CG-APP9 - Capital Gains Tax: avoidance through the creation and use of capital losses

Introduction
“Arrangements” and “tax advantage”
“Tax advantage”
Restriction on allowable losses
Examples
Example 1 - loss on second-hand life insurance policy
Example 2 - capital loss set against income
Example 3 - artificial loss from matched options, etc.
Example 4 - sale of shares to realise capital loss
Example 5 - sale of shares to realise capital loss
Example 6 - sale of shares to realise capital loss
Example 7 - sale of shares to realise capital loss
Example 8 - sale of shares to realise capital loss
Example 9 - sale of shares to realise a capital loss
Example 10 - sale of shares to realise a capital loss
Example 11 - sale of asset by trustees
Example 12 - sale of asset by trustees
Example 13 - sale of asset by trustees
Example 14 - trustees distributing assets to beneficiaries
Example 15 - investment in EIS shares
Example 16 - deferred gain covered by capital loss on EIS shares
Example 17 - capital loss following disposal of company assets
Example 18 - trustees make a deliberate transfer of value
ANNEX

Introduction

This guidance explains HM Revenue and Customs’ interpretation of section 16A of the Taxation of Chargeable Gains Act 1992 and how the legislation applies. The guidance does not affect a taxpayer’s right to argue for a different interpretation, if necessary in an appeal to the First-tier Tribunal.

This guidance is intended to be read in conjunction with the statement on capital losses first published on 6 December 2006 and included as an annex to this guidance. This guidance was first published in draft form on 6 December 2006 and revised and extended before being issued again for comments on 21 March 2007.

The guidance published on 27 July 2006 relating to the anti-avoidance rule for companies remains valid (with the proviso that references to section 8 in that guidance should be read in future as references to section 16A).

Statutory references in this note are to the Taxation of Chargeable Gains Act 1992, unless otherwise indicated.

1. Draft anti-avoidance legislation was published at Pre-Budget Report 2006 targeting arrangements intended to avoid UK tax through the creation and use of contrived capital losses. Final legislation is at section 27 of Finance Act 2007.
2. The legislation applies to capital losses which arise on disposals on or after 6 December 2006 and give rise to a tax advantage. Where the legislation applies to a capital loss, the loss is not to be an “allowable loss” and may not, therefore, be set off against chargeable gains, nor against income, to reduce liability to capital gains tax, income tax or corporation tax. It will replace the legislation which applies currently to capital losses of companies subject to corporation tax, but does not alter its effect. The guidance published on 27 July 2006 relating to the anti-avoidance rule for companies will remain valid (with the proviso that references to section 8 in that guidance should be read in future as references to section 16A). This paper provides guidance on how the legislation will apply in relation to capital gains tax and income tax.
3. Besides continuing to apply to companies liable to corporation tax in respect of chargeable gains, the legislation now applies also to any person liable to tax on capital gains, including individuals, trustees, and the personal representatives of deceased persons. But, because it is targeted at arrangements that are intended to avoid UK tax, most persons will not be affected, nor will it apply to the majority of transactions undertaken. In particular it is unlikely that individuals with a normal portfolio of investments who make disposals in the ordinary course of managing their portfolio would be affected by these new rules because there is currently little evidence to suggest that such individuals undertake the type of arrangements that are targeted by this legislation.
4. The rule does not apply to a simple sale at arm’s length of an investment standing at a loss and the setting of that loss against gains, utilising the statutory relief for losses. Such a transaction does not constitute arrangements whose main purpose is to secure a tax advantage, as the main purpose is the disposal of the unprofitable investment.
5. The legislation is intended to have effect where a person enters deliberately and knowingly into arrangements to gain a tax advantage.
6. The effect of the legislation will be to restrict the use of capital losses resulting from the arrangements where the gaining of a tax advantage is the main purpose or one of the main purposes of the arrangements.

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“Arrangements” and “tax advantage”

1. This section provides information about the terms “arrangements” and “tax advantage” used in the legislation.

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“Arrangements”

1. The term “arrangements” is widely drawn to include any agreement, understanding, scheme, transaction or series of transactions, whether or not legally enforceable.
2. Whether a transaction forms part of a series of transactions, or a scheme, or an arrangement is in general a question of fact, but this conclusion will follow in any case where one transaction would not have taken place without another transaction, or would have taken place on different terms without that other transaction. However, it is not necessary that transactions must depend on each other in this way in order that they form part of a scheme or arrangements.

