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In the case of Davis vs HM Revenue and Customs (HMRC), Mr. Davis, a sole trader, was providing financing for second-hand car sales. Unfortunately, his only customer defaulted on their repayments, causing Mr. Davis to suffer a loss. To deal with the situation, Mr. Davis formed a company. However, the defaulting customer never interacted with the new company, and the company’s activities were different from Mr. Davis’s sole trading business. Instead of financing car sales, the new company purchased vehicles directly and sold them through third-party garages.
Mr. Davis wanted to claim the unused sole trade loss against his income from the new company under Section 86 of the Income Tax Act 2007. HMRC, however, refused his claim, stating that his sole trading business and the new company’s activities were separate, meaning there was no incorporation of the trade.
According to HMRC guidance, Section 86 of the Income Tax Act 2007 allows losses from an unincorporated business to offset income, such as dividends, from a company where the unincorporated business’s trade is transferred to the corporate entity. This provision prevents the wastage of losses that would otherwise be unutilized.
The First-tier Tribunal, in its decision, concluded that there was no transfer of trade between Mr. Davis’s sole trading business and the new company. There were no physical assets transferred, the consideration was minimal, and the activities of both entities were different. Mr Davis argued that he had transferred the right to carry on the business, but the Tribunal dismissed this argument, stating that the trade was not protected and anyone could carry it on. It did not help Mr Davis’s case that he had a single defaulting customer and continued trading as a sole trader for two years after forming the new company. The debts from the customer were pursued in Mr Davis’s name, not the company’s. Consequently, the Tribunal dismissed the appeal.
The Davis vs HMRC case demonstrates how easy it can be to lose the right to relief under Section 86 without proper advice. For instance, it might have been sufficient for the new company to purchase the right to recover the debt from Mr Davis if the company’s activities were substantially similar to his sole trading business. However, in this case, the business structure had changed considerably, which affected the outcome.
If you need help to plan your taxes, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.