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Tony Wickenden: A closer look at sideways loss relief schemes

Sideways loss relief schemes are considered in relation to purposive legislation

Last week, I looked at the already existing limitations on “sideways” loss relief schemes for partners and members of an LLP.

The first limits the annual relievable amount to £25,000 and only for “non-active partners”, that is those who do not spend, on average, at least 10 hours a week engaged in the relevant trade.

The second (introduced in 2010) represents an excellent example of targeted, purposive, anti-avoidance legislation. The GAAR that is currently being consulted on with a view to its introduction in tax year 2013 will also not only be firmly “purposive” but will, self-evidently, be capable of general application instead of, as has been the case to date, being targeted at specific activities.

That it (the GAAR) is needed illustrates the inevitable weaknesses inherent in “targeted, albeit purposive” legislation as a means of ensuring that the purpose of Parliament in relation to particular legislation is enforced.

However , the targeted but purposive legislation introduced is nevertheless worth a look as it gives an indication of how the “purposive” part of a GAAR could look. It also replicates, substantially, the approach underlying “substance over form” decisions on tax avoidance in the courts.

BIM 75762, explaining the provisions, states that “ITA07/S74ZA is a targeted anti-avoidance measure which prevents sideways relief (relief against general income or early trade losses relief) or capital gains relief where the loss arises from relevant tax avoidance arrangements. ‘Trade’ includes professions and vocations”.

“The legislation is specifically targeted at persons who enter into tax avoidance arrangements with the purpose of obtaining a tax reduction by way of sideways loss relief”. HMRC states that “It will have no relevance for the vast majority of taxpayers who do not enter into such arrangements.”

The restriction applies to losses which arise as a result of tax avoidance arrangements entered into on or after 21 October 2009.

This restriction on relief applies if:

  • a person makes a loss for a tax year from carrying on a trade, profession or vocation and
  • the loss arises directly or indirectly in consequence of, or otherwise in connection with, “relevant tax avoidance arrangements.”

These “relevant tax avoidance arrangements” are defined as arrangements to which the person is a party and the main purpose, or one of the main purposes, of the arrangements is the obtaining of a reduction in tax liability by means of sideways loss relief.

The term arrangements is widely drawn and includes any agreement, understanding, scheme, transaction or series of transactions, whether or not legally enforceable.

Whether a transaction forms part of a series of transactions, or a scheme, or an arrangement is in general a question of fact but this conclusion will follow in any case where one transaction would not have taken place without another transaction or would have taken place on different terms without that other transaction. However, it is not necessary that transactions must depend on each other in this way in order that they form part of a scheme or arrangement.

For the legislation to apply it is a condition that the main purpose or one of the main purposes of a person being party to the arrangement(s) is the obtaining of a reduction in tax liability by means of sideways loss relief. As clear a “purposive condition” as you could see. This type of wording appears in other such “targeted purposive” legislation . An example is the provision in the relevant life policy legislation denying relief where the main purpose or one of the main purposes of effecting the RLP is tax avoidance.

In relation to the “sideways” provisions, HMRC states in the BIM that the fact that a reduction in tax liability is an inevitable outcome if sideways loss relief is allowed does not mean that a main purpose of the taxpayer must be to obtain a tax advantage. In the case of the vast majority of taxpayers, their purpose for entering into a transaction will be determined by commercial considerations and tax relief is an incidental consequence. However, in the case of an avoider, the main purpose, or one of the main purposes, is always the securing of a tax advantage.

In applying this condition it is, therefore, necessary to consider the purpose of the person entering into the arrangements and the relevant circumstances. Factors to consider are:

  • The overall economic objective was the transaction inextricably linked to a core commercial activity and in a form not driven by considerations of tax advantage
  • If the objective is one which that the parties involved might ordinarily be expected to have, and if the transaction giving rise to the reduction in tax liability would have otherwise taken place at all
  • If the objective of the arrangements is being fulfilled in a straightforward way or whether the introduction of any additional, complex or costly steps would have taken place were it not for the reduction in tax liability that could be obtained
  • If the reduction in tax liability would have been of the same amount without the arrangements and if the transaction would have been made under the same terms and conditions
  • If the loss has arisen in connection with a marketed tax avoidance scheme.

Where ITA07/S74ZA applies, no sideways relief or capital gains relief may be given for the loss. It may, however, be carried forward against any profits of the same trade, profession or vocation.

Most important, in relation to the film partnership investment schemes being reported currently, ITA07/S74ZA does not apply to qualifying film expenditure as defined in ITA07/S74D.

Tony Wickenden is joint managing director of Technical Connection

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