In more detail
Recently, there has been a noticeable shift in approach from auditors. Some now consider that the surrender of tax losses within a UK group for no consideration – or for consideration that is less than the fair value of those assets - amounts to an unlawful distribution by the surrendering company if that company does not have sufficient distributable reserves.
To make a valid distribution, a company must have enough distributable reserves to cover the book value of the non-cash asset (such as tax losses) being distributed. If a company attempts to make a distribution when it does not have those reserves, the distribution is unlawful and, broadly, must be unwound before the company’s annual accounts can be approved. The steps required to remedy an unlawful distribution depend on the specific facts, including the amount of the company’s distributable reserves at the time of the distribution and, in the case of a surrender of tax losses, whether the losses appeared on the balance sheet of the surrendering company at that time.
One perspective is that, if the tax losses are not recorded on the balance sheet of the surrendering company (and the company is not required to record them on it under applicable accounting standards), the risk of a surrender being treated as an unlawful distribution is reduced. However, auditors may still challenge this conclusion, arguing that tax losses have value to the group even if their carrying value is nil. In those cases, it is advisable to treat a proposed surrender of losses as a distribution and ensure that the distributing company either:
- Receives a capital injection to ensure it has sufficient distributable reserves to cover the book value of the tax losses
- Avoids the application of the rules on distributions by structuring the surrender as a sale under which the recipient parent pays to the surrendering company consideration equal to the surrender value of the tax losses
Given the increased scrutiny at audit, groups should review the past group relief position and the reserves position of any UK companies that have surrendered losses. Looking ahead, groups that do not currently charge for the surrender of tax losses may wish to consider implementing such a policy to mitigate risk. Formalising arrangements through group relief payment agreements can also help to provide clarity and ensure compliance.
If you have any questions about how these developments could affect your group, or would like to discuss practical steps and solutions, please contact us or your usual Baker McKenzie advisor.
