United Kingdom: We need to talk about the UK's loss relief restriction

In brief

The coronavirus pandemic is the first real test of the UK's loss relief restriction. Its operation coupled with the instalment regime for 'very large' companies and the timing of a vaccine induced recovery could lead to groups suffering cash outflows at a crucial moment.

The solution to this problem is straightforward - the Chancellor should use his budget on 3 March to announce the unrestricted use of 'Coronavirus losses', i.e. losses incurred during the pandemic. This should ensure that groups only pay corporation tax once they have made good the losses imposed by the crisis, thereby providing a stable foundation for business to fund the recovery.


Key takeaways 

  • The UK's loss relief restriction broadly only allows 50% of current year profits to be offset by brought forward losses.

  • Groups expecting a vaccine induced recovery to return them to profitability in 2021 will have to pay corporation tax because of the operation of the loss relief restriction, even if their 2020 losses dwarf their anticipated profits in 2021.

  • Under the quarterly instalment regime for 'very large' companies, companies with December year-ends will be required to pay their first instalment of corporation tax on their 2021 profits on 14 March.

  • Groups may therefore have to pay corporation tax on 14 March on profits they hope to earn later in the year - creating a cash flow crunch at a crucial moment.

  • A simple solution is to allow the unrestricted use of losses incurred during the coronavirus pandemic. The Chancellor should use his budget on 3 March to avoid imposing a cash flow crunch on businesses on 14 March. 

Background

Loss relief restriction: announced in a bygone era

In the spring of 2016, the Chancellor at that time, George Osborne, revealed in his annual budget a road map for business taxation. Amongst other things, that plan included a further reduction in the rate of corporation tax to 17% by 2020, alongside a reform of loss relief rules and implementation of many of the recommendations made in the BEPS Action Reports released in late 2015.

By the summer of that year, Osborne was out of No. 11 Downing Street with the UK facing a significant period of politically uncertainty as it sought to negotiate its exit from the EU. Fast forward to 2021: the UK is now on its third Chancellor since Osborne; is no longer a member state of the EU; and, like the rest of the world, is facing unprecedented fiscal challenges as it seeks to recover from a painful and tragic public health crisis.

The reduction to 17% never materialised. The Government scrapped the planned reduction at Budget 2020 having included the reversal as part of the costing of its 2019 Manifesto. Indeed, there is an increasing probability that 2021 will see a rise in the corporation tax rate from its current level of 19%.

Likewise, the BEPS Action Reports of 2015 look increasingly likely to be supplemented by further reform to the international tax system in the form of the Pillar One and Two Blueprints.

However, one thing remains as envisaged in Osborne's 2016 road map - the loss relief restriction.

The Coronavirus pandemic - the loss relief restriction's first crisis

The theory behind loss relief is simple: companies pay corporation tax on their profits. The division of a company's activities into accounting periods provides opportunity to administer and govern the affairs of a company (as well as to tax it), but creates an artificial separation of what are continued activities. Allowing losses incurred in one period to be offset against profits generated in later periods therefore ensures a company is subject to tax on its true profits, not a perception of profit based on arbitrary dividing lines.

The loss relief restriction distorts that position by ensuring companies continue to pay UK corporation tax when making good earlier incurred losses if their UK taxable profits exceed £5m (calculated on a group basis).

The Coronavirus pandemic will be the first crisis to test the operation of the loss relief restriction and in some respects represents the perfect storm. Many companies will have experienced a painful 2020 as large swathes of the economy was forced to shut down in order to protect public health. Many of those restrictions remain, but businesses' ability to adapt, coupled with the remarkable efforts of the Government vaccine rollout, allow for the prospect of a recovery during 2021. The hope is that a fully vaccinated UK will deliver robust domestic demand later in the year. 

Businesses will be eager to facilitate and capitalise on a summer of recovery but some may face a bill for advance payment of taxes as result.

Advanced payment of tax on an uncertain recovery

For periods ending on or after 1 April 2019, companies that are part of a large group must make the first instalment of their anticipated corporation tax liability for the period by the 14th day of the third month of that period.

Many groups adopt a calendar year end for accounting purposes and so the year ended 31 December 2020 will have been the first time this came into effect - when the vast majority would have been loss making and therefore had no corporation tax to pay.

For those groups who envisage that a vaccine induced recovery can return them to profitability in 2021, the operation of the loss relief restriction will require them to pay corporation tax on those profits, even if their returns for 2021 are dwarfed by their 2020 losses. Moreover, the new quarterly instalment regime for 'very large' companies requires an instalment of that corporation tax due on 14 March for companies with a December year-end.

This will result in companies suffering cash outflows at a crucial moment.

A simple solution: unrestricted use of 'Coronavirus losses'

The Government has delivered unprecedented support to the economy to help it navigate the crisis, but now is not the time to burden recovering businesses - particularly if they will be funding the recovery with an increased corporation tax rate.

Absent a more fundamental reform to the operation of the loss relief restriction, a straightforward solution is the unrestricted use of losses incurred during the Coronavirus pandemic. This would ensure that only once business have recovered the costs of the pandemic, would they begin paying corporation tax again.

We would recommend the Chancellor use his budget on 3 March to announce this change to avoid businesses having to pay tax on profits they have not yet earned on 14 March.


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