Taxation Practitioner by Mark McLaughlin ATII TEPA 'major change in the nature or conduct of the trade' can result in the application of certain anti-avoidance provisions. But what is a 'major change', and what are the tax implications?
(Major change in the nature or conduct of a trade)
'If tax legislation was a colour, it would have to be grey', commented a rather bemused client. As a chartered tax adviser, I could certainly relate to that analogy - and sympathize with his sentiments! The client in question was contemplating the acquisition of shares in a trading company with losses brought forward. I had just finished outlining how the anti-avoidance provisions concerning a 'major change in the nature or conduct of a trade or business' applied to changes in company ownership. In addition to highlighting the tax implications of a "major change", this article briefly considers related topics, such as the commencement and discontinuance of a trade (all references are to TA 1988 unless otherwise stated).
The tax implications
A 'major change in the nature or conduct of a trade or business' is an event that can have serious implications where any of the following corporation tax anti-avoidance provisions are deemed to apply.
Section 768 - Change in ownership of company: disallowance of trading lossesThis section prevents a trading loss incurred in an accounting period beginning before a change in company ownership from being carried forward under s 393(1) and set against trading income of an accounting period ending after the change. One of the instances in which loss relief is denied is:
'if, within any period of three years there is both a change in ownership of the company and... a major change in the nature or conduct of a trade'.
The rules governing a change in ownership are contained in s 769. Broadly, such a change takes place where one or more persons acquire more than half the ordinary share capital of the company, with each person holding at least 5 per cent.
Section 768AThis section prevents a trading loss incurred in an accounting period following a change in ownership from being carried back under s 393A(1) and set against profits of an accounting period before the change in ownership. In the context of a 'major change', the same criteria applies as for the s 768 loss restriction.
Section 768BThis section prevents excess management expenses, charges on income and debits on loan relationships of investment companies incurred in an accounting period before a change in ownership from being carried forward and deducted against corporation tax profits of an accounting period following the change.
Note that the relevant period for a major change here is six years, commencing three years before and ending three years after the change in ownership (s 768B(1)(b)). For these purposes, a 'major change in the nature or conduct of a business' includes a major change in the nature of investments held by the company.
Section 768DThis section applies from 1 April 1998, and prevents a Schedule A loss from being carried forward under s 392A(2) and set against corporation tax profits following a change in ownership, under the circumstances mentioned in s 768B(1)(b) above.
Section 767AThis section prevents the use of company purchase schemes to avoid payment of corporation tax, by enabling the Revenue to collect unpaid tax from persons who previously controlled the company. The relevant period for a change in the nature or conduct of the trade or business is six years, being three years either side of the change in ownership.
Section 245This section prevents the carry-forward or carry-back of ACT through an accounting period in which a change in ownership has taken place, in circumstances including those in which a major change in the nature or conduct of the trade or business has taken place within a three-year period.
Section 245AThis section prevents ACT surrendered by a parent company to its subsidiary in an accounting period before a change in ownership from being carried forward and set against a corporation tax liability arising after the change. The relevant period for a change in the nature or conduct of the trade or business is six years, being three years either side of the change in ownership.
Note that the provisions of sections 245 and 245A cease to apply in relation to changes in ownership occurring after 5 April 1999.
TCGA 1992 Sch 7AThis schedule restricts the offset of pre-entry capital losses when a company joins a group, and specifies the gains from which pre-entry losses are deductible. Schedule 7A(8) applies where a major change in the nature or conduct of a trade occurs three years either side of a change in ownership, by effectively disregarding the pre-entry trade. This means that a pre-entry capital loss cannot be offset against a post-entry gain, if the asset in question was used in a trade in which a major change has occurred.
What is a 'major change'?
The legislation briefly defines a 'major change in the nature or conduct of a trade or business' as including (s 768(4)):-
a) a major change in the type of property dealt in, or services or facilities provided, in the trade; or
b) a major change in customers, outlets and markets of the trade'
This interpretation is extended in appropriate circumstances by s 245(4), to include:
c) a change whereby the company ceases to be a trading company and becomes an investment company or vice versa; or
d) where the company is an investment company, a major change in the nature of the investments held by the investment company.
