Lockdown 3: tax implications of prolonged business interruption

22 January 2021

Many businesses have had no choice but to reduce operations, or cease them entirely, at various points during the Covid-19 pandemic. In particular, lockdown 3 has, once again, resulted in a pause in trading or a change in approach to trading for many.

This can have significant tax consequences and so businesses should be taking steps to mitigate these. The following questions can help determine what issues they should be thinking about, and what can be done about them.

Has a trade ceased?

A pause in trading can be viewed as just that; a momentary break before normal activity resumes. It can also, however, be seen as the cessation of a trade, followed by the later creation of a new trade. This can be the case even where the trade before and after “cessation” is exactly the same.

The cessation of a trade ends a company’s accounting period, which has consequences for the future use of any losses held by that company. A cessation can also limit the applicability of a number of tax reliefs that require a period of continuous trading (such as the substantial shareholding exemption or business asset disposal relief (formerly entrepreneurs’ relief)).

The key question HMRC asks in such situations is whether there is an intention to continue trading, despite the temporary pause in activity. HMRC’s guidance confirms that where “the new activity is similar in scale and nature to the old, it is relevant to look at all the circumstances in which the break occurred, including the length of the break and the intention of the business proprietors (as shown by their actions)”.

The pandemic has drawn comparisons to the world wars, and two key cases from war time illustrate the principles that will apply in relation to Covid-19 business interruption. In Kirk & Randall v Dunn, the business continued bidding for work despite its assets being requisitioned during the first world war. Although no business was carried on for years, it was clear that the intention was to continue trading when possible, and so the court found that there was no cessation. In contrast, in Goff v Osborne & Co, the company in question held no meetings and filed no returns between 1939 and 1944. There was no suggestion that there was an intention to continue trading in the future and so the court found that the trade had ceased.

Provided there is an intention to continue the same trade after the impact of the pandemic has eased, then any pause in trade suffered by a business should not result in the cessation of that trade. It is crucial, however, that the business documents that intention. It should continue to hold board meetings in which the directors discuss the desire to continue trading post-pandemic and ensure that all returns are submitted. Where possible, the business should continue to bid for work and build relationships and contacts within its industry.

Has there been a “major change in the nature or conduct” of a trade?

A major change in the nature or conduct of a business’ trade can result in that business no longer being able to use carried forward losses against its taxable profits. The cessation of a trade (discussed above) counts as a “major change” for these purposes.

There is much complex case law in this area. Whether there has been a major change to the nature or conduct of a trade is extremely fact specific, but there are certainly arguments to be made that changes as a result of the pandemic (including the scaling down or change in focus of a business) could constitute such a change.

Helpfully, HMRC has released updated guidance in this area which suggests that they are sympathetic to businesses that have had to adjust due to the pandemic. For example, they state that where there has been a temporary break in trading activity, followed by a resumption of the same or similar activities, this will not count as a major change in the nature or conduct of the trade in question.

There are, however, limits to the guidance. For example, HMRC states that if a clothing manufacturer begins to make gowns and face masks using the same staff and premises, this would be an extension of its existing trade (and so not a major change). Where a restaurant business starts to do so, however, this would count as the commencement of a separate trade. Losses made by the restaurant business could not be used to reduce the taxable profits of the gown and mask production business.

There is clearly some flexibility from HMRC here, but a business would need to think carefully about any new product lines or services it has created in order to react to the trading conditions brought about by the pandemic in order to determine whether they represent a major change. For example, if a restaurant has closed and then begun to operate as a food delivery business, this may represent a “major change” (and therefore a new business).

It is important that to be aware of this as early as possible, to ensure that returns made to HMRC are accurate, and that additional advice or guidance can be sought if the situation is unclear or borderline.

Has a business reduced to a “small or negligible” amount?

Many businesses will be making losses during the pandemic that they hope to utilise to reduce their taxable profits in the future, when the economy has improved. There are a number of rules that restrict these carried forward losses, and one in particular is concerning from a Covid-19 perspective.

The rule in question states that where a business has reduced to a “small or negligible” amount, losses occurring in the “small or negligible” period are unusable in future accounting periods. On the face of it, this rule potentially puts all Covid-19 losses at risk.

Although the rule is extremely broad, in our experience HMRC has not sought to apply it strictly. Instead, they tend to look at whether there is a degree of permanence to the decision to reduce or cease trading. Where a business has had a reduction in trading due to circumstances beyond its control, any losses arising during that period should be useable in the future.

Losses arising because a business has had to reduce or cease trading during the pandemic should, therefore, not be lost purely as a result of this rule. Again, we recommend that businesses keep contemporaneous evidence of the reasons behind its actions and note that any reduction in business is not as a result of a decision by the directors of the company, but rather a necessity due to Covid-19 and the associated restrictions.

Is a Covid-disrupted business still a “going concern”?

The sale of an ongoing business will normally be outside the scope of VAT by virtue of it being the transfer of a going concern (a TOGC). This is important because where a purchaser makes exempt supplies, any VAT due if TOGC treatment does not apply will be either partially or fully irrecoverable. In addition, even if the VAT is recoverable, the timing of any such recovery can cause cash flow issues for the purchasing entity.

The courts do not require a business to be commercially viable in order to qualify for TOGC treatment. Rather, the business needs to be live or operating. Even in situations where a business has been scaled down due to financial difficulties or in anticipation of a sale, that business can still be a going concern. HMRC has confirmed in their guidance that they accept this view, including the fact that businesses in liquidation or receivership can qualify.

HMRC further accept that a break in trading is not automatically fatal to a TOGC analysis. For example, a seasonal business sold in the off season can qualify. Where, however, there has been a total cessation in business before a sale, the transfer cannot qualify.

Because a break in trade due to the pandemic is wholly outside of a business’ control, it should not automatically cause TOGC treatment to fail. We understand that HMRC has indicated that they agree with this view where a cessation of trade is in order to comply with Government guidelines (i.e. where it is legislatively imposed). What is less clear, unfortunately, is HMRC’s view where the reduction or cessation of trade is a by-product of the pandemic (such as due to a temporary reduction in customer base).

In our view, the conclusion should be no different in this latter situation. We have raised the point with HMRC and hope that guidance will be released in the near future to confirm that where a business was clearly a going concern prior to Covid-19, a cessation in business related to the pandemic should not be fatal to a TOGC analysis.

Until any such guidance is released, it may be necessary to approach HMRC for non-statutory clearance in borderline situations.


Businesses should be aware of, and prepared for, the issues that can arise as a result of prolonged business interruption. In particular, we recommend businesses:

  • review the availability of tax assets and other tax attributes that might be affected by a change in trading;
  • document their intentions and any internal discussions regarding future trading;
  • document actions taken to keep the business going through a period of low activity, particularly outward facing efforts such as profile raising; and
  • have good understanding of the taxable trades undertaken, acknowledging that the answer may be different to a purely commercial answer.

If you have questions, or if your situation is complex or borderline, please don’t hesitate to contact us for help.