Inland Revenue’s draft guidance on the Business Continuity Test (BCT) provides additional context on how the new rules for carrying forward tax losses, introduced in 2020, could be applied by Inland Revenue. The guidance focuses on anti-avoidance provisions not covered in Inland Revenue’s previous interpretation statement, particularly how companies should avoid using tax arrangements solely for the purpose of gaining tax advantages.
Key Highlights of the Draft Guidance
- Anti-Avoidance Provisions: The draft guidance explains that if a tax advantage is obtained inappropriately, such as shifting deductions or income between profit and loss companies without valid commercial reasons, the tax advantage will be undone. For example, income in a loss company could be treated as schedular income, making it ineligible to offset losses.
- Strict Rules: The anti-avoidance rules are strict, with a relatively low threshold for triggering them. The rules apply in cases where companies make changes or transactions that lack commercial substance, such as shifting costs or income between businesses solely for tax benefits.
- Commercial Rationale Requirement: The commercial rationale behind any business restructuring or transactions involving loss companies must be clear and defensible. If Inland Revenue determines that tax advantages are the sole purpose of the arrangement, the anti-avoidance provisions will likely apply.
Examples and Implications for Businesses
The draft guidance provides examples illustrating the application of these rules, including cases of intergroup cost recharges. Inland Revenue emphasizes that these transactions must be priced commercially and robustly. The guidance also includes the Parliamentary contemplation test, which examines whether the arrangement aligns with the intended purpose of the BCT, ensuring that tax benefits aren't misused.
In some cases, the draft guidance seems to overly prioritise preventing tax avoidance, limiting the commercial flexibility that the BCT was designed to offer. For example, Inland Revenue objects to a scenario in which a loss-making company’s losses are used by a profitable company, even though the new shareholder did not contribute to the losses. This seems contrary to the original intent of the BCT, which was designed to allow exactly such situations.
Overall, while the guidance is useful, it could benefit from recognising a broader range of commercial situations and a less restrictive interpretation of what is deemed artificial. In the current economic climate, businesses seeking new partners for growth may need greater flexibility in applying the BCT.
Important Note: Even if specific anti-avoidance provisions do not apply, the general anti-avoidance rule (section BG 1) can still be enforced. Therefore, companies should carefully assess the commercial arrangements involving group members and BCT losses to avoid potential challenges from Inland Revenue.
Navigating Uncertainty with BCT Rules
While the draft guidance provides a comprehensive look at the BCT rules, uncertainty remains. There has not been significant activity in mergers and acquisitions (M&A) valuing tax losses under the BCT, likely due to uncertainty around its application. As more scenarios are tested, the BCT may become better understood and more widely used. However, caution is advised due to the strict approach Inland Revenue seems to be taking in determining what constitutes artificial arrangements.
If you have any questions about how the BCT and anti-avoidance provisions may apply to your business, or if you are considering a transaction that could involve tax losses, contact Bellingham Wallace for tailored advice. We are here to help you navigate these complex rules and ensure your arrangements meet Inland Revenue's requirements. Let our experienced team of tax consultants assist you in making informed decisions to support your business growth while staying compliant.
