English segregation: use of losses

/ 19 December 2017

David Whiscombe

Occasionally one’s response to an assertion is “that can’t possibly be right”: but without quite being able to identify the flaw in the argument.  It’s an unsettling position to be in: the more so when one finds that the courts can’t find the flaw either.  Thus it was in HMRC v English Holdings (BVI) Ltd [2017] UKUT 842 (TCC) in which the Upper Tribunal has recently upheld the decision of the First-tier Tribunal.

English Holdings carried on a trade in the UK through a permanent establishment here.  It also, separately, derived income from letting UK property (not through the permanent establishment).  Accordingly, any profits from the trade were chargeable to Corporation Tax (“CT”) and any rental profits were chargeable to Income Tax (“IT”).

So far so uncontroversial.  But what if (as was the case for English Holdings) the trade made losses and the rental business was profitable?

Normally, of course, a company liable to CT can make a claim to set trading losses against its total profits.  And a taxpayer subject to IT can make a claim to set trading losses against other income.  But did that mean that English Holdings could set a loss arising in its “Corporation Tax” trade against its “Income Tax” rental profits?

Of course not, said HMRC.  Corporation Tax and Income Tax were separate codes: Parliament had plainly provided that the two activities of the company should each be dealt with under the appropriate code and kept rigorously apart.  Trying to mix them would cause all sorts of difficulty.

Most obviously, the rules for working out profits and losses are different as between the two taxes: the results of a period could conceivably give rise to a profit for CT purposes but a loss for IT purposes, or vice versa – then where would you be?  And if the loss (however you worked it out) was not fully relieved against rental income, there was no machinery in the legislation telling you how to deal with the balance of the loss.  No: segregation had to be maintained – the alternative was just too awful to contemplate.

As against that, however, is the awkward fact that a strict reading of the legislation does seem to allow you to do exactly what English Holdings wanted to do.  And, according to the Tribunal, a careful analysis of the surrounding law did not suggest that reading the legislation in this way was contrary to Parliament’s intention.  Yes, there was some awkwardness that had to be got over if the law was to be read in that way: but on balance that was not a reason to ignore what the words of the Act actually said.  If you wanted to claim the loss against income, you worked out the loss using Income Tax rules.

Normally, our prediction would be that a future Finance Act would “clarify” the position by amending the law so as to accord with HMRC’s contentions.  However, from 6 April 2020, non-resident companies will be charged to Corporation Tax rather than Income Tax in respect of UK rental income (see the HMRC document here) so it is to be expected that the difficulty encountered by English Holdings will from that date disappear.  Nonetheless the case is a reminder that something that can’t possibly be right sometimes is.

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David Whiscombe


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