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“Tax advantage”

1. It is a condition for the legislation to apply that the main purpose, or one of the main purposes, of any arrangement(s) is to gain a “tax advantage”. This expression is defined in the legislation, and has four legs covering relief from tax, repayment of tax, reduction or avoidance of a charge to tax, and avoidance of an assessment to tax.
2. If a tax advantage arises out of a transaction that is part of the arrangements, the legislation asks whether the main purpose or one of the main purposes of the arrangements (referred to as “a main purpose” in this guidance) is to achieve a tax advantage. The purpose of the arrangements is determined by the purpose of the participants in entering into the arrangements. If any participant who has entered into the arrangements has done so with a main purpose of achieving a tax advantage, that will constitute a main purpose of the arrangements.
3. There is no one factor that determines whether the obtaining of a tax advantage is a main purpose of an arrangement. All the circumstances in which the arrangements were entered into need to be taken into consideration. The circumstances might include:

• the overall economic objective: this should be considered not only from the perspective of individual participants in the arrangements, but also from any wider perspective, such as that of the settlor or beneficiaries of a settlement whose trustees were participants: for these purposes an economic objective does not include tax motivated reasons;
• whether this objective is one which the parties involved might ordinarily be expected to have, and which is genuinely being sought;
• whether the objective is being fulfilled in a straightforward way or whether the introduction of any additional, complex or costly steps would have taken place were it not for the tax advantage that could be obtained.

1. The straightforward use of a statutory relief does not of itself bring arrangements within the TAAR. Equally, the existence of a tax advantage, such as obtaining a deduction for tax purposes, is not enough in itself to show that the arrangements have a main purpose of obtaining a tax advantage.
2. For instance, where there is evidence that a person considered two ways to achieve an economic objective and chose on economic grounds to pursue one of them, the fact that there was a beneficial difference in tax treatment for the chosen route would not meet the main purpose test. Where the potential tax treatment was a factor in choosing between alternative arrangements, then it would still be necessary that securing a tax advantage was a main purpose to the arrangements. There may be situations where the tax advantage secured through undertaking one arrangement rather than another is so significant that this indicates that achieving a tax advantage was a main purpose. This is unlikely to be the case where the arrangements chosen do not involve additional, complex or costly steps included solely to secure or enhance a tax advantage.
3. Where a person has entered into a marketed tax avoidance scheme, this will be taken as an indicator that securing a tax advantage was a main purpose of the arrangements.
4. Hence it will be relevant to draw a comparison in order to consider whether, in the absence of the tax considerations:

• the transaction giving rise to the advantage would have taken place at all;
• if so, whether the tax advantage would have been of the same amount; and
• whether the transaction would have been made under the same terms and conditions.

1. Nothing in the new legislation prevents relief for losses under section 24 where a genuine loss has been incurred on an asset which has been lost or extinguished, etc., or where an asset has genuinely become of negligible value. Nor will the new legislation ordinarily prevent a genuine loss on a real disposal of an asset from being set off against a person’s own gains, including the case where, before the real disposal that gives rise to the genuine loss, the person acquires the relevant asset from a spouse or civil partner at no gain/no loss under section 58.

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Restriction on allowable losses

1. There is evidence to show that a variety of schemes to generate capital losses which the existing legislation was never intended to produce are being marketed and implemented. Typically the schemes involve the generation of a capital loss for tax purposes where there is no genuine economic loss and/or no genuine economic disposal, often through schemes with no economic rationale.
2. The intent of this targeted anti-avoidance rule (“TAAR”) is to apply the principle set out in the HMRC statement of 6 December 2006, that relief for capital losses should be available only where a person has suffered a genuine economic loss and made a real economic disposal.
3. This legislation will not apply where there is a genuine economic transaction that gives rise to a real economic loss as a result of a real disposal. In these circumstances there will be no arrangements with a main purpose of securing a tax advantage. Conversely, where there is either no real disposal, or no real economic loss, or any combination of the foregoing, then there are likely to be arrangements in place with a main purpose of securing a tax advantage so the legislation will apply.
4. Nor will the legislation apply where the Act provides that an event is treated as a disposal, such as in the case of a negligible value claim, or where a capital sum is derived from an asset - provided that such an occasion of charge does not form part of arrangements which have been entered into with a main purpose of securing a tax advantage.
5. The effect of the new legislation is that any capital loss arising on a disposal on or after 6 December 2006 does not qualify as an allowable loss when it arises in connection with arrangements having a main purpose of obtaining a tax advantage.
6. In order to prevent abuse where losses are created either for immediate use or for use in future years, the legislation applies even if, at the time the loss arises, there are no chargeable gains from which the loss could otherwise have been deducted.
7. It also prevents abuse where the tax advantage would ultimately have arisen to a person other than the person to whom the loss arises, for example where the trustees of a settlement enter into arrangements to create a loss that would ultimately confer a tax advantage on the settlor because the trustees’ gains are, in effect, charged on the settlor.
8. Whilst we will not give advice under Code of Practice 10 in respect of transactions which, in our view, may have been undertaken with the purpose of avoiding tax, HMRC will provide advice about the interpretation of the wording of the legislation where there is genuine uncertainty, in accordance with the principles set out in Code of Practice 10.

