An article by Mark McLaughlin
The ‘associated company’ rules are changing in Finance Act 2011. The rules are essentially an anti-avoidance measure, to prevent the creation of multiple, closely controlled companies to split a wider economic whole and take advantage of the small companies’ corporation tax rate. That rate reduced to 20% from 1 April 2011, but the main rate reduced to 26% from the same date and is gradually reducing to 23%. Whilst the associated company rules therefore assume less importance than in previous years, they remain a significant issue for many business owners. Before considering the new rules and their effect, it is necessary to point out what the amendments will not do. The associated company rules will broadly continue to apply where companies are under common ‘control’, as defined. A participator’s own rights and powers are always taken into account for those purposes. In addition, an individual may still control one company through his shareholding, and control another company (even if all the shares are owned by (say) his wife) by making a loan which entitles him to the greater part of his wife’s company assets on a winding up.Companies can still be associated in such circumstances. Group companies will also generally be associated.
Attributions of Rights
Legislation in Finance Bill 2011 (which has not received Royal Assent at the time of writing) amends the rules which automatically attribute to a person the rights and powers of associates in determining whether companies are under common control, and hence associated (CTA 2010, s 451 (4), (5)). The changes replace CTA 2010, s 27. The ‘old’ section 27 attributes the rights of business partners where the tax planning arrangements between the parties have secured a ‘relevant tax advantage’. The new legislation ‘switches off’ the automatic attribution of an associate’s rights and powers if there is no ‘substantial commercial interdependence’ between the companies. A long standing Extra Statuary Concession (ESC C9 – ‘Associated Companies’) disregards the rights of relatives other than spouses and minor children, in respect of companies where there is no substantial commercial interdependence between them. However, the new rules are more generous than ESC C9, in that they apply to all associates, including business partners.
Substantial Commercial Interdependence
What is ‘Substantial Commercial Interdependence’? Draft secondary legislation (‘The Corporation Tax Act 2010 (factors determining Substantial Commercial Interdependence) Order 2011) provides that the answer depends on the degree to which the companies are ‘financially’, ‘economically’ or ‘commercially’ interdependent. Companies are treated as associated if ‘caught’ by any one (or more) of these links, which are broadly defined in the legislation. Unfortunately, the statutory definitions of the links are not very precise. For example, under the draft legislation companies are 'economically interdependent' if they seek to realise the same economic objective, or if the activities of one company benefit the other, or if the companies have common customers. The brevity and lack of clarity in the legislation means companies and their advisers will look to HMRC for guidance in many cases. HMRC has produced quite detailed guidance on the substantial commercial interdependence rules, which replaces previous guidance in the Company Tax Manual. HMRC's Marginal Small Companies Relief Toolkit will presumably also be amended to reflect the legislative changes. Of course, HMRC manuals and toolkits do not carry the force of law, and are therefore a poor substitute for clear tax law.HMRC published the draft HMRC guidance with the draft secondary legislation on 9th December 2010. The guidance (which will appear at CTM03750 and following) includes a number of examples of situations in which companies are (or are not) financially, economically and organisationally interdependent. However, in practice circumstances will obviously vary from case to case, so the examples are only illustrative of HMRC's approach.
The new attribution rules for associated companies purposes apply to accounting periods ending from 1 April 2011. However, this is subject to an option for companies to elect for the amended legislation to apply only to accounting periods starting from 1 April 2011. In its draft guidance on the new rules, HMRC states that the new rules will benefit the vast majority of companies, it is "theoretically possible" that a small number of companies (i.e. those separately controlled by business partners) may be retrospectively disadvantaged by the change. Those companies may be associated by the Finance Act 2011 rules, but not under the previous rules (i.e. where no "tax planning arrangements" exist between the two companies). HMRC provide the following example:
"Mrs Y & Mrs Z are partners in a law firm. Mrs Y owns 100% of the shares in a holiday cottage letting business - Company A. Mrs Z owns 100% of the shares in a photography business - Company B. Company B has struggled in recent years and survives solely because of a sizeable loan provided to it by Company A. No tax planning arrangements exist between Company A and Company B so the two companies would previously not have been associated but the loan between the two makes them “substantially commercially interdependent” and thus associated
under the new rules."
Note that non-retrospective treatment is not automatic. It must be claimed by making an election. The election must be made within a year of the end of the accounting period to which it relates.