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HMRC Clampdown On Capital Losses Causes Confusion, Advisors Say

by Robert Lee,, London

06 June 2007

Clampdowns on the 'artificial' creation and use of capital losses by individuals and trustees may soon be put in place, but how such planning can be regulated by HM Revenue & Customs (HMRC) is questionable, according to business and financial advisers, Grant Thornton.

HMRC introduced draft legislation in the 2006 Pre-Budget Report (PBR) which sought to prevent the 'artificial' creation and use of capital losses where arrangements had been made to guarantee a tax advantage. These rules are now being debated, as they form part of the Finance Bill 2007 currently subject to Parliamentary scrutiny.

However, Grant Thornton noted that the guidance accompanying the legislation, which explains HMRC's interpretation of the law, is not subject to the same formal examination, and it is this guidance that has raised a number of queries about how the new rules will be applied.

Ian Luder, tax partner at Grant Thornton, commented: "Grey areas do not embed confidence in the general public and are even a good scare tactic for those using legislation in a smart but legal way."

Guidance was issued by HMRC on draft rules last December, focusing on capital losses where there is no genuine commercial loss or genuine commercial disposal. One of the examples that HMRC cited in its guidance concerned "bed-and-spousing" whereby one spouse, 'Jane,' sells an asset for a gain and the other, 'John,' holds an asset standing at a loss. John transfers a half share of their asset to Jane at nil gain/nil loss. When they jointly sell the asset to a third party they realise the loss. Jane can then use the loss to offset her share of the gain on the sale of their asset.

According to HMRC's 2006 guidance, despite the inter-spouse transfer, they had recognised a real, commercial loss on the subsequent sale and would therefore not be subject to anti-avoidance legislation. However, fresh guidance released with the Finance Bill 2007 would appear to contradict this, says Grant Thornton.

The 2007 guidance uses two different examples: If Mary sells shares at a loss and then Mike purchases them shortly after without the prior knowledge of the disposing spouse, the anti-avoidance rules would not apply. Where the rules would apply, however, is when the spouses make arrangements between themselves for the shares to be re-acquired, Grant Thornton notes.

"This is a ridiculously tricky concept. Judging whether spouses or civil partners have discussed their individual and joint finances, and to what depth, could prove extremely challenging and ambiguous," says Ian Luder.

"The legal status of HMRC's guidance has been the subject of much debate recently. One case that immediately springs to mind is the Gaines-Cooper case concerning residence and domicile where advisers and taxpayers have been reliant on HMRC's guidance for a number of years. It would be better if the legislation itself is drafted clearly so that guidance explaining its application did not need to be relied upon," he added.

Although anti-avoidance rules for companies have been in place since December 2005, these will be replaced by the new rules that also cover individuals and trustees, and which were first announced in the 2006 PBR, as soon as the Finance Bill has been passed. The legislation will be effective for disposals made on or after 6 December 2006.

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