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Examples

1. Examples of how the legislation will apply in particular circumstances are set out below. These examples are intended to show how different factors will be taken into consideration in deciding whether or not the TAAR applies in a given set of circumstances. They are not designed as templates for deciding whether a loss is or is not caught by the TAAR in any particular case. That can be determined only in the light of all the actual facts and circumstances.

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Example 1 - loss on second-hand life insurance policy

1. An individual, C, acquires a life insurance policy “second-hand” for £1 million. The policy had been issued a few days earlier to a third party for a single premium of (say) £990,000. The policy falls within the income tax regime for ‘chargeable event gains’.
2. C surrenders 95% of the policy back to the insurance company, receiving (say) £955,000 for the surrender. A few days later C surrenders the remaining 5% of the policy, receiving (say) £55,000 in final settlement.
3. C’s intention is to generate a capital loss broadly equal to the cost to him of acquiring the policy, even though he has made no economic loss. There are two legs to the disposal: it is claimed that the interaction of the income tax rules for chargeable event gains in Chapter 9 of Part 4 of the Income Tax (Trading and Other Income) Act 2005 and the capital gains part-disposal rules mean that the first part-disposal results in neither a chargeable gain nor an allowable loss, while the second results in a loss equivalent to virtually the whole of the £1million paid by C for the policy, with only a very small chargeable event gain on which C is chargeable to income tax.
4. But any such loss will be generated as a result of arrangements. To decide whether a main purpose of those arrangements is to obtain a tax advantage, it is necessary to look at all the circumstances in which the arrangements were entered into, including the participants’ overall economic objective, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. In this case, it seems clear that the overall objective of C has nothing to do with investing in the life insurance policy, as the main outcome of the transactions is in fact the tax loss that has been obtained. Furthermore, C has entered into an intricate series of steps the only purpose of which appears to be to deliver this tax loss. This suggests that obtaining the tax advantage was a main purpose of the arrangements, in which case the TAAR will apply and the losses will not be allowable.

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Example 2 - capital loss set against income

1. An individual, F subscribes £20 for 20 ordinary shares in a company, G Ltd., which meet the requirements for any loss on disposal of the shares to be relievable against F’s income (section 574 ICTA 1988, or, from 6 April 2007, section 131 Income Tax Act 2007).
2. F arranges to sell the shares for their current value to a third party, P. F also grants P an option to sell the shares back for their market value at the time the option is exercised.
3. P injects (say) £1 million into G Ltd. by subscribing for another share at a premium of £999,999. P then exercises the option (within 30 days of F’s original sale) and sells the 20 shares back to F for their current value of (say) £1 million.
4. The CGT ‘bed and breakfasting’ identification rules in section 106A(5) match the shares disposed of (by F) with the later reacquisition, and a loss of £999,980 arises to F. F claims to set this loss off against income. In order to decide whether or not the TAAR applies, it is necessary to determine whether there have been arrangements, and, if so, whether those arrangements were entered into with a main purpose of securing a tax advantage. In the present case, there appears to have been a series of transactions, which would be within the statutory definition of arrangements. To determine whether or not the arrangements were entered into with a main purpose of securing a tax advantage, it is necessary to take account of all the circumstances, including the overall economic objective of the participants in the arrangements, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. Here, the intricate series of transactions have the effect of procuring a tax loss unrelated to the economic reality, which suggests that F entered into the arrangements with a main purpose of gaining a tax advantage. In such a case, the new rule will apply and the capital loss will not be an allowable loss, and therefore cannot be set off against F’s income (or against F’s capital gains).

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Example 3 - artificial loss from matched options, etc.

1. A body of trustees, W, takes out two options or futures, designed so that one will yield a loss and the other a corresponding (or similar) gain, depending on how the value of the underlying assets has changed. The contracts are completed so that a loss and a matching (or similar) gain arise.
2. A tax advantage could be obtained by setting the loss on one of the contracts against chargeable gains on some other disposal (in the same year that the loss arises or another year) while the gain on the other contract is perhaps

• not taxed at all, or
• taxed at a lower rate than the ‘saving’ achieved by setting the loss against the other chargeable gains, or
• not taxed until a later year.

1. In order to determine whether or not the TAAR applies to these transactions, it is necessary to consider whether or not arrangements have been entered into with a main purpose of securing a tax advantage. The matching contracts are clearly arrangements, so the question is whether the trustees have entered into them with the aim of gaining a tax advantage. This can only be decided by looking at all the circumstances surrounding the arrangements, including the trustees’ overall economic objective, and whether that objective has been realised in a straightforward way, or whether additional, complex or costly steps have been inserted. In the present case, the trustees have obtained a loss and a gain, designed to ensure that the loss can be set against real gains, while the gain is either not taxable, or taxable at a lower rate, or perhaps in a later year. So additional and complex steps which have been inserted, and the tax outcome of the transactions does not reflect the economic reality of the situation. These factors suggest that a main purpose of the arrangements was the obtaining of a tax advantage, and so the loss will fall within the terms of the TAAR and will not be allowable.

