Back to basics
Relief for capital losses
T
he general rule on capital losses is that they
can only be offset against capital gains.
However where an individual incurs a capital
loss on the disposal of shares in an unquoted
trading company a claim can be made to offset the
loss against income provided certain conditions are
met. This claim can be made for the year of the loss
or for the previous tax year or both tax years. This is
a valuable relief and thought should always be given
at the outset of an investment to structure it in a
way to ensure that this relief is available should the
venture fail.
Qualifying conditions
The shares must be qualifying shares. Qualifying
shares are those in a qualifying trading company
which were subscribed for by the individual or
shares on which enterprise investment scheme (EIS)
relief has been claimed. Shares are subscribed for
by an individual if they are issued to the individual
by the company in exchange for money (or money’s
worth), ITA 2007 s 135(2). So second-hand shares
will never qualify for relief unless they were
transferred from a spouse or civil partner and the
spouse or civil partner had originally subscribed
for the shares. The parties do not need to have been
married or in a civil partnership at the time of the
subscription.
Where EIS relief has been claimed on the shares
there are no further tests in relation to the qualifying
conditions. However where EIS relief was not claimed
the shares must be in a qualifying company. A
qualifying company is one which meets each of the
conditions A to D as set out in ITA 2007 s 134.
Condition A: The company must meet one of the
following tests:
at the date of disposal, the company meets
the trading requirement, the control and
independence requirement, the qualifying
subsidiaries requirement and the propertymanaging subsidiaries requirement (see below);
or
at the date of disposal, the company has ceased
to meet any of the requirements in one above
within the previous three years and it has not
since that time been an excluded company, an
investment company or a trading company.
Condition B: The company must either:
meet the requirement mentioned in condition A
for a period of six years ending with the disposal;
or
meet each of the requirements in condition A
for a shorter continuous period ending with the
date of disposal or, at the date of disposal, has
not before the beginning of that period been an
excluded company, an investment company or a
trading company.
Condition C: The company meets the gross-assetrequirement test both immediately before and
immediately after the issue of the shares which are
the subject of the loss-relief claim and also meets
the unquoted test at the relevant time. Gross assets
must not exceed £7m before the share issue and
9 November 2012 ~ www.taxjournal.com
SPEED READ Losses on the disposal of shares are
usually treated as capital losses for tax purposes,
and will be available to set off against capital gains
in the same year or future years (without time limit).
So long as certain conditions are met, losses on the
disposal of shares can be set against income in the
year of the loss or the preceding year. CGT relief is
available for losses arising on loans to traders, so long
as certain requirements are met. Principally, the loan
must become irrecoverable, and the right to recover
the loan cannot be assigned. It is possible to capitalise
loans into shares, and if the shares subsequently give
rise to a loss, this can, so long as various requirements
are met, be set off against income. There are also
a number of pitfalls that need to be borne in mind
before making such a claim.
Paula Tallon is managing partner of Gabelle LLP.
Gabelle provides independent tax support for
accountants and other professionals. Paula’s areas
of expertise include company reorganisations and
reconstructions and other tax issues facing ownermanaged businesses. Email: paula.tallon@gabelletax.
com; tel: 020 7182 4710.
£8m after the share issue. The limits for a qualifying
company under the EIS rules were increased to
£15m and £16m with effect from 6 April 2012 but
the limits have not been increased for non-EIS
shares.
Condition D: The company must have carried on
its business wholly or mainly in the UK throughout
the period beginning with the incorporation of the
company, or, if later, 12 months before the shares
were issued, and ending with the date of disposal.
Wholly or mainly is taken to mean more than
50%.
The general rule on capital losses is
that they can only be offset against
capital gains
Trading requirement: The company exists wholly
(ignoring incidental purposes) for the purposes of
carrying on one or more qualifying trades, or the
company is the parent company and the business of
the group does not consist wholly or to a substantial
extent of the carrying on of non-qualifying
activities. Non-qualifying activities are excluded
activities and activities (other than research and
development) carried on otherwise than in the
course of a trade. Excluded activities follow the EIS
definition and include:
dealing in land, in commodities or futures in
shares, securities or other financial instruments;
dealing in goods, other than in an ordinary
trade of retail or wholesale distribution;
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financial activities such as banking, insurance,
money-lending, debt-factoring, hire-purchase
financing or any other financial activities;
leasing or letting assets on hire, except in the
case of certain ship-chartering activities;
receiving royalties or licence fees (though if these
arise from the exploitation of an intangible asset
which the company itself has created, that is not
an excluded activity);
providing legal or accountancy services;
property development.
Substantial in this context is accepted as 20%.
Qualifying subsidiary: This is a 51% subsidiary and
no other person other than the relevant company,
or another of its subsidiaries, have control of the
subsidiary.
Control and independence: The company must
not control any company which is not a qualifying
subsidiary. For the independence part of the test to
be met, the company must not be a 51% subsidiary
of another company; neither should it be under the
control of another company or of another company
and a person connected with it. Also there must be
no arrangements in place which could result in the
company becoming under the control of another
company.
Property-managing subsidiaries: This is a
subsidiary whose business consists wholly or mainly
in the holding or managing of land. Any propertymanaging subsidiary must be a 90% subsidiary.
Income tax relief for losses on shares
should not be overlooked, although there
are strict conditions for the relief to apply
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2001 and they had difficulty in seeing how £330
could be paid for a share in December 2000 and
that same share became of negligible value in April
2001. The taxpayers’ negligible value claims were
upheld by the tribunal which accepted that when
taking into account the information that would
have been available to a prospective purchaser the
shares would not have a market value.
