How can companies make better use of carried forward trade losses? A recent Tribunal decision could be a game-changer.
Once in a while a case comes along that has the potential to be a game-changer in an area of law that we probably thought was settled. The case of Leekes Ltd v HMRC, heard at the First-tier Tribunal earlier this year, might be such a case. What makes it even more interesting is that it concerns a common scenario, namely the hive-up of a trade from a newly acquired subsidiary into its parent company. The case considers what happens to carried forward trading losses when a trade is transferred between two companies. The decision given by the First-tier Tribunal is not strictly a precedent, as decisions at this lower level court do not have that status; however the result is very much in the tax payer’s favour, contradicting long-established practice set out in HMRC published guidance.
Leekes carried on a trade running out of town department stores, selling furniture and home goods. It acquired another company, Coles, which also ran furniture stores. Coles and Leekes had a wide range of common brands and suppliers in the furniture sector and shared similar demographics in terms of customer base. On acquisition, Coles had accumulated carried forward trading losses of £2m. Immediately post acquisition, the trade of Coles was transferred in its entirety into Leekes and was subsumed within that business. Coles’ stores were rebranded as Leekes and continued to trade with the same staff selling substantially the same types of products to the same customers.
Leekes filed its post hive-up tax return on the basis that the losses brought in from Coles could be relieved against the profits of the combined trade. This is contrary to the well-established practice of streaming, whereby in this case profits of a hypothetical separate post-hive up Coles trade would be identified, usually based on just and reasonable estimates, such that the utilisation of losses is restricted to the Coles trade profits only. Although HMRC protested, the tribunal sided with Leekes, allowing offset of Coles’ losses against the entire trading profits.
Leekes’ interpretation was based on applying a fresh reading of the detailed and complex legislation to the facts, rather than following the common interpretation. The tribunal’s analysis is interesting though, because it focusses in on the commercial reality, especially after the hive-up when for all practical and commercial purposes there was one combined trade as a question of fact. The old Coles trade did not exist separately, so to require the Coles-only profits to be identified was a fiction, even if they may have been relatively easily derived due to the stores being separate. The judgement also made it clear that the whole Coles loss would be available to Leekes going forward.
Companies that have previously streamed profits against losses from a predecessor trade may wish to revisit their computations as the Leekes decision may provide an opportunity for a more favourable use of losses. Care should be taken though, as any case-law based filing position will attract HMRC scrutiny and the judgement may be overturned when HMRC’s appeal is heard at the Upper Tribunal.
If you require further information on this judgment, please contact Rebecca Reading or your usual RSM adviser.