By the time the government’s business support measures come to an end, a perfect storm of tax clouds will have gathered. Corporate taxes which have been deferred will become due in quick succession. Under new rules, accrued trading losses will be further restricted from reducing taxable profits. Interest payments above a certain level will no longer be tax deductible.
The great tax deferral
To help prevent businesses from kicking the bucket, the government has itself kicked the tax-collection can down the road. As a consequence, a number of deferred tax payments will become payable within the first months of 2021.
- Income tax which was payable on account in July 2020 by the self-employed or individual members of trading and professional partnerships will be due by 31 January 2021.
- VAT deferred by businesses for the period 20 March to 30 June 2020 will be due by 31 March 2021.
- Corporation tax instalment payments which have been deferred under a Time to Pay arrangement with HMRC could be payable by 31 January 2021.
- Even if a company’s traditional income revenues have slumped, tax will still be payable on any grants made available to the company by central or local government.
To compound the liquidity problem created by the various taxes owed, businesses which had taken the earliest opportunity to borrow via the Coronavirus Business Interruption Scheme (CBILS) or the Bounce Back Loan scheme, will be faced with their first capital and interest payments in May 2021.
Monetising trading losses is part of standard corporate tax management. For the majority of 2020, many companies will be accumulating losses. These losses will be subject to the new set off regime effective for post April 2017 losses which has been tightened up for post April 2020 losses. These rules restrict the amount of brought forward losses which can be offset in any one year.
Post April 2017 brought forward trading losses can be set off in full up to a £5m profits “deductions allowance” after which they can only relieve up to 50 per cent of profits. For losses arising from April 2020, the £5m allowance must also take into account brought forward capital losses, further restricting the availability of losses to reduce corporation tax.
Whilst previously a £5m allowance would have meant the corporate tax position of most small and medium sized businesses would remain unaffected, in this economic climate this is no longer a given.
There is nonetheless a silver lining of some sort. Alongside the restriction on the quantity of losses available for use, there is now more flexibility as to the how these losses can be used.
For losses arising from 1 April 2017:
- Trade losses can be carried forward against total profits of the company, rather than only profits of the same trade.
- Deficits on non-trading loans can be carried forward against total profits of the company, and not just non-trading profits.
- Certain carried forward losses may be available for group relief, including trading losses, non-trading losses on intangible fixed assets, management expenses, non-trading loan deficits and property business losses.
To benefit from this flexibility, a company must now make a claim to carry forward losses (it is no longer automatic) and meet a number of conditions which include:
- The company must continue to carry on the trade in all subsequent accounting periods up to and including the one in which the losses are offset.
- The trade must not have become small or negligible in the loss making period.
- The trade must be ‘commercial’ in both the loss-making period and period of set off.
In ‘normal times’, satisfying these conditions would rarely have posed a problem, but these times are not normal. Every company will have adapted their business model in reaction to the coronavirus pandemic, many drastically so. Some companies will have changed their product lines, a number will have commenced new or additional trades, and many will have paused trading altogether during the first weeks of lockdown.
HMRC has acknowledged that businesses have been obliged to change course and recently published new guidance on “Crisis-driven changes to trading activities”. The guidance purports to clarify how HMRC view these shifts in trading patterns for the purposes of assessing tax and some useful examples are provided. But the advice is far from comprehensive and companies who fear they will be unable to deploy trading losses to the detriment of their tax position should seek advice. HMRC guidance is not the law.
Another point for companies with losses to consider is whether to carry the losses forward against future profits where, if corporation tax rates increase (as many think is inevitable), they might be worth more, or to carry them back against last year's profits and so obtain a short term cash boost.
Since 1 April 2017, the Corporate Interest Restriction rules have limited the amount of tax relief a company can obtain for deducting net interest and other financing costs. Individual companies or groups of companies that will deduct over £2m in a 12-month period are subject to restrictions.
Again, in normal times, the majority of companies would not be impacted by the interest restrictions, but as a consequence of the pandemic it is likely that more companies will be brought within its remit. The following practical points should be borne in mind:
- If interest costs will not exceed the £2m threshold during an accounting period, the company or group does not need to submit a Corporate Interest Restriction return.
- However, in order to preserve the company’s ability to carry forward an unused interest allowance, it will need to submit an ‘abbreviated’ corporate interest return.
The effect of the measures described above may lead companies to seek debt write downs or convert their debt to equity (see our summary of tax planning in this area here). As an alternative, some companies will sell businesses or assets to raise cash. Others will seek merger partners. Whichever survival route is adopted, the year 2021 is likely to see accelerated activity in the corporate finance sphere.
If you require further information about anything covered in this briefing, please contact Charlotte Black, or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, July 2020