Apr 102013

In Part One, we saw how a company with tax losses can be prevented from claiming tax relief following a takeover. In particular, the carry forward of past trading losses is disallowed if there have been “major changes in the nature and conduct” of the company’s trade.

In this article, we shall take a closer look on what this phrase actually means.

But first a recap

As in Part One, we shall call the company with the tax losses Tradeco, which is to be sold to a corporate buyer called P. The losses accrued  prior to the sale cannot be carried forward in either of the following two situations1:

  • A major change in the nature or conduct of the trade occurs within any 3 year period that includes the date on which Tradeco was transferred to P2;
  • The scale of Tradeco’s activities had become small or negligible prior to being acquired by P, with no significant revival in the interim3 – in other words, the company is effectively dormant.

Recall that trading losses can only be carried forward against profits from the same trade. The major change rules are directed against changes that are so radical that after they have been made, the original trade can no longer be easily identified. In short, the original trade has effectively come to an end and a new one has taken its place. In these circumstances, the effect of carrying forward past trading losses would be to set off losses of one trade against the profits of another.

Trading losses major change 4

The second condition has a similar objective. If the company’s activities had become small or negligible, it is as good as dormant. The trading losses aren’t likely to be carried forward, because it 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?

A closer look at “a major change in the nature and conduct of the trade”

How does P ensure that the trading losses are preserved? The safest course would be to make no changes until at least three years have passed, but this isn’t realistic. Thankfully, HMRC has issued some guidance – hooray!

First of all, the legislation states that a major change includes4:

  • A major change in the type of property dealt in or services or facilities provided in the trade; and
  • A major change in customers, outlets or markets of the trade.

Secondly, there is a Statement of Practice SP 10/91 which sheds further light on the additional factors that may be taken into account:

  • The location of the company’s business premises;
  • The identity of the company’s suppliers, management, or staff;
  • The company’s methods of manufacture;
  • The company’s pricing or purchasing policies.

As can be seen, there is no hard and fast rule that can be applied automatically to any given situation. A range of factors is taken into account – which is never entirely satisfactory when having to actually make a decision on the point.

HMRC have given specific examples, which shed some further light on what constitutes a major change. What is clear, is that changes which keep the business up to date – increasing efficiency, improved technology and management techniques – these types of changes are not considered to be of a major kind.

The company is also permitted to “rationalise its product range” – in other words, throw out those products that are unprofitable and replace them with others – provided that the new products are of a similar kind to the old. Presumably one can also sell off non-core assets or business divisions, though this is not specifically spelt out in the guidance.

Examples given by HMRC

(I have rearranged the order in which they appear in the guidance):

The following are all permitted:

  • Closing down factories and moving production to a brand new one – this is an increase in efficiency;
  • A company manufacturing kitchen utensils replaces enamel with plastic – keeping pace with developing technology;
  • A watch maker switches from mechanical to electronic timepieces – again, keeping pace with developing technology – though frankly, I can’t see why – there’s still a demand for the “old stuff”!
  • A company manufacturing both filament and fluorescent lamps concentrates solely on the latter, which forms the greater part of its output – this is permitted as a rationalisation of the product range – getting rid of the non-core part of the business;

The following are cases that show two ends of a spectrum – the borderline case must be somewhere in between:

  • A car dealer switches from one car model to another, but satisfying the same market – this is permitted, as there is not a major change in the type of product – BUT switching from cars to tractors is not allowed;
  • In the last example, HMRC have been careful to state that switching the make of car is not accompanied by a new market of customers – presumably this is not allowed (this is not made explicitly clear in the guidance, but the statutory definition states that a major change includes new customer outlets);
  • An investment company holding UK quoted shares and securities makes changes to its portfolio – this is okay, as it is not a change in the nature of investments held. However, switching from quoted shares to property is a major change5.
  • The last example isn’t completely satisfactory – HMRC doesn’t say what changes are allowed in the portfolio – is it okay to switch to unquoted private equity type investments? What about foreign held securities?

And the last two examples – what is not allowed:

  • A company running a pub converts it into a disco – a major change in the services or facilities provided;
  • A company fattening pigs for their owners decides to buy their own before feeding them and selling them on to be butchered and turned into bacon sandwiches – a major change from a service provider to a primary producer.

Going back to Ocado…

What could a prospective buyer expect on acquiring this company? What is the likelihood of the trading losses being available?

In the first place, there is a major problem in that Waitrose happens to be the company’s primary supplier. If Ocado is taken over, the arrangement comes to an end and Waitrose is to be paid a termination fee, calculated as the lower of £40m or 4% of the purchase price.

The “poison pill” has two aspects:

  • Who will pay? The buyer is not going to be happy about this, and will most likely insist that the selling shareholders foot the bill – this will simply be reflected in a lower purchase price. If the sellers don’t want to do this, end of deal!
  • Even if the deal goes ahead, the loss of Waitrose as a supplier is a problem for the buyer, especially if the result is that there isn’t much of a business left. Note a change in supplier is one of the factors taken into account in considering whether there has been a major change in the nature and conduct of the trade;
  • Even if Ocado can argue that there has been no such change, the time taken to rebuild the supplier base and move into profit may be considerable. The longer it takes, the less valuable the tax losses;
  • On the other hand, if Morrisons were to buy Ocado, the former can simply take over from Waitrose as the main supplier. In this case, it is arguable that there has been no major change.

Suppose there was no poison pill. What could the buyer do or not do?

  • Upgrading software, fixing technical glitches in the system should be permissible, as these are efficiency measures;
  • What about building more distribution centres? Would this involve a major change in customers, outlets or markets of the trade? Arguably not if this is simply a continuation of a policy that was in place before the company changed hands;
  • Suppose Ocado were to start opening up real stores – the ones where customers actually go in through the front door and fill a basket and go to the checkout. This must surely be a major change, given that the company is known as an online grocer. Would one store be sufficient, or would there need to be a critical mass?
  • On the other hand, compare the position of one of the big supermarkets with little or no online presence, such as Morrisons. What if they were to start investing in new technology to go on the web?6 This is the reverse of the previous situation, but arguably, there is no major change here – following HMRC guidance, they are just keeping up to date.

There aren’t any hard and fast answers to these questions. What should be clear from the above is that the fact that the target company has tax losses is only the starting point. The buyer cannot simply assume that these losses will continue to be available after the acquisition – this requires further investigation before the deal is completed.

It should be pointed out that tax should not be the sole reason driving the transaction. The buyer should be interested in the target company because it considers that there is still value in the business.

Having said that, the presence of tax losses should not be ignored by either party – it is an important factor in setting the purchase price. The seller will certainly not be happy for the buyer to have the benefit of the losses without paying for them, while the buyer should not be paying extra if the losses are likely to be disallowed.


HMRC Manual CTM06300.

Commentary on the “major change in the nature and conduct of the trade” is at: CTM06370.

Commentary on negligible activities is at: CTM06390.

  1. CTA 2010 s 673(4).
  2. CTA 2010 s 673(2).
  3. CTA 2010 s 673(3).
  4. CTA 2010 s 673(4).
  5. This is not a trading operation, but the restrictions on trading losses also apply to losses in investment businesses.
  6. Arguably there is nothing wrong with Ocado’s technology – it is Morrisons that don’t have the online presence. This is probably why they might be interested in Ocado – assuming the stories are true.
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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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