This article is produced by our London Tax team, which is part of our global Tax practice. Our series, "Understanding Tax", explores commercially relevant and recent changes to the UK's tax code.
The true value of UK tax losses
Somewhat counter-intuitively, the title given to "tax losses" belies their useful nature, and you will no doubt have come across these assets at some point in your career and therefore be aware of this curious contradiction.
However, have you ever paused to think how value can best be extracted from these unusual assets – how much, in real cash terms, these assets are truly worth? The London Tax team at White & Case works closely with our corporate and restructuring teams to maximize the value extracted from tax losses, and in recent years have found ourselves having to consider this question more often, and much more thoroughly.
Recent introductions to the UK tax code and new tax initiatives have led to many of our clients adjusting their approaches to managing the tax losses that sit on their balance sheets. For example, the changes introduced from 1 April 2017 have potentially broadened how tax losses may be employed in many organisations. At the same time, these same changes have placed new restrictions on the quantum of profits that may be reduced by tax losses and new anti-tax avoidance measures now also contain further rules limiting "loss buying".
While it may be tempting to conclude that the economic benefit of any tax loss should at least approximate to its value on paper or gross "book" value, the myriad of intricate rules governing how tax losses may be utilized almost ensures that is not the case. This is a complex area of law that is constantly evolving, and given the current economic and political climate, it has never been more important to have an overview of the different approaches to valuing and determining the true value of UK tax losses. Such an understanding should prove useful in a variety of situations – whether in the context of a merger, acquisition, reorganization, takeover, or even shareholder activism.
The types of tax losses
At the outset, it is important to understand that there is no aggregated concept of a tax loss. In other words, it is potentially misleading to look to a single line on a balance sheet and hope to gain an accurate picture of how valuable such tax losses are. Rather, the types of tax losses an entity possesses dictate the rules that govern what these losses may be set off against and when, as well as how much of them, may be utilized in any particular tax period.
The main categories of tax losses that are often of interest to our clients are as follows:
- tax losses that derive from loan relationships; and
- management expenses.
Of these four categories of tax losses, losses that derive from loan relationships and management expenses tend to appear in more specialized contexts than trading and capital losses. Consequently, we discuss in more detail below the more generally relevant trading and capital losses.
Current account period and "carry back"
Broadly speaking, since 1 April 2017, trading losses may be set off against total profits of the current accounting period and "carried back" to be set off against total profits of the 12 months preceding the loss – in that order of priority.
Various restrictions apply to using tax losses in this manner. For example, relief may not available when a trade is carried on wholly outside the UK or when for the loss-making period the trade is not commercial and carried on with a view to making a profit.
The rules regarding "carrying forward" trading losses are potentially more complex.
Depending on when the loss was generated, such losses may be set off against total profits of the business or may be set off only against profits of the same trade. A time limit may also apply in utilising such losses. Moreover, such losses may be automatically utilised in certain scenarios, and elections have to be actively made in others.
In addition, as of 1 April 2017, limitations were introduced in respect of calculating a company's taxable total profit for an accounting period. In other words, limitations were introduced in respect of how much "carried forward" trading losses may be utilised in a particular accounting period. Speaking simply, the effect of these restrictions is that, upon reaching a particular threshold, "carried forward" trading losses may only be set off against a maximum of 50 per cent of a company's total profits (the 50 per cent rule), such that companies that generate significant amounts of profit will likely always have to pay some tax.
Current account period and "carry back"
Broadly speaking, capital losses in an accounting period may be set off against total chargeable gains of the same accounting period. Capital losses are not allowed to be "carried back".
Generally, if there are excess capital losses, these may be carried forward and set against total chargeable gains in the earliest possible subsequent accounting period.
It should also be noted that whilst there is currently no equivalent to the 50 per cent rule in the context of capital losses, there are plans, from 1 April 2020, to introduce a similar restriction on the use of "carried forward" capital losses.
Finally, attention should also be paid to anti-avoidance rules that have developed in respect of tax losses. Of particular note is the rule preventing "loss buying" in certain scenarios.
In summary, the rule against "loss buying" potentially applies when, within a certain timeframe, there is a change in the ownership of a company and a major change in the nature or scale of a trade carried on by the company. If applicable, the rule will prevent both "carrying forward" and "carrying back" of tax losses. As you may have guessed, this anti-avoidance rule, alongside various others, should always be considered in the context of a merger, acquisition, takeover, or reorganization.
Lily Teh (White & Case, Associate, London) contributed to the development of this publication.