With a private company, a claim for negligible
value is normally proved by showing that the
company has become insolvent and that there is
little prospect of recovery. In making a claim, the
taxpayer is treated as disposing of the shares and
immediately reacquiring them at the negligible
value. This gives rise to a loss. An earlier time may
be specified in the claim if the claimant owned
the shares at that earlier time and the shares had
become of negligible value at that earlier time, and
that earlier time is not more than two years before
the beginning of the year of assessment in which the
claim was made. This provides some flexibility for
the taxpayer in deciding against which year’s income
to set the loss.
Giving effect to a s 131 loss
The individual can deduct the loss in calculating
the income for the tax year of the loss or of the
previous year, i.e. if the loss arises in 2012/13 the
loss can be claimed against income in 2012/13 or
2011/12. Where a claim is made in relation to two
tax years, any part of the loss not deducted in one
year is taken against the income for the other tax
year.
The claim must be made by the first anniversary
of the filing deadline for the tax year in which the
loss arose.
Share disposal
Relief for loans to traders and
conversion of loans
To be eligible for relief the loss must arise on the
disposal of the shares.
A disposal arises when:
there is a sale of the shares in an arm's-length
transaction;
there is a distribution in the course of dissolving
or winding-up a company;
there is a disposal within TCGA 1992 s 24(1) –
this refers to the entire loss or extinction of an
asset; or
there is a negligible value claim under TCGA
1992 s 24(2).
A negligible-value claim is made where the shares
have become of negligible value. In the 2011 case
of Barker and Others v HMRC [2011] UKFTT 645
(TC01487), shares were found to be of negligible
value where they had no ‘market value’. The facts of
the case are complex but in essence the taxpayers
claimed that shares were of negligible value in
April 2001 one year before the company went into
creditors’ voluntary liquidation but just over three
months after investing funds into the company.
HMRC rejected the claim on the basis that the
shares were not worth ‘next to nothing’ in April
Relief for loans to traders is available under TCGA
1992 s 253. This is contrary to the general rule
for loans which is that they are exempt for CGT
purposes. Relief is available where a loan is made to
a UK-resident borrower wholly for the purposes of
a trade and that loan becomes irrecoverable.
The individual can make a claim if:
the principal has become irrecoverable;
the claimant has not assigned the right to
recover that amount; and
the claimant and the borrower are not spouses
or civil partners or companies in the same
group when the loan was made or at any
subsequent time.
Whether the loan has become irrecoverable has
been the subject of several cases. Where a company
continues to trade HMRC will want to see
evidence that there is no prospect of recovery in
the future. Where the lender makes further loans,
HMRC will seek to challenge claims for earlier
loans where these claims have already been made.
Where an individual has guaranteed a loan and
that guarantee is called upon, relief may also be
available.
www.taxjournal.com ~ 9 November 2012
However any loss arising is a capital loss and
cannot be used against income. Therefore it is not
uncommon to see the conversion of loans into
shares so that the more flexible relief under s 131
can be claimed. Where loans are converted into
shares and a subsequent loss is claimed HMRC is
likely to challenge the loss on the grounds that the
shares were worth less at the time of conversion.
When dealing with conversions and the future
of the company is uncertain all the evidence as
to the value should be recorded at the time of the
conversion. This will help in the event of an enquiry
at a later date.
Example: Mixed holdings
The history of share purchases is as follows:
Number of
shares
Amount paid
(£)
Note
01/02/1998
100
100
Cash
02/10/1999
20,000
0
Bonus shares
04/07/2001
10,000
20,000
Second hand
07/11/2002
60,000
60,000
Subscribed
31/07/2003
30,000
30,000
Subscribed
01/01/2004
80,000
80,000
Second hand
Mixed holdings
01/06/2008
340,000
340,000
Capitalisation of loan
Where the taxpayer has both second-hand shares
and shares which were subscribed for in the
company, the capital loss cannot be fully used
against income. If the whole of a mixed holding
is disposed of there is no difficulty in identifying
those shares with specific acquisitions. However,
if only part of a mixed holding is disposed of, then
we need to know if any qualifying shares have
been disposed of and, if qualifying shares have
been disposed of, which acquisitions of qualifying
shares do the disposal relate to? The basic rule
is that the share identification rules are applied.
The shares disposed should be matched in the
following order:
first against acquisitions on the same day; then
against acquisitions within the 30 days
following the disposal; then
against shares in a section 104 holding (but
without identifying any particular shares in
that holding); and finally
against acquisitions following the disposal (and
not already identified under the 30 day rule),
taking the earliest acquisition.
02/06/2008
400,000
20,000
Second hand
940,100
550,100
Conclusion
Income tax relief for losses on shares should
not be overlooked, although there are strict
conditions for the relief to apply. If the individual
has insufficient income to absorb all the loss,
the excess will be available to carry forward as
If the shares were disposed of or became of negligible value in 2009 and
the taxpayer made a claim for the loss against income, HMRC would seek
to restrict the amount of the loss for income tax purposes. It would argue
that the value attributed to the shares on conversion of the loan was too
high as there is a transaction a day later, with a third party, for a much
lower price. Even in the absence of a third party transaction, HMRC would
look closely at a loan conversion where a subsequent s 131 loss is claimed.
Relief for loans to traders is available
even where the lender controls the
borrowing company
a capital loss which can be set off against future
capital gains.
Relief for loans to traders is available even
where the lender controls the borrowing company.
However, HMRC will look closely at this type of
relationship to ensure that when the loans were
made there was a reasonable prospect of being able
to recover the loan. Relief would not be available in
situations where the proprietor had used his funds
to prop up an ailing company which had no real
prospect of recovery.
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