HMRC calls a halt to transfer of "latent" capital allowances

By Justin Lyon Taylor

On 21 July 2009, HMRC issued a technical note to prevent tax avoidance schemes involving capital allowances on plant and machinery. This will apply where an entitlement to claim capital allowances is transferred and the main purpose of the transfer is to access capital allowances where the tax written down value of the plant and machinery exceeds its balance sheet value. These are referred to as "latent" capital allowances.

The proposed legislation will be introduced in the 2010 Finance Bill and the draft legislation is expected to be released shortly. It applies to the sale of companies and to changes in consortium structure and partnerships that take place on or after 21 July 2009.

The aim of this anti-avoidance measure is to prevent transactions where one of the primary purposes is for the purchaser to access the allowances held in the disposed company. It will also apply to consortia and partnerships where there are changes, such as to profit sharing arrangements or the change in ownership of consortia, for which a main purpose is to access the allowances.

HMRC has become increasingly aware of tax groups seeking to acquire companies with large pools of unclaimed capital allowances with the sole intention of utilising the allowances. In these circumstances, the price paid for the company is likely to reflect the balance sheet value of the plant and machinery, rather than the tax written down value. Once the company is acquired, there is often no intention for that company to continue trading and the allowances are offset against group profits. To counteract these types of transactions, new “streaming” anti-avoidance rules have been introduced to ensure the allowances remain in the original company.

A typical example of this type of avoidance could be where a group acquires a company that carries on a trade of leasing. If the company has disclaimed capital allowances, there could be latent capital allowances available. Following the acquisition, as the company is now a member of the group, the capital allowances would be available to the wider group. However, the value of the net assets in the company are likely to be far lower than the value of the allowances and the consideration paid for the acquisition would be unlikely to take into account the value of the allowances. Therefore, the group is gaining the benefit of the allowances at a fraction of their actual worth to the group.

For the new anti-avoidance measure to apply, a series of conditions must be met:

• there is a change in ownership of a company, or a change in consortia or partnerships involving companies;
• the company has latent capital allowances; and
• the changes take place as part of arrangements that have a tax avoidance purpose.

This last criteria will be the most likely to be disputed and the technical note advises that “the purpose of the arrangements will be determined by reference to all the relevant circumstances of the change of ownership and is a fact based test”. If HMRC believes that the benefit of the latent allowances is one of the primary reasons for the transaction, then the anti-avoidance legislation will be triggered. If, however, the company is acquired with a view to carrying on the trade as a going concern and the latent capital allowances are an incidental part of the transaction, then this will not trigger the anti-avoidance.

Where the three above conditions are satisfied, any writing down allowances or balancing allowances originating from the latent capital allowances will not be available to reduce profits of the new tax group. They will instead be “streamed” and only available to set against profits that would have been eligible had the arrangement not been entered into. As the note says, the allowances can be “set against profits of the trade of the company as it was carried on at the time it was acquired”. Therefore, this prevents a trade or other business being merely transferred into the company to access the allowances.

We await the published draft legislation, but in the meantime, the HMRC technical note is sure to have an impact on some tax groups' planning strategy and suggests HMRC will be taking a keen interest in transfers involving latent capital allowances.

Justin Lyon Taylor
www.bournebc.com

Justin is a consultant at Bourne Business Consulting LLP. He specialises in asset taxation advising clients in the retail, real estate, utility and leisure and hospitality sectors.