English Holdings: CT losses against IT profits

Most practitioners will believe that corporation tax and income tax are two separate taxes with their own rules. The decision in the recent case of English Holdings Ltd v HMRC [2016] UKFTT 0346 (reported in Tax Journal, 8 July 2016) may therefore come as a surprise.

 

 

The case involved a company, English Holdings Ltd, registered in the British Virgin Isles. The company was not resident in the UK but carried out a trade in land situated in the UK through a permanent establishment (PE). As such, the company was chargeable to corporation tax on any profits arising on this trade under CTA 2009 ss 5 and 19. For the year to 31 March 2011, however, the trade suffered a loss of over £2m.

 

The company also held a number of investment properties situated in the UK on which rental income was received. As this letting activity was not carried on through a PE in the UK, this income was chargeable to income tax under ITTOIA 2005 s 26. In the year to 31 March 2010, the profit from renting the properties was £1,015,219.73, which gave rise to a tax liability of £203,043.95.

 

The company made a claim on the 2009/10 tax return (submitted late) to set off the loss arising from the trade against the rental profit. It was subsequently accepted, however, that this claim was incorrect and the correct procedure was to make a claim outside the return under TMA 1970 Sch 1B.

 

HMRC rejected the claim and issued a closure notice, which is the subject of the appeal heard by the FTT. In addition, the company appealed against a penalty of £40,608 raised on the late filing of the 2009/10 return.

 

 

The first point considered by the tribunal judge was whether a loss arising on a trade subject to corporation tax could be offset against a profit subject to income tax. The company relied on ITA 2007 s 64 to support its claim. This section permits a person to claim for ‘trade loss relief’ against other income, provided they carry on a trade in a tax year and make a loss in the trade in the tax year. The company pointed out that HMRC had accepted that the company had carried on a trade during 2010/11 (through the PE in the UK), so it therefore followed that the company was entitled to claim relief for a trading loss against other income.

 

HMRC did not believe a claim for trade loss relief could be made under ITA 2007 s 64, as a proper interpretation of the legislation would not allow a s 64 claim for a loss which, had it been a profit, would have been within the charge to corporation tax. This followed from ITA 2007 s 5, which states that:

 

 

This provision is mirrored in CTA 2009 s 3.

 

The definition of chargeable profits is within CTA 2009 s 19, and includes trading income which arises through or from a PE, as well as income arising from property held by a PE. It makes no mention of losses. In addition, as the company’s profits arose from the rental income, which was not undertaken by a PE, those profits remained within the charge to income tax.

 

The judge did not think that ‘income’ could be read as including losses and, even if it could, CTA 2009 s 19 only refers to ‘income’ and ‘gains’, so a loss could not be within the chargeable profits falling within that section.

 

The judge therefore concluded that, on a literal reading of ITA 2007 s 64, a taxpayer could set off the losses. HMRC’s position appeared to be that a purposive reading was required or that the effect of other provisions meant the loss would be set at nil.

 

 

The first of the other provisions on which HMRC suggested the loss may be reduced to nil is within CTA 2009 s 26. This provides that losses should be calculated on the same basis as profits, but s 26 is excluded by CTA 2009 s 3 and ITA 2007 s 5. HMRC therefore believes that the losses cannot be calculated and must be taken as nil.

 

The judge did not agree with HMRC’s conclusion and concluded that CTA 2009 s 3 and ITA 2007 s 5 merely identify which profits are subject to income or corporation tax, but do not calculate those profits.

 

The second provision that HMRC argued was that there is no basis period for the loss. Section 61(2) of ITA 2007 defines a loss as being:

 

 

HMRC’s point was that the company must show a loss in the trade in the basis period for the tax year, in order to be able to make a claim.

 

The definitions of basis periods are within ITTOIA 2005 Part 2 Chapter 15. Firstly, within ITTOIA 2005 s 197, the accounting date is the date in the tax year to which accounts are drawn up. As accounts were drawn up by the company to 31 March each year, that year to that accounting date would form the basis period under ITTOIA 2005 s 198. HMRC did not agree and sought to rely on ITTOIA 2005 s 18 (in conjunction with the rules within ITTOIA 2005 ss 199 and 202), which deals with companies starting or ceasing to be within the charge to income tax.