In deciding whether a 'major change' has taken place, the conditions applying at any two points in the relevant three (or six) year periods specified in the legislation may be compared. This applies even if there is a change resulting from a gradual process that began outside those time limits.
Further guidance is provided in the following tax cases:
- In Willis v Peeters Picture Frames Ltd ( STC 453), a loss-making company manufacturing and selling picture frames and mouldings was taken over by the parent of a group of companies operating in that field. Following the change in ownership, the loss-making company continued manufacturing, but changed its selling methods from mainly wholesale on the open market to wholesale among group distribution companies. The Court of Appeal held that this did not constitute a significant change in the nature or conduct of the company's trade.
- In Purchase (Insp of Taxes) v Tesco Stores Ltd  STC 304, the Court held that the word 'major' meant something more than 'significant', but less than 'fundamental'.
Statement of Practice 10/91
Specific guidance on the Revenue's interpretation of a 'major change' is provided in SP 10/91 'Corporation tax: major change in the nature or conduct of the trade or business'. The extent of changes such as in business premises, the identity of the company's suppliers, management or staff, the company's methods of manufacture or the company's pricing or purchase policies are all potential factors to be taken into consideration. A major change in one factor may be decisive. The statement considers situations in which the transfer of the whole or part of a business may itself constitute a major change.
A change will not generally be regarded as 'major' which:
- increases efficiency;
- is designed to keep pace with developing technology;
- is not a major change in the type of property dealt in;
- rationalises a product range without a major change in the type of property dealt in; or
- is not a change in the nature of investments held.
Examples where a major change would be regarded as occurring include:
- a saloon car dealership switching to tractors;
- a public house converting to a discotheque;
- a company that fattens pigs switching to buying pigs for fattening and resale; and
- a company investing in quoted shares switching to investing in property for rent.
Commencement of a trade
The commencement of trading by a company is one of several events that can trigger a corporation tax 'accounting period' (s 12(2)-(4)). This is significant because the end of an accounting period determines both the nine-month corporation tax payment period, and the start of time limits for many claims and elections. For example, pre-trading expenditure in the seven years prior to commencement is treated as having been incurred on the date that trading commences (s 401), where an election is made within 2 years from the end of the accounting period. Similar provisions apply in respect of pre-trading capital expenditure and certain interest payments.
Discontinuance of a trade
Where a company ceases to trade, the company's income is generally computed as though the trade had discontinued, even if the trade itself is being continued; the company continuing the trade is deemed to be commencing a new trade (s 337(1)). On a change in ownership to which the anti-avoidance legislation mentioned above applies, there are provisions to treat an accounting period which overlaps the date of change as comprising separate accounting periods (see for example 768(2)).
Specific legislation relevant to the discontinuance of a trade include (CT 160)-
- s 100 - Valuation of trading stock at discontinuance of trade;
- s 89 - Debts proving irrecoverable after event treated as discontinuance; and
- ss 103-110 - Receipts and losses after discontinuance
Relief for 'terminal losses' is available if a company ceases to trade (s 393A(2A-B). Trading losses and unrelieved trade charges incurred in the 12 months prior to cessation may be carried back up to 3 years against the company's total profits.
A major change in an existing trade can adversely affect the availability of trading losses, even without a change in ownership. Companies can carry forward trading losses against profits of the same trade in succeeding accounting periods (s 393(1). It is therefore important that any changes to the existing trade (eg a part-disposal of the trade, or any alterations in trading activities) do not trigger a cessation of the old trade, and commencement of a new one (see Rolls Royce Motors Ltd v Bamford  STC 162). However, where all or part of the same trade is transferred to a company under the same (ie 75% beneficial) ownership, the trade will be deemed to continue for the purposes of carrying forward a trading loss (s 343).