MTT21150 - Calculating the effective tax rate: Adjusted profits: Excluded equity gain or loss
Excluded equity gains and losses are to be excluded when calculating the adjusted profits.
Where the underlying profits include these items, an adjustment is required in accordance with section 142 of Finance (No.2) Act 2023
However, an election can be made, under section 165 of the Act, in respect of all the members of a territory to treat certain gains and losses as not being excluded.
Meaning of ‘excluded equity gain or loss’
There are three types of excluded equity gain or loss. The treatment of each of these is set out below.
Gain or loss from changes in fair value of a qualifying interest – section 142(2)(a)
A gain or loss is an excluded equity gain or loss under section 142(2)(a) if it arises from:
- a change in fair value of a qualifying interest, or
- the impairment of a qualifying interest.
Additionally, the members of the group must between them have aggregate qualifying interests that entitle them, at the relevant time, to 10% or more of the profits, capital, reserves, or voting rights of the entity in which the qualifying interest is held.
Profit or loss in respect of a qualifying interest – section 142(2)(b)
A profit or loss is an excluded equity gain or loss under section 142(2)(b) if it arises in respect of a qualifying interest that is included in underlying profits under the equity method of accounting.
Gain or loss from the disposal of a qualifying interest – section 142(2)(c)
A gain or loss is an excluded equity gain or loss under section 142(2)(c) if it arises from the disposal of a qualifying interest.
Additionally, the members of the group must between them have aggregate qualifying interests that entitle them, at the relevant time, to 10% or more of the profits, capital, reserves, or voting rights of the entity in which the qualifying interest is held.
Qualifying interest
An interest in an entity is a ‘qualifying interest’ if it is a direct ownership interest (see MTT17030).
This is defined in section 141(9) of F(No.2)A23.
Relevant time
The ‘relevant time’ is:
- for a gain or loss falling under section 142(2)(a) or 142(2)(b), the end of the period in which the gain or loss arose, or
- for a gain or loss from the disposal of a qualifying interest (section 142(2)(c), immediately before the disposal.
Election under section 165 to have excluded equity gains or losses included
An election can be made under section 165 to treat qualifying gains or losses as not being excluded equity gains or losses. Where the election applies, the qualifying gains and losses are to be reflected in the adjusted profits.
This election is made in respect of all the members of a territory.
This election is a long term election. See MTT52200 for guidance on making elections.
Meaning of ‘qualifying gain or loss’
Gain or loss under section 142(2)(a)
A gain or loss falling under section 142(2)(a) is a qualifying gain or loss if either:
- the gain or loss is subject to covered taxes (as taxable gains or allowable losses) in the territory in respect of which the election is made, or
- the gain or loss is not subject to covered taxes in that territory, but gains or losses on disposal of the qualifying interest in question are subject to covered taxes in the territory in respect of which the election is made.
Gain or loss under section 142(2)(b)
A profit or loss falling under section 142(2)(b) is a qualifying gain or loss if:
- the gain or loss is subject to covered taxes (as taxable gains or allowable losses) in the territory in respect of which the election is made, and
- the members of the group between them have aggregate qualifying interests that entitle them, at the relevant time, to 10% or more of the profits, capital, reserves, or voting rights of the entity in which the qualifying interest is held.
See above for guidance on the meaning of ‘the relevant time’.
(Note that the latter condition also applies to the other types of excluded equity gains or losses, but it is already part of the conditions of 142(2)(a) and (c). See above for guidance on those conditions.)
Gain or loss under section 142(2)(c)
A gain or loss falling under section 142(2)(c) is a qualifying gain or loss if the gain or loss is subject to covered taxes (as taxable gains or allowable losses) in the territory in respect of which the election is made.
Revocation of section 165 election
A special rule applies where an excluded equity gain election is revoked.
Where an election is revoked, the revocation will not have effect in relation to equity gains or losses in respect of a particular ownership interest if:
- that ownership interest gave rise to a loss that would have been excluded as an excluded equity loss in accordance with section 142, and
- the adjusted profits of any member of the group have included that loss, as a result of a section 165 election.
In this case, the election will continue to apply to the gains or losses in respect of that particular ownership interest.
This ensures that where a group has excluded equity losses reflected in the adjusted profits, subsequent gains on the same ownership interest will not be excluded.
Tax equity partnerships
Example 1 – 142(2)(a)
In its underlying profits accounts for the 2024 period, A Ltd records a decrease in the fair value of B Ltd of £25 million, arising from a direct ownership interest of 20%. A Ltd is subject to covered taxes on such gains or losses in Territory A, where it is located.
The loss in respect of B Ltd is an excluded equity loss for A Ltd under section 142(2)(a) because:
- the interest held by A Ltd in B Ltd is direct, and it is therefore a qualifying interest,
- the loss arose from a change in fair value of that qualifying interest, and
- members of the group hold an entitlement to 10% or more of the profits, capital, reserves and voting rights of B Ltd.
For the 2024 period onwards, A Ltd's group makes an election under section 165 to treat qualifying excluded equity gains and losses as not being excluded for members in Territory A.
The loss of £25 million is a qualifying excluded equity loss because the loss is subject to covered taxes under the domestic tax regime of Territory A and is treated as an allowable loss.
Had the section 165 election not been made, section 142(2)(a) would apply to exclude this loss when calculating the adjusted profits of A Ltd. However, a section 165 election was made, and the loss is qualifying, the loss will be treated as not excluded and no adjustment is required. It will therefore be reflected in the adjusted profits for A Ltd.
If the election is later revoked, any gain or loss in relation to the ownership interest held by A Ltd in B Ltd will remain subject to the election, despite the revocation, because:
- the adjusted profits of a group member (A Ltd) included an excluded equity loss in respect of its ownership interest in B Ltd as a result of a section 165 election, and
- had that election not been made, that loss would have been excluded in accordance with section 142.
Example 2 – 142(2)(b)
X Ltd holds a direct ownership interest in Z Ltd that entitles it to 40% of the profits of Z Ltd, but does not provide any other entitlements or voting rights. It records a loss of £100,000 in relation to this ownership interest in its underlying profits for the 2030 period under the equity method of accounting.
X Ltd is located in Territory X and a section 165 election applies to it for the 2030 period. X Ltd is subject to covered taxes in Territory X on its gains and losses in respect of Z Ltd.
No other member of the X Ltd’s group holds any interest in Z Ltd.
The loss is an excluded equity gain or loss because:
- it is a direct ownership interest and therefore a qualifying interest,
- the profit or loss is included in the underlying profits under the equity method of accounting.
Although X Ltd is not entitled to at least 10% of the capital, reserves and voting rights of Z Ltd, this does not prevent the loss from being an excluded equity gain or loss under section 142(2)(b).
The section 165 election will not apply to the loss because:
- although the loss is subject to covered taxes,
- it falls within section 142(b), and
- the members of X Ltd’s group do not collectively hold at least 10% of the profits, capital, reserves and voting rights of Z Ltd.
The loss must therefore be excluded when determining the adjusted profits of Z Ltd.
If the election is later revoked, the revocation may apply to the ownership interest held by X Ltd in Z Ltd as no gain or loss has been included as a result of the election.