 

The judge concluded that this section has no application to the trade carried on by the PE. As the company never started or ceased to be within the charge to income tax, the sections to which HMRC referred do not apply; therefore, the general rule within ITTOIA 2005 s 198(1) applies. The basis period is therefore the 12 months ending on the accounting date; and the losses for that period may be calculated and offset against the trading income.

 

 

Even if the judge had decided against it on the above points, HMRC considered that a purposive reading of the legislation is possible. Any such purposive reading should exclude the loss from ITA 2007 s 64, so no relief would be available. The judge agreed with the company that no purposive reading was possible, as HMRC had failed to suggest an alternative reading of the words. This is supported by Pepper v Hart [1992] STC 898 and Chilcott [2011] STC 456, which both confirmed that a purposive approach was not possible unless the statutory language is reasonably capable of bearing at least two meanings.

 

Even if a purposive approach were possible, the judge could find no obvious reason to conclude that there was no intention to allow a company in these circumstances not to be able to offset a loss from one trade against a profit from another trade, even though one trade may be subject to corporation tax and the other to income tax.

 

When looking at the possibility of claiming the loss against the rental income, and also carrying the loss forward for offset against future profits liable to corporation tax from the same trade, the judge did not believe parliament would have intended this consequence. Any purposive reading of the legislation on this point must therefore conclude either that the taxpayer would be prevented from claiming the same loss twice; or that the company would be prevented from claiming relief against the profits liable to income tax, as it would appear that the loss could be claimed twice. However, as pointed out by the judge, HMRC did not propose an interpretation of ITA 2007 s 64 or the basis period rules that would achieve this purpose.

 

 

In concluding, the judge stated that there was no obvious reason why parliament would have intended taxpayers in similar situations to be unable to set a loss from one trade against a profit from another trade. There was, however, every reason to suppose that it was not intended for any taxpayer to obtain relief twice for the same loss. If a purposive construction were permissible, then it would seem that this could be achieved by a purposive interpretation of ITA 2007 s 63 or the basis period rules. The judge was satisfied, though, that it is not possible to give a purposive interpretation of any of these provisions that would prevent the claim. The appeal was therefore allowed.

 

 

The situation in which English Holdings Ltd found itself is likely to be unusual. It would not be common to find trading activity to be undertaken through a company that also holds property investments. For this reason, the decision may seem to be something that arose from a situation not contemplated by the legislation.

 

In recent years, the courts have taken a more purposive approach to cases. It is therefore encouraging to see a decision where the purposive approach was considered rejected as inappropriate, in favour of a more literal reading of the legislation. Whether this approach will be followed if HMRC takes this decision to appeal may be doubtful. It might, however, encourage practitioners to take a more solid stance when dealing with an HMRC argument on a purposive approach.

 

 

As indicated at the start of this article, the company also appealed against a penalty of £40,608 raised under TMA 1970 s 93. The total penalty consisted of £200 in fixed penalties and a tax geared penalty of £40,408, as the 2009/10 return was filed more than 12 months late. The tax geared penalty was applied at a rate of 20% after maximum reductions for disclosure and cooperation, together with a reduction of one half to reflect the level of seriousness.

 

The judge referred to TMA 1970 s 93(5), which states that: ‘the taxpayer shall be liable to a penalty of an amount not exceeding the liability to tax which would have been so shown’.

 

The tax that would have been shown as due from the 2009/10 return is the full amount of the income tax charge before offsetting the losses. The tribunal therefore concluded that the penalty was correctly charged.

 

The tribunal also considered whether the penalty was reasonable in size or whether the company had a reasonable excuse. Both of these were also rejected.

 

This part of the decision is a useful reminder that tax geared penalties may still be raised where a subsequent claim outside the return would reduce or eliminate a tax charge based on a proper return. Practitioners should not, therefore, assume that a carry back of losses or other claims will automatically result in penalties being cancelled.