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Example 4 - sale of shares to realise capital loss

1. Mr H, sells shares in a company, S plc, in order to crystallise a loss which can be set against his chargeable gains arising in the year. Unbeknown to Mr H, his wife Mrs H buys shares of the same class in S plc a few days later, at the same price as Mr H sold the original holding.
2. In order to determine whether or not the rule applies to these transactions, it is necessary to consider whether or not arrangements have been entered into with a main purpose of securing a tax advantage. As the statutory definition of arrangements includes a “transaction”, both the sale of the shares and their subsequent purchase by Mrs H are arrangements for the purposes of the rule. It is then necessary to consider whether securing a tax advantage was a main purpose of those arrangements, and to do so it is necessary to take account of all the circumstances in which the arrangements were entered into, including the participants’ overall economic objective, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. Mrs H’s decision to acquire shares in S plc was unconnected with Mr H’s disposal of similar shares, and Mr H has simply taken advantage of the statutory relief for capital losses in section 2(2) in a straightforward way. Moreover, Mr H has incurred a real economic loss on a genuine disposal to a third party. Mrs H has made a genuine purchase on arm’s-length terms. These factors suggest there was no main purpose of obtaining a tax advantage, so these transactions do not fall foul of the TAAR.

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Example 5 - sale of shares to realise capital loss

1. Mr H has shares in S plc which are standing at a loss. Mrs H has shares in a separate company, T plc, standing at a gain. Mr H transfers his shares to Mrs H under the no-gain, no-loss rule in section 58 TCGA, and she then sells both holdings of shares. The loss on the shares in S plc covers the gain arising from the shares in T plc, and so no CGT is payable by Mrs H.
2. Taking the spouses together, Mr and Mrs H each have shares which they want to sell. What happens in fact is that they do sell their shares, and the economic consequence is that they realise a gain on one set of shares and a loss on the other set. To decide whether or not the TAAR applies, it is necessary to consider whether there have been arrangements, and whether a main purpose of those arrangements was the securing of a tax advantage. In this case, it seems clear that there have been arrangements, namely the transfer of the shares from Mr H to Mrs H. It is then necessary to look at what the main purpose of Mr and Mrs H in entering into these arrangements was. This can be determined only by looking at all the circumstances surrounding the arrangements. In the present example, Mr and Mrs H wanted to dispose of their shareholdings, and they did this in a straightforward way. They made use of the provisions of section 58 TCGA, which provides the opportunity for spouses (or civil partners) to bring together gains and losses, but again the straightforward use of a statutory relief in this way does not (of itself) bring arrangements within the TAAR. Moreover, the tax outcome of the transactions reflects the economic reality of Mr and Mrs H’s situation. In all the circumstances, this suggests that there was no main purpose of achieving a tax advantage, and where there is no such main purpose the rule does not apply.

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Example 6 - sale of shares to realise capital loss

1. As in example 4, Mr H sells shares in a company, in order to crystallise a loss which can then be set against his chargeable gains arising in the year. Mr H makes arrangements for his wife Mrs H to purchase the same number and class of shares. Mrs H then transfers the shares back to Mr H on the following day. By virtue of section 58 TCGA this is a no-gain, no-loss transaction.
2. To decide whether or not the TAAR applies, it is necessary to consider whether there have been arrangements, and whether a main purpose of those arrangements was the securing of a tax advantage. In this case it is clear that there have been arrangements, as Mr H has arranged for his wife to purchase the same number and class of shares. It is then necessary to look at what the main purpose of Mr and Mrs H in entering into these arrangements was, and to do so it is necessary to consider the overall economic objective of the arrangements, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. Clearly the real economic ownership of the shares has remained with Mr H, which suggests that the disposal of the shares was incidental to some other main purpose of the arrangements. The only substantive change here is that a tax loss has been obtained. Since Mr & Mrs H have the same effective holding of shares and no less cash at the end of the arrangements as at the beginning, they have not suffered any corresponding economic loss, which suggests that a main purpose of the arrangements was the securing of that tax advantage. The TAAR will therefore apply and the capital losses claimed by Mr H will not be allowable losses.
3. On a subsequent sale by Mr H any chargeable gain would be greater (or any allowable loss would be smaller) than would have been the case if the arrangements had not been entered into. This does not affect the operation of the TAAR in relation to the losses generated under the arrangements.

