Restrictions on Carry-forward of Company Losses

16.136. The general provisions of the law in regard to the carry-forward of losses has been explained in Chapter 8.

16.137. Until 1944 no restrictions were imposed on the carry-forward of losses by companies. In that year provisions were inserted in the Act denying the carry-forward of losses by a private company unless shares having not less than 25 per cent of the voting power in the company were beneficially held by the same persons in both the year of loss and the year in which it was sought to apply the loss.

16.138. The reason for adopting these provisions was explained by the Ligertwood Committee in the terms of the Treasurer's speech when introducing the Bill. The Treasurer referred to a practice by persons who had been refused Capital Issues Board permission to form companies ‘of buying up shares in practically defunct companies and then operating those companies for purposes other than those for which they were originally registered’.

16.139. After the war-time capital issues controls had ceased to function, the provisions continued to be part of the law as a means of limiting the carry-forward by private companies of losses of previous years. In this they were designed to control the practice of buying the shares in a company that has suffered losses in order to be able to take advantage of those losses by applying them against future profits of the company. But they proved quite ineffective. Schemes were devised by which they were easily avoided and they became no more than traps for the unwary.

16.140. The Ligertwood Committee considered the policy of limiting the allowance of company losses of previous years by reference to the need for continuity of shareholding in the company and questioned whether the principle of limiting, for taxation purposes, ‘the allowance of losses of previous years incurred by companies which have substantially changed their shareholders, is soundly based’. In recommending the repeal of the provisions inserted in 1944, the Ligertwood Committee referred to its view that a company, in fact as well as in law, is a legal entity separate from its shareholders and concluded that a company's losses should be treated for fiscal purposes without regard to the identity of its shareholders.

16.141. The Ligertwood Committee's conclusion was not adopted. In 1964 new provisions were inserted in the Act limiting the carry-forward of losses by companies, whether private or public. A continuity of ownership of shares carrying 40 per cent of voting and dividend rights and rights to capital was now required. In 1965 these provisions were qualified to some extent by further provisions under which a failure of the required continuity could be disregarded if the company continued the same business. The qualification was so strictly drafted that it did not significantly modify such effect as there was in the continuity of ownership provisions.

16.142. However, the continuity of ownership provisions enacted in 1964, like the 1944 provisions, proved ineffective in preventing the practice of acquiring the shares in companies that had suffered losses in order to exploit the potential tax savings to be gained by the application of the losses when carried forward. Arrangements were adopted whereby the continuity of ownership required by the law was satisfied even

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though, in substance, there was no continuity. Further provisions were inserted in the Act in 1973 to defeat such arrangements, as a result of which a more than 50 per cent continuity of ownership is now required.

16.143. The Committee agrees with the policy of these provisions limiting the carry-forward of company losses and is not persuaded by the reasoning of the Ligertwood Committee. In the taxation of companies it is necessary to go behind the veil of separate legal personality. An individual carrying on business as a sole proprietor or partner who suffers losses has no means open to him of obtaining their equivalent in tax relief except by subsequently making profits against which those losses will be deductible. Moreover, he is limited in thus taking advantage of the losses by the span of his life: losses suffered by an individual cannot be applied against profits made by his personal representative after his death. If there were no restrictions, by reference to continuity of ownership, on the carry-forward of losses by companies, an individual who conducts business through a company would have an unfair advantage: by selling his shares he would obtain immediately the tax equivalent of the losses suffered by the company; and the value of the losses could be turned to advantage after his death.

16.144. The objective that the seller of shares in a loss company seeks to further is to obtain the tax equivalent of those losses immediately. Other ways of doing this which do not involve any unfair advantage will be available if recommendations of the Committee in regard to carry-back of losses and transfer of losses are adopted. The Committee has recommended in Chapter 8 that carry-back of losses be allowed. It has also recommended in this chapter that the law allow a loss to be moved from one company in a group to another in the same group. In addition, it has suggested that losses of companies electing to be taxed as partnerships be allocated to shareholders.