Apr 082013

It is well known that during a recession, many businesses are forced to close down due to financial difficulties. While this is bad news for the owners, it can provide attractive buying opportunities, especially if there are trading losses available for which a purchaser is prepared to pay an acceptable price.

Take the example of Ocado, the online grocer. This company was set up in 2002 by a group of former Goldman Sachs bankers and floated on the stock market in 2010. The company has never made a profit and there has been talk about a possible sale. This is not a straightforward matter, as there is a poison pill arrangement in the event of Ocado being taken over. However, there are also reported to be about £100m worth of tax losses in the company – losses that a prospective buyer may well find attractive 1.

But before getting too excited about all this, one needs to bear in mind that there are some major restrictions on how these losses can be utilised.

  • First of all, trading losses are only worth while if there are profits available to set against them – so where are the profits to come from?
  • The ideal solution would be to use the profits from the buyer’s group, especially if the target company has been in difficulties and has no profits of its own. But  under the group relief rules, losses built up in the target company prior to the sale, cannot be surrendered to members of the buyer’s group ;
  • Until recently it might have been possible to get round this by effecting an intra-group transfer of the target’s trade – however, the recent Budget has put paid to that;
  • The only alternative is to use the target company’s own profits – but what if it doesn’t have any? The short answer is that it will simply have to start making money;

In other words, if the buyer is to gain any benefit from the tax losses, it must be sufficiently confident that the target business can recover. This leads to another complication. The buyer will probably wish to make changes to the business in order to effect a turnaround. But if “too many” changes are made, there is a risk that the losses will be lost altogether.

Note that it is essential that the target company’s trade continues to operate if the losses are to be utilised. If the buyer’s intention is to break up the business by selling off the assets, the losses are lost.

We shall assume that the target business is operated by a UK company, which we shall call Tradeco, and the buyer is a UK company, which we shall call P. P has the choice between buying Tradeco’s share capital, or buying the underlying business assets instead. We shall see that whichever route is taken, the same restrictions apply.

So what are the restrictions when P buys Tradeco?

Tradeco will be unable to carry forward its past trading losses in either of the following two situations 2:

  • A major change in the nature or conduct of the trade occurs within any 3 year period that includes the date on which the company was transferred to P 3;
  • The scale of Tradeco’s activities had become small or negligible prior to the sale to P, with no significant revival in the interim 4.

These rules apply whenever a company undergoes a change in ownership. But what does it all mean?

The starting point is that a company can only carry forward its past losses against future profits from the same trade. So once P has acquired Tradeco it can’t simply close down operations and start afresh, and it certainly can’t indulge in any asset stripping. The trade must go on.

But what if P decided to introduce a few alterations, gradually over a period of time, arguing that this is in fact the same trade? It is not always easy to tell when one trade has ended and another one begins – hence the first condition. It is recognised that the new owner will make changes, especially if the objective is to effect a turnaround in the company’s prospects. Accordingly, the legislation permits changes to be made, BUT such changes shouldn’t be significant.

Trading losses major change 4

The second condition has a similar objective. If the company’s activities have become small or negligible, it is as good as dormant. The trading losses aren’t likely to be carried forward, because the company isn’t doing anything likely to generate any future profits. But if after acquiring Tradeco, P were to revive the trade, this begs the question: Is it really the same trade, or a new one altogether?

Note that these restrictions apply only to past trading losses incurred before the company changed hands. Losses arising after the change of ownership can still be carried forward, and even relieved against profits earned elsewhere in the buyer’s group.

Can P avoid these restrictions by buying the assets instead?

The idea is that the rules we have just discussed only apply when there is a change in ownership of the company – this is avoided if P simply buys the underlying business assets. This is also attractive on the grounds that asset sales tend to be cleaner than share sales, as the buyer isn’t taking on the target company’s history – the latter could have all sorts of unwelcome liabilities that are best avoided.

Unfortunately this idea doesn’t work.

If P buys the assets directly from Tradeco, the trading losses are left behind with the seller. It is possible to transfer the losses under an asset sale, but only by indirect means. However, since this involves using a new corporate vehicle, the “major change” rules still apply.


We assume this is a loss making trade. When Newco is sold, it takes the trading losses with it.

The way it works is as follows:

  • Tradeco incorporates a wholly owned subsidiary Newco;
  • Tradeco sells, or hives down the trade to Newco – the consideration can either be left on intercompany loan account, or by issuing new shares;
  • Tradeco then sells Newco to P.

