider, commercial driver of the need to hedge cannot be part of the tax arrangement as the group would not have closed out the hedges in this example unless it sought to obtain a tax advantage in doing so. This is evidenced by the replacement hedging arrangements; commercially the group is no better or worse off having closed down one hedging structure and replaced it with another, apart from the tax advantage.

Considering the conditions in CTA10/s730G:

  1. The in-the-money derivative was transferred to D4, who has relevant carried-forward losses which can be set against the profits arising from the derivative. The group had commercial need for the derivatives (and replaced them), so the profit on the in-the-money derivative has arisen as a consequence of choosing to close it out now –i.e. the profit arises to D4 as a consequence of the tax arrangements. Condition A is met.
  2. Similarly to condition A, closing out the out-of-the money derivative has created a non-trading debit, which is a deductible amount within CTA10/s730H. Absent the arrangements, the derivatives would not have been closed out and no debit would have arisen in this accounting period. Condition B is met.
  3. One of the main purposes of the arrangements was to secure a tax advantage involving the increased profits in D4 and the use of D4’s carried-forward deficits against it, and the creation of a new deduction. Condition C is met.
  4. On the scope of the tax arrangements, there seems little if any non-tax value to the companies involved in entering the arrangements. The anticipated tax value will therefore be greater than the anticipated non-tax value. Condition D is met.
  5. D4 is not a banking company, so CTA10/s269CK will not apply. Condition E is met.

As all the conditions are met, the rule will apply. D4 will be denied use of its carried-forward relief against the profits arising from closing out the in-the-money derivative.

Arrangement 2: Plant and machinery sale and lease-back

The facts are as follows:

·P Ltd acquires plant and machinery for use in its trade.

·Q Ltd (100% subsidiary of P) has substantial carried-forward trading losses from a trade of leasing plant and machinery that is now insufficient to utilise all the losses.

P and Q undertake the following arrangement in order to make use of the carried-forward losses:

·P sells the plant and machinery to Q at market value.

·Q leases the plant and machinery back to P at arm’s length rates.

Analysis of Arrangement 2

The tax arrangement to be considered here is the arrangements giving rise to:

  • The ‘relevant profit’ in Q (arising from payments received from leasing the plant and machinery to P).
  • The ‘deductible amount’ which arises in P (as a consequence of payments made to Q under the lease).

The tax arrangement is therefore the sale and lease-back of the plant and machinery between P and Q, and not the original acquisition of the plant and machinery by the group. This example focusses on the leaseback aspect, but the sale between P and Q may also generate profit and could therefore also fall within the rules.

Considering the conditions in CTA10/s730G:

  1. Q, the ‘relevant company’, has relevant profits which arise as a result of the tax arrangement between P and Q, against which Q’s carried-forward trading losses can be set. Condition A is met.
  2. P, a company connected with Q, has a new deduction in consequence of the tax arrangement, which it would not otherwise have had. Condition B is met.
  3. One of the main purposes of the arrangements was to secure a tax advantage involving Q’s carried-forward trading losses. Condition C is met.
  4. On the scope of the tax arrangements, there seems little if any non-tax value to the companies involved in entering the arrangements, although that may not be the case for all sale and lease-backs. The anticipated tax value will therefore be greater than the anticipated non-tax value. Condition D is met.
  5. Neither P nor Q are banking companies, so CTA10/s269CK will not apply. Condition E is met.

As all the conditions are met, the rule will apply. Q will be denied use of its carried-forward losses against the profits arising from the leasing of the plant and machinery to P.

Arrangement 3: Intra-group loan and share issue

The facts are as follows:

  • Company A, part of ABC group, has substantial amounts of non-trading loan relationship deficits brought-forward.
  • ABC group wants to acquire shares in a third party (Company Q) as part of a commercial acquisition by the group.

The ABC group enters into the following arrangements:

Arrangement 3 (2 MB) (New)

  • Company A obtains equity finance from its immediate parent, Company B, by issuing shares to Company B for £100m.
  • Company A lends this £100m to its subsidiary, Company C.
  • Company C uses the £100m to purchase all the shares in Company Q.
  • Company C will pay interest on the loan to Company A.
  • The terms of the shares Company A issued means it will pay an amount equal to this interest to Company B as dividends.

Analysis of Arrangement 3

The tax arrangement to be considered is:

  • The acquisition of Company Q, and
  • The way in which the funding for the acquisition of Company Q was structured.

Company A will receive a non-trading loan relationship credit, leading to a non-trading profit which will be covered by carried-forward non-trading deficits. Company C will receive a non-trading loan relationship debit for the interest it pays.

Company A will not receive any deduction for payment of the dividend to Company B, and Company B will not be charged tax on receipt of the dividend.

Overall, the funding structure leads to an increased profit in Company A, which has relevant carried-forward losses, and a new deduction for the period and subsequent periods in Company C.

Considering the conditions in CTA10/s730G:

  1. As a consequence of the funding structure, Company A has an increased profit, against which it would be able to set its carried-forward non-trading loan relationship deficits. Condition A is met.
  2. As a consequence of the funding structure Company C will receive a new deduction for the interest paid; the deduction is a non-trading loan relationship debit, which is a deductible amount for the purposes of the rule. Condition B is met.
  3. One of the main purposes of structuring the acquisition funding in this way was to obtain a relevant corporation tax advantage from creating profits in Company A against which it could use relevant carried-forward losses, and to create a new deduction in Company C. Condition C is met.
  4. The non-tax value of the tax arrangements will be substantial. The companies acquire a new asset in the form of Company Q, together with the anticipation of future profitability of that company. It is unlikely that the tax value will be the greater part of the overall value of the economic benefits, when this non-tax value is taken into account. Condition D will not be met.

As condition D is not met, the rules will not apply, and there will be no restriction on Company A’s use of its carried-forward deficits.

Arrangement 4: Transfer of a profitable income stream

The facts are as follows:

  • Company F has substantial trading losses carried-forward, and little prospect of making profits in the future.
  • Company S, a company that has been in the same group as F for some time, has a profitable trade.
  • Company S transfers its trade to F (Part 14 of CTA 2010 which restricts relief for losses where there is a change in ownership of a company is assumed not to apply), and S is liquidated.

Analysis of Arrangement 4

Considering the conditions in CTA10/s730G:

  1. As a consequence of acquiring the trade, Company F has an increased profit, against which it would be able to set its carried-forward trading losses. Condition A is met.
  2. Condition B is not met because there is no new deduction arising from the tax arrangement.

The TAAR will not apply.