BIM75750 - Trading losses: restriction of relief: first year allowances: background

From the 1970s up until 1984 first year allowances (FYAs) at the 100% rate were generally available on plant and machinery. Schemes were designed to take advantage of this by letting an individual set FYAs against his or her other income without being taxed on the associated income or balancing charges.

One scheme involved FYAs on leased plant and machinery. Other schemes involved other types of activity.

This is how the first scheme worked. An individual liable to higher rate tax would go into partnership with a company and perhaps another individual to carry on a trade of leasing plant and machinery. The individual liable to higher rate tax would provide most of the partnership capital. The profit sharing (and loss) sharing ratios were based on the capital contributions. This meant that that individual got most of the FYAs.

Once the FYAs had been obtained the person liable to higher rate tax then left the partnership. When he or she left, a continuation election was made and the company and the other individual (if there was one) were left to pay tax on the leasing income and any balancing charges. Continuation elections are no longer needed in cases like that because of ICTA88/S113 (2). Where there is a partnership change ICTA88/S113 (2) treats the trade as continuing provided that the old and the new partnership have at least one member in common.

Sometimes the partnership’s leasing of plant and machinery did not amount to a trade. The legislation also applies in a case like that.

Since nowadays FYAs are not normally available on plant that is leased you are unlikely to see a case where this applies.

Other schemes involved a claim for higher rate tax relief on FYAs followed by a change in arrangements so that higher rate tax is not payable on the related income or on any balancing charges when the plant is disposed of.

Example

Bob has a lot of investment income and is liable to higher rate tax. He goes into partnership on 1 January 2003 with Jim, who has no other income. The partnership trades as fencing manufacturers. It is agreed that the first accounts will be drawn up to 5 April 2003 and that the partnership profit sharing ratios for that period will be Bob 95%: Jim 5%. After that they will be Bob 10%: Jim 90%.

In the period 1 January 2003 to 5 April 2003 the partnership spends £2 million on plant and machinery that is information and communications technology and qualifies for FYAs at the 100% rate. It claims the FYAs. Its expenses match its income and so there is a loss of £2 million created by the capital allowances for that period allocated in accordance with the profit sharing ratios. Bob’s share of the loss is £1.9 million and he sets that against his investment income. Profits in future will be shared Bob 10% : Jim 90% and so Bob will not pay much higher rate tax on future income.

Examples of changes in arrangements are:

• a change in the persons carrying on the qualifying activity,
• a change in the partners’ profit sharing ratios,
• the transfer of the qualifying activity to a connected company,
• the transfer of an asset on which capital allowances had been given to a connected company, or
• the transfer of an asset on which capital allowances had been given to an unconnected person at less than market value.

Legislation was introduced in 1976 to deal with schemes like these. It is now in ICTA88/S384A. You are unlikely to have a case where the legislation in ICTA88/S384A applies because it seems to have had the desired deterrent effect.

For details of the action of the legislation see BIM75755.