Although there is a company involved, this is substantially an asset sale. Newco is, as the name suggests, brand new, incorporated specifically for the purpose of acquiring the loss making trade before being sold to P. Apart from the trading losses, Newco doesn’t inherit Tradeco’s corporate history.

Newco inherits the losses, on the basis that it was Tradeco’s subsidiary when it acquired the trade 5. These losses are available going forward, provided that there is a reasonable gap between the initial hive down and the share sale 6

Immediately, we can see that there is a problem. The transaction involves the sale of a company, which triggers the “major change” rules. Newco is deemed to stand in Tradeco’s shoes when considering whether the restrictions apply – it isn’t possible to argue that the three year period before the sale should be disregarded on the basis that Newco didn’t exist at this time 7.

Can the restrictions be avoided if Newco transfers the trade intra-group?

Suupose, shortly after acquiring Newco, P arranges for the trade, together with the tax losses, to be transferred to a new subsidiary Q. What is the position if Q were to make major changes? For example:

  • Could Q subsequently buy in assets from other group members – assets that generate sufficient profits to utilise against the losses from the Newco trade?
  • Could Q even buy a profit-making trade from elsewhere in the group, and merge it with Newco’s?8

The argument is that there is no restriction on Q utilising the Newco losses in this way. This is because Q hasn’t changed hands and therefore can’t be subject to the major change rules. The rules  can only apply to the company whose ownership has changed – which is Newco. But since Newco  no longer has the losses,  the restrictions have nothing to bite on.

Trading losses - post acquisition planning

This argument might have worked until the recent changes in the 2013 Budget. It is no longer possible because Newco is now made to stand in Q’s shoes, just as it was made to stand in Tradeco’s 9.

The key question is:

“Can Newco retain its trading losses after being sold to P?”

And to answer this question we need to ask: “What is Newco’s trade?” This is determined by the following exercise:

  • Looking backwards, we pretend that for the previous three years, Newco was carrying on Tradeco’s trade – even though Newco only came into existence shortly before being sold to P;
  • Looking forwards, we pretend that during the following three years, Newco, carries on Q’s trade as well as its own. So if Q starts to introduce a new trade or buy in other income generating assets, we are in trouble. If, as a result of Q’s activities, Newco is deemed to have undergone a major change in its own trade, the Newco losses are lost, not only to Newco, but to Q as well.

So what questions must P ask if it wants to buy the tax losses?

These are questions to be considered during the due diligence exercise.

  • Has Tradeco become dormant, or is it nearly dormant?
  • What has Tradeco been doing in the last three years?
  • What is P intending to do with respect to the business if it buys Tradeco, or a subsidiary such as Newco? Is this likely to be a major change?

Note that it is quite possible that the tax losses are found to be worthless even before P opens the corporate cheque book. For example, the company may in fact be nearly dormant, or the major change may have already taken place. In these circumstances, P – assuming it still wants to buy – needs to make sure that the price is heavily discounted for the tax losses that will be unavailable.

In Part Two

In Part Two we shall look at what actually constitutes a major change in the nature or conduct of the trade, and shall attempt to see how this might affect a possible takeover of online grocer Ocado.

  1. “Ocado’s options hit by Waitrose clause” – Financial Times 24/25 December 2011 page 10.
  2. CTA 2010 s 674(2).
  3. CTA 2010 s 673(2).
  4. CTA 2010 s 673(3).
  5. CTA 2010 ss 941, 942. The losses are available for carry forward, but are capped to the extent that there are no debts left behind in Tradeco – CTA 2010 s 945.
  6. It is important that Newco begins to carry on the business before it is sold to P – otherwise the losses are lost – CTA 2010 ss 940B(2), 941. See also HMRC Manual CTM06210 Barkers of Malton Ltd v HMRC SpC 689. (We shall look at hive-downs in more detail in a later article).
  7. CTA 2010 ss 674(2), 676, 944(3).
  8. This is slightly tricky. The Newco losses can only be carried forward against profits of the Newco trade. For this to work, it must be argued that the Newco trade remains intact following the merger.
  9. New CTA 2010 s 676(4) to be inserted by FB 2013 Cl 32
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Satwaki Chanda

Satwaki Chanda

Satwaki Chanda is a tax lawyer with a First Class degree in Mathematics. Called to the Bar in 1992, he is the Editor of Tax Notes.
Satwaki Chanda

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