This First Tier Tribunal (“FTT”) case examined whether loss relief on succession to a trade is available. The FTT held that all the losses of the predecessor’s trade that had been subsumed with the successor’s trade were available for offset against the combined profits of the successor company.

Often when a company is acquired for its trading activities it will be amalgamated shortly thereafter with the activities of other group trading companies in the acquiring group. This case would appear to open up opportunities for a profitable company to achieve tax savings through acquiring the trades of loss-making companies, allowing the value of otherwise trapped tax losses to be unlocked. However, it seems likely that HMRC will appeal this decision.

Fundamental to the decision was that there was a succession to an entire trade. The greater the changes to the transferred trade as a result of the trade combination, the greater the risk that what has taken place is not a succession to an entire trade, but something less than or different from the trade of the predecessor, bringing section 343(8) ICTA 1998 (now section 951 CTA 2010) and streaming into play.

The change in ownership rules in section 674 CTA 2010 could also be triggered where there is a major change in the nature or conduct of the trade of the successor. Finally, consideration will need to be given to the application of the new anti-avoidance rules in schedule 3 Finance Act 2015 which seek to prevent “loss refreshing”.

Similar rules in the Irish tax system are provided for under section 401 Taxes Consolidation Act 1997.

Background and key arguments

In November 2009 the appellant, Leekes Ltd (“Leekes”), acquired all of the shares in Coles of Bilston Limited (“Coles”) for £1. Coles trade at that date comprised three furniture stores plus warehousing facilities. In the eight months of trading prior to sale Coles had a trading loss for the period of £950,321. It had trading losses carried forward of £2,262,120.

Leekes decided there was no need to keep the Coles business as a separate trading entity; their stores could be operated within the same structure as the existing Leekes stores. After the acquisition the stores continued to sell substantially the same products and customers were served by the same staff. Thus, on the day after the acquisition, the entire business of Coles was hived up to Leekes at fair value. Coles became dormant following the transfer of its business and retained no liabilities.

Post-hive up, the Coles stores were rebranded as Leekes stores and continued to sell the same types of products. One of the Coles stores was renovated and re-opened in November 2010 selling Leekes products.

Leekes stated in the notes to its tax computation that it had succeeded to the Coles trade and had losses available for offset under section 343 ICTA 1988. The profits of Leekes were relieved in full by using (part of ) Coles’ pre-hive up trading losses.

HMRC opened an enquiry into the Leekes corporation tax return for the period ended 31 March 2010. This was followed by the issue of a closure notice in September 2013 disallowing the losses claimed. Leekes requested a review in October 2013. That review decision was issued in December 2013 and confirmed the disallowance of the losses. The company then appealed to the Tribunal.

The dispute concerned the correct interpretation of section 343(3) ICTA 1988 (now rewritten to section 944 CTA 2010) in circumstances where there has been a succession to the entire trade of one company by a second company with an existing trade. Section 343 is the provision which allowed trading losses to be carried forward on a transfer of a trade from one company (the predecessor) to another (the successor), subject to meeting a common ownership requirement. Section 343(3) provided that the successor is entitled to carried forward trading loss relief “as for a loss sustained by the successor in carrying on the trade, for any amount for which the predecessor would have been entitled to relief if it had continued to carry on the trade”.

The fundamental point in dispute was whether this should be interpreted as:

• allowing the successor to an entire trade to offset the predecessor’s unutilised trading losses against the whole of the profits of the combined trade carried on by the successor post-transfer, or
• requiring the successor to ‘stream’ the predecessor’s unutilised trading losses against the profits (if any) of the predecessor’s trade, as then carried on as part of the combined trade of the successor.

Under this interpretation, if the predecessor’s trade (as now carried on by the successor) never made any profits, the predecessor’s losses would remain unutilised. Leekes had filed its 2010 corporation tax return on the basis that the first of these was the correct interpretation. There was a clear advantage to Leekes in doing so.

On the facts, the Coles business was loss making and this did not change post-acquisition by Leekes. However, Leekes interpretation of section 343(3) allowed it to achieve an immediate and material cash benefit in the accounting period in which it acquired Coles. It obtained access to the unutilised trading losses of Coles which would otherwise have remained ‘trapped’ with no immediate value either to Coles or Leekes, and with no future value for so long as Coles’ trade continued to be loss making.

Leekes argued that if the intention was that the predecessor’s losses be ‘streamed’ against profits identified as arising from the former trade, this would be explicit in the legislation.

HMRC favoured the second interpretation, given that the first interpretation put the group in a considerably better position than if the succession had not occurred. HMRC contended that the two trades should be treated as separate parts, for the purpose of identifying tax losses.

Decision

Section 343 was the principal provision which set out the tax effects of a succession to a trade:-

Company reconstructions without a change of ownership:

Section 343(1):

“Where, on a company (“the predecessor”) ceasing to carry on a trade, another company (“the successor”) begins to carry it on, and

1. on or at any time within two years after that event the trade, or an interest amounting to not less than a three-fourths share in it belongs to the same persons as the trade, or such an interest belonged to at some time within a year before that event; and
2. the trade is not, within the period taken for the comparison under paragraph (a) above, carried on otherwise than by a company which is within the charge to tax in respect of it;

then the Corporation Tax Acts shall have effect subject to subsections (2) to (6) below.

