Tax losses and anti-avoidance: decoding Inland Revenue’s finalised guidance

By Campbell Rose, Vyshi Hariharan and Lily Li
 

Inland Revenue has recently finalised its guidance on when specific anti-avoidance rules may apply to taxpayers relying on the business continuity test (BCT) to carry forward tax losses. In October 2024, we reviewed the Inland Revenue’s draft guidance and in this article we explore what has changed in the final version.

In 2022 the Inland Revenue published specific guidance on the BCT rules (IS 22/06), however it did not comment in any detail on the anti-avoidance rules. This new guidance is therefore a welcome clarification on when the Inland Revenue considers the anti-avoidance rules could apply, including through a number of examples.

A brief recap of the BCT rules

The BCT rules were announced in 2020 and enacted in 2021, as part of a COVID-19 relief package, and supplemented the shareholder continuity test for loss carry-forward. Under the general BCT, losses are not forfeited when there is a breach in shareholder continuity (49%), provided there is no “major change” in the nature of the loss company’s business activities within five years following the breach; or if there is a major change, provided it is one of four “permitted changes”.

A number of specific anti-avoidance measures were introduced alongside the BCT rules, to prevent the rules being applied in a way that Parliament had not intended. For a detailed explanation of the specific anti-avoidance measures, please refer to our October 2024 article.

Key additional guidance/changes to the draft guidance

• Shifting costs out of the loss company

The specific anti-avoidance rule in s GB 3BAC of the Income Tax Act 2007 (ITA) counteracts an arrangement to remove costs (and so deductions) from a loss company, with the main or sole purpose of tax avoidance. Inland Revenue had previously noted in the draft guidance that “a key consideration in determining whether an arrangement has a sole or main purpose of tax avoidance for the purposes of [this rule] will be the existence or otherwise of intra-group recharges for expenditure shifted out of the loss company and the level of any such recharge”.

In the finalised guidance, Inland Revenue has clarified that this rule only applies to existing costs. If, for example, the loss company received services under an agreement with a member of its previous (pre-ownership change) group and was not charged for those services, then the rule would not be triggered by the absence of a recharge for those services in the new (post-ownership change) group.

Deloitte view: We acknowledge that a recharge may be required to ensure that costs are not inappropriately shifted out of a loss company, and we welcome the clarification that the cost shifting rule is focussed on pre-existing costs. In practice, however, Inland Revenue’s expectation that all expenditure is recharged (to at least recover the service provider’s costs) may be administratively burdensome. It would have been useful to see a de-minimis threshold introduced to exclude clearly immaterial costs from the practical application of this rule. 

IS 25/14 does not comment on how intra-group recharges should be considered in the context of a loss company that is or becomes a member of a consolidated income tax group (noting that intra-group transactions are usually ignored in such a group). We have raised this with Inland Revenue, and understand that the issue has been referred to Inland Revenue’s Policy team for full consideration. Further guidance on this matter would be welcomed.

• Relationship with the general anti-avoidance provision

The draft statement had noted that s BG 1 of the ITA (the general anti-avoidance provision) may also apply to an arrangement that is the same, similar or close to an arrangement covered by the specific anti-avoidance rules.

Inland Revenue has included further commentary on this issue in the guidance, noting that the general anti-avoidance provision may apply to arrangements that avoid tax in a way that is ‘different’ from arrangements caught by the specific anti-avoidance rules. For example, Inland Revenue indicates that even if parties are not ‘associated’ (under black letter law) when entering into an arrangement (a requirement under the cost-shifting and income-injection specific anti-avoidance rules), the general anti-avoidance provision may apply. 

Deloitte view: The passing reference to a single potential s BG 1 scenario, without further examples or commentary on the features that may cause s BG 1 to be invoked, creates uncertainty. Ideally Inland Revenue would publish an item (perhaps a “Question We’ve Been Asked”) in this regard; or taxpayers seeking valuable certainty could engage with Inland Revenue through applying for a private binding ruling. 

• Understanding Parliament’s purpose

The guidance includes further commentary on understanding Parliament’s purpose for specific provisions used or circumvented by an arrangement (being the carry-forward and grouping/commonality rules). In doing so, the guidance references the Minster of Revenue’s statements in August 1991, when the loss carry-forward and grouping rules were first introduced. 

Deloitte view: Despite the BCT rules including a purpose provision and specific anti-avoidance measures, Inland Revenue clearly considers they may also look to material published decades ago – when the broader loss carry forward and grouping rules were introduced - when determining whether a sole or main purpose of tax avoidance exists. As noted above, obtaining a private binding ruling would provide valuable certainty where post-merger integration and synergy-related arrangements are being considered in a transaction context.

• Artificiality and contrivance

Example 7 in the draft guidance discussed an arrangement involving the injection of income into a loss company relying on the BCT rules, and whether tax avoidance is the sole or main purpose of the arrangement. The finalised guidance expands on certain additional facts and commentary in this example.

Deloitte view: The finalised example indicates that, in Inland Revenue’s eyes, the bar for artificiality and contrivance - which in turn indicates that tax avoidance could be the main purpose - is not high. 

Deloitte’s overall view 

Inland Revenue’s finalised guidance on the specific anti-avoidance rules is welcomed. However, some areas are still not addressed (e.g. recharges within a consolidated group); and in some cases the guidance gives rise to uncertainty (e.g. the reference to the general anti-avoidance provision with limited practical guidance on its scope for application).

Businesses should implement appropriate tax governance and control frameworks (with real time documentation) when applying the BCT rules. 

Please contact your usual Deloitte advisor if you would like to discuss this further or are relying on the BCT rules to carry forward tax losses. In a transaction setting, we recommend undertaking the BCT and specific anti-avoidance analysis early, to avoid unwelcome surprises post-completion; and also to identify whether a binding ruling application could be warranted to achieve a greater degree of certainty.