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Example 7 - sale of shares to realise capital loss

1. The situation may arise where variants on the arrangements in example 6 occur. For example, instead of making arrangements for Mrs H to buy back the same number of shares as had been sold by Mr H, the couple might arrange for a slightly different number of shares to be bought. Or she might purchase the shares and retain them as part of her own portfolio, not transferring them back to Mr H at all.
2. To decide whether or not the TAAR applies in such cases, it is still necessary to consider whether there have been arrangements, and whether a main purpose of those arrangements was the securing of a tax advantage. In each case it is clear that there have been arrangements, and so it is necessary to look at what the main purposes of these arrangements were. All the circumstances surrounding the arrangements have to be taken into account, and to do so it is necessary to consider the overall economic objective of the arrangements, whether that objective is one that the participants might ordinarily be expected to have, whether that objective is genuinely being sought, and whether it is being fulfilled in a straightforward way, or additional, complex or costly steps have been inserted.
3. In a case where a slightly different number of shares has been bought back by Mrs H, but those shares are immediately transferred back to Mr H, it is likely that the securing of a tax advantage would still be one of the main purposes, in which case the TAAR would still apply. But if only a very small proportion of the shares sold by Mr H were then purchased by Mrs H and transferred back to Mr H, or if Mrs H bought the shares and retained them as part of her own share portfolio, it is less likely that the securing of a tax advantage was one of the main purposes of the arrangements, in which case the TAAR would not apply.

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Example 8 - sale of shares to realise capital loss

1. A further variant on the situation in example 6 is that Mrs H could buy back the same number and class of shares that had been sold by Mr H, but that she does not do so until, say, 31 days after Mr H has sold the shares.
2. Again, it seems clear that there have been arrangements, and so it is necessary to look at what the main purpose of Mr and Mrs H in entering into these arrangements was. So to determine whether or not the TAAR applies all the circumstances surrounding the arrangements have to be taken into account, considering:

• the overall economic objective of the arrangements,
• whether that objective is one that the participants might be expected to have, and which is genuinely being sought, and
• whether that objective is being fulfilled in a straightforward way, or additional, complex or costly steps have been inserted.

If Mrs H bought back the same number and class of shares which had been sold by Mr H, but did not do so until some weeks after his disposal, it is less likely that the securing of a tax advantage will have been a main purpose of the arrangements, because there will have been a degree of exposure to market fluctuations and therefore a genuine economic risk. As a general rule of thumb HMRC considers that the TAAR will not apply in any case where a sale of shares is followed by their re-purchase after a period exceeding 30 days, provided that the exposure to market fluctuations in that period is real and there are, for example, no additional contracts or arrangements in place that significantly limit any economic risk. This 30 day rule of thumb is derived from the time limit in section 106A(5) TCGA 1992, the rule which operates to counteract so-called “bed and breakfasting” transactions.

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Example 9 - sale of shares to realise a capital loss

1. An individual, R, who has realised a chargeable gain in a particular tax year, sells shares in a company, X plc., which are standing at a loss, to an unconnected third party. R wishes to offset the resulting capital loss against the other chargeable gain. 31 days later R buys back the same number of shares in X plc., again from an unconnected third party.
2. To decide whether or not the TAAR applies, it is necessary to consider whether there have been arrangements, and as for example 8, this seems to be the case here. The next question, therefore, is whether the arrangements have a main purpose of securing a tax advantage. As for previous examples, this entails examining all the circumstances surrounding the arrangements, considering their overall economic objective, whether that objective is one that the participants might be expected to have, and which is genuinely being sought, and whether that objective is being fulfilled in a straightforward way, or additional, complex or costly steps have been inserted. In this case, the shares were bought back after the 30 day time limit in section 106A(5) TCGA, so the transaction is not within those “bed and breakfasting” rules. In disposing of the shares in X plc. R has incurred a real economic loss on a genuine disposal to a third party. Provided that R has not entered into some form of contract or agreement to ensure that he is not exposed to a genuine economic risk in respect of the shares during the period they were not in his ownership, this suggests that he has not entered into arrangements with a main purpose of securing a tax advantage. The transactions therefore fall outside the scope of the TAAR.

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Example 10 - sale of shares to realise a capital loss

1. R (from example 9) sells the same shares in X plc. to an unconnected third party, again in order to realise a capital loss which can be set against a chargeable gain. However, the contract specifies that R has the right to require the same third party to sell the shares back for their market value within 35 days, provided that the market value has not risen or fallen by more than 5%. R duly buys the shares back after 31 days.
2. Again, it seems clear that arrangements have been entered into, and so the question is whether or not those arrangements have been entered into with a main purpose of securing a tax advantage. To determine whether or not this is the case all the circumstances surrounding the arrangements have to be taken into account, so it is necessary to consider their overall economic objective, whether that objective is one that the participants might be expected to have, and which is genuinely being sought, and whether that objective is being fulfilled in a straightforward way, or additional, complex or costly steps have been inserted. In this example, an additional step has been inserted when compared with the previous example, and the effect of that additional step is that R will suffer no, or very little, real economic risk on the disposal of the shares. Following these transactions R still has the same shareholding in X plc., but he has used the capital losses to secure a tax advantage by reducing the CGT he has to pay, and other than the realisation of the loss there has been no real economic change. As there have been arrangements entered into with a main purpose of securing a tax advantage, the transactions fall within the scope of the TAAR and R’s losses will not be allowable losses.

