In the Draft Finance Bill 2017 the government has set out reforms to the substantial shareholding exemption ("SSE").
SSE is an exemption from corporation tax on gains realised on the disposal of certain substantial shareholdings. It was introduced to make the UK holding company regime more attractive and to address concerns that businesses might be forced to adopt unusually complex offshore holding structures to give flexibility for future restructuring and reinvestment.
In its simplest terms SSE was available to an investing company where:
- the investing company held at least 10% of the ordinary share capital of the investee company for at least a 12-month period in the two years prior to the disposal;
- the investing company and investee company were trading companies during the 12-month holding period; and
- immediately after the disposal remained trading companies.
The exemption test was quite cumbersome and led to results which did not align with the policy intention. For example:
- an investing company would be denied SSE in a situation where it was selling off its last trading company asset such that after that disposal it was no longer a trading group;
- where an investing company was required to dispose of a substantial shareholding in tranches, as soon as a tranche disposal left it with a <10% shareholding it needed to dispose of all remaining shares within one year to qualify for SSE; and
- an investing company would be denied SSE if after its disposal of the investee company the new owners of the investee company changed the nature of its business such that it was no longer a trading company.
The test also presented problems for institutional investors where they sought to hold investments in trading companies through a UK corporate holding structure.
The key changes that the government has decided to make are to:
- remove the investing company trading condition;
- extend the period over which the substantial shareholding requirement can be satisfied from 12 months within two years to 12 months within six years prior to disposal;
- remove the post-disposal investee trading condition; and
- introduce a broader exemption for companies owned by qualifying institutional investors.
These changes will apply to disposals occurring on or after 1 April 2017.
Removal of investing company trading condition
The removal of the requirement that the investing company must be a trading company or part of a trading group will provide all companies which have substantial shareholdings in trading companies or subgroups with exemption from tax on their gains and losses on those disposals. This should remove much of the administrative burden on investing companies claiming SSE, in particular those that are part of larger groups, and will remove the anomaly of the potential non-availability of SSE where a company disposes of its last trading company asset.
Extension of period over which holding period can be
This change should provide greater certainty and flexibility for companies in situations where shareholdings are to be sold off in tranches.
Removal of the post-disposal investee company trading
This will remove the uncertainty that investing companies had and tried to protect against in contractual drafting of whether the investee company will remain a qualifying company after its sale.
Broader qualifying institutional investor
The broader exemption for qualifying institutional investors will mean that UK companies owned by such investors will be exempt from gains and losses on disposals of substantial shareholdings without regard to the trading status of the investing or the investee companies or subgroups.
In this context the meaning of "substantial shareholding" has been extended to cover investments below 10% but worth at least £50m.
For the purposes of the exemption "qualifying institutional investors" are:
- pension schemes;
- life assurance companies;
- sovereign wealth funds;
- investment trusts; and
- widely marketed UK investment schemes (including alternative investment funds and exempt unauthorised unit trusts).
To cater for the scenario where a qualifying institutional investor invests along with other investors, some of whom are not tax-exempt, there will be a proportionate exemption for disposals of non-trading companies or subgroups by companies which are at least 25% owned by one or more qualifying institutional investors. Where the company's share capital is owned 80% or more by one or more qualifying investors the disposal of a substantial shareholding will be exempt in full.
The changes announced by the government will be welcomed as a step towards creating a more user-friendly participation exemption. However the government's changes stop short of the broader exemption many were hoping for, particularly in the real estate sector. Participation exemptions in other EU countries such as Ireland, Germany, the Netherlands and Luxembourg do not include any trading requirements.
In relation to the broader qualifying institutional investor exemption, it remains to be seen whether the government's objective of bringing more corporate holding structures onshore will be achieved. Allocating distributions where there is a mixture of institutional and other investors could be quite complicated. Also, corporate investors may still prefer an offshore corporate holding structure, on the basis that a future sale of that holding structure would be more attractive to a non-qualifying buyer.
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