UK authorities reconsider approach to the taxation of sales of
leasing companies.
UK lessors are currently contemplating HM Revenue & Customs’
(HMRC) proposals to amend the UK ‘sale of lessor’ tax provisions in
order to reduce their impact on genuine commercial
transactions.
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In response to industry concerns that the legislation,
introduced as an anti-avoidance measure in Schedule 10 to the
Finance Act 2006, is hindering sales of lessor businesses in
non-avoidance contexts, HMRC published on July 29 a discussion
paper setting out a number of possible options that they hope would
alleviate the issues.
The paper explains that Schedule 10 was enacted to counter
well-established avoidance schemes involving the sale of a lessor
company to a loss-making group. The opportunity for avoidance
arises because the effect of capital allowances is to defer the
recognition of profits for tax purposes. However, where a purchaser
can use its losses to shelter those profits, this temporary
deferral becomes, in effect, a permanent deferral of tax.
In broad terms, Schedule 10 seeks to counter such planning by
requiring the lessor to bring into account a tax charge at the
point of sale, effectively accelerating the deferred tax at that
time. A corresponding tax relief is then available to the lessor
going forward and, subject to restrictions, can be used to shelter
profits in the wider purchaser group.
However, while the legislation has been effective at closing
down the tax schemes at which it was directed, the lack of a
let-out for non-avoidance transactions can cause it to have
unintended consequences in the context of genuine commercial
activity.
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By GlobalDataEven if the purchaser intends the lessor company to carry on its
business as before, and to pay the same amount of tax, the deferred
tax is accelerated. And Schedule 10 applies just as much to
ordinary operating lessors as it does to traditional tax-based
lessors. Furthermore, selling the lessor’s business is no
alternative to selling the lessor company itself: under general
principles, a sale of the business assets would also, in broad
terms, trigger the deferred tax.
The fundamental problem here is that, although the corresponding
tax relief available under Schedule 10 produces, in principle, a
form of tax symmetry, the purchaser may well have insufficient UK
tax capacity to absorb fully the relief and so will be unable to
attribute material value to it (for example, where it has little or
no other UK business or is not currently profitable).
Lender security
Issues may also arise in the context of lender security in
leveraged transactions since the normal approach of taking security
over the shares in the lessor would risk Schedule 10 tax charges on
enforcement. Although some restructuring strategies have been
conceived to mitigate the impact of Schedule 10, in extreme cases
the charge may render businesses effectively unsellable. It can
also deter future investment in and expansion of the business.
In its discussion paper, HMRC describes four options to mitigate
the impact of the legislation on commercial transactions. Its
preferred approach is to focus on maximising the value of the
Schedule 10 relief to a purchaser group. In its view, this could be
achieved either by extending the period in which the relief is
available for offset against profits elsewhere in the purchaser’s
group (currently up to two years) and/or by applying a form of
indexation each year to the unutilised portion of the relief in
order to negate the timing cost that arises from paying tax upfront
but only realising the benefit of the relief over time.
The alternative approaches suggested are either to spread the
charge and the relief over time or to introduce, at the parties’
election, a ring fence of the lessor’s trade, with losses arising
outside the ring fence being incapable of sheltering profits within
it.
While HMRC’s acknowledgement that Schedule 10 needs to be
revisited is welcome, the initial reaction from some market
participants is that (at least outside smaller ticket businesses)
its preferred proposals do not address the real problems.
In particular, the focus on maximising the value of the Schedule
10 relief, rather than, for example, introducing a motive test,
fails to address the issues faced by non-UK purchasers or
purchasers with no UK tax capacity – with such purchasers likely to
remain unable to attribute material value to the relief.
An example is private equity or infrastructure fund purchasers,
which typically have no other business under common ownership and,
therefore ,would not benefit from an extension to the period in
which the relief can be offset against profits elsewhere in the
purchaser’s group.
The spreading and ring fencing proposals are, in principle, more
promising (although spreading as explained by HMRC would appear to
be cumbersome and rigid in nature). Ring fencing, in particular,
would deal elegantly with the concerns that led to the introduction
of Schedule 10.
Narrowly formulated
However, the concept is very narrowly formulated in the
discussion paper, which contemplates that profits arising from
leases entered into before the change of ownership could not be
sheltered by “losses of the wider group, losses arising within the
company from separate activities [or] new losses generated by new
investment in the same trade”.
An exclusion of group relief and sideways relief in respect of
losses arising in the new ownership is understandable in view of
the purpose of Schedule 10. But it seems unnecessarily restrictive
to exclude losses referable to new investment where the business is
simply carried on as it was before. It is to be hoped that progress
can be made in this area.
HMRC has invited comments from interested parties on its
proposals by the end of September.