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Example 11 - sale of asset by trustees

1. A body of trustees sell a capital asset and realise a chargeable gain. In the same year, they also sell an asset which is standing at a loss in order to crystallise that loss. The loss can be set against the gain, and so no CGT is payable in that year.
2. To decide whether or not the TAAR applies, it is necessary to consider whether there have been arrangements, and whether a main purpose of those arrangements was the securing of a tax advantage. The two disposals will constitute arrangements within the meaning of the new section 16A TCGA, so the issue is whether or not the arrangements have been entered into with a main purpose of securing a tax advantage. To decide this, it is necessary to take account of all the circumstances in which the arrangements were entered into, including the participants’ overall economic objective, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. In the present case, the trustees have made two genuine disposals, the relief they receive for their loss is explicitly provided for by section 2(2) TCGA, and the tax consequences of the transactions match the real change in the economic ownership of both assets. This suggests that, as indicated in paragraph 4 above, the trustees have not entered into arrangements which have a main purpose of securing a tax advantage and as a result the TAAR does not apply.

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Example 12 - sale of asset by trustees

1. A body of trustees sell a capital asset and realise a chargeable gain on disposal to third parties. In the same year, they also sell to a third party an asset which is standing at a loss in order to crystallise that loss. The loss can be set against the gain, and so no CGT is payable in that year. The trustees have also entered into an agreement with the sole beneficiary of the settlement, Z, that they will appoint funds to him sufficient to allow him to buy the asset on which the loss has been realised from the third party to whom the asset was sold, and Z then does so.
2. Where trustees sell an asset and realise a capital loss in the normal course of administering the trust it is highly unlikely that the rule will apply. This is so even if a beneficiary of the trust later buys the asset from a third party in a genuine arm’s length transaction unconnected with the disposal by the trustees, whether from funds advanced to him or her by the trustees, or from his or her own resources. However, the rule is likely to apply if arrangements have been made to manipulate the value of the asset so that the loss claimed by the trustees does not reflect the true economic loss they have sustained
3. As in previous examples, it is clear that arrangements have been entered into, so the question is whether or not there was a main purpose of securing a tax advantage. To decide this, it is necessary to take account of all the circumstances in which the arrangements were entered into, including the participants’ overall economic objective, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. In the present case, the fact that the trustees are required to administer the trust for the benefit of the sole beneficiary, Z, means that there is a degree of common interest in the outcome of the transactions. However, trust law allows trustees to choose either to sell assets and pass the proceeds to a beneficiary or simply to transfer those assets to him or her, and such a choice is for the trustees to make. Unless there is an additional factor to indicate a degree of manipulation, such as evidence that the loss claimed by the trustees does not reflect their true economic loss on the asset, the rule will not apply.

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Example 13 - sale of asset by trustees

1. In a variation of example12, the trustees are administering a discretionary trust for a number of beneficiaries, and Z is one of that class of beneficiaries. The trustees sell a capital asset and realise a chargeable gain. In the same year, they also sell an asset which is standing at a loss. The loss can be set against the gain, and so no CGT is payable in that year. Also in that year, the trustees advance funds to a number of the beneficiaries, including Z, who uses the sum he receives to buy the asset on which the loss has been realised by the trustees.
2. As in previous examples, it is clear that arrangements have been entered into, so the question is whether or not there was a main purpose of securing a tax advantage. To decide this, it is necessary to take account of all the circumstances in which the arrangements were entered into, including the participants’ overall economic objective, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. In this example, there are several beneficiaries for whose benefit the trustees are required to administer the trust, which means that the trustees are under an obligation to balance the different beneficiaries’ interests in the trust assets. The fact that the trustees have advanced funds to a number of the beneficiaries suggests that the disposals made by the trustees were genuine disposals, effected as part of the normal course of administering the trust. Although one beneficiary has used the funds advanced to him to purchase an asset previously owned by the trustees, this does not of itself mean that the economic objective of the trustees was other than the effective disposal of both the assets, nor that the economic objective of the beneficiary was other than the purchase of the asset on which the loss was previously realised by the trustees. The fact that the tax outcome for the persons associated with the arrangements matches the economic outcome suggests that obtaining a tax advantage was not a main purpose of the arrangements, and in such a case the TAAR will not apply to disallow the losses.

