Revenue & Customs Brief 18/07

Tackling Avoidance – Individuals in Partnership – Restriction of Loss Relief

Overview

  1. Trading losses arising to an individual can be set against their other income and capital gains. This includes an individual who carries on a trade in partnership. These reliefs are generally known as “sideways loss reliefs”.
  2. Currently, the amount of trading losses for a tax year for which a non-active partner can claim sideways loss relief is restricted broadly to the amount of capital that the partner has contributed to the partnership. The Government proposes to introduce new legislation to exclude certain capital contributions from this amount. The capital contributions to be excluded will be those paid by non-active partners on or after 2 March 2007 where the main purpose, or one of the main purposes, for contributing the capital to the partnership is for the partner to have access to losses for which sideways loss relief can be claimed.
  3. The Government also proposes to introduce an annual limit on the amount of trading losses for a tax year for which an individual who is a non-active partner in a partnership can claim sideways loss reliefs. The new limit will apply to trading losses sustained as a non-active partner on or after 2 March 2007.
  4. The limit for each tax year, for trading losses from all partnerships in which the individual was a non-active partner for that year, will be the lower of:
  • £25,000; or
  • The amount of trading losses for the tax year for which the individual would otherwise be able to claim sideways loss reliefs.
  1. A non-active partner for these purposes will be a limited partner or any other partner who spends an average of less than 10 hours a week personally engaged in carrying on the partnership’s trading activities.
  2. A trading loss for which sideways loss relief is not available can be carried forward and set against the individual’s share of the partnership’s trading profits for future tax years.
  3. The new limit will not apply to losses from carrying on a profession or a Lloyd’s underwriting business.
  4. All references in this note to a partnership include a limited liability partnership (LLP), and all references to a partner include a member of a LLP.

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Background

  1. Individuals who carry on a trade (on their own or in partnership) can set off their losses, or their share of these losses, against their other income under sections 380 and 381 Income and Corporation Taxes Act 1988 (ICTA 1988) or against their chargeable gains under section 72 Finance Act 1991. These are commonly known as “sideways loss reliefs”.
  2. A partner’s share of the profits or losses from a trade carried on in partnership is determined by the rights and liabilities of the partners under the profit and loss sharing arrangements agreed by the partners for the period to which the profits or losses relate.
  3. The extent to which some partners can claim sideways loss relief for their share of trading losses is restricted, broadly to the amount of capital that the partner has contributed to the partnership (sections 117, 118ZB and 118ZE ICTA 1988). Partners subject to these restrictions are limited partners, members of a limited liability partnership and other partners who on average spend less than 10 hours per week actively carrying on the trade.
  4. Non-active partners in a partnership carrying on a trade of exploiting films can only set their losses against profits from the same trade if there is an agreement in existence that guarantees the partner an amount of income (section 118ZL ICTA 1988).
  5. For tax year 2007-08 and later years the provisions in ICTA 1988 and FA 1991 referred to above are rewritten by the Income Tax Act (ITA) 2007.

Details of the proposed legislation

  1. Under the changes announced today additional restrictions will apply to the amounts that a relevant partner may claim as relief for trading losses under:
  • section 380 ICTA 1988 – relief for trading losses against general income of the same or preceding tax year
  • section 381 ICTA 1988 – relief for trading losses incurred in the early years of trade
  • section 72 Finance Act 1991 – trading losses relieved against capital gains.

These are referred to in this note as “sideways loss reliefs”.

  1. There will be two changes affecting the amount of trading losses for a tax year for which a relevant partner can claim sideways loss relief:
  • A ‘purpose test’ for capital contributions by a relevant partner to a partnership when applying the existing restrictions based on capital contributed in sections 117, 118ZB and 118ZE ICTA 1988.
  • An annual limit of £25,000 (or, if lower, the amount of trading losses for that tax year for which the relevant partner can claim sideways loss relief after applying existing restrictions in sections 117, 118ZB, 118ZE and 118ZL ICTA 1988).

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Partners affected

  1. A relevant partner for this purpose will be an individual who, on or after 2 March 2007:
  • Carries on a trade as a partner in a partnership at any time during the tax year; and
  • Is a limited partner, or any other partner who does not devote a significant amount of time to the trade in the relevant period for the tax year.

These are referred to in this note as “non-active partners”.

  1. For this purpose:
  • an individual does not devote a significant amount of time to a trade in the relevant period for a tax year if, in that period, the individual spends an average of less than 10 hours a week personally engaged in activities carried on for the purposes of the trade
  • the relevant period means the partner’s basis period for the tax year, unless the basis period is shorter than 6 months
  • if the partner’s basis period for a tax year is shorter than 6 months because the tax year is the first year of trading, the relevant period is the period of 6 months beginning with the date on which the individual first started to carry on the partnership trade
  • if the partner’s basis period for a tax year is shorter than 6 months because the tax year is the last year of trading, the relevant period is the period of 6 months ending with the date on which the individual permanently ceased to carry on the trade (if the basis period ends with that date).

