The Government confirmed on 26 March 2002 that the new chargeable gains exemption regime for substantial shareholdings held by companies will apply for disposals on or after 1 April 2002. However, just five days before the new regime comes into effect, revised draft legislation has been published containing a number of key changes from the proposals published in November 2001.
Most of the changes are welcome relaxations adopted as a result of the consultation process. Unfortunately, there is a sting in the tail – a new and potentially widely applicable anti-avoidance rule. It should be noted that the legislation is still not yet in final form: it will form part of the Finance Bill 2002, which will not be enacted until the summer.
Threshold now 10%
The threshold for a substantial shareholding has been reduced from 20% to 10%. The special threshold for life insurance companies has been reduced from 40% to 30% and the minimum qualifying threshold for interests in joint venture companies has been reduced from 30% to 10%.
The other requirements applying to the substantial shareholding remain the same. In particular:
- the shareholding must represent at least 10% of the ordinary share capital of the company being sold (referred to in the legislation as "the investee company") and give a right to at least 10% of the profits and 10% of the assets available for distribution to equity holders. Schedule 18 ICTA 1988 applies for these purposes;
- the shareholding must have been held for a continuous period of 12 months falling at any time within the two years prior to the disposal; and
- all shares held by members of a group are aggregated and intra-group disposals, stocklending and repos are looked through.
Changes to definitions of trading company, trading group and trading activities
The meaning of these expressions is key to the scope of the exemption. As before, in order for the exemption to apply, the vendor company must be either a single trading company or a member of a trading group and the company being sold must be either a trading company or the holding company of a trading group. A trading company or a trading group exists where, broadly, the company (or group) carries on trading activities and the company’s (or the group’s, as appropriate) activities do not include to a substantial extent activities which are not trading activities. A number of changes have been made which broaden, or in some cases, clarify these expressions:
- Restrictions on the financial and investment activities permissible for the company being sold have been removed.
- The definition of trading activities has been amended so that, as well as including activities carried on for the purposes of a trade which the company or group is preparing to carry on, it also includes activities carried on with a view to the company or group acquiring or starting to carry on a trade. However, the revised draft now specifies that neither set of activities will qualify as trading activities unless the acquisition is made or the trade commences within a reasonable time.
- It has been made clear that the activities of the members of a group are treated as one business and that therefore intra-group activities are ignored in determining whether the trading criteria are satisfied.
New anti-avoidance rule: profits of company sold untaxed at time of disposal
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The revised draft legislation contains a new, broadly-worded, anti-avoidance rule. This rule will deny the substantial shareholdings exemption when the following conditions are satisfied: |
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1. A gain accrues to disposing company ("A") on the disposal of shares in the company being sold ("B"), or of an interest in shares in B or of an asset related to shares of B. Assets related to shares include call options and convertible or exchangeable debt; |
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2. A controls or has at any time controlled B, or A and B are or have at any time been under common control; |
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3. The gain (or all but an insubstantial part of the gain) accruing to A represents accrued profits which have not been brought into account for tax purposes (whether in the UK or overseas) for a period ending on or before the date of the disposal; and |
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4. Circumstances 1, 2 and 3 occur in pursuance of, or as a result of, arrangements from which the sole or main benefit which could be expected to arise is that the gain accruing to A on the disposal would be entitled to the substantial shareholdings exemption. |
"Arrangements" is construed very widely and includes any scheme, agreement or understanding.
The ambit of this provision is very wide, particularly as "accrued profits" includes latent gains, as well as unrealised income. For example, as currently drafted, it could potentially apply to the disposal of a company which, at the date of the disposal, holds a property which is standing at a latent gain. It could be argued that the sale of the company holding the property, rather than a direct sale of the property, is an "arrangement" of which one of the main benefits is the availability of the exemption.
Equally, the sale of a company which has not yet paid tax on current year profits would also seem potentially to fall within the rule. The Revenue have stated that the purpose of this anti-avoidance rule is not to deny the exemption in these circumstances. However, we consider it unsatisfactory that taxpayers must rely on Revenue assurances rather than clear law in such a common situation.
Further relaxations of the chargeable gains degrouping charge
The draft legislation published in November 2001 contained two welcome proposals in this area: the ability to claim business assets rollover relief in respect of a section 179 TCGA 1992 "degrouping charge" and a facility to elect for a degrouping charge to be re-allocated to a member of the vendor’s retained group rather then the company being sold. The 26 March 2002 draft legislation adds further flexibility in this area. From 1 April 2002:
- It will be possible to claim business assets rollover relief for a degrouping charge which has been the subject of a re-allocation election in favour of another group company.
- A timing point which would deny the substantial shareholdings exemption to a degrouping charge relating to a holding of shares which was transferred intra-group prior to 1 April 2002 has been remedied. Under the revised draft, the intra-group transfer is deemed to take place when the company holding the shares leaves the relevant group.
Goodwill and intangibles - new tax regime
The Government also confirmed on 26 March that the new corporation tax regime for goodwill, intellectual property and other intangibles will take effect from 1 April 2002. As previously announced, the new rules will, generally, apply to all intangibles created on or after 1 April 2002 or acquired from an unrelated party on or after 1 April 2002.
All expenditure and receipts in respect of intangibles will be taxed or relieved as income, broadly in line with the accounting treatment. This offers significant opportunities for UK companies to accelerate tax relief in respect of expenditure on intangibles.
Research and Development tax credit
Finally, it was also confirmed on 26 March 2002 that large companies will be entitled to a "super-deduction" for R&D expenditure incurred from 1 April 2002. The large company R&D tax credit will be given by means of an extra deduction from a company’s taxable income, in addition to the normal 100% deduction for current expenditure. The rate of the extra deduction will be announced in the Budget on 17 April, although information apparently leaked by the Revenue in error suggests that the extra deduction will be 20%.
The credit will be calculated on a volume basis – based on all qualifying spending, rather than just on increased spending.
Large companies will be entitled to the credit for direct R&D expenditure on staff costs and consumable stores. Credit will generally only be given to a company for work actually carried out by the company. Where R&D work is sub-contracted, the company which carries out the work will be entitled to the credit and not the company which has sub-contracted the work. An exception will be made to this rule where the work is subcontracted to organisations which cannot benefit from the credit such as charities, academic institutions and scientific research organisations.
© Herbert Smith 2002
The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.
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