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Example 14 - trustees distributing assets to beneficiaries

1. The trustees of a settlement wish to distribute an asset to a beneficiary of the settlement. They are aware that this will give rise to a chargeable gain. They are also aware that they own a second capital asset which is standing at a capital loss. They therefore transfer that second asset to the beneficiary in the same year. The loss the trustees incur on the transfer of the second asset is set against the gain arising on the transfer of the first asset.
2. Again, to decide whether the TAAR will operate to make the claimed losses disallowable it is necessary to determine whether arrangements have been entered into with a main purpose of securing a tax advantage. The main purpose test is operated by looking at the main purpose of the participants in entering into these arrangements. This requires an analysis of the overall economic objective of the arrangements, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. In this case, the trustees have arranged to dispose of the two assets in the same tax year, and have done so. The economic consequence of the transactions, namely the realisation of a gain on the transfer of the first asset and a loss on the transfer of the other, matches the tax outcome. There have been no additional, complex or costly steps inserted into the arrangements. These factors suggest that the main purpose of the arrangements was not to secure a tax advantage. The two disposals have been made with a view to taking advantage of the statutory relief in section 2(2) in a straightforward way. In such a case the TAAR will not apply and the losses will be available to set against the chargeable gains.

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Example 15 - investment in EIS shares

1. An individual, J, invests in shares under the Enterprise Investment Scheme (EIS), with a view to securing income tax relief. In order to fund the purchase of the shares J sells a capital asset which is standing at a loss to a third party.
2. To decide whether or not the TAAR applies, it is necessary to consider whether there have been arrangements, and whether a main purpose of those arrangements was the securing of a tax advantage. In this case it is clear that there have been arrangements within the meaning of the legislation, as J has disposed of the capital asset and used the proceeds to fund the purchase of the EIS shares. To decide what J’s main purpose was in entering into these arrangements, it is necessary to consider the overall economic objective of the arrangements, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. J has made a real disposal of a capital asset in a straightforward way, and has incurred a genuine economic loss. There have been no additional, costly or complex steps inserted into the transactions. The fact that the disposal has been made with a view to using the proceeds to invest in shares which fall within the EIS tax regime does not mean that the arrangements have been entered into with a main purpose of securing a tax advantage, because the straightforward use of a statutory relief does not of itself bring arrangements within the TAAR. Hence the TAAR does not apply.

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Example 16 - deferred gain covered by capital loss on EIS shares

1. Y has disposed of a capital asset and realised a chargeable gain, but the gain is deferred because he invests a sufficient amount in shares issued under the Enterprise Investment Scheme (EIS). Unfortunately the EIS company in which Y has invested does not succeed, and the shares later become worthless. Y makes a negligible value claim under section 24(2) and the resulting loss on the shares is set against the original gain that is brought back into charge under the EIS rules, or possibly against Y’s income under section 574 ICTA.
2. To determine whether or not the TAAR applies so that the losses Y has realised on the shares in the EIS company are not allowable, it is necessary to decide whether or not arrangements have been entered into with a main purpose of realising a tax advantage. It is clear that there have been arrangements, and to decide whether securing a tax advantage was a main purpose of those arrangements it is necessary to take account of all the circumstances in which the arrangements were entered into, including the participants’ overall economic objective, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. In this case, Y has made a real investment in an EIS company, and there is nothing to suggest that the EIS company was other than a genuine investment opportunity from Y’s perspective. The negligible value claim only creates a disposal for capital gains purposes. No additional, costly or complex steps have been inserted as part of the arrangements; Y is taking advantage of the tax reliefs offered in respect of EIS investments in a straightforward manner. The loss Y suffers on the shares in the company is a real economic loss. Taken together, these factors suggest that there was no main purpose of securing a tax advantage and so Y’s loss is allowable. It makes no difference that a gain on the EIS shares may have been exempt. The new legislation does not have any effect on the normal operation of the relief.

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Example 17 - capital loss following disposal of company assets

1. M and K are married and between them own all the shares in a property investment company, B Ltd. The shares are standing at a loss but B Ltd owns a valuable property. M and K jointly buy the property from B Ltd. for cash at its open market value and the company distributes its remaining assets, the cash, during its winding up. M and K realise losses on their shares.
2. To decide whether or not the TAAR applies, it is necessary to consider whether there have been arrangements, and whether a main purpose of those arrangements was the securing of a tax advantage. In this case, it seems clear that there have been arrangements, so it is necessary to look at what M and K’s main purpose in entering into these arrangements was. This can be determined only by looking at all the circumstances surrounding the arrangements. In the present example, M and K wanted to wind up B Ltd, but also to retain ownership of the valuable property they controlled via the company. The property was purchased by them from the company at market value, and paid for with real consideration, so there was no artificial reduction in the value of the company. The winding-up of the company allowed the shareholders to realise the economic value of their investment in it in a straightforward way. B Ltd. has simply converted value represented by property into the same value represented by cash, and M and K now own the property directly. This, coupled with the fact that the tax effect of the transactions reflects the economic outcome suggests that there was no main purpose of realising a tax advantage, and so the TAAR will not apply.

