Section 135 Finance Act 1992 - Financial Freedom

Section 135 of the Finance Act 1992 in the United Kingdom introduced significant changes to the taxation of company profits and losses, particularly concerning losses brought forward and group relief. Its primary aim was to address perceived abuses of the existing tax system, improve fairness, and prevent tax avoidance strategies employed by companies.

Before the Finance Act 1992, companies could often manipulate their tax liabilities by using losses brought forward from previous accounting periods to offset profits in subsequent years, sometimes without any real economic connection between the profits and the losses. This was especially prevalent in situations involving corporate restructuring and changes in ownership. Section 135 aimed to curb these practices by introducing more stringent rules concerning the use of carried-forward losses.

One key aspect of Section 135 was the introduction of the “continuity of business” test. This test stipulates that a company can only utilize losses brought forward if it continues to carry on the same trade or business in the accounting period in which it claims the relief as it did in the period when the loss was incurred. If there’s a major change in the nature or conduct of the trade or business within a specified period (generally five years), the ability to offset profits with those earlier losses is restricted. This provision aimed to prevent companies from artificially acquiring loss-making entities simply to exploit their accumulated losses.

Furthermore, Section 135 also impacted the rules related to “group relief.” Group relief allows companies within the same corporate group to surrender losses to other profitable companies within the group, effectively reducing their overall tax burden. The Act introduced measures to prevent the artificial creation or manipulation of group structures solely for the purpose of maximizing group relief benefits. It strengthened the conditions for claiming group relief, ensuring a genuine economic connection between the companies involved and restricting the use of contrived arrangements to transfer losses.

Specifically, the legislation targeted situations where companies were acquired or merged primarily to take advantage of their accumulated losses. The “continuity of business” requirement, in conjunction with stricter rules on group relief, made it more difficult for acquiring companies to utilize the acquired entity’s losses if the underlying business underwent substantial changes after the acquisition. This effectively addressed the problem of “loss trafficking,” where loss-making companies were bought and sold solely for their tax advantages.

The impact of Section 135 was substantial. It increased the compliance burden for companies with carried-forward losses and those participating in group relief arrangements, requiring them to demonstrate the continuity of business and the genuine economic substance of the group structure. While it arguably added complexity to the tax system, it also contributed to a more robust and equitable tax framework by limiting opportunities for tax avoidance and ensuring that profits were taxed more fairly. It forced companies to conduct their businesses with a greater focus on economic reality rather than purely tax-driven considerations.

Over the years, the provisions of Section 135 have been subject to interpretation and refinement through case law and subsequent legislative amendments. However, its core principles of requiring business continuity and preventing artificial loss exploitation remain fundamental to the UK’s corporate tax regime. It serves as a key example of how legislation can be used to address perceived loopholes in the tax system and promote greater fairness and integrity.