As I have demonstrated over the past few weeks, HM Revenue & Customs has been acutely aware of and active in attempting to prevent the use of tax-motivated sideways loss relief.
The timeline of action taken in relation to sideways loss relief provides an excellent background to understanding why the Government feels the only way to make meaningful progress in this, and tackling the seemingly never ending number of schemes exploiting what HMRC sees as loopholes in specific/targeted legislation, is a general anti-abuse rule.
But in addition to this, the Government also proposes reliefs that do not already incorporate their own cap, eg pensions, Isas, VCTs etc, will have an overall cap on the annual amount that can qualify for income tax relief.
Many people expressed surprise when the proposal was introduced in this year’s Budget, and we have since had the U-turn in relation to its non-application to charitable donations.
But the cap on relief already had a bit of history ahead of the Budget. As well as the cap on sideways loss relief claimed by non-active partners, in June 2011, HMRC issued a consultative document entitled ‘High risk areas of the tax code: relief for income tax losses’.
The consultation document was issued due to HMRC’s belief that income tax loss relief is being misused for tax avoidance purposes. Specifically, the consultation document stated: “HMRC is aware from disclosures under the disclosure of tax avoidance schemes regime and other sources that, despite the changes to the legislation, avoidance arrangements purporting to provide income tax losses are still being used by a small but significant number of people and involve substantial amounts of tax.”
The consultation document states that in HMRC’s view, the anti-avoidance legislation is currently sufficient – it has clearly changed its mind since, with the apparent commitment to introduce a general anti-abuse rule – but it is concerned about the possible risk of loss of significant amounts of tax to the Exchequer and believes that too much time is being spent trying to defend the existing loss relief provisions through the courts and in negotiations with taxpayers. Even apart from whether or not the current tax rules are defendable at the current time, there is a concern that taxpayers are delaying making tax payments that subsequently are determined to be due on the basis of aggressive loss claims, such that a cash advantage is obtained.
HMRC identifies three particular types of loss relief for action:
sideways loss relief under ITA 2007, s64;
property business loss relief against general income under ITA 2007, s120; and
employment loss relief against general income under ITA 2007, s128.
The consultation document set out three possible approaches to target these loss reliefs better:
a principle-based approach;
a universal £25,000 cap in respect of losses in any other tax year; or
a change to the self-assessment system so there would be no repayment or credit for loss relief for amounts in excess of £25,000 in respect of any one year until a claim was agreed by HMRC, ie back to the pre-self-assessment approach.
As stated in a previous article, a cap of £25,000 already applies for non-active partners and sole traders. Individuals are non-active if they spend less than 10 hours per week, on average, personally engaged in the activities of the trade and those activities are undertaken on a commercial basis and with a view to the realisation of profits.
The proposed GAAR is at least partially rooted in a principle/purposive approach. The proposed cap of £25,000 seems to have emerged in the form of the currently proposed cap on income tax relief of the greater of £50,000 and 25 per cent earnings.
Since the £25,000 cap on sideways loss relief was introduced for non-active taxpayers, it has been necessary to more carefully examine loss claims in excess of that amount to ensure the individual is ‘active’ and, more fundamentally (in relation to other than qualifying film partnerships), whether the main purpose or one of the main purposes is tax avoidance.
Despite the dropping of charitable donations from the proposed restrictions, the £50,000 or 25 per cent of taxpayer’s income limitations on income tax deductibility look likely to proceed to implementation.
Tony Wickenden is joint managing director of Technical Connection
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