The purpose test

  1. A relevant partner’s contribution of capital to the partnership for the purpose of applying restrictions in sections 117, 118ZB and 118ZE ICTA 1988 will exclude any amount of capital paid by the partner to the partnership where the main purpose, or one of the main purposes, for contributing the capital to the partnership is to obtain a reduction in tax liability by means of sideways loss relief.
  2. The ‘purpose’ test will apply to all contributions of capital paid by a relevant partner to a partnership on or after 2 March 2007, except those paid under a relevant pre-existing obligation. A relevant pre-existing obligation for this purpose is an obligation in a contract made before 2 March 2007 where the obligation cannot be varied or extinguished by the exercise of a right conferred on the individual (whether or not under the contract).

The annual limit

  1. The limit on the amount of trading losses for a tax year for which sideways loss relief can be claimed by an individual who is a relevant partner will be the lower of:
  • £25,000; or
  • the amount of trading losses for that tax year for which the relevant partner can claim sideways loss relief after applying restrictions based on capital contributed in sections 117, 118ZB and 118ZE ICTA 1988.
  1. Under the proposed legislation the Treasury will be given powers to amend the amount of the annual limit. This will allow the amount of the limit to be kept under review to ensure that it strikes the right balance.
  2. The annual limit will apply to the aggregate of all trading losses for a tax year from all partnerships in which the individual was a relevant partner for that tax year.
  3. The annual limit will only apply to trading losses sustained by a relevant partner on or after 2 March 2007.
  4. The annual limit will therefore apply to a relevant partner’s share of:
  • all trading losses from any partnership of which they are a relevant partner for a tax year for which their basis period starts on or after 2 March 2007; and
  • trading losses sustained on or after 2 March 2007 from any partnership of which they are a relevant partner for a tax year for which their basis period starts before and includes (straddles) 2 March 2007.
  1. The annual limit will not apply to losses from a trade which consists of the underwriting business of a member of Lloyd’s (within the meaning of section 183 Finance Act 1993).

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Tax years where partner’s basis period straddles 2 March 2007

  1. Losses sustained on or after 2 March 2007 for a partner’s basis period that straddles 2 March 2007 are the losses for that basis period less any “pre-announcement losses”.
  2. For this purpose “pre-announcement losses” are:
  • Any part of the trading losses for the basis period as is derived from a capital allowance or relevant film-related expenditure deducted under Part 2 Chapter 9 ITTOIA 2005, where the expenditure giving rise to these specific statutory reliefs was paid before 2 March 2007, or was paid on or after 2 March 2007 in meeting a relevant unconditional obligation to pay, and
  • The relevant proportion of any part of the trading losses for the basis period not derived from a capital allowance or relevant film-related expenditure.
  1. A relevant unconditional obligation to pay is one where the relevant expenditure was incurred pursuant to an unconditional obligation in a contract made before 2 March 2007 where the obligation may not be varied or extinguished by the exercise of any right conferred on the partnership (whether or not under the contract).
  2. The relevant proportion of any part of the trading losses for the basis period not derived from a capital allowance or relevant film-related expenditure depends on when (during or before the start of the basis period which straddles 2 March 2007) the relevant partner first paid a capital contribution to the partnership.
  3. If the relevant partner first paid a capital contribution to the partnership on or before the first day of their basis period which straddles 2 March 2007, the relevant proportion is calculated by reference to:

The number of days in the basis period which fall before 2 March 2007

divided by

The total number of days in the basis period.

  1. If the relevant partner’s first capital contribution to the partnership is paid after the start of their basis period which straddles 2 March 2007, but before 2 March 2007, the relevant proportion is calculated by reference to:

Number of days on or after date contribution paid which fall before 2 March 2007

divided by

The total number of days in the basis period.

  1. If the relevant partner’s first capital contribution to the partnership is paid on or after 2 March 2007, the losses for the basis period not derived from a capital allowance or relevant film-related expenditure will not be “pre-announcement losses”.

Sideways loss relief otherwise due for losses sustained on or after 2 March 2007

  1. Where the relevant partner’s basis period for a tax year straddles 2 March 2007 the annual limit of £25,000 applies to sideways loss relief which could otherwise be claimed for that year for losses sustained on or after 2 March 2007.
  2. For this purpose the sideways loss relief which could otherwise be claimed for that tax year for losses sustained on or after 2 March 2007 is:
  • The amount of losses for the whole of the relevant partner’s basis period for which sideways loss relief could otherwise be claimed; less
  • The amount of any “pre-announcement losses”.

Contacts

Questions about or comments on this note can be addressed to:

Technical issues:

Linda Grant
CT & VAT Products & Processes
Trading & Property Income
3rd Floor
100 Parliament Street
London SW1A 2BQ

Tel: 020 7147 2628

Email: Linda Grant

Other issues:

Mark Anderson
CT & VAT Products & Processes
Trading & Property Income
3rd Floor
100 Parliament Street
London SW1A 2BQ

Tel: 020 7147 2621

Email: Mark Anderson

Issued 3 March 2007

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