In paragraphs (a) and (b) above references to the trade shall apply also to any other trade of which the activities comprise the activities of the first mentioned trade............

Section 343(3):

“Subject to subsection (4) below and to any claim made by the predecessor under s 393A(1), the successor shall be entitled to relief under s 393(1) as for a loss sustained by the successor in carrying on the trade, for any amount for which the predecessor would have been entitled to relief had it continued to carry on the trade.”

Sections 343(8) and (9) deal with situations in which there has been a succession to something different than the trade of the successor company. HMRC accepted that these provisions were not in point in this case.

HMRC accepted that post succession Leekes carried on the trade of Coles “as an identifiable part of its expanded business” as that principle was set out in Bell v National Provincial Bank of England Ltd (5 TC 1).

The appeal thus revolved around a question of statutory interpretation of the legislation which had been on the UK statute book unchanged since 1965. Perhaps surprisingly there were no authorities which were directly relevant to the point of interpretation in question. Although a number of authorities were cited by both parties involved in the case, the parties accepted than none of these were directly relevant.

Leekes argued that both on a narrow approach, looking only at the terms of the legislation itself, and on a wider approach, taking account of various case authorities and the principles behind the legislation, there was no justification for restricting the losses which are available to the successor company as suggested by HMRC.

The losses available were all of the losses stated in Coles’ accounts as at the date of succession which could be used against the new combined trade of the two companies.

Leekes explained that many of the interpretive points made by HMRC to suggest that the trade referred to in the first limb of section 343 was a separate trade, being the trade originally carried on by Coles, were relevant only in situations in which what had been transferred was something less than the trade of the predecessor company, so that the predecessor trade could no longer be identified.

In that situation section 343(8) referred to the activities of a trade, which was intended to cover situations, as in Falmer Jeans, when the profit making apparatus of a trade had not been transferred. (Falmer Jeans Ltd v Rodin (63 TC 55)) It was in these specific circumstances only that “streaming” was intended to apply, not as here, where a whole trade had been succeeded to.

Where section 343(1) and section 343(3) apply and there is an identity of trade before and after the succession, there is no restriction of losses which can be offset against the same, but enlarged, post succession trade.

Leekes did not accept that it is possible to interpret section 343(3) as restricting the quantum of losses available by reference to the profits of the predecessor either before or after the succession. Even if it is correct that “the trade” in the second limb of section 343(3) is a reference to the predecessor’s original trade, the reference in section 343(3) to “any amount for which the predecessor would have been entitled to relief ” only takes account of the quantum of the losses available and is not intended to extend to considering what, if any, profits the predecessor might have had against which those losses could be utilised.

This is intended to ensure that the amount of loss available for relief is the amount which the predecessor would have been entitled to had it continued to carry on the trade. The “relief ” available, via section 393 is relief against the profits of the new trade; it is not measured or capped by the profits of the predecessor’s trade. If parliament had intended losses to be streamed under section 343(3), specific wording would have been included in the legislation as was in fact included in section 343(8).

Leekes also stated that there is no reason in principle why the full amount of the losses should not be available against the new combined trade. The “real” losses from the Coles trade should be available to be offset against the “real” profits from the combined trade post succession.

Section 343 is intended to be a relieving provision; had Coles continued to trade it would have been able to use these losses against its future profits and there is no reason that Leekes Ltd as the successor company should be put in a worse position.

Leekes referred to the Laycock v Freeman Hardy & Willis Ltd (22 TC 288) and Briton Ferry Steel Co Ltd v Barry (23 TC 414) cases stressing that they both considered pre-1965 legislation in which it was in HMRC’s favour to argue that there had been a succession to bring profits of the predecessor companies into tax.

In their view, the judgement of Sir Wilfrid Greene MR in the Briton Ferry case recognised the artificiality of splitting a newly acquired business from an existing business when deciding whether there had been a succession.

Splitting the successor business into two separate parts is an artificial exercise rather than a reflection of a fundamental approach of the tax legislation. That artificial splitting should only be applied in limited circumstances where it is required by statute. In other cases it is necessary to consider “the reality of the whole matter” as was made clear in the Aviation & Shipping decision. (Aviation & Shipping Co, Ltd v Murray (39 TC 595)) 27.

The only relevant decision on the succession rules is the Falmer Jeans decision. Leekes Limited stressed that that case did not concern the general succession rules at section 343 (1) and (3) but the specific rules at section 343(8) where something other than a “trade” had been succeeded to.

However, Millet J’s decision in that case made it clear that section 343(1) and section 343(8) and (9) are mutually exclusive.

The Tribunal agreed with Leeke’s interpretation. In its view the words ‘as for a loss sustained by the successor in carrying on the trade’ in section 343(3) should be interpreted as reading ‘as if the successor had sustained the losses in the post succession trade’ and no restriction in the quantum of losses – by reference to the profits available in the notional trade of the predecessor post succession – could be implied.

The full judgement in this case is available from http://www.Tribunals.gov.uk/financeandtax/