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Example 18 - trustees make a deliberate transfer of value

1. A body of trustees who fall within the terms of Schedule 4B have outstanding borrowing which has not been used for trust purposes (Schedule 4B is a measure introduced to discourage trustees avoiding capital gains tax by incurring debt and advancing funds from the settlement). The trustees intentionally make a transfer of value which triggers off a charge under Schedule 4B, and as they expect this transaction results in a capital loss. The trustees have realised chargeable gains in the same year, and claim to set the loss against those gains.
2. It is necessary to look at the arrangements which have been entered into by the trustees to determine whether these have been entered into with a main purpose of securing a tax advantage. There are arrangements in this case, so the question is whether or not those arrangements were entered into with a main purpose of securing a tax advantage, and to decide this it is necessary to take account of all the circumstances surrounding the transactions. It will be relevant to consider what the trustees’ overall economic objective was, and whether that objective is being fulfilled in a straightforward way, or whether additional, complex or costly steps have been inserted. It is significant that Schedule 4B is itself anti-avoidance legislation, intended to counter avoidance of tax on gains by contrived arrangements between settlements. The fact that the trustees have deliberately triggered the operation of the schedule is an indicator that one of their main purposes was to secure the advantage of the capital loss. In such a case, the TAAR will apply and the loss will not be an allowable loss.

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ANNEX

HMRC Statement (6 December 2006)

Tax avoidance through the creation and use of capital losses

Purpose of the statement

1. This statement sets out the principle underlying the new Targeted Anti-Avoidance Rule (TAAR) for capital losses. The rule is aimed at preventing the ‘artificial’ creation and use of capital losses where there are arrangements and the main purpose or one of the main purposes of those arrangements is to secure a tax advantage.
2. The new TAAR supersedes the TAAR applying to contrived capital losses of companies introduced with effect from 5 December 2005 and found in section 8(2A) to (2C) of the Taxation of Chargeable Gains Act 1992 (TCGA). The principle underlying both TAARs is the same and this statement incorporates the principle for the earlier TAAR.
3. How the legislation is intended to operate, and the types of arrangements to which it will apply, are set out below. We will be consulting with interested parties, and welcome comments from anyone with an interest in this area on whether the draft legislation and draft guidance properly capture and explain the purpose and principle set out in this statement, but not on the principle itself.

Who is likely to be affected?

1. The TAAR will apply to the capital losses of all persons within the scope of tax on chargeable gains. References below to “people” therefore include companies as well as individuals, trustees and personal representatives chargeable to capital gains tax (CGT) on their gains.
2. Most people do not use schemes or arrangements to create capital losses “artificially”, nor do they generally use such capital losses in ways unintended by the legislation in order to avoid tax. The schemes and arrangements that this legislation is designed to address can be complex and will have tax avoidance as a main purpose; therefore it will not apply to the majority of people, whose disposals are made in the normal course of managing their investments.

Why the provision is necessary

1. The legislation addresses the contrived creation of capital losses, and prevents such contrived losses being set either against chargeable gains or, in some cases, against taxable income.
2. The provision is necessary because there is evidence from disclosures and other sources that tax avoidance using capital losses is becoming more widespread, and that the intended effect of existing legislation is being circumvented by new avoidance schemes. The evidence includes schemes to create artificial capital losses which may be set off against individuals’ taxable income. There are therefore significant new risks of loss of both CGT and income tax, in addition to the risk to corporation tax addressed by the earlier TAAR (see paragraph 2 above). The Government is therefore acting now to prevent the further creation and utilisation of capital losses in circumstances unintended by the legislation.
3. The Government will monitor the impact of the new TAAR, and its effect on people’s behaviour, and if necessary will consider whether further action is required.

Principle underlying the TAAR

1. The existing capital gains legislation generally reflects the principle that relief for capital losses should be available only where a person has suffered a genuine commercial loss on a real disposal.
2. However, people are using schemes and arrangements in such a way as to contravene this principle. Therefore the TAAR is necessary to ensure that the capital gains legislation more closely reflects this principle.

General description of the measure

1. The measure applies to “contrived” capital losses arising on disposals made on or after 6 December 2006.
2. Any capital loss arising on a disposal made on or after that day will not qualify as an allowable capital loss when it arises in connection with arrangements that have the obtaining of a tax advantage as one of the main purposes.
3. A further explanation of tax advantage and the main purpose test is set out in the guidance, along with examples of the type of schemes caught.
4. Transactions where a tax advantage is not one of the main purposes will not be caught by the TAAR. Ordinary transactions made in the normal course of managing investments that give rise to a real loss as a result of a real disposal will not be affected by the TAAR.