UK: "Substantial Relief For Substantial Disposals - The New Proposals"

The current position:

At present, where a UK company sells an investment in another company and realises a profit, that profit is liable for tax as a capital gain at a rate of 30%. No relief is available if the profit achieved is re-invested. However, in July 2001 HM Treasury and the Inland Revenue issued a joint consultation document detailing revised proposals for a new tax relief for companies disposing of substantial shareholdings- Large Business Taxation: The Government’s strategy and corporate tax reforms- a consultation document (available at www.hm-treasury.gov.uk or www.inlandrevenue.gov.uk). The government intends any such relief only to apply to shares and not to any other securities. Legislation implementing the new relief is expected to be introduced in the Finance Bill 2002.

The proposals envisage that a substantial shareholding would be defined as a beneficial entitlement to at least 20% of the investee company’s ordinary share capital, distributable profits and distributable assets (as amplified by the rules in Schedule 18 of the Income and Corporation Taxes Act 1988).

Where the qualifying shareholder company is a member of a trading group, it may be possible to take into account other group members’ beneficial interests in the qualifying investee company when determining whether the shareholding is a substantial shareholding. Aggregation of members’ interests would be possible at any time when the shares could be transferred between them on a no gain/ no loss basis under the Taxation of Chargeable Gains Act 1992.

Whilst the government has already considered introducing deferral relief for companies that dispose of a substantial shareholding and reinvest the proceeds in a replacement shareholding, the new consultation document contains an alternative proposal- exempting gains and losses arising from disposals of substantial shareholdings altogether.

The fundamental difference between the proposed exemption relief and deferral relief is the method by which relief is given. An exemption relief would apply automatically and would make any gains achieved tax free, although losses would be unallowable. A company could only take advantage of deferral relief on the other hand where it reinvested the disposal proceeds in a replacement shareholding. The tax charge arising on gains would be delayed and losses would remain allowable.

• The introduction of a relief for disposals of substantial shareholdings may encourage vendor companies to structure business disposals as share, rather than asset sales. At present, companies are able to obtain deferral relief on gains arising from business asset disposals under s152 of the Taxation of Chargeable Gains Act 1992 where the company reinvests the proceeds of the disposal in replacement business assets. Sellers have consequently preferred to dispose of businesses rather than shares in any subsidiaries. Clearly the introduction of a new relief for disposals of substantial shareholdings may reverse this pattern. A share sale as opposed to a business sale is advantageous both to the seller as it is an effective "clean break" and to the purchaser, as a share sale may result in a lower Stamp Duty charge where the assets involved are real property or goodwill. For the purchaser the fact that it will assume the liabilities of the company it is buying may still act as a deterrent.

• Large listed companies which own substantial shareholdings in other listed companies are able to achieve a profit on disposal without suffering immediate taxation by issuing exchangeable bonds. Such structures may be encountered less frequently.

• In order to obtain the maximum benefit of the relief companies intending to dispose of a subsidiary will need to carefully structure the disposal. The substantial shareholding must be held for a period of 12 consecutive months. This can fall at any time during the 2 years preceding the disposal. In order to fulfil this proposed 12 month ownership requirement, the parent company would have to transfer the businesses to be retained to another company within the Group, leaving only the businesses to be sold in the subsidiary, allowing the subsidiary itself subsequently to be sold.

• It may be advantageous for groups considering the disposal of companies standing at a gain to defer the disposal, awaiting the introduction of the new relief.

• As it appears that the government favours the introduction of an exemption relief, rather than a deferral relief, companies intending to dispose of any subsidiaries resulting in a capital loss should consider hastening the disposal, thereby avoiding the crystallisation of non-allowable losses.

The substantial shareholdings relief, combined with the UK’s relatively low rate of corporation tax, form part of the Government’s strategy for making the UK a more competitive environment for multinational companies to locate. Deferral relief would seem to be more generous than exemption as the latter would deny relief for losses. Exemption relief would be administratively simpler. Exemption would also align the UK’s corporation tax system with that of many other European Union states.